|As filed with the Securities and Exchange Commission on June 10, 2005.
|----------------------------------------------------------------------
|                                                                      
|UNITED STATES                                                         
|SECURITIES AND EXCHANGE COMMISSION                                    
|Washington, D.C. 20549                                                
|                                                                      
|FORM 20-F                                                             

(Mark One)

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

or

Annual
Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the
fiscal year ended December 31, 2004

or

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

Commission File Number 000-29992

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

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

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

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

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

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

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

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

Indicate the number of outstanding
shares of each of the issuers classes of capital or common stock as of the close of
December 31, 2004, the period covered by the annual report: 13,144,605Ordinary
Shares, par value NIS 0.13 per share.

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

Yes
  No

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

Item
17 Item 18



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TABLE OF CONTENTS

|                                                              | PAGE
|------------------------------------------------------------- | ----
|
|
|
|
|Part I                                                        | 5   
|Item 1. Identity of Directors, Senior Management and Advisers | 5   
|Item 2. Offer Statistics and Expected Timetable               | 5   
|Item 3. Key Information                                       | 5   
|Selected consolidated financial data                          | 5   
|Capitalization and Indebtedness                               | 6   
|Reasons for the offer and use of proceeds                     | 6   
|Risk factors                                                  | 6   
|Item 4. Information on the Company                            | 20  
|History and development of the company                        | 20  
|Business overview                                             | 22  
|Organizational structure                                      | 37  
|Property, plants and equipment                                | 38  
|Item 5. Operating and Financial Review and Prospects          | 38  
|Overview                                                      | 38  
|Operating results                                             | 39  
|Liquidity and capital resources                               | 48  
|Research and development, patents and licenses, etc           | 49  
|Trend information                                             | 50  
|Off balance sheet arrangements                                | 50  
|Tabular disclosure of contractual obligations                 | 50  
|Item 6. Directors, Senior Management and Employees            | 51  
|Directors and senior management                               | 51  
|Compensation                                                  | 53  
|Board Practices                                               | 54  
|Employees                                                     | 57  
|Share ownership                                               | 58  
|Item 7. Major Shareholders and Related Party Transactions     | 60  
|Major shareholders                                            | 60  
|Related party transactions                                    | 62  
|Interests of experts and counsel                              | 63  

- 2 -

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|                                                                                      |    | 
|------------------------------------------------------------------------------------- | -- | 
|
|
|
|
|Item 8. Financial Information                                                         | 63 | 
|Consolidated statements and other financial information                               | 63
|Significant changes                                                                   | 64
|Item 9. The Offer and Listing                                                         | 64
|Item 10. Additional Information                                                       | 65
|Share capital                                                                         | 65
|Memorandum and Articles of Association                                                | 65
|Material contracts                                                                    | 67
|Exchange controls                                                                     | 68
|Taxation                                                                              | 68
|Dividend and paying agents                                                            | 74
|Statement by experts                                                                  | 74
|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                       | 76
|                                                                                      |    | 
|Part II                                                                               | 76
|Item 13. Defaults, Dividend Arrearages and Delinquencies                              | 76
|Item 14. Material Modifications to the Rights of Security Holders and Use Of Proceeds | 76
|Item 15. Controls and Procedures                                                      | 76
|Item 16A.  Audit Committee Financial Expert                                           | 76
|Item 16B.  Code of Business Conduct and Ethics                                        | 76
|Item 16C.  Principal Accountant Fees and Services                                     | 77
|Item 16D.  Exemptions from Listing Standard For Audit Committees                      | 78
|Item 16E.  Purchases of Equity Securities by the Issuers and Affiliated Purchasers    | 78
|Item 17. Financial Statements                                                         | 78
|                                                                                      |    | 
|Part III                                                                              | 78
|Item 18. Financial Statements                                                         | 78
|Item 19. Exhibits and Financial Statements Schedules                                  | 79
|Signatures                                                                            | 81

- 3 -

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# Currency of Presentation
and Certain Defined Terms

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

We
have registered Optibase and the accompanying design,
Progression,MPEGLAB, VideoPlex, MPEG
COMMOTION, Media 100 and the accompanying design and Finish
as registered trademarks. In addition, the names MPEG MovieMaker 200, Media
Gateway, MGW5100", MGW1100", MGW2000",
VideoPlex Xpress, VideoPlex Pro, MPEG MovieMaker,
Videoplex, MPEG ComMotion, MPEG Composer,
VideoPump, 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.

- 4 -

---

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# Part I

# Item 1. Identity of
Directors, Senior Management and Advisers

Not
applicable.

# Item 2. Offer Statistics
and Expected Timetable

Not
required.

# Item 3. Key Information

3.A.
Selected Consolidated Financial Data.

We
derived the consolidated statement of operations data for the years ended
December 31, 2002, 2003 and 2004, and consolidated balance sheet data as of
December 31, 2003 and 2004 from the audited consolidated financial statements
appearing elsewhere in this Annual Report. These financial statements have been prepared
in accordance with U.S accounting principles generally accepted (U.S. GAAP).
We derived the consolidated statement of operations data for the years ended
December 31, 2000 and 2001 and the consolidated balance sheet data as of
December 31, 2000, 2001 and 2002 from audited consolidated financial statements that
are not included in this Annual Report, which statements have also been prepared in
accordance with U.S. GAAP. The selected financial data set forth below should be read in
conjunction with ITEM 5  OPERATING AND FINANCIAL REVIEW AND PROSPECTS
and the financial statements, including the notes thereto, included elsewhere in this
Annual Report.

|                                                       | Year Ended December 31,
|------------------------------------------------------ | -----------------------
|
|
|
|
|Consolidated Statement of Operations Data:             |                        
|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                        |                        
|Impairment of goodwill                                 |                        
|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 income (loss)                                      |                        
|                                                       |                        
|Net income (loss) per share:                           |                        
|Basic                                                  |                        
|Diluted                                                |                        
|Weighted  average shares used in computing net earning |                        
|(loss) per share (in thousands):                       |                        
|Basic                                                  |                        
|                                                       |                        
|Diluted                                                |                        

- 5 -

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|                                                 | December 31,
|------------------------------------------------ | ------------
|
|
|
|
|Consolidated Balance Sheet Data:                 |             
|Cash, cash equivalents and marketable securities |             
|Working capital                                  |             
|Total assets                                     |             
|                                                 |             
|Long term loans and capital lease obligations,   |             
|including current maturities                     |             
|Total shareholders' equity                       |             

3.B
Capitalization and indebtedness

Not
applicable.

3.C
Reasons for the offer and use of proceeds

Not
applicable.

3.D
Risk Factors

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

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

- 6 -

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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 have been operating 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 operate
in loss. As of December 31, 2004, we have accumulated losses of $66 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 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.

The
deterioration of the general economy in the United States and worldwide began in 2000 and
continued through 2002, which has especially curtailed the business opportunities of
technology companies. Although during 2004 there were signs of improvement in the economy
in the United States and worldwide, there is no assurance that the improvement will be
sustained or that it will lead to an improvement in the results of our operations. Weak
economic conditions have caused, and may continue to cause, reductions in spending in
technology markets in general, including spending in digital video 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
accurately gauge the effect of the general economy on our business. As a result, we may
not react to such changing conditions in a timely manner, and that may result in an
adverse impact on our results of operations. Any such adverse impact to the result of our
operations from a changing economy may cause the price of our ordinary shares to decline.

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

We
manage our available cash through investments of various holdings, types and maturities.
Approximately 65% of our available cash is invested in structured notes, or the Notes,
acquired from several banks. Under the terms of the Notes, for each day in which the
relevant LIBOR rate is below an agreed annual fixed rate, which ranges from 3% to 7%, 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. 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 portfolio. As a result, we may recognize in earnings the
decline in fair value of our portfolio investments when the decline is judged to be other-
than- temporary. For further information regarding the investment of our available cash,
see ITEM 5.B  LIQUIDITY AND CAPITAL RESOURCES.

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
couldlose our entire investment in these companies.

Our
officers, directors and affiliated entities own a large percentage of our ordinary
sharesand could significantly influence the outcome of actions.

Our
executive officers, directors and entities affiliated with them, in the aggregate,
beneficially own approximately 17.1%of our outstanding ordinary shares, of which
Tom Wyler, our President and Executive Chairman of our Board of Directors holds 14.5%(calculated taking into consideration shares subject to options that are currently
exercisable or exercisable within 60 days of May 31, 2005 which are deemed to be
outstanding); see ITEM 7A  MAJOR SHAREHOLDERS. These shareholders, if
acting together, would be able to significantly influence all matters requiring approval
by our shareholders, including the election of directors and the approval of mergers or
other business combination transactions.

- 7 -

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The
threat of terrorism worldwide, combined with political unrest in Israel could have
amaterial adverse effect on our results of operations.

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

We
have experienced significant fluctuations in our results of operations at times in the
past and expect these fluctuations to continue. These fluctuations may result in
volatility in our share price.

We
have experienced at times in the past, and may in the future experience, significant
fluctuations in our quarterly and annual results. Factors that may contribute to the
fluctuations in our quarterly results of operations include:

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

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

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

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

| | Market
acceptance of IP based video applications;
|- | -------------------------------------------------

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

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

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

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

| | Personnel
changes;
|- | ------------------

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

| | General
economic conditions, particularly in those countries or regions where we sell our
products.
|- | ---------------------------------------------------------------------------------------------------

Historically,
the prices of video encoders and decoders and content authoring tools have decreased over
the life of individual products, while the complexity of new product introductions has
increased concurrently. As a result, we have reduced prices for our products and we 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 and the
development of 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, our share price may drop.

The
trading price of our ordinary shares has been highly volatile, and may continue
tofluctuate significantly due to factors beyond our control.

The
trading price of our ordinary shares is and will continue to be subject to significant
fluctuations in response to numerous factors, including:

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

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

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

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

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

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

| | Seize
a substantial business opportunity by our competitors or us.
|- | ------------------------------------------------------------------

- 8 -

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We
expect this volatility to continue in the future. In addition, any shortfall or changes in
our revenues, gross margins, earnings or other financial results could cause the price of
our ordinary shares to fluctuate significantly. In recent years, the stock market has
experienced significant price and trading volume fluctuations, which have particularly
affected the market price of many technology companies and which may not be related to the
operating performance of those companies. Volatility in the price of stock of companies in
the digital 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 2004 through May 31, 2005, the price of our ordinary shares rose to
a high of $8.32 from a low of $3.8. 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.

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. ADDITIONAL INFORMATION 
TAXATION, UNITED STATES FEDERAL INCOME TAX CONSEQUENCES for a more complete
discussion of the U.S. federal income tax risks related to owning and disposing of our
ordinary shares.

Following
the Implementation of SFAS No. 123R, we will be required to record a compensation
expense in connection with share based compensation, and, as a result, our profitability
may be reduced significantly.

On
December 16, 2004, the Financial Accounting Standards Board (FASB) issued Statement No.
123 (revised 2004), Share-Based Payment (SFAS No. 123R), which is a revision
of SFAS No. 123. Generally, the approach in SFAS 123(R) is similar to the approach
described in Statement 123. However, SFAS No. 123 permitted, but did not require,
share-based payments to employees to be recognized based on their fair values while SFAS
No. 123(R) requires, as of the first quarter of 2006, all share-based payments to
employees to be recognized as a compensation expense based on their fair values. SFAS No.
123R also revises, clarifies and expands guidance in several areas, including measuring
fair value, classifying an award as equity or as a liability and attributing compensation
cost to reporting periods. The impact of the adoption of SFAS No. 123R cannot be predicted
at this time because it will depend also on levels of share-based compensation granted in
the future. Had we adopted this standard in prior period, however, we would have recorded
a material amount as compensation expense, which would have had a material adverse effect
on our profitability. The adoption of this standard could materially adversely affect our
profitability in the future. In addition, if as a result of SFAS No. 123R we would stop or
limit the use of stock options as an incentive and retention tool, it could have a
negative effect on our ability to recruit and retain employees.

We
may in the future be the target of securities class action or other litigation, which
couldbe 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.

- 9 -

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We
may be required to pay stamp duty on agreements executed by us on or after June 1,
2003.This would increase our expenses.

The
Israeli Stamp Duty on Documents Law, 1961 (the Stamp Duty Law), provides that
most documents signed by Israeli companies are subject to a stamp duty, generally at a
rate of between 0.4% and 1% of the value of the subject matter of such document. De facto,
it has been common practice in Israel not to pay such stamp duty, unless a document is
filed with a governmental authority or with the courts. As a result of an amendment to the
Stamp Duty Law that came into effect on June 1, 2003, the Israeli tax authorities have
approached many companies in Israel and requested the disclosure of all agreements signed
by such companies after June 1, 2003 with the aim of collecting stamp duty on such
agreements. The legitimacy of the aforementioned amendment to the Stamp Duty Law and of
such actions by the Israeli tax authorities are currently under review by the Israeli High
Court of Justice. Based on advice from Israeli counsel, we believe that there is a
reasonable ground to the contention that though the amendment to the Law came into effect
on June 1, 2003, the tax authorities may not enforce stamp duty on documents signed before
August 2004, the date at which they commenced approaching companies and requested a
documents disclosure. Based of the aforementioned advice we also believe that there is
some ground to the contention that the tax authorities may not enforce stamp duty till
guidelines to the Law (as amended) is published. However, we cannot provide any assurance
that the tax authorities or the courts will accept such views and those views may fully or
partially be rejected. Although at this stage it is not yet possible to evaluate the
effect, if any, on our business operations of the amendment to the Stamp Duty Law, it
could materially adversely affect our results of operations. In January 2005,
Israels Minister of Finance signed an order in accordance with which the requirement
to pay stamp duty was cancelled with effect from January 1, 2008. Furthermore, pursuant to
such order, as of January 1, 2005, stamp duty is no longer chargeable on loan agreements,
among other documents.

We
may not be able to raise additional financing for our future capital needs on
favorableterms, or at all, which could limit our growth and increase our costs and could
adversely affect theprice 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 the core of Hi-TV in October 2000, Viewgraphics in
December 2000 and certain other assets and liabilities, see also Item 4.A Capital
Expenditures for the Past Three Years. 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.

| | (b) | 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 inreduced revenues.

We
have three product lines: (i) the IPTV product line, or IPTV, which enable telephone
operators and service providers to leverage their digital subscriber lines, or DSL, and
fiber communications infrastructure to offer TV services to their subscribers; (ii), the
Video Technologies product line, or Video Technology, which enable a variety of content
creation and streaming applications in the Enterprise, Government, Broadcast and Post
production markets and (iii) the Digital Non-Linear Editing product line, or Digital
Non-Linear Editing, which are used by media post-production professionals and editors.
Competition in each of the markets addressed by each product line is intense, and we
expect competition to increase. 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. Our principal
competitors in the IPTV market include TUT Systems, Skystream Networks Inc, Nextream,
Tandberg Television ASA, Harmonic Inc., Minerva Inc and Scopus Network Technologies.

- 10 -

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In
recent years the Video Technologies market has become matured and is subject to fierce
competition. The principal competitors of our Video Technologies products in the
Enterprise and Government markets are VBrick Systems Inc., Amnis Systems (formerly
Optivision, Inc.), 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.

The
principal competitors of our Digital Non-Linear Editing products are
Accom®, Inc., Adobe Systems Inc., Apple Computer, Inc.and Avid
Technology, Inc. There are many other small and medium size competitors in the market
which have either introduced or announced plans to introduce disk-based systems. Because
the market is constantly changing, it is difficult to predict future sources of
competition; however, competitors are likely to continue to include larger vendors, such
as Apple Computer, Matsushita, and Sony.

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.

In
addition, 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.

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 52% of our revenues in 2002, 43% of
our revenues in 2003 and 36% of our revenues in 2004. We expect that this product family
will continue to account for a significant portion of our revenues in the foreseeable
future. If this product fails to match the price, availability, quality or other features
of competing products or to otherwise meet our expectations with respect to market demand,
it would have a material adverse affect on our results of operations.

We
depend on several large customers and the loss of one or more of these customers, or
asignificant decrease in revenue from any of these customers, could have an adverse
impact on ourrevenues and income.

Historically,
a substantial portion of our revenues has come from large purchases by a small number of
customers. For example, our top three customers in 2002, accounted for approximately 30%
of our revenues, our top three customers in 2003 accounted for 18% of our revenues, and
our top three customers in 2004 accounted for 11% of our revenues. We expect to continue
to depend on sales to a small number of customers. We have a limited number of long-term
purchase agreements with our top customers, and as such, we have a limited number of
commitments from our top customers to purchase specific quantities of products. We cannot
assure that we will be able to continue those agreements under current or future market
conditions. We expect that our largest customers will vary from period to period. If we
lose, one or more of our large customers, and we fail to add new customers that generate
significant revenues, it could have an adverse affect on our results.

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We
have a limited backlog of orders and have to plan production and inventory levels
on unpredictable ordering patterns. Maintaining sufficient inventory levels to meet
anticipated demand increases the risk of inventory obsolescence and associated write-offs,
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 varies substantially from early estimates provided by
customers to us for planning purposes.

We
depend on third parties to distribute and market our products. If we cannot retain
effective distributors or fail to develop new distributor relationships, we may be unable
to effectively market and distribute our products.

A
significant portion of our sales efforts worldwide is conducted through a network of
independent distributors. Our combined sales to three of these distributors accounted for
approximately 14% of our revenues in 2002, approximately 15% of our revenues in 2003 and
approximately 10% of our revenues in 2004. 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.

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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.

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, and digital video and streaming products and tools
specifically, are part of a rapidly evolving market. Our growth will depend on our ability
to predict which segments of that market are most likely to succeed and to successfully
penetrate those segments. We have devoted substantial effort and expense to the
development of new products based on our prediction of the market trends, and our future
growth will depend on our ability to successfully market these products. The demand for
these products depends on the rate and level of penetration of networked video
applications and digital video 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.
Microsoft has developed a different standard for compression and decompression of digital
video, which is called VC-1, and is currently not supported by our products. Microsoft is
currently making efforts to have this standard approved and accepted by the industry. If
the market accepts VC-1 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.

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.

As
we market our products internationally, our business is affected by a variety of
regulatory directives. Our inability to comply with the directives in each country may
adversely affect our operations.

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)
and the Waste Electrical and Electronic Equipment (WEEE) Directive (2002/96/EC) apply to
our operation in Europe. If we will fail to meet these regulatory directives, we may not
be able to market our products effectively in some European countries and as a result, our
operations will be adversely affected.

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Our
products could contain defects, which would reduce sales of those products or result
inclaims against us.

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

We
depend on a number of third parties to manufacture, distribute and supply
criticalcomponents of our products and we may be unable to operate our business if these
parties fail to performtheir obligations.

We
depend upon sole source suppliers for key components used in our products. These key
components include, for example:

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

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

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

| | 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;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | HD
compression chips manufactured by NEL
|- | ----------------------------------------

| | SDI
interface chips manufactured by Gennum.
|- | -------------------------------------------

| | Video
A/D and D/A chips from Philips which are used in our encoders and decoders;
|- | ---------------------------------------------------------------------------------

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

| | Decoder
chips manufactured by Zoran Corporation, which are used in our decoders;
|- | --------------------------------------------------------------------------------

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

| | Asics
manufactured by Toshiba, which is used in our 844/X hardware;
|- | -------------------------------------------------------------------

| | A
processor manufactured by IDT, which is used in our 844/X hardware;
|- | ---------------------------------------------------------------------

| | Advanced
Image processors by Genesis and Silicon Optix, which are used in our 844/X hardware;
     and
|- | ------------------------------------------------------------------------------------------------------

| | Programmable
devices by Xilinx, which are used in our Mediapump and HDX hardware.
|- | ---------------------------------------------------------------------------------

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.

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Some
of our products were designed a number of years ago and we may face problems acquiring
components for these products 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 adversely
affecting our reputation and our sales.

We
depend on a limited number of key personnel who would be difficult to replace, and if
welose the services of these individuals or cannot hire additional qualified personnel,
our business willbe 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. In addition, our U.S. operations are largely based in Silicon
Valley, a highly competitive marketplace. Therefore, we may be at a disadvantage to the
extent potential employees may favor larger, more established employers, and we may not be
able to retain our current personnel, or obtain the services of additional qualified
personnel if and when needed.

Our
long streaming products sales cycle depends on factors beyond our control and may
causerevenues to vary significantly.

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

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

During
2004, we continued implementing various cost-control measures affecting various aspects of
our business operations. In September 2001, we reduced our workforce by approximately 19%
of our total workforce at that time. During 2002 we performed additional reductions mainly
in our U.S based research and development workforce and during 2003 we performed
additional reductions mainly in our Israel-based research and development workforce.
During 2004 we have decided to perform an additional reduction in our U.S based research
and development workforce. The reduction took place on January 2005. 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
adiversion of resources and our incurring additional expenses, which could disrupt our
business and harmour financial conditions.

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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:

| | additional
operating expenses without additional revenues;
|- | ----------------------------------------------------------

| | potential
dilutive issuances of equity securities;
|- | --------------------------------------------------

| | the
incurrence of debt and contingent liabilities;
|- | --------------------------------------------------

| | amortization
of goodwill and other intangibles;
|- | -----------------------------------------------

| | research
and development write-offs;
|- | ------------------------------------

| | Impairment
charges;
|- | -------------------

| | other
acquisition-related expenses.
|- | -----------------------------------

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

Our
proprietary technology is difficult to protect and unauthorized use of our
proprietary technology by third parties may impair our ability to compete effectively.

Our
success and ability to compete depend in large part upon protecting our proprietary
technology including both hardware and software components of our products. We 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.

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The
prices of our products may become less competitive due to foreign exchange fluctuations.

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

Business
interruptions could adversely affect our business.

Our
operations are vulnerable to interruption by fire, earthquake, power loss,
telecommunications failure and other events beyond our control, especially because our
facilities are located in Israel, the State of California, and the Commonwealth of
Massachusetts. 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.

| | (c) | Risks
Relating to Operations in Israel
| | --- | --------------------------------------

Deterioration
in the economic conditions in Israel may adversely affect our financial conditionand
results of operations.

Following
two years of decline in economic activity from 2001 to 2002, the Israeli economy in 2003
was characterized by stabilization of activity at a low level and experience from
recession. Year 2004 was the first year of economic growth following three years of
economic instability. 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
also adversely affect our financial conditions and results of operation 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. Hostilities involving Israel, the interruption or
curtailment of trade between Israel and its trading partners and political instability
within Israel or its neighboring countries are likely to cause our revenues to fall and
harm our business.

From
October 2000, until recently, terrorist violence in Israel increased significantly,
primarily in the West Bank and Gaza Strip, and Israel has experienced terrorist incidents
within its borders. On June 6, 2004, the Government of Israel approved a disengagement
plan, stating that it is Israels intention to relocate all Israeli settlements in
the Gaza Strip and four settlements in the West Bank by the end of 2005. There can be no
assurance that the recent relative calm and renewed discussions with Palestinian
representatives will continue.

