---

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# UNITED STATESSECURITIES AND
EXCHANGE COMMISSIONWASHINGTON, DC 20549

# FORM 20-F

(Mark One)

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

or

|x | Annual
report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ------------------------------------------------------------------------------------

# For the fiscal year
ended December 31, 2006

or

|o | Transition
report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ----------------------------------------------------------------------------------------

# For the transition
period from ________ to ________

or

|o | Shell
Company report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | -------------------------------------------------------------------------------------------

Date of event requiring this shell company report_____

# Commission file number
0-30348

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

Israel 
(Jurisdiction
of incorporation or organization)

10 Amal Street, Park
Afek, Rosh Haayin 48902, Israel 
(Address
of principal executive offices)

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

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

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

Indicate the number of outstanding
shares of each of the Issuers classes of capital or common stock as of December 31,
2006: 16,364,668 Ordinary
Shares, nominal value NIS 0.04 per share

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

o Yes    x No

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

o Yes    x No

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

x Yes    o No

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

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

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

Item 17 o Item 18 x

If this is an annual report, indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).

o Yes    x No



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TABLE OF CONTENTS

|PART I | 1
|------ | -

|        |                                                       |  
|------- | ----------------------------------------------------- | -
|Item 1. | Identity of Directors, Senior Management and Advisers | 1
|Item 2. | Offer Statistics and Expected Timetable               | 1
|Item 3. | Key Information                                       | 1

| | A. | Selected Financial Data                   | 1
| | -- | ----------------------------------------- | -
| | B. | Capitalization and Indebtedness           | 2
| | C. | Reasons for the Offer and Use of Proceeds | 2
| | D. | Risk Factors                              | 2

|        |                            |   
|------- | -------------------------- | --
|Item 4. | Information on the Company | 11

| | A. | History and Development of the Company | 11
| | -- | -------------------------------------- | --
| | B. | Business Overview                      | 11
| | C. | Organizational Structure               | 17
| | D. | Property, Plants and Equipment         | 18

|         |                                              |   
|-------- | -------------------------------------------- | --
|Item 4A. | Unresolved Staff Comments                    | 18
|Item 5.  | Operating and Financial Review and Prospects | 18

| | A. | Operating Results                              | 18
| | -- | ---------------------------------------------- | --
| | B. | Liquidity and Capital Resources                | 27
| | C. | Research and Development, Patents and Licenses | 30
| | D. | Trend Information                              | 31
| | E. | Off-Balance Sheet Arrangements                 | 32
| | F. | Tabular Disclosure of Contractual Obligations  | 32

|        |                                            |   
|------- | ------------------------------------------ | --
|Item 6. | Directors, Senior Management and Employees | 32

| | A. | Directors and Senior Management | 32
| | -- | ------------------------------- | --
| | B. | Compensation                    | 34
| | C. | Board Practices                 | 34
| | D. | Employees                       | 37
| | E. | Share Ownership                 | 37

|        |                                                   |   
|------- | ------------------------------------------------- | --
|Item 7. | Major Shareholders and Related Party Transactions | 38

| | A. | Major Shareholders              | 38
| | -- | ------------------------------- | --
| | B. | Related Party Transactions      | 40
| | C. | Interests of Expert and Counsel | 40

|        |                       |   
|------- | --------------------- | --
|Item 8. | Financial Information | 40

| | A. | Consolidated Financial Statements and Other Financial Information | 40
| | -- | ----------------------------------------------------------------- | --
| | B. | Significant Changes                                               | 40

|        |                       |   
|------- | --------------------- | --
|Item 9. | The Offer and Listing | 41

| | A. | Offer and Listing Details | 41
| | -- | ------------------------- | --
| | B. | Plan of Distribution      | 41
| | C. | Markets                   | 41
| | D. | Selling Shareholders      | 41
| | E. | Dilution                  | 41
| | F. | Expenses of the Issue     | 41

|         |                        |   
|-------- | ---------------------- | --
|Item 10. | Additional Information | 41

