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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON,
DC 20549

FORM 20-F

(Mark
One)

xAnnual
report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For
the transition period from ________ to ________

Commission
file number 0-30348

ECtel  Ltd.(Exact name of registrant as specified in its charter)

Israel(Jurisdiction of incorporation or organization)

43
Hasivim Street, Petah Tikva 49130, Israel(Address of principal executive offices)

Securities
registered or to be registered pursuant to Section 12(b) of the Act:
None

Securities
registered or to be registered pursuant to Section 12(g) of the Act:
Ordinary Shares, Nominal Value NIS 0.04 Per Share(Title of Class)

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

Indicate
the number of outstanding shares of each of the Issuers classes of capital or
common stock as of December 31, 2003:

17,995,628
Ordinary Shares, nominal value NIS 0.04 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 x   No
o

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

Item 17 o   Item
18 x

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TABLE OF CONTENTS

|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 
|                                                               |   
|A.
  Selected Financial Data                                   | 5 
|                                                               |   
|B.
  Capitalization and Indebtedness                           | 7 
|                                                               |   
|C.
  Reasons for the Offer and Use of Proceeds                 | 7 
|                                                               |   
|D.
  Risk Factors                                              | 7 
|                                                               |   
|Item
  4. Information on the Company                           | 19
|                                                               |   
|A.
  History and Development of the Company                    | 19
|                                                               |   
|B.
  Business Overview                                         | 19
|                                                               |   
|C.
  Organizational Structure                                  | 27
|                                                               |   
|D.
  Property, Plants and Equipment                            | 27
|                                                               |   
|Item
  5. Operating and Financial Review and Prospects         | 28
|                                                               |   
|A.
  Operating Results                                         | 28
|                                                               |   
|B.
  Liquidity and Capital Resources                           | 37
|                                                               |   
|C.
  Research and Development, Patents and Licenses            | 39
|                                                               |   
|D.
  Trend Information                                         | 40
|                                                               |   
|E.  Off-Balance Sheet
  Arrangements                           | 41
|                                                               |   
|F.  Tabular Disclosure of
  Contractual Obligations            | 41
|                                                               |   
|Item
  6. Directors, Senior Management and Employees           | 41
|                                                               |   
|A.
  Directors and Senior Management                           | 41
|                                                               |   
|B.
  Compensation                                              | 43
|                                                               |   
|C.
  Board Practices                                           | 43
|                                                               |   
|D.
  Employees                                                 | 46
|                                                               |   
|E.
  Share Ownership                                           | 47
|                                                               |   
|Item
  7. Major Shareholders and Related Party Transactions    | 48

2

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|                                                                                          |   
|----------------------------------------------------------------------------------------- | --
|A.
  Major Shareholders                                                                   | 48
|                                                                                          |   
|B.
  Related Party Transactions                                                           | 49
|                                                                                          |   
|C.
  Interests of Experts and Counsel                                                     | 52
|                                                                                          |   
|Item
  8. Financial Information                                                           | 52
|                                                                                          |   
|A.
  Consolidated Statements and Other Financial Information                              | 52
|                                                                                          |   
|B. Significant Changes                                                                    | 52
|                                                                                          |   
|Item
  9. The Offer and Listing                                                           | 53
|                                                                                          |   
|A.
  Offer and Listing Details                                                            | 53
|                                                                                          |   
|B.
  Plan of Distribution                                                                 | 53
|                                                                                          |   
|C.
  Markets                                                                              | 53
|                                                                                          |   
|D.
  Selling Shareholders                                                                 | 53
|                                                                                          |   
|E.
  Dilution                                                                             | 53
|                                                                                          |   
|F.
  Expenses of the Issue                                                                | 53
|                                                                                          |   
|Item
  10. Additional Information                                                         | 54
|                                                                                          |   
|A.
  Share Capital                                                                        | 54
|                                                                                          |   
|B.  Memorandum and Articles of
  Association                                              | 54
|                                                                                          |   
|C.  Material Contracts                                                                    | 59
|                                                                                          |   
|D.  Exchange Controls                                                                     | 60
|                                                                                          |   
|E.
  Taxation                                                                             | 60
|                                                                                          |   
|F.
  Dividends and Paying Agents                                                          | 69
|                                                                                          |   
|G.  Statement by Experts                                                                  | 69
|                                                                                          |   
|H.
  Documents on Display                                                                 | 69
|                                                                                          |   
|I.
  Subsidiary Information                                                               | 69
|                                                                                          |   
|Item
  11.  Quantitative and
  Qualitative Disclosures about Market Risk                  | 69
|                                                                                          |   
|Item
  12.  Description of
  Securities other than Equity Securities                      | 71
|                                                                                          |   
|PART II                                                                                   | 71
|                                                                                          |   
|Item
  13. Defaults, Dividend Averages and Delinquencies                                  | 71
|                                                                                          |   
|Item
  14. Material Modifications to the Rights of Security Holders
  and Use of Proceeds | 71
|                                                                                          |   
|Item
  15. Controls and Procedures                                                        | 71

3

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|                                                                   |   
|------------------------------------------------------------------ | --
|Item
  16A. Audit Committee Financial Expert                       | 72
|                                                                   |   
|Item
  16B. Code of Ethics                                         | 72
|                                                                   |   
|Item
  16C. Principal Accountant Fees and Services                 | 72
|                                                                   |   
|Item
  16D. Exemptions from Listing Standards for Audit Committees | 73
|                                                                   |   
|PART III                                                           | 73
|                                                                   |   
|Item
  17. Financial Statements                                    | 73
|                                                                   |   
|Item
  18. Financial Statements                                    | 73
|                                                                   |   
|Item
  19. Exhibits                                                | 73

4

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PART   I

Unless
the context otherwise requires, all references in this annual report to
ECtel, us, we, our and the Company refer to ECtel Ltd. and its
subsidiaries, and all references to ECI refer to ECI Telecom Ltd.  References to dollars or $ are to United
States Dollars. References to NIS are to New Israeli Shekels.

On
March 31, 2004, we sold our government surveillance business to Verint
Systems.  Accordingly, our statements of
operations, including those of prior periods, reflect the results of operations
of this business in the line item called income (loss) from discontinued
operations. All data in this Annual Report derived from statements from our
statements of operations, unless otherwise specified, exclude our government
surveillance business.

Statements
in this annual report concerning our business outlook or future economic
performance; anticipated revenues, expenses or other financial items;
introductions and advancements in development of products, and plans and
objectives related thereto; and statements concerning assumptions made or
expectations as to any future events, conditions, performance or other matters,
are forward-looking statements as that term is defined under the United
States Federal Securities Laws.  In some
cases, you can identify forward-looking statements by our use of words such as
expect, anticipate, believe, intend, plan, seek, and estimate and
similar expressions. Forward-looking statements are subject to risks,
uncertainties and other factors which could cause actual results to differ
materially from those in such statements. 
Factors that could cause or contribute to these differences include, but
are not limited to, those set forth under Item 3D - Risk Factors in this
annual report and elsewhere in this annual report as well as our reports on
Form 6-K submitted to the Securities and Exchange Commission.

Item 1. Identity Of Directors, Senior Management And
Advisers

Not
Applicable.

Item 2. Offer Statistics And Expected Timetable

Not
Applicable.

Item 3. Key Information

A.     Selected Financial Data

We
derived the following selected consolidated statements of income data for the
years ended December 31, 2001, 2002 and 2003 and the selected consolidated
balance sheet data as of December 31, 2002 and 2003 from the audited
consolidated financial statements incorporated by reference in this annual
report.  The selected consolidated
statements of income data for the years ended December 31, 1999 and 2000, and
the selected consolidated balance sheet data as of December 31, 1999, 2000 and
2001 have been derived from our audited consolidated financial statements not
included in this annual report. These figures have been adjusted to reflect the
sale of our government surveillance business as described in the next
paragraph.  Our consolidated statements
have been prepared in dollars in accordance with generally accepted accounting
principles in the United States and have been audited by Somekh Chaikin, a
member of KPMG International, independent public accountants in Israel, whose
report with respect to these financial statements is incorporated by reference
in this annual report.  The following
selected financial data should be read in conjunction with Item 5 - Operating
and Financial Review and Prospects and the consolidated financial statements
and the notes thereto incorporated by reference in this annual report. These
data should not be construed as indicative of our future operating results or
financial position.

In
March 2004, we sold our government surveillance business to Verint Systems
pursuant to an asset purchase agreement, which is described below under Item
10.C Additional InformationMaterial Agreements.  The results of operations of this business for each of the five
years ended December 31, 2003 are reflected in our statements of income in the
line item called income (loss) from discontinued operations, and the assets
and liabilities of this business as of December 31, 2003 are reflected in our
balance sheet in separate line items, as well.

5

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|                                                                                                       |  | Year ended December 31,                         |           
|------------------------------------------------------------------------------------------------------ |  | ----------------------------------------------- | ----------
|                                                                                                       |  |                                                 |           
|                                                                                                       |  | (*)1999                                         |           
|                                                                                                       |  |                                                 |           
|                                                                                                       |  | (in thousands, except share and per share data) |           
|                                                                                                       |  |                                                 |           
|Statements of Income Data:                                                                             |  |                                                 |           
|                                                                                                       |  |                                                 |           
|Revenues                                                                                               |  | $                                               | 28,559    
|Cost of  revenues                                                                                      |  |                                                 | 12,093    
|                                                                                                       |  |                                                 |           
|                                                                                                       |  |                                                 |           
|Gross profit                                                                                           |  |                                                 | 16,466    
|Research and  development costs, net                                                                   |  |                                                 | 4,280     
|Selling and  marketing expenses                                                                        |  |                                                 | 6,210     
|General and  administrative expenses                                                                   |  |                                                 | 3,242     
|In process
  research and development 
  costs                                                         |  |                                                 |          
|Amortization
  of goodwill                                                                             |  |                                                 | 950       
|Goodwill
  impairment                                                                                  |  |                                                 |          
|                                                                                                       |  |                                                 |           
|Total
  operating expenses                                                                             |  |                                                 | 14,682    
|                                                                                                       |  |                                                 |           
|Operating income (loss)                                                                                |  |                                                 | 1,784     
|Financial
  income, net                                                                                |  |                                                 | (236      
|Other income
  (expenses), 
       net                                                                 |  |                                                 | 178       
|                                                                                                       |  |                                                 |           
|Income (loss) before taxes on 
  income                                                                |  |                                                 | 1,842     
|Taxes on
  income (tax benefit)                                                                        |  |                                                 | 1,010     
|                                                                                                       |  |                                                 |           
|Net income from continuing operations before
  cumulative effect of change in accounting 
  principles |  |                                                 | 832       
|Cumulative
  effect of change in accounting principles                                                 |  |                                                 |          
|Income (loss) from discontinued operations                                                             |  |                                                 | 3,074     
|                                                                                                       |  |                                                 |           
|Net income (loss) for the
  year                                                                       |  | $                                               | 3,906     
|                                                                                                       |  |                                                 |           
|Earnings (loss) per
  share                                                                            |  |                                                 |           
|Basic
  earnings per share:                                                                            |  |                                                 |           
|Continuing
  operations                                                                                |  | $                                               | 0.07      
|Cumulative
  effect of change in accounting
  principles                                               |  |                                                 |           
|Discontinued
  operations                                                                              |  |                                                 | 0.24      
|                                                                                                       |  |                                                 |           
|                                                                                                       |  | $                                               | 0.31      
|                                                                                                       |  |                                                 |           
|Weighted
  average number of shares 
  outstanding                                                     |  |                                                 | 12,766,336
|Diluted
  earnings per
  share:                                                                        |  |                                                 |           
|Continuing
  operations                                                                                |  | $                                               | 0.06      
|Cumulative
  effect of change in accounting 
  principles                                              |  |                                                 |           
|Discontinued
  operations                                                                              |  |                                                 | 0.23      
|                                                                                                       |  |                                                 |           
|                                                                                                       |  | $                                               | 0.29      
|                                                                                                       |  |                                                 |           
|Weighted
  average number of shares 
  outstanding                                                     |  |                                                 | 13,311,643
|                                                                                                       |  |                                                 |           

|    
|----
|(*) 
|(**)

6

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|                                                                    |  | December
  31,   |       
|------------------------------------------------------------------- |  | ---------------- | ------
|                                                                    |  |                  |       
|                                                                    |  | 1999             |       
|                                                                    |  |                  |       
|                                                                    |  | (in
  thousands) |       
|                                                                    |  |                  |       
|Balance Sheet Data:                                                 |  |                  |       
|                                                                    |  |                  |       
|Cash and cash equivalents                                           |  | $                | 42,595
|Working capital                                                     |  |                  | 55,546
|Assets - discontinued operations                                    |  |                  |       
|Total assets                                                        |  |                  | 73,001
|Due to (from) parent and fellow
       subsidiary companies, net    |  |                  | 3,176 
|Due to parent and fellow subsidiary
       companies, net long-term |  |                  | 3,176 
|Shareholders equity                                                |  |                  | 55,886

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B.      Capitalization and Indebtedness

Not applicable.

C.     Reasons for the Offer and Use of
Proceeds

Not applicable.

D.      Risk Factors

We
believe that the occurrence of any one or some combination of the following
factors could have a material adverse effect on our business, financial
condition and results of operations.

Risks
Related to Our Business and Our Industry

The
general deterioration of the global economy, the slow-down in expenditures by
telecommunications service providers and other trends in our industry could
continue to have a material adverse effect on our results of operations.

Our
business is dependent on current and anticipated market demand for our
products.  Since 2003, such market
demand has been negatively impacted by the general deterioration of the global
economy and economic uncertainty in the telecommunications market.  These conditions and the uncertainties
surrounding growth rates worldwide resulted in a curtailment of capital
investment by telecommunications carriers and service providers beginning late
in 2000.  Several major telecommunications
service providers such as Global Crossing have failed, as have many new and
small providers.  In addition, existing
service providers have been reducing or delaying expenditures on new equipment
and applications as a result of the continued deterioration in the
telecommunications market.

7

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Many
companies, including current and potential customers of ours, have postponed or
decreased further capital investment or have indicated to us that they intend
to do so.  This decline in capital
expenditures has resulted in a significant decline in our sales and pressure on
the price of our products.  Due to the
past volatility of the market, it is difficult to predict the conditions of our
market going forward.  A continued
decline in capital expenditures would reduce our sales further and could result
in additional downward pressure on the price of our products, either of which
would have a continued material adverse effect on our operating results.

In 2003
and the first quarter of 2004 our revenues significantly declined, resulting in
net losses and negative cash flows. If our sales do not increase or if they
should continue to decline and we continue to experience low visibility with
respect to the timing and closing of sales, our results of operations will
continue to be materially adversely affected.

Our
revenues for 2003, excluding our government surveillance business, were $28.9
million, compared to $52.4 million for 2002. 
Our net loss for 2003 was $40.7 million, of which $4.9 million was
attributable to our discontinued government surveillance business, compared
with net income of $17.3 million for 2002. Revenues for the first quarter of
2004, which, following the sale of our government surveillance business,
consist exclusively of our telecom business, were $3.3 million, compared with
$10.0 million for the first quarter of 2003. Net income for the first quarter
of 2004 was $2.9 million, of which $12.2 million was attributable to our
discontinued government surveillance business, compared with a net loss of $3.8
million, for the first quarter of 2003. 
Net loss from continuing operations for the first quarter of 2004 was
$9.3 million, compared with a loss of $4.8 million, for the first quarter of
2003.

The
results reflect the economic situation described above, including long sales
cycles.  It also reflects the impact of
the extended negotiations associated with the sale of our government
surveillance business and management transition.   We are taking measures to lower our operating expenses and
decrease our cost structure, including reducing our labor force, wages and
overhead expenses.  We may be unable,
however, to decrease some of our expenses in a timely manner.  If our sales do not increase or if they
should continue to decline and we are unable to decrease our expenses
accordingly, our annual and quarterly results will continue to be materially
adversely affected. In addition, decreased revenues could necessitate
adjustments in the value of goodwill, other intangible assets and inventory.

Our
recovery plan may not succeed.

We
are currently formulating a recovery plan which we expect to implement in the
second half 2004. We cannot guarantee that we will succeed in fully
implementing the plan or, even if fully implemented, that the plan will achieve
its recovery goals.

Many of
our customers require a lengthy, detailed and comprehensive evaluation process
before they order our products.  Our
sales process has been subject to delays that have significantly decreased our
revenues and which could result in the eventual cancellations of some projects.

We
derive substantially all of our revenues from the sale of products and related
services for telecommunications service providers.  The purchase of our products represents a relatively significant
capital expenditure for our customers. 
As a result, our products generally undergo a lengthy evaluation and
purchase process before we can sell them. 
Due to the current economic climate, our customers are conducting a more
stringent and detailed evaluation of our products, and decisions are subject to
additional levels of internal review. 
As a result, the evaluation process has significantly lengthened.  This evaluation process is currently taking
between six and 18  months.  The following factors, among others, affect
the length of the approval process:

| | the time involved for our customers to determine and
  announce their specifications;
|- | -------------------------------------------------------------------------------------
|  |                                                                                      
| | the time required for our customers to process
  approvals for purchasing decisions; 

8

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|  |                                                                                         
|- | ----------------------------------------------------------------------------------------
| | the complexity of the products involved;                                                
|  |                                                                                         
| | the technological priorities and budgets of our
  customers; and                        
|  |                                                                                         
| | the need for our customers to obtain or comply with
  any required regulatory approvals.

Delays
in project approval have significantly decreased our revenues.  If this trend of delays continues, if delays
lengthen further, or if such continued delays result in the eventual
cancellation of any projects, it would continue to seriously harm our business
and results of operations.

We have
experienced and may continue to experience fluctuations in our quarterly
results of operations, which has resulted and may continue to result in
volatility in our share price.  In
addition, we may experience fluctuations in our annual results of operations,
which may have a similar impact on our share price.

We
have experienced and may continue to experience significant fluctuations in our
quarterly results of operations, and we may likewise experience significant
fluctuations in our annual results of operations.  Factors which have contributed and may in the future contribute
to fluctuations in our results of operations include:

| | general economic conditions;                                                                                                  
|- | ------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                               
| | the capital spending patterns of our customers;                                                                               
|  |                                                                                                                               
| | the size and timing of orders, including order
  deferrals, and subsequent shipments;                                         
|  |                                                                                                                               
| | market acceptance of new products;                                                                                            
|  |                                                                                                                               
| | the timing of our product introductions or
  enhancements or that of our competitors or providers of complementary
  products;
|  |                                                                                                                               
| | the timing of approval of Israeli government
  research and development grants;                                               
|  |                                                                                                                               
| | the percentage of sales for which we pay sales
  commissions;                                                                 
|  |                                                                                                                               
| | disruptions in our sources of supply; and                                                                                     
|  |                                                                                                                               
| | increasing delays between the receipt of awards and
  the formal issuances of purchase orders.                                

The
results of past periods should not be relied upon as an indication of our
future performance.  It is likely that
in some future periods, our operating results may again be below expectations
of public market analysts or investors, which may cause our share price to
drop.

We are
dependent upon Verint Systems to complete the implementation of certain
government projects and provide warranty services to our government customers,
and we could be exposed to liability if Verint System fails to do so
satisfactorily.

In
connection with the sale to Verint Systems of our government surveillance
business, we retained substantially
all our existing government surveillance projects and
warranty obligations and agreed to subcontract the performance thereof to
Verint Systems upon agreed terms. 
However, since we remain legally bound to the applicable government
customers, we could have difficulties collecting payments from these customers
and be exposed to claims by them if Verint Systems fails for any reason to
perform in a manner that these customers consider to be satisfactory.  In addition, with respect to some of these
obligations, we are obligated to pay Verint Systems for their services even if
we have not received payment from the customers.  Therefore, our financial condition and results of operations
would suffer if these customers do not pay us on a timely basis.  If we would be required for any reason to
seek a new subcontractor to provide these services, a new subcontractor may not
be available at all and, in any event, switching to a new subcontractor would
involve significant delay and expense, which could further expose us to claims
by these government customers.

9

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---

We have
a limited backlog of orders and must maintain sufficient inventory levels to
meet anticipated demand.  If we cannot
predict orders accurately, our inventory may become obsolete and our financial
performance may be harmed.

The
timing and volume of orders are difficult to forecast for each quarter, as a
substantial majority 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. For example, in the first quarter of 2004, we recorded an
inventory write-off of approximately $950,000, which derives from inventory
that became obsolete or that we estimate that we will not be able to sell.

We
depend on several relatively large customers and the loss of one or more of
these customers, or a significant decrease in revenue from any of these
customers, could have a disproportionate impact on our revenue and income.

A
substantial portion of our revenue has come from relatively large purchases by
a small number of customers.  Sales to
our top ten customers accounted for 75.1% of our revenues in 2003, with sales
to one customer in Europe  accounting
for 13.9% of our revenues  and sales to
a customer in Latin and North America accounting for 11.4% of our
revenues.  Sales to our top ten
customers accounted for 68.8% of our revenues in 2002, with sales to one
customer in the Asian Pacific region accounting for 27.0% of our revenues. We
expect to continue to depend on sales to a small number of customers.   However, we do not have long-term
commitments from any of our top customers to purchase any specific quantities
of products.  We expect that our largest
customers will vary from period to period. 
If we lose one or more large customers and fail to add new customers our
results of operations could be seriously harmed.

The
payment cycle for our receivables has lengthened and could lengthen
further.  This has reduced, and any
further lengthening in the payment cycle could further reduce, the cash we have
available to operate and expand our business.

As
is typical in the telecommunications industry, our contracts may provide for
payments under a variety of payment schedules. 
For example, we may receive a deposit prior to shipment, a partial
payment upon delivery and final payment after 180 or 360 days from
delivery.  Because of the current issues
affecting our industry, we have been required to provide extended payment terms
to facilitate sales to customers.  When the
payment cycle for our receivables lengthens, we use more of our cash reserves
to fund our operations.  Any further
increase in the payment cycle for our receivables would further decrease the
cash available to us for our operations and the expansion of our business.  In addition, we sell certain trade
receivables in the ordinary course of business, and the lengthening payment
cycle may have an adverse impact on our ability to continue to do so.

Because
the telecommunications market is characterized by rapid technological and other
changes, our success depends on our ability to continually develop new and more
technologically advanced products and product enhancements that achieve market
acceptance.

The
telecommunications market is characterized by rapid technological advances and
frequent new product introductions and enhancements.  We believe that our future success will largely depend upon our
ability to continue to enhance our existing products and to successfully
develop and market new products on a cost-effective and timely basis.  The technologies applicable to our products
include applications capable of analyzing and processing data based on accepted
telephony standards and protocols.  If
other technological standards and protocols gain broad market acceptance, we
will be required to redesign our existing products or design new products that
are able to view and analyze networks based on these new standards and
protocols.  For example, the types of
fraudulent schemes to which service providers are subject change with the
emergence of new technologies, networks and other developments.  We cannot assure you that we will be
successful in developing and marketing new applications or systems that will respond
to technological change.

10

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---

The market
for our products is highly competitive.  
Because many of our competitors have much greater resources than we
have, it may be difficult for us to return to, and maintain, profitability.

Competition
in our industry is intense, and we expect it to continue.  To compete effectively, we have, at times,
been required to grant substantial discounts on our products.  In addition, we could lose sales to our
competitors.  Lower prices and reduced
demand for our products would reduce our ability to generate revenue, which
would harm our business.

Many
of the companies that compete with us have greater name recognition, longer
operating histories, larger customer bases and significantly greater financial,
marketing, public relations, sales, distribution and other resources.  Some of our competitors and potential
competitors are among the largest and most capitalized software and hardware
companies in the world.  Also, some of
our competitors have located their research and development facilities in
countries where labor costs for engineers and other experienced personnel are
far lower than in Israel and the United States, where our research and
development facilities are located.

We
may also face competition from our customers. 
Some of our customers are developing their own solutions internally or
through strategic alliances.  Also, the
internal information technology departments of some service providers, are
acting as our competitors for the provision of various revenue assurance solutions
within their own companies.  As a
result, solutions developed by our customers may replace and/or compete with
products that we currently sell to them or that we may seek to sell to them in
the future.

In efforts to cope with capital expenditure cuts,
some customers have developed revenue sharing models for the purchase of
systems such as ours.  If we are unable
or unwilling to accept these models, we may lose sales to other suppliers.

Faced with the need to
decrease their capital expenditures, some of our customers and potential
customers are choosing to purchase solutions such as ours from providers who
are willing to participate in revenue sharing models rather than requiring
agreed-upon fixed payments.  Under these
models, the solution provider typically is paid a proportion of the revenues
that the service provider saves as a result of implementing the solution.  Some of our competitors are offering revenue
sharing models themselves in order to make their solutions more
attractive.  We have made proposals
pursuant to a limited revenue-sharing model under which we require payment of
part of the price of our products, while the remainder of the price is subject
to a revenue-sharing arrangement.  If we
are unwilling to accept the revenue sharing models proposed by our customers
and potential customers, and cannot create an equally attractive alternative
solution through our limited revenue-sharing model, our sales may
decrease.  As a result, our results of
operations may suffer.  Furthermore, revenue
sharing for the types of revenue assurance solutions that we provide is
relatively untried.  We do not know
whether any of the proposed models can effectively demonstrate the revenue to
which we would be entitled. In addition, even if we do participate in revenue
sharing arrangements, a portion of revenues would be deferred, which could have
a short-term adverse affect on our results of operations.

Most of
our products are based on a single technology platform, and our business will
suffer if we cannot develop new products based on this platform to meet the
needs of our customers.

Most
of our software applications are based on a single technology platform.  If we are unable to develop new products
that meet the needs of our customers because of our reliance on this single
technology platform, sales of our products could decline.  Any significant decrease in the sales of our
products could seriously harm our results of operations.

Our
customers generally operate their networks using a wide variety of software
applications, network equipment and software and hardware platforms.  If our products fail to integrate properly
with our customers equipment, our ability to generate future sales will be harmed.  For example, our platform uses the Windows
NT operating system.  Most companies in
the telecommunications industry currently use UNIX and may not be willing to
implement a solution based on Windows NT. 
If service providers are unwilling to accept a Windows NT-based
solution, our business will be harmed.

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Our
business and its future growth depend on increased market acceptance of
services based on packet-switched technology and third generation wireless
networks.  If these services are not
fully developed and accepted in the marketplace, our growth plans will be
materially adversely affected.

Several
of our newer products are designed to meet the specific requirements of new
value-added services being made available by packet-switched technology and
third generation wireless networks. 
Demand and market acceptance for these services are subject to a high
level of uncertainty.  For example, the
deployment of third generation networks has been delayed throughout the world
in comparison with initial expectations. 
At the same time, service providers are hesitating to invest in their
existing networks due to their perception that these networks have a relatively
short life-cycle.  If third generation
networks and VoIP services are not fully developed and accepted in the
marketplace, or if the implementation by service providers of third generation
wireless networks continues to be significantly delayed due to economic or
other problems, the market for some of our newer products may not develop or be
sustainable.  In that case, our business
would be materially adversely affected.

