**SECURITIES ANDEXCHANGE COMMISSIONWASHINGTON, DC 20549FORM 20-F**

  (Mark One)

 

   Registrationstatement pursuant to Section 12(b) or (g) of the Securities Exchange

  Act of 1934 

or

 

x    Annualreport pursuant to Section 13 or 15(d) of the Securities Exchange Act of 

1934

 

For the fiscal year endedDecember 31, 2002

or

   Transitionreport 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 ofRegistrant as Specified in its Charter)

** **

**Israel**

(Jurisdiction ofIncorporation or Organization)

** **

**43 HasivimStreet, Petah Tikva 49130, Israel**

(Address of PrincipalExecutive Offices)

** **

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

**None**

 

Securities registeredor 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 whichthere 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 theIssuer`s classes of capital or common stock as of December 31, 2002:

 

**17,917,848Ordinary Shares, Nominal Value NIS 0.04 Per Share**

** **

 

 

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

Yes     X      No  ____

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

Item 17 ____ Item 18    X  

____(1)____ 

TABLEOF CONTENTS

 

| PART   I |                                                          |                                                       | 4  |
|--------------------|---------------------------------------------------------------|------------------------------------------------------------|----|
|               | Item 1.Identity Of Directors, Senior Management And  Advisers | 4                                                          |
|               | Item 2 Offer Statistics And Expected Timetable                | 4                                                          |
|               | Item 3 Key Inform                                             | 4                                                          |
|               |                                                          | A. Selected Financial Data.                                | 4  |
|               |                                                          | B Capitalization and Indebtedness.                         | 6  |
|               |                                                          | C. Reasons for the Offer and Use of Proceeds               | 6  |
|               |                                                          | D. Risk Factors.                                           | 6  |
|               | Item 4. Information on the Company.                           | 21                                                         |
|               |                                                          | A. History and Development of the Company.                 | 21 |
|               |                                                          | B. Business Overview.                                      | 22 |
|               |                                                          | C.Organizational Structure                                 | 33 |
|               |                                                          | D. Property, Plants and Equipment                          | 33 |
|               | Item 5. Operating and Financial Review and Prospects.         | 34                                                         |
|               |                                                          | A. Operating Results.                                      | 34 |
|               |                                                          | B. Liquidity and Capital Resources.                        | 45 |
|               |                                                          | C. Research and Development, Patents and Licenses          | 50 |
|               |                                                          | D. Trend Information                                       | 50 |
|               | Item 6 Directors, Senior Management and Employees.            | 51                                                         |
|               |                                                          | A. Directors and Senior Management.                        | 51 |
|               |                                                          | B. Compensation.                                           | 53 |
|               |                                                          | C. Board Practices                                         | 54 |
|               |                                                          | D. Employees.                                              | 57 |
|               |                                                          | E. Share Ownership.                                        | 57 |
|               | Item 7. Major Shareholders and Related Party Transactions.    | 59                                                         |
|               |                                                          | A. Major Shareholders.                                     | 59 |
|               |                                                          | B. Related Party Transactions                              | 60 |
|               |                                                          | C. Interests of Expert and Counsel.                        | 63 |
|               | Item 8. Financial Information.                                |                                                       | 63 |
|               |                                                          | A.Consolidated Statements and Other Financial Information. | 63 |
|               |                                                          | B.Significant Changes.                                     | 63 |
|               | Item 9. The Offer and Listing.                                | 64                                                         |
|               |                                                          | A. Offer and Listing Details.                              | 64 |
|               |                                                          | B. Plan of Distribution.                                   | 64 |
|               |                                                          | C.Markets.                                                 | 64 |
|               |                                                          | D.Selling Shareholders.                                    | 64 |
|               |                                                          | E.Dilution.                                                | 64 |
|               |                                                          | F.Expenses of the Issue.                                   | 64 |
|               | Item 10.   Additional Information.                  | 64                                                         |

 

 

 

____(2)____ 

 

|                 |                                                                                    | A. Share Capital.                                     | 64 |
|----------------------|-----------------------------------------------------------------------------------------|-------------------------------------------------------|----|
|                 |                                                                                    | B.  Memorandum and Articles of Association. | 64 |
|                 |                                                                                    | C.  Material Contracts.                     | 67 |
|                 |                                                                                    | D.  Exchange Controls.                      | 67 |
|                 |                                                                                    | E. Taxation                                           | 68 |
|                 |                                                                                    | F. Dividends and Paying Agents.                       | 75 |
|                 |                                                                                    | G.  Statement by Experts.                   | 75 |
|                 |                                                                                    | H. Documents on Display.                              | 75 |
|                 | Item 11.  Quantitative and Qualitative  Disclosures about Market Risk         | 76                                                    |
|                 | Item 12.  Description of Securities Other Than  Equity Securities             | 77                                                    |
| PART   II  |                                                                                    |                                                  | 78 |
|                 | Item 13. Defaults,  Dividend Averages and  Delinquencies.                     | 78                                                    |
|                 | Item 14. Material Modifications to the Rights of Security  Holders and Use of Proceeds. | 78                                                    |
|                 | Item 15. Controls and Procedures.                                                       | 78                                                    |
|                 | Item 16 [Reserved]                                                                      | 78                                                    |
| PART   III |                                                                                    |                                                  | 79 |
|                 | Item 17. Financial Statements                                                           | 79                                                    |
|                 | Item 18 Financial Statements.                                                           | 79                                                    |
|                 | Item 19 Exhibits                                                                        | 79                                                    |

____(3)____ 

 

PART  I

*Unless the context otherwise requires, all referencesin this annual report to "ECtel," "us," "we," "our" and the "Company" refer toECtel Ltd. and its subsidiaries, and all references to "ECI" refer to ourparent, ECI Telecom Ltd.  References to "dollars" or "$" are toUnited States Dollars.*

*Statements in this annual report concerning ourbusiness outlook or future economic performance; anticipated revenues, expensesor other financial items; introductions and advancements in development ofproducts, and plans and objectives related thereto; and statements concerningassumptions made or expectations as to any future events, conditions, performanceor other matters, are "forward-looking statements" as that term is definedunder the United States Federal Securities Laws.  Forward-lookingstatements address matters that are subject to risks, uncertainties and otherfactors which could cause actual results to differ materially from those inthese statements.  Factors that could cause or contribute to thesedifferences include, but are not limited to, those set forth under "Item 3D -Risk Factors" in this annual report as well as those discussed elsewhere inthis annual report and in our other filings with the Securities and ExchangeCommission.*

**Item 1. Identity OfDirectors, Senior Management And Advisers.**

Not Applicable.

**Item 2. Offer StatisticsAnd Expected Timetable.**

Not Applicable.

**Item 3. Key Information.**

 

**A.               SelectedFinancial Data**

 

We derived the following selected consolidated statementsof income data for the years ended December 31, 2000, 2001 and 2002 and theselected consolidated balance sheet data as of December 31, 2001 and 2002 fromthe audited consolidated financial statements incorporated by reference in thisannual report.  The selected combined statements of income data forthe year ended December 31, 1998, the selected combined balance sheet data asof December 31, 1998, the selected consolidated statements of income data forthe year ended December 31,1999, and the selected consolidated balance sheetdata as of December 31, 1999 and 2000 have been derived from our auditedconsolidated/combined financial statements not included in this annual report.  Ourconsolidated/combined statements have been prepared in dollars in accordancewith generally accepted accounting principles in the United States and havebeen audited by Somekh Chaikin, a member of KPMG International, independentpublic accountants in Israel, whose report with respect to these financialstatements is incorporated by reference in this annual report.  Thefollowing selected financial data should be read in conjunction with "Item 5 -Operating and Financial Review and Prospects" and the consolidated financialstatements and the notes thereto incorporated by reference in this annualreport. 

 

 

 

____(4)____ 

 

|  ****
Year ended December 31,

 
 

1998(1)

1999

2000

2001

2002

 
 

(in thousands, except share and per share data)

**Statements of Income Data:**

 

 

 

 

 

 

 
 
**Revenues**...

$28,904

$42,093

$59,735

$80,598

$95,777

 
 
Cost of revenues**(2)**

15,827

20,040

26,021

33,888

38,115

 
 
 

 

 

 

 

 

 
 
**Gross profit**

13,077

22,053

33,714

46,710

57,662

 
 
Research and development costs, net**(2)**.

3,978

4,937

8,338

11,253

12,917

 
 
Selling and marketing expenses**(2)**.

3,507

7,174

11,263

15,293

17,933

 
 
General and administrative expenses**(2)**.

1,808

3,683

5,788

8,368

9,604

 
 
In process research and development costs

―

―

―

  916 

― 

 
 
Amortization of goodwill

950

950

142

-

-

 
 
 

 

 

 

 

 

 
 
Total operating expenses.

10,243

16,744

25,531

35,830

40,454

 
 
**Operating income**.

2,834

5,309

8,183

10,880

17,208

 
 
Financial expenses (income), net

15

(348)

(1,861)

(1,023)

(491)

 
 
Other expenses, net.

94

262

189

36

23

 
 
**Income before taxes on income**

2,725

5,395

9,855

11,867

17,676

 
 
Taxes on income (tax benefit)

2,020

1,489

1,310

(103)

356

 
 
Net income before cumulative effect of change in  accounting principles..

705

3,906

8,545

11,970

17,320

 
 
Cumulative effect of change in accounting principles.

-

-

-

34

-

 
 
 

 

 

 

 

 

 
 
**Net income for the year**

$705

$3,906

$8,545

$11,936

$17,320

 
 
**Earnings per share**

 

 

 

 

 

 
 
Basic earnings per share.

$0.06

$0.31

$0.53

$0.72

$0.97

 
 
Weighted average number of shares outstanding  .

12,062,500

12,766,336

16,144,473

16,652,509

17,802,492

 
 
Diluted earnings per share..

$0.06

$0.29

$0.49

$0.67

$0.93

 
 
Weighted average number of shares outstanding .

12,063,886

13,311,643

17,291,382

17,838,633

18,551,836

 
____________________

(1)                     Until 1999, ourfinancial statements were prepared on a combined, rather than a consolidated,basis.  Please see "Item 5A - Operating Results."

(2)                     Stock-basedcompensation was presented in one line item in years prior to 2002 and is nowdivided between cost of revenues and other operating expenses. Accordingly, thepresentation for prior years has been reclassified. Stock-based compensationhas been divided between cost of revenues and other operating expenses asfollows:
**____(5)____ 

 

 

** **

Cost of revenues.

$              2

  $          47

$            79

$            73

$          12

Research and  development costs

8

173

291

267

43

Selling and  marketing expenses

6

125

212

195

31

General and  administrative expenses

56

1,226

2,067

1,900

304

 

$72

$    1,571  

$2,649

$2,435  

$390

 

December 31,

 

1998

1999

2000

2001

2002

 

(in thousands)

**Balance Sheet Data:**

 

 

 

 

 

Cash and cash  equivalents

$1,140

$42,595

$41,735

$40,525

$52,786

Working  capital

5,709

55,546

60,985

72,246

88,600

Total assets

20,291

73,001

85,882

124,173

150,634

Due to (from)  parent and fellow subsidiary companies, net

4,317

3,176

(1,597)

2,246

284

Due to parent  and fellow subsidiary companies, net long-term

2,328

3,176

-

-

-

Shareholders`  equity

7,215

55,886

67,351

     97,681

   116,529

 

**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 somecombination of the following factors could have a material adverse effect onour business, financial condition and results of operations.
**____(6)____ 

 

**Risks Related toOur Business and Our Industry**

** **

**The continuing general deterioration of the economyworldwide, the ongoing instability in the Middle East, the slow-down inexpenditures by telecommunications service providers and other trends in ourindustry are having an adverse effect on our results of operations, which hasbeen material.**

** **

The continuing general deterioration of the economyworldwide and economic uncertainty in the telecommunications market resulted ina curtailment of capital investment by telecommunications carriers and serviceproviders beginning late in 2000.  Several major telecommunicationsservice providers such as MCI Worldcom and Global Crossing have failed, as havemany new and small providers.  In addition, existing serviceproviders have been reducing or delaying expenditures on new equipment andapplications as a result of the continued deterioration in thetelecommunications market.

The attacks on the United States on September 11, 2001 andthe threat of acts of terrorism worldwide caused a further decline in theglobal economy.  In addition, we believe that the uncertainlypreceding the war in Iraq, as well as the current instability in Iraq havecontributed to the uncertainty and poor market environment. As a result, manycompanies, including current and potential customers of ours, have postponed ordecreased further capital investment or have indicated to us that they intendto do so.  This decline in capital expenditures has resulted in asignificant decline in our sales and pressure on the price of our products. Webelieve that this slow-down in telecommunications-related expenditures willcontinue through 2003.  A continued decline in capital expenditureswould reduce our sales further and could result in additional downward pressureon the price of our products, either of which would have a continued materialadverse effect on our operating results.

**In the first quarter of 2003our revenues significantly declined, resulting in a net loss and negative cashflow. Based on preliminary estimates, our results of operations continued to beadversely affected in the second quarter.****If our sales do not increaseor if they should continue to decline and we continue to experience lowvisibility with respect to the timing and closing of sales, our results ofoperations will continue to be materially adversely affected.**

Our revenues for the first quarter of 2003 were $15.1million, compared to $23.1 million for the corresponding period in 2002.  Ournet loss for the first quarter of 2003 was $3.8 million, compared to net incomeof $4.1 million for the first quarter of 2002. The decline in revenues was notexpected.  Based on preliminary estimates, our results of operationscontinued to be adversely affected in the second quarter.  As aresult, we are taking measures to lower our operating expenses and decrease ourcost structure, including reducing our labor force, wages and overheadexpenses.  We may be unable, however, to decrease some of ourexpenses in a timely manner in response to short-term or unexpected decreasesin revenues.  If our sales do not increase or if they should continueto decline and we are unable to decrease our expenses accordingly, our annualand quarterly results will continue to be materially adversely affected. Inaddition, decreased revenues could necessitate adjustments in the value ofgoodwill, other intangible assets and inventory.
**____(7)____ 

 

**Many of our customersrequire a lengthy, detailed and comprehensive evaluation process before theyorder our products.  Our sales process has been subject to delaysthat have significantly decreased our revenues and which could result in theeventual cancellations of some projects.**

We derive substantially all of our revenues from the saleof products and related services for telecommunications service providers andgovernmental agencies.  The purchase of our products represents arelatively significant capital expenditure for our customers.  As aresult, our products generally undergo a lengthy evaluation and purchaseprocess before we can sell them.  Due to the current economicclimate, our customers are conducting a more stringent and detailed evaluationof our products, and decisions are subject to additional levels of internalreview.  As a result, the evaluation process has significantlylengthened.  This evaluation process is currently taking between nineand 24 months for our service provider customers and between 12 and 24 monthsfor our governmental agency customers.  The following factors, amongothers, 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;

 
- 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 significantlydecreased our revenues.  If this trend of delays continues, if delayslengthen further, or if such continued delays result in the eventualcancellation of any projects, it would continue to seriously harm our businessand results of operations. 

**We have experienced and maycontinue to experience fluctuations in our quarterly results of operations,which has resulted and may continue to result in volatility in our share price.  Inaddition, 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 experiencesignificant fluctuations in our quarterly results of operations, and we maylikewise experience significant fluctuations in our annual results ofoperations.  Factors which have contributed and may in the futurecontribute 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 regarding 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. 
**____(8)____ 

 

 

The results of past periods should not be relied upon asan indication of our future performance.  Our operating results forthe first quarter of 2003 were below our projections and the expectations ofpublic market analysts and investors.  Our share price decreased by34% on the day following our announcement of the expected results for thatquarter.  It is likely that in some future periods, our operatingresults may again be below expectations of public market analysts or investors,which may cause our share price to drop.

**We have a limited backlog oforders and must maintain sufficient inventory levels to meet anticipateddemand.  If we cannot predict orders accurately, our inventory maybecome obsolete and our financial performance may be harmed.**

The timing and volume of orders are difficult to forecastfor each quarter, as a substantial majority of our sales are booked and shippedin the same quarter pursuant to purchase orders.  We have a limitedbacklog of orders for our products and must maintain or have availablesufficient inventory levels to satisfy anticipated demand on a timely basis.  Maintainingsufficient inventory levels to assure prompt delivery of our products increasesthe risk of inventory obsolescence and associated write-offs.  Ashift in demand could also result in inventory write-offs, which could harm ourfinancial performance.

**We depend on several largecustomers and the loss of one or more of these customers, or a significantdecrease in revenue from any of these customers, could have a disproportionateimpact on our revenue and income.  **

Historically, a substantial portion of our revenue hascome from large purchases by a small number of customers.  Sales toour top ten customers accounted for 70.5% of our revenues in 2002, with salesto one customer in the Asian Pacific region accounting for 30.1% of ourrevenues and sales to one customer in Latin America accounting for 10.5 % ofour revenues.  Sales to our top ten customers accounted for 65.4% ofour revenues in 2001, with sales to one customer in the Asian Pacific regionaccounting for 24.8% of our revenues.  We expect to continue todepend on sales to a small number of customers.   However, we do nothave long-term commitments from any of our top customers to purchase anyspecific quantities of products.  We expect that our largestcustomers will vary from period to period.  If we lose one or morelarge customers and fail to add new customers our results of operations couldbe seriously harmed.

**Standards and technologiesregarding IP surveillance technology are in the process of being defined andadopted by many governmental agencies around the world.  If ourproducts are not compatible with the standards that are eventually adopted, oursales of government, or IP surveillance, solutions will be materially adverselyaffected.  Sales of our IP surveillance solutions are also subject toother risks related to these evolving standards.**

Governmental agencies in many countries are in the processof establishing standards regarding the implementation of IP surveillancetechnology in the networks of telecommunications service providers that operatein their country.  We cannot be certain which standards and/ortechnologies  these agencies will eventually adopt.  Equipmentmanufacturers are proposing various technologies to implement these newstandards.  For example, Cisco Systems is proposing that router-basedtechnology be used to implement the standards.  If a sufficientnumber of government agencies do not adopt standards with which the probe-basedtechnology that we use is compatible, we will lose much of our competitiveadvantage in the marketplace.  As a result, sales of IP surveillancesolutions would significantly decrease, and our results of operations would bematerially adversely affected.

Other factors related to the adoption of these newstandards may also affect our sales of IP surveillance solutions.  Forinstance, we do not know when the service providers will be required to implementthe new standards.  In addition, governments may require the serviceproviders to pay for the implementation of these standards.  As aresult, our sales of IP surveillance solutions in the future may shift to theservice providers, as opposed to the governmental agencies.  We donot know what the impact of these new arrangements will be once they arefinalized.  Until these issues are resolved, we will likelyexperience a delay in sales of these solutions. 
**____(9)____ 

Finally, there is a growing trend among governmentagencies to require solution providers to demonstrate that their productscomply with the standards adopted by the respective agencies. 

If we are unable to demonstratethat our technology complies with the new standards or if we can demonstrate thatour technology does comply but we incur substantial costs in doing so, ourbusiness and our results of operations could be materially harmed.

 

**Sales to governmentalagencies represent a significant portion of our business.  Thesesales significantly declined in the first quarter of 2003.  If salesto governmental agencies continue to decline our business and results ofoperations will suffer.**

Sales to governmental agencies substantially increased andaccounted for 45.3% of our revenues in 2002, compared with 24.4% of ourrevenues in 2001 and 20.6% of our revenues in 2000.  Our ability toobtain orders from governmental agencies may be affected by decisions ofpotential governmental customers to develop their own products or technicalsolutions internally, rather than purchasing them from outside suppliers. Thelack of predictability in the timing and scope of governmental procurements maymake planning more difficult for us and increases the risks of conducting asubstantial amount of business with governmental customers.

Selling to governmental agencies involves numerousadditional risks, including the following:
- delays in receipt by our customers of appropriations to     fund their purchases;

 
- termination of contracts or subcontracts for the     convenience of the government;

 
- the need for compliance with new laws and regulations     related to IP surveillance, such as the European Telecommunications     Standards Institute (ETSI) and the North American Communications     Assistance for Law Enforcement Act (CALEA);

 
- termination, reduction or modification of contracts or     subcontracts in the event of political developments, changes in     governmental policies or budgetary constraints; and

 
- requirements to obtain and maintain security clearances     for key personnel.

 

 

If we continue to lose revenuedue to the occurrence of any of these risks associated with our sales togovernmental agencies, our business and operating results will continue tosuffer.

**The payment cycle for ourreceivables has lengthened and could lengthen further.  This hasreduced, 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, ourcontracts may provide for payments under a variety of payment schedules.  Forexample, we may receive a deposit prior to shipment, a partial payment upondelivery and final payment after 180 or 360 days from delivery.  Becauseof the current issues affecting our industry, we have been required to provideextended payment terms to facilitate sales to customers.  When thepayment cycle for our receivables lengthens, we  use more of our cashreserves to fund our operations.  Any further increase in the paymentcycle for our receivables would further decrease the cash available to us forour operations and the expansion of our business.  In addition, wesell certain trade receivables in the ordinary course of business, and thelengthening payment cycle may have an adverse impact on our ability to continueto do so.
**____(10)____ 

*** ***

**Because thetelecommunications market is characterized by rapid technological and otherchanges, our success depends on our ability to continually develop new and moretechnologically advanced products and product enhancements that achieve marketacceptance.**

The telecommunications market is characterized by rapidtechnological advances and frequent new product introductions and enhancements.  Webelieve that our future success will largely depend upon our ability tocontinue to enhance our existing products and to successfully develop andmarket new products on a cost-effective and timely basis.  Thetechnologies applicable to our products include applications capable ofanalyzing and processing data based on accepted telephony standards andprotocols.  If other technological standards and protocols gain broadmarket acceptance, we will be required to redesign our existing products ordesign new products that are able to view and analyze networks based on thesenew standards and protocols.  For example, the emergence of a newgeneration of data-oriented telecommunications networks based on InternetProtocols has brought about a need for a new generation of surveillancesystems.  Similarly, the types of fraudulent schemes to which serviceproviders are subject change with the emergence of new technologies, networksand other developments.  We cannot assure you that we will besuccessful in developing and marketing new applications or systems that willrespond to technological change.

**The market for our productsis highly competitive.   Because many of our competitors have muchgreater resources than we have, it may be difficult for us to return to, andmaintain, profitability.**

Competition in our industry is intense, and we expectcompetition and price reductions to increase due to the continued slow-down inthe telecommunications market.  To compete effectively, we have, attimes, been required to grant substantial discounts on our products.  Inaddition, we could lose sales to our competitors.  Lower prices andreduced 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 greatername recognition, longer operating histories, larger customer bases andsignificantly greater financial, marketing, public relations, sales,distribution and other resources.  Some of our competitors andpotential competitors are among the largest and most capitalized software andhardware companies in the world.  Also, some of our competitors havelocated their research and development facilities in countries where laborcosts for engineers and other experienced personnel are far lower than inIsrael and the United States, where our research and development facilities arelocated.

We may also face competition from our customers.  Someof our customers are developing their own solutions internally or throughstrategic alliances.  For example, British Telecom has decided tocommercialize its own internally developed fraud management system, Sheriff,through its subsidiary Azure.  Also, the internal informationtechnology departments of some service providers, such as Qwest, are acting asour competitors for the provision of various revenue assurance solutions withintheir own companies.  As a result, solutions developed by ourcustomers may replace and/or compete with products that we currently sell tothem or that we may seek to sell to them in the future.
**____(11)____ 

 

In efforts tocope with capital expenditures cuts, many customers have developed "revenuesharing" models for the purchase of systems such as ours.  If we areunable or unwilling to accept these models, we may lose sales to othersuppliers.

Faced with the need to decrease their capitalexpenditures, many of our customers and potential customers are choosing topurchase solutions such as ours from providers who are willing to participatein revenue sharing models rather than requiring agreed-upon fixed payments.  Underthese models, the solution provider typically is paid a proportion of the revenuesthat the service provider saves as a result of implementing the solution.  Someof our competitors are offering revenue sharing models themselves in order tomake their solutions more attractive.  We have made initial proposalsand sales pursuant to a limited revenue-sharing model under which we requirepayment of part of the price of our products, while the remainder of the priceis subject to a revenue-sharing arrangement.  If we are unwilling toaccept the revenue sharing models proposed by our customers and potentialcustomers, and cannot create an equally attractive alternative solution throughour limited revenue-sharing model, our sales may decrease.  As aresult, our results of operations may suffer.  Furthermore, revenuesharing for the types of revenue assurance solutions that we provide isrelatively untried.  We do not know whether any of the proposedmodels can effectively demonstrate the revenue to which we would be entitled.In addition, even if we do participate in revenue sharing arrangements, aportion of revenues would be deferred, which could have a short-term adverseaffect on our results of operations.