| | A. | Share Capital                          | 41
| | -- | -------------------------------------- | --
| | B. | Memorandum and Articles of Association | 42
| | C. | Material Contracts                     | 46
| | D. | Exchange Controls                      | 47
| | E. | Taxation                               | 48
| | F. | Dividends and Paying Agents            | 55
| | G. | Statement by Experts                   | 55
| | H. | Documents on Display                   | 55
| | I. | SUBSIDIARY INFORMATION                 | 55

|         |                                                            |   
|-------- | ---------------------------------------------------------- | --
|Item 11. | Quantitative and Qualitative Disclosures about Market Risk | 55
|Item 12. | Description of Securities Other Than Equity Securities     | 56

|PART II | 57
|------- | --

|          |                                                                              |   
|--------- | ---------------------------------------------------------------------------- | --
|Item 13.  | Defaults, Dividend Arrearages and Delinquencies                              | 57
|Item 14.  | Material Modifications to the Rights of Security Holders and Use of Proceeds | 57
|Item 15.  | Controls and Procedures                                                      | 57
|Item 16A. | Audit Committee Financial Expert                                             | 57
|Item 16B. | Code of Ethics                                                               | 57
|Item 16C. | Principal Accountant Fees and Services                                       | 57
|Item 16D. | Exemptions from Listing Standards for Audit Committees                       | 58
|Item 16E: | Purchases of Equity Securities by the Issuer and Affiliated Purchasers       | 58



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|PART III | 58
|-------- | --

|         |                      |   
|-------- | -------------------- | --
|Item 17. | Financial Statements | 58
|Item 18. | Financial Statements | 58
|Item 19. | Exhibits             | 58



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# PART I

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

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

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

Not
Applicable.

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

Not
Applicable.

|Item 3. |  | Key Information
|------- |  | ---------------

| | A. | Selected
Financial Data
| | -- | -----------------------

The
selected consolidated balance sheet data as of December 31, 2006 and 2005 and the selected
consolidated statements of operations data for each of the three years in the period ended
December 31, 2006 have been derived from our audited consolidated financial statements
included elsewhere in this annual report, which have been prepared in accordance with
accounting principles generally accepted in the United States, or U.S. GAAP, and audited
by Somekh Chaikin, Independent Registered Public Accountants, a member firm of KPMG
International. Its report appears elsewhere in this annual report. The selected
consolidated balance sheet data as of December 31, 2004, 2003 and 2002 and the selected
consolidated statements of operations data for the years ended December 31, 2003 and 2002
have been derived from our audited consolidated financial statements which are not
included in this annual report. The following selected financial data should be read in
conjunction with Item 5  Operating and Financial Review and Prospects
and the consolidated financial statements as of December 31, 2006 and 2005 and for each of
the years in the three-year period ended December 31, 2006, the related notes and Somekh
Chaikins report, appearing elsewhere in this annual report. Somekh Chaikins
report refers to (a) a class action lawsuit that has been filed against the Company and
(b) adoption of the fair value method of accounting for stock-based compensation as
required by Statement of Financial Accounting Standards No. 123(R), Share-Based
Payment. These data should not be construed as indicative of our future operating results
or financial position.

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

In
December, 2005, we acquired all of the outstanding shares of Elron Telesoft Ltd. (the name
of which was later changed to ECtel Telesoft Ltd.) and Elron Telesoft Export Ltd. (the
name of which was later changed to ECtel Telesoft Export (98) Ltd.), two sister companies
held by Elron Electronic Industries Ltd., which we refer to collectively as Telesoft. The
effect of this acquisition is reflected in our consolidated balance sheet as at December
31, 2005.