Implementation
of certain new technologies by telecom carriers may result in a decline in
demand for our products.

New
technologies, such as VoIP, are facilitating the use of cheaper communications
media by some telecom service providers.  
Such service providers may be less inclined to invest in high-end
solutions like ours. Moreover, since these technologies enable the service
providers to offer relatively low calling rates to subscribers, this may reduce
the incentive to commit telecom fraud and thereby reduce the demand for
anti-fraud solutions like ours. This trend may harm our revenues and results of
operation.

We do
business with companies located in countries around the world, which subjects
us to additional risks.  If these risks
materialize, our business will be materially adversely affected.

Because
of the global nature of our business, we are exposed to the risk of economic or
political instability in countries where our customers are located,
particularly in developing countries. 
Various Latin American and African countries are currently suffering
from economic instability, which could spread to additional countries in the
region, and we do business in a number of countries in Central and Latin
America.  In addition, there are often
longer sales and payment cycles in developing countries, as well as greater
difficulties in collecting accounts receivable.

We
face additional risks from our international operations including:

| | difficulties of obtaining licenses, the imposition
  of tariffs and the effects of other trade barriers;
|- | --------------------------------------------------------------------------------------------------------
|  |                                                                                                         
| | difficulties in staffing and managing foreign
  operations;                                             
|  |                                                                                                         
| | potentially adverse tax consequences;                                                                   
|  |                                                                                                         
| | laws and business practices favoring local
  competitors;                                               
|  |                                                                                                         
| | costs and difficulties of customizing products for
  foreign countries;                                 
|  |                                                                                                         
| | compliance with a wide variety of complex foreign
  laws and treaties; and                              
|  |                                                                                                         
| | variance and unexpected changes in local laws and
  regulations.                                        

If
we fail to overcome the challenges we encounter in our international
operations, our business will be materially adversely affected.

12

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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 our protection of our
proprietary technology, including both hardware and software components of our X-ellence platform.  We currently rely on a combination of
patents, trade secret and copyright laws, nondisclosure and other contractual
agreements and technical measures to protect our proprietary rights. We have
filed several patent and trademark applications covering some of our technology
and are in the process of preparing and filing additional patent and trademark
applications.  We cannot assure you that
any of these applications will be granted. 
These agreements and measures may not be sufficient to protect our
technology from third-party infringement, or to protect us from the claims of
others.  Additionally, our products may
be sold in foreign countries that provide less protection to intellectual
property than that provided under U.S. or Israeli laws.  Moreover, competitors and potential
competitors may attempt to copy or reverse engineer aspects of our product line
or to obtain and use information that we regard as proprietary.  If we are unable to maintain the security of
our proprietary technology for these or any other reasons, our business may
suffer.

Because
our products may infringe on the intellectual property rights of third parties,
our business will suffer if we are sued for infringement or cannot obtain
licenses to these rights on commercially acceptable terms.

We
are subject to the risk of adverse claims and litigation alleging infringement
by us of the intellectual property rights of others.  Many participants in the telecommunications industry have an
increasing number of patents and patent applications and have frequently
demonstrated a readiness to pursue litigation based on allegations of patent
and other intellectual property infringement. 
All of our products rely on technology that could be the subject of
existing patents or patent applications of third parties.  We have agreed to indemnify our customers
with respect to infringement by our products of the proprietary rights of third
parties.  Third parties may assert
infringement claims in the future with respect to our current or future
products.  These claims may require us
to enter into license arrangements or result in protracted and costly
litigation, 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 our products in some or all
countries, and our business would be seriously harmed.

Because
we currently depend on licensed software as part of some of our products, our
results of operations will suffer if we are unable to maintain these licenses
on commercially reasonable terms or if the vendors are unable to provide the
necessary support and maintenance.

We
currently rely upon software that we license from third parties as part of some
of our products, including software that is integrated with our internally
developed software and used in our products to perform key functions. For
example, we utilize a software package of i2 Technologies in our fraud
management solution.  We may be unable
to maintain these software licenses from third parties on commercially
reasonable terms, if at all. This could result in shipment delays or reductions
until equivalent replacement software could be developed or licensed and
integrated into our products.  Any
inability to maintain these licenses could harm our business.  Furthermore, some software is licensed from
relatively small vendors, who may not be able to survive if the current
difficult economic climate continues. 
If any of these vendors cease their operations, we may face difficulties
in obtaining the necessary support and maintenance for the software originally
provided by them.

Currency
fluctuations could cause customers to decrease or cancel orders or default on
payment.

Currently
our international sales are denominated primarily in U.S. dollars.  Accordingly, devaluation in the local
currencies of our customers relative to the U.S. dollar could cause customers
to decrease or cancel orders or default on payment.  An increasing portion of our international sales is now
denominated in Euros, and in the future additional sales may be denominated in
currencies other than U.S. dollars, thereby exposing us to gains and losses on
non-U.S. currency transactions.  We may
choose to limit this exposure by entering into hedging transactions.  However, hedging transactions may not
prevent exchange-related losses, and our business may be harmed by exchange
rate fluctuations.  Furthermore, as we
seek to expand our sales to regions throughout the world, we might be exposed
to risks of customers located in countries suffering from uncertain economic
environments such as high inflation and solvency problems.

13

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We could
be subject to warranty claims and product recalls, which could be very
expensive and harm our financial condition.

We
typically provide one-year warranty programs with respect to our products.  Our warranty generally provides that we will
repair or replace products with defects in materials or workmanship or that
fail to meet agreed-upon specifications. 
Any significant product returns or warranty claims under our purchase
orders could adversely affect our results of operations.  We offer sophisticated products that may
contain software with undetected errors. 
In addition, new products may experience failures when first introduced,
and both current and future products may experience failures as new versions
are released.  We rely to a large extent
on our reputation among industry leaders in conducting our sales efforts.  As a result, any product recall as a result
of errors or failures, and the associated negative publicity, could result in
the loss of, or delay in, market acceptance of our products and hurt our
business.

Breaches
in the security of the data collected by our systems could adversely affect our
reputation and results of operations.

Our
customers rely on third-party security features to protect the privacy and
integrity of customer data.  Our
products may be vulnerable to breaches in security due to defects in the
security mechanisms, the operating system, the hardware platform or the
networks linked to the platform.  Our QualiWeb product, which provides
information using Web access, presents additional security issues for our
customers.  Exploitation of any
vulnerabilities could jeopardize the security of information stored in and
transmitted through the computer systems of our customers.  If the security of our products were compromised,
our reputation and future product acceptance would be significantly harmed,
which would cause our business to suffer. 
In addition, we may be liable to our customers for any breach in
security.  We may be required to expend
significant capital and other resources to further protect against security
breaches or to correct problems caused by any breach.

We
depend on a limited number of key personnel who would be difficult to
replace.  If we lose the services of
these individuals or cannot hire additional qualified personnel, our business
will be harmed.

Our
business and future growth and success largely depend on the managerial and
technical skills of Eitan Naor, our President and Chief Executive Officer, and
other members of senior management.  If
either Mr. Naor or other 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.

During
the last seven months, our chief executive officer and six of our vice
presidents, including the vice presidents in charge of research and
development, marketing, business development, operations, U.S. operations,
projects, sales and Western Europe sales have left our employ. During such
period, five of our directors resigned, one of whom was our chief executive
officer and three of whom were ECI nominees who resigned upon the share
distribution of ECI in May 2004. If we are unable to replace these officers and
directors with qualified individuals, our business and results of operations
could be harmed.  In addition, a
reduction of our workforce as part of our recovery measures could, in the
aggregate, have a negative impact on our operations.

Our
success also depends to a substantial degree upon our ability to attract,
motivate, and retain other highly-qualified personnel.  Despite the slow-down in high technology
industries in Israel, there is still considerable competition for the services
of highly-qualified technical and engineering personnel. There is also
considerable competition for the services of experienced sales and marketing
personnel.  We may not be able either to
retain our current personnel or hire additional qualified personnel if and when
needed.

We may
seek to expand our business through mergers and acquisitions that could result
in diversion of resources and extra expenses, which could disrupt our business
and harm our financial condition.

We
may pursue mergers and 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 or product could cause a diversion of
managements time and our resources. 
Future acquisitions could also result in:

14

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|  |                                                    
|- | ---------------------------------------------------
| | dilutive issuances of equity securities;           
|  |                                                    
| | the incurrence of debt and contingent liabilities; 
|  |                                                    
| | impairment of goodwill and other intangible assets;
|  |                                                    
| | research and development write-offs; and           
|  |                                                    
| | other acquisition-related expenses.                

We
cannot be sure that we will successfully integrate the business of any acquired
companies or joint ventures with our operations.  We may not receive the intended benefits of any future
acquisition or joint venture.  In
addition, we have limited experience with respect to operating acquired
businesses.  If the operation of the
business of any future acquisitions disrupts our operations, our business may
suffer.

We may be classified as a passive foreign investment company and, as a result, our U.S. shareholders may suffer
adverse tax consequences.

Generally,
if for any taxable year 75% or more of our gross income is passive income, or at least 50%
of our assets are held for the production of, or produce, passive income, we would be
characterized as a passive foreign investment company (PFIC) for U.S. federal
income tax purposes. This characterization could result in adverse U.S. tax consequences
to our shareholders, including having gain realized on the sale of our ordinary shares be
treated as ordinary income, as opposed to capital gain income, and having potentially
punitive interest charges apply to such sale proceeds. A decline in the value of our
ordinary shares may result in our being a PFIC. U.S. shareholders should consult with
their own U.S. tax advisors with respect to the United States tax consequences of
investing in our ordinary shares.

We
believe that we were not a PFIC for U.S. federal income tax purposes for our 2003 tax year
or for any prior year. It is possible that the Internal Revenue Service will attempt to
treat us as a PFIC for 2003 or prior years. The tests for determining PFIC status are
applied annually and it is difficult to make accurate predictions of future income and
assets, which are relevant to this determination. Accordingly, there is no assurance that
we will not become a PFIC in 2004 or in subsequent years. For a discussion of how we might
be characterized as a PFIC and related tax consequences, please see the section of this
annual report entitled Taxation  U.S. Federal Income Tax Considerations.

We
depend on a single supplier for key product components in our legacy probing devices,
and we cannot control the manufacturing and delivery of these components.  Our
business will be interrupted if this supplier is
unable or unwilling to provide these components.

A third party
manufactures critical components needed for our X-ellence platform. 
We cannot control the delivery schedule for these components.  Any problems
that may occur with respect to
the delivery, quality, which is our single source for these components,
or cost of these components could result in product
shortages or quality assurance problems. Our supplier has special expertise in
engineering these components.  If it is
unable or unwilling to provide these components, we will experience substantial
delays in the manufacturing of certain of our products, and our business will
suffer. In addition, in connection with our sale to Verint Systems of our
government surveillance business, we agreed to sell some of these components to
Verint Systems for a period of seven years. Any problems with our supplier
that cause us to breach
our obligations to Verint Systems, which problems may not be under our control,
could expose us to claims by Verint Systems. 
Such claims could materially harm our financial condition.

Our
costs may increase as a result of ECIs cessation of the control of us.

In
May 2004, ECI distributed 7.6 million of our ordinary shares to its
shareholders, causing its holdings of our outstanding ordinary shares to decrease
from 57.9% to 16.0%. In the past we benefited from certain cost savings as a
result of discounts afforded by third parties to members of the ECI group.
Following the share distribution, we may lose some of these benefits, which
would increase our expenses.

Risks
Related to Operations in Israel

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

Our
principal offices and manufacturing facilities and many of our suppliers are
located in Israel.  Accordingly,
political, economic and military conditions in Israel directly affect our
operations.  Since the establishment of
the State of Israel in 1948, a number of armed conflicts have taken place
between Israel and its Arab neighbors. 
A state of hostility, varying in degree and intensity, has led to
security and economic problems for Israel. 
Since October 2000, there has been a high level of violence between
Israel and the Palestinians, which has led to a breakdown of the entire peace
process and has affected Israels relationship with its Arab citizens and
several Arab countries. Furthermore, several countries restrict business with
Israel and Israeli companies, and additional companies may restrict doing
business with Israel and Israeli companies as the result of the recent increase
in hostilities. These restrictive policies have had and may continue to have an
adverse impact on our business.  We
could be adversely affected by any major hostilities involving Israel, the
interruption or curtailment of trade between Israel and its trading partners or
a significant downturn in the economic conditions in Israel.

15

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Our
results of operations may be negatively affected by the obligation of key
personnel to perform military service.

Some
of our executive officers and employees in Israel are obligated to perform
military reserve duty annually.  They
may also be further subject to being called to active duty at any time under
emergency circumstances.   Our
operations could be disrupted by the absence for a significant period of one or
more of our executive officers or key employees due to military service, and
any disruption in our operations would harm our business.  The full impact on our workforce or business
if some of our executive officers and employees will be called upon to perform
military service, especially in times of national emergency, is difficult to
predict.

Because
most of our revenues are generated in U.S. dollars but a significant portion of
our expenses are incurred in New Israeli Shekels, our results of operations may
be seriously harmed by inflation and currency fluctuations.

We
generate most of our revenues in U.S. dollars but incur a significant portion
of our expenses in New Israeli Shekels, commonly referred to as 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 such 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.  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 tax
benefits that we currently receive from the Investment Center of the Israeli
Ministry of Industry, Trade and Labor require us to meet several conditions and
may be terminated or reduced in the future, which would increase our taxes.

We
receive tax benefits under Israeli law for capital investments that are
designated as approved enterprises.  To
maintain our eligibility for these tax benefits, we must continue to meet
conditions stipulated in applicable law and in our specific approvals,
including making specified investments in fixed assets.  If we fail to comply with these conditions,
in whole or in part, with respect to any approved enterprise program we
establish, we may be required to pay additional taxes for the period in which
we benefited from the tax exemption or reduced tax rates and we would likely be
denied these benefits in the future. The applicable law regarding approved
enterprise programs will expire on June 30, 2004. Accordingly, requests for new
programs or expansions that are not approved on or before June 30, 2004 will
not confer any tax benefits, unless the term of the law will be extended.  These tax benefits may not continue in the
future at their current levels or at any level.  From time to time, we submit requests for expansion of our
approved enterprise programs or for new programs to be designated as approved
enterprises.  These requests might not
be approved, particularly in light of difficult economic conditions in Israel.
We received an approval in principle from the Investment Center with respect to
the sale of our government surveillance business to Verint Systems in March
2004. If the Investment Center declines, for any reason, to grant us the final
approval, our tax benefits under Israeli law will be materially reduced.  The termination or reduction of these tax
benefits could seriously harm our financial condition and results of
operations.

Because
we receive grants from the Office of the Chief Scientist, we are subject to
ongoing restrictions, and certain of our large shareholders are required to
undertake to observe such restrictions. 
Our grant programs may be terminated or reduced in the future, which
would increase our costs.

16

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We
receive royalty-bearing grants from the Office of the Chief Scientist of the
Israeli Ministry of Industry Trade and Labor for research and development
programs that meet specified criteria. According to Israeli law, any products
developed with grants from the Office of the Chief Scientist are required to be
manufactured in Israel, unless we obtain prior approval of a governmental
committee.  As a condition to obtaining
this approval, we may be required to pay the Office of the Chief Scientist up
to 300% of the grants we received and to repay such grants at a quicker
rate.  In addition, we are prohibited
from transferring to third parties in Israel the technology developed with these
grants without the prior approval of a governmental committee and we are
prohibited from transferring such technology to third parties outside
Israel.  Any non-Israeli who becomes a
holder of 5% or more of our outstanding ordinary shares will be required to
notify the Office of the Chief Scientist and to undertake to observe the law
governing the grant programs of the Office of the Chief Scientist, the
principal restrictions of which are the transferability limits described above
in this paragraph.

We
recorded grant participations of an aggregate of $842,000 in 2003 and
approximately $900,000 in 2002.  As of
December 31, 2003, our contingent liability to the Office of the Chief
Scientist with respect to grants received was approximately $2.4 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 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 Office of the Chief Scientist.  These requests might not be approved, particularly in light of the
difficult economic conditions in Israel. 
The termination or reduction of these grants could seriously harm
financial condition and results of operations.

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

Service
of process upon us, since we are incorporated and headquartered in Israel  and upon our directors and officers,
substantially all of whom reside outside the United States, may be difficult to
obtain within the United States. 
Furthermore, because substantially all of our assets and ECIs assets,
and substantially all of our directors and officers are located outside the
United States, any judgment obtained in the United States against us or any of
them may not be collectible within the United States.

There
is doubt as to the enforceability of civil liabilities under the Securities Act
of 1933 and the Securities Exchange Act of 1934 in original actions instituted
in Israel.  However, subject to
specified time limitations, Israeli courts may enforce a U.S. final executory judgment
in a civil matter, provided that:

| | adequate service of process has been effected and
  the defendant has had a reasonable opportunity to be heard;                                                   
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                   
| | the judgment and its enforcement are not contrary to
  the law, public policy, security or sovereignty of the State of Israel;                                    
|  |                                                                                                                                                                   
| | the judgment was obtained after due process before a
  court of competent jurisdiction according to the rules of private
  international law prevailing in Israel;
|  |                                                                                                                                                                   
| | the judgment was not obtained by fraudulent means
  and does not conflict with any other valid judgment in the same matter
  between the same parties;            
|  |                                                                                                                                                                   
| | an action between the same parties in the same
  matter is not pending in any Israeli court at the time the lawsuit is
  instituted in the U.S. court; and        
|  |                                                                                                                                                                   
| | the U.S. court is not prohibited from enforcing
  judgments of Israeli courts.                                                                                    

If
a foreign judgment is enforced by an Israeli court, it generally will be
payable in NIS, which can then be converted into non-Israeli currency and
transferred out of Israel.  The usual
practice in an action to recover an amount in non-Israeli currency is for the
Israeli court to render judgment for the equivalent amount in NIS at the rate
of exchange on the date of payment, but the judgment debtor also may make
payment in non-Israeli currency. 
Pending collection, the amount of the judgment of an Israeli court
stated in NIS ordinarily will be linked to the Israel Consumer Price Index plus
interest at the annual rate (set by Israeli law) prevailing at that time.  Judgment creditors bear the risk of
unfavorable exchange rates.

17

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Provisions
of Israeli law may delay, prevent or make more difficult a merger or other
business combination, and therefore depress the price of our stock.

The
Israeli Companies Law  1999 includes restrictions on mergers, such as special
voting requirements, the ability of creditors to seek court intervention to
delay or prevent a merger and a mandatory waiting period.  In addition, under certain circumstances,
the Companies Law requires that acquisitions be performed via tender
offer.  For more information, see Item
10B  Memorandum and Articles of Association -- Mergers and Acquisitions Under
Israeli Law.

Risks
Related to the Market for Our Ordinary Shares

Our
stock price has decreased significantly and could continue to fluctuate
significantly.

The
market price for our ordinary shares, as well as the prices of shares of other
technology companies, has been volatile. Our share price has decreased
significantly since the first quarter of 2003. 
In particular, on the day following our announcement of our expected
results for the first quarter of 2003, our share price decreased by 34%.  Numerous factors, many of which are beyond
our control, have caused and may continue to cause the market price of our
ordinary shares to fluctuate significantly, such as:

| | shortfalls in our operating results from levels
  forecast by securities analysts.               
|- | -------------------------------------------------------------------------------------------------
|  |                                                                                                  
| | fluctuations in our quarterly revenues and earnings
  and those of our publicly held competitors;
|  |                                                                                                  
| | announcements concerning us, our affiliates, or our
  competitors;                               
|  |                                                                                                  
| | the introduction of new telecommunications services;                                             
|  |                                                                                                  
| | changes in pricing policies by us or our
  competitors;                                          
|  |                                                                                                  
| | market conditions in our industry and the global economy
  in general; and                       
|  |                                                                                                  
| | the general state of the securities market
  (particularly the technology sector).               

In
addition, trading in shares of companies listed on the Nasdaq National Market
in general and trading in shares of technology companies in particular have
experienced extreme price and volume fluctuations that have often been
unrelated or disproportionate to operating performance.  The price levels of technology stocks traded
on the Nasdaq National Market decreased significantly during 2001, 2002 and
2003.  These broad market and industry
factors may depress our share price, regardless of our actual operating
results.

Substantial
future sales of our ordinary shares may depress our share price.

On
May 10, 2004, ECI distributed 7,600,000 ordinary shares to its shareholders,
which constitutes approximately 42% of our outstanding shares. As a result, ECI
holds 2,890,325, or 16%, of our outstanding ordinary shares.  These shares have been pledged to banks by
ECI to secure indebtedness under a credit facility agreement.  If ECI defaults under this agreement, the
banks may foreclose on the shares and seek to sell them in the public market.



In addition, in June 2004, ECI placed
into an irrevocable trust approximately 550,000 of our ordinary shares, which it
withheld from its shareholders pursuant to Israeli tax law, with instructions to sell
on the Nasdaq Stock Market to reimburse the tax payable by ECI to the Israeli government,
subject to the terms of the trust and applicable securities laws.




An additional 369,035 shares are held by Telrad Networks Ltd.  ECI and Telrad both have rights to require
us to register their ordinary shares with the Securities and Exchange
Commission. In March 2002 we registered an aggregate of 2,422,175 shares for
resale with the SEC.  These shares
consisted of 850,000 shares that we issued to Telrad in connection with our
acquisition of NetEye from Telrad, and an aggregate
of 1,572,175 shares that ECI sold to investors, as described below in Item 7.
If our shareholders sell substantial amounts of our
ordinary shares, including


Shares distributed by ECI to its shareholders and



shares issued upon the exercise of outstanding
employee options, or if the perception exists that our shareholders may sell a
substantial number of our ordinary shares, the market price of our ordinary
shares may fall.  Any substantial sales
of our shares in the public market also might make it more difficult for us to
sell equity or equity related securities in the future at a time we deem
appropriate.

18

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Item 4. Information on the Company

A.     History and Development of the
Company

ECtel
Ltd. is our legal and commercial name. 
Until April 1998, we operated under the name ECI Telesystems Ltd.  We were incorporated as a wholly-owned
subsidiary of ECI Telecom Ltd. on April 4, 1990, under the laws of the State of
Israel. Our principal executive offices are located at 43 Hasivim Street, Petah
Tikva 49130, Israel and our telephone number is (972-3) 926-6102.  Our agent in the United States, ECtel Inc.,
is located at 22527 Gateway Center Drive, Clarksburg, MD 20871.

In
March 2004, we sold our government surveillance business to Verint Systems
pursuant to an asset purchase agreement, which is described below under Item
10.C Additional InformationMaterial Agreements.

Principal
Capital Expenditures

Our
principal capital expenditures in the past three years have been the purchase
of equipment and other fixed assets used in our business (mainly in
Israel).  These purchases totaled
approximately $1.8 million in 2001, approximately $2.0 million in 2002 and
approximately $1.4 million in 2003.  Our
capital expenditures in 2003 were spent primarily for the procurement of test
and production equipment computers.  We
used internal working capital to finance these capital expenditures.

B.     Business Overview

The
following description does not include our government surveillance business.
Our surveillance solutions enabled governmental agencies to perform real-time,
comprehensive surveillance on telecommunications networks. We sold this
business to Verint Systems in March 2004.

General

We
develop and market revenue assurance solutions for circuit-switched and
packet-switched wireline and wireless networks.  Our solutions equip telecommunications service providers with
comprehensive data gathering and analysis capabilities to improve their
operational efficiency and profitability by:

| | detecting and preventing fraud;                                                                           
|- | ----------------------------------------------------------------------------------------------------------
|  |                                                                                                           
| | supporting billing assurance, including billing
  mediation functions of interconnection arrangements; and
|  |                                                                                                           
| | monitoring the quality of service over their
  networks.                                                  

Industry
Overview

Changes
in the Telecommunications Industry

The
telecommunications industry is characterized by, among others, the following
factors:

Convergence
of Circuit-Switched and Packet-Switched Networks.Telecommunications networks of the early 1990s
were not designed to handle the dramatic increases in data traffic which have
been fueled by the growing use of the Internet.  This led to the development of a new generation of data-oriented
communications networks, often based on Internet Protocols, that use
packet-networking technology, as an alternative to traditional,
circuit-switched telephone networks. 
These packet-based, or next-generation, networks, however, are not
expected to immediately replace circuit-switched networks.  As a result, packet-switched and
circuit-switched networks are expected to coexist and interconnect with each
other for the foreseeable future, creating what is known as converged networks.

19

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Development
of Value-Added Services.Greater
competition and advances in technology have led service providers to seek to
differentiate themselves by offering advanced, value-added services.  The increased connectivity to the Internet
is making Internet-based communications, such as multimedia content, including
video and audio, and e-commerce services, an integral part of these value-added
services.  Service providers are also
expanding the range of wireless services to include data services such as
e-mail, Short Message Service (SMS) and limited Internet access.  The emerging third generation wireless (3G)
technology will enable the wireless provisioning of an even broader range of
services, including full Internet access, downloading music and video, video
conferencing and mobile banking, trading and online games.

Increased
Network Interconnectivity. 
Advanced technologies and expanded product offerings have caused
telecommunications networks of multiple service providers to be increasingly
interconnected. For example, the value-added services offered by service
providers are often obtained from a number of different content providers,
requiring interconnections among their networks to provide the services to
customers. In addition, although recently there has been a trend of
consolidation among service providers in response to deteriorating conditions
in the industry, deregulation and privatization have led to a large increase in
the number of service providers operating worldwide.  These service providers must interconnect their networks with
those of other providers to enable their respective subscribers to communicate
with each other.

Increased
Focus on Revenue Assurance. Recently, in response to the
deterioratingindustry conditions, service providers have often been forced to
lower the prices they charge for value added services.  In turn, lower prices have resulted in lower
profit margins for the service providers with respect to these value added
services.  As a result, there is an increased
need for service providers to ensure that they capture as much of the revenues
associated with these value added services as possible.

Service
Provider Challenges

As
service providers increase their focus on revenue assurance, they face
challenges in the following areas:

Fraud
Prevention.Fraud
typically represents a significant loss of revenues for service providers.  Due to the following factors, there are
greater opportunities for fraud, and acts of fraud are potentially
significantly more damaging:

| | Value-added service offerings create vulnerabilities
  in telecommunications networks, making fraud schemes easier.  Service offerings include high value
  transactions such as on-line banking, mobile commerce, and content, which has
  significantly increased the potential losses caused by acts of fraud;                                                                                                                                                                                                                                                                                                                                                                                                                                         
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | The growth of interconnected networks makes it more
  difficult for any provider in the chain to detect fraud and hold a defrauder
  responsible;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | Under their interconnection agreements, service
  providers are often committed to make partial payments to each other relating
  to fraudulent sessions that they may not be able to recoup from their
  customers.  This has increased the
  out-of-pocket costs incurred by service providers as a result of fraud; and                                                                                                                                                                                                                                                                                                                                                                                                                                
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | In some countries, pirate service providers have
  begun providing international voice service on data lines that the pirate
  providers lease on PABX exchanges in the local country network.  These leased data lines are generally not
  permitted by various laws governing data and voice traffic in these countries
  to carry voice traffic.  By using
  these data lines, the pirate providers bypass the high international toll
  tariffs that traditional service providers are required to pay when providing
  international voice service.  As a
  result, the pirate providers can charge less to customers than traditional
  service providers can, which in turns results in the loss of customers by
  traditional service providers.