**Most of our products arebased on a single technology platform, and our business will suffer if wecannot develop new products based on this platform to meet the needs of ourcustomers.**

Most of our software applications are based on a singletechnology platform.  If we are unable to develop new products thatmeet the needs of our customers because of our reliance on this single technologyplatform, sales of our products could decline.  Any significantdecrease in the sales of our products could seriously harm our results ofoperations.

Our customers generally operate their networks using awide variety of software applications, network equipment and software andhardware platforms.  If our products fail to integrate properly withour customers` equipment, our ability to generate future sales will be harmed.  Forexample, our platform uses the Windows NT operating system.  Mostcompanies in the telecommunications industry currently use UNIX and may not bewilling to implement a solution based on Windows NT.  If serviceproviders are unwilling to accept a Windows NT-based solution, our businesswill be harmed.

**Our business and its future growthdepend on increased market acceptance of services based on packet-switchedtechnology and third generation wireless networks.  If these servicesare not fully developed and accepted in the marketplace, our growth plans willbe materially adversely affected.**

Several of our newer products are designed to meet thespecific requirements of new value-added services being made available bypacket-switched technology and third generation wireless networks.  Demandand market acceptance for these services are subject to a high level ofuncertainty.  For example, the deployment of third generationnetworks has been delayed throughout the world, except for limited deploymentby one service operator in Japan and initial implementation by another inEurope.  In addition, VoIP service has not been widely accepted, duein part to the difficulties of providing high quality service.  Atthe same time, service providers are hesitating to invest in their existingnetworks due to their perception that these networks have a relatively shortlife-cycle.  If third generation networks and VoIP services are notfully developed and accepted in the marketplace, or if the implementation byservice providers of third generation wireless networks continues to besignificantly delayed due to economic or other problems, the market for many ofour newer products may not develop or be sustainable.  In that case,our business would be materially adversely affected.  
**____(12)____ 

 

**We do business withcompanies and governments located in countries around the world, which subjectsus to additional risks.  If these risks materialize, our businesswill be materially adversely affected.**

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

We face additional risks from our international operationsincluding: 
- 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 competition; 

 
- 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 ourinternational operations, our business will be materially adversely affected.  

**Our proprietary technologyis difficult to protect and unauthorized use of our proprietary technology bythird parties may impair our ability to compete effectively.**

Our success and ability to compete depend in large partupon our protection of our proprietary technology, including both hardware andsoftware components of our *X-ellence* platform.  We currentlyrely on a combination of trade secret and copyright laws, nondisclosure andother contractual agreements and technical measures to protect our proprietaryrights. We have filed several patent and trademark applications covering someof our technology and are in the process of preparing and filing additionalpatent and trademark applications.  We cannot assure you that any ofthese applications will be granted.  These agreements and measuresmay not be sufficient to protect our technology from third-party infringement,or to protect us from the claims of others.  Additionally, ourproducts may be sold in foreign countries that provide less protection tointellectual property than that provided under U.S. or Israeli laws.  Moreover,competitors and potential competitors may attempt to copy or reverse engineeraspects of our product line or to obtain and use information that we regard asproprietary.  If we are unable to maintain the security of ourproprietary technology for these or any other reasons, our business may suffer.  
**____(13)____ 

 

**Because our products mayinfringe on the intellectual property rights of third parties, our businesswill suffer if we are sued for infringement or cannot obtain licenses to theserights on commercially acceptable terms.**

We are subject to the risk of adverse claims and litigationalleging infringement by us of the intellectual property rights of others.  Manyparticipants in the telecommunications industry have an increasing number ofpatents and patent applications and have frequently demonstrated a readiness topursue litigation based on allegations of patent and other intellectualproperty infringement.  All of our products rely on technology thatcould be the subject of existing patents or patent applications of thirdparties.  We have agreed to indemnify our customers with respect toinfringement by our products of the proprietary rights of third parties.  Thirdparties may assert infringement claims in the future with respect to ourcurrent or future products.  These claims may require us to enterinto license arrangements or result in protracted and costly litigation,regardless of the merits of these claims.  Any necessary licenses maynot be available or, if available, may not be obtainable on commerciallyreasonable terms.  If we cannot obtain all necessary licenses on commerciallyreasonable terms, we may be forced to stop selling our products in some or allcountries, and our business would be seriously harmed. 

**Because we currently dependon licensed software as part of some of our products, our results of operationswill suffer if we are unable to maintain these licenses on commerciallyreasonable terms or if the vendors are unable to provide the necessary supportand maintenance.**

We currently rely upon software that we license from thirdparties as part of some of our products, including software that is integratedwith our internally developed software and used in our products to perform keyfunctions. For example, we utilize a software package of i2 Technologies in ourfraud management solution and a Convera software package in our surveillancesolution.  We may be unable to maintain these software licenses fromthird parties  on commercially reasonable terms, if at all. Thiscould result in shipment delays or reductions until equivalent replacementsoftware could be developed or licensed and integrated into our products.  Anyinability to maintain these licenses could harm our business.  Furthermore,some software is licensed from relatively small vendors, who may not be able tosurvive if the current difficult economic climate continues.  If anyof these vendors cease their operations, we may face difficulties in obtainingthe necessary support and maintenance for the software originally provided bythem. 

**Future regulation of theInternet, VoIP market and third generation networks may slow growth in theseareas resulting in decreased demand for some of our products and increasedcosts of doing business, which could have a material adverse effect on ourresults of operations.**

Regulators on national and local levels worldwide mayadopt laws and regulations that impose additional burdens on companiesconducting business with Internet, VoIP or third generation networkapplications.  The adoption of any additional laws or regulations mayimpair expansion in these areas, which could in turn decrease demand for ourproducts and services or otherwise harm our business.  Moreover, theapplicability to the Internet, VoIP technology and third generation networks ofexisting laws in various jurisdictions regulating issues such as communications,copyright protection, sales tax, libel, obscenity and personal privacy isuncertain and may take years to resolve.  Some of these laws arechanging, and new laws continue to be adopted from time to time by variouscountries around the world.  For example, following the attacks ofSeptember 11, 2001 the Patriot Act was passed into law in the United States andthe Anti-Terrorism Act was adopted in the United Kingdom.  Thelong-term effect of these laws on the growth of areas relevant to our businessremains to be seen.  However, if any of these issues are resolved ina manner that causes the market for our products to decline, our results ofoperations could be materially adversely affected.
**____(14)____ 

 

**Because we must obtainIsraeli governmental approval to sell surveillance products, these sales aresubject to restrictions and delays that could limit our ability to generaterevenues from our surveillance systems, which could harm our business.**

Our export sales of surveillance systems are subject toapproval by the Israeli Ministry of Defense.  Current Israeli policypermits export of systems and products of the type manufactured by us toapproved customers.  However, a permit is required prior to theinitiation of each export sale proposal and, prior to shipment, an exportpermit for the actual transaction is also necessary.  We typicallyreceive these permits in the ordinary course.  However, the Ministryof Defense notifies us from time to time not to conduct business with specificcountries that are undergoing political unrest, violating human rights orexhibiting hostility toward Israel.  We may be unable to obtainexport permits for surveillance products we could otherwise sell in particularcountries in the future.  Permits already issued may be revoked atany time prior to shipment of our products.  Failure to obtain exportpermits can cause us to default under our customer contracts and may result inthe imposition of contractual penalties.  Governmental policy withrespect to our surveillance systems could be altered from time to time ingeneral or specifically with respect to sales in particular foreign countries.  Anychange in governmental policy or in the permits issued to us could limit orprohibit altogether our sales of surveillance products and consequently harmour business.

**Currency fluctuations couldcause customers to decrease or cancel orders or default on payment.**

Currently our international sales are denominatedprimarily in U.S. dollars.  Accordingly, devaluation in the localcurrencies of our customers relative to the U.S. dollar could cause customersto decrease or cancel orders or default on payment.  An increasingportion of our international sales is now denominated in Euros, and in thefuture additional sales may be denominated in currencies other than U.S.dollars, thereby exposing us to gains and losses on non-U.S. currencytransactions.  We may choose to limit this exposure by entering intohedging transactions.  However, hedging transactions may not preventexchange-related losses, and our business may be harmed by exchange ratefluctuations.  Furthermore, as we seek to expand our sales to regionsthroughout the world, we might be exposed to risks of customers located incountries suffering from uncertain economic environments such as high inflationand solvency problems.

**We could be subject towarranty claims and product recalls, which could be very expensive and harm ourfinancial condition.**

We typically offer one-year warranty programs with respectto our products.  Our warranty generally provides that we will repairor replace products with defects in materials or workmanship or that fail tomeet agreed-upon specifications.  Any significant product returns orwarranty claims under our purchase orders could adversely affect our results ofoperations.  We offer sophisticated products that may containsoftware with undetected errors.  In addition, new products mayexperience failures when first introduced, and both current and future productsmay experience failures as new versions are released.  We rely to alarge extent on our reputation among industry leaders in conducting our salesefforts.  As a result, any product recall as a result of errors orfailures, 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 ofthe data collected by our systems could adversely affect our reputation andresults of operations.**

Our customers rely on third-party security features toprotect the privacy and integrity of customer data.  Our products maybe vulnerable to breaches in security due to defects in the securitymechanisms, the operating system, the hardware platform or the networks linkedto the platform.  Our *QualiWeb* product, which providesinformation using Web access, presents additional security issues for ourcustomers.  Exploitation of any vulnerabilities could jeopardize thesecurity of information stored in and transmitted through the computer systemsof 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 beliable to our customers for any breach in security.  We may berequired to expend significant capital and other resources to further protectagainst security breaches or to correct problems caused by any breach.
**____(15)____ 

 

**We depend on a limitednumber of key personnel who would be difficult to replace.  If welose the services of these individuals or cannot hire additional qualifiedpersonnel, our business will be harmed.**

Our business and future growth and success largely dependon the managerial and technical skills of Aharon Shech, our President and ChiefExecutive Officer, and other members of senior management.  If eitherMr. Shech or other members of the senior management team are unable orunwilling to continue in our employ, our results of operations could bematerially and adversely affected.  Our success also depends to asubstantial degree upon our ability to attract, motivate, and retain otherhighly-qualified personnel.  Despite the slow-down in high technologyindustries in Israel, there is still considerable competition for the servicesof highly-qualified technical and engineering personnel. There is alsoconsiderable competition for the services of experienced sales and marketingpersonnel.  We may not be able either to retain our current personnelor hire additional qualified personnel if and when needed.

**We may seek to expand ourbusiness through mergers and acquisitions that could result in diversion ofresources and extra expenses, which could disrupt our business and harm ourfinancial 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 potentialacquisitions or joint ventures as well as the integration of an acquired orjointly developed business, technology or product could cause a diversion ofmanagement`s time and our resources.  Future acquisitions could alsoresult in:
- 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 thebusiness of any acquired companies or joint ventures with our operations.  Wemay not receive the intended benefits of any future acquisition or jointventure.  In addition, we have limited experience with respect tooperating acquired businesses.  If the operation of the business ofany future acquisitions disrupts our operations, our business may suffer.
****____(16)____ 

**Risks Related to ourRelationship with ECI**

**We depend solely on ECI forkey product components in our legacy probing devices, and we cannot control themanufacturing and delivery of these components.  Our business will beinterrupted if ECI is unable or unwilling to provide these components.**

ECI manufactures critical components needed for our *X-ellence*platform.  We cannot control the delivery schedule for thesecomponents.  Any problems that may occur with respect to thedelivery, quality or cost of these components could result in product shortagesor quality assurance problems. ECI has special expertise in engineering thesecomponents.  If ECI is unable or unwilling to provide thesecomponents, we will experience substantial delays in the manufacturing ofcertain of our products, and our business will suffer. 

**All of our ordinary sharesheld by ECI have been pledged as security for indebtedness under a creditfacility.  Any foreclosure and sale of the pledged shares couldresult in a change of control of our company, which could, in turn, have amaterial adverse effect on our business and a negative effect on our shareprice.**

ECI beneficially owns 10,490,325, or approximately 58.4%,of our outstanding shares. These shares have been pledged to banks by ECI tosecure indebtedness under a $300 million credit facility, under whichapproximately $100 million was outstanding as of May 31, 2003.  IfECI defaults under the credit agreement, the banks may foreclose on the sharesand sell them to satisfy ECI`s obligation to the banks.  This willresult in a change of control of ECtel, which could, in turn, have a materialadverse affect on our business.  In addition, any sale by the banksof a substantial number of shares into the public market could have a negativeeffect on our share price.  ECI`s relationships with its creditorscould have other adverse impacts on our business.  

**ECI is in a position tocontrol matters requiring a shareholder vote.  This may adverselyaffect the market price of our ordinary shares or deny our shareholders anopportunity to realize a premium on their shares.**

ECI beneficially owns approximately 58.4% of ouroutstanding shares.  ECI therefore has, subject to special approvalsrequired by Israeli law for transactions involving controlling shareholders,sufficient voting power to: 
- elect all of our directors (subject to the provisions of     the Companies Law with regard to outside directors)

 
- control our management, and  

 
- approve or reject any merger, consolidation or sale of     substantially all of our assets.

 

This concentration of ownership of our ordinary sharescould delay or prevent proxy contests, mergers, tender offers, open-marketpurchase programs or other purchases of our ordinary shares that mightotherwise give our shareholders the opportunity to realize a premium over thethen-prevailing market price for our ordinary shares.  Thisconcentration of ownership may also adversely affect our share price.  Inaddition, the market price of our ordinary shares may be adversely affected byevents relating to ECI that are unrelated to us.

**Some members of our board ofdirectors may have conflicts of interest with us, and some of these conflictsmay be resolved in a manner adverse to us.**

Four of the members of our board of directors areexecutive officers of ECI.  These individuals may have conflicts ofinterest with respect to business opportunities and similar matters that mayarise in the ordinary course of the business of ECI and ECtel and could favorECI in negotiations or relationships between ECI and us.
**____(17)____ 

 

**Risks Related toOperations in Israel**

**Potential political,economic and military instability in Israel may adversely affect our results ofoperations.**

Our principal offices and manufacturing facilities andmany of our suppliers are located in Israel.  Accordingly, political,economic and military conditions in Israel directly affect our operations.  Sincethe establishment of the State of Israel in 1948, a number of armed conflictshave taken place between Israel and its Arab neighbors.  A state ofhostility, varying in degree and intensity, has led to security and economicproblems for Israel.  Since October 2000, there has been a high levelof violence between Israel and the Palestinians which has led to a breakdown ofthe entire peace process and affected Israel`s relationship with its Arabcitizens and several Arab countries Furthermore, several countries which didconduct business with Israel and Israeli companies prior to the outbreak ofhostilities with the Palestinians have terminated all business relations withIsraeli companies.  Some countries which have not terminated businessrelations nevertheless restrict business with Israel and Israeli companies.  Theserestrictive laws and policies have had and may continue to have an adverseimpact on our business

**Our results of operationsmay be negatively affected by the obligation of key personnel to performmilitary service.**

Some of our executive officersand employees in Israel are obligated to perform military reserve dutyannually.  Our operations could be disrupted by the absence for asignificant period of one or more of our executive officers or key employeesdue to military service.  Our officers and employees have been calledup by the military for temporary service with increasing frequency since theoutbreak of the hostilities with the Palestinians.  Any disruption inour operations would harm our business.

**Because most of our revenuesare generated in U.S. dollars but a significant portion of our expenses areincurred in New Israeli Shekels, our results of operations may be seriouslyharmed by inflation and currency fluctuations.**

We generate most of our revenues in U.S. dollars but incura significant portion of our expenses in New Israeli Shekels, commonly referredto as NIS.  As a result, we are exposed to risk to the extent thatthe rate of inflation in Israel exceeds the rate of devaluation of the NIS inrelation to the dollar or if the timing of such devaluation lags behindinflation in Israel.  In either event, the dollar cost of ouroperations in Israel will increase and our dollar-measured results ofoperations will be adversely affected.  Our operations also could beadversely affected if we are unable to guard against currency fluctuations inthe future.  Accordingly, we may enter into currency hedgingtransactions to decrease the risk of financial exposure from fluctuations inthe exchange rate of the dollar against the NIS.  These measures,however, may not adequately protect us from material adverse effects due to theimpact of inflation in Israel.
**____(18)____ 

 

**The government programs andtax benefits that we currently participate in or receive require us to meetseveral conditions and may be terminated or reduced in the future, which wouldincrease our costs.**

We receive grants from the Office of the Chief Scientistof the Israeli Ministry of Industry and Trade for research and developmentprograms that meet specified criteria.  We also receive tax benefitsunder Israeli law for capital investments that are designated as "ApprovedEnterprises."  To maintain our eligibility for these programs and taxbenefits, we must continue to meet conditions, including paying royalties withrespect to grants received and making specified investments in fixed assets.  Inaddition, some of these programs restrict our ability to manufacture particularproducts or transfer particular technology outside of Israel.  If wefail to comply with these conditions in the future, the benefits received couldbe cancelled.  We could also be required to refund any paymentspreviously received under these programs or pay increased taxes.  Werecorded grant participations of an aggregate of approximately $900,000 in 2002and approximately $1.4 million in 2001.  As of December 31, 2002, ourcontingent liability to the Office of the Chief Scientist with respect togrants received was approximately $1.8 million. The Israeli government hasreduced the benefits available under these programs in recent years and hasindicated that it may reduce or eliminate these benefits in the future.  Theseprograms and tax benefits may not continue in the future at their currentlevels or at any level.  From time to time, we submit requests fornew grants from the Office of the Chief Scientist and for expansion of ourApproved Enterprise programs or for new programs to be designated as ApprovedEnterprises.  These requests might not be approved particularly inlight of the deteriorating economic conditions in Israel.  Thetermination or reduction of these grants and tax benefits could seriously harmour business, financial condition and results of operations.

**It may be difficult toenforce a U.S. judgment against us, our officers and directors, our controllingshareholder and our Israeli auditors or to assert U.S. securities law claims inIsrael.**

Service of process upon ECtel and ECI, our controllingshareholder, each of which is incorporated in Israel, and upon our directorsand officers and our Israeli auditors, substantially all of whom reside outsidethe United States, may be difficult to obtain within the United States.  Furthermore,because substantially all of our assets and ECI`s assets, and substantially allof our directors and officers and our Israeli auditors are located outside theUnited States, any judgment obtained in the United States against us or any ofthem may not be collectible within the United States.

There is doubt as to the enforceability of civilliabilities under the Securities Act of 1933 and the Securities Exchange Act of1934 in original actions instituted in Israel.  However, subject tospecified time limitations, Israeli courts may enforce a U.S. final executoryjudgment 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.

 
**____(19)____ 

 

If a foreign judgment is enforced by an Israeli court, itgenerally will be payable in NIS, which can then be converted into non-Israelicurrency and transferred out of Israel.  The usual practice in anaction to recover an amount in non-Israeli currency is for the Israeli court torender judgment for the equivalent amount in NIS at the rate of exchange on thedate of payment, but the judgment debtor also may make payment in non-Israelicurrency.  Pending collection, the amount of the judgment of anIsraeli court stated in NIS ordinarily will be linked to the Israel ConsumerPrice Index plus interest at the annual rate (set by Israeli law) prevailing atthat time.  Judgment creditors bear the risk of unfavorable exchangerates.

**Provisions of Israeli lawcould delay, prevent or otherwise inhibit a change of control and thereforedepress the price of our stock.**

The Israeli Companies Law - 1999 includes restrictions onmergers, such as special voting requirements, the ability of creditors to seekcourt intervention to delay or prevent a merger and a mandatory waiting period.  Inaddition, under certain circumstances, the Companies Law requires thatacquisitions be performed via tender offer.  For more information,see "Item 10B - Memorandum and Articles of Association -- Mergers andAcquisitions Under Israeli Law."

**Risks Related to theMarket for Our Ordinary Shares**

**Our stock price hasdecreased significantly and could continue to fluctuate significantly.**

The market price for our ordinary shares, as well as theprices of shares of other technology companies, has been volatile. Our shareprice has decreased significantly in the past year.  In particular,on the day following our announcement of our expected results for the firstquarter of 2003, our share price decreased by 34%.  Numerous factors,many of which are beyond our control, have caused and may continue to cause themarket price of our ordinary shares to fluctuate significantly, such as:
- shortfalls in our operating results from levels forecast     by securities analysts, such as occurred during the first quarter 2003; 

 
- fluctuations in our quarterly revenues and earnings and those     of our publicly held competitors;

 
- announcements concerning us, ECI, 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 general global     economy; and

 
- the general state of the securities market (particularly     the technology sector)

 

In addition, trading in shares of companies listed on theNasdaq National Market in general and trading in shares of technology companiesin particular have experienced extreme price and volume fluctuations that haveoften been unrelated or disproportionate to operating performance.  Theprice levels of technology stocks traded on the Nasdaq National Marketdecreased significantly during 2000, 2001 and 2002.  These broadmarket and industry factors may depress our share price, regardless of ouractual operating results.
**____(20)____ 

 

**Substantial future sales ofour ordinary shares may depress our share price.**

ECI owns 10,490,325, or 58.4%,of our outstanding ordinary shares.  These shares have been pledgedto banks by ECI to secure indebtedness under a credit facility.  IfECI defaults under the credit agreement, the banks may foreclose on the sharesand seek to sell them in the public market. ECI signed a Letter Agreement withthe banks on May 30, 2003, which effectively cured, effective on June 30, 2003,the earlier covenant default status of ECI. An additional 391,335 shares aswell as warrants to purchase an additional 1,250,000 shares are held by TelradNetworks Ltd.  ECI and Telrad both have rights to require us toregister their ordinary shares with the Securities and Exchange Commission. InMarch 2002 we registered an aggregate of 2,422,175 shares for resale with theSEC.  These shares consisted of 850,000 shares that we issued toTelrad in connection with our acquisition of NetEye from Telrad, describedbelow in Item 5, and an aggregate of 1,572,175 shares that ECI sold toinvestors, as described below in Item 7.  If our shareholders sellsubstantial amounts of our ordinary shares, including shares issued upon theexercise of outstanding employee options, or if the perception exists that ourshareholders may sell a substantial number of our ordinary shares, the marketprice of our ordinary shares may fall.  Any substantial sales of ourshares in the public market also might make it more difficult for us to sellequity or equity related securities in the future at a time and in a place wedeem appropriate.
 
**Item4. Information on the Company.**

 
A.                       Historyand Development of the Company.
 

ECtel Ltd. is our legal and commercial name.  UntilApril 1998, we operated under the name ECI Telesystems Ltd.  We wereincorporated 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 arelocated at 43 Hasivim Street, Petah Tikva 49130, Israel and our telephonenumber is (972-3) 926-8200.  Our agent in the United States, ECtelInc., is located at 22527 Gateway Center Drive, Clarksburg, MD 20871.

We initially focused primarily on the development and saleof telecommunication monitoring and communication control systems togovernmental agencies.  In 1993, ECI acquired a 75% interest in acompany now named ECtel Inc., a Maryland corporation engaged primarily in thedevelopment and sale of quality-of-service solutions to telecommunicationsservice providers.  ECI purchased the remaining 25% interest in ECtelInc. in 1997.  In January 1998, we began to coordinate our operationswith those of ECtel Inc. as an initial step to combining our two companies.  Weacquired ECtel Inc. from ECI in October 1998.  The combination of thetwo companies, which use similar technology architectures, enabled us to drawfrom the strengths of both companies to improve and expand the solutions wecould offer to our customers.  The combination also allowed us torealize operating and administrative efficiencies, as we were able toconsolidate our research and development, manufacturing and marketing efforts.

In October 1999, we completed an initial public offeringof 4,025,000 of our ordinary shares.  We received net proceeds ofapproximately $43.2 million from this offering.

In October 2001, we acquired Telrad Hawk Net-I Ltd., orNetEye, from Telrad Networks, Ltd.  Please see "Item 5A - OperatingResults - Acquisition of NetEye" for more information on this acquisition.

**Principal Capital Expenditures**

** **

Our principal capital expenditures in the past three yearshave been the purchase of equipment and other fixed assets used in our business(mainly in Israel).  These purchases totaled approximately $2.2million in 2000, approximately $1.8 million in 2001 and approximately $2.0million in 2002.  Our capital expenditures in 2002 were spentprimarily for the procurement of test and production equipment computers.  Weused internal working capital to finance these capital expenditures.
**____(21)____ 

** **
B.                       BusinessOverview.
**General**

** **

We develop and market revenue assurance and surveillancesolutions for circuit-switched and packet-switched wireline and wirelessnetworks.  Our revenue assurance solutions equip telecommunicationsservice providers with comprehensive data gathering and analysis capabilitiesto improve their operational efficiency and profitability by:
- detecting and preventing fraud; 

 
- monitoring the quality of service over their networks; and

 
- supporting billing assurance, including billing mediation     functions of interconnection arrangements.