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 6.5% in
2002, the deflation rate in Israel was approximately 1.9% in 2003 and in 2004 the
inflation rate was approximately 1.2%. At the same time the devaluation of the NIS against
the dollar was approximately 7.3% in 2002, the valuation of the NIS was approximately 7.6%
in 2003, and approximately 1.6% in 2004. As a result of this differential, we experienced
a decrease in the dollar costs of operations in Israel in 2002, and an increase in 2003
and 2004, 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 and Trade for research and development programs that meet specified criteria. In
addition, we received grants for overseas marketing from the Israel Fund for the
Encouragement of Marketing Activities, or the Marketing Fund. We also receive tax benefits
under Israeli law for capital investments that are designated as Approved
Enterprises. To maintain our eligibility for these programs and tax benefits, we
must continue to meet conditions, including paying royalties with respect to grants
received and making specified investments in fixed assets. In addition, the terms of the
OCS grants prohibit us from manufacturing products or transferring technologies developed
using these grants outside of Israel without special approvals. 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.
On March 29, 2005, the Israeli parliament approved an amendment to 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. If we fail to comply with these conditions in the future, the benefits
received could be cancelled. We could also be required to refund any payments previously
received under these programs of up to 300% of the granted funds, or pay increased taxes.
Through December 2004, we received an aggregate of $5.3 million in grants from the OCS.
Since 1992, grants from the Marketing Fund have totaled $2.8 million, although no new
grants were received in 2002, 2003 or 2004.

The
Israeli Law for the Encouragement of Capital Investment, 1959 and regulations, or the Law,
prescribe 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 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 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 Israels Ministry of
Industry and Trade and under a series of research and development programs sponsored by
the Commission of the European Union. Through December 31, 2004, we have received an
aggregate of $4.5 million in grants from the Magnet program. In 2003 and 2004, grants from
the OCS, the Magnet and the European Union programs totaled $4.3 million. The Israeli
government has reduced the benefits available under these programs in recent years and has
indicated that it may reduce or eliminate these benefits in the future. These programs and
some tax benefits may not continue in the future at their current levels or at any level.
From time to time, we submit requests for new grants from the OCS and the Magnet program
and for expansion of our Approved Enterprise programs (see ISRAELI TAXATION
 ITEM 10.E) or for new programs. These requests might not be approved. The
termination or reduction of these grants and tax benefits could harm our business,
financial condition and results of operations.

- 18 -

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Anti-takeover
provisions could negatively impact our shareholders.

The
Israeli Companies Law of 1999, or the Companies Law, provides that an acquisition of
shares in a public company must be made by means of a special tender offer if as a result
of such acquisition the purchaser becomes a holder of 25% or more of the voting rights in
the company. This rule does not apply if there already is another holder of 25% or more of
the voting rights in the company. Similarly, the Companies Law provides that an
acquisition of shares in a public company must be made by means of a special tender offer,
if as a result of the acquisition the purchaser becomes a holder of more than 45% of the
voting rights in the company. This rule does not apply if another party already holds more
than 45% of the voting rights in the company.

Furthermore,
under the Companies Law, a person is not permitted to acquire shares of a public company
or a class of shares of a public company, if following such acquisition such person holds
90% or more of the companys shares or class of shares, unless such person conducts a
tender offer for all of the companys shares or class of shares (a Full Tender
Offer). In the event that holders of less than 5% of the companys issued share
capital or of the issued class of shares did not respond to the tender offer, then such
offer will be accepted and all of the companys shares or class of shares with
respect to which the offer was made will be transferred to the offeror, including all of
the companys shares or class of shares held by such non-responsive shareholders that
will be transferred to the offeror by way of a compulsory sale of shares. In the event
that holders of 5% or more of the issued shares did not respond to the tender offer, the
offeror may not purchase more than 90% of the shares or class of shares of such company.

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.

The
Companies Law provides that for as long as a shareholder in a publicly held company holds
more than 90% of the companys shares or of a class of shares, such shareholder shall
be precluded from purchasing any additional shares.

Israeli
courts might not enforce judgments rendered outside of Israel, which may make itdifficult
to collect on judgments rendered against us.

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

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

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

| | the
judgment can longer be appealed
|- | -----------------------------------

| | the
obligation imposed by the judgment is enforceable according to the rules relating to the
     enforceability of judgments in Israel and the substance of the judgment is not
contrary to      public policy; and
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

- 19 -

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

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

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

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

| | The
judgment is at variance with another judgment that was given in the same matter between
the same parties and which is still valid; or
|- | -----------------------------------------------------------------------------------------------------------------------------------------

| | At
the time the action was brought in the foreign court a suit in the same matter and
between the same parties was pending before a court or tribunal in Israel.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

# Item 4. Information on
the Company

4.A
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 Opitbase 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 1250 Space Park Way, Mountain View, California 94043 and has
another branch in the U.S. located at 260 Cedar Hill St. Marlborough, 01752.

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 the Schedule 13D filed with the SEC on June 9, 2005 by Tom
Wyler and Arthur Mayer-Sommer, Mr. Wyler holds 1,800,000 ordinary representing 13.6%of our capital stock and Mr. Mayer-Sommer holds 1,200,000 ordinary representing 9.1%
of our capital stock Mr. Wyler also serves as our President and Executive Chairman of the
Board of Directors.

Capital
Expenditures for the Past Three Years

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 in consideration for $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 shares. 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 shares. In May 2004 we decided to
participate in another financing round in the amount of $400,000 in Mobixells Series
C preferred shares. As a result, our holdings in Mobixell represent 9.35% of its equity.
We may participate in future financing rounds in Mobixell and our holdings may be further
diluted.

- 20 -

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In
December 2000, we acquired Viewgraphics Incorporated, a privately held company based in
Mountain View, California and a provider of hardware and software products for digital
video and streaming infrastructure applications. The people and technology of Viewgraphics
served as the basis for our DVB and open system media gateway capabilities. Immediately
following the acquisition, Viewgraphics became a wholly owned subsidiary of Optibase,
Inc., our U.S. subsidiary, and operated under the name of Optibase U.S., Inc., until it
was merged into Optibase, Inc. in June 2001. In connection with the acquisition, we paid
an aggregate consideration of approximately $43.6 million, of which $11.8 million (net of
issuance expenses) was paid in 1.37 million newly issued ordinary shares. Substantially
all of the employees of Viewgraphics accepted our employment offers. John Krooss, the
principal shareholder and the Chief Executive Officer of Viewgraphics, joined us as the
Chief Technology Officer of Optibase, Inc. and as a member of our board of directors. Mr.
Krooss ceased to be the Chief Technology Officer in September 2001, and resigned from his
service as a director of the Company in July 2002. 364,023 ordinary shares, which were
held in escrow as part of the acquisition agreement with Viewgraphics, were returned to us
by a former employee and by the shareholders of Viewgraphics, following a settlement
agreement that we signed with them in January 2002. As a result, the aggregate
consideration paid by Optibase for the acquisition of Viewgraphics decreased to $43.3
million, including the value of 1.006 million ordinary shares. During the second quarter
of 2002, due to the sudden decrease of Mediapump sales to SeaChange, one of our leading
system integrators at that time, and due to the decrease of our market value at that time,
we recorded an impairment of intangibles related with the acquisition. Related impairment
of intangibles consists of an adjustment made for the valuation of the technology
purchased from Viewgraphics and totaled at approximately $6.8 million. During the second
quarter of 2002 and in accordance with the requirements of SFAS 142 Goodwill and
other Intangible Assets (SFAS 142), we completed our goodwill impairment
analysis and recognized a transitional goodwill impairment loss of $854,000 as of January
1, 2002, which was recorded as the cumulative effect of a change in accounting principle
in our consolidated statement of operations.

In
July 2001, we signed an agreement with a privately held Israeli company called V.Box
Communication Ltd., or V.Box. We committed to invest through one of our subsidiaries an
initial amount of $250,000. We continued to invest in V.Box, with the other shareholders
pro rata to our holdings in V.Box. To date we have invested an aggregate of $2.05 million
in. 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.
Following V. Boxs acquisition of BroadLogics Satellite Express(TM) and DTV
Product Lines, we signed an agreement with V.Box to sell and distribute the
above-mentioned products in the North America market. Additionally, we support V.Box
operational activities. In June 2005 we have decided to invest an additional $175,000 in
V.Box subject to terms to be negotiated.

During
the quarter ended September 30, 2002 we decided to cease additional research and
development efforts for the MediaPump, VideoPump and the MGW 3100. We also decided to shut
down the VideoPump and MGW 3100 product lines. The restructuring costs related to these
actions were approximately $505,000.

In
June 2004 we acquired certain assets and liabilities of Media 100 Inc. as part of a
pre-packaged bankruptcy filing of Media 100. As a result of the acquisition two main
Digital Non-Linear Editing products were added to our product portfolio. We paid $2.5
million in cash and incurred costs totaling $401,000 in connection with this acquisition.
During the quarter ended December 31, 2004, we decided to significantly reduce the
operation of the Digital Non-Linear Editing product line. As a result we wrote down during
the quarter ended December 31, 2004 long lived assets and goodwill related to the
acquisition totaling approximately $2 million in accordance with the requirements of
Statement Of Financial Accounting No 144  Accounting for the Impairment of Long-
Lived Assets and for Long- Lived Assets to be Disposed of (SFAS 144) and SFAS
142.

Recent
developments

On
January 7, 2005 we announced a restructuring of our Digital Non-Linear Editing product
line. While we will continue to sell and support the existing suite of the Digital
Non-Linear Editing product line, a considerable number of employees (approximately 20% of
the total company workforce) were laid off and our research and development efforts were
significantly reduced. In order to better leverage the remaining resources of the unit we
decided to concentrate the development efforts on the Digital Non-Linear Editing MEDIA 100
HD product that targets the traditional installed base. During the quarter ended March 31,
2005, we recorded restructuring expenses totaling approximately $80,000. During the quarter
ended December 31, 2004 we wrote down long-lived assets and goodwill totaling
approximately $2 million.

- 21 -

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In
2005 we established a new office in Singapore that will focus on marketing, promoting and
supporting the companys IPTV product sales efforts in Asia.

4.B
Business overview

Our
business is to provide high quality equipment for a wide range of professional video
applications in the Broadband IPTV, Broadcast, Government, Enterprise and Post-production
markets, which we perform through the operation of three product lines: Video Technologies
(previously called Building Blocks) IPTV (previously called Broadband
TV), and Digital Non-Linear Editing. Our products in all three product lines are
generally manufactured by the same subcontractors by the use of similar raw materials
purchased from the same suppliers. We sell our products directly and through independent
distributors, system integrators and resellers.

The
following is a description of our three product lines:

Video Technologies

Target
Markets

The
Video Technologies products target the enterprise market, the governmental market and the
broadcasting market. In the enterprise markets, our encoding and streaming products enable
applications such as corporate training, videoconferencing, TV to desktop, corporate video
messages distributed over the corporate network. In the governmental markets, our products
enable the logging and streaming of legal and legislative proceedings, base 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.

Products

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. We also market and
sell Media Gateways the name we have given to our family of encoding and
streaming devices that can be controlled remotely over an IP network. 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. The platforms
comprise of encoders, decoders and DVB interface platforms. They are provided with
documented SDKs (Software Developer Kits) to facilitate the development by our customers.
Following is a description of our PCI platforms and the markets and applications in which
they are typically used:

|Encoder Platforms                          
|-------------------------------------------
|Product                                    
|MovieMaker 200S
Last Release: Q2/2004      
|MovieMaker 400Released: Q1/2004            
|RTE SDK              
Last Release: Q2/2004

- 22 -

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|Decoder Platforms                           
|--------------------------------------------
|Product                                     
|VideoPlex Plus   
Released: Q1/1996         
|VideoPlex Pro    
Released: Q2/1998         
|VideoPlex Xpress     
Last release: Q4/2003 
|VideoPlex HD          
Last release: Q2/2005
|RTD SDK              
Last Release: Q1/2002 

|DVB Interface Platforms                     
|--------------------------------------------
|Product                                     
|MediaPump             
Last Release: Q1/2005
|MediaPump SDK         
Last release: Q1/2005

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

|Content Creation Software Applications      
|--------------------------------------------
|Product                                     
|Composer              
Last release: Q2/2004
|Composer for MAC      
Last release: Q4/2004

Also
based on the encoder and decoder platforms, we have developed and we market the following
video streaming applications that run on the PC.

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
have called 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:

|Streaming Media Gateways                   
|-------------------------------------------
|Product                                    
|MGW 2000e            
Last release: Q1/2005

- 23 -

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|Streaming Media Gateways                    
|--------------------------------------------
|Product                                     
|MGW 2400              
Last release: Q1/2005

Products
under Development

We
are currently developing new features for the MovieMaker200S product line and a new PCI
Encoder capable of encoding both SD (Standard Definition) and HD (High Definition) video.
Both are scheduled for release during 2005.

IPTV

Target
Markets

The
IPTV target market is mainly composed of telephone operators and service providers all over the world.
The IPTV products address the needs of telephone operators and service providers, who are
leveraging their DSL (digital subscriber line), which is a family of digital
telecommunication protocols designated to allow high speed data communication over
existing telephone lines, or fiber communications infrastructure to add multi-channel
television services to the data and telephony services that they offer today. These
services are offered to home subscribers, to organizations, gated communities or within
hotels for entertainment.

In
these applications, the products are integrated in a video head-end, receiving content
from various sources, including satellite, and distribute the content over the access
network.

Two
key features of the IPTV products are their ability to transcode and to transrate
compressed video feeds. Transcoding means the conversion of a bitstream from one
compression format to another. Transrating is the reduction of the bitrate of the content
without changing the compression format. These features enable the adaptation of content
received by satellite to the compression formats and bitrates required for distribution
over low bandwidth networks.

The
television over DSL market is expected to grow significantly over the next few years.
According to Multimedia Research Group (MRG) market research from February 2005, the
number of worldwide DSL subscribers will grow from 109 million on 2004 to 204 million in
2008. We are partnering with vendors and system integrators to make service deployments
easier.

The
IPTV products are also suitable for certain enterprise and governmental applications,
including surveillance and monitoring for the military and police. In these markets the
IPTV products complement 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 is needed.

- 24 -

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Products

We
develop and market high reliability Media Gateway product lines, which enable service
providers and Telcos to stream digital video over their broadband infrastructures, such
as: Digital Subscriber Line (DSL) or Fiber. The product line include: MGW5100, MGW1100 and
suite of management solutions for controlling and monitoring the MGWs. Both products are
being used in video head ends, to create digital video streams which are received from
variety of sources such as satellite receivers, video cameras and video storage.

The
following is a list of the IPTV products including a description of their typical markets
and applications:

|Carrier Grade Streaming Media Gateway Products
|----------------------------------------------
|Product                                       
|MGW 5100     
Last release:
Q4/2004           
|MGW 1100  
Introduced
Q4/2004                 

Products
under Development

For
our carrier grade product line, the MGW5100 and MGW1100, we are continuing the development
of the MPEG-4 AVC (H.264), to be released during 2005. We believe that this new Codec
whose standardization process was completed in 2004, will provide better performance than
the most common MPEG-2, which is currently being used by cable and satellite operators.
MPEG-4 AVC will be an important addition to our line of products and will enable broadcast
video quality over limited bandwidth DSL infrastructure.

- 25 -

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Digital Non-linear Editing

Target
Markets

The
customers for our Digital Non-Linear Editing products are media post-production
professionals and editors. Many of our customers in the Digital Non-Linear Editing market
are full-time broadcast designers, visual effects artists, and video editors operating as
employees of professional television and post-production establishments, such as major
networks, cable networks, independent post-production facilities, and small creative
boutiques. The remaining customers are full-time or part-time video editors operating at
businesses, schools, government offices, hospitals, or non-profit institutions. In some
cases, our customers are independent; they are self-employed and operate on
their own typically on behalf of both broadcast-related and non-broadcast or industrial
clients.

Products

We
develop and market professional video editing systems on the Apple Macintosh platform. The
Media 100 HD product handles high definition and high quality standard definition video
signals through a combination of proprietary video hardware (PCI boards) and software.
This combination allows us to provide real-time video effects and a range of input and
output choices. These products are used to create video programming for broadcast,
educational and corporate uses. Media 100 products are owned by video production
companies, broadcast stations and networks, schools, churches and government agencies
around the world.

Our
844/X is a PC based combination of proprietary hardware and software for a high end
compositing and video finishing for standard definition video. This product is designed to
produce many layers of real-time video effects in a very cost effective combination.The
following is a list of the main Digital Non-Linear Editing products, including a
description of their typical markets and applications:

|Digital Non-Linear Editing                  
|--------------------------------------------
|Product                                     
|844/X                 
Last release: Q1/2005
|Media 100 HD          
Last release: Q1/2005

Products
under Development

We
are currently developing a software only version of Media 100 HD and a 10.5 release of the
same product with incremental new features on the same hardware. We are currently involved
in a series of feasibility studies that include releasing a timed out version of the Media
100 sw product while it is under development. This product is a fully functioning version
of the Media 100 HD product, but does not depend on proprietary hardware in order to
function. We will be collecting data from users during this public beta
without guaranteeing support or a level of functionality. A parallel feasibility study is
underway to determine the scope of the 10.5 release for the Media 100 HD product. Since
the two products share the same codebase, these development will serve both products.

- 26 -

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Examples of Product
Deployments

Listed
below are examples of product deployments from our three product lines that illustrate the
use of our products in the markets and the applications they address.

|Markets                                              | Applications                                                                                                            | Integrators/End-Users                                                                                                                                           
|---------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------
|Telecom Operators (IPTV)                             | Multi channel TV over DSL and FTH                                                                                       | Chunghwa TelecomFastwebHTCPiedmont CommunicationsMagnet NetworksFalcon CommunicationsCitizens CablevisionDaktelScott CountyVenus Telephone Corporation
|Broadcasting                                         | Video on Demand (VOD), 
Near VOD, Hospitality                                                                           | SeaChange InternationalPrediwaveN2 Broadband                                                                                                                 
|Ad Insertion                                         | CCTV (China Central)SeaChange InternationalIBM CorporationAdTech, Inc.Maddox Broadcasting                         
|MPEG-2 transport stream splicing                     | Seachange International                                                                                               
|Interactive TV                                       | Open TVWorldgateLiberate                                                                                            
|Enterprise                                           | Business TV                                                                                                             | CiscoLegislative Yuan of R.O.CChina's life insurance companyKIA Motor                                                                                       
|eLearning                                            | Midwest ConceptsRockford Public SchoolsGreenCastle DistrictNanyang Technological UniversitySeoul Institute of Arts
|Monitoring and Satellite
News Gathering              | Antena 3PaltelIsrael's Channel 2 and Channel 10                                                                     
|Telemedicine                                         | Biologic                                                                                                              
|Professional Content
Creation and post   
production | Video Archiving/Cataloging                                                                                              | CNNBritish Broadcasting CorporationFrench National LibraryCorbis MotionBritish PatheHolocaust Rememberance Authority                                      

- 27 -

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|Markets | Applications                                                                                                                             | Integrators/End-Users                  
|------- | ---------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------
|        | DVD and VCD creation                                                                                                                     | CFA Communications                    
|        | Broadcast promotions, post production 
boutiques, single owner/operator      
production companies, corporate       
in-house production | KLRN-TexasJohn HancockMagic Eye GmbH

Fastweb.
          Italys largest competitive operator offers integrated broadband
          telecommunications services using IP-based architecture both over its fiber
          optic and its DSL network. The services are provided to both business and
          residential customers in the main Italian cities. FastWeb offers the integration
          of voice, broadband Internet connectivity, data transmission and television over
          a single connection and is constantly focused on the development of new value
          added services. FastWeb TV allows subscribers to access the main Italian
          broadcast TV channels, a selection of satellite channels and a Video-on-Demand
          service, which offers more than 4500 titles on-demand. FastWeb chose the MGW
          5100 for the streaming of some of its channels in multicast mode over the
          network to a set top box located in the premises of approximately 110,000
          residential end users.

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

Broadcasters
Channel 10 & 2Israeli commercial broadcasters, Channel 2 and Channel 10 have used
our encoding & streaming platforms to deliver round-the-clock live video programming
from the Athens 2004 Olympic Games. By using our streaming solution, the broadcasters are
able to implement IP multicasts and utilize IP networks, which allow for the delivery of 4
Mpbs streams at a fraction of the cost of satellite broadcasts. A web based management
system facilitates remote control and configuration of the system at all times.

Cisco
          In order to provide the best financial services to its customers, a large
          international banking institution wanted to keep its stock traders constantly
          updated on market changes with live news feeds and stock analysis data. To meet
          this challenge, Cisco Systems and Optibase teamed together to provide a private
          video distribution network to the stock traders. The network is powered by the
          Cisco IP/TV 3400 broadcast server using our MPEG MovieMaker 200 encoder.
          The MovieMaker captures live video feeds and encodes and compresses the
          data, which is then streamed to the desktops of 750 stock traders. There are
          four monitors on each stock traders desktop which are powered by an
          Hewlett Packard Kayak computer containing our VideoPlex XpressMPEG
          decoder. Stock traders can view live transmissions of news services such as
          Bloomberg news or Financial Times TV in a small window on any of the monitors
          along with real-time financial data. Besides its importance as a real-time
          information tool, the network will also be used for live video briefings and
          updates from the banks senior account managers.

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

- 28 -

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Geller/Goldfine
Productions.Geller Goldfine Productions produces and directs feature-length
documentaries for theatrical, broadcast, and home video release. With the Media 100 844/X
Geller Goldfine edited the two hour film, cutting was done with the Media 100 i system.
For the sound mix, Geller/Goldfine exported an OMF file from the Media 100 i system, and
then re-imported a mixed-down stereo file back into 844/X to output the final theatrical
master.

Sales
and Marketing

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

Our
sales efforts in North America, Central America and South America are managed by Optibase,
Inc., which is headquartered in Mountain View, California. Our North American sales
activities are conducted primarily through our direct sales organization, which focuses on
key accounts, which include telecommunication operators, system integrators and OEM
accounts that offer strategic opportunities or large volume potential. North American
sales efforts are supplemented by our VAR (Value Added Reseller) channel, through which
our products are sold directly to end-users. North America accounted for approximately 61%
of our total sales in 2002, approximately 56% of our total sales in 2003 and approximately
60% of our total sales in 2004.

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 a vast majority 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 and our Massachusetts office. In Europe these
distributors and customers are supported by three Optibase sales managers, one in France,
one in the UK and the other 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. Sales to Asia Pacific, or APAC are managed directly from
our headquarters in Israel. European sales constituted approximately 12% of our total
revenues in 2002, approximately 17% of our total revenues in 2003, and approximately 16%
of our total revenues in 2004, while sales in Eastern Asia, including Japan, constituted
approximately 23% of our total revenues in 2002, approximately 24% of our total revenues
in 2003, and approximately 15% of our total revenues in 2004. Sales in Israel and other
areas outside of North America was approximately 4% of our total revenues in 2002,
approximately 3% of our total revenues in 2003 and approximately 9% of our total revenues
in 2004. Please also see item 5.A. Combined sales to our three leading distributors of our
products accounted for approximately 14% of our worldwide sales in 2002, approximately 15%
of our worldwide sales in 2003, and approximately 10% of our worldwide sales in 2004.
Combined sales to our three leading system integrators accounted for approximately 30% of
our sales in 2002, approximately 13% of our sales in 2003, and approximately 10% of our
sales in 2004.