20

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Service
providers require increasingly sophisticated fraud prevention solutions in
order to overcome these challenges and effectively detect and prevent fraud in
modern telecommunications networks.

Quality
of Service.In order
to compete effectively, service providers must emphasize the quality and
reliability of their services.  In
addition, the transmission of integrated voice and data traffic over converged
networks has created new quality-of-service problems that did not exist in
traditional, circuit-switched networks. 
For example, as a result of the packet technology used in next
generation networks, a delay or loss of some of the packets making up a
specific message may render that message incomprehensible.  In addition, service providers with interconnecting
networks enter into service level agreements with each other requiring the
provision of a specified minimum level of service.  The growing variety of value-added services being offered demand
a higher level of coordination between service providers to maintain quality of
service.  Service providers must meet
these quality-of-service challenges to provide the high quality, reliable
service that is essential to attract and retain customers.

Interconnect
Billing.The number
of interconnections among service providers is continually increasing, making
it more important to verify the accuracy of inter-carrier billing under
interconnection arrangements.  In
addition, the current flat rate billing solutions do not enable service
providers to bill other providers based on usage of new value-added services,
such as SMS or cellular roaming, over their networks.  In order to maximize potential revenues, service providers
require usage-based billing solutions.

In
order for service providers to effectively address these challenges and remain
competitive, they require comprehensive revenue assurance solutions to prevent
fraud, maintain quality of service and accurately bill for interconnected
transmissions.  These solutions must be
capable of processing tens of millions of sessions per day from an objective
source, operating with hardware and software provided by multiple vendors and
supporting the multiple technologies that exist in converged networks.  In addition, solutions must be flexible in
order to adapt easily to rapidly changing technologies.  Finally, service providers seek revenue
assurance solutions that meet all of these objectives and provide a
demonstrable and rapid return on investment.

The
ECtel Solution

We develop and market
revenue assurance for circuit-switched and packet-switched wireline and
wireless networks.  Our products consist
of proprietary software and hardware components, as well as off-the-shelf
hardware and software components.  We
believe that our solutions provide our customers with the following benefits:

| | Comprehensive View of the
  Network.Modern
  international communications networks function on a variety of transmission
  protocols.  For example, transmission
  protocols for circuit-switched networks are different from those used in
  packet-switched networks.  Our
  solutions have the capability to view and analyze many of the transmission
  protocols used in converged networks. 
  In addition, our solutions are capable of viewing and analyzing not
  only the signaling information, but also the embedded session
  information.  Signaling information
  consists of basic information, such as time and place of origin and
  destination of the message.  Embedded
  session information includes the classification of message type (e.g., voice,
  fax or data) and information regarding the message content, such as touch
  tones initiated during a call.  Most
  alternative solutions provided by our competitors only analyze the signaling
  information.  Moreover, our solutions
  perform the crucial mediation function, which is necessary in order to
  analyze and correlate data from a wide variety of information sources in a
  packet-switched network.  These
  information sources include specialized probes that provide value-added
  services and other applications.  As a
  result, our solutions are generally able to provide a more comprehensive view
  of modern, interconnected networks than those of our competitors.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | Real-Time Functionality.Our revenue assurance
  platform is designed to collect, process and present data about the network
  in real-time.  This allows our
  customers to react to network conditions and events generally as they
  occur.  For example, using our fraud
  prevention product, a service provider can detect and interrupt fraudulent
  activity as it occurs or even before it begins, thereby reducing losses.  This real-time functionality is of
  increasing importance with respect to data services that support high value
  transactions, such as on-line banking or securities trading, in which both
  the network provider and the subscriber bear the risk of substantial losses
  as a result of acts of fraud.  In
  addition, using our quality-of-service monitoring products, a service
  provider can monitor network quality and detect service problems in its
  network.  Based on this information,
  the provider can reroute traffic and initiate maintenance on its network
  within minutes.                                                                                                                                                                                                                                                                                                                                                                                                                                           

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|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Flexible, Scalable, Multi-Application Platform.Our revenue assurance
  platform has been designed to meet the continually evolving requirements of
  service providers.  Our platform is
  based on a modular architecture, which enables our customers to easily and
  cost-effectively add capacity and network coverage.  In addition, because all of our applications run on the same
  platform, our customers can easily add new functionalities to their installed
  solution.  Our solutions can also be
  easily upgraded to keep up with the rapid introduction of new technologies
  and services.                                                                                                                                                                      
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | Vendor Independent Solutions.  Our probing solutions analyze raw
  signaling information and embedded session information, each captured
  directly from the network.  These
  solutions do not rely on information provided in vendor-specific format such
  as data that is processed and formatted for billing systems.  By analyzing raw information, our fraud
  prevention system enables our customers to detect types of fraud that would
  not be detected by analyzing only processed data.  For example, our solutions capture and analyze information
  about unsuccessful call attempts, which is not usually registered with
  billing systems, and which is important in detecting some types of fraud and
  implementing a proactive approach for fraud prevention.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | Sophisticated Algorithms.We have developed
  sophisticated proprietary algorithms to enable our products to perform
  comprehensive session analyses.  Using
  these algorithms and supporting hardware, our solutions can analyze signaling
  information and embedded session information on multiple channels
  simultaneously.  For example, our
  powerful data-mining algorithm uses neural networks and decision tree
  techniques that enable our fraud prevention solutions to detect types of
  fraud that the rule-based solutions of many of our competitors are unable to
  detect.  We have also developed
  proprietary digital signal processing algorithms to enable our products to
  perform comprehensive session signal analysis.                             
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | User-Defined Operational
  Parameters.Our
  revenue assurance platform and applications provide service providers with
  the flexibility to have their personnel define the scope of the data they
  require and the preferred method of viewing this data.  For example, a service providers quality
  assurance professional may use our quality-of-service products to view a bar
  graph showing the ratio of successful call connections to various
  destinations.  At the same time, its
  marketing professional may use the same product to view usage
  information.  Using a standard personal
  computer, each user can generate customized reports and easily select, organize
  and analyze the data relevant to the user.                                          

Business
Strategy

Our
objective is to be the leading provider of revenue assurance solutions for
converged networks worldwide.  The
following are key elements of our strategy:

| | Offer Comprehensive Revenue
  Assurance Solutions.We
  offer our service provider customers comprehensive solutions to meet their
  revenue assurance needs.  We also
  continually add new applications to our products to ensure that our customers
  are able to meet the full range of revenue assurance challenges that exist in
  converged networks. We continually adapt our existing revenue assurance to be
  compatible with emerging technologies and services.                                                                                                     
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | Maintain and Enhance Our
  Technological Leadership.We
  believe that our technology platform provides us with a competitive advantage
  in developing revenue assurance solutions to meet the rapidly changing needs
  of service providers.  We have
  invested significant resources over a number of years for both internal
  development and selective acquisitions. 
  We intend to continue to invest in our technology, through internal
  development and selective acquisitions, to maintain our position as a
  technological leader in revenue assurance solutions.

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|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Focus on Leading Worldwide Service
  Providers.We focus
  our marketing efforts on leading worldwide service providers of wireline,
  wireless and next-generation communication services, many of whom have global
  affiliations.  Our customer base
  includes many of the worlds largest telecommunications service providers,
  including Austria Telekom, Belgacom, Cable & Wireless Group, Hutchison
  H3G, MM02, Portugal Telecom, MCI, BellSouth group, Vodafone Sweden, Kievstar,
  Qwest Communications International, Swisscom, and the Telefonica Group. We
  believe that sales to market leaders will assist our marketing efforts to
  other industry participants.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | Maintain Direct and Interactive
  Relationships With Our Customers.We
  work closely with our existing customers, both to service the solutions
  already sold to them, and to provide additional consulting services to help
  them continually refine and upgrade their solutions.  This enables us to market complementary
  products to our customers to meet their changing needs and to stay abreast of
  the continually evolving needs of the marketplace.                                                                                                                                                                                                                  

Products

Revenue
Assurance Solutions

All
of our revenue assurance solutions are based on our X-ellence platform, which consists of:

| | Probes;                    
|- | ---------------------------
|  |                            
| | Mediation software; and    
|  |                            
| | Data analysis applications.

Probes.  Our application-specific probes are attached
to the service providers network.  Our
probes for circuit-switched networks are a combination of our proprietary
software and hardware components.  Our
probes for next generation networks are a combination of our proprietary
software and off-the-shelf probe hardware. 
The probes capture, filter, aggregate, correlate and merge data
collected from network links, such as E-1/T-1 links, and Internet, fast
Internet and gigabit Internet links. 
Our probes gather information from all layers of the network, from the
physical layer to the application layer, without disrupting the operation of
the network service.

Mediation
Software.Our
software solutions perform the crucial mediation function.  Mediation consists of extracting,
collecting, re-formatting and filtering raw information from various network
elements, including routers, firewalls, authentication servers, domain name
servers, Web servers, e-mail servers, video servers, and VoIP gateways.  This information can be combined with
information obtained from probes to create complete data records relating to
sessions passing through the network.

Data
Analysis Applications.Our
solutions analyze the data records created by the probes and mediation software
and create the reports used for the revenue assurance needs of our
clients.  Our solutions are capable of
presenting reports in real-time for tens of millions of sessions per day.

Our
platforms flexible, scalable architecture is designed to evolve and grow with
emerging technologies and the changing needs of our customers.  It enables our customers to:

| | Scale the capacity and processing power of our
  products;                
|- | --------------------------------------------------------------------------
|  |                                                                           
| | Add new applications to an installed system; and                          
|  |                                                                           
| | Assimilate new and emerging network standards,
  devices and applications.

We have the following
revenue assurance solutions that operate on our platform:

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Fraud
Prevention Solutions

Our fraud prevention
solutions gather information about calls both in real-time and offline and
compare it to fraudulent scenarios established within user-specified filter
parameters, subscriber profiles and thresholds.  When defined thresholds are reached, an alert is automatically
generated and appropriate intervention can take place according to the users
chosen parameters. Our FraudView  system provides comprehensive fraud
detection and prevention solution for wireline, circuit-switched and next
generation networks.

Billing
Assistance Solutions

Our billing assistance
solutions are designed to support service providers that offer multiple
services and interconnect with numerous other providers on circuit-switched or
packet-switched networks.

Quality
of Service Solutions

Our quality-of-service
solutions enable service providers to identify whether their services or
networks are operating according to desired standards, and also to pinpoint the
source of any network problem.  Once the
problem is found, the service provider can address the problem by repairing
faulty equipment, adjusting network settings or choosing a different route for
sessions to avoid areas of heavy traffic or poor service.

Sales
and Marketing

As
of April 1, 2004, our direct sales force and marketing staff consisted of 40
employees.  We market our revenue
assurance solutions to service providers worldwide primarily through a direct
sales force.  Our sales staff operates
out of our offices in Israel, the United States and the United Kingdom.  In addition, in 2002 we established a new
subsidiary in Germany for marketing and sales to customers in Austria, Germany,
Liechtenstein and Switzerland. We also offer our products in other countries
through local sales representatives or integrators, either on a commission or
other payment basis.  We offer ongoing
support services for our customers worldwide through our facilities in Israel,
the United States, the United Kingdom and Germany.

Sales
of our revenue assurance solutions are made predominantly to large service
providers and involve lengthy evaluation processes before the customers issue
purchase orders.  Because the purchase
of our products is a relatively significant capital expenditure, prospective
customers generally commit substantial resources to an evaluation of our
solutions and require us to expend significant time, effort and money educating
them about the value of our solutions. 
This sales cycle for our revenue assurance solutions is an average of between
six and 18 months. Our primary marketing activities include raising awareness
among existing and potential customers of the benefits provided by the features
of our products.  To accomplish these
tasks, we use local sales representatives and sales and various marketing
efforts.  We participate in exhibitions
and industry trade shows.We have sold our
solutions to miscellaneous worldwide customers, including the following:

Belgacom

|BellSouth group        | MCI             
|---------------------- | ----------------
|                       |                 
|Cable & Wireless Group | MM02            
|                       |                 
|Cellcom                | Portugal Telecom
|                       |                 
|Embratel               | Qwest           
|                       |                 
|Hutchison H3G          | Swisscom        
|                       |                 
|Kievstar               | Telefonica Group
|                       |                 
|                       | Vodafone Sweden 

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In
2003, our top ten customers accounted for 75.1% of our revenues, with sales to
one customer in the Europe region accounting for 13.9% of our revenues and
sales to one customer in Latin and North America accounting for 11.4% of our
revenues.  In 2002, our top ten
customers accounted for 68.8% of our revenues, with sales to one customer in
the Asian Pacific region accounting for 27.0% of our revenues and sales to one
customer in Latin America accounting for 10.8% of our revenues.

The following table shows
a breakdown of our sales of telecommunication products by geographical region
during 2001, 2002 and 2003 (in thousands):

|               |  | Year ended
  December 31 |       
|-------------- |  | ------------------------ | ------
|               |  |                          |       
|               |  | 2001                     |       
|               |  |                          |       
|Israel         |  | $                        | 2,787 
|Asia Pacific   |  |                          | 22,692
|North America  |  |                          | 1,032 
|Europe         |  |                          | 10,317
|Africa         |  |                          | 456   
|South America  |  |                          | 23,667
|               |  |                          |       
|Total Revenues |  | $                        | 60,951
|               |  |                          |       

Manufacturing

We
purchase some hardware, such as servers and storage devices, from third party
vendors such as IBM and Hewlett Packard. 
Our manufacturing operations consist primarily of final assembly and
testing, involving the application of extensive testing and quality control
procedures to materials, modules, subassemblies and systems.  Although we generally use standard parts and
modules in our products, certain modules are presently available only from a
limited number of sources.  In addition,
we purchase various customized components from ECI, such as digital signaling
processing boards and mechanical wiring. 
To date, we have been able to obtain adequate supplies of all components
in a timely manner from existing sources or, when necessary, from alternative
sources.

We
maintain organization-wide quality assurance procedures, coordinating the
quality control activities of our research and development and manufacturing
departments.  Our primary manufacturing
and research and development facilities have received certification to Quality
Standard ISO 9001:2000.  ISO 9001:2000
is an international standard of quality assurance for companies involved in the
design, development, manufacturing, installation and servicing of products or
services.  This standard is set by the
International Organization for Standardization (ISO), an international
federation of national standards bodies. 
To be recommended for ISO 9001:2000 certification, a company must be
audited by an ISO-accredited auditing company and must meet or surpass the ISO
standards.  We believe that our
customers value the process, control and traceability that are required to
achieve ISO 9001:2000 certification.

Research
and Development

In
order to accommodate the rapidly changing needs of our markets, we place
considerable emphasis on research and development projects designed to improve
our existing product lines, develop new product lines and customize our
products to meet our customers needs. 
As of April 1, 2004, 64 of our employees were engaged primarily in
research and development activities, including customization and testing.  We expect that we will continue to commit
substantial resources to research and development in the future.

As
a recipient of grants from the Office of the Chief Scientist, we are obligated
to perform all manufacturing activities for projects subject to the grants in
Israel unless we receive an exemption. 
Know-how from the research and development which is used to produce
these products may not be transferred to third parties without the approval of
the Office of the Chief Scientist. 
Approval is not required for the export of any products resulting from
the research and development based on these grants.  For further information regarding the Office of the Chief
Scientist of the Israeli Ministry of Industry, Trade and Labor, see Item 5C -
Research and Development, Patents and Licenses  Grants from the Office of the
Chief Scientist.

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Competition

The
telecommunications industry is characterized by intense competition.  Many of the companies that compete with us
have greater name recognition, longer operating histories, larger customer
bases and significantly greater financial, marketing, public relations, sales,
distribution and other resources.  Some
of our competitors and potential competitors are among the largest and most
well capitalized software and hardware companies in the world.

We
also face competition from our customers and new vendors, and we expect this
trend to continue in the future.  Some
of our customers are developing their own solutions internally or through
strategic alliances.

Our
competitors in the fraud prevention market are HP, Neural Technologies,
Agilent/Cerebrus, Alcatel, Mantas (merged with Sotas), Lightbridge and
Subex.  Our competitors in the
quality-of-service solutions market include Agilent, Radcom and Mantas
(formerly Sotas).  Our competitors in
the sale of billing assistance solutions include Azure, ConnexN, Cerebrus,
Elron Telesoft and Vibrant.

We
believe that the principal competitive factors in the markets in which we
compete are product functionality, the ability to provide effective and
comprehensive solutions, pricing, timely introduction of new products,
especially products of next generation networks, and responsive customer
support.

Intellectual
Property and Proprietary Rights

The
telecommunications industry is characterized to a great extent by its reliance
on proprietary technology.  We believe
that we own or have the license to use the technologies used in our
products.  We depend on a combination of
technical innovations, trade secrets, and non-disclosure agreements for the
protection of this technology.  Also, we
are filing patent applications to protect our technology and trademark
applications to register our trademarks. 
Various trademarks have already been registered in certain countries.

Although
we intend to protect our rights in technology vigorously, we cannot be sure
that these measures will be successful. 
It may be possible for unauthorized third parties to misappropriate or
reverse engineer aspects of our products or technology, independently develop
technology of substantially similar functionality or performance, or obtain
information that we regard as proprietary. 
Moreover, the laws of some foreign countries in which we sell or may
sell our products may not fully protect, or may not protect at all, our
proprietary rights in products.

Third
parties may, from time to time, claim that our current or future products
infringe their intellectual property rights. Intellectual property litigation
is complex and we cannot assure you of the outcome of any such litigation.  Any future intellectual property litigation,
regardless of outcome, could result in substantial expense and significant
diversion of the efforts of our technical and management personnel and disrupt
or otherwise severely impact our relationships with current and potential
customers.  An adverse determination in
any such proceeding could subject us to significant liabilities to third
parties, require disputed rights to be licensed from those parties, assuming
licenses to the rights could be obtained, or require us to cease using the
technology and expend significant resources to develop non-infringing
technology.  We may not be able to
obtain a license at an acceptable price.

CashView,  FraudView, HawkEye, IC-Guard,  I-Probe, NeTrace, NGN FraudView, ProfEdge,
PreView, QualiMobile, QualiVOIP, Quali.Net, QualiView, QualiWeb, SigView,
X-ellence, ValueRoute, BillGuard, FllowGuard, ServeGuardandX-pertVieware among the trademarks of
ECtel.

Government
Regulations

We
receive grants from the Office of the Chief Scientist of the Israeli Ministry
of Industry, Trade and Labor for research and development programs.  We also receive tax benefits under Israeli
law for capital investments that are designated as approved enterprises.  Our participation in these programs is
subject to our compliance with certain conditions and imposes certain
restrictions upon us.

26

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Demand
for products by service providers is affected by various types of laws and
regulations in the areas of use of communications customer records, network
service standards, billing for use of interconnected networks, certification of
and charges paid by VoIP service providers and opening markets to
competition.  For more information
regarding the Office of the Chief Scientist and tax benefits for approved
enterprises, see Item 5C  Research and Development, Patents and Licenses 
Grants from the Office of the Chief Scientist and Item 10E  Taxation 
Israeli Taxation  Tax Benefits under the Law for the Encouragement of Capital
Investments, 1959, respectively.

C. Organizational Structure

Prior
to May 10, 2004, ECI held of record 10,490,325, or approximately 57.9%, of our
outstanding ordinary shares. On May 10, 2004 ECI distributed 7,600,000 ordinary
shares to its shareholders. As a result, ECI holds 2,890,325, or 16.0%, of our
outstanding ordinary shares.  ECI is a
provider of integrated network solutions which designs, develops, manufactures
and markets digital telecommunications and data transmission systems, enabling
network operators to deliver cost-effective services.

We
own all the outstanding shares of:

| |  | ECtel Inc., a Maryland corporation;                                                                 
| | - | ----------------------------------------------------------------------------------------------------
| |   |                                                                                                     
| |  | ECtel (2000) U.K. Ltd., a U.K. company; and                                                         
| |   |                                                                                                     
| |  | ECtel BV, a Dutch company which, in turn, holds all
  of the shares of ECtel GmbH, a German company.

D. Property, Plants and Equipment

Our
main office, research and development and production facilities are located in
Petah Tikva, Israel and occupy approximately 74,950 square feet. The term of
the lease is through February 19, 2005, with a renewal option of three years.

ECtel
Inc., our U.S. subsidiary, leases an approximately 24,000 square-foot office
and production facility in Clarksburg, Maryland and approximately 1,500 square
feet of office space in Florida. The term of the Clarksburg lease is through
March 31, 2008, with a renewal option of three years.

ECtel
(2000) U.K. Ltd., our U.K. subsidiary, leases approximately 2000 square feet of
office space in London, England.  The
term of this lease is through November 2010, with an option to terminate in
2005.

ECtel
GmbH leases approximately 970 square feet of office space from ECI Telecom GmbH
in Frankfurt, Germany.  The term of this
lease is one year from October 1, 2002, with an automatic one year renewal,
unless either party notifies the other party, no later than 180 days prior to
the termination of the initial term, of its wish not to renew.

27

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Item 5. Operating and Financial Review and Prospects

A. Operating Results

You
should read this discussion in conjunction with the consolidated financial
statements and the other financial information appearing elsewhere in this
annual report.

On
March 31, 2004, we sold our government surveillance business to Verint
Systems.  Accordingly, our statements of
operations, including those of prior periods, reflect the results of operations
of this business in the line item called income (loss) from discontinued
operations. All data in this Annual Report derived from statements from our
statements of operations, unless otherwise specified, exclude our government
surveillance business.

Overview

We
develop and market revenue assurance solutions for circuit-switched and
packet-switched wireline and wireless networks.  Our solutions equip telecommunications service providers with
comprehensive data gathering and analysis capabilities to improve their
operational efficiency and profitability by:

| | detecting and preventing fraud;                                                                           
|- | ----------------------------------------------------------------------------------------------------------
|  |                                                                                                           
| | supporting billing assurance, including billing
  mediation functions of interconnection arrangements; and
|  |                                                                                                           
| | monitoring the quality of service over their
  networks.                                                  

Our
business deteriorated in the first quarter of 2003, in which we experienced a
sharp decline in revenues and recorded a net loss.  Until then, we had maintained strong revenues and remained
profitable despite the slowdown in the worldwide telecommunications industry,
which resulted in decreases and delays in the procurement and deployment of new
telecommunications equipment.  We
believe that the war in Iraq, including the lead-up thereto, contributed to the
hesitancy of customers to commit to large technology investments.  Our sales continued to decline in 2003 and
into 2004.   During this period, we also
experienced intensifying competition, causing us to lose potential contracts
due to aggressive pricing on the part of some of our competitors.  This reduction in revenues and prices resulted
in worsening gross margins and increasing net losses.  In response to this decline in revenues, we implemented
cost-cutting measures in the second quarter of 2003, such as a reduction in
workforce and salaries.

During
much of 2003, we were engaged in negotiations with Verint Systems, to whom we
sold our government surveillance business on March 31, 2004.  This complex, protracted transaction
diverted management attention and distracted our employees, further harming our
operations.  Moreover, we believe that
rumors of a pending transaction with Verint System caused potential customers
to award contracts to our competitors. 
Finally, in the past seven months, our chief executive officer and six
vice presidents resigned, either in connection with the transaction with Verint
Systems or for their own personal or professional reasons.  This has further harmed our business and
results of operations.

The
sale of our government surveillance business will enable us to focus on our
telecom business.  With sale proceeds of
approximately $35 million, the transaction with Verint Systems also left us in
a strong cash position.  At March 31,
2004, we had cash and cash equivalents, short-term deposits and long-term
investments of approximately $61.8 million.

In
mid-February 2004, Eitan Naor assumed the position of president and chief
executive officer.  Mr. Naor worked for
Amdocs Ltd. (NYSE: DOX) for the past four and a half years, most recently as
Division President, OSS & Order Management Systems.  With deep experience in and knowledge of the
telecom market, Mr. Naor is assembling a new management team and leading our
efforts in formulating a comprehensive recovery plan aimed at rebuilding our core
telecom business and increasing our customer focus.  The plan will include measures both to improve our telecom
business and to further reduce our cost structure.  We expect to commence implementation of the recovery plan in the
third quarter of 2004.

28

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Results
of Operations

The
following table sets forth the percentage relationships of certain items from
our consolidated statements of operations, as a percentage of revenues for the
periods indicated:

|                                                                  |  | Year ended
  December 31, |      
|----------------------------------------------------------------- |  | ------------------------- | -----
|                                                                  |  |                           |      
|                                                                  |  | 2001                      |      
|                                                                  |  |                           |      
|Revenues                                                          |  |                           | 100.0
|Cost of revenues                                                  |  |                           | 39.5 
|                                                                  |  |                           |      
|Gross profit                                                      |  |                           | 60.5 
|Research and development costs, net                               |  |                           | 14.0 
|Selling and marketing expenses                                    |  |                           | 20.0 
|General and administrative expenses                               |  |                           | 11.5 
|In process research and development                               |  |                           | 1.5  
|Goodwill impairment                                               |  |                           |     
|                                                                  |  |                           |      
|Total operating expenses                                          |  |                           | 47.0 
|                                                                  |  |                           |      
|Operating income (loss)                                           |  |                           | 13.5 
|Financial income, net                                             |  |                           | (1.3 
|Other income (expenses), net                                      |  |                           | (*   
|                                                                  |  |                           |      
|Income (loss) from continuing operations
  before taxes on income |  |                           | 14.8 
|Taxes on income (tax benefit)                                     |  |                           | (0.1 
|                                                                  |  |                           |      
|Cumulative effect of change in accounting 
       principles      |  |                           | (*   
|                                                                  |  |                           |      
|Net income (loss) from continuing operations                      |  |                           | 14.9 
|                                                                  |  |                           |      
|Net income (loss) from discontinued operations                    |  |                           | 4.7  
|                                                                  |  |                           |      
|Net income (loss)                                                 |  |                           | 19.6 
|                                                                  |  |                           |      

|                                            
|--------------------------------------------
|(*) Represent a percentage
  less than 0.1%.

Comparison
of 2001, 2002 and 2003

Revenues

Revenues
consist primarily of the sale to telecommunications service providers of our
hardware and software solutions, as well as third parties hardware and
software. A small portion of our revenues comes from fees for maintenance and
other services.