 

Our surveillancesolutions enable governmental agencies to perform real-time, comprehensivesurveillance on telecommunications networks.

**Industry Overview**

** **

*Changes in the Telecommunications Industry*

The telecommunications industry has undergone dynamicchange over the last few years, a trend that is expected to continue.  Thesechanges include: 

*Convergence of Circuit-Switched and Packet-SwitchedNetworks.  *Telecommunications networks of the early 1990s werenot designed to handle the dramatic increases in data traffic which have beenfueled by the growing use of the Internet.  This led to thedevelopment of a new generation of data-oriented communications networks, oftenbased on Internet Protocols, that use packet-networking technology, as analternative to traditional, circuit-switched telephone networks.  Thesepacket-based, or next-generation, networks, however, are not expected toimmediately replace circuit-switched networks.  As a result,packet-switched and circuit-switched networks are expected to coexist andinterconnect with each other for the foreseeable future, creating what is knownas converged networks.

*Development of Value-Added Services.  *Greatercompetition and advances in technology have led service providers to seek todifferentiate themselves by offering advanced, value-added services.  Theincreased 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 providersare also expanding the range of wireless services to include data services suchas e-mail, Short Message Service (SMS) and limited Internet access.  Theemerging third generation wireless (3G) technology will enable the wirelessprovisioning of an even broader range of services, including full Internetaccess, downloading music and video, video conferencing and mobile banking,trading and online games.  

*Increased Network Interconnectivity.*  Advancedtechnologies and expanded product offerings have caused telecommunicationsnetworks of multiple service providers to be increasingly interconnected. Forexample, the value-added services offered by service providers are oftenobtained from a number of different content providers, requiringinterconnections among their networks to provide the services to customers. Inaddition, although recently there has been a trend of consolidation amongservice providers in response to deteriorating economic conditions,deregulation and privatization have led to a large increase in the number ofservice providers operating worldwide.  These service providers mustinterconnect their networks with those of other providers to enable theirrespective subscribers to communicate with each other.
**____(22)____ 

 

*Increased Focus on Revenue Assurance.  *Recently, in response to the deteriorating global economic conditions, serviceproviders have often been forced to lower the prices they charge for valueadded services.  In turn, lower prices have resulted in lower profitmargins for the service providers with respect to these value added services.  Asa result, there is an increased need for service providers to ensure that theycapture as much of the revenues associated with these value added services aspossible.

*Increased Focus on Surveillance Capabilities.  *Asa result of the attacks of September 11, 2001, there has been an increase inconcern regarding national security, cyber-terrorism and othercommunications-related crimes.  These increased concerns, along withexisting laws such as CALEA and the passage of laws such as the Patriot Act inthe United States and the Anti-Terrorism Act in the United Kingdom, have led toa global trend of increased surveillance by government agencies in a number ofcountries.  

*Service Provider Challenges*

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

*Fraud Prevention.  *Fraud typicallyrepresents a significant loss of revenues for service providers.  Dueto the following factors, there are greater opportunities for fraud, and actsof 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.

 

Service providers require increasingly sophisticated fraudprevention solutions in order to overcome these challenges and effectivelydetect and prevent fraud in modern telecommunications networks.

*Quality of Service.  *In order to competeeffectively, service providers must emphasize the quality and reliability oftheir services.   In addition, the transmission of integrated voiceand data traffic over converged networks has created new quality-of-serviceproblems that did not exist in traditional, circuit-switched networks.  Forexample, 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 renderthat message incomprehensible.  In addition, service providers withinterconnecting networks enter into service level agreements with each otherrequiring the provision of a specified minimum level of service.  Thegrowing variety of value-added services being offered demand a higher level ofcoordination between service providers to maintain quality of service.  Serviceproviders must meet these quality-of-service challenges to provide the highquality, reliable service that is essential to attract and retain customers.
**____(23)____ 

*Interconnect Billing.  *The number ofinterconnections among service providers is continually increasing, making itmore important to verify the accuracy of inter-carrier billing underinterconnection arrangements.  In addition, the current flat ratebilling solutions do not enable service providers to bill other providers basedon usage of new value-added services, such as SMS or cellular roaming, overtheir networks.  In order to maximize potential revenues, serviceproviders require usage-based billing solutions.

In order for service providers to effectively addressthese new challenges and remain competitive, they require comprehensive revenueassurance solutions to prevent fraud, maintain quality of service andaccurately bill for interconnected transmissions.  These solutionsmust be capable of processing tens of millions of sessions per day from anobjective source, operating with hardware and software provided by multiplevendors and supporting the multiple technologies that exist in convergednetworks.  In addition, solutions must be flexible in order to adapteasily to rapidly changing technologies.  Finally, service providersseek revenue assurance solutions that meet all of these objectives and providea demonstrable and rapid return on investment.  

*Government Agency Challenges*

*Rapidly Changing Environment.  *As aresult of the rapid evolution of converged networks and the growing variety ofvalue-added services available, it has become more difficult for governmentagencies to conduct surveillance operations. At the same time, the ongoingderegulation of the telecommunications industry has required governmentalagencies conducting surveillance to monitor a larger number of serviceproviders.  Governmental agencies require more sophisticated andhighly-scalable solutions in order to effectively monitor telecommunicationsnetworks in this continuously changing environment. Moreover, they requirereal-time solutions that are capable of monitoring all the services used by thetargets of surveillance, including voice, data, cellular and value-addedservices.  Since the attacks of September 11, 2001, networksurveillance capabilities and security generally have become a much higherpriority for governments and, as a result, for service providers. 

In order for government agencies to conduct effectivesurveillance in the current environment, they require solutions that can monitorthe full range of services used by the targets of surveillance and that areable to work with different network technologies and protocols.
**____(24)____ 

 

**The ECtel Solution**

** **

We develop and market revenue assurance and surveillancesolutions for circuit-switched and packet-switched wireline and wirelessnetworks.  Our products consist of proprietary software and hardwarecomponents, as well as off-the-shelf hardware and software components.  Webelieve 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. 

 
- 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.

 

* *
**____(25)____ 
- 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 her.

 

**Business Strategy**

** **

Our objective is to be the leading provider of revenueassurance and surveillance solutions for converged networks worldwide.  Thefollowing are key elements of our strategy:
- Offer Comprehensive Revenue Assurance and Surveillance     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 offer our governmental agency and law     enforcement customers solutions that enable them to conduct surveillance     in real time over rapidly growing, converged networks.  In     particular, we offer solutions that allow monitoring of advanced services     used by targets of surveillance, including data and value-added services.  We     continually adapt our existing revenue assurance and surveillance     solutions 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 and surveillance solutions to     meet the rapidly changing needs of service providers and governmental     agencies.  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 and surveillance solutions.

 
- 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, Deutsche Telekom,     Hutchison H3G, MM02, Portugal Telecom, 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.

 

 
**____(26)____ 
- Expand Our Global Presence.   We are     expanding our global presence by adding local support offices to better     serve our customers.  For example, we added an office in Ft.     Lauderdale, Florida to serve our Latin American client base and we have an     agreement with a third party to provide sales and support services in     Brazil.  We intend to use these locations not only to     enhance service to our current customers, but also to more effectively     market to new customers in these regions.  We also have an     agreement with a third party to provide sales and support services in     Singapore, with another in Hong Kong to provide sales and support services     in the rest of the Asian Pacific region and with another to provide sales     services for India.  

 

**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 probesare attached to the service provider`s network.  Our probes forcircuit-switched networks are a combination of our proprietary software andhardware components.  Our probes for next generation networks are acombination of our proprietary software and off-the-shelf probe hardware.  Theprobes capture, filter, aggregate, correlate and merge data collected fromnetwork links, such as E-1/T-1 links, and Internet, fast Internet and gigabitInternet links.  Our probes gather information from all layers of thenetwork, from the physical layer to the application layer, without disruptingthe operation of the network service.

*Mediation Software.  *Our softwaresolutions perform the crucial mediation function.  Mediation consistsof extracting, collecting, re-formatting and filtering raw information fromvarious network elements, including routers, firewalls, authentication servers,domain name servers, Web servers, e-mail servers, video servers, and VoIPgateways.  This information can be combined with information obtainedfrom probes to create complete data records relating to sessions passingthrough the network.

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

Our platform`s flexible, scalable architecture is designedto evolve and grow with emerging technologies and the changing needs of ourcustomers.  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.

 

Following is a description of our revenue assurancesolutions that operate on our platform:

* *

*Fraud Prevention Solutions*

Our fraud prevention solutions gather information aboutcalls both in real-time and offline and compare it to fraudulent scenariosestablished within user-specified filter parameters, subscriber profiles andthresholds.  When defined thresholds are reached, an alert isautomatically generated and appropriate intervention can take place accordingto the user`s chosen parameters. The following table describes our fraudprevention solutions: 
**____(27)____ 

 

**Solution**

**Description/Functionality**

*FraudView*

Comprehensive fraud detection  and prevention solution for wireline, circuit-switched and next generation  networks.

*FraudView-M*

Comprehensive fraud detection  and prevention solution for wireless (2,2.5 and 3G) networks that detects and  prevents subscription, roaming and prepaid fraud, as well as cloning.

*MineView*

Add-on application that enables detection of dynamic and  sophisticated fraud patterns by using comprehensive data-mining algorithms.

 

*Quality of Service Solutions*

Our quality-of-service solutions enable service providersto identify whether their services or networks are operating according todesired standards, and also to pinpoint the source of any network problem.  Oncethe problem is found, the service provider can address the problem by repairingfaulty equipment, adjusting network settings or choosing a different route forsessions to avoid areas of heavy traffic or poor service.  Thefollowing table describes our quality of service solutions:

**Solution**

**Description/Functionality**

*QualiView/SigView*

Monitoring solution based on  an automated measurement device that continuously measures multiple  performance parameters on a circuit-switched network.  

*QualiWeb*

Add-on application to *QualiView*that creates Web-based reports and alerts for multiple users. 

*Quali.Net*

Network characterization and  performance measurement system based on intrusive testing for wireline  networks.

 

*Billing Assistance Solutions*

Our billing assistance solutions are designed to supportservice providers that offer multiple services and interconnect with numerousother providers on circuit-switched or packet-switched networks.  Thefollowing table describes our billing assistance solutions:

**Solution**

**Description/Functionality**

*IC-Guard*

Interconnect billing  verification solution for wireline and wireless networks.

*SS7Counter*

Usage-based  billing solution that defines, monitors, analyzes, verifies and allows for  accurate charging of multiple services between service providers based on raw  signaling information for wireline and wireless networks.

*Hawk-Eye*

Billing mediation solution that allows usage-based billing  for telecommunications and data services for telephony and next generation  networks.  

 

 
**____(28)____ 

 

 

*Surveillance Solutions*

All of our surveillance solutions are based on our *Intelli-View*platform, which is similar to our *X-ellence* platform.  Ourapplications are capable of monitoring and extracting content from Internettraffic, e-mail, messaging applications, File Transfer and Telnet Protocols.  Oursystems enable several users to simultaneously monitor and process voice, faxand data communications over multiple channels in a variety of analog anddigital formats.  Agencies can then store large volumes of data usingthird-party disks to permit quick and easy access by using advancedtechnologies for analysis and data retrieval operations.  Thefollowing table describes our network surveillance solutions: 

**Solution**

**Description/Functionality**

*Telephony Monitoring and  Recording System*

Surveillance solution that  enables government agencies to monitor calls within wireline networks.

*Cellular Monitoring and  Recording System*

Surveillance solution that  enables government agencies to monitor calls within wireless networks.

*Internet Protocol  Monitoring and Recording System*

Surveillance solution that  enables government agencies to monitor sessions within next generation  networks.

*X-pose*

An advanced monitoring center  that supports storage of selected sessions in wireline, wireless and next  generation networks.

 

 

**Sales and Marketing**

** **

As of December 31, 2002, our direct sales force andmarketing staff consisted of 68 employees.  We market our revenueassurance solutions to service providers worldwide primarily through a directsales force.  Our sales staff operates out of our offices in Israel,the United States and the United Kingdom.  In addition, in 2002 weestablished a new subsidiary in Germany for marketing and sales to customers inAustria, Germany, Liechtenstein and Switzerland.  We also offer ourproducts in other countries through local sales representatives or integrators,either on a commission or other payment basis.  We offer ongoingsupport services for our customers worldwide through our facilities in Israel,the United States, the United Kingdom and Germany.  In addition, weobtain sales and support services through a third party in Singapore and wehave also entered into agreements with various third parties to provide salesand support services in Brazil, the Asia Pacific region and India.  

Sales of our revenue assurance solutions are madepredominantly to large service providers and involve lengthy evaluationprocesses before the customers issue purchase orders.  Because thepurchase of our products is a relatively significant capital expenditure,prospective customers generally commit substantial resources to an evaluationof our solutions and require us to expend significant time, effort and moneyeducating them about the value of our solutions.  This sales cyclefor our revenue assurance solutions has grown substantially to an average ofbetween nine and 24 months.  Our primary marketing activities includeraising awareness among existing and potential customers of the benefitsprovided by the features of our products.  To accomplish these tasks,we use direct sales and various marketing efforts.  We participate inexhibitions and industry trade shows.  We have established annualinternational user-group meetings to demonstrate our capabilities to ourservice provider customers and get their feedback on our products.  Inaddition, we hold seminars for our strategic customers to enhance our dialoguewith them and to help focus our product development efforts.  We alsoactively participate in the activities of standards-setting bodies.
**____(29)____ 

We market our surveillance systems internationally tovarious governmental agencies through a direct sales force operating out of ouroffices in Israel.  The sales cycle for our surveillance systemsproducts typically ranges from 12 to 24 months.  

**Customers**

We have sold our solutions for more than 180 customers inover 60 countries, including the following:

Austria Telekom

Hutchison H3G

Belgacom 

MM02

British Telecommunications  plc.

Portugal Telecom 

Cable & Wireless Group

Qwest 

Cellcom

Swisscom 

Deutsche Telekom

Telefonica Group 

Embratel

 

 

In 2002, our top ten customersaccounted for 70.5% of our revenues in 2002, with sales to one customer in theAsian Pacific region accounting for 30.1% of our revenues and sales to onecustomer in Latin America accounting for 10.5 % of our revenues.  In2001, our top ten customers accounted for 65.4% of our revenues, with sales tothe same customer in the Asian Pacific region accounting for 24.8% of ourrevenues.

 

The following table shows a breakdown of our sales bygeographical region during 2000, 2001 and 2002 (in thousands):

** **

Year ended December 31

** **

2000

2001

         2002

Israel

$6,163

$5,671

$1,227

Asian Pacific 

14,043

29,332

42,965

North America

7,192

1,041

634

Europe

18,298

15,162

11,286

Africa

2,015

456

2,100

South America

12,024

28,936

37,565

Total Revenues

$59,735

$80,598

$95,777

 

Please see Note 13D to our consolidated financialstatements incorporated by reference in this annual report for information onour sales by product segment (sales of revenue assurance solutions for serviceproviders and sales of surveillance solutions for government agencies).

 

 
**____(30)____ 

 

**Manufacturing**

** **

We purchase some hardware, such as servers and storagedevices, from third party vendors such as IBM and Hewlett Packard.  Ourmanufacturing operations consist primarily of final assembly and testing,involving the application of extensive testing and quality control proceduresto materials, modules, subassemblies and systems.  Although wegenerally use standard parts and modules in our products, certain modules arepresently available only from a limited number of sources.  Inaddition, we purchase various customized components from ECI, such as digitalsignaling processing boards and mechanical wiring.  To date, we havebeen able to obtain adequate supplies of all components in a timely manner fromexisting sources or, when necessary, from alternative sources.

We maintain organization-wide quality assurance procedures,coordinating the quality control activities of our research and development andmanufacturing departments.  Our primary manufacturing and researchand development facilities have received certification to Quality Standard ISO9001.  ISO 9001 is an international set of quality assurancestandards for companies involved in the design, development, manufacturing,installation and servicing of products or services.  These standardsare set by the International Organization for Standardization (ISO), aninternational federation of national standards bodies.  To berecommended for ISO 9001 certification, a company must be audited by anISO-accredited auditing company and must meet or surpass the ISO standards.  Webelieve that our customers value the process, control and traceability that arerequired to achieve ISO 9001 certification.

**Research and Development**

** **

In order to accommodate the rapidly changing needs of ourmarkets, we place considerable emphasis on research and development projectsdesigned to improve our existing product lines, develop new product lines andcustomize our products to meet our customers` needs.  As of December31, 2002, 134 of our employees were engaged primarily in research anddevelopment activities, including customization and testing.  Weexpect that we will continue to commit substantial resources to research anddevelopment in the future.

As a recipient of grants from the Office of the ChiefScientist, we are obligated to perform all manufacturing activities forprojects subject to the grants in Israel unless we receive an exemption.  Know-howfrom the research and development which is used to produce these products maynot be transferred to third parties without the approval of the Office of theChief Scientist.  Approval is not required for the export of anyproducts resulting from the research and development based on these grants.  Forfurther information regarding the Office of the Chief Scientist of the IsraeliMinistry of Industry and Trade, see "Item 5B - Liquidity and Capital Resources- Grants from the Office of the Chief Scientist."

**Competition**

** **

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

We have also begun to face competition from our customersand new vendors, and we expect this trend to continue in the future.  Someof our customers are developing their own solutions internally or throughstrategic alliances.  

Our competitors in the fraud prevention market areAgilent/Cerebus, Alcatel, Amdocs, Compaq, Ericsson, Lightbridge and NeuralTechnologies.  Our competitors in the quality-of-service solutionsmarket include Agilent, Radcom, Sotas, Tekelec, Tektronix, Inc. and TTITelecom.  Our competitors in the sale of billing assistance solutionsinclude Agilent, Cerebrus, Azure, Accenture, Amdocs and PricewaterhouseCoopers.  Our competitors in the sale of surveillance systems includeswitch manufacturers such as Siemens and surveillance equipment vendors such asVerint and Nice. 
**____(31)____ 

We believe that the principal competitive factors in themarkets in which we compete are product functionality, the ability to provideeffective and comprehensive solutions, pricing, timely introduction of newproducts, especially products of next generation networks, and responsivecustomer support.

For a breakdown of total revenues by category of activity,or segments, for each of the last three financial years, see "Item 5A -Revenues." 

**Intellectual Property and Proprietary Rights**

** **

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

Although we intend to protect our rights in technologyvigorously, we cannot be sure that these measures will be successful.  Itmay be possible for unauthorized third parties to misappropriate or reverseengineer aspects of our products or technology, independently developtechnology of substantially similar functionality or performance, or obtaininformation that we regard as proprietary.  Moreover, the laws ofsome foreign countries in which we sell or may sell our products may not fullyprotect, or may not protect at all, our proprietary rights in products.

Third parties may, from time to time, claim that ourcurrent or future products infringe their intellectual property rights.  Forexample, we were recently approached by a company registered in Germany,claiming that a certain product of ours was infringing its patent.  Uponreview of this claim by our patent attorney, we came to the conclusion thatthis claim was unfounded and so advised this company.  We have notreceived any further communication from this company. Intellectual propertylitigation is complex and we cannot assure you of the outcome of any suchlitigation.  Any future intellectual property litigation, regardlessof outcome, could result in substantial expense and significant diversion ofthe efforts of our technical and management personnel and disrupt or otherwiseseverely impact our relationships with current and potential customers.  Anadverse determination in any such proceeding could subject us to significantliabilities to third parties, require disputed rights to be licensed from thoseparties, assuming licenses to the rights could be obtained, or require us tocease using the technology and expend significant resources to developnon-infringing technology.  We may not be able to obtain a license atan acceptable price.

*CashView, CMRS, FraudView, HawkEye, IC-Guard,Intelli-View, IPMRS, IntraSight, I-Probe, NeTrace, NGN FraudView, ProfEdge,PreView, QualiMobile, QualiVOIP, Quali.Net, QualiView, QualiWeb, SigView, TMRS,X-ellence, X-pertView, X-pose*and*X-Probe*are among the trademarksof ECtel.

**Government Regulations**

** **

Our export sales of surveillance systems are subject toapproval by the Israeli Ministry of Defense.  Current Israeli policypermits export of systems and products of the type manufactured by us toapproved customers.  However, a permit is required prior to theinitiation of each export sale proposal and, prior to shipment, an exportpermit for the actual transaction is also necessary.  We typicallyreceive these permits in the ordinary course.  However, the Ministryof Defense notifies us from time to time not to conduct business with specificcountries that are undergoing political unrest, violating human rights orexhibiting hostility toward Israel.

We receive grants from the Office of the Chief Scientistof the Israeli Ministry of Industry and Trade for research and developmentprograms.  We also receive tax benefits under Israeli law for capitalinvestments that are designated as "Approved Enterprises."  Ourparticipation in these programs is subject to our compliance with certainconditions and imposes certain restrictions upon us.
**____(32)____ 

Demand for products by service providers and governmentalagencies is affected by various types of laws and regulations in the areas ofsurveillance of electronic communications, as well as in use of communicationscustomer records, network service standards, billing for use of interconnectednetworks, certification of and charges paid by VoIP service providers andopening markets to competition.  In addition, various countries arenow formalizing standards for the implementation of IP surveillance technologyin the networks of service providers that operate in those countries. Theoutcome of these new laws and regulations is difficult to predict.  Formore description of the Office of the Chief Scientist, tax benefits forApproved Enterprises and export controls, see "Item 5B - Liquidity and CapitalResources - Grants from the Office of the Chief Scientist" and "Item 10E -Taxation - Israeli Taxation - Tax Benefits under the Law for the Encouragementof Capital Investments, 1959," respectively. 

**C. Organizational Structure**

** **

We are a subsidiary of ECI Telecom Ltd.  ECIholds of record 10,490,325, or approximately 58.4%, of our outstanding ordinaryshares.  ECI is a provider of integrated network solutions whichdesigns, develops, manufactures and markets digital telecommunications and datatransmission systems, enabling network operators to deliver cost-effectiveservices. 

We own all the outstanding shares of:

ECtel Inc., a Maryland corporation, 

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

ECtel GmbH, a German company, 

Telrad Hawk Net-I Ltd., an Israeli company and

ECtel BNV, a Dutch company.
D. Property,Plants and Equipment
 

Our main office, research and development and productionfacilities, to which we have moved recently, are located in Petah Tikva, Israeland occupy approximately 74,950 square feet. The term of the lease is throughFebruary 19, 2005, with a renewal option of three years.

ECtel Inc., our U.S. subsidiary, leases an approximately24,000 square-foot office and production facility in Clarksburg, Maryland andapproximately 1,500 square feet of office space in Florida. The term of theClarksburg lease is through March 31, 2008, with a renewal option of threeyears.

ECtel (2000) U.K. Ltd., our U.K. subsidiary, leasesapproximately 2000 square feet of office space in London, England.  Theterm of this lease is through November 2010, with an option to terminate in2005.

ECtel GmbH leases approximately 970 square feet of officespace from ECI Telecom GmbH in Frankfurt, Germany.  The term of thislease 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 tothe termination of the initial term, of its wish not to renew. 
**____(33)____ 
Item 5. Operatingand Financial Review and Prospects.A.                   Operating Results.
 

You should read this discussion with the consolidatedfinancial statements incorporated by reference in this annual report and theother financial information included in this annual report.

We operated as a wholly-owned subsidiary of ECI until ourinitial public offering in October 1999.  Until the second quarter of1998, some activities in the United States relating to sales and production ofsurveillance solutions were carried out by ECI Telecom Inc., a fellowsubsidiary of ECI and, at that time, also the parent company of ECtel Inc., nowa subsidiary of ours.  (See "Non-Cash Accounting Charges" below formore information on our acquisition of ECtel Inc.)  Effective as ofthe second quarter of 1998, these activities formerly carried out by ECITelecom Inc. are performed by our wholly owned subsidiary ECtel Inc.  Inaddition, some administrative and other expenses relating to sales of otherproducts borne by ECI prior to the second quarter of 1998, and by us sincethen, have been included in respect of the first quarter of 1998. For the firstquarter of 1998, these carve-out operations included in the financialstatements were under the control of the management of ECI or its wholly-ownedsubsidiaries and are presented as if they were discrete operations under commoncontrol.  Inter-company accounts and transactions involving thecarve-out operations have been eliminated for presentation purposes.  Unlessotherwise specified, all discussions in this annual report of our operationsand results of operations refer to the operations and results of operations ofthe combined companies and activities.