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We
also received grants from the Marketing Fund. The government of Israel through the Fund
for Encouragement of Marketing Activities awarded the company grants for participation in
foreign marketing expenses. The grants were based upon the expenses reported by us to the
Marketing Fund. All marketing grants recorded from the Marketing Fund until 1997 are
linked to the dollar and are repayable as royalties at the rate of 3% of the amount of
increases in export sales realized by us, up to a total amount equal to the grants we
received from the Marketing Fund. Grants recorded from programs beginning on or after
January 1, 1998 bear royalties of 4% plus interest at LIBOR. We will face royalty
obligations on grants from the Marketing Fund only to the extent we actually achieve
increases in export sales. The proceeds of these grants were presented in our consolidated
financial statements as a reduction of selling and marketing expenses. Through December
31, 2004, we had recorded grants from the Marketing Fund in the aggregate amount of $2.8
million, and had no contingent liability for which we had not yet recognized royalty
obligations. No funds were received from the Marketing Fund during the years 2002, 2003
and 2004.

Technology

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

In
November 2000, we released our MGW 2000, which is the first product of our MGW product
line that provides streaming media gateway solutions for enterprises and broadband
markets. In November 2002 we released the MGW 2400, which enables direct streaming of
video over the Internet, Intranets and other broadband IP networks using the MPEG-4 format
and compliant with Windows Media Technologies (WMT).

In
December 2000, we acquired Viewgraphics Inc. Viewgraphics brought to Optibase critical
expertise in DVB (Digital Video Broadcast) technology, which primarily involves the
transmission of MPEG-2 over digital cable networks. Viewgraphics has also contributed
expertise in uncompressed serial digital video technology and open systems based software
technology. Viewgraphics was founded in 1985. Between 1985 and 1991 Viewgraphics designed
and developed imagery frame buffer technology under contract to US defense contractors.
Between 1991 and 2000 Viewgraphics sold a product called Viewstore, a high-end video
sequencer, to the video research marketplace. Over this period Viewgraphics became a
leader in advanced video technologies and interface methodologies. In 1996, Viewgraphics
brought out the MediaPump and VideoPump products for DVB and SDI (Serial Digital
Interface) respectively. Viewgraphics had become a leader in DVB interface technology
primarily through superior technology in the areas of video stream processing, video
stream splicing and overall signal integrity and operational reliability. During 2001, we
redesigned and enhanced the MediaPump introducing an improved, low cost product, the
MediaPump 533. We also introduced the MGW 3100 DVB/IP Gateway system, based on the
MediaPump products and based on the technology developed for DTV:Net, a product introduced
by Viewgraphics in 2000. The MGW 3100 is a bridge between DVB and IP networks for the
transmission of video over IP between two remote sites, or backhaul, and the distribution
of DVB content over IP. In addition, we successfully incorporated the DVB de-multiplexing
technology of the MediaPump into the MGW 5100 to enable the transcoding of video content
from satellite and cable feeds and its distribution over IP and ATM-based access networks.
In the third quarter of 2002 due to a sudden decrease in MediaPump sales to SeaChange, one
of our leading system integrators at that time, and after assessing markets conditions, we
decided to cease additional research and development efforts for the MediaPump, VideoPump
and MGW 3100. We decided to shut down the VideoPump and MGW 3100 product lines, and to
reduce the investment in the MediaPump. We continue to sell and support the MediaPump

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In
December 2002, we released the MGW 5100, a carrier gradeproduct that enables the
encoding and transcoding of video content from one format to another and the streaming of
video over broadband IP networks. The MGW 5100 is the first member of our IPTV product
line.

In
December 2004, we released the MGW 1100, a cost effective carrier grade that enables
encoding, transcoding and streaming digital video solution. The MGW1100 will mainly be
used by service providers who are looking for a small-scale cost effective solution for
master and regional head ends.

Encoder
and decoder related technology. Firmware, the low-level software that resides on the
printed circuit board in our products, provides for the basic audio/video compression
operations. We have implemented the MPEG-audio compression algorithm known as Layer II on
a dedicated digital signal processor, or DSP, and we have integrated an implementation of
a Dolby AC3audio encoder on the same DSP. We have developed a high quality MPEG-4
encoder on a powerful multimedia DSP from Equator Technologies for some of our products.
We have also researched and developed algorithms to be implemented by firmware and DSP to
improve the quality of our encoders using advanced preprocessing techniques. Real-time
audio and video layers handle the real-time processing of the elementary audio and video
streams that are generated through the encoder hardware. At the audio/video
synchronization layer, a patented technology we call EverSync assures the
synchronization of both audio and video, even with unstable video sources or random noise
and disconnections, eliminating the need for an external timing correction device. Another
related technology that we have developed is a two-pass variable bit rate encoding process
that allows for better optimization of the bit per frame ratio to improve the overall
perceived quality throughout the entire video clip. In cooperation with a certain
technology vendor, we have developed an encoder that supports the H.264 (or MPEG-4 part
10, or AVC) format for our IPTV products. We have also developed a PCI encoder of high
definition video for broadcasters and digital signage.

Another
layer is used to handle the multiplexing, of the elementary audio and video streams into a
single stream. This layer allows for multiplexing of programs originated from multiple
encoders into a single transport stream and can handle multiplexing of variable bit rate
MPEG streams as well as constant bit rate streams. In addition, despite the fact that 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. Another component handles the frame accurate operation of the encoding
process and the frame accurate control of a VCR or similar device to enable frame accurate
capture and encoding from the device for our content creation products. A real-time
preview component allows for previewing encoded material via an external MPEG decoder.

Because
our proprietary software is compatible across most of our hardware platforms, a separate
component is able to automatically detect the hardware installed, determine its
capabilities and report them to the user application without the user needing to know
which hardware platform is installed.

DVB
(Digital Video Broadcast) Technology. We provide proprietary technology to record,
play and process multiple program transport streams, or MPTS, of DVB. Our MediaPump PCI
card can capture all the programs in a multiple program transport stream. Also, on output,
the MediaPump takes several single program transport streams, 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 splicetogether the digital data
bits for two single program transport streams. This patent pending technology represents
an important technological advantage since it makes it possible to switch between MPEG-2
streams without either losing the picture entirely for a second or generating an ugly
break-up of the television picture. We have 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 product that scrambles the content emitted by the MediaPump before
transmission. Having the scrambling feature implemented in our hardware reduces for our
customers the total costs of providing a service.

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IP
Network-related technology. We have developed transport and control protocols for the
streaming of multimedia over IP networks, such as the real time transport protocol, or
RTP, the real time control protocol, or RTCP, and the real time streaming protocol, or
RTSP, that are becoming widely adopted and standard in the industry. In particular, we
have implemented the specifications of the ISMA (Internet Streaming Media Alliance) for
the transmission of audiovisual content over the Internet. We have also developed
proprietary mechanisms that allow system integrators to develop packet-based network
solutions. These mechanisms bridge the real-time nature of MPEG encoders and the
non-real-time nature of packet-based networks, and allow for unicast, broadcast and
multicast capabilities. One of these mechanisms, known as smoothing, is used to reduce
congestion of the network and prevent the dropping of packets in routers and by other
networking interfaces. Another mechanism enables our decoders to recovery gracefully when
encountering packet loss. We support de-multiplexing on the host processor and also on our
decoder hardware. The latter allows the PC to perform other time critical tasks and also
enables multiple boards to run on one PC without overloading the PC processor. The MGW
3100 product is based on sophisticated streaming software for streaming DVB over IP, and
includes patent pending techniques for clock locking, drift compensation and data
multiplexing for packet networks. The MGW 3100 also employs some multicast and quality of
service, or QoS, technologies. In the third quarter of 2002 after assessing markets
conditions, we decided to shut down the MGW 3100 product line.

SDK
(software development kit) technology. Our PCI encoder, decoder and DVB related
technology as well as the networking related technology described above is 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, DVB interfaces, and SDI video interface hardware platforms
into their own digital video systems and establish links with existing end-user
applications, exploiting the full range of our core technologies for their applications in
a productive manner. The SDK has been designed so that once it has been used to
incorporate one of our products into a customers system the same system can easily
be upgraded to incorporate new generations of our products or expanded to incorporate new
products and capabilities.

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

Broadband
Internet related technology. We are developing the video and audio compression
algorithms targeted to meet the broadband Internet bandwidth and quality requirements. We
define the broadband Internet to include the bandwidth range of 10kbps to 3.5 Mbps, which
can be served by cable modems, various types of digital subscriber line, or xDSL, modems
and wireless technology. The video encoding technology that we are developing is based on
the MPEG-2, MPEG-4 and AVC international standards and Microsofts proprietary WMT
streaming format. We have implemented some of these technologies on a powerful multimedia
DSP. Our technology includes pre-processing algorithms, motion estimation algorithms and
improved rate control algorithms. We have also integrated an advanced audio coding, or
AAC, encoder into our MPEG-4 products.

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

Transcoding
technology. An important feature developed for the MGW 5100 is the ability to
transcode one media format to another. We have developed the ability to transcode
compression formats from MPEG-2 to MPEG-4, from MPEG-2 to Windows Media compliant
compression and to transrate from MPEG-2 at a high bit rate to MPEG-2 at a lower bit rate.
The source can be either a variable bit rate, or VBR, or constant bit rate, or CBR,
compression format. 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.

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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.

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

Technology
Acquired with the purchase of certain assets and liabilities of Media 100.The
Non-linear Editing products acquired with the certain assets and liabilities of Media 100
are designed as integrated software and hardware systems. The hardware engine comprises
one or more PCI cards that fit into the backplane of either a Windows NT or Macintosh
computer. The hardware provides the essential video and audio processing functions. The
software has two layers: a user interface and software that functions as an intermediary
between the application and the hardware. The intermediary software controls the hardware
functions and the transfer of data between the hardware and the host computer.

The
844/X is built upon a set of PCI cards collectively called the GenesisEngine. The
GenesisEngine houses proprietary Application-Specific Integrated Circuits, or ASICs, that
were designed to perform calculation-intensive video processing operations. The
GenesisEngine supports concurrent image, audio, and signal processing operations with
real-time throughput and high-precision. A major innovation of the software architecture
is the Intelligent Layering Architecture, or ILA. A video layer is a clip of video that is
superimposed over another clip during a process called compositing with some visual effect
being implemented between the clips. The implementation of the visual effects between
layers, or rendering, is usually very computationally intense. Most compositing products
cannot render in real time and are limited to rendering a few layers at a time. The ILA
implements a recursive processing of layers, which, combined with the hardware
acceleration of the GenesisEngine, allows users to quickly manipulate, usually in real
time, very large numbers of layers, such as hundreds of layers.

Unlike
the 844/X, the Media 100 i and iFinish are dual-stream, Non-linear editing systems and not
compositing systems. That is, they support editing and splicing of two streams only and do
not support the compositing of video layers. The Media 100 i runs on a Macintosh computer
and iFinish runs on Windows. They both use a PCI card suite called P6000 (formerly
called Vincent and Vincent 601). The P6000 comprises one or two
PCI cards that fit into the host computer and support the essential video and audio
processing functions. The P6000 includes broadcast-quality video input and output
decoder/encoder subsystems, a 16-bit multi-track high quality digital audio subsystem, and
two high-speed 32-bit microprocessors responsible for transferring digital audio and video
data, at throughput rates of up to 30 megabytes per second to and from the host
computers central processing unit, or CPU.

Media
100 HD is our latest editing product for the Macintosh, released after the acquisition of
the Media 100 assets and liabilities in 2004. Its new HDX hardware engine provides high
quality conversion between Standard Definition, or SD, and High Definition, or HD, video
formats. The Media 100 HD supports high precision editing of SD and HD content within the
same project.

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 to be incorporated
into the MovieMaker product line. We continue to add new functionality to our products.
For instance, we recently added support for MXF. MXF is an open standard that enables
exchange of multimedia files prepared during the production and post-production workflow.
We are also researching algorithms to improve the quality of our encoders using advanced
preprocessing.

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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 May 31, 2005, our
research and development department was comprised of 48 employees all of whom are located
in our headquarters in Israel and our facilities in Massachusetts. Our research and
development net expenses were $8.1 million in 2002, $4.8 million in 2003, and $6.3 million
in 2004. During the quarter ended June 30, 2004 in connection with the acquisition of
certain assets and liabilities we recorded write off of in process research and
development associated with the Media 100 HD. Research and development grants we received
from the OCS and the European Union Research and Development Program were $2.2 million in
2002, $2.2 million in 2003, and $2 million in 2004.

Our
research and development efforts have been financed through internal resources as well as
through programs sponsored by the Office of the Chief Scientist, or OCS, in the Israeli
Ministry of Industry and Trade, and the European Union Research and Development Program.
Generally, grants from the OCS constitute up to 50% of qualifying research and development
expenditures for particular approved projects. Under the terms of the OCS participation, a
royalty of 3% to 5% is due on revenues from sales of products and related services that
are developed from projects funded by the OCS. Royalty obligations vary between 100% and
150% of the dollar-linked amount of the OCS grant. Royalties on grants recorded for
programs beginning on or after January 1, 1999 bear interest linked to the LIBOR. The
terms of the OCS grants prohibit us from manufacturing products or transferring
technologies developed using these grants outside of Israel without special approvals.
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. On March 29, 2005, the Israeli parliament approved an
amendment to Israeli Law for Encouragement of Industrial Research and Development, 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, 2004, we received grants from the OCS
aggregating $5.3 million for certain of our research and development projects. As of
December 31, 2004, accrued and paid royalties to the OCS totaled $3.3 million.

In
addition to the general OCS grants, we have received OCS royalty-free grants through our
participation in consortium research programs supported by the MOST Consortium and the
STRIMM Consortium, which participate in the OCS Magnet royalty-free program. One of the
goals of the MOST project was the creation and distribution of digital video over networks
for on-line services. The MOST consortium project was terminated on March 31, 2000.
The goals of the STRIMM project are to provide seamless usage of internet-base video and
audio mail messaging services. Various clients (using a PC, PDA, cellular phone or similar
terminals) on various access networks (broadband and narrowband) would be able to receive
and play video messages in stream mode without the need to download the (large) video
message to their device. Video format and network protocols will be transcoded without
user intervention, according to the connection and device capabilities of the terminal.
The STRIMM project started in July 2000 and will continue until July 2005. Through
December 31, 2004, we recorded grants from the MAGNET, MOST and STRIMM consortiums,
aggregating $4.5 million.

We
are also involved in joint development projects with large European companies, such as
Philips research, Deutsche Telecom, TDF, Aerospatiale Matra, Beta Research and THALES,
conducted under the auspices of, and with financial assistance from, the European Union
Research and Development Program. Among the goals of these projects are providing
solutions aimed at bridging between video streaming standards for the broadband and
narrowband Internet and the development of tools and applications for the creation and
secure distribution of digital video content. We believe that participation in such
projects increases our exposure to new technologies, products and potential customers.
These programs provide royalty-free funding to consortia of industrial companies and
academic institutions aimed at improving the competitiveness of European industry through
technological research and development, partnerships and strategic alliances. Through
December 31, 2004 we have obtained approvals for grants for thirteen research and
development projects for a total amount of approximately $6.4 million (of which
approximately $4.8 million has already been offset against research and development
expenses).

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Service
and Support

We
believe that providing a high level of customer service and support is essential to our
success. Our technical support personnel provide worldwide services through each of our
main offices in Israel, United States, China and Japan. In the United States, we provide
the first-line of support through our wholly owned subsidiary, Optibase Inc from the
Mountain View office and the Marlborough 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. Provide a one-year warranty on
our hardware products. For the Non-Linear Editing products we also offer the Platinum
One-Stop service in which subscribers can obtain telephone technical support for
compatible third-party products that have been integrated with their media systems. We
also organize technical seminars from time to time to further enhance the technical
knowledge of distributors and resellers in the use of our products.

Manufacturing
and Sources of Supply

Our
manufacturing facilities, located in Herzliya, Israel, perform procurement of components,
final assembly, testing and quality control of our products. We out-source assembly of
hardware modules to multiple manufacturers in Israel who work in accordance with our
designs and specifications. This outsourcing strategy has improved product quality and our
gross margins. Quality control of our products is conducted at various production stages,
both at the subcontractors and our facilities. We have implemented a supplier
qualification program to ensure subcontractor quality standards. We monitor printed
circuit performance by way of statistical survey and a reporting system that tracks boards
from initial inspection to shipment. To accommodate increased production levels, we have
initiated a program of subcontracting the manufacturing of high-volume products to
manufacturers who also procure the required components. Under this system, we purchase
fully assembled and tested products at predetermined prices. We intend to continue to
outsource additional products as production levels increase and we are satisfied as to the
quality control of our subcontractors. These types of arrangements will allow us to focus
on the manufacture of low-volume products, which are generally more complex in nature and
require more rigorous assembly, testing and quality control procedures.

Key
components used in our VideoPlex Xpress, MovieMaker 200, MovieMaker, MM200S, MM100S,
MGW 5100, MGW 1100, MGW 2000e, MediaPump844/X, Media 100 HD and other products and
systems are presently available from, or supplied by, only one source and other components
are available from limited sources. These key components include, for example:

| | Video
 compression  and  decompression  chips  manufactured  by LSI  Logic  which are used in
our      MPEG-2 encoders and decoders;
|- | ------------------------------------------------------------------------------------------------------------------------------------

| | Processors compression
chips manufactured by Equator Technologies Inc, which are used in our MGW 5100, MGW 1100,
MGW 2400, MGE 400 and Movie Maker 400 products;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | SDI
interface chips from Gennum;
|- | --------------------------------

| | Video
A/D and D/A chips from Philips which are used in our encoders and decoders;
|- | ---------------------------------------------------------------------------------

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

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

| | Decoder
chips manufactured by Zoran Corporation, which are used in our decoders;
|- | --------------------------------------------------------------------------------

| | Audio
Analog to Digital Converters (A/D), Digital to Analog Converters (D/A) and decompression
chips manufactured by Crystal, which are used in our encoders and decoders;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Various
modules, which are integrated in our systems, the MGW 5100 and MGW1100, as follows:
Switch by PTI Performance Technologies, Inc), host by Freesacle, Switch by Intel,
backplane board by Kaparel Corporation, Pentium module by Kontron ,and compact PCI
platform by EPS. (Israel) TECH 1992 LTD;
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A
video processing chipset from Gennum which is used in our MM200s and HDX hardware;
|- | ------------------------------------------------------------------------------------

| | Asics
manufactured by Toshiba, which are used in our 844/X hardware;
|- | --------------------------------------------------------------------

| | A
processor manufactured by IDT, which is used in our 844/X hardware;
|- | ---------------------------------------------------------------------

| | Advanced
Image processor by Genesis and Silicon optix, which are used in our 844/X hardware; and
|- | ------------------------------------------------------------------------------------------------

| | Programmable
devices by Xilinx, which are used in our MediaPump and HDX hardware.
|- | ---------------------------------------------------------------------------------

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Although
we generally do not have long term supply contracts with our suppliers, we have, in the
past, been able to obtain supplies of components and raw materials in a timely manner and
upon acceptable terms. We cannot assure you that we will not face in the future
interruptions or delays in 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

As
a provider of high quality MPEG-based video products, we face actual and potential
competition from numerous competitors.

Our
most direct competitors offer MPEG based encoding and decoding hardware and software
development tools similar to those we offer with varying feature sets and at varying price
ranges. Competition in each of the markets addressed by each product line is intense, and
we expect competition to increase. 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
principle competitors of our Video Technologies products in the Enterprise and Government
markets are VBrick Systems Inc., Amnis Systems (formerly Optivision, Inc.), 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.

The
principal competitors in the IPTV market include TUT Systems, Skystream Networks Inc,
Nextream, Tandberg Television ASA, Harmonic Inc., Minerva Inc and Scopus Network
Technologies.

The
principle competitors of our Digital Non-Linear Editing products are
Accom®, Inc., Adobe Systems Inc., Apple Computer, Inc., Avid
Technology, Inc. Discreet (a division of Autodesk, Inc.),
Leitch®, Inc., Matrox® Electronic Systems Ltd., Pinnacle®
Systems, Inc., and Quantel Ltd. Competition also comes from Matsushita®
Electric Industrial Company Ltd. (Matsushita) and Sony Corporation
(Sony), which have either introduced or announced plans to introduce
disk-based systems. Because the market is constantly changing, it is difficult to predict
future sources of competition; however, competitors are likely to continue to include
larger vendors, such as Apple Computer, Matsushita, and Sony

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.

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Intellectual
Property

Our
future success and ability to compete are dependent, in part, upon our proprietary
technology. We rely on patent, trade secret, trademark, 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 and six granted in the
United States. We also have two patents in the United States and in Europe and two PCT
patent applications pending in the WIPO and in Israel, relating to the MGW 5100.

We
also acquired one patent in connection with the Viewgraphics transaction, relating to the
DVB splicing technology. We have also acquired with the Viewgraphics transaction one
allowed patent and four pending patent applications in the United States concerning our
DVB technology. One of these applications is also pending in Israel and Japan.

With
the acquisition of the assets and Liabilities of Media 100 we acquired additional 18
patents on various technologies used in their products, as well as five pending patents,
all in the United States.

Effect
of Government Regulation of our Business

Regulation
of our business by the Israeli government affects our business in several ways. We benefit
from certain tax incentives promulgated by the government of Israel, including programs
sponsored by the OCS, in the Israeli Ministry of Industry and Trade, for the support of
research and development activities. We also obtained funding from the MOST and STRIMM
consortium, which is a part of the OCS Magnet program. The manufacture of products
developed with OCS grants must be performed in Israel, unless otherwise approved by the
OCS. Such approvals will generally be conditioned upon accelerating the rate of royalties
and increasing the total amount to be paid to as high as 300% of the grant. The Company is
prohibited from transferring to third parties of technologies developed under projects in
which the government participates. However, we are allowed to export from Israel of
products developed with such technologies.

We
are subject to the Israeli Companies Law, which regulates the activities of companies
incorporated in Israel. Please see the section entitled Risks Related to Operating
in Israel  in ITEM 3.D. RISK FACTORS, as well as ITEM 10.
ADDITIONAL INFORMATION, for more information on the effects of governmental
regulation of our business.

4.C
Organizational Structure

Optibase
has one wholly owned subsidiary: Optibase Inc. was incorporated in the United States.
Incorporated in 1991 and is currently located in Mountain View, California and
Marlborough, Massachusetts. Optibase Inc. manages our North American sales, marketing and
customer support activities. Optibase Europe Ltd. and Optibase B.V., former subsidiaries
of Optibase were dissolved in July 2002, and in September 2003, respectively.

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 9.35% of Mobixells issued and outstanding share capital, which designs,
develop and markets solutions for mobile rich media adaptation, optimization and delivery.
Our sales activities in Europe, the U.K and 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 a new
office in Singapore that will focus on marketing, and supporting the companys IPTV
product in Asia Pacific.

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4.D
Property, Plants and Equipment

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

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

Optibase
Inc.s facilities in Marlborough Massachusetts occupy approximately 19,182 square
feet. The current lease expires on December 31, 2007.At the present time, we maintain a
small one-man office in the UK. We also rent an office of approximately 1,496 square feet
in Beijing, China pursuant to a one-year lease that will expire in December 2005. We rent
an office of approximately 590 square feet in Singapore.

# 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 3.D RISK FACTORS ITEM 5.D
 TREND INFORMATION, as well as those discussed elsewhere in this Annual
Report. You should read the following discussion and analysis in conjunction with the
Selected Consolidated Financial Data and the Consolidated Financial Statements
included elsewhere in this Annual Report.