2003
vs. 2002

Total
revenues decreased 45% from $52.4 million in 2002 to $28.9 million in 2003 due
mainly to the general slowdown in the telecommunications market, exacerbated by
the war in Iraq, which contributed to the hesitancy of customers to commit to
large technology investments, and intensifying competition. Our revenues were
also adversely affected by the extended negotiations with Verint Systems,
reorganization activities and management transition.

29

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2002
vs. 2001

Total
revenues decreased 14.0% from $61.0 million in 2001 to $52.4 million in 2002.
This decrease was primarily due to the continuing general deterioration in the
global telecommunications market.

The
following is the breakdown of our revenues by geographical distribution and as
a percentage of total revenues for the years indicated (continuing operations
only):

|($in millions) |  | 2001 |      | 2002 |  | 2003  |  
|-------------- |  | ---- | ---- | ---- |  | ----- | -
|               |  |      |      |      |  |       |  
|Israel         |  |      | 2.8  |      |  | 4.6   | %
|Asia Pacific   |  |      | 22.7 |      |  | 37.2  | %
|North America  |  |      | 1.0  |      |  | 1.7   | %
|Europe         |  |      | 10.3 |      |  | 16.9  | %
|Africa         |  |      | 0.5  |      |  | 0.8   | %
|South America  |  |      | 23.7 |      |  | 38.8  | %
|               |  |      |      |      |  |       |  
|Total Revenues |  | $    | 61.0 |      |  | 100.0 | %
|               |  |      |      |      |  |       |  

The
increase in revenues from sales to customers located in North America and
Europe from 2002 to 2003 resulted mainly from our enhanced marketing efforts in
these regions.  The decrease in revenues
in 2003 from sales to customers located in Asia Pacific resulted mainly from
the decrease in the scope of purchasing by one of our largest customers, which
is located in this region.

Cost
of Revenues

Cost
of revenues consists primarily of the cost of materials, employee compensation
expenses, payments to sub-contractors and outsourcing, payments to consultants,
depreciation related to the manufacturing, allocated overhead, installation and
support of our products and royalties to the Office of the Chief Scientist in
Israel.

2003
vs. 2002

Gross
profit decreased 62.1% from $30.1 million in 2002 to $11.4 million in
2003.  Gross profit margin decreased
from 57.3% in 2002 to 39.5% in 2003. 
This decrease derives primarily from the following reasons:

| | (1)     Our
  cost of revenues is combined of both fixed and variable costs.  Our low volume of revenues in 2003
  compared to 2002 and similar level of fixed costs reduced gross margins
  significantly.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                            
| | (2)
       The industry-wide price erosion resulting from
  an enhanced competitive environment and global economic conditions.                                                                            

2002
vs. 2001

Gross
profit decreased 18.5% from $36.9 million in 2001 to $30.1 million in
2002.  Gross profit margin decreased
from 60.5% in 2001 to 57.3% in 2002. 
This decrease was primarily due to the the industry-wide price erosion
resulting from an enhanced competitive environment and global economic
conditions.

30

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Operating Expenses

|($in
  millions)                            |  | Year ended December 31, |      | %Change |  | %Change |     
|------------------------------------------- |  | ----------------------- | ---- | ------- |  | ------- | ----
|                                            |  |                         |      |         | 
|                                            |  | 2001                    |      | 2002    |  | 2003    |     
|                                            |  |                         |      |         |  |         |     
|                                            |  |                         |      |         |  |         |     
|Research and development
  costs, net       |  |                         | 8.5  |         |  |         | 9.1 
|Selling and marketing
  expenses            |  |                         | 12.2 |         |  |         | 13.7
|General and administrative
  expenses       |  |                         | 7.0  |         |  |         | 8.9 
|In process research and 
       development |  |                         | 0.9  |         |  |         |    
|Goodwill impairment                         |  |                         |     |         |  |         |    
|Total
  operating expenses                  |  |                         | 28.6 |         |  |         | 31.7

Research
and Development Costs, Net

Research
and development costs consist primarily of employee compensation expenses,
payments to sub-contractors and consultants and allocated overhead, costs of
materials and software and amortization of purchased technologies associated
with our research and development activities. Grants received from the Office
of the Chief Scientist in Israel are deducted from gross research and
development expenses to determine net research and development expenses.

2003
vs. 2002

Gross
research and development costs increased 8.8% from $10.0 million in 2002 to
$10.9 million in 2003. This increase was primarily due to an increase in
materials and subcontracting expenses in 2003 as well as an increase in
purchased technology amortization partially offset by a decrease in labor
expenses due to the cost-cutting measures that we took in the second quarter of
2003. Research and development grants from the Office of the Chief Scientist
decreased 5.3% from approximately $900,000 in 2002 to $842,000 in 2003.

2002
vs. 2001

Gross
research and development costs increased 1.4% from $9.9 million in 2001 to
$10.0 million in 2002.   This increase
was primarily due to an increase in labor expenses, partially offset by a
decrease in materials expenses in 2002 and because of the consolidation of NetEyes
results of operations with ours for the full year of 2002, compared with only
the fourth quarter of 2001. Research and development grants from the Office of
the Chief Scientist decreased 34.9% from $1.4 million in 2001 to $900,000 in
2002.

Selling
and Marketing Expenses

Selling
and marketing expenses consist primarily of employee compensation expenses,
payments to consultants, agents commissions and costs associated with
advertising, exhibitions, market research, industry trade shows, travel and
allocated overheads.

2003
vs. 2002

The
increase was due primarily to the continuing expansion of our worldwide sales
and marketing organization, and an increase in the rates of agent
commissions.  Sales and marketing
expenses increased as a percentage of revenues from 26.1% in 2002 to 49.5% in
2003.

31

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2002
vs. 2001

The
increase was due primarily to the expansion of our worldwide sales and
marketing organization, and an increase in marketing activities.    Sales and marketing expenses increased as
a percentage of revenues from 20.0% in 2001 to 26.1% in 2002.

General
and Administrative Expenses

General
and administrative expenses consist primarily of employee compensation expenses,
professional fees, including legal and accounting fees, recruiting costs,
allocated overheads and the provision for doubtful debt.  General and administrative
expenses in 2003
and 2002 increased primarily due to an increase in expenses for doubtful debts
from $5.5 million in 2002 to $13.2 million in 2003 due to a deterioration in the financial condition
of some of our customers and our best estimation of the recoverability of open accounts.  This increase
was partially offset by a decrease in various other general and administrative
expenses.

Goodwill
impairment

On
October 1, 2001, we acquired all of the outstanding shares of Telrad Hawk Net-I
Ltd., or Net-I.  As a result of the
purchase of Net-I, goodwill in the amount of $16.3 million was created as at
the date of purchase. Goodwill is subject to SFAS No. 142, which provides that
goodwill and other intangible assets with indefinite lives are no longer
amortized, but instead are to be tested for impairment at least annually in
accordance with the provisions of SFAS No. 142.  During 2002, a third party expert examined the value of the
reporting unit to which the goodwill was attributed.  We concluded then that, in accordance with SFAS No. 142, there
was no impairment in the value of the goodwill.

In
June 2003, due to significant reduction in our revenues, goodwill was impaired. We obtained an independent
appraisal to assess whether the goodwill carried on our books needed to be
written down. We impaired the goodwill by $6.0 million to its fair value in the
amount of $10.3 million.

Please
see Note 7 to our consolidated financial statements incorporated by
reference in this annual report.

Operating
profit (loss)

2003
vs. 2002

Operating
loss increased from $1.7 million in 2002 to $36.0 million in 2003. This
increase was primarily due to a decrease in revenues, as well as a decrease in
gross profit margins, an increase in research and development costs, net, and
in general and administrative expenses and the goodwill impairment recorded in
2003.

2002
vs. 2001

Operating
profit was $8.3 million in 2001 compared to operating loss of $1.7 million in
2002. This change was primarily due to a decrease in revenues, a decrease in
gross profit margins in 2002, and an increase in all other operating expenses
in 2002.

Financial
income, net

2003
vs. 2002

Financial
income, net decreased 28.6% from $269,000 in 2002 to $192,000 in 2003.  This decrease was primarily due to the
reduction in cash and cash equivalents as well as a reduction in interest rates
we received on our cash and cash equivalents and currency revaluations.

32

---

---

2002
vs. 2001

Financial
income, net decreased 65.3% from $774,000 in 2001 to $269,000 in 2002. This
decrease was primarily due to the reduction in interest rates we received on
our cash and cash equivalents.

Taxes
on Income (Tax Benefit)

2003
vs. 2002

We
had tax benefit of $29,000 in 2002, compared to tax expense of $38,000 in 2003,
which was primarily in respect of prior years. In 2002 a large portion of our
pre-tax income resulted from our Israeli operations, offset by the pre-tax loss
from our U.S. operations.  Our effective
tax rate in Israel is significantly lower than our effective tax rate in the
United States.

2002
vs. 2001

Tax
benefit decreased from $78,000 in 2001 to $29,000 in 2002.

Net
income (loss) from continuing operations

Net
income from continuing operations was $9.1 million in 2001 compared to net loss
of $1.4 million in 2002 and net loss of $35.8 million in 2003.  Net income from continuing operations margin
was 14.9% in 2001, Net loss from continuing operations margin increased from
2.7% in 2002 to 124.1% in 2003. These changes were primarily due to the
increase in operating loss as described above.

Net
income (loss) from discontinued operations

Discontinued
operations refers to our government surveillance business, which we sold to
Verint Systems on March 31, 2004.

2003
vs. 2002

Net
income from discontinued operations in 2002 was $18.7 million compared to net
loss of $4.9 million in 2003.  This
change was primarily due to a decrease of 71% in revenues from government
surveillance solutions as well as a decrease in gross profit, and an increase
in research and development costs, partially offset by a decrease in selling and
marketing expenses.

2002
vs. 2001

Net
income from discontinued operations increased from $2.9 million in 2001 to
$18.7 million in 2002.  This increase
was primarily due to an increase in revenues from the government surveillance
solutions, as well as an increase in gross margin, partially offset by an
increase in research and development costs and selling and marketing costs.

Net
income (loss)

2003
vs. 2002

Net
income was $17.3 million in 2002 compared to net loss of $40.7 million in
2003.  This change derived from the
increase in net loss from continuing operations as well as the shift from net
income to net loss of our discontinued operations.

33

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2002
vs. 2001

Net
income increased 45.1% from $11.9 million in 2001 to $17.3 million in
2002.  Net income margin increased from
19.6% in 2001 to 33.0% in 2002.  The
increase is due to the increase in net income from discontinued operations,
partially offset by the shift from net income to net loss of our continued
operations.

Critical
Accounting Policies

The
preparation of our financial statements in conformity with generally accepted
accounting principles requires our management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period,
which could potentially result in materially different results under different
assumptions and conditions.  These are
our managements best estimates based on experience and historical data;
however, actual results could differ materially from these estimates.  The following sections include references to
certain critical accounting policies that are impacted significantly by
judgments, assumptions and estimates used in the preparation of our
consolidated financial statements. For a detailed discussion on the application
of these and other accounting policies, see Note 2 in the notes to our
consolidated financial statements incorporated by reference in this annual
report.

Revenue
Recognition

We
have adopted the requirements of SOP 97-2.  Revenue
from product sales (which include software) is recognized, in accordance with
SOP 97-2, Software Revenue Recognition, upon delivery to customers and when
the following criteria are met: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred; (3) the vendors fee is fixed or
determinable and (4) collectibility is probable.  We include post contract customer support, or PCS, within the
price of the product sale.  This PCS is
for a one-year period and includes a standard product warranty and upgrades and
enhancements to correct minor bugs or errors in the software.  The cost of providing the PCS is
insignificant and the warranty and bug fixes have been infrequent.  Therefore, the PCS revenue is recognized
upon delivery of the product in accordance with SOP 97-2.

In
certain cases, when the sale contract includes provisions under which the
customers acceptance is conditioned upon our compliance with performance
guarantees, we recognize revenue when we have demonstrated that the criteria
specified in the provisions have been satisfied.

Revenue
is recognized from the initial sale of a new technology product only after the
customer has notified us of its acceptance of the product.  Revenue is recognized from subsequent sales
are recognized as described above.

Long-term
contracts are those requiring design, development, engineering and modification
and are of a significantly longer duration than contracts for system sales.  Revenues from long-term contracts are
recognized under the percentage of completion method using the ratio of actual
costs incurred, consisting of labor, materials and overhead, with respect to
total expected costs under the contract. 
Amounts received from customers in excess of revenues earned under this
method are recorded as advance payments from customers.  If we anticipate a loss on a particular
contract, the loss is provided for in full in the period when the loss is first
anticipated. The percentage of completion method of accounting involves the use
of various estimating techniques to project costs at completion. These
estimates involve various assumptions and projections relative to the outcome
of future events, including the quantity and timing of product deliveries. Also
included are assumptions relative to future labor performance prices and rates,
and projections relative to material and overhead costs. These assumptions
involve various levels of expected performance improvements. If actual costs
are materially different than our assumptions, our estimates of anticipated
revenues and operating expenses could adversely change.

Revenues
from sales involving long-term credit arrangements at less than normal
commercially acceptable interest rates are recorded at the present value of the
related future cash flows.  The
difference between the amounts receivable and their present value is recognized
as interest income over the period of the debt.  Service revenues from product maintenance contracts and
separately priced extended warranty contracts are generally recognized ratably
over the contract period.

34

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When
a sale involves multiple elements, we account for the sale according to the
provisions of EITF 00-21, Revenue Arrangements with Multiple Deliverables.
According to EITF 00-21, in an arrangement with multiple deliverables, the
delivered item(s) should be considered a separate unit of accounting if all of
the following criteria are met: (1) the delivered item(s) has value to the
customer on a stand-alone basis; (2) there is objective and reliable evidence
of the fair value of the undelivered item(s) and (3) if the arrangement
includes a general right of return, delivery or performance of the undelivered
item(s) is considered probable and substantially in the control of the vendor.
If all the conditions above are met and there is objective and reliable
evidence of fair value for all units of accounting in an arrangement, the
arrangement consideration should be allocated to the separate units of
accounting based on their relative fair value. However, there may be cases in
which there is objective and reliable evidence of the fair value(s) of the
undelivered item(s) in an arrangement but no such evidence for one or more of
the delivered items. In those cases, the residual method should be used to
allocate the arrangement consideration.

Inventory

Inventories
are stated at the lower of cost or market. 
As regards to raw materials (including components), the cost is
determined on the moving average basis. 
As regards to work in process and finished products: (1) the cost of raw
materials and components is determined on the moving average basis and (2)
labor costs and the cost of overhead components are determined on the basis of
actual manufacturing costs.  We estimate
a provision for damaged, obsolete, excess and slow-moving inventory based on
inventory aging reports and specific identification. If actual market
conditions are less favorable than those projected by us or if there is no
future demand for part or all of our inventories, we will need to write off the
affected inventories. This would result in an increase in our operating
expenses. For example, in the first quarter of 2004, we recorded an inventory
write off of approximately $950,000, which derives from inventory that became obsolete
or that we estimate that we will not be able to sell.

Allowance
for Doubtful Debts

Our
financial statements include an allowance which we believe reflects adequately
the loss inherent in receivables for which collection is in doubt. 
In determining the fairness of the
allowance, we review and consider information at hand about debtors financial
situation, the volume of their operations, aging of the balance and evaluation
of the security received from them or their guarantors.  At year end, we
used our best estimate to assess the recoverability of open accounts. If there is a major
deterioration in a major customers credit worthiness or actual defaults are
higher than our historical experience, our estimates of the recoverability of
amounts due to us could be adversely affected. 
This would result in an increase in our general and administrative
expenses by increasing the allowance for bad and doubtful debts and would
decrease the amount of our trade receivables.

Goodwill
and other intangible assets

We
adopted SFAS No. 142 requirements regarding goodwill and other intangible
assets with indefinite useful lives. In 2002 an independent expert examined the
value of the reporting unit to which the goodwill was attributed.  We concluded that, in accordance with SFAS
No. 142, there was no impairment in the value of the goodwill.

In
June 2003, due to significant reduction in the revenues, goodwill was impaired. We obtained an independent
appraisal to assess whether goodwill carried on the books needs to be
writen-down.  The independent appraisal
used the discounted cash flow approach to measure the fair value of the
goodwill.  Under the discounted cash
flow approach, the fair value of the goodwill is dependent on the present value
of future economic benefits to be derived from the reporting unit to which the
goodwill was attributed.  Future net
cash flows available for distribution are discounted at a discount rate of
17.7%, which we believe reflects our risk. We impaired the goodwill by $6.0
million to its fair value in the amount of $10.3 million.

If
our estimates regarding future revenues, operating expenses or other
assumptions made in order to determine the fair value of the segment to which
goodwill was attributed need to be adjusted, the fair value estimation of the
segment could be adversely affected. As a result, we might be required to
amortize part or all of the goodwill, which would result in an increase in our
operating expenses.

35

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---

We
amortize other intangible assets with definite useful lives over their
respective estimated useful lives to their estimated residual values, and
review for impairment in accordance with Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets.

Deferred
Taxes

We
account for income taxes under SFAS 109, Accounting for Income
Taxes.  Under SFAS 109, deferred tax
assets or liabilities are recognized in respect of temporary differences
between the tax bases of assets and liabilities and their financial reporting
amounts as well as in respect of tax losses and other deductions which may be
deductible for tax purposes in future years, based on tax rates applicable to
the periods in which such deferred taxes will be realized.  Deferred tax
assets for future tax benefits
from realization are included when their realization is more likely than not. 
At year end we estimated that the
deferred taxes can be utilized against the gain on the sale of the government surveillance
business.

Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be
realized.  We have decided to recognize
deferred tax benefits based on our history
and our expectation that future taxable earnings will be achieved.  A valuation allowance has been made for
certain of our deferred tax assets and those of our subsidiary companies, where
we believe that it is more likely than not that a portion of the deferred tax
assets will not be realized. We have made a valuation allowance as we are uncertain as to whether carry
forward losses will be utilizable in the foreseeable future.



Deferred
tax assets and liabilities are presented as current or long-term items in accordance
with the nature of assets or liabilities to which they relate, according to the
date of their realization. If we are not able to realize the full amount of our
deferred tax assets, we will be required to write down our tax assets. A write
down will result in an increase in our tax expenses.

Impairment
of long-lived assets and assets to be disposed of

We have investments in tangible and
intangible long lived assets. Changes in technology or changes in
our intended of these assets may cause the value of these assets to change.

We
account for long-lived assets under the provisions of FAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets. SFAS 144 addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. SFAS 144 requires that long-lived assets be reviewed for impairment
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 future
net cash flows expected to be generated by the asset. If the carrying amount of
an asset exceeds its estimated future cash flows, an impairment charge is
recognized by the amount by which the carrying amount of the asset exceeds the
fair value of the asset. SFAS 144 requires companies to separately report
discontinued operations and extends that reporting to a component of an entity
that either has been disposed of (by sale, abandonment, or in a distribution to
owners) or is classified as held for sale. 
See also Note 19 to our consolidated financial statement incorporated
by reference in this annual report.

Non-Cash
Accounting Charges

In
the second quarter of 2003 we impaired the goodwill by $6.0m to its fair value
in the amount of $10.3m as described above under Critical Accounting Policies 
Goodwill and other Intangible Assets.

Our
Functional Currency

Our
consolidated financial statements are prepared in dollars in accordance with
U.S. generally accepted accounting principles. 
The currency of the primary economic environment in which we operate is
the U.S. dollar.  Transactions and
balances denominated in dollars are presented at their original amounts.  Non-dollar transactions and balances have
been translated into dollars in accordance with the principles set forth in
Statement No. 52 of the Financial Accounting Standards Board (FASB) of the
United States.  All exchange gains and
losses from translation of monetary balance sheet items denominated in
non-dollar currencies are reflected in the income statement when they
arise.  These exchange gains and losses
are included in the same income statement items in which the related
transactions are included.

36

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B. Liquidity and Capital Resources

As
of December 31, 2003, we had $28.0 million in cash and cash equivalents,
compared to $52.8 million in cash and cash equivalents as of December 31, 2002.
As of December 31, 2003, we had $2.0 million in short-term deposits and $6.3
million in long-term marketable securities.

Net
Cash Provided by/Used in Operating Activities.  Net cash used in our operating activities
was approximately $14.3 million in 2003. Cash used in operations for 2003 was
primarily attributable to net loss of $40.7 million, a decrease in trade
payables and other payables and accrued liabilities, and an increase in
inventories, offset by a decrease in other receivables and trade
receivables.  The decrease in trade
receivables was primarily attributable to a decrease in revenues recorded
during 2003 and an increase in the net of provision for doubtful debts from
$5.8 million in 2002 to $13.1 million in 2003. 
From time to time, we sell trade accounts receivable to unaffiliated
financial institutions.  At December 31,
2003, we had sold trade account receivables aggregating $2.6 million to these
institutions.  Our ability to sell such
receivables to the financial institutions on current terms and conditions is
uncertain and is dependent on the creditworthiness of the customers involved,
the credit risks in the specific countries concerned and the institutions
policies from time to time, all of which have become less favorable in the
current economic environment.

In
2002, our operating activities provided cash in the amount of approximately
$13.3 million, compared to $1.2 million in 2001.  Cash provided by operations for 2002 was primarily attributable
to net income of $17.3 million and an increase in trade payables and other
payables and accrued liabilities, and a decrease in inventories, offset by an
increase in other receivables and trade receivables.  The increase in trade receivables was primarily attributable to
an increase in revenues recorded during 2002 and a longer collection cycle for
accounts receivable due to the need to grant credit with longer payment terms
to some customers in order to continue to achieve penetration in target markets
and in response to weakened general economic conditions in other
markets.  When the payment cycle for our receivables lengthens, we
use more of our cash reserves to fund our operations. As is typical in both
telecommunications and governmental industries, our contracts may provide for
payments under a variety of payment schedules.

Capital
Expenditures. Our
capital expenditures were $1.4 million in 2003, $2.0 million in 2002 and $1.8
million in 2001.  Our capital
expenditures in each of these periods related primarily to the purchase of
testing and computer equipment.  In
addition, we invested $870,000 and $250,000 for rights to technology in 2003
and 2002, respectively.

We
invest in capital expenditures pursuant to the requirements applicable to our
approved enterprise programs.  At
December 31, 2003, in order to comply with current approved programs, $ 643
thousand remain to be invested.  These
programs provide us with tax benefits in the future.

Net
Cash Provided by/Used in Financing Activities. Our financing
activities provided $169,000 in 2003 and $1.1 million in 2002, primarily due to
the issuance of our ordinary shares to employees upon the exercise of share
options.  Our financing activities used
$326,000 in 2001, primarily due to the repayment of a bank loan in connection
with the acquisition of NetEye, offset by the issuance of our ordinary shares
to employees upon the exercise of share options.

Bank
Credit. In September
2002, we executed a negative pledge in favor of an Israeli bank, in which we
undertook not to perform the following without the banks prior written
consent:

| | mortgage, or undertake to mortgage, in any manner or
  form, any of our assets; or
|- | ----------------------------------------------------------------------------------

37

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|  |                                                                                                                     
|- | --------------------------------------------------------------------------------------------------------------------
| | sell assets (other than in the ordinary course of
  business) the value of which exceed $1 million in the aggregate.

This bank supplies us
with various credit facilities, such as bank guarantees to our customers to
guarantee our contractual obligations to such customers. As of December 31,
2003, the amount of the said bank guarantees totaled approximately $2.4
million.

In
addition, from time to time other banks make credit available to us in the form
of bonds to secure our obligations to our customers or in connection with
hedging transactions.

We
believe our cash and cash equivalents reserve will be sufficient to meet our
anticipated cash needs for working capital and capital expenditures for the
next twelve months.  However, if we
carry out acquisitions of other companies or new technologies by paying cash,
there may be a need to raise additional capital by issuing debt or equity
during the year.

Impact
of Related Party Transactions

We
have entered into several agreements with ECI. 
Of these agreements, only the agreement for the supply of certain
components by ECI is material to our operations.  The pricing of the transactions was arrived at based on
arms-length negotiations between the parties. 
We reviewed the pricing of the agreements and believed that they were
not less favorable to us than could have been obtained from unaffiliated third
parties.  Please see Item 7  Major
Shareholders and Related Party Transactions for information on our
relationship with ECI.

Corporate
Tax Rate

Israeli
companies are generally subject to income tax at the rate of 36% and to capital
gains tax at a rate of 25% for capital gains derived after January 1,
2003.  However, our manufacturing
facilities in Petah Tikva have been granted approved enterprise status under
the Law for the Encouragement of Capital Investments, 1959.  Consequently, these facilities are eligible
for tax benefits.  We have derived, and
expect to continue to derive, a substantial portion of our income from our
approved enterprise facilities.  Subject
to compliance with applicable requirements, the income derived from our
approved enterprise facilities will be subject through 2012 to a reduced tax
rate of a maximum of 25%.  The actual
tax rate will depend upon the percentage of non-Israeli holders of our share
capital.  In 2003, our effective income tax
rate was 0.1%.  See Item 10E 
Taxation below and Note 12 to our consolidated financial statements
incorporated by reference in this annual report for more information on our
income taxes.

The
above benefits are conditioned upon our fulfillment of conditions stipulated by
the Law for the Encouragement of Capital Investments, the regulations
promulgated thereunder and the instruments of approval for the specific
investments in approved enterprises.  If
we fail to comply with these conditions, our benefits may be canceled and we may
be required to refund the amount of the benefits received, in whole or in part.

Impact
of Inflation, Devaluation and Fluctuation of Currencies on Results of
Operations, Liabilities and Assets

The
dollar cost of our operations is influenced by the extent to which any increase
in the rate of inflation in Israel is offset by the devaluation of the NIS in
relation to the U.S. dollar.  Inflation
in Israel will cause contracts under which we are to receive payment in dollars
or dollar-linked NIS, while incurring expenses in NIS linked to the Israeli
consumer price index, to be less profitable, unless such inflation is offset by
a devaluation of the NIS.

Most
of our sales are denominated in dollars or are dollar linked.  However, a significant portion of our
expenses, primarily expenses associated with employee compensation, is
denominated in NIS unlinked to the dollar. 
A devaluation of the NIS in relation to the dollar has the effect of
decreasing the dollar value of any asset of ours which consists of NIS or
receivables payable in NIS, unless such receivables are linked to the
dollar.  Such a devaluation also has the
effect of reducing the dollar amount of any of our expenses or liabilities
which are payable in NIS, unless such expenses or payables are linked to the
dollar.  Conversely, any increase in the
value of the NIS in relation to the dollar has the effect of increasing the
dollar value of any of our unlinked NIS assets and the dollar amounts of any of
our unlinked NIS liabilities and expenses.