For more information on our relationship with ECI, see"Item 7 - Major Shareholders and Related Party Transactions."

**Revenues**

We operate our business in two segments, sales of revenueassurance solutions to service providers and sales of surveillance solutionsfor governmental agencies.  Sales to service providers accounted for54.7% of our revenues in 2002, 75.6% of our revenues in 2001 and 79.4% of ourrevenues in 2000.  For more information regarding the change in themix of our sales, see the discussion below in "Year Ended December 31, 2002,compared with Year Ended December 31, 2001."

Historically, a substantial portion of our revenue hascome from large purchases by a small number of customers.  Sales toour top ten customers accounted for 70.5% of our revenues in 2002, with salesto one customer in the Asian Pacific region accounting for 30.1% of ourrevenues and sales to one customer in Latin America accounting for 10.5 % ofour revenues.  Sales to our top ten customers accounted for 65.4% ofour revenues in 2001, with sales to one customer in the Asian/Pacific regionaccounting for 24.8% of our revenues.  We expect to continue todepend on sales to a small number of customers.  We expect that ourlargest customers will vary from period to period.

**Critical AccountingPolicies**

** **

The preparation of our financial statements in conformitywith generally accepted accounting principles requires our management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period, which could potentially result in materially differentresults under different assumptions and conditions.  These are ourmanagement`s best estimates based on experience and historical data; however,actual results could differ materially from these estimates.  Thefollowing sections include references to certain critical accounting policiesthat are impacted significantly by judgments, assumptions and estimates used inthe preparation of our consolidated financial statements. For a detaileddiscussion on the application of these and other accounting policies, see Note1 in the notes to our consolidated financial statements incorporated byreference in this annual report.
**____(34)____ 

 

***Revenue Recognition***

We have adopted the requirements of SAB101.  Revenuesfrom the sale of systems of proven technology, for which the supply cycle isgenerally short, are recognized generally when all manufacturing of hardwareand/or software development and factory testing have been completed, theproduct has been shipped, risk of economic loss has passed to the customer, ourprice to the customer is fixed or determinable, collection is reasonablyassured and payment is not conditioned on any future performance by us.**  **Incertain cases, when the sale contract includes provisions under which thecustomer`s acceptance is conditioned upon our compliance with performanceguarantees, we recognize revenue when we have demonstrated that the criteriaspecified in the provisions have been satisfied.

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

Long-term contracts are those requiring design,development, engineering and modification and are of a significantly longerduration than contracts for system sales.  Revenues from long-termcontracts are recognized under the percentage of completion method using theratio of actual costs incurred, consisting of labor, materials and overhead,with respect to total expected costs under the contract.  Amountsreceived from customers in excess of revenues earned under this method arerecorded as advance payments from customers.  If managementanticipates a loss on a particular contract, the loss is provided for in fullin the period when the loss is first anticipated. The percentage of completionmethod of accounting involves the use of various estimating techniques toproject costs at completion. These estimates involve various assumptions andprojections relative to the outcome of future events, including the quantityand timing of product deliveries. Also included are assumptions relative tofuture labor performance prices and rates, and projections relative to materialand overhead costs. These assumptions involve various levels of expectedperformance improvements. If actual costs are materially different than ourassumptions, our estimates of anticipated revenues and operating expenses couldadversely change. 

Revenues from sales involving long-term creditarrangements at less than normal commercially acceptable interest rates arerecorded at the present value of the related future cash flows.  Thedifference between the amounts receivable and their present value is recognizedas interest income over the period of the debt.  Service revenuesfrom product maintenance contracts and separately priced extended warrantycontracts are generally recognized ratably over the contract period.

Service revenues from product maintenance contracts andseparately priced extended warranty contracts are recognized ratably over thecontract period.

**Inventory**

** **

Inventories are stated at the lower of cost or market.  Asregards to raw materials (including components), the cost is determined on themoving average basis.  As regards to work in process and finishedproducts: (1) the cost of raw materials and components is determined on themoving average basis and (2) labor costs and the cost of overhead componentsare determined on the basis of actual manufacturing costs.  If actualmarket conditions are less favorable than those projected by management or ifthere is no future demand for part or all of our inventories, we will need towrite-off the affected inventories. This would result in an increase in ouroperating expenses. 

 
**____(35)____ 

 
 
***Allowance for Doubtful Debts***

Our financial statements include an allowance which webelieve reflects adequately the loss inherent in receivables for whichcollection is in doubt.  In determining the fairness of the allowancewe review and consider information at hand about debtors` financial situation,the volume of their operations, aging of the balance and evaluation of thesecurity received from them or their guarantors.  If there is a major deterioration in a major customer`s creditworthiness or actual defaults are higher than our historical experience, ourestimates of the recoverability of amounts due to us could be adverselyaffected.  This would result in an increase in our general andadministrative expenses by increasing the allowance for bad and doubtful debtsand would decrease the amount of our trade receivables.

***Goodwill and other intangible assets***

We adopted SFAS No. 142 requirements regarding goodwilland other intangible assets with indefinite useful lives. In 2002 anindependent expert examined the value of the reporting unit to which thegoodwill was attributed.  We concluded that, in accordance with SFASNo. 142, there was no impairment in the value of the goodwill. If our estimatesregarding future revenues, operating expenses or other assumptions made inorder to determine the fair value of the segment to which goodwill wasattributed need to be adjusted, the fair value estimationof the segment could be adversely affected. As a result, we might be requiredto amortize part or all of the goodwill, which would result in an increase inour operating expenses.

We amortize other intangible assets with definite usefullives over their respective estimated useful lives to their estimated residualvalues, and review for impairment in accordance with Statement of FinancialAccounting Standards No. 144, "Accounting for the Impairment or Disposal ofLong-Lived Assets."

***Deferred Taxes***

We account for income taxes under SFAS 109"Accounting for Income taxes".  

Under SFAS 109 deferred tax assets or liabilities arerecognized in respect of temporary differences between the tax bases of assetsand liabilities and their financial reporting amounts as well as in respect oftax losses and other deductions which may be deductible for tax purposes infuture years, based on tax rates applicable to the periods in which suchdeferred taxes will be realized.  Deferred tax assets for future taxbenefits from realization are included when their realization is more likelythan not.  Valuation allowances are established when necessary toreduce deferred tax assets to the amount expected to be realized.  Deferredtax assets and liabilities are presented as current or long-term items inaccordance 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 thefull amount of our deferred tax assets, we will be required to write down ourtax assets. A write down will result in an increase in our tax expenses. 

**Non-Cash Accounting Charges**

** **

ECI`s acquisition of ECtel Inc. was accounted for underthe purchase method of accounting and the excess of the purchase cost over theestimated value of the net assets acquired was allocated to goodwill.  Asa result of our purchase of ECtel Inc. from ECI and the treatment of thatacquisition similar to a pooling of interests, we recognize the goodwillarising from ECI`s acquisition of ECtel Inc. in our results of operations.Total amortization was $950,000 in each of 1998 and 1999.  Theamortization was completed in the first quarter of 2000 with amortization inthat quarter of $142,000.
**____(36)____ 

We have granted options to our officers, directors andemployees from time to time since 1998.  At the various times ofissuance of the options in 1998 and 1999 the fair market value of the sharesunderlying the options exceeded the option exercise prices by an aggregate ofapproximately $7.3 million.  Accordingly, we incurred a non-cashcharge in this amount to be amortized over the vesting period of these options,which commenced in the fourth quarter of 1998.  In 2000 this non-cashcharge was $2.6 million, in 2001 it was $2.4 million and in 2002 it was$400,000. This stock based compensation charge was presented as one line itemin our consolidated statements of income for years prior to 2002 and now has beendivided between cost of revenues and other operating expenses in accordancewith SEC guidelines.  The presentation of figures for prior years hasbeen reclassified accordingly. 

A one-time write-off in the amount of$916,000, included in "In process research and development costs" in 2001, wasincurred in connection with the acquisition of NetEye in October 2001,discussed below.

**Acquisition of Net Eye**

** **

In October 2001 we acquired all of the outstanding sharesof Telrad Hawk Net-I Ltd., or Net Eye, from Telrad Networks Ltd. in exchangefor the issuance of 850,000 ordinary shares, and warrants to acquire anadditional 1,000,000 ordinary shares for an exercise price of $24.00 per shareand 250,000 ordinary shares for an exercise price of $28.00 per share.  NetEye is engaged in the research, development and marketing of real-time frauddetection and prevention solutions for IP and third generation networks.  

The acquisition of Net Eye was accounted for under thepurchase method.  The excess of the purchase cost over the estimatedvalue of the net assets acquired totaled $17.6 million, and was allocated asfollows: 
- $16.3 million to goodwill;

 
- $916,000 to in process research and development costs;

 
- $251,000 to technology with five years of useful life; and

 
- $119,000 to customer contracts with one year of useful     life.

 

Our operatingresults include those of NetEye beginning with the fourth quarter of 2001.

**Our Functional Currency**

** **

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

**Recent Developments**

Our revenues for the first quarter of 2003 were $15.1million, compared to $23.1 million for the corresponding period in 2002.  Ournet loss for the first quarter of 2003 was $3.8 million, compared to net incomeof $4.1 million for the first quarter of 2002.  Based on preliminaryestimates, our results of operations continued to be adversely affected in thesecond quarter. The decrease in revenues resulted from lower sales of both ourrevenue assurance solutions and our government surveillance solutions.  Webelieve that, in addition to the general slowdown in the economy that has nowcontinued for several years, our sales were also adversely affected byuncertainty surrounding geopolitical events toward the end of the firstquarter, primarily the war in Iraq.  Please see Section D below,"Trend Information," for more information on trends that are affecting ourbusiness and results of operations.
**____(37)____ 

 

**Results of Operations**

** **

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

 

Year ended December 31,

 

2000

2001

2002

Revenues

100.0%

100.0%

100.0%

Cost of  revenues

43.5

42.0

39.8

 

 

 

 

Gross profit

56.5

58.0

60.2

Research and  development costs, net

14.0

14.0

13.5

Selling and  marketing expenses

18.9

19.0

18.7

General and  administrative expenses

9.7

10.4

10.0

Amortization  of goodwill

0.2

―

―

In process  research and development

―

1.1

―

 

 

 

 

Total  operating expenses

42.8

44.5

42.2

Operating income

13.7

13.5

18.0

Financial  income, net

(3.1)

(1.2)

(0.5)

Other expenses  - net

0.3

―

―

Income before  taxes on income

16.5

14.7

18.5

Taxes on  income

2.2

(0.1)

0.4

Cumulative effect of change in accounting principles

―

―

―

Net income

14.3%

14.8%

18.1%

 

**Year Ended December 31, 2002 Compared with Year EndedDecember 31, 2001**

** **

*Revenues*****

Revenues consist primarily of the sale of our solutions toservice providers and governmental agencies.  Total revenuesincreased 18.8% from $80.6 million in 2001 to $95.8 million in 2002.  Salesof revenue assurance solutions to service providers decreased 14.0% from $61.0million in 2001 to $52.4 million in 2002.  This decrease wasprimarily due to the continuing general deterioration in the globaltelecommunications market.  Sales of surveillance solutions togovernment agencies increased 120.6% from $19.6 million in 2001 to $43.4million in 2002.  This increase was primarily due to the heightenedconcern regarding terrorism and terrorist attacks worldwide following theSeptember 11, 2001 events.

Revenues from sales to customers located outside of Israelincreased from 93.0% in 2001 to 98.7% in 2002.  This increase was aresult of our increased sales to international governmental agencies andservice providers, primarily in Latin America and the Asian Pacific region.  Thisincrease was partially offset by decreased sales in North America and Europe.  
**____(38)____ 

 

*Cost of Revenues*

Cost of revenues consists primarily of the cost ofmaterials, employee compensation expenses, payments to sub-contractors andoutsourcing, payments to consultants, depreciation related to themanufacturing, installation and support of our products and royalties to theOffice of the Chief Scientist in Israel.  Gross profit increased23.4% from $46.7 million in 2001 to $57.7 million in 2002.  Grossprofit margin increased from 58.0% in 2001 to 60.2% in 2002.  Thisincrease was primarily due to reductions in our manufacturing costs and theincrease in sales of government agencies solutions, which had significantlyhigher profit margins in 2002 than sales of revenue assurance solutions.

*Research and Development Costs, Net*

Research and development costs consist primarily ofemployee compensation expenses, payments to sub-contractors and consultants andcosts of materials associated with our research and development activities.Grants received from the Office of the Chief Scientist in Israel are deductedfrom gross research and development expenses to determine net research anddevelopment expenses.  Gross research and development costs increased9.4% from $12.6 million in 2001 to $13.8 million in 2002.   Thisincrease was primarily due to an increase in labor and materials expenses in2002 and because of the consolidation of NetEye`s results of operations withours for the full year of 2002, compared with only the fourth quarter of 2001.Research and development grants from the Office of the Chief Scientistdecreased 34.9% from $1.4 million in 2001 to $900,000 in 2002.  

*Selling and Marketing Expenses*

Selling and marketing expenses consist primarily ofemployee compensation expenses, payments to consultants, agents` commissionsand costs associated with advertising, exhibitions, market research, industrytrade shows and travel.  Sales and marketing expenses increased 17.3%from $15.3 million in 2001 to $17.9 million in 2002.  The increasewas due primarily to the continuing expansion of our worldwide sales andmarketing organization, and an increase in marketing activities.  Inaddition, the increase in sales resulted in an increase in agents` commissions.Sales and marketing expenses decreased as a percentage of revenues from 19.0%in 2001 to 18.7% in 2002.

*General and Administrative Expenses*

General and administrative expenses consist primarily ofemployee compensation expenses, professional fees, including legal andaccounting fees, recruiting costs and the provision for doubtful debt.  Generaland administrative expenses increased 14.8% from $8.4 million in 2001 to $9.6million in 2002.  The increase was primarily due to an increase inprovision for doubtful debts partially off-set by a decrease in various othergeneral and administrative expenses.

As a percentage of revenues, general and administrativeexpenses decreased from 10.4% in 2001 to 10.0% in 2002.  

*Amortization of Goodwill*

Goodwill relating to the acquisition of NetEye is subjectto SFAS No. 142, which provides that goodwill and other intangible assets withindefinite lives are no longer amortized, but instead are to be tested forimpairment at least annually in accordance with the provisions of SFAS No. 142.  During2002, a third party expert examined the value of the reporting unit to whichthe goodwill was attributed.  We concluded that, in accordance withSFAS No. 142, there was no impairment in the value of the goodwill.
**____(39)____ 

 

*Operating profit*

Operating profit increased 58.2% from $10.9 million in2001 to $17.2 million in 2002. Operating profit margin increased from 13.5% in2001 to 18.0% in 2002.  This increase was primarily due to anincrease in sales, as well as an increase in gross profit margins, partiallyoff-set by an increase in research and development costs, net, in sales andmarketing expenses and in general and administrative expenses.

*Financial income, net*

Financial income, net decreased 52.0% from $1.0 million in2001 to $491,000 in 2002, this decrease was primarily due to the reduction ininterest rates we received on our cash and cash equivalents.

*Other Expenses, net*

Other expenses decreased from $36,000 in 2001 to $23,000in 2002.  In both 2002 and 2001, other expenses consisted of losseson the sale of fixed assets and write-offs of fixed assets.

*Taxes on Income (Tax Benefit)*

Tax benefitwas $103,000 in 2001, compared to tax expense of $356,000 in 2002, an effectivetax rate of 2.0%.  This shift from tax benefit to tax expense is aresult of the increase in pre-tax income from our Israeli operations, partiallyoffset by an increase in the pre-tax loss from our U.S. operations.  Oureffective tax rate in Israel is significantly lower than our effective tax ratein the United States.

 

*Net income*

Net income increased 45.1% from $11.9 million in 2001 to$17.3 million in 2002.  Net income margin increased from 14.8% in2001 to 18.1% in 2002.  This increase was primarily due to anincrease in operating profit, partially off set by a decrease in financialincome, net and a shift from tax benefit to tax expense.

**Year Ended December 31, 2001 Compared with Year EndedDecember 31, 2000**

** **

*Revenues*

Total revenues increased 34.9% from $59.7 million in 2000 to$80.6 million in 2001.  Sales of revenue assurance solutions toservice providers increased 28.5% from $47.4 million in 2000 to $61.0 millionin 2001.  This increase was primarily due to sales to new customersoutside of Israel and repeat sales to existing customers.  Sales ofsurveillance solutions to government agencies increased 59.7% from $12.3million in 2000 to $19.6 million in 2001.  This increase wasprimarily due to sales of our existing products and a sale of a new real-timenext-generation surveillance solution that was launched in 2001.  

Revenues from sales to customers located outside of Israelincreased from 89.7% in 2000 to 93.0% in 2001.  This increase was aresult of our increased sales to international service providers, primarily inSouth America and the Asian Pacific region.  This increase waspartially offset by decreased sales in North America and Europe.  

*Cost of Revenues*

Gross profit increased 38.4% from $33.8 million in 2000 to$46.8 million in 2001, after giving effect to the re-classification ofroyalties to the Chief Scientist.  Gross profit margin increased from56.6% in 2000 to 58.0% in 2001.  This increase was primarily due toreductions in our manufacturing costs and the increase in sales of revenueassurance solutions to service providers, which have higher profit margins thansales of surveillance solutions to government agencies.
**____(40)____ 

 

*Research and Development Costs, Net*

Gross research and development costs increased 34.4% from$9.2 million in 2000 to $12.4 million in 2001.  This increase wasprimarily due to an increase in labor and materials expenses in 2001 andbecause of the consolidation of NetEye`s results of operations with ours in thefourth quarter of 2001.  Research and development grants from theOffice of the Chief Scientist increased 19.5% from $1.1 million in 2000 to $1.4million in 2001.  

*Selling and Marketing Expenses*

Selling and marketing expenses increased 36.6% from $11.1million in 2000 to $15.1 million in 2001, after giving effect to there-classification of royalties to the Chief Scientist.  Sales andmarketing expenses increased as a percentage of revenues from 18.5% in 2000 to18.7% in 2001.  The increases were due primarily to the continuingexpansion of our worldwide sales and marketing organization, including theaddition of sales and marketing personnel and an increase in marketingactivities.  In addition, the increase in sales resulted in anincrease in agents` commissions.****

*General and Administrative Expenses*

General and administrative expenses increased 73.8% from$3.7 million in 2000 to $6.5 million in 2001.  As a percentage ofrevenues, general and administrative expenses increased from 6.2% in 2000 to8.0% in 2001.  The increases were primarily due to an increase insome components of general and administrative expenses, including an increasein provision for doubtful debts.  

*Amortization of Goodwill*

Amortization of goodwill relates to the acquisition of theshares of ECtel Inc. in 1993 and 1997 and was completed in the first quarter of2000.

*Operating profit*

Operating profit increased 33.0% from $8.2 million in 2000to $10.9 million in 2001.  Operating profit margin decreased from13.7% in 2000 to 13.5% in 2001.  This decrease was primarily due toan increase in research and development costs, net, in sales and marketingexpenses and in general and administrative expenses.

Operating expenses and one time in process research anddevelopment costs were recorded in 2001 in connection with NetEye acquisition,off set by an increase in sales as well as an increase in gross profit margins.

*Financial income, net*

Financial income, net decreased 55.0% from $1.9 million in2000 to $1.0 million in 2001, the decrease was primarily due to the reductionin interest rates we received on our cash and cash equivalents.
**____(41)____ 

 

*Other Expenses, net*

Other expenses decreased from $189,000 in 2000 to $36,000in 2001.  In both 2001 and 2000, other expenses consisted of lossesupon the sale of fixed assets and write-offs of fixed assets.

*Taxes on Income (Tax Benefit)*

Taxes on income were an expense of $1.3 million in 2000,an effective tax rate of 13.3%, compared to a tax benefit of $103,000 in 2001.  Thisshift from tax expense to tax benefit is a result of the increase in pre-taxincome from our Israeli operations offset by a pre-tax loss from our UnitedStates operations.  Our effective tax rate in Israel is significantlylower than our effective tax rate in the United States.  The lossfrom our U.S. operations resulted in a tax benefit in excess of the tax expensefrom our Israeli operations.  

*Net income*

Net income increased 40.0% from $8.5 million in 2000 to$11.9 million in 2001.  Net income margin increased from 14.3% in2000 to 14.8% in 2001.  This increase was primarily due to increasein operating profit as well as decrease in tax expenses, partially off set by adecrease in financial income, net.

* *

**Recently Enacted Accounting Standards  **

** **

***SFAS143 - Accounting for Asset Retirement Obligations:***

In June 2001, the FASB issued SFAS 143, *"Accounting forAsset Retirement Obligations".*  SFAS 143 requires that we recordfair value of an asset retirement obligation as a liability in the period inwhich it incurs a legal obligation associated with the retirement of tangiblelong-lived assets that result from the acquisition, construction, developmentand/or normal use of the assets.  We are also required to record acorresponding asset, the value of which is depreciated over the life of theasset. Subsequent to the initial measurement of the asset retirementobligation, the obligation will be adjusted at the end of each period toreflect the passage of time and changes in the estimated future cash flowsunderlying the obligation.  SFAS 143 is effective for financialstatements issued for fiscal years beginning after June 15, 2002.  Earlierapplication is permitted.  The adoption of SFAS 143 willnot have a significant impact on our consolidated financialstatements.

***SFAS 145 - Rescission of FASB Statement 4, 44 and 64, Amendmentof FASB No. 13 and Technical Corrections***

In April 2001, the FASB issued SFAS 145, "Rescissionof FASB Statement 4, 44 and 64, Amendment of FASB No. 13 and TechnicalCorrections".  SFAS 145 rescinds FASB Statement No. 4, "ReportingGains and Losses from Extinguishments of Debt", and an amendment of that Statement,FASB Statement No. 64, "Extinguishments of Debt Made to Satisfy Sinking-FundRequirements".  SFAS 145 also rescinds FASB Statement No. 44,"Accounting for Intangible Assets of Motor Carriers".  This Statementamends FASB Statement 13, "Accounting for Leases", to eliminate aninconsistency between the required accounting for sale-leaseback transactionsand the required accounting for certain lease modifications that have economiceffects that are similar to sale-leaseback transactions.  SFAS 145also amends other existing authoritative pronouncements to make varioustechnical corrections, clarify meanings, or describe their applicability underchanged conditions.  The provisions of this Statement related to therescission of Statement 4 are applicable in fiscal years beginning after May15, 2002.  Early adoption is encouraged. A calendar-year entity mayadopt the Statement 4 rescission in the fourth quarter of 2002.  Theprovisions of this Statement related to Statement 13 are effective fortransactions occurring after May 15, 2002, with early application encouraged.  Allother provisions of this Statement are effective for financial statementsissued on or after May 15, 2002, with early application encouraged.  Webelieve that the adoption of all of SFAS 145 requirements will notsignificantly impact on our consolidated financial statements.
**____(42)____ 

 

***SFAS. 146.  - Accounting for Costs Associated withExit or Disposal Activities***

In July 2002, the FASB issued SFAS 146, *"Accounting forCosts Associated with Exit or Disposal Activities"*. SFAS 146 nullifies EITF94-3. According to SFAS 146, commitment to a plan to exit an activity ordispose of long-lived assets will no longer be enough to record a one-timecharge for most anticipated costs.  Instead, companies will recordexit or disposal costs when they are "incurred" and can be measured at fairvalue, and they will subsequently adjust the recorded liability for charges inestimated fair value. SFAS 146 also revises accounting for specified employeeand contract terminations that are part of restructuring activities. SFAS 146is effective for exit and disposal activities that are initiated after December31, 2002.  Earlier application is encouraged.  We believethat the adoption of SFAS 146 will not have a significant impact on itsconsolidated financial statements.
*****____(43)____ 

***SFAS 147 - Acquisitions of Certain Financial Institutions - anamendment of FASB Statements No. 72 and 144 and FASB Interpretation No.9" ***

In October 2002, the FASB issued SFAS 147, "*Acquisitionsof Certain Financial Institutions - an amendment of FASB Statements No. 72 and144 and FASB Interpretation No. 9"* ("SFAS 147"). The Statementclarifies that a branch acquisition that meets the definition of a businessshould be accounted for as a business combination, otherwise the transactionshould be accounted for as an acquisition of net assets that does not result inthe recognition of goodwill. In addition, the industry-specific guidance inStatement 72 will no longer apply to transactions in the scope of this Statement.  Theprovision of SFAS 147, which relates to the application of the purchase methodof accounting, is effective for acquisitions for which the date of acquisitionis on or after October 1, 2002.  The provisions related to accountingfor the impairment or disposal of certain long-term customer-relationshipintangible assets are effective on October 1, 2002. Transition provisions forpreviously recognized unidentifiable intangible assets are effective on October1, 2002, with earlier application permitted.  We believe that theadoption of SFAS 147 will not have a significant impact on our consolidatedfinancial statements.