Overview

We
provide high quality 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 three product lines: Video Technologies, IPTV and Digital
Non-Linear Editing. Our products are sold both directly and through various indirect
channels, such as independent distributors, system integrators, OEMs and resellers.
We sell our products around the world, while the majority of our sales (approximately 60%)
are derived from North America. In addition, as of December 31, 2004, we had available
cash of approximately $47 million. For information regarding the investment of our
available cash, see ITEM 5.B  LIQUIDITY AND CAPITAL RESOURCES.

During
2004 we acquired certain assets and liabilities of Media 100 Inc. in consideration for
$2.5 million in cash and incurred costs totaling approximately $401,000, the acquisition
enabled us to add 2 main products to our product portfolio.

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

|                           | Year Ended December 31,
|-------------------------- | -----------------------
|
|
|
|
|Video Technology           |                        
|IPTV                       |                        
|Digital Non-Linear Editing |                        

Our
level of revenues stayed relatively stable in recent years ($20.4 million in 2002 compared
to $19.4 million in 2003 and $20.8 million in 2004). The increase can mainly be attributed
to the addition in sales of the Digital Non-Linear Editing product line, which generated
revenues in the year 2004 of approximately $3 million, offset by a decrease of the IPTV
product line revenues. However, our profitability in recent years has changed
significantly from a net loss of $12.9 million in 2002 to a net profit of $1.8 million in
2003 and to a net loss again of $3.7 million in 2004. The increase in our net loss in 2004
can be mainly attributed to the increase in our operating expenses associated with our
Digital Non-Linear Editing product line, the decrease in our financial income and by the
increase in other income. As of December 31, 2004, we had accumulated losses of $66
million.

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During
the quarter ended December 31, 2004 our board of directors decided to remove certain
portions of our Media 100 activities and focus our resources on initiatives that may
better position us for growth. As a result, 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 of the above mentioned we recorded impairment of long lived assets of
approximately $2 million in the quarter ended December 31, 2004 and restructuring charges
of approximately $80,000 in the quarter ended March 31, 2005.

Our
headquarters are located in Herzliya Pituach, Israel; our subsidiary facilities in the
United States are located in Mountain View, California and Marlborough, Massachusetts. We
maintain offices in France, U.K, Japan, China and Singapore in order to establish and
expand our local presence at the markets and use the advantages, related to
culture and language, of that approach.

5.A
Operating results

Revenue
and Sales

The
following table sets forth, for the periods indicated, the percentage of total
consolidated sales derived from sales into each of the regions identified in the table,
regardless of the operating unit, which generated the sale. For certain financial
information presented on the basis of geographic operating units, please see note 15a
to our Consolidated Financial Statements included elsewhere in this Annual Report.

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

The
percentage and the dollar amount of our revenues derived from sales into North America
increased in 2004 compared to 2003. The increase resulted primarily from some improvement
in market conditions of the technology sector in North America. The percentage of revenues
derived from sales into Europe had decreased while the dollar amount remained stable. Our
sales into Eastern Asia had decreased in terms of absolute dollars and as a percentage of
out total revenues during the period. The increase in sales in other countries, including
Israel, in 2004 can be attributed primarily to improvement in our sales to local
customers. in North America. We sell directly to system integrators, OEMs and value-added
resellers, or VARs. Outside of North America, we sell directly to system integrators,
OEMs, VARs and other distributors. Sales of our products to system integrators can involve
a lengthy process and the timing of volume orders from system integrators can be difficult
to forecast. As a result, revenues may fluctuate from quarter to quarter depending on the
timing and volume of orders. Since these types of customers typically request initial
delivery within four to eight weeks of their placement of orders, we have historically had
a minimal backlog of orders. Combined sales to our three leading system integrators
accounted for 30% of our revenues in 2002, 19% of our revenues in 2003 and 10% of our
revenues in 2004. The decrease is mainly due to a sharp decrease in Mediapump sales to
SeaChange, one of our leading system integrators at that time, the sales for which
accounted for approximately 14% of our sales in year 2002. Combined sales by three leading
distributors of our products accounted for 13% of our revenues in 2002, 15% of our
revenues in 2003 and 10% of our revenues in 2004.

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. Except
for those situations that provide the potential for large orders or strategic
relationships with well-known market leaders. The percentage of revenues represented by
standard products and customized products, respectively, fluctuates from period to period
depending on a variety of factors, including the number, size and timing of customized
product activities. In each of 2003 and 2004, revenues derived from special engineering
projects were insignificant.

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

|                                                 | Year Ended December 31
|------------------------------------------------ | ----------------------
|
|
|
|
|Revenues                                         |                       
|Cost of revenues                                 |                       
|Gross margin                                     |                       
|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                  |                       
|Impairment of goodwill                           |                       
|Restructuring cost                               |                       
|Total operating expenses                         |                       
|Operating (loss)                                 |                       
|Other income (expenses), net                     |                       
|Financial income, net                            |                       
|Net income (loss) before tax                     |                       
|Provision for tax                                |                       
|Net income (loss) before  cumulative  effect     |                       
|of changes in accounting principle               |                       
|Cumulative  effect of changes in  accounting     |                       
|principle                                        |                       
|Net income (loss)                                |                       
|                                                 |                       

# Results of Operations
for the Years Ended 2004 and 2003

Revenues.
          Revenues consist of gross sales of products, less discounts, refunds and
          returns. Our revenues increased by 7.6% to $20.8 million in 2004 from $19.4
          million in 2003. The increase can mainly be attributed to the addition in sales
          of the Digital Non-Linear Editing product line as a result of our purchase of
          certain assets of Media 100 Inc., offset by a decrease of the IPTV
product line revenues.

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. Cost of revenues increased by approximately 10% to $9.4 million
in 2004 from $8.5 million in 2003. Cost of revenues as a percentage of revenues increased
to approximately 44.9% in 2004 compared to approximately 43.9% in 2003. The increase was
primarily due to the higher cost of goods of our Digital Non-Linear Editing products. 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.Research and development expenses, net, consist
primarily of labor expenses, development-related raw materials, acquisition related costs
and stock option compensation charges and related overheard, offset by grants. Our net
research and development expenses increased by approximately 29.4% to $6.3 million in 2004
from $4.8 million in 2003. As a percentage of revenues, net research and development
expenses increased to approximately 30% in 2004 from approximately 25% in 2003. The
increase in research and development expenses can primarily be attributed to research and
development costs related to the Digital Non-Linear Editing product line totaling
approximately $2.4 million which was offset by the closing of the research and development
center of our subsidiary, Optibase Inc., located in Mountain View, California totaling
approximately $768,000 in year 2003. Research and development grants received from the
OCS, including the OCS Magnet program, and from the European Union decreased to
approximately $2 million in 2004 from approximately $2.2 million in 2003.

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Selling
and Marketing Expenses, Net. Selling and marketing expenses, net, consist primarily of
compensation expenses, promotional expenses, travel costs and related overhead and
expenses. Our net selling and marketing expenses increased approximately by 21.2% to $9.6
million in 2004 from $7.9 million in 2003. As a percentage of revenues, net selling and
marketing expenses increased to approximately 46.1% in 2004 from approximately 40.9% in
2003. The increase in selling and marketing expenses can be primarily attributed to the
Digital Non-Linear Editing product line totaling $1.6 million. 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 consist primarily of
compensation costs, fees to outside consultants, legal and accounting fees and stock
option compensation charges and certain office maintenance costs. General and
administrative expenses increased approximately 56.5% to $3.1 million in 2004 from $2
million in 2003. As a percentage of revenues, general and administrative expenses
increased to approximately 14.8% in 2004 from approximately 10.2% in 2003. The increase in
dollar amount is attributed to the Digital Non-Linear Editing product line totaling
$638,000 and increase in labor costs.

Impairment
of Long- Lived Assets and Goodwill. During the quarter ended December 31, 2004 we
decided to focus our resources on initiatives that may better position Optibase presence
in the IPTV market. We decided to restructure our Digital Non-Linear Editing product lines
in order to improve the financial results of this product line, we have evaluated the
ongoing value of all long lived assets acquired from Media 100 Inc. Impairment of these
assets was required in accordance with SFAS 144 and SFAS 142. As a result, we recorded an
impairment charge of long-lived assets and goodwill totaling approximately $2 million.

Operating
income. As a result of the foregoing, we recorded operating loss of $10.3 million in
2004 compared with an operating loss of $3.9 million in 2003.

Other
Income (Expenses), Net. We recorded other income of $933,000 in 2004, compared to
other expenses of $2.3 million in 2003. 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
recorded capital gain relating to sales of fixed assets in the amount of $124,500 in 2004
compared with $4,000 in 2003. In respect of our investment in V.Box, by way of convertible
notes, we followed the guidelines of the hypothetical liquidation method and recorded
expenses totaling approximately $574,000 in 2004 compared with approximately $907,000 in
2003.

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. Our exchange differences occur primarily as a result of the
change of the NIS value relative to the U.S. dollar. We recorded financial income, net of
financial expenses, of $5.7 million in 2004, compared with $8 million in 2003. The
decrease is mainly attributed to realized gains on marketable securities in the amount of
$1 million in 2004 compared with $4.5 million in 2003 offset by the increase in interest
income on marketable securities.

Net
Income (Loss). We recorded net loss of $3.7 million in 2004, compared with a net
income of $1.8 million in 2003. The main reasons to the decrease in our net income, as
mentioned above, are the increase in our operating expenses that can mainly attributed to
our Digital Non-Linear Editing product line including write off of in process R&D and
impairment of long-lived assets and goodwill totaling approximately $2.8 million, the
decrease in our financial income and by the increase in other income.

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# Results of Operations
for the Years Ended 2003 and 2002

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

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

Research
and Development Expenses, Net.Research and development expenses, net, consist
primarily of labor expenses, development-related raw materials, acquisition related costs
and stock option compensation charges and related overheard, offset by grants. Our net
research and development expenses decreased by approximately 40.5% to $4.8 million in 2003
from $8.1 million in 2002. As a percentage of revenues, net research and development
expenses decreased to approximately 25% in 2003 from approximately 39.8% in 2002.
Amortization of intangible assets and deferred stock compensation expenses beginning in
the fourth quarter of 2000, as a result of the acquisitions of Viewgraphics and HiTV,
decreased to $(49,000) in 2003 from $1.5 million in 2002. The decrease in research and
development expenses can be primarily attributed to the decrease in labor and
subcontractors costs totaling approximately $4.3 million and $6.1 million in 2003 and 2002
respectively. Research and development grants received from the OCS, including the OCS
Magnet program, and from the European Union remained stable at $2.2 million in 2003 as in
2002.

Selling
and Marketing Expenses, Net. Selling and marketing expenses, net, consist primarily of
compensation expenses, promotional expenses, travel costs, royalties paid to the Marketing
Fund and related overhead and expenses. Our net selling and marketing expenses decreased
approximately by 1% to $7.9 million in 2003 from $8 million in 2002. As a percentage of
revenues, net selling and marketing expenses increased to approximately 40.9% in 2003 from
approximately 39.1% in 2002. The dollar amount decrease in selling and marketing expenses
is primarily due to a reduction in sales compensation expenses and a reduction in
tradeshows and marketing and communications activities. Selling and marketing expenses 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 consist primarily of
compensation costs, fees to outside consultants, legal and accounting fees, acquisition
related costs and stock option compensation charges and certain office maintenance costs.
General and administrative expenses decreased by approximately 3.8% to $2 million in 2003
from $2.1 million in 2002. As a percentage of revenues, general and administrative
expenses remained stable at approximately 10% in 2003 as in 2002. The decrease in dollar
amount is due primarily to a decrease in amortization of deferred stock compensation
expenses resulting from the purchase of Viewgraphics during the forth quarter of 2000,
reduced labor costs, decreasing usage of consultants and experts.

Impairment
of Acquired Intangibles and Related Tangible Assets. In September 2001, following a
continued decrease in our market capitalization we implemented an impairment test on our
acquired intangibles. As a result of the analysis (conducted by an independent evaluator)
we recorded expenses totaling $20.9 million due to impairment of acquired intangibles.
Since in the second quarter of 2002 we experienced sudden decrease of MediaPump sales to
SeaChange, and due to the decrease in our market value at that time, we have reassessed
several assets, mainly intangibles, in our financial statements. Impairment of these
assets was required according to the rules of SFAS 144. As a result, we recorded an
impairment charge of acquired intangibles totaling approximately $6.8 million during 2002.
No impairment of acquired intangibles and related tangible assets was charged in fiscal
year 2003.

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

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

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

Financial
Income (Expenses), Net. Financial expenses consist primarily of interest we paid 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. Our exchange differences occur primarily as a result of the
change of the NIS value relative to the U.S. dollar. We recorded financial income, net of
financial expenses, of $8 million in 2003, compared with $3.7 million in 2002. The
increase in 2003 resulted primarily from higher yields and realized gains on certain
investment grade financial investments made through 2003.

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

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

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

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

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

# 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.

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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:

| |  | Revenue
recognition;
| | - | --------------------

| |  | allowance
for doubtful debts;
| | - | -----------------------------

| |  | Inventories
valuation.
| | - | ----------------------

| |  | Impairment
of goodwill and long- lived assets
| | - | ---------------------------------------------

| |  | Impairment
of other long- term investment; and
| | - | ----------------------------------------------

| |  | Impairment
and classifications of marketable securities investments.
| | - | --------------------------------------------------------------------

| |  | 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.

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

Revenues
from software sales 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 the Company has
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, support and services) is
determined based on the price charged for the undelivered element when 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.

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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.

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, 2004, our provision for doubtful
debt was approximately $662,000.

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.

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

As
discussed in Note 2 to the Consolidated Financial Statements, we adopted SFAS
No. 144 in January 2002. In the second quarter of 2002, we reassessed the technology
acquired from Viewgraphics in December 2000, and determined that it was unlikely that any
future value would be realized from such technology. As of June 30, 2002, the
carrying value of the technology, which was recorded as intangibles, was
$6.8 million. Based on SFAS No. 144, our intangible assets carrying value
of $6.8 million was in excess of its fair value of zero. Therefore, we wrote-off the
$6.8 million carrying value of our intangible assets as of June 30, 2002.

In
the quarter ended December 31, 2004, we decided to significantly reduce the operations of
its Digital Non-Linear Editing product lines associated with Media 100. Consequently, we
performed a recoverability test on its long-lived assets associated with its product
lines. As a result, we recorded a non-cash charge of $ 1.5 million in accordance with
Statement of Financial Accounting Standard No. 144.

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As part of annually goodwill
impairment test and in connection with the evaluation we recognized a goodwill impairment
loss in the amount of $ 540,000 in accordance with Accounting Standard No. 142. The fair
value of the product lines was estimated using the expected present value of future cash
flows.

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. 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.

Impairment
and classifications of marketable securities investments         As of December 31,
2004 all marketable securities investments are classified as available for sale and
recorded at fair value, and unrealized investment gains and losses are reflected in
shareholders equity. Investment income is recorded when earned. Investments are
reviewed periodically to determine if they have suffered an impairment of value that is
considered other than temporary. If investments are determined to be impaired, a capital
loss is recognized at the date of determination.

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

Contingencies

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

We
are currently involved in certain legal proceedings and are required to assess the
likelihood of any adverse judgments or outcomes of these proceedings as well as potential
ranges of probable losses. A determination of the amount of accruals required, if any, for
these contingencies is made after careful analysis. It is possible, however, that future
results of operations for any particular quarter or annual period could be materially
affected by changes in our assumptions or as a result of the effectiveness of our
strategies related to these legal proceedings.

# 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.
However, a peace agreement between Israel and Egypt was signed in 1979, a peace agreement
between Israel and Jordan was signed in 1994 and, since 1993, several agreements between
Israel and Palestinian representatives have been signed. As of the date hereof, Israel has
not entered into any peace agreement with Syria or Lebanon. From October 2000, until
recently, terrorist violence in Israel increased significantly, primarily in the West Bank
and Gaza Strip, and Israel has experienced terrorist incidents within its borders. On June
6, 2004, the Government of Israel approved a disengagement plan, stating that it is
Israels intention to relocate all Israeli settlements in the Gaza Strip and four
settlements in the West Bank by the end of 2005. There can be no assurance that the recent
relative calm and renewed discussions with Palestinian representatives will continue We
could be adversely affected if these hostilities intensify or spread to additional areas
in Israel. Further deterioration of the situation into a full scale armed conflict might
require more widespread military reserve service by some of our employees and officers,
which may have a material adverse effect on our business.

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

Generally,
all male adult citizens and permanent residents of Israel under the age of 48are
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-1980s, low foreign exchange reserves, fluctuations in world
commodity prices, military conflicts and civil unrest. The Israeli government has, for
these and other reasons, intervened in various sectors of the economy, employing, among
other means, fiscal and monetary policies, import duties, foreign currency restrictions
and controls of wages, prices and foreign currency exchange rates. In 1998, the Israeli
currency control regulations were liberalized significantly, as a result of which Israeli
residents generally may freely deal in foreign currency and non-residents of Israel
generally may freely purchase and sell Israeli currency and assets. There are currently no
Israeli currency control restrictions on remittances of dividends on the ordinary shares
or the proceeds from the sale of the shares; however, legislation remains in effect
pursuant to which currency controls can be imposed by administrative action at any time.
The Israeli government has periodically changed its policies in all these areas.

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.

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As
of May 31, 2005, the inflation rate in Israel has increased at a rate of 0.1% and the NIS
had devaluated against the dollar by approximately 2.5%. The inflation rate in Israel was
approximately 6.5% in 2002, a deflation rate of approximately 1.9% in 2003 and inflation
rate of approximately 1.2% in 2004. At the same time the devaluation of the NIS against
the dollar was approximately 7.3% in 2002, the appreciation of the NIS against the dollar
was 7.6% in 2003and 1.6% in 2004 As a result of this differential, we experienced an
increase in the dollar costs of operations in Israel in 2004 and 2003, and a decrease in
2002, all of which did not materially affect our results in such period. The fluctuations
in the dollar costs of our operations in Israel related primarily to the costs of salaries
in Israel, which are paid in NIS and constitute a significant portion of our expenses. We
cannot assure you that we will not be materially adversely affected in the future if
inflation in Israel exceeds the devaluation of NIS against the dollar or if the timing of
such devaluation lags behind increases in inflation in Israel.

5.B
Liquidity and Capital Resources.

We
have funded our operations primarily through private and public sales of our equity
securities, banks credit, research and development grants from, among others, the
Commission of the European Union and the OCS, and through cash generated from our
operations. As of December 31, 2004, we had cash, cash equivalents and marketable
securities of $52.5 million. Our operating activities yielded cash of $2.5 million in 2004
and $23.4 million in 2002, and in 2003 used $96,000. Cash generated by operating
activities in 2002 was primarily the result of our net loss for the period, as adjusted
for trading of marketable securities, net, impairment of other assets, depreciation and
amortization, amortization of deferred stock compensation, a significant decrease in trade
receivables, decrease in inventories, cumulative effect of changes in accounting
principle, other expenses, partially offset by gain on sale of available-for-sale
marketable securities, a decrease in trade payables, accrued expenses and other
liabilities. Cash used by operating activities in 2003 was primarily the result of our net
income for the period, as adjusted for impairment of long-term investment, depreciation
and amortization, other expenses, decrease in inventories, offset by gain on sale of
available-for-sale marketable securities, a decrease in trade payables, accrued interest
and amortization of premium and discount on available-for-sale marketable securities. 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.

Net
cash used in investing activities in each of 2004, 2003 and 2002 reflects primarily the
purchase of financial assets, fixed assets and investments in companies. 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. In 2003, $53.6 million were used primarily for
the purchase of financial assets, $898,000 were used for investments in companies,
partially offset by $51.2 millions of proceeds from sale of available-for-sale marketable
securities. In 2002, $64.9 million were used primarily for the purchase of financial
assets, $946,000 were used for an investment in a company, partially offset by $43
millions of proceeds from sale of available-for-sale marketable securities, and redemption
of matured available-for-sale marketable securities

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. Net cash provided by financing activities in 2003
reflects primarily the increase in bank credit, net proceeds from the exercise of stock
options in the amount of $2.1 million, partially offset by principal payments of long-term
capital lease obligations in the amount of approximately $129,000. Net cash provided by
financing activities in 2002 reflects primarily the net proceeds from the issuance of
ordinary shares and exercise of stock options and warrants approximately in the amount of
$342,000, and $35,000, respectively, partially offset by principal payments of long-term
capital lease obligations in the amount of approximately $197,000. As of December 31,
2004, both our short-term and long-term indebtedness were no longer affected by
obligations undertaken during the acquisition of Viewgraphics. As of December 31, 2004, we
have an authorized credit line in the amount of $10.5 million (out of which $0.5 million
utilized). an amount of approximately $25 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.

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In
the second quarter of 2003, we transferred approximately $39.3 million of our monies and
investments to Optibase, Inc. to achieve better net profit from the investment. We manage
our 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 US dollars of commercial paper, bankers acceptances,
certificates of deposit, euro-dollar time deposits and variable rate issues; (iii)
corporate notes and bonds rated investment grade (BAA/BBB- and above), provided that
investments in any one corporation or entity will not exceed $3 million; (iv) hedge funds
up to $10 million pursuant to the following guidelines: (1) Volatility below 10%; (2)
Minimum 5 years of positive performance; (3) Low beta; (4) Positive sharp ratio; (5) Size
of fund of at least $1 BL; and (6) Multi manager and strategy; (v) Investments in bonds
and notes with lower rating than BBB- and higher rating than B, provided that investments
in any one corporation or entity will not exceed $1 million. (vi) Widely held funds that
invests in corporate and sovereign debt. We may also be engaged in hedging transactions
against the U.S. dollar only to protect anticipated exposure and not for speculative
purposes. Hedging transactions may be made against the underlying assets only. The
investment guidelines are to be reviewed periodically by our board of directors with the
Chief Financial Officer.

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.

On
February 5, 2002 we filed a statement of claim against Merrill Lynch & Company and its
subsidiary brokerage firm Merrill Lynch, Pearce, Fenner & Smith, or collectively
Merrill Lynch, claiming the sum of US$2,270,198 as compensation and US$10 million as
punitive damages due to alleged mismanagement of our nostro funds by Merrill Lynch.
Merrill Lynch, an international financial management and advisory company, was in charge
of investing our nostro funds. The lawsuit was referred to arbitration and on December 24,
2003, the arbitrators panel issued an award in favor of Optibase. The panel awarded
Optibase approximately $1.8 million in damages inclusive of interest, and assessed $33,850
in costs associated with the arbitration against Merrill Lynch. We received the award
payments during February 2004. As a result, during the quarter ended March 31, 2004, we
recorded other income at the amount of approximately $1.4 million net of expenses.