38

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The
following table presents information about the rate of inflation in Israel, the
rate of devaluation of the NIS against the U.S. dollar, and the rate of
inflation of Israel adjusted for the devaluation:

|Year Ended
  December 31, |  | Israeli
  Inflation
  Rate |      | Israeli
  Devaluation Rate |  | Israel Inflation
  Adjusted for 
  Devaluation |     
|------------------------- |  | -------------------------- | ---- | -------------------------- |  | ---------------------------------------------- | ----
|                          |  |                            |      |                            |  |                                                |     
|                          |  |                            |      |                            |  |                                                |     
|1998                      |  |                            | 8.6  |                            |  |                                                | 17.6
|1999                      |  |                            | 1.3  |                            |  |                                                | (0.2
|2000                      |  |                            | 0.0  |                            |  |                                                | (2.7
|2001                      |  |                            | 1.4  |                            |  |                                                | 9.3 
|2002                      |  |                            | 6.5  |                            |  |                                                | 7.3 
|2003                      |  |                            | (1.9 | )                          |  |                                                | (7.6

Because
exchange rates between the NIS and the dollar fluctuate continuously, albeit
with a historically declining trend in the value of the NIS, exchange rate
fluctuations and especially larger periodic devaluations will have an impact on
our profitability and period-to-period comparisons of our results. The effects
of foreign currency re-measurements are reported in our consolidated financial
statements. We believe that inflation in Israel and exchange rate fluctuations
between the NIS and the dollar have not had a material effect on our results of
operations.

Market
Risk

For
information on our market risk, see Item 11  Quantitative and Qualitative
Disclosures About Market Risk.

C. Research and Development, Patents and Licenses

In
order to accommodate the rapidly changing needs of our markets, we place
considerable emphasis on research and development projects designed to improve
our existing product lines, develop new product lines and customize our products
to meet our customers needs.  As of
December 31, 2003, 125 of our employees were engaged primarily in research and
development activities, including customization and testing. As of April 1,
2004, following the sale of our government surveillance business to Verint
Systems, 64 of our employees were engaged in these activities. We expect that
we will continue to commit substantial resources to research and development in
the future.

Grants
from the Office of the Chief Scientist

From
time to time we receive grants under programs of the Office of the Chief
Scientist of the Ministry of Industry, Trade and Labor of the Government of
Israel.  We recorded grant
participations from the Office of the Chief Scientist totaling $1.4 million in
2001, $889,000 in 2002, and $842,000 in 2003. 
Pursuant to the terms of these grants we are obligated to pay royalties
of 3.5% of revenues derived from sales of products funded with these grants. As
of December 31, 2003, our contingent liability to the Office of the Chief
Scientist in respect of grants received was approximately $2.4 million.

This
governmental support is conditioned upon our ability to comply with certain
applicable requirements and conditions specified in the Chief Scientists
program and with the provisions of the Law for the Encouragement of Research
and Development in the Industry, 1984, and the regulations promulgated
thereunder, or the Research and Development Law.

Under
the Research and Development Law, research and development programs that meet
specified criteria and are approved by the research committee of the Office of
the Chief Scientist are eligible for grants of up to 50% of certain approved
expenditures of such programs, as determined by said committee.

39

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In
exchange, the recipient of such grants is required to pay the Office of the
Chief Scientist royalties from the revenues derived from products incorporating
know-how developed within the framework of each such program or derived
therefrom (including ancillary services in connection therewith), up to an
aggregate of 100% of the dollar-linked value of the total grants received in
respect of such program, plus interest, or up to 150% thereof in the case of
some of our earliest programs.

The
Research and Development Law generally requires that the product developed
under a program be manufactured in Israel. However, upon the approval of the
Chief Scientist, some of the manufacturing volume may be performed outside of
Israel, provided that the grant recipient pays royalties at an increased rate,
which may be substantial, and the aggregate repayment amount is increased to
120%, 150% or 300% of the grant, depending on the portion of the total
manufacturing volume that is performed outside of Israel. Effective April 1,
2003, the Research and Development Law also allows for the approval of grants
in cases in which the applicant declares that part of the manufacturing will be
performed outside of Israel or by non-Israeli residents and the research committee
is convinced that doing so is essential for the execution of the program.  This declaration will be a significant
factor in the determination of the Office of Chief Scientist whether to approve
a program and the amount and other terms of benefits to be granted.  For example, the increased royalty rate and
repayment amount will be required in such cases.

The
Research and Development Law also provides that know-how developed under an
approved research and development program may not be transferred to third
parties in Israel without the approval of the research committee.  Such approval is not required for the export
of any products resulting from such research or development. The Research and
Development Law further provides that the know-how developed under an approved
research and development program may not be transferred to any third parties
outside Israel.

The
Research and Development Law imposes reporting requirements with respect to
certain changes in the ownership of a grant recipient.  The law requires the grant recipient and its
controlling shareholders and interested parties to notify the Office of the
Chief Scientist of any change in control of the recipient or a change in the
holdings of the means of control of the recipient that results in a non-Israeli
becoming an interested party directly in the recipient and requires the new
interested party to undertake to the Office of the Chief Scientist to comply
with the Research and Development Law. 
In addition, the rules of the Office of the Chief Scientist may require
prior approval of the Office of the Chief Scientist or additional information
or representations in respect of certain of such events. For this purpose,
control is defined as the ability to direct the activities of a company other
than any ability arising solely from serving as an officer or director of the
company.  A person is presumed to have
control if such person holds 50% or more of the means of control of a company.  Means of control refers to voting rights
or the right to appoint directors or the chief executive officer.  An interested party of a company includes
a holder of 5% or more of its outstanding share capital or voting rights, its
chief executive officer and directors, someone who has the right to appoint its
chief executive officer or at least one director, and a company with respect to
which any of the foregoing interested parties owns 25% or more of the
outstanding share capital or voting rights or has the right to appoint 25% or
more of the directors.  Accordingly, any
non-Israeli who acquires 5% or more of our ordinary shares will be required to
notify the Office of the Chief Scientist that it has become an interested party
and to sign an undertaking to comply with the Research and Development Law.

The
funds available for Office of the Chief Scientist grants out of the annual
budget of the State of Israel were reduced in 1998, and the Israeli authorities
have indicated in the past that the government may further reduce or abolish Office
of the Chief Scientist grants in the future. 
Even if these grants are maintained, we cannot presently predict what
would be the amounts of future grants, if any, that we might receive.

D. Trend Information

The
deterioration of the global economy in general and economic uncertainty in the
telecommunications market in particular has resulted in a decline of capital
investment by telecommunications service providers since late 2000.  Several major as well as many new and small
service providers have failed.  In
addition, other service providers have been reducing or delaying expenditures
on new equipment and applications.  The
attacks of September 11, 2001 caused a further decline in the global
economy.  As a result, many companies,
including current and potential customers of ours, have postponed or decreased
further capital investment.  This
decline in capital expenditures has already reduced our sales and has resulted
in pressure on the prices we charge for our products.  The slow-down in telecommunications-related spending continued in
2003.

40

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New
technologies, such as VoIP, are facilitating the use of cheaper
communications media by some telecom service providers.  Such service providers may be less inclined
to invest in high-end solutions like ours. Moreover, since these
technologies enable the service providers to offer relatively low calling rates
to subscribers, this may reduce the incentive to commit telecom fraud and
thereby reduce the demand for anti-fraud solutions like ours. This trend may
harm our revenues and results of operations.

E. Off-Balance Sheet Arrangements

We
have no off-balance sheet arrangements.

F. Tabular Disclosure of Contractual Obligations

The
following table sets forth, as of December 31, 2003, our known contractual obligations
by type of obligation and for the periods indicated:

|                                                            |  | Payments
  due by period  (in thousands) |      
|----------------------------------------------------------- |  | ---------------------------------------- | -----
|Contractual Obligations                                     |  | Total                                    |      
|                                                            |  |                                          |      
|Operating lease obligations (vehicles 
  and facilities)    |  | $                                        | 6,352
|Purchase obligations (vendors of 
  equipment and services) |  |                                          | 615  
|Total                                                       |  | $                                        | 6,967

As to our royalty
obligations and outstanding guarantees as at December 31, 2003, see Note 10 to
our consolidated financial statements incorporated by reference in this
annual report.

Item 6. Directors, Senior Management and Employees.

A. Directors and Senior Management

The
following table sets forth information with respect to our directors and senior
managers:

|Name           | Age | Position                                                
|-------------- | --- | --------------------------------------------------------
|               |     |                                                         
|Eitan Naor     | 41  | President, 
  Chief Executive Officer and Director      
|               |     |                                                         
|Avi Goldstein  | 39  | Senior Vice President and Chief Financial Officer       
|               |     |                                                         
|Bruno Escojido | 38  | Senior Vice President, Worldwide Sales                  
|               |     |                                                         
|Itzik Dvir     | 38  | Vice President, Projects and R&D                        
|               |     |                                                         
|Noam Kimmel    | 44  | Vice President, Management Resources                    
|               |     |                                                         
|Hadar Solomon  | 47  | Vice President, General Counsel and Corporate  Secretary

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|Harel Beit-On               | 44 | Chairman of the Board of Directors
|--------------------------- | -- | ----------------------------------
|                            |    |                                   
|Gil Epstein (2) (3) (4) (5) | 39 | Director                          
|                            |    |                                   
|Giora Bitan (1) (4) (5)     | 50 | Director                          

|                                        
|----------------------------------------
|(1) Member of the compensation committee
|(2) Member of the audit committee       
|(3) Member of the credit committee      
|(4) Member of the executive committee   
|(5) Member of the investment committee  

Eitan
Naorhas served as our President and Chief Executive Officer since February 2004 and as a
director since June 2004. Prior thereto, he worked at Amdocs Limited, where he served as
Division President, OSS & Order Management Systems, from 2002 to 2004 and as Vice
President, Customer Care and Billing from 1999 to 2002. From 1996 to 1999, Mr. Naor served
as Vice President, Oracle Applications at Oracle Israel and from 1993 to 1996 he served as
Head of Professional Services at Hewlett Packard Israel. Mr. Naor holds a B.A. degree in
Economics from the Tel-Aviv University and an M.B.A. in Strategic Management from the
Hebrew University in Jerusalem.

Avi
Goldstein has served as our Senior Vice President and Chief
Financial Officer since September 2001. 
From 1992 to September 2001, Mr. Goldstein served as our Vice President
and Chief Financial Officer.  Mr.
Goldstein holds a B.A. in Economics and Foreign Relations and an M.A. in
Economics and Business Administration from the Hebrew University in Jerusalem.

Bruno
Escojidohas served as our Senior Vice President of Worldwide
Sales since May 2004. From 2001 to April 2004, he led the worldwide sales
team of the Order Management System Division of Amdocs.  Prior thereto, he served as Vice President
of Sales at PowerDsine from 1999 to 2001 and led the sales team in Europe
and Asia for the Access Division of ECI from 1995 to 1999. Mr. Escojido
holds a B.Sc. in Electronic Engineering from the Jerusalem College of Technology.

Yitzik
Dvirhas served as our Vice President of Projects and R&D
since October 2003.  From 1999 to
September 2003, Mr. Dvir served as our Director of Customer Projects.  Prior to joining ECtel, Mr. Dvir served as
Technical Director in RAD WIN from 1998 to 1999 and as Manager of Projects
Group in ECI from 1993 to 1996. He holds a B.Sc. in Electronic Engineering from
Tel Aviv University.

Noam
Kimmelhas served as our Vice-President, Management Resources
since October 2002.  Mr. Kimmel is a
veteran of the Israeli Defense Forces, where he served in various positions
relating to human and management resources from 1978 to 2002.  His last position was head of the human
resource division of the Intelligence Corp. Mr. Kimmel retired from the IDF as
a colonel in 2002.  Mr. Kimmel holds a
B.Sc. in Mathematics and Computer Science from Tel-Aviv University and an
M.B.A. from Beer Sheva University.

Hadar
Solomon joined us in March 2003 and has served as Vice
President and General Counsel since May 2003. 
From February 2002 until March 2003, he was Managing Director of Lumenis
Luxembourg Sarl, Schaffhausen Branch. 
Prior to that, Mr. Solomon served as Executive Vice President, General
Counsel and Corporate Secretary of Lumenis Ltd. and as Vice President,
Corporate Affairs, General Counsel and Secretary of Laser Industries Ltd. since
May 1988.  Mr. Solomon is a Graduate of
the Faculty of Law of the Hebrew University of Jerusalem and is a member of the
Israeli Bar.

Harel Beit-On
has served as Chairman
of our Board of Directors since June 21, 2004. Mr. Beit-On has served as Chairman of the
Board of Directors of Tecnomatix Technologies Ltd. since December 2001 and as a Director
since 1999. From 1996 until February 2004 Mr. Beit-On served as the Chief Executive
Officer of Tecnomatix. Mr. Beit-On also served as the President of Tecnomatix from 1995
until October 2002. From 1994 to 1996, Mr. Beit-On served as Chief Operating Officer of
Tecnomatix. Between 1991 and 1994, Mr. Beit-On served as Executive Vice President of Sales
and Engineering of Tecnomatix. From 1988 to 1991, Mr. Beit-On served as President of
Tecnomatixs United States Sales and Support subsidiary. From 1985 to 1988, Mr.
Beit-On served in various marketing positions with Tecnomatix. Mr. Beit-On holds a B.A.
degree in Economics from the Hebrew University and an M.B.A. degree from MIT.

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Gil
Epsteinhas served as one of our directors since June
2000.  Prof. Epstein has been a member
of the Department of Economics at Bar-Ilan University since 1996 and is
currently Vice-Chairman of the Department.  
Prior to that, he was a visiting lecturer at the University of
Pennsylvania (Department of Economics). 
Prior to that, Prof. Epstein was a lecturer in the Department of
Economics and Department of Statistics at the Hebrew University in Jerusalem.  Prof. Epstein holds a B.A., M.A. and Ph.D.
in Economics and Statistics from the Hebrew University of Jerusalem.

Giora
Bitan has served as one of our directors since October
2002.  Mr. Bitan has served as Executive
Vice President and Chief Financial Officer of ECI since joining ECI in August
1, 2002.  From 1997 to 2002, Mr. Bitan
was a general partner at Giza Venture Capital, where he focused on investments
in the communications and software sectors. 
From 1982 until 1996, he served in senior management positions in Scitex
Corporation Ltd., nine years of which he served as Executive Vice President and
CFO.  Mr. Bitan holds an MBA from the
University of California at Los Angeles and a BA in Economics and International
Relations from the Hebrew University in Jerusalem.

There
are no family relationships between any director or senior manager.

B. Compensation

The
aggregate direct remuneration paid to all persons as a group (12 persons) who
served in the capacity of director or executive officer during 2003 was
approximately $2.6 million, including $145,000 set aside or accrued for
pension, retirement  or similar
benefits.  This does not include amounts
expended by us for automobiles made available to our officers, expenses
(including business, travel, professional and business association dues and
expenses) reimbursed to officers and other fringe benefits commonly reimbursed
or paid by companies in Israel. Employee directors do not receive additional
fees for their services as directors, and our other directors do not receive any
fees except as described below.

In 2003, each of our outside directors received an annual payment of
approximately $45,000.

Our board of directors granted options to executive officers to purchase an
aggregate of 120,000 ordinary shares, at an exercise price of $4.67 per share,
during 2003.  The exercise price was
equal to the fair market value of our ordinary shares on the date of
grant.  These options vest over three
years in twelve equal quarterly installments, commencing on various dates from
March 2003 to May 2003, unless terminated sooner in accordance with their
terms.

C. Board Practices

Board of
Directors

According
to the Companies Law and our articles of association, the management of our
business is vested in our board of directors. 
The board of directors may exercise all powers and may take all actions
that are not specifically granted to our shareholders.  As part of its powers, our board of
directors may cause us to borrow or secure payment of any sum or sums of money
for our purposes, at times and upon terms and conditions as it thinks fit,
including the grant of security interests in all or any part of our
property.

Our
directors are elected at annual meetings of our shareholders. Except for
outside directors, our directors hold office until the next annual meeting of
shareholders following the annual meeting at which they were appointed, which
is required to be held at least once during every calendar year and not more
than fifteen months after the last preceding meeting.  Directors may be removed earlier from office by resolution passed
at a general meeting of our shareholders. 
Our board of directors may temporarily fill vacancies in the board until
the next annual meeting of shareholders.

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There
are no arrangements or understandings between us and any of our directors for
benefits upon termination of service, except that the vesting date of the
options held by directors may accelerate upon termination in certain
circumstances.

Upon
the distribution by ECI of 7,600,000 of our ordinary shares to its shareholders
in May 2004, three of our four directors who had been nominated by ECI resigned
from our board of directors.  We are
currently in the process of searching for appropriate directors to replace
them.

Audit
Committee

Nasdaq
Requirements

Our
ordinary shares are listed for quotation on the Nasdaq National Market and we
are subject to the rules of Nasdaq applicable to listed companies.  Pursuant
to the current listing requirements of the Nasdaq National Market, as a foreign
private issuer which was already public in December 1999, we are required to
have at least two independent directors on our board of directors and to
establish an audit committee, a majority of whose members must be
independent.  Gil Epstein is an
independent director and, since our second independent director has resigned
from our board of directors, we plan to propose a new independent director for
election at our next shareholder meeting.

We have adopted an audit committee charter, which
sets forth the powers and responsibilities of our audit committee.  Our audit committee assists the board in
fulfilling its responsibility for oversight of the quality and integrity of our
accounting, auditing and financial reporting practices and financial statements
and the independence qualifications and performance of our independent
auditors.  Our audit committee
also has the authority and responsibility to oversee our independent auditors,
to recommend for shareholder approval the appointment and, where appropriate,
replacement of our independent auditors and to pre-approve audit engagement
fees and all permitted non-audit services and fees.

Our board of directors has resolved to authorize
our audit committee to serve as our qualified legal compliance committee. As
such, our audit committee will be responsible for investigating reports, made
by attorneys appearing and practicing before the SEC in representing us, of
perceived material violations of U.S. federal or state securities laws,
breaches of fiduciary duty or similar violations by us or any of our agents.

Companies
Law Requirements

Under
the Companies Law, the board of directors of a public company is required to
appoint an audit committee, which must be comprised of at least three directors
and include all of the outside directors, but may not include:

| |  | the chairman of the board of directors;                                                        
| | - | -----------------------------------------------------------------------------------------------
| |   |                                                                                                
| |  | any controlling shareholder or any relative of a
  controlling shareholder; and                
| |   |                                                                                                
| |  | any director employed by the company or providing
  services to the company on a regular basis.

The
duty of the audit committee is to identify flaws in the management of the
company s business, including in consultation with the internal auditor and
the companys independent accountants, and to recommend remedial action.  In addition, the approval of the audit
committee is required under the Companies Law to effect certain related-party
transactions.

Outside
Directors

Under
the Companies Law, public companies are required to have two outside directors.
Gil Epstein is   an outside director and, since our second outside director has
resigned from our board of directors, we plan to propose a new outside director
for election at our next shareholder meeting.

44

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The
Companies Law provides that a person may not be appointed as an outside
director of a company if the person or the persons relative, partner, employer
or any entity under the persons control has, as of the date of the persons
appointment to serve as an outside director, or had, during the two years
preceding that date any affiliation with:

|                                 |  | the company;                                                            
|-------------------------------- | - | ------------------------------------------------------------------------
|                                 |   |                                                                         
|                                 |  | any entity controlling the company; or                                  
|                                 |   |                                                                         
|                                 |  | any entity controlled by the company or by its
  controlling entity.    
|                                 |   |                                                                         
|The
  term affiliation includes:
|                                 |   |                                                                         
|                                 |  | an employment relationship;                                             
|                                 |   |                                                                         
|                                 |  | a business or professional relationship maintained
  on a regular basis;
|                                 |   |                                                                         
|                                 |  | control; and                                                            
|                                 |   |                                                                         
|                                 |  | service as an office holder.                                            

The
Companies Law defines the term office holder of a company to include a
director, the chief executive officer, the chief business manager, a vice
president and any officer that reports directly to the chief executive officer.

No
person can serve as an outside director if the persons position or other
business creates, or may create conflict of interests with the persons
responsibilities as an outside director or may otherwise interfere with the
persons ability to serve as an outside director. Until the lapse of two years
from termination of office, a company may not engage an outside director to
serve as an office holder and cannot employ or receive services from that
person, either directly or indirectly, including through a corporation
controlled by that person.

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

| |  | at least one third of the shares of non-controlling
  shareholders voted at the meeting vote in favor of the election; or                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                             
| |  | the total number of shares voted against the
  election of the outside director does not exceed one percent of the aggregate
  voting rights in the company.

The
initial term of an outside director is three years and may be extended for an
additional three years.  Outside
directors may be removed from office only by the same percentage of
shareholders as is required for their election, or by a court, and then only if
the outside directors cease to meet the statutory qualifications for their
appointment or if they violate their duty of loyalty to the company.  Each committee of a companys board of
directors is required to include at least one outside director, except for the
audit committee, which is required to include all outside directors.

Other
Committees

Subject
to the provisions of the Companies Law, our board of directors may delegate its
powers to committees consisting of board members.  In addition to our audit committee, which is described above, our
board of directors has also appointed a compensation committee, which
administers our share option plan and determines the salaries of our executive
officers, and a credit committee, which sets policies with respect to granting
credit to customers.  In addition, our
board of directors has appointed an executive committee to act and meet between
meetings of the board of directors, and has empowered the executive committee
with all the powers and authorities of the board, other than those which cannot
be delegated to a committee pursuant to the Companies Law. The board of
directors has also established an investment committee to review and approve
our investment policy.

45

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Internal
Auditor

Under
the Companies Law, our board of directors is also required to appoint an
internal auditor proposed by the audit committee.  The role of the internal auditor is to examine, among other
things, whether our activities comply with the law and orderly business
procedure.  The internal auditor may not
be an interested party or office holder, or a relative of any interested party
or office holder, nor a member or representative of our independent accounting
firm.  The Companies Law defines the
term interested party to include a person who holds 5% or more of the
companys outstanding share capital or voting rights, a person who has the
right to appoint one or more directors or the general manager, or any person
who serves as a director or as the general manager.

Mr.
Meir Schweitzer serves as our internal auditor, as well as the internal auditor
of ECI.

D. Employees

Number.The following table
describes the number of our employees as of April 1, 2004 and December 31 of
each of the years indicated:

|Approximate
  numbers of employees by geographic location:            |  | April 1, 2004 |  | 2003 |     | 2002 |  | 2001 | 
|--------------------------------------------------------------------- |  | ------------- |  | ---- | --- | ---- |  | ---- | 
|                                                                      |  |               |  |      |     |      |  |      | 
|Israel                                                                |  | 150           |  |      | 217 |      |  | 251  | 
|                                                                      |  |               |  |      |     |      |  |      | 
|United States                                                         |  | 24            |  |      | 43  |      |  | 47   | 
|                                                                      |  |               |  |      |     |      |  |      | 
|Europe and elsewhere                                                  |  | 15            |  |      | 21  |      |  | 22   | 
|                                                                      |  |               |  |      |     |      |  |      | 
|Total workforce                                                       |  | 189           |  |      | 281 |      |  | 320  | 
|                                                                      |  |               |  |      |     |      |  |      | 
|Approximate numbers of employees by
  category of activity:           |  |               |  |      |     |      |  |      | 
|                                                                      |  |               |  |      |     |      |  |      | 
|Management and administration                                         |  | 21            |  |      | 21  |      |  | 23   | 
|                                                                      |  |               |  |      |     |      |  |      | 
|Research and development + Testing + Customization                    |  | 64            |  |      | 117 |      |  | 133  | 
|                                                                      |  |               |  |      |     |      |  |      | 
|Operations                                                            |  | 16            |  |      | 23  |      |  | 25   | 
|                                                                      |  |               |  |      |     |      |  |      | 
|Sales and marketing                                                   |  | 40            |  |      | 58  |      |  | 68   | 
|                                                                      |  |               |  |      |     |      |  |      | 
|Other (project managers, field engineering, customer
  support, etc.) |  | 48            |  |      | 62  |      |  | 71   | 
|                                                                      |  |               |  |      |     |      |  |      | 
|Total workforce                                                       |  | 189           |  |      | 281 |      |  | 320  | 

Relationship
with Employees.Competition
for highly-qualified technical and engineering personnel in the
telecommunications industry is intense. 
We believe we have been able to attract talented engineering and other
technical personnel.  None of our
employees are represented by a labor union, and we have not experienced any
work stoppage.  We believe our relations
with our employees to be good and that our future success will depend in part
on a continuing ability to hire, assimilate and retain qualified personnel.

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Labor
Laws; Pension Funds.Israeli
labor laws and regulations apply to all of our employees in Israel.  The laws principally concern matters such as
paid vacation, paid sick days, length of the workday, payment for overtime and
severance payments upon the retirement or death of an employee or termination
of employment under specified circumstances. 
The severance payments may be funded, in whole or in part, through
Managers Insurance or a Pension Fund, as described below.  The payments to the Managers Insurance fund
or Pension Fund toward severance amount to 8.3% of wages.  Furthermore, Israeli employees and employers
are required to pay predetermined sums to the National Insurance Institute,
which is similar to the U.S. Social Security Administration.  Since January 1, 1995, these amounts also
include payments for health insurance. 
The payments to the National Insurance Institute amount to approximately
14.5% of wages, of which the employee contributes 66% and the employer
contributes 34%.

Our
general practice is to contribute funds on behalf of all of our employees to
Managers Insurance or a Pension Fund. 
Each employee who agrees to participate in the Managers Insurance plan
contributes 5% of his or her base salary and we contribute 13.3%.  Each employee who agrees to participate in
the Pension Fund contributes 5.5% of his or her base salary and we contribute 14.3%.  Another savings plan we offer some of our
employees, although not legally required, is known as the Advanced Studies
Fund.  Each employee who agrees to
participate in the Advanced Studies fund contributes 2.5% of his or her base
salary and we contribute 7.5%.

Labor
Unions.We are a
member of the Industrialists Association in Israel, an employers union.  As a result of this membership, a number of
collective bargaining agreements apply to us. 
These agreements principally concern cost-of-living wage increases, paid
vacation and holidays, length of the workday, wage tariffs, termination,
severance payments and other conditions of employment.  We provide our employees with benefits and
working conditions that are at least as favorable as the conditions specified
in the collective bargaining agreements.