***FASB Statement No. 149, Amendment of Statement 133 on DerivativeInstruments and Hedging Activities SAB 74 disclosure.***

On April 30, 2003, the FASB issued FASB Statement No. 149,Amendment of Statement 133 on Derivative Instruments and Hedging Activities,which amends FASB Statement No. 133, Accounting for Derivative Instruments andHedging Activities, to address (1) decisions reached by the DerivativesImplementation Group, (2) developments in other Board projects thataddress financial instruments, and (3) implementation issues related to thedefinition of a derivative.  Statement 149 has multiple effectivedate provisions depending on the nature of the amendment to Statement 133.  Webelieve that the adoption of SFAS 149 will not have a significant impact on ourconsolidated financial statements.

***FASB Statement No. 150, Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity***

On May 15, 2003, the FASB issued FASB Statement No. 150,Accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity.  This Statement establishes standards for howan issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity. It requires that an issuerclassify a financial instrument that is within its scope as a liability (or anasset in some circumstances). Many of those instruments were previouslyclassified as equity. This Statement is effective for financial instrumentsentered into or modified after May 31, 2003, and otherwise is effective at thebeginning of the first interim period beginning after June 15, 2003, except formandatorily redeemable financial instruments of nonpublic entities. It is to beimplemented by reporting the cumulative effect of a change in an accountingprinciple for financial instruments created before the issuance date of theStatement and still existing at the beginning of the interim period ofadoption. Restatement is not permitted. For nonpublic entities, mandatorilyredeemable financial instruments are subject to the provisions of thisStatement for the first fiscal period beginning after December 15, 2003.  Webelieve that the adoption of SFAS 150 will not have a significant impact on ourconsolidated financial statements.

***FIN No. 45 Guarantor`s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others***

In November 2002, the Financial Accounting Standards Boardissued Interpretation No. 45, Guarantor`s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers (hereinafter the Interpretation), which addresses, among other things,the disclosure to be made by a guarantor in its interim and annual financialstatements about its obligations under guarantees.  These disclosurerequirements are included in Note 9 to the consolidated financial statements.  TheInterpretation also requires the recognition of a liability by a guarantor atthe inception of certain guarantees. 
**____(44)____ 

 

The Interpretation requires the guarantor to recognize aliability for the non-contingent component of the guarantee, this is the obligationto stand ready to perform in the event that specified triggering events orconditions occur.  The initial measurement of this liability is thefair value of the guarantee at inception.  The recognition of theliability is required even it is not probable that payments will be requiredunder the guarantee or if the guarantee was issued with a premium payment or aspart of a transaction with multiple elements.  The Company hasadopted the disclosure requirements of the Interpretation and will apply therecognition and measurement provisions for all guarantees entered into ormodified after December 31, 2002. We believe that the adoption of FIN 45 willnot have a significant impact on our consolidated financial statements.

***FIN No.46* "*Consolidation of Variable Interest Entities*", an interpretationof ARB 51:**

 

In January 2003, the Financial Accounting Standard Boardissued FIN No. 46, "*Consolidation of Variable Interest Entities*"..According to the interpretation, a Variable Interest Entity will be consolidatedby an enterprise that is subject to a majority of the risk of loss from theVariable Interest Entity`s activities or entitled to receive a majority`s ofthe entity`s residual returns or both. The enterprise that consolidates aVariable Interest Entity is called the primary beneficiary of that entity. Theinterpretation requires certain disclosures to be made by the primarybeneficiary and by an enterprise that holds a significant variable interest ina Variable Interest Entity but is not the primary beneficiary. Theconsolidation requirements of Interpretation 46 apply immediately to VariableInterest Entities created after January 31, 2003. The consolidationrequirements apply to older entities in the first fiscal year or interim periodbeginning after June 15, 2003. Certain of the disclosure requirements apply inall financial statements issued after January 31, 2003, regardless of when thevariable interest entity was established. We believe that the adoption of FIN46 will not have a significant impact on our consolidated financial statements.

**B.                   ****Liquidity and Capital Resources.**

** **

Prior to our initial public offering in October 1999, wefinanced our operations through funding from ECI and cash generated byoperations.  ECI provided loans to us and extended credit relating tocomponents and administrative services provided to us by them.  Werepaid all loans to ECI prior to or during 2000.  In October 1999, wecompleted our initial public offering of 4,025,000 shares, including theexercise of the underwriters` over-allotment option.  We received netproceeds of approximately $43.2 million from this offering.  As ofDecember 31, 2002, we had $52.8 million in cash and cash equivalents, comparedto $40.5 million in cash and cash equivalents as of December 31, 2001.

Our operating activities provided cash in the amount ofapproximately $13.3 million in 2002, compared to $1.2 million in 2001 and $8.1million in 2000.  Cash provided by operations for 2002 was primarilyattributable to operating income of $17.2 million, an increase in tradepayables and other payables and accrued liabilities, and a decrease ininventories, offset by an increase in other receivables and trade receivables.  Theincrease in trade receivables was primarily attributable to (1) an increase inrevenues recorded during 2002 and (2) a longer collection cycle for accountsreceivable due to the need to grant credit with longer payment terms to somecustomers in order to continue to achieve penetration in target markets and inresponse to weakened general economic conditions in other markets.  Whenthe payment cycle for our receivables lengthens, we use more of our cashreserves to fund our operations. As is typical in both telecommunications andgovernmental industries, our contracts may provide for payments under a varietyof payment schedules.  

From time to time, we sell trade accounts receivable tounaffiliated financial institutions.  At December 31, 2002, we hadsold trade account receivables aggregating $12.3 million to these institutions.  Ourability to sell such receivables to the financial institutions on current termsand conditions is uncertain and is dependent on the creditworthiness of thecustomers involved, the credit risks in the specific countries concerned andthe institutions` policies from time to time, all of which have become lessfavorable in the current economic environment. 
**____(45)____ 

In 2001 our operating activities provided cash in theamount of approximately $1.2 million, compared to $8.1 million in 2000.  Cashprovided by operations for 2001 was primarily attributable to operating incomeof $10.9 million and an increase in other payables and accrued liabilities,offset by an increase in trade receivables.  The increase in tradereceivables was primarily attributable to (1) an increase in revenues recordedduring 2001 and (2) a longer collection cycle for accounts receivable due tothe need to grant credit with longer payment terms to some select customers inorder to achieve penetration in new target markets and in response to weakenedgeneral economic conditions in other markets.  

We invest in capital expenditures pursuant to ApprovedEnterprise programs.  At December 31, 2002, no further amounts remainto be invested in order to comply with current approved programs.  Theseprograms provide us with tax benefits in the future.  

Our financing activities provided $1.1 million in 2002,primarily due to the issuance of our ordinary shares to employees upon theexercise of share options.  Our financing activities used $326,000 in2001, primarily due to the repayment of a bank loan in connection with theacquisition of NetEye, offset by the issuance of our ordinary shares toemployees upon the exercise of share options.  Our financingactivities used $6.5 million in 2000, primarily due to repayment of a loan fromECI.

Our capital expenditures were $2.0 million in 2002, $1.8million in 2001 and $2.2 million in 2000.  Our capital expendituresin each of these periods related primarily to the purchase of testing andcomputer equipment.  In addition, we invested $250,000 and $838,000for rights to technology in 2002 and 2001, respectively.

Inventories decreased from $6.9 million at the end of 2001to $5.8 million at the end of 2002.  This decrease was primarily dueto usage of inventories during the year.

In September 2002, we executed anegative pledge in favor of an Israeli bank, in which we undertook not toperform the following without the bank`s prior written consent:

(1)Mortgage,or undertake to mortgage, in any manner or form, any of our assets;

(2)Sell assets (other than in the ordinary course of business) thevalue of which exceed $1 million in the aggregate. 

 

This bank supplies us with various credit facilitiessuch as bank guarantees to our customers to guarantee our contractualobligations to such customers. As of  December 31, 2002, the amountof the said bank guarantees totaled approximately $3,8 million.

In addition, from time to time other banks make creditavailable to us in the form of bonds to secure our obligations to our customersor in connection with hedging transactions. 

The following tablepresents information on our short-term and long-term contractual obligations.

 

Payments Due By Period  (in thousands)

**Contractual Obligations**

Total

2003

2004

2005

2006

2007 and thereafter

Operating leases (vehicles and facilities)

$7,102

$2,494

$2,409

$1,032

$568

$599

Purchase obligations (vendors of equipment and services)

2,600

2,600

-

-

-

-

Total contractual cash obligations

$9,702

$5,094

$2,409

$1,032

$568

$599

 

 

 

 

 

 

 

 

As to our royalty obligations and outstanding guarantees asat December 31, 2002, see Note 9 to our consolidated financial statementsincorporated by reference in this annual report. 
**____(46)____ 

 

 

Management believes our cash and cash equivalents reservewill be sufficient to meet our anticipated cash needs for working capital andcapital expenditures for the next twelve months.  However, if wecarry out acquisitions of other companies or new technologies by paying cash,there may be a need to raise additional capital by issuing debt or equityduring the year. 

**Impact of Related Party Transactions**

** **

Our acquisition of NetEye was a "related partytransaction" because Koor Industries Ltd., the sole shareholder of Telrad, heldapproximately 35% of the outstanding ordinary shares of ECI at the time of thetransaction, which in turn owned approximately 73% of our ordinary shares atthat time.  Accordingly, as required by the Israeli Companies law,the acquisition was approved by our Audit Committee, Board of Directors and a specialmajority of our shareholders.  In addition, Salomon Smith BarneyInc., our financial advisor in connection with the acquisition, delivered toour board of directors a written opinion as to the fairness to us, from afinancial point of view, of the consideration to be paid by us in connectionwith the acquisition.

We have also entered into several agreements with ourparent company, ECI.  Of these agreements, only the agreement for thesupply of certain components by ECI is material to our operations.  Thepricing of the transactions was arrived at based on negotiations between theparties.  Members of our management reviewed the pricing of theagreements and confirmed that they were not less favorable to us than couldhave been obtained from unaffiliated third parties.

**Corporate Tax Rate**

** **

Israeli companies are generally subject to tax at the rateof 36% of taxable income (and to capital gains tax at a rate of 25% for capitalgains derived after January 1, 2003).  However, our manufacturingfacilities in Petah Tikva have been granted Approved Enterprise status underthe Law for the Encouragement of Capital Investments, 1959.  Consequently,these facilities are eligible for tax benefits.  We have derived, andexpect to continue to derive, a substantial portion of our income from ourApproved Enterprise facilities.  Subject to compliance withapplicable requirements, the income derived from our Approved Enterprisefacilities will be subject through 2012 to a reduced tax rate of a maximum of25%.  The actual tax rate will depend upon the percentage ofnon-Israeli holders of our share capital.  In 2002, our effectiveincome tax rate was 2.0%.  See Note 11 to our consolidated financialstatements incorporated by reference in this annual report for more informationon our income taxes.

The above benefits are conditioned upon our fulfillment ofconditions stipulated by the Law for the Encouragement of Capital Investments,the regulations promulgated thereunder and the instruments of approval for thespecific investments in Approved Enterprises.  If we fail to complywith these conditions, our benefits may be canceled and we may be required torefund the amount of the benefits received, in whole or in part. 

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

** **

The dollar cost of our operations is influenced by theextent to which any increase in the rate of inflation in Israel is offset bythe devaluation of the NIS in relation to the U.S. dollar.  Inflationin Israel will cause contracts under which we are to receive payment in dollarsor dollar-linked NIS, while incurring expenses in NIS linked to the Israeliconsumer price index, to be less profitable, unless such inflation is offset bya devaluation of the NIS.

Most of our sales are denominated in dollars or are dollarlinked.  However, a significant portion of our expenses, primarilyexpenses associated with employee compensation, is denominated in NIS unlinkedto the dollar.  A devaluation of the NIS in relation to the dollarhas the effect of decreasing the dollar value of any asset of ours whichconsists of NIS or receivables payable in NIS, unless such receivables arelinked to the dollar.  Such a devaluation also has the effect ofreducing the dollar amount of any of our expenses or liabilities which arepayable in NIS, unless such expenses or payables are linked to the dollar.  Conversely,any increase in the value of the NIS 
**____(47)____ 

in relation to the dollar has the effect of increasing thedollar value of any of our unlinked NIS assets and the dollar amounts of any ofour unlinked NIS liabilities and expenses.

Until 1997, inflation in Israel exceeded the devaluationof the NIS against the dollar and we experienced increases in the dollar costof our operations in Israel.  For example, the rate of inflation inIsrael was 10.6% in 1996, while the devaluation of the NIS against the dollarwas 3.7% in 1996.  This trend was partially reversed beginning in1997, as the rate of inflation was 7.0% in 1997, 8.6% in 1998, 1.3% in 1999, 0%in 2000, 1.4% in 2001 and 6.5% in 2002, while the rate of devaluation was 8.8%in 1997, 17.6% in 1998, (0.2)% in 1999, (2.7)% in 2000, 9.3% in 2001 and 7.3%in 2002.

Because exchange rates between the NIS and the dollarfluctuate continuously, albeit with a historically declining trend in the valueof the NIS, exchange rate fluctuations and especially larger periodicdevaluations will have an impact on our profitability and period-to-periodcomparisons of our results.

We believe that inflation in Israel and exchange ratefluctuations between the NIS and the dollar have not had a material effect onour results of operations.

Please see "Item 7 - Major Shareholders and Related PartyTransactions" for information on our relationship with ECI.

**Market Risk**

** **

For information on our market risk, see "Item 11 -Quantitative and Qualitative Disclosures About Market Risk."

**Grants from the Office of the Chief Scientist**

** **

*Office of the Chief Scientist*

Under the Law for the Encouragement of Industrial Researchand Development, 1984, or the Research and Development Law, a research anddevelopment program that meets specified criteria is eligible for grants of upto 50% of the program`s expenses.  The program must be approved by acommittee of the Office of the Chief Scientist of the Israeli Ministry ofIndustry and Trade.  The recipient of the grants is required toreturn the grants, linked to the U.S. dollar plus interest, by the payment ofroyalties on the sale of products developed using the grants.  In thecase of unsuccessful development of a product following Office of the ChiefScientist participation, or if the product does not generate any revenues, wewould not be obligated to repay the grants we received for the product`sdevelopment.

The terms of grants under the law require that wemanufacture the products developed with these grants in Israel, unless priorapproval is received from the Office of the Chief Scientist.  Ordinarily,any such approval will be conditioned upon acceleration of the rate ofroyalties and increasing the total amount to be repaid to as high as 300% ofthe grants.  Separate governmental consent is required to transfer tothird parties the technology developed under the plans.  In practice,the Office of Chief Scientist does not consent to the transfer out of Israel ofthe ownership of the technology developed under a plan.  No approvalis required with respect to the sale or export from Israel of productsdeveloped under a funded plan.

We recorded grant participations from the Office of theChief Scientist totaling $1.1 million in 2000, $1.4 million in 2001 and$889,000 in 2002.  Pursuant to the terms of these grants, we areobligated to pay royalties of 3.5% of revenues derived from sales of productsfunded with these grants.  As of December 31, 2002, our contingentliability to the Office of the Chief Scientist in respect of grants receivedwas approximately $1.8 million.

The Israeli authorities have indicated that the governmentmay reduce or abolish Office of the Chief Scientist grants in the future.  Evenif these grants are maintained, we cannot presently predict what would be theamounts of future grants, if any, that we might receive.
**____(48)____ 

 

*Amendment to the Research andDevelopment Law*

In November 2002, the Israeli parliament approved an amendment to the Researchand Development Law.  The amendment became effective on April 1,2003. 

As opposed to the Research andDevelopment Law prior to the amendment, which requires an undertaking in theapplication that all manufacturing will be performed in Israel, the amendmentto the Research and Development Law allows for the approval of grants in casesin which the applicant declares that part of the manufacturing will not takeplace in Israel.   This declaration is required to include detailsregarding the locations in which the manufacture of the product will beperformed in Israel and out of Israel, the manufacture activities to beperformed in such locations (including the reasons for performing suchmanufacture activities out of Israel) and the proportionate manufacturingexpenditures in Israel and out of Israel.  This declaration will be asignificant factor in the determination of the Office of Chief Scientistwhether to approve a plan and the amount and other terms of benefits to begranted.

In accordance with theamendment to the Research and Development Law, a plan will be approved if theapplicant is an Israeli corporation and as a result of the plan the applicantwill develop in Israel, by Israeli residents, a new product or a significantimprovement to an existing product, unless the Office of Chief Scientist isconvinced that it is essential for the execution of the plan that part of itwill be performed out of Israel or by non-Israeli residents.  

The amendment to the Researchand Development Law further allows the Office of Chief Scientist to providegrants for portions of 20%, 30%, 40% or 50% of certain approved expenditures ofa research and development.  The Research and Development Law priorto the amendment only allowed for grants covering 50% of such expenditures.

The amendment to the Researchand Development Law imposes reporting requirements with respect to certainchanges in the ownership of a grant recipient.  The amendmentrequires the grant recipient and its controlling shareholders and interestedparties to notify the Office of the Chief Scientist of any change in control ofthe recipient or a change in the holdings of the means of control of therecipient that results in a non-Israeli becoming an interested party directlyin the recipient and requires the new interested party to undertake to theOffice of the Chief Scientist to comply with the Research and Development Law.  Forthis purpose, "control" is defined as the ability to direct the activities of acompany other than any ability arising solely from serving as an officer ordirector of the company.  A person is presumed to have control ifsuch person holds 50% or more of the means of control of a company.  "Meansof control" refers to voting rights and the right to appoint directors or thechief executive officer.  An "interested party" of a company includesa holder of 5% or more of its outstanding share capital or voting rights, itschief executive officer and directors, someone who has the right to appoint itschief executive officer or at least one director, and a company with respect towhich any of the foregoing interested parties owns 25% or more of theoutstanding share capital or voting rights or has the right to appoint 25% ormore of the directors.  Accordingly, any non-Israeli who acquires 5%or more of our ordinary shares will be required to notify the Office of theChief Scientist that it has become an interested party and to sign anundertaking to comply with the Research and Development Law. 
**____(49)____ 

 

**C. Research and Development,Patents and Licenses**

** **

In order to accommodate therapidly changing needs of our markets, we place considerable emphasis onresearch and development projects designed to improve our existing productlines, develop new product lines and customize our products to meet ourcustomers` needs.  As of December 31, 2002, 134 of our employees wereengaged primarily in research and development activities, includingcustomization and testing, compared to 108 in 2001 and 79 in 2000.  Forinformation on our research and development expenditures and grants from theOffice of the Chief Scientist of the Israeli Ministry of Industry and Trade,see "Item 5A - Operating Results - Results of Operations."  We expectthat we will continue to commit substantial resources to research anddevelopment in the future.

As a recipient of grants fromthe Office of the Chief Scientist, we are obligated to perform allmanufacturing activities for projects subject to the grants in Israel unless wereceive an exemption.  Know-how from the research and developmentwhich is used to produce these products may not be transferred to third partieswithout the approval of the Office of the Chief Scientist.  Approvalis not required for the export of any products resulting from the research anddevelopment based on these grants. For further information regarding the Officeof the Chief Scientist of the Israeli Ministry of Industry and Trade, see "Item5B - Liquidity and Capital Resources-Grants from the Office of the ChiefScientist." 

**D. Trend Information.**

 

The deterioration of the global economy in general andeconomic uncertainty in the telecommunications market in particular hasresulted in a decline of capital investment by telecommunications serviceproviders since late 2000.  Several major as well as many new andsmall service providers have failed.  In addition, other serviceproviders have been reducing or delaying expenditures on new equipment andapplications.  The attacks of September 11, 2001 caused a furtherdecline in the global economy.  As a result, many companies,including current and potential customers of ours, have postponed or decreasefurther capital investment.  This decline in capital expenditures hasalready reduced our sales and has resulted in pressure on the prices we chargefor our products.  We believe that this slow-down intelecommunications-related spending will continue through 2003. 

Our revenues for the first quarter of 2003 were $15.1million, compared to $23.1 million for the corresponding period in 2002.  Ournet loss for the first quarter of 2003 was $3.8 million, compared to net incomeof $4.1 million for the first quarter of 2002.  Based on preliminaryestimates, our results of operations continued to be adversely affected in the secondquarter.  The decrease in revenues resulted from lower sales of bothour revenue assurance solutions and our government surveillance solutions.  Inparticular, revenues from customers in the Asian Pacific region and revenuesfrom the governmental sector were significantly lower than we expected.  Webelieve that, in addition to the general slowdown in the economy that has nowcontinued for several years, our sales during the first quarter were alsoadversely affected by uncertainty surrounding geopolitical events toward theend of the first quarter, primarily the war in Iraq.  Our sales inthe first half of 2003 were also harmed by the SARS epidemic in the AsianPacific region. Accordingly, we are taking measures to lower our operatingexpenses and decrease our cost structure, including reducing our labor force,wages and overhead expenses.

As a result of the attacks of September 11, 2001 there hasbeen an increase in concern regarding national security, cyber-terrorism andother communications-related crimes.  These increased concerns, alongwith existing laws such as CALEA in the United States and the passage of newlaws such as the USA Patriot Act and the UK Anti-Terrorism Act, have led to aglobal trend of increased telecommunications surveillance.  This hasgenerally caused greater demand for our IP surveillance solutions, orgovernment systems. Standards and technologies regarding IP surveillancetechnology are in the process of being defined and adopted byvarious governmental agencies around the world.  If ourprobe-based technology is not compatible with the new standards, we will loseour competitive advantage, and our sales of IP surveillance solutions willsuffer.
**____(50)____ 

 

There is also a trend toward a business model of revenuesharing in lieu of fixed fee payments for solutions such as the ones that wesell.  This trend is emerging as a result of the economic climate andthe emergence of competitors willing to accommodate customers` requests forthis business model.  This trend is resulting in deferred revenuesfor solution providers who agree to participate in this model.  Wemay be forced to participate in this model or face the risk of losing sales,either of which could have an adverse impact on our results of operations.

**Item6.Directors, Senior Management and Employees**. 

 

**A. Directorsand Senior Management.**

 

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

**Name**

**Age**

**Position**

Aharon Shech

52

President, Chief Executive  Officer and Director

Avi Goldstein

38

Senior Vice President and  Chief Financial Officer

Avi Rubinstein

37

Senior Vice President,  Marketing and Business Development; General Manager of ECtel, Inc. 

Mordechai Gejbrowitz                                            

54

Vice President, Sales

Reuven Della-Torre

38

Vice President, Research and  Development

Eliezer Geller

50

Vice President, Operations  and Engineering

Nathan Winer

47

President, ECtel (2000) UK  Ltd.

Hadar Solomon 

46

Vice President, Legal Counsel  and Corporate Secretary

Noam Kimmel 

43

Vice President, Management  Resources

Gil Epstein (2) (3) (4) (5)

38

Director

Emily Furman (1)(2)

50

Director

Shmuel Gitlin (2)(3)(5)

50

Director

Doron Inbar (1) (4)

53

Director

Joshua Piasetzky

55

Director

Giora Bitan(1) (4) (5), 

48

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
**____(51)____ 

 

*Aharon Shech*has served as our President and ChiefExecutive Officer and a director since 1996.  From 1991 to 1996 Mr.Shech served as the President of ECI Telecom Americas Inc., a wholly ownedsubsidiary of ECI.  Mr. Shech holds a B.sc. degree in ElectricalEngineering from the Technion-Israel Institute of Technology.

*Avi Goldstein* has served as our Senior VicePresident and Chief Financial Officer since September 2001.  From1992 to September 2001, Mr. Goldstein served as our Vice President and ChiefFinancial Officer.  Mr. Goldstein holds a B.A. in Economics and ForeignRelations and an M.A. in Economics and Business Administration from the HebrewUniversity in Jerusalem.

*Avi Rubinstein* has served as our Corporate SeniorVice President, Marketing and Business Development since September 2001 and asGeneral Manager of ECtel Inc. since July 2001.  From January 1998 toSeptember 2001, Mr. Rubinstein served as our Vice President, Marketing andBusiness Development.  From 1996 to 1998, Mr. Rubinstein served asour Associate Vice President, Business Development.  Mr. Rubinsteinholds a B.sc. degree in Electrical Engineering and an M.B.A. in Marketing andFinance from Tel-Aviv University.