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

Research
and development expenses, net, consist primarily of labor expenses, development-related
raw materials, acquisition related costs and stock option charges and related overhead,
offset by grants. Our net research and development expenses have decreased from $8.1
million in 2002 to $4.8 million in 2003, constituting a decrease of 40.5% from the
previous year, while in 2004 our net research and development have increased to $6.3
million, an increase of 29.4% from 2003. As a percentage of revenues, our net research and
development expenses changed to approximately 30% in 2004 from approximately 25% in 2003
and approximately 39.8% in 2002. The dollar amount increase in research and development
can primarily be attributed to the research and development costs related to the Digital
Non-Linear Editing product line. Research and development grants decreased to $2 million
in 2004 from $2.2 million in 2003 and 2002. We expect research and development expenses to
decrease in absolute dollars and as a percentage of revenues during 2005 primarily due to
a restructuring plan of the activity acquired with the assets of Media 100 that should
significantly reduce the research and development expenses and as a result of the
managements ongoing efforts to tighten cost controls and improve financial
performance while introducing additional products and conducting ongoing improvements to
our standard and custom products. We receive grants from certain entities, see Item 4
above under the heading Research and Development.

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5.D
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. 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 2005.

5.E
Off-Balance Sheet Arrangements

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

5.F
Tabular Disclosure of Contractual Obligations

Set
forth below are our contractual obligations and other commercial commitments as of
December 31, 2004:

|Contractual Obligations           | Payments Due by Period
(USD in thousands)
|--------------------------------- | -----------------------------------------
|
|Long-Term Debt                    | 0                                        
|Capital Lease Obligations         | 0                                        
|Operating Leases                  | 4,943                                    
|Purchase Obligations              | 292                                      
|Other Long-Term Obligations       | 0                                        
|Total Contractual CashObligations | 5,235                                    

|Other Commercial Commitments   | Amount of Commitment Expiration Per Period
(USD in thousands)
|------------------------------ | -------------------------------------------------------------
|
|Lines of Credit                | 10,464                                                       
|Standby Letters of Credit      | 1,010                                                        
|Guarantees                     | 117                                                          
|Standby Repurchase Obligations | 0                                                            
|Other Commercial Commitments   | 0                                                            
|Total Commercial Commitments   | 11,591                                                       

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# Item 6. Directors,
Senior Management and Employees

6.A
Directors and senior management

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

|Name                    | Age | Position                                                                      
|----------------------- | --- | ------------------------------------------------------------------------------
|
|
|
|
|Tom Wyler(3)            | 53  | President and Executive Chairman of the Board of Directors.                   
|Uzi Breier              | 45  | Chief Executive Officer and general manager of IPTV product line              
|Danny Lustiger          | 38  | Chief Financial Officer                                                       
|David Sackstein         | 39  | General Manager of Video Technology product line.                             
|Adam Schadle            | 42  | President of Optibase Inc. and Vice President of Sales North and South America
|Yaron Comarov           | 40  | Vice President of Operations                                                  
|Orna Gil-Bar            | 40  | Vice President of Human Resources                                             
|Amir Goren              | 35  | General Manager of the Digital Non-Linear Editing product line                
|Ofer Harari             | 38  | VP Professional Services                                                      
|Dana Tamir(2)           | 56  | Director                                                                      
|Chaim Labenski(1)(2)(3) | 58  | Director                                                                      
|Alex Hilman(2)          | 53  | Director                                                                      
|Gil Weiser(2)(1)        | 63  | Director                                                                      

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

Tom
Wyler serves as President and Executive Chairman of our Board of Directors since
November 2004. Since his investment in us in September 2001 (through Festin Management
Corp.) and until his recent appointment, 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.

Uzi
Breierwas appointed our Chief Executive Officer in November 2004. Mr. Breier has
management background in the telecommunications and semiconductor industries where he held
a number of senior executive positions. Prior to joining us, Mr. Breier served as Chief
Executive Officer of Emblaze Semiconductor. Mr. Breier has also held senior executive
positions at Emblaze Systems, Flextronics International, Ltd., and National Semiconductor.
Mr. Breier holds an MBA in Management and International Trade from San Jose State
University, and graduated summa cum laude from New York Institute of Technology where he
received a B.Sc. in computer science and a B.Sc. in industrial engineering.

Danny
Lustiger serves 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.  positions he held from July 2001 and November 2003 respectively. 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 Birghtman 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 the Tel-Aviv University.

David
Sackstein joined us in November 1994 and serves as the General Manager of the Video
Technologies product line since November, 2003. Prior to his present position Mr.
Sackstein was the Senior Vice President of Research & Development. Since joining us,
Mr. Sackstein has held various technical and managerial positions in the research &
development departments, including Vice President of Advanced Technologies Ltd.. Prior to
joining us, Mr. Sackstein held the position of Research Fellow at IBMs Research
Center in Haifa. Mr. Sackstein holds a B.Sc. in Electrical Engineering and a B.A. in
Mathematics, both from the Technion Israel Institute of Technology. Mr. Sackstein holds an
Executive MBA degree from Tel-Aviv University.

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Adam
Schadle joined us in December 2000 in the acquisition of Viewgraphics, Inc. and serves
as president of Optibase Inc. since October 2004. Serving 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 the San Jose University.

Yaron
Comarov, joined us in 1994 and serves as our Vice President of Operations since 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 in Tel Aviv.

Orna
Gil-Bar serves as our Vice President of Human Resources since her joining us in
September 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. From 1994 to 1996, Ms. Gil-Bar served as an organizational
consultant for the Israeli Defense Forces. Ms. Gil-Bar holds an MBA degree (Organizational
and Consulting) from the Tel-Aviv University.

Amir
Gorenjoined us in 2000 and serves as our general manager of the Digital Non-Linear
Editing product line since June 2004. Prior to his present position, Mr. Goren served as
Vice President Strategy and Business Development and Vice President Marketing since
September 2002. Between the years 2000 and 2002 , Mr. Goren held a position of product
manager at Optibase. Before joining Optibase, Mr. Goren was a team leader at P.O.C, a
strategic and marketing planning consulting firm, where he lead strategic planning and
fund raising projects for technological companies at various stages of development in the
fields of communications, biotechnology, electronic control, Internet and services. Mr.
Goren holds an MBA and B.Sc in Industrial Engineering from Tel Aviv University.

Ofer
Hararijoined us in June 1999 and serves as Vice President of Professional Services
since January 2005. From 1999 until 2003 Mr. Harari led numerous research and development
projects and in 2004 was appointed to Vice President of Research & Development for the
Video Technologies product line. Prior to joining us, Mr. Harari held research and
development positions at one of the Israeli government computer centers where he lead a
development team of real-time control systems and coordinated large-scale integration
projects. Mr. Harari holds a B.Sc.E.E. from Ben Gurion university Israel and M.Sc.E.E
(Communications and Computers) from Tel Aviv University, Israel.

Dana
Tamirjoined our board of directors in September 2000. Presently Ms. Tamir is serving
as Head of Operations for Comverse MMS. From January 1997 to May 2000, Ms. Tamir served as
the Chief Executive Officer of Qronus, Inc., a company that was spun off by Mercury. Prior
to that 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 Securities Division of Bank Hapoalim BM, including
being First Vice President and Head of Foreign Securities and was involved in consulting,
securities research, trading and I.P.O coordination with global investment houses. Since
1999 he acts as a private investor. Mr. Labenski holds a B.Sc degree in Civil Engineering
from Astor University, U.K, a M.Sc degree in Engineering Management from Leeds University
and 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 taxation in Tel-Aviv University, has published professional works on
tax and accounting, among them, The Israel Tax Guide. Mr. Hilman holds a B.A.
degree in Accountancy and Economics from the Tel Aviv University.

- 52 -

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Gil
Weiser joined 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
Chairman of the Executive Board of Haifa University, Carmel and BBP and is a member of the
Board of Directors at Fundtech, Clicksoftware and the Formula Group. Between
2002 and 2004 Mr. Weiser was a board member of the Tel Aviv Stock Exchange. 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. Weiser holds a Master of
Science degree in Electrical Engineering Electronics/Computer from the University of
Minnesota and a Bachelor of Science degree in Electrical Engineering from The Technion.

6.B.
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, 2004 was $1.19
million, including amountspaid 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 current directors and
executive officers (13 persons) held as of December 31, 2004, 2,382,597shares (out
of which 543,171 options are currently vested or will vest within 60 days as of May 31
2005), and share options to purchase an aggregate of 1,081,640 ordinary shares. The
exercise price of the options varies between $1.52 to $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.

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.

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

| | a
breach of the duty of care vis-a-vis the Company or vis-a-vis another person;
|- | -------------------------------------------------------------------------------

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

| | a
monetary obligation imposed on the officer in favor of another person.
|- | ------------------------------------------------------------------------

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

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

| | a
monitory obligation imposed on the director and/or officer in favor of another person
pursuant to a judgment, including a judgment given in a settlement or a court approved
arbitrators award; and
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 53 -

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| | reasonable
litigation costs, including advocates professional fees incurred by a director
and/or officer or which he or she is ordered to pay by a court, in proceedings filed
against the director and/or officer by the Company or on the Companys behalf or by
another person, or in a criminal charge of which the director and/or officer is
acquitted, or in a criminal charge of which the director and/or officer is convicted of
an offence that does not require proof of criminal intent.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In
addition, our articles of association provide that we may exempt a director and/or an
officer in advance and retroactively for all or any of the directors and/or
officers liabilities for damages in consequence of a breach of the duty of care
vis-a-vis the Company. A recent amendment to the Companies Law prohibits us to exempt any
of its directors and officers in advance from its liability towards the company for the
breach of its duty of care in distribution as defined in the Companies Law (including
distribution of dividend and purchase of the companys shares).

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

| | a
breach of the fiduciary duty vis-a-vis the Company, unless the officer acted in good
faith and had a reasonable basis to believe that the act would not harm the Company;
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | an
intentional or reckless breach of the duty of care;
|- | ------------------------------------------------------

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

| | a
fine imposed on the officer.
|- | ------------------------------

A
recent amendment to the Companies Law amended the events in which insurance,
indemnification and exemptions cannot be provided. Therefore, notwithstanding the
foregoing, exemption cannot be provided for a breach of fiduciary duty (whether or not the
director or officer acted in good faith and had a reasonable basis to believe that the act
would not harm the Company) and neither exemption nor indemnification or insurance can be
provided in the event of an intentional or reckless breach of the duty of care, except if
such breach of duty of care was made in negligence.

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

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

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

.6.C
Board 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.

- 54 -

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Under
Israeli law, we are required to appoint two directors as members of our board of directors
who meet certain independence requirements set out in the Companies Law for external
directors. External directors are elected by a special majority as determined by the
Companies Law, and serve for a three-year term. External directors may be re-elected for
one additional three-years term only. External directors may not be dismissed during their
term of service, unless one of the events specified in the Companies Law occurs. Our
shareholders approved in December 2004 to continue the service of Mr. Chaim Labenski as
our external director, for an additional 3-year term and to appoint Mr. Gil Weiser as our
external director for a 3-year term.

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

Audit
Committee.  The Companies Law requires 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 responsibilities of the audit committee under the NASDAQ rules include the
selection and evaluation of the outside auditors and evaluation of their independence.

Pursuant
to the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission (the
SEC) issued new rules that, among other things, required Nasdaq to impose
independence requirements on each member of the audit committee. Nasdaq has adopted rules
that comply with the SECs requirements and which are applicable to foreign private
issuers on July 31, 2005.

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

The
SEC has defined affiliate for non-investment companies as a person that
directly, or indirectly through one or more intermediaries, controls, or is controlled by,
or is under common control with, the person specified. The term control
is intended to be consistent with the other definitions of this term under the Securities
Exchange Act of 1934, as the possession, direct or indirect, of the power to direct
or cause the direction of the management and policies of a person, whether through the
ownership of voting securities, by contract, or otherwise.

- 55 -

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Under
the Nasdaq rules to be applicable to foreign private issuers commencing July 31, 2005,
members of the audit committee will also need to comply with the independence standards
described under Independent Directors below.

The
Companys audit committee satisfies both the current Israeli law and the NASDAQ
requirements.

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

We
believe that the current composition of the audit committee 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 and SEC rules.

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

The
Israeli Companies Law requires the board of 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. The service of Eyal Weizman,
CPA, as our internal auditor was ended during February 2004 and he was replaced by Doron
Cohen, CPA (Isr.), CIA (USA).

We
currently do not have in place nomination or compensation committees that meet NASDAQ
requirements, and the actions ordinarily be taken by such committees are resolved by the
majority of our independent directors.

Independent
Directors.Pursuant to the current listing requirements of the NASDAQ SmallCap®
Market applicable to foreign private issuers, we are required to appoint a minimum of
three independent directors meeting the applicable qualification requirements set by
NASDAQ, who are to serve on our audit committee.

Under
rules adopted by Nasdaq applicable to foreign private issuers as of July 31, 2005, the
majority of the members of the board of directors of listed companies will need to be
independent.  An independent director for these purposes means a person
other than an officer or employee of a company or its subsidiaries or any other individual
having a relationship, which, in the opinion of the companys board of directors,
would interfere with the exercise of independent judgment in carrying out the
responsibilities of a director.

The
following persons are not considered independent under the rules to be applicable to us
commencing July 31, 2005:

| |  | a
director  who is or was employed by the company or by any parent or  subsidiary  of the
company                   within the last three years;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
director who accepted or has family member (by blood, marriage or adoption or has the
same residence) who accepted any payments from the company or any parent or subsidiary of
the company in excess of $60,000 during the current fiscal year or any of the past three
fiscal years, other than (i) compensation for board or board committee service, (ii)
payments arising solely from investments in the companys securities, (iii)
compensation paid to a family member who is a non-executive employees of the company or a
parent or subsidiary of the company, (iv) benefits under a qualified plan or
non-discretionary compensation and (v) certain loans;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

- 56 -

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| |  | a
director who is a family member of an individual who is, or within the past three years
was, employed by the company or by any parent or subsidiary of the company as an
executive officer;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
director who is, or has a family member who is, a partner in, or a controlling
shareholder or an executive officer of, any organization to which the company made, or
from which the company received, payments for property or services in the current or any
of the past three fiscal years that exceed 5% of the recipients consolidated gross
revenues for that year, or $200,000, whichever is more, other than (i) payments arising
solely from investments in the companys securities or (ii) payments under
non-discretionary charitable contribution matching programs;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
director of the listed company who is, or has a family member who is, employed as an
executive officer of another entity where at any time during the past three years any of
the executive officers of the listed company serve on the compensation committee of such
other entity; or
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
director who is, or has a family member who is, a current partner of the companys
outside auditor, or was a partner or employee of the companys outside auditor who
worked on the companys audit at any time during any of the past three years.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

Based
on representations from our current directors, we believe that Gil Weiser, Chaim Labenski,
Alex Hilman and Dana Tamir, which constitute the majority of our directors, comply with
the independence standards set forth above.

Employment
Agreements

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

6.D
Employees

As
of May 31, 2005, we had, including our subsidiary and offices, 160 employees, out of which
approximately 9 are part-time employees. The following is a list of our employees as of
December 31, 2004 compared to December 31, 2003 and to December 31, 2002 divided by our
divisions and location.

|Division                                               | December 31,
|------------------------------------------------------ | ------------
|
|
|Research & Development                                 | 10          
|Sales and Technical Marketing                          | 17          
|Marketing                                              | 1           
|Operations                                             | 3           
|General and Administrative,Finance and Human Resources | 5           
|Total                                                  | 36          
|169                                                    | 157         

---

| | * | 7
employees in Asia, 3 employees in Europe.
| | - | -------------------------------------------

| | ** | 3
employees in Asia, 2 employees in Europe.
| | -- | -------------------------------------------

| | *** | 3
employees in Asia, 1employee in Europe.
| | --- | -----------------------------------------

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The
increase in the number of employees between December 31, 2003 and December 31, 2004 is
mainly the result of the additional employees who joined us in the acquisition of our
Digital Non-Linear Editing product line in June 2004. The reduction in our workforce
between December 31, 2004 and May 31, 2005 is primarily due to a considerable lay off of
employees in our Digital Non-Linear Editing product line as a result of a restructuring of
such product line announced on January 7, 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 Labor and
Welfare. 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 CPI, which was extended by an extension
order. The amounts and frequency of such adjustments are modified from time to time.

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

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

6.E
Share ownership

As
of May 31, 2005, our current directors and executive officers (13 persons) held an
aggregate of 2,382,597 ordinary shares of our Company of which 543,171 shares issuable
upon exercise of options that may be exercisable within 60 days after May 31, 2005. Our
current directors and executive officers (13 persons) holds as of May 31,2005 options to
purchase an aggregate of 1,081,640 ordinary shares, of which options to purchase 543,171
shares are vested or exercisable within 60 days as of May 31, 2005.

- 58 -

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Option
Plans

Since
1990, we have granted options to employees and directors to purchase ordinary shares at
exercise prices ranging from $0.17 to $32. As of May 31, 2005, options and warrants to
purchase 2,997,655 of our ordinary shares were outstanding, with exercise prices ranging
from $0.17 to $32 per share. As of May 31, 2005, 1,882,095 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,
2004 the number of options outstanding and reserved for issuance under our plans was
3,270,556 and 517,579, respectively. The following table shows as of May 31, 2005 the
number of options outstanding and reserved for issuance under each of the our share
options plans.

|Plan                                | Number of options
outstanding | Number of options
reserved for issuance
|----------------------------------- | ----------------------------- | ---------------------------------------
|1994 Plan                           | 63,784                        | -                                      
|1999 Plans                          | 2,501,125                     | 581,806                                
|2001 Non-statutory shareoption plan | 432,746                       | 161,100                                
|Total                               | 2,997,655                     | 742,906                                

The
following is a description of our share option 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 May 31, 2005 an aggregate of 581,806 ordinary shares has
been reserved for issuance under this plan, and 2,501,125 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 30 days from termination.
We may make, from time to time, certain exceptions in the vesting and expiration terms of
options granted to certain grantees.

Options
Issued in Connection with the Acquisition of Viewgraphics.In connection with
the acquisition of Viewgraphics in December 2000, we assumed all options to acquire
Viewgraphics common stock outstanding prior to the acquisition and issued in an aggregate
options to acquire 753,384 ordinary shares at exercise prices ranging from $0.17 to
$12.03. As of May 31, 2005, 6,411 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,
directors and consultants and to promote the success of our business. The options to be
granted under the plan are limited to non-statutory options, thus there will be no
incentive stock options. In addition, we plan to use this plan to grant options to
employees only, thus excluding officers and directors from the plan. As such, we do not
need shareholder approval of this plan under U.S. laws or applicable Nasdaq rules. As of
May 31, 2005 an aggregate of 161,100 ordinary shares has been reserved for issuance under
this plan, and 432,746 were granted and are outstanding. The plan otherwise has terms
similar to those contained under the 1999 U.S. Plan.

- 59 -

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# Item 7 Major
Shareholders and Related Party Transactions

7.A
Major Shareholders

The
following table sets forth certain information regarding the beneficial ownership of the
ordinary shares at May 31, 2005 of (i) each person or group known by us to own
beneficially 5% or more of the outstanding ordinary shares and (ii) the beneficial
ownership of all officers and directors as a group, in each case as reported to by such
persons.

|Name of Beneficial Owner                        | Class of
Security | No. Of Shares
Beneficially Held(1) | Percentage of
Class
|----------------------------------------------- | ----------------- | ---------------------------------- | -------------------
|
|
|
|
|Tom Wyler(2)                                    |                   |                                    | Ordinary shares    
|Arthur Mayer - Sommer                           |                   |                                    | Ordinary shares    
|Avraham and Moshe Namdar(3)                     |                   |                                    | Ordinary shares    
|Bricoleur Capital Management LLC (5)            |                   |                                    | Ordinary shares    
|Kern Capital Management LLC(6)                  |                   |                                    | Ordinary shares    
|Shareholding of all directors and officers as a |                   |                                   
|group (13 persons)                              |                   |                                    | Ordinary shares    

---

|1. | Number
of shares and percentage ownership is based on 13,192,252 ordinary shares
                    outstanding as of May 31, 2005. Such number excludes 531,023 shares
held by the                     Company, which have no rights in equity and no voting
rights. Beneficial                     ownership is determined in accordance with rules
of the SEC and includes voting                     and investment power with respect to
such shares. Shares subject to options that                     are currently exercisable
or exercisable within 60 days of May 31, 2005 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 serves as President and Executive Chairman of our Board of
                    Directors since November 2004 and prior to that served in other
senior executive                     positions in us. In December 2002, our shareholders
approved a grant of 200,000                     options exercisable into 200,000 of our
shares to Mr. Wyler, subject to certain                     adjustments at an exercise
price of $2.38 per option and vesting over a 4-year                     period and in
December 2004 our shareholders approved an additional grant to Mr.
                    Wyler of 100,000 options exercisable into 100,000 of our shares at an
exercise                     price of $6 per option and vesting over a 4-year period.
129,167 of the                     aforementioned options are currently vested or will
vest within 60 days after                     May 31, 2005.
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3. | Avraham
and Moshe Namdar are brothers.
|-- | --------------------------------------

|4. | Includes
761,914 shares held by Moshe Namdar, and 262,162 shares held by Avraham
                    Namdar.
|-- | ------------------------------------------------------------------------------------------------------------

|5. | To the best of our  knowledge,  the  information  is accurate as of March 31, 2005 and is based
on the website of Nasdaqonline whose address is www.nasdaq.net.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

|6. | The
information is accurate as of June 2, 2005 and is based on an e-mail sent to
                    us by Kern Capital Management LLC on June 3, 2005.
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------

|7. | Includes
1,839,426 ordinary shares and 543,171 shares issuable upon exercise of
                    options that may be exercisable within 60 days after May 31, 2005.
|-- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

Significant
changes in the ownership of our shares.

The
following table specifies significant changes in the ownership of our shares by Festin
Management Corp. This information is based on the forms 13D filed by Festin Management
Corp beginning March 3, 2001 (whose holdings were transferred to Tom Wyler and Arthur
Mayer-Sommer on September 10, 2004), regarding ownership of our: shares:

- 60 -

---

---



|Beneficial Owner -     | Date              | No. Of Shares Beneficially Held
|---------------------- | ----------------- | -------------------------------
|
|
|
|
|Festin Management Corp | March 3 2001      | 1,599,100                      
|Festin Management Corp | April 24, 2001    | 1,981,900                      
|Festin Management Corp | May 17, 2001      | 2,325,400                      
|Festin Management Corp | June 19, 2001     | 2,588,800                      
|Festin Management Corp | July 15, 2001     | 3,100,000                      
|Festin Management Corp | November 25, 2003 | 3,000,000                      
|                       |                   |                                
|Tom Wyler              | June 9, 2005      | 1,800,000                      
|Arthur Mayer-Sommer    | June 9, 2005      | 1,200,000                      

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

|Beneficial Owner -
Avraham and Moshe Namdar | Date              | No. Of Shares Beneficially Held
|------------------------------------------- | ----------------- | -------------------------------
|
|
|
|
|                                            | July 24, 2002     | 1,338,800                      
|                                            | August 1, 2002    | 1,474,300                      
|                                            | October3, 2002    | 1,684,300                      
|                                            | November 25, 2002 | 1,834,300                      
|                                            | December 30, 2002 | 1,964,300                      
|                                            | February 27, 2003 | 2,159,300                      
|                                            | October 10, 2003  | 1,668,436                      
|                                            | December 10, 2003 | 1,401,136                      
|                                            | January 6, 2004   | 1,151,136                      
|                                            | February 11, 2004 | 1,024,076                      

- 61 -

---

---



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

|Beneficial Owner - Bricoleur Capital Management LLC | Date              | No. Of Shares Beneficially Held
|--------------------------------------------------- | ----------------- | -------------------------------
|
|
|
|
|                                                    | February 11, 2005 | 717,641                        
|                                                    |                   | 705,641*                       

*        

         To the best of our  knowledge,  the  information  is accurate as of March 31, 2005 and is based
on the website of Nasdaqonline whose address is www.nasdaq.net

All
of our shares have the same voting rights.