E. Share Ownership

Security
Ownership of Our Directors and Executive Officers

As
of May 31, 2004, none of our directors or executive officers beneficially owns
shares, including options to acquire our ordinary shares that are vested or
vest within 60 days, which represent more than 1% of our outstanding ordinary
shares.  As of May 31, 2004, our
officers and directors as a group held 20,109 of our ordinary shares and
options to purchase additional 690,400 of our ordinary shares. The following
table sets forth detailed information about the granted options, for the
periods indicated:

|Grant date                      |  | 1999 |        | 2000 |   | 2001   |  | 2001 |        | 2002 |   | 2003   |  | 2004 |        | Total |  
|------------------------------- |  | ---- | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ |  | ---- | ------ | ----- | -
|                                |  |      |        |      |   |        |  |      |        |      |   |        |  |      |        |       |  
|Exercise price                  |  | $    | 4.66   |      | $ | 15.75  |  | $    | 8.82   |      | $ | 11.55  |  | $    | 7.90   |       | $
|                                |  |      |        |      |   |        |  |      |        |      |   |        |  |      |        |       |  
|Granted amount                  |  |      | 18,100 |      |   | 13,000 |  |      | 36,000 |      |   | 45,000 |  |      | 66,000 |       |  
|                                |  |      |        |      |   |        |  |      |        |      |   |        |  |      |        |       |  
|Vested options                  |  |      | 12,067 |      |   | 13,000 |  |      | 36,000 |      |   | 43,333 |  |      | 22,000 |       |  
|                                |  |      |        |      |   |        |  |      |        |      |   |        |  |      |        |       |  
|Non-vested options              |  |      | -      |      |   | -      |  |      | -      |      |   | -      |  |      | 44,000 |       |  
|                                |  |      |        |      |   |        |  |      |        |      |   |        |  |      |        |       |  
|Options which 
  were exercised |  |      | 6,033  |      |   | -      |  |      | -      |      |   | -      |  |      | -      |       |  

All these options expire
ten years after the date of grant unless terminated sooner in accordance with
their terms.

Options
to Purchase Our Ordinary Shares

In
1998, our board of directors adopted a share option plan for our
employees.  In 1999, our board of
directors adopted a share option plan for our non-employee directors.  Terms of the options granted under the
plans, such as length of term, exercise price, vesting and exercisability, are
determined by our board of directors.

In
2003, our board of directors adopted the ECtel Ltd. 2003 Share Option Plan
for our officers, directors and consultants who are Israeli residents.  Pursuant to the Israeli tax reform
(described below under Item 10E  Taxation-Israeli Taxation), our board of directors
resolved to elect the capital gains route. Accordingly, subject to the
fulfillment of certain conditions, gains realized by Israeli residents from the
sale of shares issued upon exercise of options will be taxed at a rate of only
25% and not at the marginal income tax rate applicable to the grantee (up to
50%).  Also in 2003, our board of directors adopted
the ECtel Ltd. U.S. Employee Stock Option Plan for residents of the United
States to enable eligible grantees to benefit from favorable U.S. federal
income tax treatment of options that qualify as incentive stock options.  These plans were approved by our
shareholders and have initial pools of 200,000 shares and 50,000 ordinary
shares, respectively.  Terms of the
options granted under the plans, such as length of term, exercise price,
vesting and exercisability, are determined by our board of directors.

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As
of May 31, 2004, options to purchase a total of 3,040,352  of our ordinary shares were
outstanding.  As of May 31, 2004, options
to purchase an aggregate of 1,174,646 ordinary shares granted under the plans
have been exercised.  During 2003, our
board of directors granted options to our employees, including executive
officers, to purchase an aggregate of 120,000 ordinary shares.  The exercise price was equal to the fair
market value of our ordinary shares on the date of grant.  These options vest over three years in
twelve equal quarterly installments, commencing on various dates from March
2003 to May 2003, unless terminated sooner in accordance with their terms.

Item 7. Major Shareholders and Related Party
Transactions

A. Major Shareholders

The
following table shows the number of our ordinary shares beneficially owned by
the only shareholders known to us as of June 24, 2004, to beneficially own more
than 5% of our outstanding ordinary shares. 
As of that date, 18,112,146  of
our ordinary shares were issued and outstanding.  In accordance with the rules of the Securities and Exchange
Commission, the number of ordinary shares used in calculating the percentage
for each person listed below includes the shares underlying options or warrants
held by such person that are exercisable within 60 days, but excludes the
shares underlying options or warrants held by any other person.

| |                                  |  | Shares
  Beneficially Owned |          
| | -------------------------------- |  | --------------------------- | ---------
| |                                  |  |                             |          
| | Name                             |  | Number                      |          
| |                                  |  |                             |          
| |                                  |  |                             |          
| | Koor Industries Ltd. (1)         |  |                             | 3,937,452
| | ECI Telecom Ltd. (2)             |  |                             | 2,890,325
| | FMR Corp. (3)                    |  |                             | 2,519,066
| | Royce
  & Associates, LLC (4)    |  |                             | 1,500,200
| | Clal Electronics Industries Ltd. |  |                             | 1,067,556

---

(1)
Includes 369,035 ordinary shares and currently exercisable warrants to purchase
1,000,000 ordinary shares at an exercise price of $24 per share and 250,000
ordinary shares at an exercise price of $28 per share, held by Telrad Networks
Ltd., which is a subsidiary of Koor Industries Ltd.  Also includes 2,318,417 ordinary shares held by M.A.G.M. Chemistry
Holdings Ltd., which is a subsidiary of Koor Industries Ltd.  M.A.G.M. is a shareholder of ECI and
acquired its ECtel shares in ECIs share distribution in May 2004. Koor
Industries Ltd. is an Israeli corporation whose ordinary shares are traded on
the Tel Aviv Stock Exchange and whose ADRs (American depositary shares) are
traded on the New York Stock Exchange.

(2)
These shares have been pledged to banks by ECI to secure indebtedness under a
credit facility agreement.  Mr. Bitan,
who serves as our director and also as an officer of ECI, may be deemed to
beneficially own the shares held by ECI by virtue of his position with
ECI.  However, he disclaims beneficial
ownership of these shares.  We were
initially a wholly owned subsidiary of ECI. After the completion of our initial
public offering in October 1999, ECI owned approximately 74% of our ordinary
shares. In March 2002, ECI sold 1,572,175 ordinary shares to institutional
investors in a private placement, which reduced its interest in us to
approximately 59%.  In May 2004, ECI
distributed 7,600,000 ordinary shares to its shareholders, of which
approximately 550,000 shares, which were withheld by ECI pursuant to Israeli
tax law, were placed in an irrevocable trust with instructions to sell on the
Nasdaq Stock Market to reimburse the tax payable by ECI to the Israeli
government, subject to the terms of the trust and applicable securities
laws.   The trust is the record owner of
the withheld shares, and ECI is the sole beneficiary with respect to the
proceeds of the sale of shares held by the trust. ECI does not have any voting
rights with respect to the shares held in the trust.

(3)
Based upon a Schedule 13D filed with the SEC in February 2004 and subsequent
information provided to us.  FMR Corp. owns Fidelity Management &
Research Company, a registered investment adviser that manages various
registered investment companies that own some of our shares.  One such investment company is a shareholder
of ECI and acquired ECtel shares in ECIs share distribution in May 2004.  FMR Corp. also owns Fidelity Management
Trust Company, a bank that owns some of our shares.  Edward C. Johnson 3d and other members of his family are the
predominate owners of, and may be deemed to form a controlling group of, FMR
Corp.

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(4)
Based upon a Schedule 13D filed with the SEC in February 2004, containing
information as of December 31, 2003.

(5)
Clal Electronics Industries Ltd. (Clal) is a wholly owned subsidiary of Clal
Industries & Investments Ltd. (CII). 
CII is controlled by IDB Development Corporation Ltd. (IDBD), which,
in turn, is controlled by IDB Holding Corporation (IDBH).  Clal is a shareholder of ECI and acquired
its ECtel shares in ECIs share distribution in May 2004.  In addition to Clals holdings, based upon
reports received by us,  we estimate
that various entities within the aforesaid group beneficially own our shares as
a result of ECIs distribution, as follows: 
IDBD (7,015 shares); Badal Securities Ltd. (Badal), a wholly owned
subsidiary of IDBH (7,015 shares); Clal Insurance Enterprises Holdings Ltd.
(Clal Insurance), a majority-owned subsidiary of IDBD (2,926 shares); and PEC
Israel Economic Corporation (PEC), a wholly owned US subsidiary of Discount
Investment Corporation Ltd. (DIC), a company controlled by IDBH (1,167
shares).  CII, IDBD, IDBH, Clal
Insurance and DIC are all Israeli corporations whose shares are publicly traded
on The Tel Aviv Stock Exchange.

Based
upon reports received by us, since May 19, 2003, IDBH is controlled by a group
comprised of:  (i) Ganden Investments
I.D.B. Ltd. (Ganden), a private Israeli company controlled by Nochi Dankner
(who is the chairman of IDBH, IDBD, CII and DIC) and his sister Shelly
Dankner-Bergman (who is a director of IDBH, IDBD, CII and DIC), which holds 31.02%
of the equity of and voting power in IDBH; 
(ii) Manor Investments  IDB Ltd. (Manor), a private Israeli company
controlled by Ruth Manor (whose husband, Isaac Manor, and their son, Dori
Manor, are directors of IDBH, IDBD, CII and DIC), which holds 10.34% of the
equity of and voting power in IDBH; and 
(iii) Avraham Livnat Investments (2002) Ltd. (Livnat), a private
Israeli company controlled by Avraham Livnat (whose son, Zvi Livnat, is a
director of IDBH, IDBD, CII and DIC), which holds 10.34% of the equity of and
voting power in IDBH.  Ganden, Manor and
Livnat, owning in the aggregate approximately 51.7% of the equity of and voting
power in IDBH, entered into a Shareholders Agreement relating, among other things,
to their joint control of IDBH, the term of which is until May 19, 2023.  In addition, Ms. Bergman owns approximately
4.75% of the equity and voting power of IDBH.

Based
on the foregoing, IDBH (by reason of its control of IDBD), Ganden, Manor and
Livnat (by reason of their control of IDBH), Mr. Dankner, Ms. Bergman, Ms.
Manor and Mr. A. Livnat (by reason of their control, respectively, of Ganden,
Manor and Livnat) may be deemed to share the power to vote and dispose:  (i) with IDBD (by reason of its control of
CII and Clal), CII and Clal, of the ECtel shares held by Clal; (ii) with Badal,
of the ECtel shares held by Badal; (iii) with IDBD, of the ECtel shares held by
IDBD; (iv) with IDBD and Clal Insurance, of ECtel shares held by Clal
Insurance; and (v) with IDBD, DIC and PEC, of the ECtel shares held by PEC.

Record
Holders

As
of June 24, 2004, there were 389 holders of record of our ordinary shares. 320
record holders, holding approximately 12,266,393, or 67.7%, of
our outstanding ordinary shares, were located in the United States.  These numbers are not representative of the
number of beneficial holders of our shares nor is it representative of where
such beneficial holders reside since many of these ordinary shares were held of
record by brokers or other nominees.

There
is currently no trading market for our ordinary shares outside of the United
States.

B.  Related Party
Transactions

Transactions
with ECI

The
following are brief summaries of the provisions of certain agreements.  The summaries are qualified in their
entirety by the agreements themselves, which are either filed as exhibits to
this annual report or have been filed as exhibits to previous annual reports.

Registration
Rights Agreement

In
January 2002, we entered into a Registration Rights Agreement with ECI, whereby
we granted to ECI rights in connection with sales, from time to time, of our
ordinary shares held by ECI. As required by the Israeli Companies Law, the
agreement was approved by our Audit Committee, Board of Directors and a special
majority of our shareholders.  Under
this agreement, ECI is entitled to demand and piggyback registration rights,
which are exercisable for a period of ten years. During this period, ECI is
entitled to five demand registrations and unlimited piggyback
registrations.  ECI has agreed to
reimburse us for the expenses reasonably incurred by us in effecting such
registrations, unless we also issue ordinary shares in the same public
offering.

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In
addition, the Registration Rights Agreement provides that in the event that
ECI, from time to time, sells ordinary shares in a private transaction which is
conditioned upon the grant of registration rights with respect to such shares,
then, at ECIs request, we shall enter into a registration rights
agreement.  Such registration rights
agreements would require us to register the purchasers shares on a shelf
registration statement and to maintain the effectiveness of the registration
statement for two years.  They would
also include, among other things, an undertaking by us to indemnify the
purchasers for liabilities and expenses that may arise from any material
misstatements or omissions in our registration statement.  ECI has agreed to reimburse us for the
expenses reasonably incurred by us in effecting such registrations.

ECI
Share Purchase Agreement

In
February 2002, we entered into a Share Purchase Agreement with ECI and several
investors under which ECI sold 1,572,175 of our ordinary shares held by ECI to
the investors.  We made representations
and warranties in the Share Purchase Agreement for the benefit of the
investors, which survived for a period of two years following the closing of
the transaction. In addition, as contemplated in the Share Purchase Agreement,
we entered into a Registration Rights Agreement with ECI and the investors to
register the ordinary shares to be purchased pursuant to the Share Purchase
Agreement.  We filed a registration
statement with the SEC registering those shares, as well as 850,000 shares held
by Telrad, which was declared effective in March 2002.  ECI has agreed to bear all the expenses
incurred by us in connection with this transaction and the registration of the
ordinary shares sold thereunder.  However,
we could be held liable to the investors, or purchasers of shares from the
investors, if, during the two-year period following the closing, our
representations and warranties are found to have been inaccurate or if our
registration statement is found to contain a material misstatement or
omission.  In addition, the Registration
Rights Agreement contains a customary undertaking by us to indemnify the
investors for liabilities and expenses that may arise from any material
misstatements or omissions in our registration statement.  If ECI agrees to sell additional ordinary
shares, we are required to accept substantially the same undertakings with
respect to such ordinary shares.  We
believe that sales of our ordinary shares into the public market as a result of
this transaction increased the public float and liquidity of our shares.

As
required by the Israeli Companies Law, the agreement was approved by our Audit
Committee, Board of Directors and a special majority of our shareholders.

Commercial
Agreements

In
January 2001, we entered into several services agreements, for the purpose of
defining our continuing relationship with ECI. 
We believe that the cost of services and other terms of the agreements
are no less favorable than those that we would be able to obtain from
independent third parties.  We agreed on
the prices and other terms in these agreements in negotiations with ECI after
considering the prices and terms offered by other providers of similar
services.

Services Arrangements

The
various services arrangements with ECI call for ECI to provide us with the
following services:

| | intellectual property management assistance;                                                  
|- | ----------------------------------------------------------------------------------------------
|  |                                                                                               
| | communications services;                                                                      
|  |                                                                                               
| | Internal audit services;                                                                      
|  |                                                                                               
| | other miscellaneous services, such as Security and
  limited human resources related services.

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For
performance of each service we pay ECI amounts we agreed on, some of which are
based on our actual use of ECIs facilities or estimations of the cost of the
services based on the ratio of the total number of our employees to the total
number of ECIs employees in the companies facilities in Petah Tikva.

We
believe that if ECI were to terminate any of these  services arrangements, we would be able to obtain the same services
from a third party on terms no less favorable than those currently contained in
our agreements with ECI.

We
entered into an administrative services arrangement with ECI Telecom GmbH,
effective October 1, 2002, for the provision of various administrative
services, including the sub-lease of office space and the provision of various
bookkeeping services to ECtel GmbH.  The
term of this agreement was for an initial period of one year and was automatically
renewed for an additional period of one year.

Supply
Agreement

In
February 2004, we executed a new supply agreement with ECI, which replaced an
earlier supply agreement entered into in October 1999. Under the terms of the
new supply agreement, ECI supplies us with the components (modules) for use
in our products.  We agreed on the
prices for these modules after intense negotiations with ECI.  ECI may discontinue the production of any
module after giving us 12 months prior notice, in which case ECI would be
obligated to provide us with all necessary information for us to manufacture
the modules ourselves and integrate them into our products, as well as to
supply us with spare parts for such modules. In addition, under the terms of
the supply agreement, ECI has granted us (i) a non-exclusive, non-transferable
license to use the software embedded in the modules that are incorporated in
our products in the course of our regular business, (ii) the right to develop
and change the modules software and (iii) the right to sub-license the
software to third parties for use solely with our products.  ECtel has undertaken not to sell certain ECI
components, other than for use and incorporation into final products of ECtel.
Under the Supply Agreement we are allowed to 
sell these modules to Verint Systems under similar terms. The supply
agreement has an initial period of seven years and may be extended subject to a
written agreement of the parties. 
Either party may terminate the agreement at any time upon a material
breach by the other party or in the event of liquidation or similar
consequences of the other party. In addition, ECI has the right to terminate
the agreement with us in the event that (i) we shall have
new controlling shareholder which is a company that directly competes with ECI
with respect to the ECI modules, or (ii) the final product in which the ECI
modules are to be used is in direct competition with ECIs DCME products.

Other
Agreements with ECI

We
may, in the ordinary course of business, also enter into certain other leases,
sub-leases, operating agreements and other agreements that serve to define
various aspects of our relationship that will exist with ECI.  None of these agreements, either alone, or
in the aggregate, is expected to materially affect the results of operations of
either company.

Acquisition
of NetEye from Telrad

In
October 2001 we acquired Telrad Hawk Net-I Ltd., or NetEye, from Telrad
Networks Ltd., or Telrad.  Under the
terms of our agreement with Telrad, we acquired all of the outstanding shares
of NetEye, a wholly-owned subsidiary of Telrad, and Telrads shareholder loan
to NetEye of approximately $5.5 million in exchange for 850,000 ordinary
shares, warrants to purchase 1,000,000 ordinary shares with an exercise price of
$24 per share and warrants to purchase 250,000 ordinary shares with an exercise
price of $28 per share.

We
registered for re-sale the 850,000 shares that we issued to Telrad.  In addition, Telrad is entitled to demand
and piggyback registration rights with respect to the ordinary shares issuable
upon exercise of the warrants.  These
rights are exercisable from April 1, 2002 until October 1, 2006, or such
earlier time as Telrad can sell all of its shares under Rule 144 within any
three month period.  During this period,
Telrad is entitled to three demand registrations but not more than a total of
five registrations.

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This
transaction was a related party transaction because Koor Industries Ltd., the
sole shareholder of Telrad, held approximately 35% of the outstanding ordinary
shares of ECI at the time of the transaction, which in turn owned approximately
73% of our ordinary shares at that time. 
Accordingly, as required by the Israeli Companies law, the acquisition
was approved by our audit committee, board of directors and a special majority
of our shareholders.  In addition,
Salomon Smith Barney Inc., our financial advisor in connection with the
acquisition, delivered to our board of directors a written opinion as to the
fairness to us, from a financial point of view, of the consideration to be paid
by us in connection with the acquisition.

C. Interests of Expert and Counsel

Not
Applicable.

Item 8. Financial Information

A. Consolidated Statements and Other Financial Information

Financial
Statements

See
Item 18.

Legal
Proceedings

We
are not party to any material legal proceedings.

Dividend
Policy

We
anticipate that we will retain earnings to support operations and to finance
the growth and development of our business. 
Therefore, we do not expect to pay cash dividends in the foreseeable
future.

We
participate in the alternative benefits program under the Israeli Law for the
Encouragement of Capital Investments, 1959, under which we realize certain tax
exemptions.  If we distribute a cash
dividend from tax-exempt income, we would have to pay corporate tax at a rate
of up to 25% on the amount distributed and to withhold an additional 15% of the
amount distributed on behalf of the recipient. 
For more information about the alternative benefits program, see
Israeli TaxationTax Benefits under the Law for the Encouragement of Capital
Investments, 1959.

Dividends
on our ordinary shares may be paid only out of profits and other surplus, as
defined in the Israeli Companies Law, as of the end of the most recent fiscal
period or as accrued over a period of two years, whichever is higher.  Our board of directors is authorized to
declare dividends, provided that there is no reasonable concern that the
dividend will prevent us from satisfying our existing and foreseeable
obligations as they become due. 
Notwithstanding the foregoing, dividends may be paid with the approval of
a court, provided that there is no reasonable concern that the dividend will
prevent us from satisfying our existing and foreseeable obligations as they
become due.

B. Significant Changes

Except
as otherwise disclosed in this annual report, there was no significant change in
our financial position since December 31, 2003.  In particular, please see the description of the sale of our
government surveillance business to Verint Systems in March 2004, under Item
10C Additional InformationMaterial Agreements.

52

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Item 9. The Offer and Listing

A.  Offer and Listing
Details

Our ordinary shares have
been quoted on the Nasdaq National Market under the symbol ECTX since October
26, 1999.  The following table sets
forth, for the periods indicated, the high and low closing prices of our
ordinary shares, as reported on the Nasdaq National Market.

|                                        |  | High |       | Low |  
|--------------------------------------- |  | ---- | ----- | --- | -
|                                        |  |      |       |     |  
|Calendar Year:                          |  |      |       |     |  
|1999 (October 26 through December
  31) |  | $    | 23.75 |     | $
|2000                                    |  |      | 39.94 |     |  
|2001                                    |  |      | 20.35 |     |  
|2002                                    |  |      | 20.00 |     |  
|2003                                    |  |      | 9.70  |     |  
|                                        |  |      |       |     |  
|Calendar Quarter:                       |  |      |       |     |  
|2002:                                   |  |      |       |     |  
|First Quarter                           |  |      | 20.00 |     |  
|Second Quarter                          |  |      | 15.01 |     |  
|Third Quarter                           |  |      | 11.60 |     |  
|Fourth Quarter                          |  |      | 10.21 |     |  
|                                        |  |      |       |     |  
|2003:                                   |  |      |       |     |  
|First Quarter                           |  |      | 9.70  |     |  
|Second Quarter                          |  |      | 8.47  |     |  
|Third Quarter                           |  |      | 6.78  |     |  
|Fourth Quarter                          |  |      | 7.41  |     |  
|                                        |  |      |       |     |  
|Calendar Month:                         |  |      |       |     |  
|December 2003                           |  |      | 5.18  |     |  
|January 2004                            |  |      | 5.49  |     |  
|February 2004                           |  |      | 5.00  |     |  
|March 2004                              |  |      | 4.24  |     |  
|April 2004                              |  |      | 3.77  |     |  
|May 2004                                |  |      | 3.44  |     |  

B. Plan of Distribution          Not
Applicable.

C. Markets

Our
ordinary shares are quoted on the Nasdaq National Market under the symbol ECTX.

D. Selling Shareholders

Not
Applicable.

E. Dilution

Not
Applicable.

F. Expenses of the Issue

Not
Applicable.

53

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Item 10. Additional Information

A.  Share Capital

Not
Applicable.

B.  Memorandum and
Articles of Association

We
were first registered under Israeli law on April 4, 1990 as a private company,
and on October 29, 1999 became a public company.  Our registration number with the Israeli registrar of companies
is 52-004446-2.

Objects
and Purposes

Our
object is to engage, directly or indirectly, in any lawful undertaking or
business whatsoever, including, without limitation, as stipulated in our
memorandum of association. See Article 1 of our articles of association which
sets forth our purposes.

The
following sections, to the extent they refer to our articles of association are
qualified in their entirety by the articles themselves, filed as an exhibit to
our annual report submitted for 1999.

Transfer
and Ownership of Shares; Notices

The
ownership or voting of our ordinary shares by non-residents of Israel, except
for citizens of countries that are in a state of war with Israel, is not
restricted in any way by our memorandum or articles of association or by the
laws of the State of Israel.

Fully
paid ordinary shares may be freely transferred pursuant to our articles of
association unless the transfer is restricted or prohibited by another
instrument.  Unless otherwise prescribed
by law, each shareholder of record will be provided at least 21 calendar days
prior notice of any general shareholders meeting.

Dividend
and Liquidation Rights

Dividends
on our ordinary shares may be paid only out of profits and other surplus, as
defined in the Israeli Companies Law, as of the end of the most recent
financial statements or as accrued over a period of two years, whichever is
higher.  Our board of directors is
authorized to declare dividends, provided that there is no reasonable concern
that payment of the dividend will prevent us from satisfying our existing and
foreseeable obligations as they become due. 
Notwithstanding the foregoing, dividends may be paid with the approval
of a court, provided that there is no reasonable concern that payment of the
dividend will prevent us from satisfying our existing and foreseeable
obligations as they become due. 
Dividends that remain unclaimed after seven years will generally be forfeited
and returned to the company.  In the
event of our liquidation, after satisfaction of liabilities to creditors, our
assets will be distributed to the holders of ordinary shares in proportion to
their respective holdings.  These
dividend and liquidation rights may be affected by the grant of preferential
dividends or liquidiation rights to the holders of a class of shares with
preferential rights that may be authorized in the future.

Voting,
Shareholders Meetings and Resolutions

Holders
of ordinary shares have one vote for each ordinary share held on all matters
submitted to a vote of shareholders. 
Under the Companies Law and our articles of association, all resolutions
of our shareholders, except for a resolution to liquidate the company, require
approval by a simple majority of the ordinary shares voting thereon.  These voting rights may be affected by the
grant of any special voting rights to the holders of a class of shares with
preferential rights that may be authorized in the future.  No cumulative voting is permitted.

54

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These
voting rights may be affected by the grant of any special voting rights to the
holders of a class of shares with preferential rights that may be authorized in
the future.  We have two types of
general shareholders meetings:  the
annual general meetings and extraordinary general meetings.  These meetings may be held either in Israel
or in any other place the board of directors determines.  An annual general meeting must be held in
each calendar year, but not more than 15 months after the last annual general
meeting.  Our board of directors may
convene an extraordinary meeting, from time to time, at its discretion and is
required to do so upon the request of shareholders holding at least 5% of our
ordinary shares or at least two directors or one quarter of our directors then
serving.

The
quorum required for a meeting of shareholders consists of at least two
shareholders present in person or by proxy who hold or represent in the
aggregate at least 33-1/3% of the outstanding voting shares.  A meeting adjourned for lack of a quorum
generally is adjourned to the same day in the following week at the same time
and place or any time and place as the chairman may designate with the consent
of the holders of a majority of the voting power represented at the meeting and
voting on the matter adjourned.

Mergers
and Acquisitions under Israeli Law

The
Israeli Companies Law includes provisions that allow a merger transaction and
requires that each company that is a party to a merger have the transaction
approved by its board of directors and a vote of the majority of its shares, at
a shareholders meeting called on at least 21 days prior notice.  For purposes of the shareholder vote, unless
a court rules otherwise, the merger will not be deemed approved if a majority
of the shares held by parties other than the other party to the merger, or by
any person who holds 25% or more of the shares or the right to appoint 25% or
more of the directors of the other party, vote against the merger.  Upon the request of a creditor of either
party to the proposed merger, the court may delay or prevent the merger if it
concludes that there exists a reasonable concern that as a result of the
merger, the surviving company will be unable to satisfy the obligations of any
of the parties to the merger.  In
addition, a merger may not be completed unless at least 70 days have passed
from the time that a proposal of the merger has been filed with the Israeli
Registrar of Companies by each merging company.

The
Companies Law also provides that an acquisition of shares of a public company
must be made by means of a tender offer if as a result of the acquisition the
purchaser would become a 25% shareholder of the company and there is not any
other existing shareholder who holds 25% or more of the company.  An acquisition of shares of a public company
must be made by means of a tender offer if as a result of the acquisition the
purchaser would become a 45% shareholder of the company and there is no
existing  majority shareholder in the
company.  If following any acquisition
of shares, the acquiror will hold 90% or more of the companys shares, the
acquisition may not be made other than through a tender offer to acquire all of
the shares of such class.  If more than
95% of the outstanding shares are tendered in the tender offer, all the shares
that the acquiror offered to purchase will be transferred to it.  However, the remaining minority shareholders
may seek to alter the tender offer consideration by court order.