*Reuven Della-Torre*has served as our VicePresident, Research and Development since 1998.  From 1990 to 1998,Mr. Della-Torre served in various research and development positions for TelradLtd. including Manager of Intelligent Network Systems.  Mr.Della-Torre holds a B.A. and an M.A. in Mathematics and Computer Science fromBar-Ilan University.

*Eliezer Geller*has served as our Vice President,Operations and Engineering since 1999.  Between 1992 and 1999, Mr.Geller held various positions with us, including, most recently, VicePresident, Sales and Marketing.  Mr. Geller has held variouspositions with ECI since 1979, including marketing manager of securityproducts.  Mr. Geller is a graduate of The Executive DevelopmentProgram of The Top Executive School (LAHAV) of Tel-Aviv University.

*Nathan Winer*has served as President of ECtel(2000) UK Limited, our United Kingdom subsidiary, since January 2002.  FromAugust 1, 2000 to December 2001, he served as General Manager of ECtel (2000)UK Ltd.  From January 2000 until July 31, 2001 he served as our VicePresident, Sales.  From 1998 to December 1999, he served as ourAssociate Vice President Sales.  Prior to that, Mr. Winer was VicePresident, International Marketing and Sales for Tadiran Appliances Ltd. forsix years.  Mr. Winer holds a B.A. in Business Management from theCollege of Management, Tel-Aviv, and an M.B.A. from Leicester University.

*Hadar Solomon* joined us in March 2003 and hasserved as Vice President and Legal Counsel since May 2003.  FromFebruary 2002 until March 2003, he was Managing Director of Lumenis LuxembourgSarl, Schaffhausen Branch.  Prior to that, Mr. Solomon served as ExecutiveVice President, General Counsel and Corporate Secretary of Lumenis Ltd. and asVice President, Corporate Affairs, General Counsel and Secretary of LaserIndustries Ltd. since May 1988.  Mr. Solomon is a Graduate of theFaculty of Law of the Hebrew University of Jerusalem and is a member of theIsraeli Bar.

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

*Mordechai Gejbrowitz* has served as our VicePresident, Sales, since March 2003.  From 2000 to 2003 he served asManaging Director of ECI Telecom (UK) Ltd., and prior to that, he served as ECITelecom`s Pan European Global Account, Sales and Marketing Director from 1996.From 1985 to 1996 he served in a number of positions at ECI Telecom.  Mr.Gejbrowitz holds a B.Sc. in Electronic and Electrical Engineering from Tel-AvivUniversity and a diploma for Practical Administration and Marketing from theSchool of Business and Administration from the Hebrew University.
**____(52)____ 

 

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

*Emily Furman*has served as one of our directorssince June 2000.  Ms. Furman is currently an independent investmentconsultant.  Prior to that, she was a senior investment analystwithin the emerging market team at Pictet & Cie in London, withresponsibility for the Middle East and North African markets.  Priorto that, Ms. Furman worked as a financial advisor at Prudential BacheSecurities and prior to that she was a member of the project development teamat the Eisenberg group of companies.  Ms. Furman holds a B.A. fromNorth London University and an M.A. from Middlesex University.

*Shmuel Gitlin*has served as one of our directorssince June 2001.  Mr. Gitlin served as the Senior Vice President andChief Financial Officer of ECI from March 2001 to August 2002, and remains aSenior Vice President. Mr. Gitlin is a director of several subsidiaries of ECI.  FromJune 1996 until March 2001, he served as ECI`s Vice President, Finance.  Hejoined ECI in 1984 and for most of the period thereafter served as ECI`sDirector of Finance and Controller.  Mr. Gitlin holds a B.A. inEconomics from Bar Ilan University and is a registered CPA in Israel.

*Doron Inbar*has served as one of our directorssince 1994.  Since November 1999, Mr. Inbar has served as President,and since February 2000 he has served as President and CEO, of ECI.  Priorto that, he served as Executive Vice President of ECI from January 1999 untilNovember 1999.  From 1996 until January 1999, Mr. Inbar served asSenior Vice President and Chief Financial Officer of ECI.  Mr. Inbarhas been employed by ECI since 1983.  Mr. Inbar holds a B.A. inEconomics and Business Administration from Bar-Ilan University.

*Joshua Piasetzky*has served as one of our directorssince 1995.  Mr. Piasetzky has served as ECI`s Senior Vice Presidentand Chief Technical Officer since 1995.  From 1991 to 1995, he heldthe positions of Vice President-Technology and Quality, and Head of Researchand Development and Chief Engineer.  Mr. Piasetzky has been employedby ECI since 1975.  A number of United States, European and Israelipatents are registered in Mr. Piasetzky`s name.  Mr. Piasetzky holdsa B.S. and an M.S. in Electrical Engineering from the Technion.

*Giora Bitan* has served as one of our directorssince October 2002.  Mr. Bitan has served as Executive Vice Presidentand Chief Financial Officer of ECI since joining ECI in August 1, 2002.  From1997 to 2002, Mr. Bitan was a general partner at Giza Venture Capital, where hefocused on investments in the communications and software sectors.  From1982 until 1996, he served in senior management positions in Scitex CorporationLtd., 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 inEconomics and International Relations from the Hebrew University, Jerusalem.

There are no family relationships between any director orsenior manager.  ECI holds approximately 58.4% of our outstandingordinary shares.  As a majority shareholder, ECI has nominated thefollowing directors to our board:  Messrs. Inbar, Piasetzky, Gitlinand Bitan. 
B.Compensation.
The aggregate direct remuneration paid to all persons as agroup (13 persons) who served in the capacity of director or executive officerduring 2002 was approximately $3.1****million, including amounts set asideor accrued for pension, retirement or similar benefits.  This doesnot include amounts expended by us for automobiles made available to ourofficers, expenses (including business, travel, professional and businessassociation dues and expenses) reimbursed to officers and other fringe benefitscommonly reimbursed or paid by companies in Israel. Employee directors do notreceive additional fees for their services as directors, and our otherdirectors do not receive any fees except as described below.
**____(53)____ 

 

Each of our outside directors receives an annual fee ofapproximately $10,000 and approximately $400 for participation at each board orcommittee meeting (and 50% of such amounts for actions taken by writtenresolutions).  These amounts are linked to the Israeli cost-of-livingindex.

  Our board of directors granted options to executive officersto purchase an aggregate of 304,000 ordinary shares, at a weighted averageexercise price of $7.90 per share, during 2002.  The exercise pricewas equal to the fair market value of our ordinary shares on the date of grant.  Theseoptions vest in three equal annual installments and terminate ten years fromthe date of grant, unless terminated sooner in accordance with their terms.

 

 

 

**C. Board Practices**

 

**Board of Directors**

** **

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

Our directors are elected at annual meetings of ourshareholders. Except for our outside directors, our directors hold office untilthe next annual meeting of shareholders following the annual meeting at whichthey were appointed, which is required to be held at least once during everycalendar year and not more than fifteen months after the last precedingmeeting.  Directors may be removed earlier from office by resolutionpassed at a general meeting of our shareholders.  Our board ofdirectors may temporarily fill vacancies in the board until the next annualmeeting of shareholders.  

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

**Outside Directors; Committees**

** **

Under the Israeli Companies Law, Israeli companies whoseshares are listed for trading on a stock exchange or have been offered to thepublic in or outside of Israel are required to appoint at least two "outsidedirectors," as described under the Companies Law.  Ms. Furman and Dr.Epstein are our outside directors.

The outside directors generally must be elected by theshareholders, including at least one-third of the shares of non-controllingshareholders voted on the matter.  However, the outside directors canbe elected by shareholders without this one-third approval if the total sharesof non-controlling shareholders voted against the election do not representmore than one percent of the voting rights in the company.  Theinitial term of an outside director is three years and may be extended for anadditional three years.  Outside directors may be removed from officeonly 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 thestatutory qualifications for their appointment or if they violate their duty ofloyalty to the company.  Each committee of a company`s board ofdirectors is required to include at least one outside director, except for theaudit committee, which is required to include all outside directors.
**____(54)____ 

 

Subject to the provisions of the Companies Law, our boardof directors may delegate its powers to committees consisting of board members.  Underthe Companies Law, our board of directors is required to appoint an auditcommittee.  The audit commit must be comprised of at least threedirectors, including all of the outside directors, but excluding the chairmanof the board, a controlling shareholder (or his or her relative) or anydirector who is employed by the company or provides services to the company ona regular basis.  Under the Companies Law, the role of the auditcommittee is (1) to identify flaws in our business management, including inconsultation with our internal auditor and independent accountants, and proposeremedial measures or courses of action to our board and (2) review for approvaltransactions between the company and office holders or interested parties,which it may not approve unless at the time of approval the two outsidedirectors are serving as members of the audit committee and at least one ofwhom was present at the meeting in which an approval was granted.  Ourboard of directors has also appointed a compensation committee, whichadministers our share option plan and determines the salaries of our executiveofficers, and a credit committee, which sets policies with respect to grantingcredit to customers.  In addition, our board of directors hasappointed an executive committee to act and meet between meetings of the boardof directors, and has empowered the executive committee with all the powers andauthorities of the board, other than those which cannot be delegated to acommittee pursuant to the Companies Law. The board of directors has alsoestablished an investment committee to review and approve our investmentpolicy.

 

**Internal Auditor**

** **

Under the Companies Law, our board of directors is alsorequired to appoint an internal auditor proposed by the audit committee.  Theinternal auditor may not be an interested party or officer holder, or arelative of any interested party or officer holder, nor a member orrepresentative of the company`s independent accounting firm.  Therole of the internal auditor is to examine, among other things, whether the ouractivities comply with the law and orderly business procedure.  Mr.Meir Schweitzer serves as our internal auditor, as well as the internal auditorof ECI.****

**Approval of Specified Related Party Transactions Under IsraeliLaw**

** **

*Fiduciary Duties of Office Holders.  *TheIsraeli Companies Law imposes a duty of care and a duty of loyalty on all"office holders" of a company.  The term "office holder" of a companyis defined under the Companies Law to include any person who, either formallyor in substance, serves as a director, general manager or the chief executiveofficer or other officer who reports directly to the general manager or chiefexecutive officer.  Each person listed in the table under "ExecutiveOfficers and Directors" is an "office holder" of ECtel.

The duty of care requires an office holder to act with thelevel of care with which a reasonable office holder in the same position wouldhave acted under the same circumstances.  The duty of care includes aduty 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;

 

 
**____(55)____ 
- 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.

 

**Disclosure of Personal Interests of an Office Holder**

** **

The Companies Law requires that an office holder discloseto the company any personal interest that he or she may have, and all relatedmaterial information known to him or her, in connection with any existing orproposed transaction by the company.  The disclosure is required tobe made promptly and in any event no later than the board of directors meetingin which the transaction is first discussed.  A personal interest of anoffice holder includes an interest of a company in which the office holder is,directly or indirectly, a 5% or greater shareholder, director or generalmanager or in which he or she has the right to appoint at least one director orthe general manager.  In the case of an extraordinary transaction,the office holder`s duty to disclose applies also to a personal interest of arelative of the office holder.  An extraordinary transaction is atransaction not in the ordinary course of business, not on market terms, orlikely to have a material impact on the company`s profitability, assets orliabilities.

Under the Companies Law, once the office holder complieswith the above disclosure requirement, the board of directors is authorized toapprove the transaction, unless the articles of association provide otherwise.  Nevertheless,a transaction that is adverse to the company`s interest may not be approved.  

If the transaction is an extraordinary transaction, thenit also must be approved by the company`s audit committee and board ofdirectors, and, under certain circumstances, by the shareholders of thecompany.  When an extraordinary transaction is considered by theaudit committee and board of directors, the interested director may not bepresent or vote, unless a majority of the members of the board of directors orthe audit committee, as the case may be, has a personal interest in the matter.  Ifa majority of members of the board of directors have a personal interesttherein, shareholder approval is also required.

Under the Companies Law, all arrangements as tocompensation of directors in public companies such as ours generally requirethe approvals of the audit committee, board of directors and shareholders, inthat order.

*Disclosure by Controlling Shareholders.  *Underthe Companies Law, the disclosure requirements that apply to an office holderalso apply to a controlling shareholder of a public company.  Acontrolling shareholder is a shareholder who has the ability to direct theactivities of a company, including a shareholder that owns 25% or more of thevoting 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 positionon the board of directors or any other position with the company.  ECIis a controlling shareholder of ECtel.

Extraordinary transactions with a controlling shareholderor in which a controlling shareholder has a personal interest, and theengagement of a controlling shareholder as an office holder or employee,require the approval of the audit committee, the board of directors and theshareholders, in that order.  The shareholder approval must be by amajority of the shares voted on the matter, which majority has to include atleast one-third of the shares of non-interested shareholders voted on thematter.  However, the transaction can be approved without thisone-third approval if the total shares of non-interested shareholders votedagainst the transaction do not represent more than one percent of the votingrights in the company.

*General Duties of Shareholders.  *Inaddition, under the Companies Law, each shareholder has a duty to act in goodfaith toward the company and other shareholders and to refrain from abusing hisor her power in the company, such as in shareholder votes.  Inaddition, specified shareholders have a duty of fairness toward the company.  Theseshareholders include any controlling shareholder, any shareholder who knowsthat it possesses the power to determine the outcome of a shareholder vote andany 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 tothe company.  However, the Companies Law does not define thesubstance of this duty of fairness.
**____(56)____ 

 

**D. Employees.******

** **

*Number.  *As of December 31, 2002, weemployed a total of 320 persons worldwide, including 134 in research anddevelopment, customization and testing, 42 in production, 121 in sales,marketing, project managers and field engineering and 23 in management andadministration.  As of December 31, 2002, 251 of our employees werebased in Petah Tikva, Israel, 47 were based in the United States, nine werebased in the United Kingdom, three were based in Germany and ten were based inother locations.

*Relationship with Employees.  *Competitionfor highly-qualified technical and engineering personnel in thetelecommunications industry is intense.  We believe we have been ableto attract talented engineering and other technical personnel.  Noneof our employees are represented by a labor union, and we have not experiencedany work stoppage.  We believe our relations with our employees to begood and that our future success will depend in part on a  continuingability to hire, assimilate and retain qualified personnel.

*Labor Laws; Pension Funds.  *Israeli laborlaws and regulations apply to all of our employees in Israel.  Thelaws principally concern matters such as paid vacation, paid sick days, lengthof the workday, payment for overtime and severance payments upon the retirementor death of an employee or termination of employment under specifiedcircumstances.  The severance payments may be funded, in whole or inpart, through Managers` Insurance or a Pension Fund, as described below.  Thepayments to the Managers` Insurance fund or Pension Fund toward severanceamount to 8.3% of wages.  Furthermore, Israeli employees andemployers are required to pay predetermined sums to the National InsuranceInstitute, which is similar to the U.S. Social Security Administration.  SinceJanuary 1, 1995, these amounts also include payments for health insurance.  Thepayments to the National Insurance Institute amount to approximately 14.5% ofwages, of which the employee contributes 66% and the employer contributes 34%.

Our general practice is to contribute funds on behalf ofall of our employees to Managers` Insurance or a Pension Fund.  Eachemployee who agrees to participate in the Managers` Insurance plan contributes5% of his or her base salary and we contribute 13.3%.  Each employeewho agrees to participate in the Pension Fund contributes 5.5% of his or herbase salary and we contribute 14.3%.  Another savings plan we offersome of our employees, although not legally required, is known as the AdvancedStudies Fund.  Each employee who agrees to participate in theAdvanced Studies fund contributes 2.5% of his or her base salary and wecontribute 7.5%.

*Labor Unions.  *We are a member of theIndustrialists Association in Israel, an employers` union.  As a resultof this membership, a number of collective bargaining agreements apply to us.  Theseagreements principally concern cost-of-living wage increases, paid vacation andholidays, length of the workday, wage tariffs, termination, severance paymentsand other conditions of employment.  We provide our employees withbenefits and working conditions that are at least as favorable as theconditions specified in the collective bargaining agreements.
- **Share Ownership**

** **

**Security Ownership of Our Directors and ExecutiveOfficers**

** **

No directoror officer listed in Item 6B. above holds more than one percent of ouroutstanding shares, including ordinary shares subject to outstanding options.  Ourofficers and directors as a group hold 20,109 of our ordinary shares.  Ourofficers and directors as a group hold as of May 31, 2003, options to purchase721,248 of our ordinary shares, as follows:

  
- 101,884 options remain of those that were granted in 1998     and 1999 at an exercise price of $1.04 per share, which have all vested;

 
- 327,468 options remain of those that were granted in 1999     at an exercise price of $4.66 per share, 305,366 of which have all vested;

 
**____(57)____ 
- 47,000 options remain of those that were granted in 2000     at an exercise price of $15.75 per share, which have all vested;

 
- 154,500 options remain of those that were granted in 2001     at an exercise price of $8.82 per share, which have all vested;

 
-   210,000 options were granted in 2001, at an exercise     price of $11. 55 per share, 90,000 of which vest over three years in 12     equal installments and the remainder of which vest in two annual     installments; 112,498 of which have vested. 

 
- 304,000 options were granted in 2002 at an exercise price     of $7.90 per share, vesting in three annual installments, none of which     have vested yet.  

 

All these options expire ten yearsafter the date of grant unless terminated sooner in accordance with theirterms.
****____(58)____ 

**Options to Purchase OurOrdinary Shares**

In 1998, ourboard of directors adopted a share option plan for our employees.  Termsof the options granted under the plans, such as length of term, exercise price,vesting and exercisability, are determined by our board of directors.  Asof December 31, 2002, options to purchase a total of 2,828,576 of our ordinaryshares were outstanding.  As of December 31, 2002, options topurchase an aggregate of 980,348 ordinary shares granted under the plans havebeen exercised.  During 2002, our board of directors granted optionsto our employees, including executive officers, to purchase an aggregate of713,400 ordinary shares.  The exercise price was equal to the fairmarket value of our ordinary shares on the date of grant.  Theseoptions vest in three equal annual installments commencing in October 2003 andterminate ten years from the date of grant, unless terminated sooner inaccordance with their terms.

 

**Item7. Major Shareholders and Related Party Transactions.**

 

**A. MajorShareholders.**

 

ECI holds approximately 58.4% of our outstanding ordinaryshares.  ECI currently has control of our board of directors and theability to control substantially all matters to be voted on by shareholders,subject to special approvals required by Israeli law for transactions involvingcontrolling shareholders.  A majority of the directors serving on ourboard of directors are officers of ECI.  

The following table shows the number of our ordinaryshares beneficially owned by (1) the only shareholders known to us as of June12, 2003, to beneficially own more than 5% of our outstanding ordinary sharesand (2) all of our directors and executive officers as a group.  Noneof our directors or executive officers beneficially holds shares and options toacquire our ordinary shares, which represent, in the aggregate, more than 1% ofour ordinary shares.  In accordance with the rules of the Securitiesand Exchange Commission, the number of ordinary shares used in calculating thepercentage for each person listed below includes the shares underlying optionsor warrants held by such person that are exercisable within 60 days, butexcludes the shares underlying options or warrants held by any other person.

 

Shares Beneficially Owned

 
**Name**

Number

Percentage

 
 

 

 

 
 
ECI Telecom Ltd. (1)(2)

10,490,325

58.38%

 
Telrad Networks Ltd. (3) 

1,641,902

8.54%

 
Fidelity Investments (4)

1,878,648

10.46%

 
Royce & Associates, LLC (4)

960,900

5.35%

 
Directors and Executive Officers as a Group (5)

721,248

3.86%

 

(1) In February 2001, ECIentered into a Facility Agreement with Bank Leumi Le-Israel B.M. and BankHapoalim B.M., which provides for a term loan in one or more installments inthe aggregate principal amount of $300 million, under which approximately $100million was outstanding as of May 31, 2003.   As security for itsobligations under the Facility Agreement, ECI granted to the banks, among otherthings, a pledge on all of our ordinary shares that it holds.  Accordingly,if ECI defaults under its obligations under the Facility Agreement, theseshares may be foreclosed upon and sold to satisfy its obligations to the banks,which could result in a change of control of ECtel.  ECI signed aLetter Agreement with the Banks on May 30, 2003, which, as of June 30, 2003,effectively cured the earlier covenant default status of ECI.  Theaddress of ECI is ECI Telecom Ltd., 30 Hasivim Street, Petah Tikva 49157, Israel.  

 

(2) Messrs. Inbar, Piasetzky,Bitan and Gitlin, who serve as our directors and also as officers of ECI, maybe deemed to beneficially own the shares held by ECI by virtue of theirpositions with ECI.  However, each has disclaimed beneficial ownershipof these shares.  
**____(59)____ 

 

(3) Includes currentlyexercisable warrants to purchase 1,000,000 ordinary shares at an exercise priceof $24 per share and 250,000 ordinary shares at an exercise price of $28 pershare.  The address of Telrad is Telrad Networks Ltd., Telrad Park,Afek, 14 Hamelacha Street, Rosh Ha`ayin,02109, Israel. 

(4) Figures quoted are based ondata received from the investors or filed publicly with the SEC. The address ofFidelity is 82 Devonshire Street, Boston, Massachussets, 02109. The address ofRoyce and Associates is 1414 Avenue of the Americas, New York, N.Y. 10019.

(5) Consists of options that arecurrently exercisable or exercisable within 60 days of June 12, 2003.

*RecordHolders*

As of December 31, 2002, 17,917,848 of our ordinary shareswere issued and outstanding.  At that date, there were 47 holders ofrecord of our ordinary shares.  Ten record holders, holdingapproximately 7,052,470, or 39.4 %,****of our outstanding ordinary shares,were located in the United States.  These numbers are notrepresentative of the number of beneficial holders of our shares nor is itrepresentative of where such beneficial holders reside since many of theseordinary shares were held of record by brokers or other nominees.

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

*Controlof Company*

To our knowledge, we are not directly or indirectly ownedor controlled (i) by any corporation other than ECI, (ii) by any foreigngovernment or (iii) by any other natural or legal person, nor are there anyarrangements, the operation of which may at a subsequent date result in achange in control of ECtel,  other than as specified in the tableabove with regard to the banks which have entered into a Facility Agreementwith ECI.

**B.Related Party Transactions**

** **

**Transactions with ECI**

** **

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

**Registration Rights Agreement**

** **

In January 2002, we entered into a Registration RightsAgreement 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 theIsraeli Companies Law, the agreement was approved by our Audit Committee, Boardof Directors and a special majority of our shareholders.  Under thisagreement, ECI is entitled to demand and piggyback registration rights, whichare exercisable for a period of ten years. During this period, ECI is entitledto five demand registrations and unlimited piggyback registrations.  ECIhas agreed to reimburse us for the expenses reasonably incurred by us ineffecting such registrations, unless we also issue ordinary shares in the samepublic offering.  

In addition, the Registration Rights Agreement providesthat in the event that ECI, from time to time, sells ordinary shares in aprivate transaction which is conditioned upon the grant of registration rightswith respect to such shares, then, at ECI`s request, we shall enter into aregistration rights agreement.  Such registration rights agreementswould require us to register the purchaser`s shares on a "shelf" registrationstatement and to maintain the effectiveness of the registration statement fortwo years.  They would also include, among other things, anundertaking by us to indemnify the purchasers for liabilities and expenses thatmay arise from any material misstatements or omissions in our registrationstatement.  ECI has agreed to reimburse us for the expensesreasonably incurred by us in effecting such registrations.  Webelieve that the sale by ECI of our ordinary shares will increase the publicliquidity and float of our shares.
****____(60)____ 

**ECI Share Purchase Agreement**

** **

In February 2002, we entered into a Share PurchaseAgreement with ECI and several investors under which ECI sold 1,572,175 of ourordinary shares held by ECI to the investors.  We maderepresentations and warranties in the Share Purchase Agreement for the benefitof the investors, which survive for a period of two years following the closingof the transaction. In addition, as contemplated in the Share PurchaseAgreement, we entered into a Registration Rights Agreement with ECI and theinvestors to register the ordinary shares to be purchased pursuant to the SharePurchase Agreement.  In March 2002, we filed a registration statementwith the SEC registering those shares, as well as 850,000 shares held by Telrad.  ECIhas agreed to bear all the expenses incurred by us in connection with thistransaction and the registration of the ordinary shares sold thereunder.  However,we could be held liable to the investors, or purchasers of shares from theinvestors, if, during the two-year period following the closing, ourrepresentations and warranties are found to have been inaccurate or if ourregistration statement is found to contain a material misstatement or omission.  Inaddition, the Registration Rights Agreement contains a customary undertaking byus to indemnify the investors for liabilities and expenses that may arise fromany material misstatements or omissions in our registration statement.  IfECI agrees to sell additional ordinary shares, we are required to acceptsubstantially the same undertakings with respect to such ordinary shares.  Webelieve that sales of our ordinary shares into the public market as a result ofthis transaction will increase the public float and liquidity of our shares.