On
May 31, 2005, there were approximately 73 shareholders of record of our ordinary shares.
As of such date, 54 record holders in the United States hold approximately 73.975% of our
ordinary shares. To the best of our knowledge, except as described above, we are not owned
or controlled directly or indirectly by any government or by any other corporation. We are
not aware of any arrangement, the operation of which may at a subsequent date result in a
change in control of the company.

7.B
Related Party Transactions

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

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

During
2004 we have also entered into severance agreements with two of our officers. The amounts
to be paid to each of these employees are not material.

On
December 16, 2004 our shareholders approved a framework resolution regarding the coverage
of Tom Wylers liability under our general directors and officers liability insurance
policies. The terms of such framework resolution are as follows: (i) the aggregate
coverage amount under each such policy shall not exceed USD $12.5 million; (ii) the annual
premium to be paid for each coverage amount shall not exceed USD $200,000; (iii) approval
by the audit committee and board of directors that the coverage amount and annual premium
with respect to such policy are reasonable under the circumstances, taking into
consideration the Companys exposure and the market conditions. This framework
resolution is in effect for a 5-year term as of October 20, 2004. Accordingly, in order
that Tom Wyler be covered by our general directors and officers liability insurance
policies, our audit committee and board of directors must approve that each such policy
complies with the terms of the framework resolution.

- 62 -

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---



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

For
a description of the grant of options to our directors and officers, see Item
6.E  SHARE OWNERSHIP. In addition, each member of our board of directors is pied an annual fee of $ 18,000 for his/her
service as a director.

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

Loans
to employees

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

7.C
Interests of experts and counsel

Not
applicable.

# Item 8. Financial
Information

8.A
Consolidated Statements and Other Financial Information

The
following financial statements of the Company and the auditors report appearing on
pages F-1 through F-42 of this Annual Report for fiscal 2004 are incorporated herein by
reference:

| | Independent
auditors report.
|- | -----------------------------

| | Balance
Sheets as of December 31, 2004 and 2003.
|- | ------------------------------------------------

| | Statements
of Income for the years ended December 31, 2004, 2003 and 2002.
|- | --------------------------------------------------------------------------

| | Statements
of Shareholders Equity for the years ended December 31, 2004, 2003 and 2002.
|- | ----------------------------------------------------------------------------------------

| | Statements
of Cash Flows for the years ended December 31, 2004, 2003 and 2002.
|- | ------------------------------------------------------------------------------

| | Notes
to financial statements.
|- | ------------------------------

Legal
proceedings

Pursuant
to an arbitration with the New York Stock Exchange between us and Merrill Lynch, we were
awarded compensation in the amount of approximately $1.8 Million of which we recorded
other income totaling approximately $1.4 Million net of expenses, for further details, see
Item 5.B LIQUIDITY AND CAPITAL RESOURCES. During the first quarter of 2004, we
were notified of an alleged dispute with our former distributor in France, Visualdis,
claiming damages in the amount of 850,000 EUR for unfair termination of our distribution
arrangement. In addition, we have become aware of a dispute between Visualdis and our new
distributor in France, Imago, in connection with the termination of the distribution
relationship with us. In November 2004, we have reached an agreement with Visualdis
pursuant to which we released Visualdis from its debt in the amount of approximately
$75,946 in exchange for Visualdis waiver of the abovementioned claim towards us.

In
March 2005, we received a letter from the receiver of Vsoft Ltd., or Vsoft, arguing that
during 2002 Optibase held negotiations with Vsoft not in good faith regarding a potential
purchase of Vsofts share capital, which led to Vsofts entering into bankruptcy
proceedings. Vsofts receiver requested Optibase to pay an amount of $2,125,000 for
settlement purposes only and without waiving his rights to sue Optibase for other damages.
As of the date hereof, no claim has yet been filed with the courts. We believe, based on
the facts known to us as of the date hereof, prima facie, that the claim for damages is
without merits.

Optibase,
Inc., has received a notification from the American Arbitration Association, or AAA, dated
March 31, 2005, indicating that Alba Editorial, Inc., or Alba (a supplier of a component
used in the 844 product, and licensed to Optibase pursuant to a Software Development and
Licensing Agreement between Alba and Media 100, Inc., dated December 10, 2001, or the
License Agreement, which was acquired by Optibase among the assets purchased by it from
Media 100 out of bankruptcy), has filed a Demand for Arbitration with the AAA dated March
2, 2005, in respect of a controversy arising out a contract between Optibase and Alba. The
AAA letter indicates that the claim is for a sum of $50,000. Optibase has not received
such Demand for Arbitration, and cannot state with specificity the nature of the claim,
though it believes it relates to an alleged failure by Optibase to pay license fees to
Alba for the year 2005 under the License Agreement. Optibase has been in discussions with
Alba to modify the license fee terms under the License Agreement.

- 63 -

---

---



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

Dividends

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

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

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

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

8.B
Significant Changes

Except
for as stated in this annual report, there are no significant financial changes as of
December 31, 2004.

# Item 9. The Offer and
Listing

9.A.
Offer and Listing Details

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

- 64 -

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|                           | High | Low
|-------------------------- | ---- | ---
|
|
|
|
|2000                       |      |    
|2001                       |      |    
|2002                       |      |    
|                           |      |    
|2003                       |      |    
|First Quarter              |      |    
|Second Quarter             |      |    
|Third Quarter              |      |    
|Fourth Quarter             |      |    
|                           |      |    
|2004                       |      |    
|First Quarter              |      |    
|Second Quarter             |      |    
|Third Quarter              |      |    
|Fourth Quarter             |      |    
|2005                       |      |    
|January                    |      |    
|February                   |      |    
|March                      |      |    
|April                      |      |    
|May (through May 31, 2005) |      |    

On
May 31, 2005, the reported closing sale price of our ordinary shares on the Nasdaq
National Market was $5.37 per share.

# Item 10. Additional
Information

10.A
Share capital

Not
applicable.

10.B
Memorandum and Articles of Association

Purposes
and Objects of the Company

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

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

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

The
Powers of the Directors

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

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

Rights
Attached to Shares

Our
registered share capital is NIS 2,500,004 divided into a single class of 19,230,800
ordinary shares, par value NIS 0.13 per share, of which 13,192,252 ordinary shares were
outstanding as of May 31, 2005. All outstanding ordinary shares are validly issued, fully
paid and non-assessable. The rights attached to the Ordinary Shares are as follows:

- 65 -

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Dividend
rights

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

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

Voting
rights

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

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

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

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

Rights
in the Companys profits

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

- 66 -

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Rights in the event
of liquidation

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

Changing
Rights Attached to Shares

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

Annual
and Extraordinary Meetings

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

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

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

Limitations
on Change in Control and Disclosure Duties

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

Changes
in Our Capital

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

10.C
Material contracts

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

- 67 -

---

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

Acquisition
of certain assets and liabilities of Media 100 Inc. On March 18, 2004, Media 100 Inc.
(Media 100) and us entered into an Assets Purchase Agreement pursuant the
court approval, we acquired certain assets and liabilities of Media 100 in consideration
for $2.5 million in cash In addition we incurred costs totaling approximately $401,000.
The closing date was June 1, 2004.

10.D
Exchange controls

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

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

10.E
Taxation

Israeli
taxation

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

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

General
Corporate Tax Structure in Israel. The regular rate of corporate tax to which Israeli
companies are subject is 35%. However, the effective rate of tax of a company that is
qualified under Israeli law as an Industrial Company (as referred to below)
and that derives income from an Approved Enterprise (as referred to below) may
be considerably lower.

- 68 -

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

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

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

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

Should
we derive income from sources other than the Approved Enterprise during the
relevant period of benefits, such income will be taxable at the regular corporate tax
rates of 35%.

Subject
to applicable provisions concerning income under the alternative package of benefits, all
dividends are considered to be attributable to the entire enterprise and their effective
tax rate is the result of a weighted average of the various applicable tax rates. Under
the Investment Law, a company that has elected the alternative package of benefits is not
obliged to attribute part of the dividend to exempt profits, and may generally decide from
which years profits to declare dividends. We currently intend to reinvest any income
derived from our approved enterprise programs and not to distribute the income as a
dividend.

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

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

- 69 -

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

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

| |  | There
is a special tax adjustment for the preservation of equity which classifies corporate
assets into fixed assets and non-fixed assets. Where a companys equity, as defined
in the law, exceeds the depreciated cost of fixed assets, a deduction from taxable income
that takes into account the effect of the applicable annual rate of inflation on the
excess is allowed up to a ceiling of 70% of taxable income in any single tax year, with
the unused portion permitted to be carried forward on a linked basis. If the depreciated
cost of fixed assets exceeds a companys equity, then the excess multiplied by the
applicable annual rate of inflation is added to taxable income.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |  | In
specified circumstances, gains on traded securities, which might otherwise be eligible
for reduced rates of tax, will be subject to company tax at the rate of 35%.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
Israeli Law for the Encouragement of Capital Investment, 1959 and regulations prescribe an
expiry date for the grant of new benefits. The expiry date has been extended several times
in the past 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 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. We have already been
granted approved enterprise status under this Law, the deadline does not have any affect
on such status or on the benefits we receive.

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

- 70 -

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

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

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

|Dividends generated by anApproved Enterprise | Dividends not generated by anApproved Enterprise
|-------------------------------------------- | ------------------------------------------------
|
|
|
|
|15%                                          | 15%                                             

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

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

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

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

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

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

- 71 -

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| | broker-dealers,
|- | ---------------

| | financial
institutions,
|- | -----------------------

| | certain
insurance companies,
|- | ----------------------------

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

| | tax-exempt
organizations,
|- | -------------------------

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

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

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

| | investors
holding ordinary shares as part of a straddle or a hedging or conversion transaction.
|- | -----------------------------------------------------------------------------------------------

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

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

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

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

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

| | a
trust if: (a) a court within the United  States is able to exercise  primary  supervision
 over      administration  of the trust,  and (b) one or more United  States  persons
have the  authority to      control all substantial decisions of the trust; or
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a
trust,  if the trust were in existence and qualified as a "United  States  person,"
 within the      meaning of the Code,  on August 20,  1996 under the law as then in
effect and elected to continue      to be so treated.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

- 72 -

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

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

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

Passive
 Foreign  Investment  Companies. There  is a  substantial  risk  that  we are a  passive
foreign investment company,  or PFIC, for U.S. federal income tax purposes.  Our
treatment as a PFIC could result in a reduction in the after-tax  return to the U.S.
 Holders of our ordinary shares and may cause a reduction in the value of such shares.

For
U.S.  federal  income tax  purposes,  we will be classified as a PFIC for any taxable
year in which  either (i) 75% or more of our gross income is passive  income,  or (ii)
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.

- 73 -

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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.

10.F
Dividend and Paying Agents.

Not
applicable.

10.G
Statement by experts

Not
applicable.

10.H
Documents on Display

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

10.I
Subsidiary information

Not
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.

- 74 -

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Interest
Rate and Rating Risks

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

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.  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
 5.B -  "LIQUIDITY  AND  CAPITAL  RESOURCES".  The  investment  guidelines  are  to be
 reviewed periodically by our board of directors with the President and Chief Financial
Officer

Approximately
65% of our available cash is invested in structured  notes, or the Notes,  acquired from
several banks.  Under the terms of the Notes,  for each day in which the relevant LIBOR
rate is below an agreed  annual  fixed rate,  which  ranges  from 3% to 7%, 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.  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,  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 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.

| | The
table set forth shows the construction of our available cash  investments  classified as
     available for sale:
| | ---------------------------------------------------------------------------------------------------------------------

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

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

Internal
controls. There were no changes in our internal control over financial reporting that
occurred during the year ended December 31, 2004 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.

# Item 16A Audit Committee
Financial Expert

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

# Item 16B Code of
Business Conduct and Ethics

We
have adopted a Code of Business Conduct and Ethics for our employees, including our chief
executive officer and senior financial officers. The Code of Business Conduct and Ethics
was attached as Exhibit 11 to the Companys annual report filed on Form 20-F on May
17, 2004.

- 76 -

---

---



# Item 16C Principal
Accountant Fees and Services

Kost,
Forer Gabbay & Kasierer, a member of Ernst & Young global Ltd., or Ernst &
Young has served as our independent public accountants for each of the fiscal years in the
three-year period ended December 31, 2004, 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 2004 and 2003.

|                       | 2004 USD in thousands | 2003 USD in thousands
|---------------------- | --------------------- | ---------------------
|Audit Fees (1)         | 68                    | 26                   
|Audit-related Fees (2) | -                     | 16                   
|Tax Fees (3)           | -                     | 13                   
|All Other Fees (4)     | 4                     | 3                    
|TOTAL                  | 72                    | 58                   

| | (1) | Audit
Fees consist of fees billed for the annual audit services engagement and           other
audit services, which are those services that only the external auditor           can
reasonably provide, and include the group audit; statutory audits; comfort
          letters and consents; attest services; and assistance with and review of
          documents filed with the SEC.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | Audit-related
Fees consist of fees billed for assurance and related services           that are
reasonably related to the performance of the audit or review of our           financial
statements or that are traditionally performed by the external           auditor, and
include consultations concerning financial accounting and reporting           standards;
internal control reviews of new systems, programs and projects;           review of
security controls and operational effectiveness of systems; review of           plans and
control for shared service centers, due diligence related to           acquisitions;
accounting assistance and audits in connection with proposed or           completed
acquisitions; and employee benefit plan audits.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | Tax
Fees include fees billed for tax compliance services, including the           preparation
of original and amended tax returns and claims for refund; tax           consultations,
such as assistance and representation in connection with tax           audits and
appeals, tax advice related to mergers and acquisitions, transfer           pricing, and
requests for rulings or technical advice from taxing authority; tax           planning
services; and expatriate tax planning and services.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (4) | All
Other Fees include fees billed for training; forensic accounting; data           security
reviews; treasury control reviews and process improvement and advice;           and
environmental, sustainability and corporate social responsibility advisory
          services.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Audit
Committee Pre-approval Policies and Procedures

Below
is a summary of the current Policies and Procedures.

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

- 77 -

---

---



During
2004, 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.

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

# 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

The
following financial statements of the Company and the auditors' report are hereby
attached.

|                                                         |               
|-------------------------------------------------------- | --------------
|
|
|
|
|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

- 78 -

---

---



Item 19. Exhibits and financial statement schedules

| | (a) | Financial
Statement Schedules
| | --- | -----------------------------

| | Schedule II | Schedule of Valuation and Qualifying Accounts at December 31, 2004
| | ----------- | ------------------------------------------------------------------

SCHEDULE II
OPTIBASE LTD.

SCHEDULE OF VALUATION AND QUALIFYING ACCOUNTS AT DECEMBER 31, 2004

|                                | Balance at
beginning of
period | Provision for
doubtful accounts | Write-off of
previously provided
accounts | Balance at
end of period
|------------------------------- | ------------------------------ | ------------------------------- | ----------------------------------------- | ------------------------
|
|
|
|
|Year ended December 31, 2004    |                                |                                 |                                           |                         
|Allowance for doubtful accounts | $517                           | $214                            | $  (69)                                   | $662                    
|Year ended December 31, 2003   
|Allowance for doubtful accounts | $814                           | $  33                           | $(330)                                    | $517                    
|Year ended December 31, 2002   
|Allowance for doubtful accounts | $739                           | $278                            | $(203)                                    | $814                    

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

| | (b) | Exhibits
| | --- | --------

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

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

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

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

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

| | Exhibit
A Form Voting Agreement
| | -------------------------------

| | Exhibit
B Form of Krooss Employment Agreement (see Exhibit 10.1)
| | ----------------------------------------------------------------

| | Exhibit
C Forms of Employment Agreement
| | ---------------------------------------

| | Exhibit
D Form of Individual Shareholder Agreement
| | --------------------------------------------------

| | Exhibit
E Form Escrow Agreement (see Exhibit 2.3)
| | -------------------------------------------------

| | Exhibit
F Form of Agreement of Merger
| | -------------------------------------

| | Exhibit
G Form of Opinion from legal counsel to Viewgraphics
| | ------------------------------------------------------------

| | Exhibit
H Forms of Opinion from legal counsels to Optibase
| | ----------------------------------------------------------

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

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

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

- 79 -

---

---



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

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

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

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

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

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

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

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

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

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

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

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

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

|4.(c).9 |  | 2003
 Amendment to the 1999 Israel Share Option Plan  (incorporated  by reference to exhibits
filed                       with the Registrant's Annual Report on Form 20-F for the
fiscal year ended December 31, 2003).
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|8.1 |  | List
of the  subsidiaries  of the Company  (incorporated  by reference  to exhibits  filed
with the                       Registrant's Annual Report on Form 20-F for the fiscal
year ended December 31, 2003).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|11 |  | Code
of  Business  Conduct and  Ethics.  (incorporated  by  reference  to  exhibits  filed
with the                       Registrant's Annual Report on Form 20-F for the fiscal
year ended December 31, 2003).
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

|13.(a).1 |  | Certification
by Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|-------- |  | ---------------------------------------------------------------------------------------------------

|13.(a).2 |  | Certification
by Principal  Financial Officer pursuant to Section 906 of the  Sarbanes-Oxley Act of
                      2002.
|-------- |  | -------------------------------------------------------------------------------------------------------------------------------

- 80 -

---

---



# OPTIBASE LTD. AND ITS
SUBSIDIARIES

# CONSOLIDATED FINANCIAL
STATEMENTS

# AS OF DECEMBER 31, 2004

# 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 Shareholders of

# OPTIBASE LTD.

We
have audited the accompanying consolidated balance sheets of Optibase Ltd. (the
Company) and its subsidiaries as of December 31, 2003 and 2004, 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, 2004. Our audits also
included the financial statement schedule listed in the index at Item 19(a). These financial
statements and schedule 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
subsidiaries as of December 31, 2003 and 2004, and the consolidated results of their
operations and their cash flows for each of the three years in the period ended December
31, 2004, in conformity with U.S. generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material respects the
information set forth therein.

|                                  |                                                              
|--------------------------------- | -------------------------------------------------------------
|Tel-Aviv, Israel
January 31, 2005 | KOST FORER GABBAY & KASIERER
A Member of Ernst & Young Global



---

---

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

|                                                                             | December 31,
|---------------------------------------------------------------------------- | ------------
|
|
|
|
|ASSETS                                                                       |             
|                                                                             |             
|CURRENT ASSETS:                                                              |             
|Cash and cash equivalents                                                    |             
|Marketable securities (Note 3)                                               |             
|Trade receivables (net of allowance for doubtful accounts of $ 517 and $ 662 |             
|as of December 31, 2003 and 2004, respectively) (Note 15a)                   |             
|Other accounts receivable and prepaid expenses (Note 4)                      |             
|Inventories (Note 5)                                                         |             
|                                                                             |             
|                                                                             |             
|Total current assets                                                         |             
|                                                                             |             
|                                                                             |             
|LONG-TERM INVESTMENTS:                                                       |             
|Long-term lease deposits (Note 11a)                                          |             
|Severance pay fund                                                           |             
|Investments in companies (Note 6)                                            |             
|                                                                             |             
|                                                                             |             
|Total long-term investments                                                  |             
|                                                                             |             
|                                                                             |             
|PROPERTY AND EQUIPMENT, NET (Note 7)                                         |             
|                                                                             |             
|                                                                             |             
|OTHER LONG-LIVED ASSETS, NET (Note 8)                                        |             
|                                                                             |             
|                                                                             |             
|Total assets                                                                 |             
|                                                                             |             

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

F - 3

---

---

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

|                                                                           | December 31,
|-------------------------------------------------------------------------- | ------------
|
|
|
|
|LIABILITIES AND SHAREHOLDERS' EQUITY                                       |             
|                                                                           |             
|CURRENT LIABILITIES:                                                       |             
|Short-term bank credit line (Note 10)                                      |             
|Current maturities of long-term capital lease obligations                  |             
|Trade payables                                                             |             
|Deferred revenues                                                          |             
|Other accounts payable and accrued expenses (Note 9)                       |             
|                                                                           |             
|                                                                           |             
|Total current liabilities                                                  |             
|                                                                           |             
|                                                                           |             
|ACCRUED SEVERANCE PAY                                                      |             
|                                                                           |             
|                                                                           |             
|COMMITMENTS AND CONTINGENT LIABILITIES (Note 11)                           |             
|                                                                           |             
|SHAREHOLDERS' EQUITY (Note 14):                                            |             
|Share capital:                                                             |             
|Ordinary Shares of NIS 0.13 par value -                                    |             
|Authorized: 19,230,800 shares as of December 31, 2003 and 2004; Issued:    |             
|13,523,531 and 13,675,625 shares as of December 31, 2003 and 2004,         |             
|respectively; Outstanding: 12,992,508 and 13,144,605 shares as of December |             
|31, 2003 and 2004, respectively                                            |             
|Additional paid-in capital                                                 |             
|Treasury shares                                                            |             
|Accumulated other comprehensive income                                     |             
|Accumulated deficit                                                        |             
|                                                                           |             
|                                                                           |             
|Total shareholders' equity                                                 |             
|                                                                           |             
|                                                                           |             
|Total liabilities and shareholders' equity                                 |             
|                                                                           |             

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

F - 4

---

---

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

|                                                                | Year ended December 31,
|--------------------------------------------------------------- | -----------------------
|
|
|
|
|Revenues (Notes 15 and 16b)                                     |                        
|Cost of revenues (Note 16d)                                     |                        
|                                                                |                        
|                                                                |                        
|Gross profit                                                    |                        
|                                                                |                        
|                                                                |                        
|Operating expenses:                                             |                        
|Research and development, net (Note 17a)                        |                        
|Selling and marketing                                           |                        
|General and administrative                                      |                        
|Write-off of in-process research and development                |                        
|(Note 1b)                                                       |                        
|Impairment of long-lived assets (Note 1c)                       |                        
|Impairment of goodwill (Note 1c)                                |                        
|Restructuring charges (Note 1d)                                 |                        
|                                                                |                        
|                                                                |                        
|Total operating expenses                                        |                        
|                                                                |                        
|                                                                |                        
|Operating loss                                                  |                        
|Other income (expenses), net (Note 12)                          |                        
|Financial income, net (Note 17b)                                |                        
|                                                                |                        
|                                                                |                        
|Income (loss) before taxes on income                            |                        
|Taxes on income (Note 13)                                       |                        
|                                                                |                        
|                                                                |                        
|Net income (loss) before cumulative effect of accounting change |                        
|Cumulative effect of accounting change (Note 1c)                |                        
|                                                                |                        
|                                                                |                        
|Net income (loss)                                               |                        
|                                                                |                        
|                                                                |                        
|Net earnings (loss) per share:                                  |                        
|Before cumulative effect of accounting change - basic           |                        
|                                                                |                        
|                                                                |                        
|Cumulative effect of accounting change - basic                  |                        
|                                                                |                        
|                                                                |                        
|Basic                                                           |                        
|                                                                |                        
|                                                                |                        
|Diluted                                                         |                        
|                                                                |                        
|                                                                |                        
|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 SUBSIDIARIES           
|---------------------------------------------
|STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
|                                             
|U.S. dollars in thousands                    