Lastly,
Israeli tax law treats some acquisitions, such as stock-for-stock exchanges
between an Israeli company and a foreign company less favorably than U.S. tax
laws. For example, Israeli tax law may, under certain circumstances, subject a
shareholder who exchanges his ordinary shares for shares in another
corporation, to taxation prior to the sale of the shares received in such
stock-for-stock swap.

Modification
of Class Rights

Our
articles of association provide that the rights attached to any class (unless
otherwise provided by the terms of that class), such as voting, rights to
dividends and the like, may be varied by a shareholders resolution, subject to
the sanction of a resolution passed by the holders of a majority of the shares
of that class at a separate class meeting.

Fiduciary
Duties of Office Holders

The
Israeli Companies Law imposes a duty of care and a duty of loyalty on all
office holders of a company.

55

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---

The
duty of care requires an office holder to act with the level of care with which
a reasonable office holder in the same position would have acted under the same
circumstances.  The duty of care
includes a duty to use reasonable means to obtain:

|                                                             | information on the advisability of a given action brought
  for his approval or performed by him by virtue of his position; and                                         
|------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                              |                                                                                                                                                                         
|                                                             | all other important information pertaining to these
  actions.                                                                                                          
|                                                              |                                                                                                                                                                         
|The duty of loyalty of an office holder includes a
  duty to:
|                                                             
|                                                             | refrain from any conflict of interest between the
  performance of his duties in the company and the performance of his other
  duties or his personal affairs;         
|                                                              |                                                                                                                                                                         
|                                                             | refrain from any activity that is competitive with
  the company;                                                                                                       
|                                                              |                                                                                                                                                                         
|                                                             | refrain from exploiting any business opportunity of
  the company to receive a personal gain for himself or others; and                                                 
|                                                              |                                                                                                                                                                         
|                                                             | disclose to the company any information or documents
  relating to the companys affairs which the office holder has received due to
  his position as an office holder.

Approval
of Related-Party Transactions under Israeli Law

The
Israeli Companies Law requires that an office holder of a company disclose to
the company any personal interest that he may have and all related material
information known to him, in connection with any existing or proposed
transaction by the company.  The
disclosure is required to be made promptly and in any event no later than the
board of directors meeting in which the transaction is first discussed.  If the transaction is an extraordinary
transaction, the office holder must also disclose any personal interest held
by:

|                                                                          |  | the office holders spouse, siblings, parents,
  grandparents, descendants, spouses descendants and the spouses of any of
  these people; or                                                   
|------------------------------------------------------------------------- | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                          |   |                                                                                                                                                                                                 
|                                                                          |  | any corporation in which the office holder is a 5% or
  greater shareholder, director or general manager or in which he has the right
  to appoint at least one director or the general manager.
|                                                                          |   |                                                                                                                                                                                                 
|Under the Companies law, an extraordinary
  transaction is a transaction:
|                                                                         
|                                                                          |  | other than in the ordinary course of business;                                                                                                                                                  
|                                                                          |   |                                                                                                                                                                                                 
|                                                                          |  | otherwise than on market terms; or                                                                                                                                                              
|                                                                          |   |                                                                                                                                                                                                 
|                                                                          |  | that is likely to have a material impact of the
  companys profitability, assets or liabilities.                                                                                               

Once an office holder
complies with the above disclosure requirement, the board of directors may
approve a transaction between the company and an office holder, or a third
party in which an office holder has a personal interest.  A transaction that is adverse to the
companys interest may not be approved.

If
the transaction is an extraordinary transaction, approval of both the audit
committee and the board of directors is required.  Under specific circumstances, shareholder approval may also be
required.  A director who has a personal
interest in an extraordinary transaction which is considered at a meeting of
the board of directors or the audit committee may not be present at this
meeting or vote on this matter, unless a majority of the members of the board
of directors or the audit committee, as the case may be, has a personal interest
in the matter.  If a majority of members
of the board of directors have a personal interest therein, shareholder
approval is also required.

56

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Under
the Companies Law, all arrangements as to compensation of directors in public
companies generally require the approvals of the audit committee, board of
directors and shareholders, in that order.

Duties of Shareholders

Disclosure
of Personal Interests of a Controlling Shareholder

Under
the Israeli Companies Law, the disclosure requirements that apply to an office
holder also apply to a controlling shareholder of a public company.  A controlling shareholder is a shareholder
who has the ability to direct the activities of a company, including a
shareholder that owns 25% or more of the voting rights if no other shareholder
owns more than 50% of the voting rights, but excluding a shareholder whose
power derives solely from his or her position on the board of directors or any
other position with the company. Extraordinary transactions with a controlling
shareholder or in which a controlling shareholder has a personal interest, and
the engagement of a controlling shareholder as an office holder or employee,
require the approvals of the audit committee, the board of directors and the
shareholders of the company, in that order. 
The shareholder approval must be by a majority of the shares voted on
the matter, provided that either:

| |  | at least one-third of the shares of shareholders who
  have no personal interest in the transaction and who vote on the matter vote
  in favor thereof; or                        
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                   
| |  | the shareholders who have no personal interest in
  the transaction who vote against the transaction do not represent more than
  one percent of the voting rights in the company.

Shareholders
generally have the right to examine document in the companys possession
pertaining to any matter that requires shareholder approval.

Duties
of Good Faith and Fairness

In addition, under the Companies Law, each shareholder has a
duty to act in good faith toward the company and other shareholders and to
refrain from abusing his or her power in the company, such as in shareholder
votes.  In addition, specified
shareholders have a duty of fairness toward the company.  These shareholders include any controlling
shareholder, any shareholder who knows that it possesses the power to determine
the outcome of a shareholder vote and any shareholder who, pursuant to the
provisions of the articles of association, has the power to appoint an office
holder or any other power with respect to the company.  However, the Companies Law does not define
the substance of this duty of fairness.

Indemnification
of Directors and Officers

Exculpation
of Office Holders

Under
the Companies Law, an Israeli company may not exempt an office holder from
liability for breach of his duty of loyalty, but may exempt in advance an
office holder from liability to the company, in whole or in part, for a breach
of his duty of care provided that the articles of association of the company
allow it to do so.  Our articles of
association allow us to exempt our office holders to the fullest extent
permitted by law.

Insurance
Relating to Office Holders

Our
articles of association provide that, subject to the provisions of the
Companies Law, it may enter into an insurance contract which would provide
coverage for any monetary liability incurred by any of our office holders, with
respect to an act performed in the capacity of an office holder for:

| | a breach of his duty of care us or to another
  person;                                                                                                                             
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                     
| | a breach of his duty of loyalty to us, provided that
  the office holder acted in good faith and had reasonable cause to assume that
  his act would not prejudice our interests; or

57

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|  |                                                                     
|- | --------------------------------------------------------------------
| | a financial liability imposed upon him in favor of
  another person.

We
have obtained liability insurance covering our officers and directors.

Indemnification
of Office Holders

Our
articles of association provide that we may indemnify an office holder against
the following obligations and expenses imposed on the office holder with
respect to an act performed in the capacity of an office holder:

|                                                    | a financial obligation imposed on him in favor of
  another person by a court judgment, including a settlement or an arbitrators
  award approved by the court; and                                                                                                                                                                          
|---------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                     |                                                                                                                                                                                                                                                                                                                                               
|                                                    | reasonable litigation expenses, including attorneys
  fees, expended by the office holder or charged to him by a court in
  connection with:                                                                                                                                                                                                 
|                                                     |                                                                                                                                                                                                                                                                                                                                               
|                                                    | proceedings we institute against him or that are
  instituted on our behalf or by another person;                                                                                                                                                                                                                                             
|                                                     |                                                                                                                                                                                                                                                                                                                                               
|                                                    | a criminal charge from which he is acquitted; or                                                                                                                                                                                                                                                                                              
|                                                     |                                                                                                                                                                                                                                                                                                                                               
|                                                    | a criminal proceeding in which he is convicted of an
  offense that does not require proof of criminal intent.                                                                                                                                                                                                                                
|                                                     |                                                                                                                                                                                                                                                                                                                                               
|Our articles of association also include provisions:
|                                                    
|                                                    | authorizing us to undertake to indemnify an office
  holder as described above, provided that the undertaking is limited to those
  types of events which our board of directors deems to be anticipated when the
  undertaking is given and to an amount determined by our board of directors to
  be reasonable under the circumstances; and
|                                                     |                                                                                                                                                                                                                                                                                                                                               
|                                                    | authorizing us to retroactively indemnify an officer
  or director.                                                                                                                                                                                                                                                                           

Limitations
on Exculpation, Insurance and Indemnification

The
Israeli Companies Law provides that a company may not exculpate or indemnify an
office holder, or enter into an insurance contract which would provide coverage
for any monetary liability incurred as a result of any of the following:

| | a breach by the office holder of his duty of loyalty
  unless, with respect to insurance coverage, the office holder acted in good
  faith and had a reasonable basis to believe that the act would not prejudice
  the company;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                 
| | a breach by the office holder of his duty of care if
  the breach was committed intentionally or recklessly;                                                                                                                    
|  |                                                                                                                                                                                                                                 
| | any act or omission committed with the intent to
  derive an illegal personal benefit; or                                                                                                                                       
|  |                                                                                                                                                                                                                                 
| | any fine imposed on the office holder.                                                                                                                                                                                          

In
addition, under the Companies Law, exculpation and indemnification of, and
procurement of insurance coverage for our office holders must be approved by
our audit committee and our board of directors and, if the beneficiary is a
director, by our shareholders.

58

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Our
articles of associations also provide that, subject to the provisions of
applicable law, we may procure insurance for, or indemnify, any person who is
not an office holder, including without limitation, any of our employees,
agents, consultants or contractors.

C.   Material Contracts

For
a description of the agreements that we entered into with ECI, please refer to
Item 7B  Related Party Transactions. 
For a description of the agreement we entered into with Telrad to
acquire NetEye, please see Item 5A  Operating Results  Acquisition of
NetEye and Item 7B  Related Party Transactions.

Transaction
with Verint Systems

On
February 9, 2004, we agreed to sell our government surveillance business to
Verint Systems Ltd., an Israeli subsidiary of Verint Systems Inc.  Verint Systems, which is listed on the
Nasdaq National Market, provides analytic software-based solutions for
communications interception, digital video security and surveillance, and
enterprise business intelligence.  The
transaction was consummated on March 31, 2004. 
The material terms of our asset purchase agreement and ancillary
agreements with Verint Systems are summarized below.  This summary is qualified in its entirety by reference to the
full agreements filed as exhibits to this annual report. See Item 19 
Exhibits.

Pursuant
to the asset purchase agreement, Verint Systems purchased certain assets and
assumed certain liabilities relating to our government surveillance business
for $35 million in cash.  The transferred
assets included certain intellectual property rights (as more fully described
below), fixed assets, backlog contracts, agreements with subcontractors and
suppliers, third-party software licenses and outstanding customer proposals.   The assumed liabilities included
employment-related liabilities in respect of our employees who were hired by
Verint Systems, including retention bonuses, severance and compensation
liabilities with respect to the termination of certain of our officers, and an
accrual for certain research and development and customization  expenses. 
We have retained our existing government surveillance projects and
warranty obligations and subcontracted the performance thereof to Verint
Systems upon agreed terms. We made customary representations and warranties to
Verint Systems under the asset purchase agreement and agreed to indemnify them
for any breaches thereof, subject to certain limitations set forth therein.

Pursuant
to a series of intellectual property agreements, we granted to Verint Systems
(i) co-ownership rights in software that is important to both our government
surveillance and telecom products, (ii) sole ownership in the intellectual
property rights that relates principally to our government surveillance
products, subject to a license-back in respect of certain rights that relate
also to our telecom products, and (iii) licenses to certain intellectual
property rights that relate principally to our telecom products and relate also
to our government surveillance products.

Pursuant
to a supply agreement, we agreed to supply to Verint Systems, and to support,
various components that are manufactured for us by ECI. The agreement is for a
period of seven years.

As
part of the asset purchase agreement we also agreed to contribute an aggregate
amount of $1.0 million for the development by Verint Systems of certain
government surveillance software.  In
exchange, we are entitled to receive royalties equal to 1% of the sales of such
software made between 2005 and 2010, up to an aggregate amount of $1.2 million.

In
addition, we agreed to cover certain expenses of up to $1.4m plus VAT, related
to the government surveillance business in 2004.

Verint
Systems hired most of our employees that worked in our government surveillance
business.  We and Verint Systems
mutually agreed to make our engineering employees available to the other,
primarily for support and bug fixing, for a period of 18 months, at fixed
hourly rates.

59

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We
have undertaken with Verint Systems mutual non-competition covenants not to
engage in the respective businesses of the other (i) generally, for a period of
three years and (ii) using our respective technologies as they exist as of the
closing of the transaction, for a period of ten years.   We also mutually agreed, for a period of
one year, not to solicit one anothers employees, customers or suppliers.

D.  Exchange Controls

Exchange
Controls and Other Limitations Affecting Security Holders

There
are currently no Israeli currency control restrictions on payments of dividends
or other distributions with respect to our ordinary shares or the proceeds from
the sale of the shares, except for the obligation of Israeli residents to file
reports with the Bank of Israel regarding some transactions. However,
legislation remains in effect under which currency controls can be imposed by
administrative action at any time.

The
ownership or voting of our ordinary shares by non-residents of Israel, except
with respect to citizens of countries which are in a state of war with Israel,
is not restricted in any way by our memorandum of association or articles of
association or by the laws of the State of Israel.

E. Taxation

The
following is a general summary only and should not be considered as income tax
advice or relied upon for tax planning purposes. 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 foreign, state or local taxes.

U.S. FEDERAL
INCOME TAX
CONSIDERATIONS

Subject
to the limitations described below, the following discussion summarizes the
material U.S. federal income tax consequences of the purchase, ownership and
disposition of our ordinary shares to a U.S. holder that owns our ordinary
share as capital assets.   A U.S. holder is a holder of our ordinary shares who is:

| | an individual citizen or resident of the United
  States,                                                                                                                                                                                                                                                                                               
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                         
| | a corporation (or other entity taxable as a
  corporation for U.S. federal tax purposes) created or organized in the United
  States or under the laws of the United States or any political subdivision
  thereof,                                                                                                                                     
|  |                                                                                                                                                                                                                                                                                                                                                         
| | an estate, the income of which is subject to
  U.S. federal income tax regardless of its source,
  or                                                                                                                                                                                                                                                   
|  |                                                                                                                                                                                                                                                                                                                                                         
| | a trust (i) if, in general, a court within the
  United States is able to exercise primary supervision over its administration
  and one or more U.S. persons have the authority to control all of its
  substantial decisions, or (ii) that has in effect a valid election under
  applicable U.S. Treasury regulations to be treated as a U.S. person.

Material  aspects of U.S.  federal  income tax relevant to a holder of our  ordinary  shares that is not a
U.S. holder (a "non-U.S. holder") are also discussed below.

This
discussion is not a comprehensive description of all of the tax considerations
that may be relevant to each persons decision to purchase ordinary
shares.

60

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

| | are broker-dealers or insurance companies,                                                           
|- | -----------------------------------------------------------------------------------------------------
| | have elected mark-to-market accounting,                                                              
| | are tax-exempt organizations or retirement plans,                                                    
| | are financial institutions or financial services
  entities,                                         
| | hold ordinary shares as part of a straddle, hedge or
  conversion transaction with other investments,
| | acquired their shares upon the exercise of employee
  stock options or otherwise as compensation,    
| | are, or hold their shares through, partnerships or other
  pass-through entities,                    
| | own directly, indirectly or by attribution at least
  10% of our voting power, or                    
| | have a functional currency that is not the dollar.                                                   

In
addition, this discussion does not address any aspect of state, local or
non-U.S. tax laws or the possible application of United States federal gift or
estate tax.

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

Taxation
of Dividends Paid on Ordinary Shares

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

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

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

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

A
U.S. holder will be denied a foreign tax credit for Israeli income tax withheld
from a dividend received on the ordinary shares:

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| | if the 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 with respect to such dividend; or
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                          
| | to the extent the U.S. holder is under an obligation
  to make related payments with respect to positions in substantially similar
  or related property.                                                

Any
days during which a U.S. holder has substantially diminished its risk of loss
on the ordinary shares are not counted toward meeting the required 16-day
holding period. Distributions of current or accumulated earnings and profits
will be foreign source passive income for U.S. foreign tax credit purposes.

Taxation
of the Disposition of Ordinary Shares

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

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

Tax
Consequences if we are a Passive Foreign Investment Company

We
would be a passive foreign investment company (a PFIC) for 2003 if (taking
into account certain look-through rules with respect to the income and assets
of our subsidiaries) either 75 percent or more of our gross income for the
taxable year is passive income or the average percentage (by value) of our
passive assets during the taxable year is at least 50 percent.  If we were a
PFIC, each U.S. holder would (unless it made one of the elections discussed
below on a timely basis) be taxable on gain recognized from the disposition of
ordinary shares (including gain deemed recognized if the ordinary shares are
used as security for a loan) and upon receipt of certain distributions with
respect to ordinary shares as if such income had been recognized ratably over
the U.S. holders holding period for the ordinary shares.  The U.S. holders income for the current
taxable year would include (as ordinary income) amounts allocated to the
current year and to any period prior to the first day of the first taxable year
for which we were a PFIC.  Tax would
also be computed at the highest ordinary income tax rate in effect for each
other period to which income is allocated, and an interest charge on the tax as
so computed would also apply. 
Additionally, if we were a PFIC, U.S. holders who acquire our ordinary
shares from decedents (other than nonresident aliens) dying before 2010 would
be denied the normally-available step-up in basis for such shares to fair
market value at the date of death and, instead, would have a tax basis in such
shares equal to the decedents basis, if lower.

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As
an alternative to the tax treatment described above, a U.S. holder could elect
to treat us as a qualified electing fund (a QEF), in which case the U.S.
holder would be taxed currently on its pro rata share of our ordinary earnings
and net capital gain (subject to a separate election to defer payment of taxes,
which deferral is subject to an interest charge).  Special rules apply if a U.S. holder makes a QEF election after
the first year in its holding period in which we are a PFIC.  We would supply U.S. holders with the
information needed to report income and gain under a QEF election if we were a
PFIC.  As another alternative to the tax
treatment described above, a U.S. holder could elect to mark our shares 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 our shares and the shareholders adjusted basis in the shares.  Losses would be allowed only to the extent
of net mark-to-market gain previously included in income by the U.S. holder.

We believe
we were not a PFIC in 2003, or for any prior taxable year,
It is  possible  that the  Internal  Revenue  Service  will attemp to
treat us as a PFIC for 2003 or prior years. In addition, there can be no
assurance that we will not become a PFIC in 2004 or in a subsequent year.  The tests for determining PFIC status are
applied annually and it is difficult to make accurate predictions of future
income and assets, which are relevant to this determination.  U.S. holders who hold our ordinary shares
during a period when we are a PFIC will be subject to these rules, even if we
cease to be a PFIC, subject to specified exceptions for U.S. holders who made a
QEF election.

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

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

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

| | the item is effectively connected with the conduct
  by the non-U.S. holder of a trade or business in the United States and:                                                                                                         
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | in the case of a resident of a country which has a
  treaty with the United States, the item is attributable to a permanent
  establishment; or                                                                                      
|  |                                                                                                                                                                                                                                      
| | in the case of an individual, the item is
  attributable to a fixed place of business in the United States;                                                                                                                          
|  |                                                                                                                                                                                                                                      
| | the non-U.S. holder is an individual who holds the
  ordinary shares as a capital asset and is present in the United States for
  183 days or more in the taxable year of the disposition and does not
  qualify for an exemption; or
|  |                                                                                                                                                                                                                                      
| | the non-U.S. holder is subject to tax under the
  provisions of U.S. tax law applicable to U.S. expatriates.                                                                                                                         

Information
Reporting and Back-up Withholding

U.S.
holders generally are subject to information reporting requirements with
respect to dividends paid in the United States on or proceeds from the disposition of
our ordinary shares.  In addition, a U.S. holder may be subject,
under certain circumstances, to backup withholding at a rate of up to 28% with
respect to dividends paid on or proceeds from the disposition of
our ordinary shares unless the U.S. holder
provides proof of an applicable exemption or correct taxpayer identification
number and otherwise complies with applicable requirements of the backup
withholding rules.  A holder of our
ordinary shares who provides an incorrect taxpayer identification number may be
subject to penalties imposed by the IRS. 
Amounts withheld under the backup withholding rules are not an
additional tax and may be refunded or credited against the holders federal
income tax liability, provided the required information is furnished to the
IRS.

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

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ISRAELI TAXATION

The
following summary describes the current tax structure applicable to companies
incorporated in Israel, with special reference to its effect on us.  It also discusses Israeli tax consequences
material to persons purchasing our ordinary shares.  To the extent that the summary is based on new tax legislation
yet to be judicially or administratively interpreted, we cannot be sure that
the views expressed will accord with any future interpretation by the Israeli
tax authorities or courts.  The summary
is not intended, and should not be construed, as legal or professional advice
and does not exhaust all possible tax considerations.  Accordingly, you should consult your tax advisor as to the
particular tax consequences of an investment in our ordinary shares.

Tax
Reform

On
January 1, 2003, the Law for Amendment of the Income Tax Ordinance (Amendment
No. 132), 5762-2002, as amended, known as the Tax Reform, came into
effect.  The Tax Reform, aimed at
broadening the categories of taxable income and reducing the tax rates imposed
on employment income, introduced, among other things, the following provisions:

| | Reduction of the tax rate levied on capital gains
  (other than gains from the sale of listed securities) derived after January
  1, 2003, to a general rate of 25% for both individuals and corporations.  Regarding assets acquired prior to January
  1, 2003, the reduced tax rate will apply to a proportionate part of the gain,
  in accordance with the holding periods of the asset, before or after January
  1, 2003, on a linear basis;                                                                                                                                                                                                                                                                       
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | Imposition of Israeli tax on all income of Israeli
  residents, individuals and corporations, regardless of the territorial source
  of income, including income derived from passive sources such as interest,
  dividends and royalties;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | Introduction of controlled foreign corporation (CFC)
  rules into the Israeli tax structure. Generally, under such rules, an Israeli
  resident who holds, directly or indirectly, 10% or more of the rights in a
  foreign corporation whose shares are not publicly traded (or which has
  offered less than 30% of its shares or any rights to its shares to the
  public), in which more than 50% of the rights are held directly or indirectly
  by Israeli residents, and a majority of whose income in a tax year is
  considered passive income, will be liable for tax on the portion of such
  income attributed to his holdings in such corporation, as if such income were
  distributed to him as a dividend;
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | Imposition of capital gains tax on capital gains
  realized as of January 1, 2003 by individuals who are Israeli residents,
  from the sale of shares of publicly traded companies on the Tel Aviv Stock
  Exchange and from the sale of shares of publicly traded Israeli companies on
  certain other stock exchanges (such gain was previously exempt from capital
  gains tax in Israel in certain cases). For information with respect to the
  applicability of Israeli capital gains taxes on the sale of ordinary shares,
  see Capital Gains Tax
  below;                                                                                                                                                      
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | Effectuation of a new regime for the taxation of
  shares and options issued to employees, officers and directors; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | Introduction of tax at a rate of 25% on dividends
  paid by one Israeli company to another (which are generally not subject to
  tax), if the source of such dividends is income that was derived outside of
  Israel;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | Elimination of the seven year limit to carry forward
  capital losses with respect to capital losses arising from and after 1996.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

General
Corporate Tax Structure

Israeli
companies are subject to tax at the rate of 36% of taxable income (and are
subject to capital gains tax at a rate of 25% for capital gains, other than
gains deriving from the sale of listed securities, derived after January 1,
2003).  However, the effective tax rate payable
by a company that derives income from an approved enterprise (as defined
below) may be considerably less, as further discussed below.

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On
June 2, 2004, the Israeli government introduced a bill to the Israeli
parliament proposing, among other things, changes to the corporate tax rate.
The bill proposes to reduce the corporate tax rate from 36% to 35% for the 2004
tax year, 34% for the 2005 tax year, 32% for the 2006 tax year and 30% for the
2007 tax year and thereafter. In order to enact the bill as law, the bill must
be approved by the Israeli parliament and published. The bill might be modified
prior to enactment or might not be enacted at all. Accordingly, we cannot
predict the consequences of the bill to us.

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

The
Law for the Encouragement of Capital Investments, 1959, as amended, provides
that upon application to the Investment Center of the Ministry of Industry,
Trade and Labor of the State of Israel, a proposed capital investment in
eligible facilities may be designated as an approved enterprise.  The applicable law regarding approved
enterprise programs is scheduled to expire on June 30, 2004.  Accordingly, requests for new programs or
expansions that are not approved on or before June 30, 2004 will not confer any
tax benefits, unless the term of the law will be extended. Each certificate of
approval for an approved enterprise relates to a specific investment program
delineated both by its financial scope, including its capital sources, and by
its physical characteristics, such as the equipment to be purchased and
utilized pursuant to the program.  The
tax benefits derived from any such certificate of approval relate only to
taxable income derived from the specific approved enterprise.  If a company has more than one approval or
only a portion of its capital investments are approved, its effective tax rate
is the result of a weighted combination of the applicable rates.  The tax benefits under the law are not
generally available with respect to income derived from products manufactured
outside of Israel.

Taxable
income of a company derived from an approved enterprise (including income
generated by a company from the grant of a usage right with respect to know-how
developed by the approved enterprise, income generated from royalties and
income derived from a service which is auxiliary to such usage right or
royalties, provided that such income is generated within the approved
enterprises ordinary course of business) is subject to company tax at the
maximum rate of 25%, rather than the usual rate of 36%, for the Benefit
Period.  The Benefit Period is seven
years (and under certain circumstances, as further detailed below, ten years),
commencing with the year in which the approved enterprise first generates
taxable income, and is limited to 12 years from commencement of production or
14 years from the date of approval, whichever is earlier.

A
company that has an approved enterprise program is eligible for further tax
benefits if it qualifies as a foreign investors company.  A foreign investors company is a company
more than 25% of whose shares of capital stock and combined share and loan
capital is owned by non-Israeli residents. 
A company that qualifies as a foreign investors company and has an
approved enterprise program is eligible for tax benefits for a ten-year benefit
period and to a reduced tax rate of 10% to 20% depending on the level of
foreign investment in each year.

A
company owning an approved enterprise may elect (as we have done) to forego
certain government grants extended to approved enterprises in return for an
alternative package of benefits.  Under
the alternative package, the companys undistributed income derived from an
approved enterprise will be exempt from 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 the tax benefits under the law for the remainder of the benefit period.