1

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|                                                                                                | Year ended December 31,
|----------------------------------------------------------------------------------------------- | -----------------------
|
|
|
|
|
|Statements of Operations Data:                                                                  |                        
|                                                                                                |                        
|Revenues                                                                                        |                        
|Cost of revenues                                                                                |                        
|                                                                                                |                        
|                                                                                                |                        
|Gross profit                                                                                    |                        
|Research and development costs, net                                                             |                        
|Selling and marketing expenses                                                                  |                        
|General and administrative expenses                                                             |                        
|Amortization of acquisition-related intangible assets                                           |                        
|Restructuring and related impairment costs                                                      |                        
|Acquisition-related expenses                                                                    |                        
|Goodwill impairment                                                                             |                        
|                                                                                                |                        
|                                                                                                |                        
|Total operating expenses                                                                        |                        
|                                                                                                |                        
|                                                                                                |                        
|Operating loss                                                                                  |                        
|Financial income, net                                                                           |                        
|Other income (expenses), net                                                                    |                        
|                                                                                                |                        
|                                                                                                |                        
|Loss from continuing operations before taxes on income                                          |                        
|Income tax (expense) benefit                                                                    |                        
|                                                                                                |                        
|                                                                                                |                        
|Net loss from continuing operations before cumulative effect of change in accounting principles |                        
|Income (loss) from discontinued operations                                                      |                        
|                                                                                                |                        
|                                                                                                |                        
|Net (loss) income for the year                                                                  |                        
|                                                                                                |                        
|                                                                                                |                        
|Earnings (loss) per ordinary share                                                              |                        
|Basic earnings (loss) per ordinary share:                                                       |                        
|Continuing operations                                                                           |                        
|Discontinued operations                                                                         |                        
|                                                                                                |                        
|                                                                                                |                        
|                                                                                                |                        
|                                                                                                |                        
|                                                                                                |                        
|Weighted average number of shares outstanding                                                   |                        
|Diluted earnings (loss) per ordinary share:                                                     |                        
|Continuing operations                                                                           |                        
|Discontinued operations                                                                         |                        
|                                                                                                |                        
|                                                                                                |                        
|                                                                                                |                        
|                                                                                                |                        
|                                                                                                |                        
|Weighted average number of shares outstanding                                                   |                        

|                                   | December 31,
|---------------------------------- | ------------
|
|
|
|
|
|Balance Sheet Data:                |             
|                                   |             
|Cash and cash equivalents          |             
|Working capital                    |             
|Assets, net - held for sale        |             
|Total assets                       |             
|Due to (from) related parties, net |             
|Shareholders' equity               |             

| | B. | Capitalization
and Indebtedness
| | -- | -------------------------------

Not
applicable.

| | C. | Reasons
for the Offer and Use of Proceeds
| | -- | -----------------------------------------

Not
applicable.

| | D. | Risk
Factors
| | -- | ------------

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

2

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# Risks Related to Our
Business and Our Industry

The market for our products is
highly competitive. Because some of our competitors have much greater resources than we
have or have a lower cost structure than us, it may be difficult for us to achieve and
maintain profitability. We may also face competition from our customers.

Competition
in our industry is intense, and we expect it to continue. To compete effectively, we have,
at times, been required to grant substantial discounts on our products, especially as some
of our competitors utilize aggressive pricing strategies. Lower prices and the loss of
sales to our competitors would reduce our ability to generate revenue, which would harm
our business.

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

We
may also face competition from our customers. Some of our customers are developing their
own solutions internally or through strategic alliances. As a result, solutions developed
by our customers may replace and/or compete with products that we currently sell to them
or that we may seek to sell to them in the future.

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

A
substantial portion of our revenue has come from relatively large purchases by a small
number of customers. Sales to our top ten customers accounted for 59.24% of our revenues
in 2006, with sales to three customers in Eastern Europe accounting for 28.9% of our
revenues one of which accounted for 16.0% of our revenues. Sales to our top ten customers
accounted for 59.1% of our revenues in 2005, with sales to three customers in Eastern
Europe accounting for 26.0% of our revenues, one of which accounted for 10.1% of our
revenues, and sales to a customer in Latin America accounting for 16.6% of our revenues.
We expect to continue to depend on sales to a small number of customers. However, we do
not have long-term commitments from any of our top customers to purchase any specific
quantities of products. We expect that our largest customers will vary from period to
period. If we lose one or more large customers and fail to add new customers our results
of operations could be seriously harmed. For example, our revenues for the first quarter
of 2007 declined and we did not meet our internal plans due in part to slower than
anticipated orders, mainly from countries within the Former Soviet Union carried out
through our exclusive reseller in said region as well as a delay in a large order from a
long-standing European customers.