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

**Commercial Agreements**

** **

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

***Servicesand Lease Agreements***

Under the terms of the various services agreement, ECIcontinues to provide us with the following services:
- intellectual property management assistance;

 
- communications and transportation services;

 
- coverage under ECI`s insurance policies; and

 
- other miscellaneous services, such as building     maintenance.

 

For performance of each service we pay ECI amounts weagreed on, some of which are based on our pro rata use of ECI`s facilities orestimations of the cost of the services based on the ratio of the total numberof our employees to the total number of ECI`s employees in our shared facilityin Petah Tikva.

Most of the various services agreements had a term of oneyear and were renewed in 2002 for an additional one year period.  Allof the agreements are terminable by either party at any time upon a materialbreach by the other party.  We believe that if ECI were to terminateany of these agreements, we would be able to obtain the same services from athird party on terms no less favorable than those currently contained in ouragreements with ECI.
**____(61)____ 

We entered into an administrative services arrangementwith ECI Telecom GmbH, effective October 1, 2002, for the provision of variousadministrative services, including the sub-lease of office space and theprovision of various bookkeeping services to ECtel GmbH.  The term ofthis agreement is for an initial period of one year.  This term shallbe automatically renewed at the end of the initial period for an additionalperiod of one year, unless either party notifies the other party in writing, atleast 180 days prior to the expiration of the initial term, of its decision notto renew the agreement.  

***SupplyAgreement***

In 1999, we entered into a supply agreement with ECI.Under the terms of the supply agreement, ECI supplies us with the componentsthat ECI had been supplying to us prior to our initial public offering for usein our products.  We agreed on the prices for these components afterresearching prices of similar components and taking into consideration the factthat ECI is currently the only provider of these components.  ECI maydiscontinue the production of any component after giving us 12 months` priornotice, in which case ECI would be obligated to provide us with all necessaryinformation for us to manufacture the components ourselves and integrate theminto our products. In addition, under the terms of the supply agreement, ECIhas granted us a non-exclusive license to use, develop, sub-license anddistribute the software embedded in the components.  The parties havealso agreed to mutual limited covenants not to compete.  ECI hasagreed not to directly compete with us in the development, manufacture,marketing or sale of revenue assurance solutions that utilize the components wepurchase from ECI.  The supply agreement has an initial period offive years and will be automatically renewed for an additional five-year termunless we notify ECI of our decision not to renew the agreement at least sixmonths prior to the expiration of the initial term.  Either party mayterminate the agreement at any time upon a material breach by the other party.

**Other Agreements with ECI**

** **

We may, in the ordinary course of business, also enterinto certain other leases, sub-leases, operating agreements and otheragreements that serve to define various aspects of our relationship that willexist with ECI.  None of these agreements, either alone, or in theaggregate, is expected to materially affect the results of operations of eithercompany.

**Acquisition of NetEye from Telrad**

** **

In October 2001 we acquired Telrad Hawk Net-I Ltd., orNetEye, from Telrad Networks Ltd., or Telrad.  Under the terms of ouragreement with Telrad, we acquired all of the outstanding shares of NetEye, awholly-owned subsidiary of Telrad, and Telrad`s shareholder loan to NetEye ofapproximately $5.5 million in exchange for 850,000 ordinary shares, warrants topurchase 1,000,000 ordinary shares with an exercise price of $24 per share andwarrants to purchase 250,000 ordinary shares with an exercise price of $28 pershare.

We registered for re-sale the 850,000 shares that weissued to Telrad.  In addition, Telrad is entitled to demand andpiggyback registration rights with respect to the ordinary shares issuable uponexercise 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 itsshares under Rule 144 within any three month period.  During thisperiod, Telrad is entitled to three demand registrations but not more than atotal of five registrations.

This transaction was a "related party transaction" becauseKoor Industries Ltd., the sole shareholder of Telrad, held approximately 35% ofthe outstanding ordinary shares of ECI at the time of the transaction, which inturn owned approximately 73% of our ordinary shares at that time.  Accordingly,as required by the Israeli Companies law, the acquisition was approved by ourAudit Committee, Board of Directors and a special majority of our shareholders.  Inaddition, Salomon Smith Barney Inc., our financial advisor in connection withthe acquisition, delivered to our board of directors a written opinion as tothe fairness to us, from a financial point of view, of the consideration to bepaid by us in connection with the acquisition.  
****____(62)____ 
 
**C.Interestsof Expert and Counsel.**

 

Not Applicable.

**Item8. Financial Information.**

 

**A.ConsolidatedStatements 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 supportoperations 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" underthe Israeli Law for the Encouragement of Capital Investments, 1959, under whichwe realize certain tax exemptions.  If we distribute a cash dividendfrom tax-exempt income, we would have to pay corporate tax at a rate of up to25% on the amount distributed and to withhold an additional 15% of the amountdistributed on behalf of the recipient.  For more information aboutthe "alternative benefits program," see "-Israeli Taxation-Tax Benefits underthe Law for the Encouragement of Capital Investments, 1959."

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

  Except as otherwise disclosed in this annualreport, there was no significant change in our financial position sinceDecember 31, 2003.  In particular, please see the risk factors inItem 3 relating to our results of operations for the first quarter of 2003 andItem 5H - "Trend Information".

 
**____(63)____ 

 

**Item 9.  The Offerand Listing**
A.  Offer andListing Details.
 

Our ordinary shares have been quoted on the NasdaqNational Market under the symbol "ECTX" since October 26, 1999.  Thefollowing table sets forth, for the periods indicated, the high and low closingprices of our ordinary shares, as reported on the Nasdaq National Market.  

 

**High**

**Low**

**1999:**

 

 

Full Year (October 26 through  December 31)

$23.75

$10.38

 

 

 

**2000:**

 

 

Full Year

$39.94

$10.25

** **

 

 

**2001:**

 

 

Full Year

$20.35

$8.69

First Quarter

18.00

8.69

Second Quarter

17.40

8.88

Third Quarter

14.88

10.03

Fourth Quarter

20.35

11.75

** **

 

 

**2002:**

 

 

Full Year

$20.00

$7.00

First Quarter

              20.00

                13.00

Second Quarter

              15.01

                11.13

Third Quarter

              11.60

                8.28

Fourth Quarter

              10.21

                  7.00

** **

 

 

**2003:**

 

 

Full Year (through June 27, 2003)

$9.70

$4.98

** **

 

 

**Most Recent Six Months:**

 

 

June 2003 (through June 27, 2003)

$6.80

$6.14

May 2003

6.90

5.30

April 2003

8.47

4.98

March 2003

8.93

7.72

February 2003

8.10

7.46

January 2003

9.70

7.75

December 2002

   9.50

      7.87

 

On June 27, 2003, the last reported sale price of ourordinary shares on the Nasdaq National Market was $6.53 per share.
B.  Planof Distribution.
Not Applicable.
C.Markets.
Our ordinary shares are quoted on the Nasdaq NationalMarket under the symbol ECTX.  
D.SellingShareholders.
Not Applicable.

**E.Dilution.**

Not Applicable.
F.Expensesof the Issue.
Not Applicable.

**Item10.   Additional Information.******
 A.  ShareCapital.
Not Applicable.
B.  Memorandumand 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.  Ourregistration number with the Israeli registrar of companies is 52-004446-2.  

**Objects and Purposes**

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

The following sections, to the extent they refer to ourarticles of association are qualified in their entirety by the articlesthemselves, 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 bynon-residents of Israel, except for citizens of countries that are in a stateof war with Israel, is not restricted in any way by our memorandum or articlesof association or by the laws of the State of Israel.

Fully paid ordinary shares may be freely transferredpursuant to our articles of association unless the transfer is restricted orprohibited by another instrument.  Unless otherwise prescribed bylaw, 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 ofprofits and other surplus, as defined in the Israeli Companies Law, as of theend of the most recent fiscal year or as accrued over a period of two years,whichever is higher.  Our board of directors is authorized to declaredividends, provided that there is no reasonable concern that payment of thedividend will prevent us from satisfying our existing and foreseeableobligations as they become due.  Notwithstanding the foregoing,dividends may be paid with the approval of a court, provided that there is noreasonable concern that payment of the dividend will prevent us from satisfyingour existing and foreseeable obligations as they become due.  In theevent of our liquidation, after satisfaction of liabilities to creditors, ourassets will be distributed to the holders of ordinary shares in proportion totheir respective holdings.  This liquidation right may be affected bythe grant of preferential dividends or distribution rights to the holders of aclass of shares with preferential rights that may be authorized in the future.
****____(64)____ 

**Voting, Shareholders` Meetings and Resolutions**

** **

Holders of ordinary shares have one vote for each ordinaryshare held on all matters submitted to a vote of shareholders.  Underthe Companies Law and our articles of association, all resolutions of ourshareholders, except for a resolution to liquidate the company, requireapproval by a simple majority of the ordinary shares voting thereon.  Thesevoting rights may be affected by the grant of any special voting rights to theholders of a class of shares with preferential rights that may be authorized inthe future.  

These voting rights may be affected by the grant of anyspecial voting rights to the holders of a class of shares with preferentialrights that may be authorized in the future.  We have two types ofgeneral shareholders meetings:  the annual general meetings andextraordinary general meetings.  These meetings may be held either inIsrael or in any other place the board of directors determines.  Anannual general meeting must be held in each calendar year, but not more than 15months after the last annual general meeting.  Our board of directorsmay convene an extraordinary meeting, from time to time, at its discretion andis required to do so upon the request of shareholders holding at least 5% ofour ordinary shares.

The quorum required for a meeting of shareholders consistsof at least two shareholders present in person or by proxy who hold orrepresent in the aggregate at least 33-1/3% of the outstanding voting shares.  Ameeting adjourned for lack of a quorum generally is adjourned to the same dayin the following week at the same time and place or any time and place as thechairman may designate with the consent of the holders of a majority of thevoting power represented at the meeting and voting on the matter adjourned.  Atsuch reconvened meeting the required quorum consists of any two members presentin person or by proxy.

**Mergers and Acquisitions under Israeli Law**

** **

The Israeli Companies Law includes provisions that allow amerger transaction and requires that each company that is a party to a mergerhave the transaction approved by its board of directors and a vote of themajority of its shares, at a shareholders` meeting called on at least 21 days`prior notice.  For purposes of the shareholder vote, unless a courtrules otherwise, the merger will not be deemed approved if a majority of theshares held by parties other than the other party to the merger, or by anyperson who holds 25% or more of the shares or the right to appoint 25% or moreof the directors of the other party, vote against the merger.  Uponthe request of a creditor of either party to the proposed merger, the court maydelay or prevent the merger if it concludes that there exists a reasonableconcern that as a result of the merger, the surviving company will be unable tosatisfy the obligations of any of the parties to the merger.  Inaddition, a merger may not be completed unless at least 70 days have passedfrom the time that a proposal of the merger has been filed with the IsraeliRegistrar of Companies.

The Companies Law also provides that an acquisition ofshares of a public company must be made by means of a tender offer if as aresult of the acquisition the purchaser would become a 25% shareholder of thecompany and there is not any other existing shareholder who holds 25% or moreof the company.  An acquisition of shares of a public company must bemade by means of a tender offer if as a result of the acquisition the purchaserwould become a 45% shareholder of the company and there is no existing  majorityshareholder in the company.  If following any acquisition of shares,the acquiror will hold 90% or more of the company`s shares, the acquisition maynot be made other than through a tender offer to acquire all of the shares ofsuch class.  If more than 95% of the outstanding shares are tenderedin the tender offer, all the shares that the acquiror offered to purchase willbe transferred to it.  However, the remaining minority shareholdersmay seek to alter the tender offer consideration by court order.

Lastly, Israeli tax law treats some acquisitions, such asstock-for-stock exchanges between an Israeli company and a foreign company,less favorable than U.S. tax laws. For example, Israeli tax law may, undercertain circumstances, subject a shareholder who exchanges his ordinary sharesfor shares in another corporation, to taxation prior to the sale of the sharesreceived in such stock-for-stock swap. 
****____(65)____ 

**Modification of Class Rights**

** **

Our articles of association provide that the rightsattached 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 ashareholders resolution, subject to the sanction of a resolution passed by theholders of a majority of the shares of that class at a separate class meeting.

**Indemnification of Directors and Officers**

** **

***Exculpation of OfficeHolders***

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

***Insurance Relating toOffice Holders***

Our articles of association provide that, subject to theprovisions of the Companies Law, it may enter into an insurance contract whichwould provide coverage for any monetary liability incurred by any of our officeholders, with respect to an act performed in the capacity of an office holderfor:
- 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 

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

 

 

We have obtained liability insurance covering our officersand directors.

***Indemnification ofOffice Holders***

Our articles of association provide that we may indemnifyan office holder against the following obligations and expenses imposed on theoffice holder with respect to an act performed in the capacity of an officeholder:
- 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:
**____(66)____ 

 
- 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 onExculpation, Insurance and Indemnification***

The Israeli Companies Law provides that a company may notexculpate or indemnify an office holder, or enter into an insurance contractwhich would provide coverage for any monetary liability incurred as a result ofany 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 andindemnification of, and procurement of insurance coverage for our officeholders must be approved by our audit committee and our board of directors and,if the beneficiary is a director, by our shareholders.

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

For a description of the agreements that we entered intowith ECI, please refer to "Item 7B - Related Party Transactions."  Fora 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."
D.  ExchangeControls.
** **

**Exchange Controls and Other Limitations AffectingSecurity Holders**

** **

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

The ownership or voting of our ordinary shares bynon-residents of Israel, except with respect to citizens of countries which arein a state of war with Israel, is not restricted in any way by our memorandumof association or articles of association or by the laws of the State of Israel.
**____(67)____ 

 

**E.  Taxation**

*The following is a general summary only and should notbe 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 theUnited States, Israeli or other tax consequences of the purchase, ownership anddisposition of ordinary shares, including, in particular, the effect of anyforeign, state or local taxes.*

**U.S.Federal Income Tax Considerations**

Subject to the limitationsdescribed below, the following discussion summarizes the material U.S. federalincome tax consequences of the purchase, ownership and disposition of ourordinary shares to a U.S. holder.  A U.S. holder is a holder of ourordinary 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 includible in gross     income for U.S. federal income tax purposes 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.

 

This discussion is not acomprehensive description of all of the tax considerations that may be relevantto each person`s decision to purchase ordinary shares.  Thisdiscussion considers only U.S. holders that will own our ordinary shares ascapital assets.

This discussion is based oncurrent provisions of the Internal Revenue Code of 1986 as amended (the"Code"), current and proposed Treasury regulations, and administrative andjudicial decisions as of the date of this annual report, all of which aresubject to change, possibly on a retroactive basis. Various legislativeproposals are currently under consideration under which, among other things,certain dividends would be excluded from income and individual income tax rateson ordinary income would be reduced.  It is not clear at this timewhether, or in what form, any of these proposals or any other proposals will beenacted, what the effective date of any such changes would be, and what otherchanges would be made that could further affect the tax consequences discussedin this section. This discussion does not address all aspects of U.S. federalincome taxation that may be relevant to any particular U.S. holder in light ofthe holder`s individual circumstances.  In particular, thisdiscussion does not address the potential application of the alternativeminimum tax or the U.S. federal income tax consequences to U.S. holders thatare 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,
- 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 discussiondoes not address any aspect of state, local or non-U.S. tax laws or thepossible application of United States federal gift or estate tax.

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

*Taxation of Dividends Paid onOrdinary Shares*

Subject to the discussion belowunder "Tax Consequences if We are a Passive Foreign Investment Company," a U.S.holder will be required to include in gross income as ordinary dividend incomethe amount of any distribution paid on our ordinary shares, including any Israelitaxes withheld from the amount paid, on the date the distribution is receivedto the extent the distribution is paid out of our current or accumulatedearnings and profits, as determined for U.S. federal income tax purposes.  Distributionsin excess of earnings and profits will be applied against and will reduce theU.S. holder`s tax basis in our ordinary shares and, to the extent in excess ofthat basis, will be treated as gain from the sale or exchange of our ordinaryshares.  The dividend portion of such distribution generally will notqualify for the dividends received deduction otherwise available tocorporations.

Distributions of current oraccumulated earnings and profits paid in foreign currency to a U.S. holder(including any Israeli taxes withheld from the distributions) will beincludible in the income of a U.S. holder in a dollar amount calculated byreference to the exchange rate on the date of the distribution.  AU.S. holder that receives a foreign currency distribution and converts theforeign currency into dollars after the date of distribution will have foreignexchange gain or loss based on any appreciation or depreciation in the value ofthe foreign currency against the dollar, which will generally be U.S. sourceordinary income or loss.

U.S. holders will have theoption of claiming the amount of any Israeli income taxes withheld at sourceeither as a deduction from gross income or as a dollar-for-dollar creditagainst their U.S. federal income tax liability. Individuals who do not claim itemizeddeductions, but instead utilize the standard deduction, may not claim adeduction for the amount of the Israeli income taxes withheld, but the amountmay be claimed as a credit against the individual`s U.S. federal income taxliability.  The amount of foreign income taxes that may be claimed asa credit in any year is subject to complex limitations and restrictions, whichmust be determined on an individual basis by each shareholder.  Theselimitations include rules which limit foreign tax credits allowable forspecific classes of income to the U.S. federal income taxes otherwise payableon each class of income.  The total amount of allowable foreign taxcredits in any year cannot exceed the pre-credit U.S. tax liability for theyear attributable to foreign source taxable income.

A U.S. holder will be denied aforeign tax credit for Israeli income tax withheld from a dividend received onthe ordinary shares:
- 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 arenot counted toward meeting the required 16-day holding period. Distributions ofcurrent or accumulated earnings and profits will be foreign source passiveincome for U.S. foreign tax credit purposes.
**____(68)____ 

 

*Taxation of the Disposition ofOrdinary Shares*

Subject to the discussion belowunder "Tax Consequences if We are a Passive Foreign Investment Company," uponthe sale, exchange or other disposition of our ordinary shares, a U.S. holderwill recognize capital gain or loss in an amount equal to the differencebetween the U.S. holder`s basis in the ordinary shares, which is usually thecost to the U.S. holder of the shares, and the amount realized on the disposition.  Adisposition of shares will be considered to occur on the trade date, regardlessof the holder`s method of accounting.  Capital gain from the sale,exchange or other disposition of ordinary shares held more than one year willbe 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 bya U.S. holder on a sale, exchange or other disposition of ordinary shares willbe treated as U.S. source income for U.S. foreign tax credit purposes.  Thedeductibility of a capital loss recognized on the sale, exchange or otherdisposition of ordinary shares is subject to limitations.

A U.S. holder that uses the cashmethod of accounting calculates the dollar value of the proceeds received onthe 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 thevalue of the proceeds of the sale as of the trade date and may thereforerealize foreign currency gain or loss.  A U.S. holder may avoidrealizing foreign currency gain or loss if he or she has elected to use thesettlement date to determine its proceeds of sale for purposes of calculatingthe foreign currency gain or loss.  In addition, a U.S. holder thatreceives foreign currency upon disposition of ordinary shares and converts theforeign currency into dollars after the settlement date or trade date(whichever date the U.S. holder is required to use to calculate the value ofthe proceeds of sale) will have foreign exchange gain or loss based on anyappreciation or depreciation in the value of the foreign currency against thedollar, which will generally be U.S. source ordinary income or loss.

*Tax Consequences if we are aPassive Foreign Investment Company*

We would be a passive foreigninvestment company (a "PFIC") for 2002 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 passiveincome or the average percentage (by value) of our passive assets during thetaxable year is at least 50 percent.  We were not a PFIC for 2002. Ifwe were a PFIC, each U.S. holder would (unless it made one of the electionsdiscussed below on a timely basis) be taxable on gain recognized from thedisposition of ordinary shares (including gain deemed recognized if theordinary shares are used as security for a loan) and upon receipt of certaindistributions with respect to ordinary shares as if such income had beenrecognized ratably over the U.S. holder`s holding period for the ordinaryshares.  The U.S. holder`s income for the current taxable year wouldinclude (as ordinary income) amounts allocated to the current year and to anyperiod prior to the first day of the first taxable year for which we were aPFIC.  Tax would also be computed at the highest ordinary income taxrate in effect for each other period to which income is allocated, and aninterest 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 thenormally-available step-up in basis for such shares to fair market value at thedate of death and, instead, would have a tax basis in such shares equal to thedecedent`s basis, if lower.

As an alternative to the taxtreatment 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 betaxed currently on its pro rata share of our ordinary earnings and net capitalgain (subject to a separate election to defer payment of taxes, which deferralis 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 whichwe are a PFIC.  We would supply U.S. holders with the informationneeded to report income and gain under a QEF election if we were a PFIC.  Asanother alternative to the tax treatment described above, a U.S. holder couldelect to mark our shares to market annually, recognizing as ordinary income orloss each year an amount equal to the difference as of the close of the taxableyear between the fair market value of our shares and the shareholder`s adjustedbasis in the shares.  Losses would be allowed only to the extent ofnet mark-to-market gain previously included in income by the U.S. holder.
**____(69)____ 

Although we were not a PFIC in2002, or for any prior taxable year, there can be no assurance that we will notbecome a PFIC in 2003 or in a subsequent year.  The tests fordetermining PFIC status are applied annually and it is difficult to makeaccurate predictions of future income and assets, which are relevant to thisdetermination.  U.S. holders who hold our ordinary shares during aperiod when we are a PFIC will be subject to these rules, even if we cease tobe a PFIC, subject to specified exceptions for U.S. holders who made a QEFelection.

The U.S. federal income taxconsequences to a U.S. holder if we were to be a PFIC are complex.  AU.S. holder should consult with his or her own advisor with regard to thoseconsequences, as well as with regard to whether he or she should make either ofthe 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 ofordinary shares will not be subject to U.S. federal income or withholding taxon the payment of dividends on, and the proceeds from the disposition of, ourordinary 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 andBack-up Withholding*

U.S. holders generally aresubject to information reporting requirements with respect to dividends paid inthe United States on our ordinary shares.  In addition, a U.S. holdermay be subject, under certain circumstances, to backup withholding at a rate ofup to 30% with respect to dividends paid on our ordinary shares unless the U.S.holder provides proof of an applicable exemption or correct taxpayeridentification number and otherwise complies with applicable requirements ofthe backup withholding rules.  A holder of our ordinary shares whoprovides an incorrect taxpayer identification number may be subject topenalties imposed by the IRS.  Amounts withheld under the backupwithholding rules are not an additional tax and may be refunded or creditedagainst the holder`s federal income tax liability, provided the requiredinformation is furnished to the IRS.

Non-U.S. holders generally are not subject to informationreporting or back-up withholding for dividends paid on, or upon the dispositionof, our ordinary shares, provided that the non-U.S. holder provides a taxpayeridentification number, certifies to its foreign status, or establishes anotherexemption to the information reporting or back-up withholding requirements.
**____(70)____ 

**ISRAELI TAXATION**

** **

The following summarydescribes the current tax structure applicable to companies in Israel, withspecial reference to its effect on us.  It also discusses Israeli taxconsequences material to persons purchasing our ordinary shares.  Tothe extent that the summary is based on new tax legislation yet to bejudicially or administratively interpreted, we cannot be sure that the viewsexpressed will accord with any future interpretation.  The summary isnot intended, and should not be construed, as legal or professional advice anddoes not exhaust all possible tax considerations.  Accordingly, youshould consult your tax advisor as to the particular tax consequences of aninvestment in our ordinary shares.

**Tax Reform**

On January 1, 2003, the Law forAmendment of the Income Tax Ordinance (Amendment No. 132), 5762-2002, asamended, known as the "Tax Reform", came into effect.  The Tax Reform, aimed at broadening the categories oftaxable 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     by individuals as of January 1, 2003, from the sale of shares of     publicly traded companies (such gain was previously exempt from capital     gains tax in Israel). For information with respect to the applicability of     Israeli capital gains taxes on the sale of ordinary shares, see  "Capital     Gains Tax"  below; 

 
- Introduction 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.     
**____(71)____ 

**General Corporate Tax Structure**

Israeli companies are subject to tax at the rate of 36% oftaxable income (and are subject to capital gains tax at a rate of 25% forcapital gains derived after January 1, 2003).  However, the effectivetax rate payable by a company that derives income from an approved enterprise(as defined below) may be considerably less, as further discussed below.