The
Investment Center bases its decision of whether to approve or reject a
companys application for designation as an approved enterprise, among other
things, on criteria set forth in the law and related regulations, the then
prevailing policy of the Investment Center and the specific objectives and
financial criteria of the applicant. 
Accordingly, a company cannot be certain in advance whether its
application will be approved.  In
addition, the benefits available to an approved enterprise are conditional upon
compliance with the conditions stipulated in the law and related regulations
and the criteria set forth in the specific certificate of approval.  In the event that a company violates these
conditions, in whole or in part, it may be required to refund the amount of tax
benefits plus an amount linked to the Israeli consumer price index and
interest.

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A
major portion of our production facilities have been granted the status of
approved enterprises.  Income arising
from our approved enterprises facilities is tax-free under the alternative
package of benefits described above for the period in which such alternative
package is in effect and thereafter, entitled to reduced tax rates based on the
level of foreign ownership for specified periods.  We have derived, and expect to continue to derive, a substantial
portion of our income from our approved enterprises facilities.  Subject to compliance with applicable
requirements, the benefits for most of our production facilities in Israel will
continue until termination between the years 2001 and 2008.  Our current investments in development
facilities are made under new approvals.

We
received an approval in principle from the Investment Center with respect to
the sale of our government surveillance business to Verint Systems in March
2004. If the Investment Center declines, for any reason, to grant us the final
approval, our tax benefits under the Law for the Encouragement of Capital
Investments will be materially reduced.

All
dividends are considered to be attributable to the entire enterprise and their
effective tax rate is the result of a weighted combination of the applicable
tax rates.  We currently intend to
reinvest the amount of our income and not to distribute such income as a
dividend.  In the event that we do pay a
cash dividend from income that is derived from our approved enterprises pursuant
to the alternative package of benefits, which income would normally be
tax-exempt, we would be required to pay tax on the amount intended to be
distributed as dividends at the rate which would have been applicable had we
not elected the alternative package of benefits, which rate is ordinarily up to
25%, and to withhold at source on behalf of the dividend recipient an
additional 15% of the amount distributed as dividends.

The
law also provides that an approved enterprise is entitled to accelerated
depreciation on its property and equipment that are included in an approved
investment program.

Tax
Benefits for Research and Development

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

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

According
to the Law for the Encouragement of Industry (Taxes), 1969, an Industrial
Company is a company located in Israel, at least 90% of the income of which,
in any tax year, exclusive of income from defense loans, capital gains,
interest and dividends, is derived from an Industrial Enterprise owned by it.  An Industrial Enterprise is defined as an
enterprise whose major activity in a given tax year is industrial production
activity.  We believe that we currently
qualify as an Industrial Company within the definition of the Law for the
Encouragement of Industry (Taxes), 1969.

Under
the law, Industrial Companies are entitled to preferred corporate tax benefits,
among others, such as:

| | deduction of purchases of know-how and patents over
  an eight-year period for tax purposes;                          
|- | ----------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                       
| | deduction over a three-year period of expenses
  involved with the issuance and listing of shares on a stock exchange;

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|  |                                                                                                                                                                            
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | the right to elect, under certain conditions, to
  file a consolidated tax return with related Israeli Industrial Companies that
  satisfy conditions set forth in the law;
|  |                                                                                                                                                                            
| | accelerated depreciation rates on equipment and
  buildings.                                                                                                               

Eligibility
for the benefits under the law is not subject to receipt of prior approval from
any governmental authority.  However,
the Israeli tax authorities may determine that we do not qualify as an
Industrial Company.  In addition, we
might not continue to qualify as an Industrial Company in the future.  As a result of either of the foregoing, the
benefits described above might not be available in the future.

Special
Provisions Relating to Taxation Under Inflationary Conditions

The
Income Tax Law (Inflationary Adjustments), 1985 represents an attempt to
overcome the problems presented to a traditional tax system by an economy
undergoing inflation.  The law is highly
complex.  Its features that are material
to us can be described as follows:

| | A special tax adjustment for the preservation of
  equity whereby certain corporate assets are classified broadly into fixed
  (inflation immune) assets and non-fixed (soft) assets.  Where a companys equity, as defined in
  the law, exceeds the depreciated cost of its fixed assets, as defined in the
  law, the company may take a deduction from taxable income that reflects the
  effect of multiplication of the annual rate of inflation on such excess, up
  to a ceiling of 70% of taxable income in any single tax year, with the unused
  portion carried forward, linked to the increase in the consumer price
  index.  If the depreciated cost of fixed
  assets exceeds a companys equity, then the excess multiplied by the annual
  rate of inflation is added to taxable income.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | Subject to certain limitations set forth in the law,
  depreciation deductions on fixed assets and losses carried forward are
  adjusted for inflation based on the increase of the Israeli consumer price
  index.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | Taxable gains on certain traded securities, which
  are taxed at a reduced tax rate with respect to individuals following the Tax
  Reform (and which were previously exempt from tax), are taxable at the
  companys tax rate in certain circumstances.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

However,
the Minister of Finance may, with the approval of the Knesset Finance
Committee, determine by order, during a certain fiscal year (or until February
28th of the following year) in which the rate of increase of the
price index would not exceed or shall not have exceeded, as applicable, 3%,
that all or some of the provisions of this Law shall not apply to such fiscal
year, or, that the rate of increase of the price index relating to such fiscal
year shall be deemed to be 0%, and to make the adjustments required to be made
as a result of such determination.

Capital
Gains Tax

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

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Pursuant
to the Tax Reform, generally, capital gains tax is imposed on Israeli residents
at a rate of 15% on real gains derived on or after January 1, 2003, from the
sale of shares in (i) companies publicly traded on the Tel Aviv Stock
Exchange (TASE), or (ii) Israeli companies publicly traded on Nasdaq or on a
recognized stock exchange or regulated market in a country that has a treaty
for the prevention of double taxation with Israel (such as our company), or
(iii) companies dually traded on both the TASE and Nasdaq or on a recognized
stock exchange or a regulated market outside of Israel. This tax rate is
contingent upon the shareholder not claiming a deduction for financing
expenses, and does not apply to: (i) the sale of shares to a relative (as
defined in the Tax Reform); (ii) the sale of shares by dealers in securities;
(iii) the sale of shares by shareholders that report in accordance with the
Inflationary Adjustment Law; or (iv) the sale of shares by shareholders
who acquired their shares prior to an initial public offering (that are subject
to a different tax arrangement).  The
tax basis of shares acquired prior to January 1, 2003 will be determined in
accordance with the average closing share price in the three trading days
preceding January 1, 2003.  However, a
request may be made to the tax authorities to consider the actual adjusted cost
of the shares as the tax basis if it is higher than such average price.

In
December 2003, regulations promulgated pursuant to the Tax Reform were amended
so that, in certain circumstances, capital gains derived from the sale and
subsequent (same day) repurchase of shares traded on the TASE or from shares of
Israeli companies publicly traded on a recognized stock exchange or regulated
market in a country that has a treaty for the prevention of double taxation
with Israel, may be taxed at a rate equal to the withholding tax rate
applicable to revenues derived from such sale. In accordance with an announcement
published by the Israeli Income Tax Commission, the withholding tax rate
applicable to the sale of such shares until the end of 2003 tax year, which was
equal at such time to 1% of the revenues generated in their sale, was
determined as the final tax rate applicable to such sale. The amended
regulations also determined that the day of such sale and repurchase shall be
considered the new date of purchase of such shares. The foregoing is not
applicable to: (i) dealers in securities; (ii) shareholders that report in
accordance with the Inflationary Adjustments Law; (iii) shareholders who
acquired their shares prior to an initial public offering; (iv) in some cases,
shareholders that received their shares within the framework of an
employer-employee relationship; or (v) shareholders claiming a deduction for
financing expenses in connection with such shares. The regulations further
provide that with respect to shares of Israeli companies traded on a stock
exchange outside of Israel, the market price determined at the close of the
trading day preceding the day of the sale and repurchase of such shares, will
constitute the new tax basis for any future sale of such shares.

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

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

Pursuant
to a treaty between the governments of the United States and Israel, the sale
of shares by a person who qualifies as a resident of the United States within
the meaning of the treaty and who is entitled to claim the benefits afforded to
a resident by the treaty will not be subject to Israeli capital gains tax.  This exemption does not apply if (i) the
person holds, directly or indirectly, shares representing 10% or more of our
voting power during any part of the 12-month period preceding the applicable
sale, or (ii) the capital gains from such sale can be allocated to a permanent
establishment in Israel.  However, the
person would be permitted to claim a credit for the capital gains tax paid in
Israel against the U.S. income tax imposed with respect to the applicable sale,
subject to the limitations in U.S. laws applicable to foreign tax credits.

Taxation
of Dividends

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 such as dividends, royalties and interest, as well as
non-passive income from services rendered in Israel.  On distributions of dividends other than bonus shares, or stock
dividends, we would be required to withhold income tax at the rate of 25%.  If the income out of which the dividend is
being paid is attributable to an approved enterprise under the Law for the Encouragement
of Capital Investments, 1959, the rate is 15%. 
A different rate may be provided in a treaty between Israel and the
shareholders country of residence. 
Under the U.S.-Israel tax treaty, if the income out of which the
dividend is being paid is not attributable to an approved enterprise, then
income tax with respect to shareholders that are U.S. corporations holding at
least 10% of our voting power in the twelve-month period preceding the
distribution of such dividends, is required to be withheld at the rate of
12.5%.

68

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F. Dividends and Paying AgentsNot
Applicable.

G. Statement by ExpertsNot
Applicable.

H. Documents on Display

We
are subject to the informational requirements of the Securities Exchange Act of
1934, as amended, applicable to foreign private issuers and fulfill the
obligations with respect to such requirements by filing reports with the
Securities and Exchange Commission, or SEC. 
You may read and copy any document we file, including any exhibits, with
the SEC without charge at the SECs public reference room at 450 Fifth Street,
N.W., Washington, D.C. 20549.  Copies of
such material may be obtained by mail from the Public Reference Branch of the
SEC at such address, at prescribed rates. 
Please call the SEC at 1-800-SEC-0330 for further information on the
public reference room.  Certain of our
SEC filings are also available to the public at the SECs website at
http://www.sec.gov.

As
a foreign private issuer, we are exempt from the rules under the Exchange Act
prescribing the furnishing and content of proxy statements, and our officers,
directors and principal shareholders are exempt from the reporting and
short-swing profit recovery provisions contained in Section 16 of the
Exchange Act.  In addition, we are not
required under the Exchange Act to file periodic reports and financial
statements with the SEC as frequently or as promptly as United States companies
whose securities are registered under the Exchange Act.

I.     SUBSIDIARY INFORMATION

Not
applicable.

Item 11. Quantitative and Qualitative Disclosures
about Market Risk

Through
our normal operations, we are exposed to market risks including movements in
currency exchange rates and interest rates. 
We are exposed to currency risks mainly because we generate most of our
revenues in dollars but incur a majority of our salaries and related expenses
and part of our other expenses in New Israeli shekels.  We do not actively hedge interest rate
exposure or engage in other transactions intended to manage risks relating to
interest rate fluctuations.  We do hedge
assets or liabilities denominated in currencies other than the dollar.

Presentation
of interest rate risk (position as of December 31, 2003)

We
do not use any derivative instruments to protect us from fluctuations in
interest rates.  Details regarding our
interest rate exposure are set forth in the table below.  Interest rate exposure is monitored by
tracking actual and projected commitments and through the use of a sensitivity
analysis.

69

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|                                   |  | Total as
  of                                                    |        | Settlement
  Date |  | Fair value
  
  as | 
|---------------------------------- |  | ---------------------------------------------------------------- | ------ | ----------------- |  | ------------------ | 
|                                   |  |                                                                  |        |                   |  |                    | 
|                                   |  | December 
  31, 2003                                             |        | 2004              |  | 2005               | 
|                                   |  |                                                                  |        |                   |  |                    | 
|                                   |  | (All
  amounts in thousands of U.S. dollars, except percentages) |       
|                                   |  |                                                                  |       
|Assets that incur interest         |  |                                                                  |        |                   |  |                    | 
|A. Cash and cash equivalents       |  |                                                                  |        |                   |  |                    | 
|U.S. dollars                       |  |                                                                  | 23,493 |                   |  | 23,493             | 
|Weighted-average interest rate     |  |                                                                  | 1.3    | %                 |  |                    | 
|NIS                                |  |                                                                  | 2,788  |                   |  | 2,788              | 
|Weighted-average interest rate     |  |                                                                  | 4.7    | %                 |  |                    | 
|EUR                                |  |                                                                  | 1,048  |                   |  | 1,048              | 
|Weighted-average interest rate     |  |                                                                  | 2.0    | %                 |  |                    | 
|B. Short-term deposit              |  |                                                                  |        |                   |  |                    | 
|U.S. dollars                       |  |                                                                  | 2,006  |                   |  | 2,006              | 
|Weighted-average interest rate     |  |                                                                  | 1.1    | %                 |  |                    | 
|C. Long-term marketable securities |  |                                                                  |        |                   |  |                    | 
|U.S. dollars                       |  |                                                                  | 6,271  |                   |  | 6,271              | 
|Weighted-average interest rate     |  |                                                                  | 5.3    | %                 |  |                    | 

Exchange
Rate Risk Management

Our
functional currency and that of our subsidiaries is the dollar.  From time to time, we enter into forward
exchange contracts to reduce the impact of fluctuations of foreign currencies
against the dollar resulting from existing trade receivables and trade
payables.  We do not believe that our
activities in entering into these contracts subject us to exchange rate risk
because gains and losses on these contracts offset losses and gains on the
trade receivables or trade payables that are hedged.

As
of December 31, 2003, we had purchased currency forward contracts, ending September 2004, as a hedge against sales
contracts receivable and firm commitments, as follows:

| | Obligation to sell EUR 1,308,353 for a total amount
  of $1,600,608; and
|- | ------------------------------------------------------------------------
|  |                                                                         
| | Obligation to sell GBP 2,185,210 for a total amount
  of $3,565,364.    

Presentation
of foreign currency-denominated assets and liabilities
(position as of December 31, 2003)

Details
regarding our foreign exchange exposure are set forth in the table below.  Foreign exchange exposure is monitored by
tracking actual and projected commitments and through the use of a sensitivity
analysis.

|                      |  | Total as
  of                                |        | Settlement
  Date |  | Fair value
  as | 
|--------------------- |  | -------------------------------------------- | ------ | ----------------- |  | --------------- | 
|                      |  |                                              |        |                   |  |                 | 
|                      |  | December 
  31, 2003                         |        | 2004              |  | 2005            | 
|                      |  |                                              |        |                   |  |                 | 
|                      |  | (All
  amounts in thousands of U.S. dollars) |       
|                      |  |                                             
|Current Assets        |  |                                              |        |                   |  |                 | 
|NIS                   |  |                                              | 3,728  |                   |  | 3,728           | 
|U.K. pound sterling   |  |                                              | 4,227  |                   |  | 4,227           | 
|Euro                  |  |                                              | 2,020  |                   |  | 2,020           | 
|Other                 |  |                                              | 2,444  |                   |  | 2,444           | 
|Total                 |  |                                              | 12,419 |                   |  | 12,419          | 
|Long-term assets      |  |                                              |        |                   |  |                 | 
|NIS                   |  |                                              | 758    |                   |  |                | 
|Current liabilities   |  |                                              |        |                   |  |                 | 
|NIS                   |  |                                              | 8,231  |                   |  | 8,231           | 
|U.K. pound sterling   |  |                                              | 273    |                   |  | 273             | 
|Euro                  |  |                                              | 189    |                   |  | 189             | 
|Other                 |  |                                              | 124    |                   |  | 124             | 
|Total                 |  |                                              | 8,817  |                   |  | 8,817           | 
|Long-term liabilities |  |                                              |        |                   |  |                 | 
|NIS                   |  |                                              | 826    |                   |  |                | 

70

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Item 12. Description of Securities Other Than Equity
Securities

Not
applicable.

PART   II

Item 13. Defaults, 
Dividend Averages and Delinquencies

Not
applicable.

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

Modification
of Rights

Not
applicable.

Use of Proceeds

The
net proceeds of our initial public offering were $43,200,000.  Of the net proceeds, we used $3.0 million to
repay a portion of our indebtedness to ECI. 
The remaining proceeds were invested in cash equivalents and are used
for general corporate purposes and funding our current activities.

Item 15. Controls and Procedures

(a)
Disclosure Controls and Procedures.

Our
chief executive officer, or CEO, and chief financial officer, or CFO, are
responsible for establishing and maintaining our disclosure controls and
procedures. These controls and procedures were designed to ensure that
information required to be disclosed in the reports that we file under the
Securities Exchange Act of 1934, as amended, is recorded, processed, summarized
and reported within the time periods specified in the rules and forms of the
SEC. We evaluated these disclosure controls and procedures under the
supervision of our CEO and CFO as of December 31, 2003.  Based on this evaluation, our CEO and CFO
concluded that our disclosure controls and procedures are effective in timely
alerting them to information required to be disclosed in our periodic reports
to the SEC.

71

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(b)
Internal Control Over Financial Reporting.

There
were no changes in the Companys internal control over financial reporting that
occurred during the year ended December 31, 2003 that have materially affected,
or are reasonably likely to materially affect, our internal control over
financial reporting.

Item 16A.      Audit Committee
Financial Expert

Mr.
Shmulik Gitlin, Senior Vice President-Finance of ECI, was our Audit Committee
financial expert. Mr. Gitlin resigned from our board of directors in May 2004
following the distribution of our shares by ECI. We expect that one of the new
board of directors members to be elected at the next shareholders meeting will
be designated by the board to serve as our Audit Committee financial expert.

Item
16B.      Code of Ethics

Our
board of directors has adopted our Code of Ethics and Business Conduct, a code
that applies to all of our directors and employees. A copy of our Code of
Ethics and Business Conduct may be obtained, free of charge, by writing to
ECtel Ltd., Attention: Corporate Secretary, 43 Hasivim Street, Petah Tikva,
Israel.

Item
16C.      Principal Accountant Fees and Services

In
the annual meeting held in September 2003, our shareholders re-appointed KPMG
to serve as our independent auditors.

KPMG
billed the following fees to us for professional services in each of the last
two fiscal years:

| |                    |  | Year Ended December 31, |        
| | ------------------ |  | ----------------------- | -------
| |                    |  | 2002                    |        
| |                    |  |                         |        
| | Audit Fees         |  | $                       | 99,000 
| | Audit-Related Fees |  |                         | -      
| | Tax Fees           |  |                         | 20,760 
| | All Other Fees     |  |                         | -      
| |                    |  |                         |        
| |                    |  |                         |        
| |                    |  |                         |        
| | Total              |  | $                       | 119,760

Audit
Fees are the aggregate fees billed for the audit of our annual financial
statements. This category also includes services that generally the independent
accountant provides, such as statutory audits (including audits required by the
Office of the Chief Scientist and other Israeli government institutes), and
consents and assistance with and review of documents filed with the SEC. Tax
Fees are the aggregate fees billed for professional services rendered for tax
compliance, other than in connection with the audit.  Tax compliance involves preparation of original and amended tax
returns, tax planning and tax advice.

Our
audit committees policy is to approve each audit and non-audit service to be
performed by our independent accountant before the accountant is engaged.

72

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Item
16D.  Exemptions from Listing Standards
for Audit Committees

Not
applicable.

PART   III

Item 17. Financial Statements

We
have responded to Item 18 in lieu of this item.

Item 18. Financial Statements

The
financial statements required by this item are hereby incorporated by reference
to our report on Form 6-K, filed with the SEC on May 10, 2004.

Item 19. Exhibits

|Exhibit No. | Exhibit                                                                                                                                       
|----------- | ----------------------------------------------------------------------------------------------------------------------------------------------
|            |                                                                                                                                               
|1.1         | Memorandum of Association*                                                                                                                    
|1.2         | Amended and Restated Articles of Association**                                                                                                
|4.1         | ECtel Managers and Employees Option Allotment Plan,
  as amended**(1)                                                                         
|4.2         | ECtel International Employee Stock Option Plan, as
  amended**                                                                                
|4.3         | ECtel Director Share Option Plan 1999*                                                                                                        
|4.4         | Form of Services Agreement by and between ECI
  Telecom Ltd. and the Registrant*                                                              
|4.5         | Supply Agreement, dated February 9, 2004, by and
  between ECI Telecom Ltd. And the Registrant                                                
|4.6         | Form of Non-Exclusive Sales Agency Agreement
  (Germany)*                                                                                     
|4.7         | Form of Infrastructure Services Agreement by and
  between ECI Telecom Ltd. and the Registrant***(2)                                          
|4.8         | Share and Asset Purchase Agreement, dated August 7,
  2001, by and among Telrad Networks Ltd., Telrad Hawk Net-I Ltd. and the
  Registrant****
|4.9         | Form of Warrants issued to Telrad Networks Ltd. on
  October 1, 2001****                                                                      
|4.10        | Registration Rights Agreement, dated October 1,
  2001, by and between Telrad Networks Ltd. and the Registrant****                            
|4.11        | Registration Rights Agreement, dated January 22,
  2002, by and between ECI Telecom Ltd. and the Registrant****                               
|4.12        | Share Purchase Agreement, dated February 6, 2002, by
  and among ECI Telecom Ltd., the Registrant and certain investors****                   
|4.13        | Registration Rights Agreement, dated February 6,
  2002, by and among certain investors and the Registrant****                                
|4.14        | ECtel 2003 Share Option Plan                                                                                                                  
|4.15        | ECtel 2003 U.S. Employee Stock Option Plan                                                                                                    
|4.16        | Asset Purchase Agreement, dated February 9, 2004, by
  and between Verint Systems Ltd. and the Registrant                                     
|4.17        | Joint Intellectual Property Agreement, dated March
  31, 2004, by and between Verint Systems Ltd. And the Registrant                          
|4.18        | Patent License-Back Agreement, dated March 31, 2004,
  by and between Verint Systems Ltd. And the Registrant                                  
|8.1         | List of Significant Subsidiaries                                                                                                              
|12.1        | Certification of Principal Executive Officer
  pursuant to 17 CFR 240.13a-14(a), as adopted pursuant to §302 of the
  Sarbanes-Oxley Act      
|12.2        | Certification of Principal Financial Officer
  pursuant to 17 CFR 240.13a-14(a), as adopted pursuant to §302 of the
  Sarbanes-Oxley Act      

73

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|     |                                                                                                                                      
|---- | -------------------------------------------------------------------------------------------------------------------------------------
|13.1 | Certification of Principal Executive Officer
  pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the
  Sarbanes-Oxley Act
|13.2 | Certification of Principal Financial Officer
  pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the
  Sarbanes-Oxley Act

|
|

|* | Incorporated
by reference to our Registration   Statement on Form F-1 (File No.333-10950).
|- | ------------------------------------------------------------------------------------------

|** | Incorporated
by reference to our Annual Report on   Form 20-F for the fiscal year ended December 31,
1999, filed June 30, 2000 (File No. 0-30348).
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------

|*** | Incorporated
by reference to our Annual Report on   Form 20-F for the fiscal year ended December 31,
2000, filed June 28,2001   
(File No. 0-30348).
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------

|**** | Incorporated
by reference to our Annual Report   on Form 20-F for the fiscal year ended December 31,
2001, filed February 28,   2002 (File No. 0-30348).
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------

|(1) | English
translation from Hebrew original.
|--- | -----------------------------------------

|(2) | Includes
an English translation from Hebrew   original of an exhibit attached to this Agreement.
|--- | ------------------------------------------------------------------------------------------------

74

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SIGNATURES

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

| | ECTEL LTD.  
| | ------------
| | (Registrant)
| |             
| | By          
| |             
| |             
| |             

Date:  June __, 2004

75

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EXHIBIT
INDEX

[INSERT HERE]

76

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Exhibit
8.1

List of
Subsidiaries

ECtel BNV, a Dutch
company

ECtel GmbH, a German
company

ECtel Inc., a Maryland
corporation

ECtel (2000) U.K. Ltd., a
U.K. company

77

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Exhibit 12.1

Certification of
Principal Executive Officer pursuant to 17 CFR 240.13a-14(a),
as adopted pursuant to § 302 of the Sarbanes-Oxley Act

|I, Eitan Naor, President and Chief Executive Officer
  of ECtel Ltd., certify that:
|-----------------------------------------------------------------------------------
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   
|                                                                                   



|                           |                                         | 
|-------------------------- | --------------------------------------- | 
|Dated:
  ___________, 2004 | Eitan Naor                             
|                           | President and Chief Executive
  Officer
|                           | (Principal Executive Officer)          

78

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Exhibit
12.2

Certification of Principal
Financial Officer pursuant to 17 CFR 240.13a-14(a),
as adopted pursuant to § 302 of the Sarbanes-Oxley Act

|I, Avi Goldstein, Senior Vice President and Chief
  Financial Officer of ECtel Ltd., certify that:
|--------------------------------------------------------------------------------------------------
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  
|                                                                                                  



|                           |                                                     | 
|-------------------------- | --------------------------------------------------- | 
|Dated:
  ___________, 2004 | Avi Goldstein                                      
|                           | Senior Vice President and
  Chief Financial Officer
|                           | (Principal Financial Officer)                      

79

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Exhibit
13.1

Certification of
Principal Executive Officer pursuant to 18 U.S.C. § 1350, 
as adopted pursuant to § 906 of the Sarbanes-Oxley Act

In connection with the
annual report on Form 20-F for the fiscal year ended December 31, 2003 of ECtel
Ltd. (the Company) as filed with the U.S. Securities and Exchange Commission
(the Commission) on the date hereof (the Report) and pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, I, Eitan Naor, President and Chief Executive Officer of the Company,
certify that:

| | the Report fully complies with the requirements of
  Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended;
  and                   
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                         
| | the information contained in the Report fairly
  presents, in all material respects, the financial condition and results of
  operations of the Company.

Date:  ___________, 2004

|                                      | 
|------------------------------------- | 
|Eitan Naor                           
|President and Chief Executive Officer
|(Principal Executive Officer)        

80

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Exhibit
13.2

Certification of
Principal Financial Officer pursuant to 18 U.S.C. § 1350,
as adopted pursuant to § 906 of the Sarbanes-Oxley Act

In connection with the annual
report on Form 20-F for the fiscal year ended December 31, 2003 of ECtel Ltd.
(the Company) as filed with the U.S. Securities and Exchange Commission (the
Commission) on the date hereof (the Report) and pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, I, Avi Goldstein, Executive Vice President and Chief Financial Officer of
the Company, certify that:

| | the Report fully complies with the requirements of
  Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended;
  and                   
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------
|  |                                                                                                                                                         
| | the information contained in the Report fairly
  presents, in all material respects, the financial condition and results of
  operations of the Company.

Date:  _________, 2004

|                                                     | 
|---------------------------------------------------- | 
|Avi Goldstein                                       
|Executive Vice President and Chief Financial Officer
|(Principal Financial Officer)                       

81

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