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

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

F - 6

---

---

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

|                                                                          | Year ended December 31,
|------------------------------------------------------------------------- | -----------------------
|
|
|
|
|Cash flows from operating activities:                                     |                        
|Net income (loss)                                                         |                        
|Adjustments required to reconcile net income (loss) to net cash           |                        
|provided by (used in) operating activities:                               |                        
|Depreciation and amortization                                             |                        
|Write-off of in-process research and development                          |                        
|Impairment of long-lived assets                                           |                        
|Impairment of goodwill                                                    |                        
|Impairment of long-term investment                                        |                        
|Other expenses                                                            |                        
|Cumulative effect of accounting change                                    |                        
|Proceeds from trading marketable securities, net                          |                        
|Accrued interest and amortization of premium and discount on              |                        
|available-for-sale marketable securities                                  |                        
|Realized gain on sale of available-for-sale marketable securities         |                        
|Loss (gain) on sale of property and equipment                             |                        
|Accrued severance pay, net                                                |                        
|Amortization of deferred stock compensation                               |                        
|Compensation related to warrants granted to consultants                   |                        
|Decrease (increase) in trade receivables, net                             |                        
|Decrease (increase) in other accounts receivable and prepaid expenses     |                        
|Decrease (increase) in inventories                                        |                        
|Increase (decrease) in trade payables                                     |                        
|Increase (decrease) in deferred revenues                                  |                        
|Increase  (decrease)  in  accrued  expenses  and  other  accounts payable |                        
|                                                                          |                        
|                                                                          |                        
|Net cash provided by (used in) operating activities                       |                        
|                                                                          |                        
|                                                                          |                        
|Cash flows from investing activities:                                     |                        
|Capitalization of computer software costs                                 |                        
|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 maturity of  available-for-sale marketable securities       |                        
|Redemption of (investment in) long-term lease deposits                    |                        
|Investment in companies                                                   |                        
|Acquisition of certain assets and liabilities of Media 100 Inc. (c)       |                        
|                                                                          |                        
|                                                                          |                        
|Net cash used in investing activities                                     |                        
|                                                                          |                        
|                                                                          |                        
|Cash flows from financing activities:                                     |                        
|Short-term bank credit                                                    |                        
|Proceeds from issuance of Ordinary Shares, net                            |                        
|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 SUBSIDIARIES   
|-------------------------------------
|CONSOLIDATED STATEMENTS OF CASH FLOWS
|                                     
|U.S. dollars in thousands            

|                                                 |  | Year ended December 31,
|------------------------------------------------ |  | -----------------------
|
|
|
|Supplemental disclosure of cash flow activities:
|                                                
|(a)                                              |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|(b)                                              |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|(c)                                              |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        
|                                                 |  |                        

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

F - 8

---

---

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

# NOTE 1:- GENERAL

| | a. | Optibase
Ltd. (the Company) was incorporated and commenced           operations in
1990.
| | -- | ------------------------------------------------------------------------------------------

| | The
Company has one  wholly-owned  subsidiary:  Optibase  Inc. in the United  States which
was                      incorporated  in  1991.  Other  previously  wholly-owned
 subsidiary,  Optibase  B.V.  in  the                      Netherlands, was dissolved in
September 2003.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 three product
lines. Video technologies (previously called Building Blocks) IPTV
(previously called Broadband TV) and Digital Non-Linear Editing.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 is made in North America, Europe and the
Far East (see Note 15a).
| | ----------------------------------------------------------------------------------------------------------------------

| | b. | On
March 18, 2004, the Company and Media 100 Inc. a U.S.  base 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 (SFAS No. 141), using the
purchase method of accounting method. Accordingly, the purchase price has been allocated
to the assets acquired and the liabilities assumed based on their fair value at the date
of acquisition fair value was established based on discounted cash flows. The excess of
the purchase price over the fair value of the net assets acquired has been recorded as
goodwill.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 9

---

---

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

# NOTE 1:- GENERAL (Cont.)

| | Based
upon a valuation of tangible and intangible assets acquired, the Company has allocated
the total cost of the acquisition to assets, as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------

|                                               | 
|---------------------------------------------- | 
|
|
|
|
|Cash and cash equivalents                      | 
|Trade receivables                              | 
|Inventory                                      | 
|Property and equipment                         | 
|                                               | 
|Intangible assets:                             | 
|In-process research and development (*)        | 
|Technology (four-year useful life)             | 
|Customer relationship (three-year useful life) | 
|Goodwill                                       | 
|                                               | 
|                                               | 
|Total assets acquired                          | 
|                                               | 
|                                               | 
|Liabilities assumed:                           | 
|Accounts payable and other accrued expenses    | 
|Deferred revenues                              | 
|                                               | 
|                                               | 
|Total liabilities assumed                      | 
|                                               | 
|                                               | 
|Net assets acquired                            | 
|                                               | 

| | (*) | Write-off
of in process research and development, for which technological           feasibility has
not yet been established and no alternative future use exists.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
accompanying consolidated financial statements include the acquired assets and
liabilities assumed of Media 100 as of December 31, 2004 and its result of operations for
the seven months ended December 31, 2004 but exclude the results of Media 100 for all
other periods presented. The following unaudited pro forma consolidated results of
operations for the years ended December 31, 2003 and 2004 were prepared assuming the
acquisition of Media 100 assets and liabilities assumed occurred on January 1, 2003. The
pro forma result of operations are not necessarily indicative of the consolidated results
that actually would have occurred had the acquisition been consummated at January 1,
2003, nor do they purport to represent the results of operations for future periods.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                 | Year ended December 31,
|-------------------------------- | -----------------------
|
|
|
|
|Total revenues                   |                        
|                                 |                        
|Net income (loss)                |                        
|                                 |                        
|Earnings (loss) per common share |                        
|Basic                            |                        
|                                 |                        
|Diluted                          |                        
|                                 |                        

F - 10

---

---

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

# NOTE 1:- GENERAL (Cont.)

| | c. | Impairment
of long-lived assets and goodwill:
| | -- | ---------------------------------------------

| | 1. | 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 significantly reduce the operations of
its digital non-linear editing product line associated with Media 100. 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 annually goodwill 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 expected present value of future cash flows. The goodwill
impairment charge is included in the consolidated statements of operations.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Impairment
of long-lived assets in 2002 (see also Note 2j and 2k):
| | -- | ------------------------------------------------------------------

| | Due
to the decrease in sales to a major customer, recurring operating losses and downward
adjustment to the Companys projections, the Company performed a recoverability test
on its long-lived assets. In connection with this analysis, the Company recorded a
non-cash charge of $ 6,791 in accordance with SFAS 144 in respect to one group of assets.
This charge is included in the impairment of long-lived assets in the consolidated
statements of operations.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 11

---

---

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

# NOTE 1:- GENERAL (Cont.)

| | The
Company and its subsidiaries reclassified certain intangible assets, acquired from
ViewGraphics and HiTV Unit, to goodwill in accordance with SFAS 141 (as of January 1,
2002).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Based
on steps the Company has taken for the adoption of SFAS 142, goodwill amounting to $ 854,
was impaired using the impairment test required by SFAS 142. The impairment, required to
be recognized when adopting SFAS 142, is reflected as a cumulative effect of accounting
change as of January 1, 2002. The goodwill impairment composed of reclassification of the
following intangible assets:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                   | 
|---------------------------------- | 
|
|
|
|
|Customer base - ViewGraphics       | 
|Assembled workforce - ViewGraphics | 
|Assembled workforce - HiTV         | 
|                                   | 
|                                   | 
|                                   | 
|                                   | 

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

| | During
the third quarter of 2001, the Company announced that it was implementing a restructuring
plan (the 2001 Plan) intended to further reduce costs. The 2001 Plan
consisted of employee termination benefits associated with the involuntary termination of
38 employees. Through the third quarter of 2001, the 2001 Plan and the benefit
arrangement were communicated to employees. The restructuring charges amounted to $ 2,064
and were utilized during 2001 and 2002.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
the third quarter of 2002, and with respect to the conditions that led to the
abovementioned impairment of intangible assets, the Company announced that it was
implementing a restructuring plan (the 2002 Plan) intended to further reduce
costs. The 2002 Plan consisted of employee termination benefits associated with the
involuntary termination of 10 employees. Through the third quarter of 2002, the plan and
the benefit arrangement were communicated to employees. The restructuring charges
amounted to $ 505 and were utilized during 2002 and 2003. The restructuring charges
in 2002 include impairment of property and equipment in the amount of $ 319.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
2001 and 2002 restructuring plans were accounted for in accordance with EITF No. 94-3
Liability Recognition for Certain Employee Termination Benefits and Costs of Exit
and Activity (Including Certain Costs Incurred in a Restructuring) (EITF 94-3),
and in accordance with Staff Accounting Bulletins No. 100, Restructuring and
Impairment Charges (SAB 100). The impairment of property and equipment
was accounted for in accordance with SFAS 144.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---

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

# NOTE 2:- SIGNIFICANT
ACCOUNTING POLICIES

| | The
 consolidated  financial  statements  have been prepared in accordance  with  generally
 accepted               accounting principles 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 primary currency of the economic environment in which the Company and each of its
subsidiaries 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 13

---

---

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

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

| | As
of December 31, 2003 and 2004, 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 17b).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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, 2003 and 2004, management has not identified any other than temporary
decline in their market value.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Structured
notes were accounted for as structured notes in accordance with the provisions of FASB
Emerging Issues Task Force (EITF) Issue No. 96-12, Recognition of Interest Income
and Balance Sheet Classification of Structured Notes. Under the notes term, for
each day in which the relevant LIBOR rate is below an agreed annual fixed rate, which
ranges from 3% to 7%, 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, 2003 and
2004, investments in structured notes securities approximate their market value.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Inventories
are stated at the lower of cost or market value. Inventory write-offs are provided to
cover risks arising from slow-moving items or technological obsolescence. In 2002, 2003
and 2004 the Company and its subsidiary recorded write-off charges in a total amount of $ 608,
$ 460 and $ 336, 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  on the basis of calculated manufacturing costs and
related overhead.
| | ----------------------------------------------------------------------------------------------------------

F - 14

---

---

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

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

| | 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 on
| |                                    | term of the lease                

| | 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, 2003 and 2004, an impairment loss in the amount of $ 0 and $ 540,
respectively, were recorded (see Note 1c1).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 4 years, and customer
relationship is amortized over a weighted average of 3 years.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | i. | Other
long-lived assets, net:
| | -- | -----------------------------

| | The
Company and its subsidiaries long-lived assets are reviewed for impairment in
accordance with SFAS 144 whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to be held
and used is measured by a comparison of the carrying amount of an asset to the future
undiscounted cash flows expected to be generated by the asset. If such assets are
considered to be impaired, the impairment to be recognized is measured by the amount by
which the carrying amount of the assets exceeds the fair value of the assets. Assets to
be disposed of are reported at the lower of the carrying amount or fair value less costs
to sell. The Company reviewed assets on a component-level basis, which is the lowest
level of assets for which there are identifiable cash flows that can be distinguished
operationally and for financial reporting purposes. The carrying amount of the asset
group was compared to the related expected undiscounted future cash flows to be generated
by those assets over the estimated remaining useful life of the primary asset. In cases
where the expected future cash flows were less than the carrying amounts of the assets,
those assets were considered impaired and written down to their fair values. Fair value
was established based on discounted cash flows.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 15

---

---

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

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

| | j. | Investment
in companies:
| | -- | ------------------------

| | Investment
in companies represents investments in: (i) Preferred Shares of a privately held company
which is recorded at the lower of cost or estimated fair value, since the Company does
not have the ability to exercise significant influence over operating and financial
policies of the investee and holds an equity stake of less than 20%, (ii) a privately
held company by a way of convertible notes.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys investment in company (i) is reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an investment may not be
recoverable, in accordance with Accounting Principles Board Opinion No. 18, The
Equity Method of Accounting for Investments in Common Stock, (APB 18).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | Revenues
from product sales are recognized in accordance with Staff Accounting Bulletin No. 104,
Revenue Recognition in Financial Statements (SAB 104), when
delivery has occurred, persuasive evidence of an agreement exists, the vendors fee
is fixed or determinable, no further obligation exist and collectibility is probable.
Estimated warranty costs, which are insignificant, are based on the Company and its
subsidiary past experience and are accrued in the financial statements. The Company and
its subsidiary do not grant a right of return.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company accounts for software sales 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 Vendor
Specific Objective Evidence (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, support and services) is
determined based on the price charged for the undelivered element when sold separately.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 16

---

---

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

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

| | 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 in the Israeli Ministry of Industry and Trade and the
European Union Research and Development Program (see also Note 11b1).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Costs
incurred by the Company between completion of the working model and the point at which
the product is ready for general release, have been capitalized.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Capitalized
software costs are amortized by the greater of the amount calculated using the: (i) ratio
that current gross revenues from sales of the software to the total of current and
anticipated future gross revenues from sales of that software, or (ii) the straight-line
method over the estimated useful life of the product (three years).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company assesses the recoverability of this asset on a regular basis by determining
whether the amortization of the asset over its remaining life can be recovered through
undiscounted future operating cash flows from the specific software product sold.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
Company and its subsidiaries account for income taxes in accordance with Statement of
Financial Accounting Standard No. 109, Accounting for Income Taxes (SFAS
No. 109). This Statement prescribes the use of the liability method, whereby
deferred tax asset and liability account balances are determined based on differences
between financial reporting and tax bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences are
expected to reverse. The Company and its subsidiaries provide a valuation allowance, if
necessary, to reduce deferred tax assets to their estimated realizable value.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 17

---

---

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

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

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

| | The
Company receives non-royalty-bearing grants from the European Union Research and
Development Program, and from the MOST and STRIMM consortiums, which are part of the
Office of the Chief Scientist Magnet program. These grants are recognized at the time the
Company is entitled to such grants on the basis of the costs incurred and are recorded as
a reduction of research and development costs.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | Cash
and cash equivalents, are invested in U.S. dollar deposits with major banks in Israel and
the United States. Such deposits in the United States may be in excess of insured limits
and are not insured in other jurisdictions. Management believes that the financial
institutions that hold the Groups cash and cash equivalents are financially sound
and, accordingly, minimum credit risk exists with respect to these financial instruments.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Investments
in marketable securities are done 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.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
trade receivables of the Company and its subsidiaries are geographically diversified and
derived from sales to customers mainly in North America, Europe and the Far East. The
Company and its subsidiaries generally do not require collateral; however, in certain
circumstances, the Company and its subsidiaries may require letters of credit, advanced
payments, insurance, other collateral or additional guarantees. An allowance for doubtful
accounts is determined with respect to those amounts that the Company and its
subsidiaries have determined to be doubtful of collection in addition to a general
allowance for the remaining accounts. The Company and its subsidiaries perform ongoing
credit evaluations of their customers. The allowance for doubtful accounts amounted to $ 517
and $ 662 as of December 31, 2003 and 2004, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 18

---

---

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

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

| | The
total weighted average number of shares related to the outstanding options and warrants,
excluded from the calculations of diluted net earnings (loss) per share since they would
be anti-dilutive, was 4,780 for the year ended December 31, 2002, 390,983 for the year
ended December 31, 2003 and 2,771,281 for the year ended December 31, 2004.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees (APB 25) and FASB Interpretation No. 44,
Accounting for certain Transactions Involving Stock Compensation (FIN 44),
in accounting for its employee stock option plans. Under APB No. 25, when the exercise
price of the Companys employee stock options is less than the market price of the
underlying stock on the date of grant, compensation expense is recognized.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company adopted the disclosure provisions of Financial Accounting Standards Board
Statement No. 148, Accounting for Stock-Based Compensation  transition and
disclosure (SFAS 148), which amended certain provisions of SFAS 123 to
provide alternative methods of transition for an entity that voluntarily changes to the
fair value based method of accounting for stock-based employee compensation, effective as
of the beginning of the fiscal year. The Company continues to apply the provisions of APB
No. 25, in accounting for stock-based compensation (see also Note 14d).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
Statement of Financial Accounting Standard No. 123 Accounting for Stock-Based
Compensation (SFAS 123), pro forma information regarding net income
(loss) and net income (loss) per share is required, and has been determined, as if the
Company has accounted for its employee options under the fair value method prescribed by
that statement. The fair value for these options was estimated at the date of the grant
using the Black-Scholes option pricing model, with the following weighted-average
assumptions for 2002, and 2003 and 2004: risk-free interest rates of 1.5%, 1.5% and 3.2%
dividend yields of 0%, for each year, volatility factors of the expected market price of
the Companys Ordinary Shares of 0.494, 0.712 and 0.6, respectively, and a weighted
average expected life of the options of 7 years, 4 years and 3 years, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 19

---

---

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

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

| | Pro
forma information under SFAS No. 123:
| | -----------------------------------------

|                                                  | Year ended December 31,
|------------------------------------------------- | -----------------------
|
|
|
|
|Net income (loss) - as reported                   |                        
|Add - stock-based employee compensation -         |                        
|intrinsic value                                   |                        
|Deduct - stock-based employee compensation -      |                        
|fair value                                        |                        
|                                                  |                        
|                                                  |                        
|Net income (loss) - pro forma                     |                        
|                                                  |                        
|                                                  |                        
|Basic net earnings (loss) per share - as reported |                        
|                                                  |                        
|Bsic net earnings (loss) per share - pro forma    |                        
|                                                  |                        
|                                                  |                        
|Diluted net earnings (loss) per share - as        |                        
|reported                                          |                        
|                                                  |                        
|Diluted net earnings (loss) per share - pro       |                        
|forma                                             |                        
|                                                  |                        

| | The
Company applies SFAS 123 and Emergency Issue Task Force No. 96-18, Accounting for
Equity Instruments that are Issued to Other than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services (EITF 96-18) with respect
to options issued to non-employees. SFAS 123 requires use of an option valuation model to
measure the fair value of these options at the measurement date, as defined in EITF 96-18.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 decrease in an employee salary, severance pay is
calculated as follows: the severance pay with respect to the period prior to the decrease
is based on the most recent salary of the employee prior to such decrease multiplied by
the number of years of the employment until the date of the decrease. The severance pay
with respect to the period following such decrease is based on the actual recent salary
of such employee multiplied by the number of years of employment following such decrease.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 20

---

---

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

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

| | The
Companys liability is fully provided by monthly deposits into severance pay funds,
insurance policies and by an accrual. The value of these funds and policies is recorded
as an asset in the Companys balance sheet.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 expenses amounted to $ 395, $ 434 and $ 346 for the years ended December 31,
2002, 2003 and 2004, 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 greater than $ 13 per
year, of their annual compensation to the plan through salary deferrals, subject to IRS
limits. The Company makes matching contribution up to 25% over a vesting period of 5
years.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | The
carrying amounts of cash and cash equivalents, 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | v. | Derivative
investments:
| | -- | -----------------------

| | The
Company uses derivative instruments to manage exposures to foreign currency, primarily
marketable securities denominated in Euros. The Companys objectives for holding
derivatives are to minimize these risks.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 21

---

---

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

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

| | Financial
Accounting Standards Board Statement No. 133, Accounting for Derivative Instruments
and Hedging Activities (SFAS 133), requires companies to recognize all
of its derivative instruments as either assets or liabilities in the statement of
financial position at fair value. The accounting for changes in the fair value (i.e.,
gains or losses) of a derivative instrument depends on whether it has been designated and
qualifies as part of a hedging relationship and further, on the type of hedging
relationship. For those derivative instruments that are designated and qualify as hedging
instruments, a company must designate the hedging instrument, based upon the exposure
being hedged, as a fair value hedge, cash flow hedge or a hedge of a net investment in a
foreign operation.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
derivative instruments that are designated and qualify as a fair value hedge (i.e.,
hedging the exposure to changes in the fair value of an asset or a liability or an
identified portion thereof that is attributable to a particular risk), the gain or loss
on the derivative instrument as well as the offsetting loss or gain on the hedged item
attributable to the hedged risk are recognized in the same line item associated with the
hedged item in current earnings during the period of the change in fair values. For
derivative instruments that are designated and qualify as a cash flow hedge (i.e.,
hedging the exposure to variability in expected future cash flows that is attributable to
a particular risk), the effective portion of the gain or loss on the derivative
instrument is reported as a component of other comprehensive income and reclassified into
earnings in the same line item associated with the forecasted transaction in the same
period or periods during which the hedged transaction affects earnings. The remaining
gain or loss on the derivative instrument in excess of the cumulative change in the
present value of future cash flows of the hedged item, if any, is recognized in other
income/expense in current earnings during the period of change.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
derivative instruments not designated as hedging instruments, the gain or loss is
recognized in other income/expense in current earnings during the period of change.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
2003 and 2004, the Company entered into forward exchange contracts to hedge certain
marketable securities denominated in foreign currencies. The purpose of the Companys
foreign currency hedging activities is to protect the Company from risk that the eventual
dollar cash flows from the sale of these marketable securities will be adversely affected
by changes in the exchange rates.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
the years 2003 and 2004, the Company recognized a net loss of $ 39 and $ 31, related
to the ineffective portion of its hedging instruments (inclusive of the time value of
money).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | In
November 2004, the FASB issued Statement of Financial Accounting Standard No. 151, Inventory
Costs, an Amendment of ARB No. 43, Chapter 4. (SAFS 151). SFAS 151
amends Accounting Research Bulletin (ARB) No. 43, Chapter 4, to clarify that
abnormal amounts of idle facility expense, freight handling costs and wasted materials
(spoilage) should be recognized as current-period charges. In addition, SFAS 151 requires
that the allocation of fixed production overheads to the costs of conversion be based on
the normal capacity of the production facilities. SAFS 151 is effective for inventory
costs incurred during fiscal years beginning after June 15, 2005. The Company does not
expect that the adoption of SFAS 151 will have a material effect on its financial
position or results of operations.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---

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

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

| | On
December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement
No. 123 (revised 2004), Share-Based Payment, which is a revision of FASB Statement No.
123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No.
25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement
of Cash Flows. Generally, the approach in Statement 123(R) is similar to the approach
described in Statement 123. However, Statement 123(R) requires all share-based payments
to employees, including grants of employee stock options, to be recognized in the income
statement based on their fair values. Pro forma disclosure is no longer an alternative.
SFAS No. 123(R) must be adopted no later than January 1, 2006. The Company expects to adopt this
statement on January 1, 2006
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Statement
123(R) permits public companies to adopt its requirements using one of two methods:
| | ---------------------------------------------------------------------------------------------

| | A
modified prospective method in which compensation cost is recognized
beginning with the effective date (a) based on the requirements of Statement 123(R) for
all share-based payments granted after the effective date and (b) based on the
requirements of Statement 123 for all awards granted to employees prior to the effective
date of Statement 123(R) that remain unvested on the effective date.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A
modified retrospective method which includes the requirements of the modified
prospective method described above, but also permits entities to restate based on the
amounts previously recognized under Statement 123 for purposes of pro forma disclosures
either (a) all prior periods presented or (b) prior interim periods of the year of
adoption.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company plans to adopt Statement 123 using the modified-prospective method.
| | -------------------------------------------------------------------------------

| | As
permitted by Statement 123, the company currently accounts for share-based payments to
employees using Opinion 25s intrinsic value method and, as such, generally
recognizes no compensation cost for employee stock options. In addition, non-compensatory
plans under APB 25 will be considered compensatory for FAS 123(R) purposes. Accordingly,
the adoption of Statement 123(R)s fair value method will have a significant impact
on the Company result of operations, although it will have no impact on the Company
overall financial position. The impact of adoption of Statement 123(R) cannot be
predicted at this time because it will depend on levels of share-based payments granted
in the future. However, had the Company adopted Statement 123(R) in prior periods, the
impact of that standard would have approximated the impact of Statement 123 as described
in the disclosure of pro forma net income and earnings per share in Note 2 to the
consolidated financial statements.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | y. | Reclassification:
| | -- | -----------------

| | Certain
2002 and 2003 figures have been reclassified to conform to the 2004 presentation.
| | -----------------------------------------------------------------------------------------