**Tax Benefits under the Law for the Encouragement ofCapital Investments, 1959**

** **

The Law for the Encouragement of Capital Investments,1959, provides that upon application to the Investment Center of the Ministry ofIndustry and Commerce of the State of Israel, a proposed capital investment ineligible facilities may be designated as an "Approved Enterprise."  Eachcertificate of approval for an Approved Enterprise relates to a specificinvestment program delineated both by its financial scope, including itscapital sources, and by its physical characteristics, such as the equipment tobe purchased and utilized pursuant to the program.  The tax benefitsderived from any such certificate of approval relate only to taxable incomederived from the specific Approved Enterprise.  If a company has morethan one approval or only a portion of its capital investments are approved,its effective tax rate is the result of a weighted combination of theapplicable rates.  The tax benefits under the law are not availablewith respect to income derived from products manufactured outside of Israel.

Taxable income of a company derived from an ApprovedEnterprise (including income generated by a company from the grant of a usageright with respect to know-how developed by the Approved Enterprise, incomegenerated from royalties and income derived from a service which is auxiliaryto such usage right or royalties, provided that such income is generated withinthe Approved Enterprise`s ordinary course of business) is subject to tax at themaximum rate of 25%, rather than the usual rate of 36%, for the "BenefitPeriod".  The Benefit Period is seven years (and under certaincircumstances, as further detailed below, ten years), commencing with the yearin which the Approved Enterprise first generates taxable income, and is limitedto 12 years from commencement of production or 14 years from the date ofapproval, whichever is earlier.  

A company that has an Approved Enterprise program iseligible 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 ownedby non‐Israeli residents.  A company that qualifies as aforeign investors` company and has an Approved Enterprise program is eligiblefor 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 wehave done) to forego certain government grants extended to Approved Enterprisesin return for an alternative package of benefits.  Under thealternative package, the company`s undistributed income derived from an ApprovedEnterprise will be exempt from tax for a period of between two and ten yearsfrom the first year of taxable income, depending on the geographic location ofthe Approved Enterprise within Israel, and the company will be eligible for thetax benefits under the law for the remainder of the Benefit Period.

The Investment Center bases its decision of whether toapprove or reject a company`s application for designation as an ApprovedEnterprise on criteria set forth in the law and related regulations, the thenprevailing policy of the Investment Center and the specific objectives andfinancial criteria of the applicant.  Accordingly, a company cannotbe certain in advance whether its application will be approved.  Inaddition, the benefits available to an Approved Enterprise are conditional uponcompliance with the conditions stipulated in the law and related regulationsand the criteria set forth in the specific certificate of approval.  Inthe event that a company violates these conditions, in whole or in part, it maybe required to refund the amount of tax benefits plus an amount linked to theIsraeli consumer price index and interest.
**____(72)____ 

A major portion of our production facilities have beengranted the status of Approved Enterprises.  Income arising from ourApproved Enterprises facilities is tax-free under the alternative package ofbenefits described above for the period in which such alternative package is ineffect and thereafter, entitled to reduced tax rates based on the level offoreign ownership for specified periods.  We have derived, and expectto continue to derive, a substantial portion of our income from our ApprovedEnterprises facilities.  Subject to compliance with applicablerequirements, the benefits for most of our production facilities in Israel willcontinue until termination between the years 2001 and 2008.  Ourcurrent investments in development facilities are made under new approvals.

All dividends are considered to be attributable to theentire enterprise and their effective tax rate is the result of a weightedcombination of the applicable tax rates.  We currently intend toreinvest the amount of our income and not to distribute such income as adividend.  In the event that we do pay a cash dividend from incomethat is derived from our Approved Enterprises pursuant to the alternativepackage of benefits, which income would normally be tax-exempt, we would berequired to pay tax on the amount intended to be distributed as dividends atthe rate which would have been applicable had we not elected the alternativepackage of benefits, which rate is ordinarily up to 25%, and to withhold atsource on behalf of the dividend recipient an additional 15% of the amountdistributed as dividends.

The law also provides that an Approved Enterprise is entitledto accelerated depreciation on its property and equipment that are included inan approved investment program.

**Tax Benefits for Research and Development**

** **

Israeli tax law allows, under specified circumstances, atax deduction for expenditures in the year incurred, including capitalexpenditures, in scientific research and development projects, if theexpenditures are approved by the relevant Israeli government ministry and theresearch and development is for the promotion of the company and carried out byor on behalf of the company seeking such deduction.  Expenditures notso approved are deductible over a three-year period.  However,expenditures made out of proceeds made available to us through governmentgrants are not deductible under Israeli law.

**Tax Benefits under the Law for the Encouragement ofIndustry (Taxes), 1969**

** **

According to the Law for the Encouragement of Industry(Taxes), 1969, an "Industrial Company" is a company located in Israel, at least90% of the income of which, in any tax year, exclusive of income from defenseloans, capital gains, interest and dividends, is derived from an "IndustrialEnterprise" owned by it.  An "Industrial Enterprise" is defined as anenterprise whose major activity in a given tax year is industrial productionactivity.  We believe that we currently qualify as an IndustrialCompany within the definition of the Law for the Encouragement of Industry(Taxes), 1969.

Under the law, Industrial Companies are entitled topreferred corporate tax benefits, 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;

 
- 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; and

 
- accelerated depreciation rates on equipment and buildings.

 

Eligibility for the benefits under the law is not subjectto receipt of prior approval from any governmental authority.  However,the Israeli tax authorities may determine that we do not qualify as anIndustrial Company.  In addition, we might not continue to qualify asan Industrial Company in the future.  As a result of either of theforegoing, the benefits described above might not be available in the future.
****____(73)____ 

**Special Provisions Relating to Taxation UnderInflationary Conditions**

** **

The Income Tax Law (Inflationary Adjustments), 1985represents an attempt to overcome the problems presented to a traditional taxsystem by an economy undergoing inflation.  The law is highlycomplex.  Its features that are material to us can be described asfollows:
- 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 on     a linked basis.  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 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 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 ofthe Knesset Finance Committee, determine by order, during a certain fiscal year(or until February 28th of the following year ) in which the rate ofincrease of the price index would not exceed or shall not have exceeded, asapplicable, 3%, that all or some of the provisions of this Law shall not applyto such fiscal year, or, that the rate of increase of the price index relatingto such fiscal year shall be deemed to be 0%, and to make the adjustmentsrequired to be made as a result of such determination.  

**Capital Gains Tax**

** **

Israeli law generally imposes on residents andnon-residents of Israel a tax on the sale of capital assets in Israel,including our ordinary shares, unless a specific exemption is available orunless a tax treaty between Israel and the shareholder`s country of residenceprovides otherwise.  The law distinguishes between the inflationarysurplus and the real gain.  The inflationary surplus is a portion ofthe total capital gain which is equivalent to the increase of the relevantasset`s purchase price that is attributable to the increase in the Israeliconsumer price index between the date of purchase and the date of sale.  Thereal gain is the excess of the total capital gain over the inflationarysurplus.  

Prior to the Tax Reform, gains on sales of our ordinaryshares by individuals were, generally, exempted from Israeli capital gains taxfor so long as our shares were quoted on Nasdaq or another stock exchangerecognized by the Israeli Controller of Foreign Currency and we qualified as anIndustrial Company.  

  Pursuant to the TaxReform, generally, capital gains tax is imposed at a rate of 15% on real gainsderived on or after January 1, 2003, from the sale of shares in companies(i) publicly traded on the Tel Aviv Stock Exchange ("TASE") or (ii)(subject to a necessary determination by the Israeli Minister of Finance)Israeli companies publicly traded on a recognized stock exchange or regulatedmarket outside of Israel (such as our company). This tax rate is contingentupon the shareholder not claiming a deduction for financing expenses, and doesnot apply to: (i) dealers in securities; (ii) shareholders that report inaccordance with the Inflationary Adjustment Law; or (iii) shareholders whoacquired their shares prior to an initial public offering (that are subject toa different tax arrangement).  The tax basis of shares acquired priorto January 1, 2003 will be determined in accordance with the average closingshare price in the three trading days preceding January 1, 2003.  However,a request may be made to the tax authorities to consider the actual adjustedcost of the shares as the tax basis if it is higher than such average price. 
**____(74)____ 

Non-Israeli residentsare exempt from Israeli capital gains tax on any gains derived from the sale ofshares publicly traded on the TASE, and are exempt from Israeli capital gainstax on any gains derived from the sale of shares of Israeli companies publicly tradedon a recognized stock exchange or regulated market outside of Israel, providedthat such capital gains are not derived from a permanent establishment inIsrael and that such shareholders did not acquire their shares prior to theissuer`s initial public offering. However, non-Israeli corporations will not beentitled to such exemption if an Israeli resident (i) has a controllinginterest of 25% or more in such non-Israeli corporation, or (ii) is thebeneficiary of or is entitled to 25% or more of the revenues or profits of suchnon-Israeli corporation, whether directly or indirectly.    

In any event, theprovisions of the Tax Reform shall not affect the exemption from capital gainstax for gains accrued before January 1, 2003, as described above.

In some instanceswhere our shareholders may be liable to Israeli tax on the sale of theirordinary shares, the payment of the consideration may be subject to thewithholding of Israeli tax at the source.

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

**Taxation of Dividends**

** **

Non-residents of Israel are subject to income tax onincome accrued or derived from sources in Israel.  These sources ofincome include passive income such as dividends, royalties and interest, aswell as non-passive income from services rendered in Israel.  Ondistributions of dividends other than bonus shares, or stock dividends, wewould be required to withhold income tax at the rate of 25%.  If theincome out of which the dividend is being paid is attributable to an ApprovedEnterprise under the Law for the Encouragement of Capital Investments, 1959,the rate is 15%.  A different rate may be provided in a treatybetween Israel and the shareholder`s country of residence.  Under theU.S.-Israel tax treaty, if the income out of which the dividend is being paidis not attributable to an Approved Enterprise, then income tax with respect toshareholders that are U.S. corporations holding at least 10% of our votingpower in the twelve-month period preceding the distribution of such dividends,is required to be withheld at the rate of 12.5%.  

**F.  Dividendsand Paying Agents.**

 

Not Applicable.

**G.  Statementby Experts.**

 

Not Applicable.

**H.  Documentson Display.**

 

We are subject to the informational requirements of theSecurities Exchange Act of 1934, as amended, applicable to foreign privateissuers and fulfill the obligations with respect to such requirements by filingreports with the Securities and Exchange Commission, or SEC.  You mayread and copy any document we file, including any exhibits, with the SECwithout 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 bymail from the Public Reference Branch of the SEC at such address, at prescribedrates.  Please call the SEC at 1-800-SEC-0330 for further informationon the public reference room.  Certain of our SEC filings are alsoavailable to the public at the SEC`s website at http://www.sec.gov.
**____(75)____ 

 

As a foreign private issuer, we are exempt from the rulesunder the Exchange Act prescribing the furnishing and content of proxystatements, and our officers, directors and principal shareholders are exemptfrom the reporting and "short-swing" profit recovery provisions contained inSection 16 of the Exchange Act.  In addition, we are not requiredunder the Exchange Act to file periodic reports and financial statements withthe SEC as frequently or as promptly as United States companies whosesecurities are registered under the Exchange Act.  

**Item11.  Quantitative and Qualitative Disclosures about Market Risk******

 

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

**Presentation ofinterest rate risk (position as of December 31, 2002)**

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

** **

Total as of 

Settlement Date

Fair value as 

** **

December 31, 2002

2003

2004

2005

2006

After 2007

of December 31, 2002

* *

(All amounts in thousands of U.S. dollars, except   percentages)

*Assets that incur interest*

 

 

 

 

 

 

 

A. Cash and cash equivalents

 

 

 

 

 

 

 

**U.S. dollars**

51,066

51,066

―

―

―

―

51,066

Weighted-average interest rate

1.4%

 

 

 

 

 

 

**NIS**

1,364

1,364

―

―

―

―

1,364

Weighted-average interest rate

8.6%

 

 

 

 

 

 

**GBP**

160

160

―

―

―

―

160

Weighted-average interest rate

0.3%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

B. Long-term receivables

 

 

 

 

 

 

 

**U.S. dollars**

5,261

―

5,233

―

―

28

5,261

Weighted-average interest rate

3.2%

 

 

 

 

 

 

 

 

*Exchange Rate Risk Management*

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

As of December 31, 2002, we had purchased currency forwardcontracts, ending between  January and February 2003 , as a hedgeagainst sales contracts receivable and firm commitments, as follows: 
**____(76)____ 

 
- Obligation to sell EUR 156,000 for a total mount of     $152,000; and

 
- Obligation to sell GBP 102,000 for a total amount of     $154,000.

 

 

**Presentation offoreign currency-denominated assets and liabilities**

**(positionas of December 31, 2002)**

Details regarding our foreign exchange exposure are setforth in the table below.  Foreign exchange exposure is monitored bytracking actual and projected commitments and through the use of a sensitivityanalysis.

** **

Total as of 

Settlement Date

Fair value as 

** **

December 31, 2002

2003

2004

2005

2006

After 2007

of December 31, 2002

* *

(All amounts in thousands of U.S. dollars)

**Current Assets**

 

 

 

 

 

 

 

 
NIS

3,161

3,161

―

―

―

―

3,161

 
U.K. pound sterling

489

489

―

―

―

―

489

 
Euro

325

325

―

―

―

―

325

 
Other

9

9

―

―

―

―

9

 
Total

3,984

3,984

―

―

―

―

3,984

 
**Long-term assets**

 

 

 

 

 

 

 

 
NIS

637

―

106

98

―

352

637

 
**Current liabilities**

 

 

 

 

 

 

 

 
NIS

15,558

15,558

―

―

―

―

15,558

 
U.K. pound sterling

155

155

―

―

―

―

155

 
Euro

835

835

―

―

―

―

835

 
Other

8

8

―

―

―

―

8

 
Total

16,556

16,556

―

―

―

―

16,556

 
**Long-term liabilities**

 

 

 

 

 

 

 

 
NIS

774

―

―

―

―

774

774

 
 

**Item12.  Description of Securities Other Than Equity Securities**

 

NotApplicable.
**____(77)____ 

 

**PART   II**

** **

**Item13. Defaults,  Dividend Averages and Delinquencies.******

 

Not Applicable.

**Item 14. MaterialModifications to the Rights of Security Holders and Useof 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 aportion of our indebtedness to ECI.  The remaining proceeds wereinvested in cash equivalents and are used for general corporate purposes andfunding our current activities. 

**Item15. Controls and Procedures.**

 

(a)Evaluation of disclosure controls and procedures.

Based on their evaluation as of a date within 90 days ofthe filing date of this annual report on Form 20-F, our principal executiveofficer and principal financial officer have concluded that, as of the date ofthe evaluation, our disclosure controls and procedures (as defined in Rules13a-15(c) and 15d-15(c) under the Securities Exchange Act of 1934 (the"Exchange Act")) are effective to ensure that information required to bedisclosed by us in reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin Securities and Exchange Commission rules and forms. 

(b)Changes in internal controls. 

There were no significant changes in our internal controlsor in other factors that could significantly affect these controls subsequentto the date of their evaluation.

**Item 16. [Reserved]**
****____(78)____ 

** **

PART  III

**Item17. Financial Statements******

 

Not Applicable.

**Item18.Financial Statements**

 

The consolidated financialstatements of ECtel for the year ended December 31, 2002, are herebyincorporated by reference from our report on Form 6-K, furnished to the SEC onMarch 31, 2003.

 

**Item19.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*

4.5

Form of Supply Agreement*

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, by and among Telrad  Networks Ltd., Telrad Hawk Net-I Ltd. and the Registrant****

4.9

Form of Warrants issued to Telrad Networks Ltd. ****

4.10

Registration Rights Agreement by and between Telrad  Networks Ltd. and the Registrant****

4.11

Registration Rights Agreement by and between ECI Telecom  Ltd. and the Registrant****

4.12

Share Purchase Agreement, by and among ECI Telecom Ltd.,  the Registrant and certain investors****

4.13

Registration Rights Agreement, by and among certain  investors and the Registrant****

8.1

List of Significant Subsidiaries

99.1

Certification of Principal Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2003 (3)

99.2

Certification of Principal Financial Officer pursuant to  Section 906 of the  Sarbanes-Oxley Act of 2003 (3)

 

_______

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

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

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

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

(1)English translation from Hebrew original.

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

(3)This document is being furnished in accordance with SECRelease No 33-8212 and 34-47551.
**____(79)____ 

**SIGNATURES**

** **

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

 

ECTEL LTD.

(Registrant)

 

 

 

By:   /s/ Aharon Shech  _________________________________

            Name: Aharon Shech

            Title     President and Chief Executive Officer

 

 

 

 

Date:  June 30, 2003
**____(80)____ 

**CHIEF EXECUTIVE OFFICER CERTIFICATION**

** **

I, Aharon Shech, President and Chief Executive Officer ofECtel Ltd., certify that: 

 

 

 

1.  I have reviewed this annual report on Form  20-F of ECtel Ltd.  (the "registrant");

 

 

 

2.  Based on my knowledge, this annual report  does not contain any untrue statement of a material fact or omit to state a  material fact necessary to make the statements made, in light of the  circumstances under which such statements were made, not misleading with  respect to the period covered by this annual report;

 

 

 

3.  Based on my knowledge, the financial  statements, and other financial information included in this annual report,  fairly present in all material respects the financial condition, results of  operations and cash flows of the registrant as of, and for, the periods  presented in this annual report;

 

 

 

4.  The registrant`s other certifying officers  and I are responsible for establishing and maintaining disclosure controls  and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the  Registrant and have:

 

 

 

a)  Designed such disclosure controls and  procedures to ensure that material information relating to the registrant,  including its consolidated subsidiaries, is made known to us by others within  those entities, particularly during the period in which this annual report is  being prepared;

 

 

 

b)  Evaluated the effectiveness of the  registrant`s disclosure controls and procedures as of a date within 90 days  prior to the filing date of this annual report (the "Evaluation Date"); and

 

 

 

c)  Presented in this annual report our  conclusions about the effectiveness of the disclosure controls and procedures  based on our evaluation as of the Evaluation Date;

 

 

 

5.  The registrant`s other certifying officers  and I have disclosed, based on our most recent evaluation, to the  registrant`s auditors and the audit committee of registrant`s board of  directors (or persons performing the equivalent functions):

 

 

 

a)  All significant deficiencies in the design  or operation of internal controls which could adversely affect the  registrant`s ability to record, process, summarize and report financial data  and have identified for the registrant`s auditors any material weaknesses in  internal controls; and

 

 

 

b)  Any fraud, whether or not material, that  involves management or other employees who have a significant role in the  registrant`s internal controls; and

 

 

 

6.  The registrant`s other certifying officers  and I have indicated in this annual report whether or not there were  significant changes in internal controls or in other factors that could  significantly affect internal controls subsequent to the date of our most  recent evaluation, including any corrective actions with regard to  significant deficiencies and material weaknesses.

 

 

 
 

Dated: June 30, 2003

 
 

 

 
 

/s/ Aharon Shech

 
 

President and Chief Executive Officer  (Principal Executive Officer)

 
 
**____(81)____ 

**CHIEF FINANCIAL OFFICER CERTIFICATION**

** **

I, Avi Goldstein, Senior Vice President and Chief FinancialOfficer of ECtel Ltd., certify that: 

 

 

 

1. I have reviewed this annual report on Form 20-F  of ECtel Ltd.  (the "registrant");

 

 

 

2. Based on my knowledge, this annual report does not  contain any untrue statement of a material fact or omit to state a material  fact necessary to make the statements made, in light of the circumstances  under which such statements were made, not misleading with respect to the  period covered by this annual report;

 

 

 

3. Based on my knowledge, the financial statements, and  other financial information included in this annual report, fairly present in  all material respects the financial condition, results of operations and cash  flows of the registrant as of, and for, the periods presented in this annual  report;

 

 

 

4. The registrant`s other certifying officers and I are  responsible for establishing and maintaining disclosure controls and procedures  (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and  have:

 

 

 

a) Designed such disclosure controls and procedures to  ensure that material information relating to the registrant, including its  consolidated subsidiaries, is made known to us by others within those  entities, particularly during the period in which this annual report is being  prepared;

 

 

 

b) Evaluated the effectiveness of the registrant`s  disclosure controls and procedures as of a date within 90 days prior to the  filing date of this annual report (the "Evaluation Date"); and

 

 

 

c) Presented in this annual report our conclusions about  the effectiveness of the disclosure controls and procedures based on our  evaluation as of the Evaluation Date;

 

 

 

5. The registrant`s other certifying officers and I have  disclosed, based on our most recent evaluation, to the registrant`s auditors  and the audit committee of registrant`s board of directors (or persons  performing the equivalent functions):

 

 

 

a) All significant deficiencies in the design or operation  of internal controls which could adversely affect the registrant`s ability to  record, process, summarize and report financial data and have identified for  the registrant`s auditors any material weaknesses in internal controls; and

 

 

 

b) Any fraud, whether or not material, that involves  management or other employees who have a significant role in the registrant`s  internal controls; and

 

 

 

6. The registrant`s other certifying officers and I have  indicated in this annual report whether or not there were significant changes  in internal controls or in other factors that could significantly affect  internal controls subsequent to the date of our most recent evaluation,  including any corrective actions with regard to significant deficiencies and  material weaknesses.

 

 

 
 

Dated: June 30, 2003

 
 

 

 
 

/s/ Avi Goldstein 

 
 

Senior Vice President and Chief Financial Officer  (Principal Financial Officer)

 
 
**____(82)____ 

**EXHIBIT INDEX**

 

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*

4.5

Form of Supply Agreement*

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, by and among Telrad  Networks Ltd., Telrad Hawk Net-I Ltd. and the Registrant****

4.9

Form of Warrants issued to Telrad Networks Ltd.****

4.10

Registration Rights Agreement by and between Telrad  Networks Ltd. and the Registrant****

4.11

Registration Rights Agreement by and between ECI Telecom  Ltd. and the Registrant****

4.12

Share Purchase Agreement, by and among ECI Telecom Ltd.,  the Registrant and certain investors ****

4.13

Registration Rights Agreement, by and among certain  investors and the Registrant****

8.1

List of Significant Subsidiaries

99.1

Certification of Principal Executive Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2003 (3)

99.2

Certification of Principal Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2003 (3)

 

_________

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

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

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

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

(1)English translation from Hebrew original.

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

(3)This document is being furnished in accordance with SECRelease No 33-8212 and 34-47551.

 
**____(83)____ 

**Exhibit 8.1**

Listof Significant Subsidiaries

ECtel BNV, a Dutch company

ECtel GmbH, a German company

ECtel Inc., a Marylandcorporation

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

Telrad Hawk Net-I Ltd., anIsraeli company  
**____(84)____ 

** **

**Exhibit 99.1**

** **

** **

**CERTIFICATION PURSUANT TO**

**18 U.S.C. SECTION 1350**

**AS ADOPTED PURSUANT TO SECTION 906**

**OF THE SARBANES-OXLEY ACT OF 2002**

 

In connection with the annualreport on Form 20-F for the fiscal year ended December 31, 2002 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 of2002, I, Aharon Shech, 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:  June 30, 2003 

 

/s/ Aharon Shech

Aharon Shech

President and Chief ExecutiveOfficer 

(Principal Executive Officer) 

 

* A signed original of thiswritten statement required by Section 906 has been provided to ECtel Ltd. andwill be retained by ECtel Ltd. and furnished to the Securities and ExchangeCommission or its staff upon request. 
**____(85)____ 

 

**Exhibit 99.2**

** **

** **

**CERTIFICATION PURSUANT TO**

**18 U.S.C. SECTION 1350**

**AS ADOPTED PURSUANT TO SECTION 906**

**OF THE SARBANES-OXLEY ACT OF 2002**

 

In connection with the annualreport on Form 20-F for the fiscal year ended December 31, 2002 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 of2002, I, Avi Goldstein, Executive Vice President and Chief Financial Officer ofthe 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:  June 30, 2003

 

/s/ Avi Goldstein

Avi Goldstein

Executive Vice President and ChiefFinancial Officer

(Principal Financial Officer)

 

* A signed original of this written statement required bySection 906 has been provided to ECtel Ltd. and will be retained by ECtel Ltd.and furnished to the Securities and Exchange Commission or its staff uponrequest.

 
**____(86)____ *************************************************************************************************************************************************************************************** |
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