F - 23

---

---

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

# 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 $ 852, $ 4,536 and $
1,003 in 2002, 2003 and 2004, respectively (Note 17b). 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 $ 389, $ 1,143 and $ (459) in 2002, 2003 and 2004, respectively.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Included
in the Companys investments are structured notes with an estimated fair value of
approximately $ 19,336 and $ 30,321 as of December 31, 2003 and 2004, 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 LIBOR.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                               | December 31, 2003 | December 31, 2004
|------------------------------ | ----------------- | -----------------
|
|
|
|
|Available-for-sale securities: |                   |                  
|Matures in one year            |                   |                  
|Matures from 1 to 5 years      |                   |                  
|Matures from 6 to 10 years     |                   |                  
|                               |                   |                  
|                               |                   |                  
|Total                          |                   |                  
|                               |                   |                  

F - 24

---

---

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

# NOTE 4:- OTHER ACCOUNTS
RECEIVABLE AND PREPAID EXPENSES

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

NOTE 5:- INVENTORIES

|                             | December 31,
|---------------------------- | ------------
|
|
|
|
|Raw materials and components |             
|Work in progress             |             
|Finished goods               |             
|                             |             
|                             |             
|                             |             
|                             |             

# 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 technologies valued at           $ 300,
based on an estimate made by management, and committed to invest           through one of
its subsidiaries at least $ 1,000 in Mobixells first round           of financing.
In December 2000, Mobixell completed its first financing round, in           which the
Company, through its subsidiary invested $ 1,064.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
the first quarter of 2003, the Companys management determined that there was other
than temporary decrease in the fair value of its investment in Mobixell. Accordingly, the
Company recorded a loss with respect to the investment in Mobixell in the amount of $ 1,364,
which is included in the statement of operations as other expenses.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
2003 and 2004, the Company decided to invest an additional $ 300 and $ 400,
respectively, in Mobixell, as part of a second and third investment round in Mobixell. As
of December 31, 2004, the Company holds approximately 9.35% of Mobixells equity.
The investment is treated on the basis of the cost method.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 25

---

---

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

# NOTE 6:- INVESTMENTS IN
COMPANIES

| | 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, 2004,
the Company           invested additional $ 1,797 in V. Box in respect for
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 $ 325, $ 907 and $ 574
in the years ended December 31, 2002, 2003 and 2004, respectively, which are included in
the statement of operations under other expenses (income), net.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2004, the outstanding balance represents the investment in Mobixell.
| | ---------------------------------------------------------------------------------------

# NOTE 7:- PROPERTY AND
EQUIPMENT, NET

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

| | As
for charges, see Note 11d.
| | -----------------------------

| | Depreciation
expenses amounted to $ 1,576, $ 1,276 and $ 778 for the years ended December
31, 2002, 2003 and 2004, respectively.
| | --------------------------------------------------------------------------------------------------------------------------------

| | As
for impairment charges in 2002, 2003 and 2004, see Note 1d.
| | --------------------------------------------------------------

F - 26

---

---

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

# NOTE 8:- OTHER
LONG-LIVED ASSETS, NET

|                                    | December 31,
|----------------------------------- | ------------
|
|
|
|
|Intangible assets:                  |             
|Original amounts:                   |             
|Capitalized computer software costs |             
|                                    |             
|Accumulated amortization:           |             
|Capitalized computer software costs |             
|                                    |             
|                                    |             
|Amortized cost                      |             
|                                    |             

| | Amortization
expenses amounted to $ 1,047, $ 80 and $ 327 for the years ended December 31,
2002, 2003 and 2004, respectively. The amortization expenses for the year 2002 included
amortization of acquired technology. The amortization for 2004 included amortization of
acquired technology and customer base, in the amount of $ 247.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 9:- OTHER ACCOUNTS
PAYABLE AND ACCRUED EXPENSES

|                               | December 31,
|------------------------------ | ------------
|
|
|
|
|Employees and payroll accruals |             
|Royalties (see Note 11b)       |             
|Accrued expenses               |             
|Others                         |             
|                               |             
|                               |             
|                               |             
|                               |             

# NOTE 10:- SHORT-TERM
BANK CREDIT LINE

| | As
of December 31, 2003 and 2004, the Company and its subsidiary had authorized lines of
credit in the amount of $ 20,457 and $ 10,464, respectively, out of which $ 457
and $ 464, respectively, are linked to the NIS and bear an annual bank interest rate of
Prime plus 1%-1.25%, and $ 20,000 and $ 10,000, respectively, bear an annual
interest rate of LIBOR plus 0.5%. The amount of approximately $ 25,000 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 $ 2,151
and $ 503 as of December 31, 2003 and 2004, respectively, used for marketable
securities purposes only (there is no material fee for the unused portion of the line of
credit).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---

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

# NOTE 11:- COMMITMENTS
AND CONTINGENT LIABILITIES

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

| | The
Companys facilities and the facilities and motor vehicles of its subsidiary, are
leased under several operating lease agreements for periods ending in 2008.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |                         | 
| | ----------------------- | 
|
|
|
|
| | Year ended December 31, | 
| |                         | 
| | 2005                    | 
| | 2006                    | 
| | 2007                    | 
| | 2008                    | 
| |                         | 
| |                         | 
| |                         | 

| | As
of December 31, 2004, the Company and its subsidiary provided for long-term deposits
amounting to $ 282 as collateral, in accordance with the lease agreements (see also
item c. below).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Rent
expenses amounted to $ 710, $ 770 and $ 858 for the years ended December 31,
2002, 2003 and 2004, respectively. Motor vehicle leasing expenses for the years ended
December 31, 2002, 2003 and 2004, were $ 517, $ 360 and $ 682,
respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | 1. | 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%-150% 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, 2004, the Company has paid or accrued royalties to the OCS in the amount of $ 3,260,
which was recorded under cost of revenues.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2004, the Company had an outstanding contingent obligation to pay
royalties in the amount of approximately $ 2,054.
| | --------------------------------------------------------------------------------------------------------------------------------------

| | 2. | The
Government of Israel, through the Fund for the Encouragement of Marketing
          Activities, provided the Company with grants for participation in foreign
          marketing expenses. The Company is committed to pay royalties at the rate of 3%
          of the increase in export sales, up to the amount received by the Company,
          linked to the dollar. Grants recorded beginning January 1, 1998, bear royalties
          of 4% plus LIBOR.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 28

---

---

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

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

| | Through
December 31, 2004, the Company has paid or accrued royalties to the Fund for the
Encouragement of Marketing Activities, in the amount of approximately $ 2,743, which
was recorded under selling and marketing expenses.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2004, the Company had no outstanding contingent obligation to pay
royalties to the Fund for the Encouragement of Marketing Activities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Guarantees:
| | -- | -----------

| | The
Company has obtained a letter of credit in favor of a customer and bank guarantees in
favor of a lessor totaling $ 117 and $ 1,010, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | 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 10).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | Contingent
liabilities:
| | -- | -----------------------

| | 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 12:- OTHER INCOME
(EXPENSES), NET

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

F - 29

---

---

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

# NOTE 13:- 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:
| | -- | ----------

| | On
June 29, 2004 the Israeli Government approved the amendment to the Income Tax Ordinance
(No. 140 and Temporary Provision), 2004, which progressively reduces the tax rates
applicable to companies from 35% in 2004 to a rate of 30% in 2007.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
Companys production facilities have been granted the status of 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 program of
investment.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the provisions of the law, the Company has elected the Alternative plan benefits  waiver
of grants in return for a tax exemption. For the first two investment programs, the
Company has also elected long-term loans under Government guarantees along with a tax
exemption. As of December 31, 2003 and 2004, 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 plan benefit, 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 (subject to an adjustment based upon the percentage of foreign
investor ownership in the Company).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 30

---

---

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

# NOTE 13:- TAXES ON
INCOME (Cont.)

| | The
law also grants entitlement to claim accelerated depreciation on equipment used by the
Approved Enterprise during 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
tax-exempt income attributable to the Approved Enterprise can be distributed
to shareholders without subjecting the Company to taxes only upon the complete
liquidation of the Company. If such 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
instruments of approval for the specific investments in Approved Enterprises.
In the event of failure to comply with these conditions, the benefits may be canceled and
the Company may be required to refund the amount of the benefits, in whole or in part,
including interest. As of December 31, 2004, management believes that the Company is
meeting all of the aforementioned conditions.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Should
the Company derive income from sources other than the Approved Enterpriseduring
the relevant period of benefits, such income will be taxable at the regular corporate tax
rates of 35%.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
Company has final tax assessments through the year 2001. The Company recorded tax
provision in the amount of $ 124, $ 0 and $ 0, in the years ended 2002,
2003 and 2004, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
Company currently qualifies as an Industrial Company under the above law and
as such is entitled to certain tax benefits, including accelerated depreciation and the
deduction of public offering expenses in three equal annual payments, and amortization of
patents and acquired technology as a deduction for tax purposes.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 - 31

---

---

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

# NOTE 13:- 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 subsidiaries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 subsidiaries have provided valuation allowances in respect of deferred
tax assets resulting from tax loss carryforward and other differences. Management
currently believes that, since the Company and its subsidiaries have a history of losses,
it is more likely than not that the deferred tax regarding the loss carryforward and
other temporary differences will not be realized in the foreseeable future. During 2004,
the Company and its subsidiaries increased its valuation allowance by approximately $ 3.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Through
December 31, 2004, Optibase Ltd. had a net operating losses carryforward for tax purposes
in Israel of approximately $ 19,400, which may be carried forward and offset against
taxable income in the future, for an indefinite period.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2004, Optibase Inc. had U.S. federal net operating loss carryforward of
approximately $ 13,400 that can be carried forward and offset against taxable income
for 20 years, no later than 2006 to 2023. Utilization of U.S. net operating losses may be
subject to the substantial annual limitation due to the change in ownershipprovisions
of the Internal Revenue Code of 1986, and similar state provisions. The annual limitation
may result in the expiration of net operating losses before utilization.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 32

---

---

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

# NOTE 13:- 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,
| | -- |  | -----------------------
|
|
|
|
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| | j. |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| | k. |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        
| |    |  |                        

F - 33

---

---

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

# NOTE 14:-
SHAREHOLDERS EQUITY

| | a. | General:
| | -- | --------

| | 1. | The
Ordinary Shares of the Company are traded on the NASDAQ National 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. | In
March 2000, the Company completed the placement of 1,962,000 Ordinary Shares           in
its second public offering. The Company raised proceeds in the amount of
          approximately $ 67,000.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | The Company's share capital consists of
12,341,388, 12,992,508 and 13,144,605 issued and outstanding
Ordinary Shares as of December 31, 2002, 2003 and 2004, respectively.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Shares
in escrow due to acquisition of ViewGraphics:
| | -- | ----------------------------------------------------

| | 1. | In
December 2000, as part of the acquisition of ViewGraphics, the Company           issued
1,370,150 Ordinary Shares to the shareholders of ViewGraphics, of which           100,000
shares that were issued to two of ViewGraphics executives are held in           escrow
for a period of up to 24 months following the date of the acquisition           (December
4, 2000). In the event that an executives employment with the           Company is
voluntarily terminated prior to the end of the employment term, the           100,000
escrowed shares shall be forfeited and returned to the Company. Such
          transaction was accounted for in accordance with Emergency Issue Task Force No.
          95-8, Accounting for Contingent Consideration Paid to the Shareholders of
          an Acquired Enterprise in a Purchase Business Combination (EITF
          95-8). Accordingly, any consideration for future services should be
          expensed over the service period. Thus, the Company recorded a related deferred
          stock compensation in the amount of $ 981, to be amortized over the escrow
          period. As of December 31, 2004, there were no shares held in escrow.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
January 2002, the Company received back approximately 364,000 of its
          outstanding Ordinary Shares worth $ 1,119, out of the 936,421 shares,
which           were previously held in an escrow account as part of the acquisition of
          ViewGraphics. The Company received these shares from former ViewGraphics
          shareholders as settlement of certain claims made by the Company relating to
          alleged breaches of representations and warranties set forth in the
ViewGraphics           purchase agreement. These shares were recorded as treasury shares.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Treasury
shares:
| | -- | ----------------

| | In
December 2000, the Company initiated a share repurchase program, in which the Company is
authorized to purchase up to 1 million shares of its outstanding Ordinary Shares, through
open-market transactions. As of December 31, 2004, the Company purchased 167,000 shares
of its outstanding Ordinary Shares for a total consideration of $ 1,159. These
shares were recorded as treasury shares.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 34

---

---

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

# NOTE 14:-
SHAREHOLDERS EQUITY (Cont.)

| | d. | Stock
options:
| | -- | --------------

| | Since
1990, the Company has granted options to employees and directors to purchase Ordinary
Shares. Under the terms of these grants, options generally become exercisable ratably
over a four-year period commencing with the date of grant. The options generally expire
no later than seven years from the date of the grant.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 7 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
connection with the acquisition of ViewGraphics, the Company granted 753,384 options, in
exchange for the options held by employees of ViewGraphics as of the acquisition date.
These options were not granted under any of the option plans mentioned above.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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. The Company remeasured the instric
value of these options in accordance with FIN 44 and APB 25 and no deferred stock
compensation was recorded. At the same date the Company adopted the Share Option
Agreement 2003 in accordance with the amended Section 102 of the Israeli 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, 2004 was 517,579.
| | --------------------------------------------------------------------------------------------

F - 35

---

---

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

# NOTE 14:-
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    |                       
|                       |                       

| | The
deferred compensation is amortized to the statement of operations over a vesting period
of up to four years. Amortization expenses during the years ended December 31, 2002, 2003
and 2004, amounted to $ 1,156, $ 246 and $ 0, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
options outstanding as of December 31, 2004, have been separated into ranges of exercise
price as follows:
| | --------------------------------------------------------------------------------------------------------------

|Range of
exercise
price | Options
outstanding
as of
December 31,
2004 | Weighted
average number
of years
remaining
contractual
life | Weighted
average
exercise
price | Options
exercisable
as of
December 31,
2004 | Weighted
average
exercise
price
|----------------------- | ------------------------------------------- | ----------------------------------------------------------- | ------------------------------- | ------------------------------------------- | -------------------------------
|
|
|
|
|$ 0.17                  |                                             |                                                             |                                 | 2,302                                       |                                
|$ 1.52 - $ 2.09         |                                             |                                                             |                                 | 18,000                                      |                                
|$ 2.38 - $ 3.25         |                                             |                                                             |                                 | 1,194,816                                   |                                
|$ 4.12 - $ 4.97         |                                             |                                                             |                                 | 353,273                                     |                                
|$ 5.02 - $ 5.93         |                                             |                                                             |                                 | 1,032,731                                   |                                
|$ 6 - $ 6.64            |                                             |                                                             |                                 | 352,325                                     |                                
|$ 12.03 - $ 16.88       |                                             |                                                             |                                 | 216,109                                     |                                
|$ 17.5 - $ 19.63        |                                             |                                                             |                                 | 32,000                                      |                                
|$ 23.75                 |                                             |                                                             |                                 | 56,000                                      |                                
|$ 28.38                 |                                             |                                                             |                                 | 8,000                                       |                                
|$ 32                    |                                             |                                                             |                                 | 5,000                                       |                                
|                        |                                             |                                                             |                                 |                                             |                                
|                        |                                             |                                                            
|                        |                                             |                                                             |                                 | 3,270,556                                   |                                
|                        |                                             |                                                             |                                 |                                             |                                

F - 36

---

---

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

# NOTE 14:-
SHAREHOLDERS EQUITY (Cont.)

| | Weighted
average fair values and weighted average exercise prices of options whose exercise price
are less, equals or exceeds market price of the shares at date of grant are as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                       | Year ended December 31,
|---------------------- | -----------------------
|
|
|
|
|Equal to market        |                        
|value at date of grant |                        
|                       |                        

| | e. | Warrants:
| | -- | ---------

| | In
December 1992, the Company issued warrants to shareholders to purchase 125,725 NIS 0.13
par value Ordinary Shares of the Company at an exercise price of $ 0.33 per share. The
warrants have no expiration date. On February 15, 1999, 41,908 of these warrants were
exercised. On August 22, 2003, the remaining 83,817 warrants were exercised.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
June 2004, the Company has committed to grant warrants, in four equal installments, to
consultants to purchase 85,000 NIS 0.13 par value Ordinary Shares of the Company at an
exercise price of $ 4.97 per share. The warrants expired after 20 months. As of December
31, 2004, the Company issued 42,500 warrants under the 1999 Plans and recorded
compensation expenses in the amount of $ 77.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 15: 
GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS

| | a. | Summary
information about geographic areas:
| | -- | -------------------------------------------

| | The
Company and its subsidiaries 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).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 37

---

---

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

# NOTE 15: 
GEOGRAPHIC INFORMATION AND MAJOR CUSTOMERS (Cont.)

| | The
following presents total revenues for the years ended December 31, 2002, 2003 and 2004
and long-lived assets as of December 31, 2002, 2003 and 2004.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------

|                           | 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. | Major
customer data as a percentage of total revenues:
| | -- | ------------------------------------------------------

| |  |  | Year ended December 31,
| |  |  | -----------------------
|
|
|
|
| |  |  |                        
| |  | 
| |  |  | c.                     
| |  | 
| |  | 
| |  |  |                        
| |  |  |                        
| |  |  |                        
| |  |  |                        
| |  | 
| |  |  |                        
| |  |  |                        

# NOTE 16:- RELATED PARTY
TRANSACTIONS

| | The
Company has signed lease, license and distribution agreements with V. Box through December 31,
2004.
| | --------------------------------------------------------------------------------------------------------

| | The
balances with and the revenues derived from related party were as follows:
| | ------------------------------------------------------------------------------

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

F - 38

---

---

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

# NOTE 16:- RELATED PARTY
TRANSACTIONS (Cont.)

| |  |  | Year ended December 31,
| |  |  | -----------------------
|
|
|
|
| |  |  | b.                     
| |  |  |                        
| |  |  |                        
| |  | 
| |  |  | c.                     
| |  |  |                        
| |  |  |                        
| |  | 
| |  |  | d.                     
| |  |  |                        
| |  |  |                        

| | See
also Note 6.
| | ----------------

# NOTE 17:- SELECTED
OPERATIONS DATA

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

|                                             | Year ended December 31,
|-------------------------------------------- | -----------------------
|
|
|
|
|Total research and development costs         |                        
|Less - grants and participation              |                        
|Capitalization of software development costs |                        
|                                             |                        
|                                             |                        
|                                             |                        
|                                             |                        

| | b. | Other
income (expenses), net
| | -- | ----------------------------

|                                              | Year ended December 31,
|--------------------------------------------- | -----------------------
|
|
|
|
|Impairment losses of V.Box                    |                        
|Impairment losses of Mobixell                 |                        
|Gain (loss) on sale of property and equipment |                        
|Other income (see Note 12)                    |                        
|                                              |                        
|                                              |                        
|                                              |                        
|                                              |                        

F - 39

---

---

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

# NOTE 17:- SELECTED
STATEMENTS OF OPERATIONS DATA (Cont.)

| | c. | Financial
income:
| | -- | -----------------

|                                              | Year ended December 31,
|--------------------------------------------- | -----------------------
|
|
|
|
|Financial income:                             |                        
|Interest                                      |                        
|Foreign currency translation adjustments      |                        
|Realized gains on sale of available-for-sale  |                        
|marketable securities                         |                        
|                                              |                        
|                                              |                        
|                                              |                        
|                                              |                        
|Financial expenses:                           |                        
|Interest                                      |                        
|Realized losses on sale of trading marketable |                        
|securities                                    |                        
|                                              |                        
|                                              |                        
|                                              |                        
|                                              |                        
|                                              |                        
|                                              |                        
|                                              |                        

| | d. | Net
earnings (loss) per share:
| | -- | ------------------------------

| | The
following table sets forth the computation of basic and diluted net earnings (loss) per
share:
| | --------------------------------------------------------------------------------------------------

|                                              | Year ended December 31,
|--------------------------------------------- | -----------------------
|
|
|
|
|Numerator:                                    |                        
|                                              |                        
|Numerator for basic and diluted net earnings  |                        
|(loss) per share- income (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.
| | -- | -------------

F - 40

---

---

# Signatures

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

|Dated:  June 10, 2005 |  | OPTIBASE LTD.BY: /S/ Uzi Breier
Uzi BreierChief Executive Officer
|--------------------- |  | -------------------------------------------------------------------------------

- 81 -

---

---



# Exhibits

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

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

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

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

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

| | Exhibit
A Form Voting Agreement
| | -------------------------------

| | Exhibit
B Form of Krooss Employment Agreement (see Exhibit 10.1)
| | ----------------------------------------------------------------

| | Exhibit
C Forms of Employment Agreement
| | ---------------------------------------

| | Exhibit
D Form of Individual Shareholder Agreement
| | --------------------------------------------------

| | Exhibit
E Form Escrow Agreement (see Exhibit 2.3)
| | -------------------------------------------------

| | Exhibit
F Form of Agreement of Merger
| | -------------------------------------

| | Exhibit
G Form of Opinion from legal counsel to Viewgraphics
| | ------------------------------------------------------------

| | Exhibit
H Forms of Opinion from legal counsels to Optibase
| | ----------------------------------------------------------

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

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

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

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

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

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

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

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

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

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

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

- 82 -

---

---



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

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

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

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

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

|4.(c).9 |  | 2003
 Amendment to the 1999 Israel Share Option Plan  (incorporated  by reference to exhibits
filed                       with the Registrant's Annual Report on Form 20-F for the
fiscal year ended December 31, 2003).
|------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|8.1 |  | List
of the  subsidiaries  of the Company  (incorporated  by reference  to exhibits  filed
with the                       Registrant's Annual Report on Form 20-F for the fiscal
year ended December 31, 2003).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|11 |  | Code
of  Business  Conduct  and  Ethics  (incorporated  by  reference  to  exhibits  filed
with the                       Registrant's Annual Report on Form 20-F for the fiscal
year ended December 31, 2003).
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

|13.(a).1 |  | Certification by Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
|-------- |  | ---------------------------------------------------------------------------------------------------

|13.(a).2 |  | Certification by Principal  Financial Officer pursuant to Section 906 of the
 Sarbanes-Oxley Act of                       2002.
|-------- |  | -------------------------------------------------------------------------------------------------------------------------------

- 83 -

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---