In previous years, we experienced
fluctuations in our annual and quarterly results of operations, which resulted, and may
continue to result in the future, in volatility in our share price.

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

| |  | general
economic conditions;
| | - | ----------------------------

| |  | the
capital spending patterns of our customers ;
| | - | ------------------------------------------------

| |  | the
size and timing of orders, including order deferrals, and subsequent shipments;
| | - | -----------------------------------------------------------------------------------

| |  | market
acceptance of new products;
| | - | ----------------------------------

| |  | the
timing of our product  introductions  or  enhancements  or that of our  competitors  or
 providers  of               complementary products;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
percentage of sales for which we pay sales commissions;
| | - | -----------------------------------------------------------

| |  | disruptions
in our sources of supply; and
| | - | -----------------------------------------

| |  | increasing
delays between the receipt of awards and the formal issuances of purchase orders.
| | - | --------------------------------------------------------------------------------------------

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

We have entered into a
distribution agreement with ECI Telecom Ltd. (ECI) under which we appointed
ECI as our exclusive distributor in significant portions of the Former Soviet Union, which
are important markets for us. Accordingly, we are presently dependent upon ECI for the
achievement of sales in those markets.

In
June 2005 we entered into a distribution agreement with ECI under which we appointed ECI
as our exclusive distributor in the Russian Federation, Ukraine and Kazakhstan,
territories from which we expect, in the aggregate, to derive a significant portion of our
revenues in the near future. In 2006 we derived a significant portion of our revenues from
sales achieved through ECI in these territories. The agreement is subject to termination
by either party upon three months notice. In addition, either party may terminate
the agreement at any time upon a material breach by the other party or in the event of
liquidation or similar consequences of the other party. If ECI were to terminate this
agreement or if it does not succeed in obtaining orders for our products and services, for
whatever reason, our business and results of operations may be seriously harmed. For
example, our revenues for the first quarter of 2007 declined and we did not meet our
internal plans due in part to slower than anticipated orders, mainly from countries within
the Former Soviet Union carried out through our exclusive reseller in said
region.

3

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We maintain significant
cooperation with distribution channels for the sale of our products and services. If our
relationship with these distribution channels is for any reason impaired, our business and
results of operations may suffer.

We
have agreements in place with distributors and system integrators to market and sell our
products and services in addition to our direct sales force. We derive about one half of
our revenues from these distribution and system integrators channels. When a sale is
directed through a distribution channel and not directly by us, if the sales efforts of
these channels are not successful, we may lose sales opportunities, customers and market
share. In addition, there can be no assurance that our channel partners will not develop
or market products or services in competition with us in the future. Furthermore, our
financial results may be affected if our contracts with distribution channels were
terminated, if our relationship with channel partners was to deteriorate or if the
financial condition of our channel partners was to weaken.

Our business could be materially
adversely affected as a result of the risks associated with acquisitions and investments.
In particular, we may not be effective in integrating our acquisitions or succeed in
making additional acquisitions.

As
part of our growth strategy, we may pursue mergers and acquisitions of businesses,
products and technologies, or the establishment of joint venture arrangements, that could
expand our business. For example, in the fourth quarter of 2005 we acquired two sister
companies engaged in the development and marketing of Revenue Assurance solutions. Also,
during 2006 we carried out a due-diligence process for a potential acquisition
opportunity. Eventually, we decided not to complete the acquisition.

The
negotiation of potential acquisitions or joint ventures as well as the integration of an
acquired or jointly developed business, technology or product may absorb significant
management attention and involves large expenditure of funds that would otherwise be
available for the ongoing development of our business. In addition, the process of
integrating an acquired companys business into our operations and/or of investing in
new technologies may result in unforeseen operating difficulties and large expenditures.
Other risks commonly encountered with acquisitions include the effect of the acquisition
on our financial and strategic position and reputation, the failure of the acquired
business to further our strategies, the inability to successfully integrate or
commercialize acquired technologies or otherwise realize anticipated synergies or
economies of scale on a timely basis and the potential impairment of acquired assets.
Moreover, there can be no assurance that the anticipated benefits of any acquisition or
investment will be realized. Future acquisitions or investments contemplated and/or
consummated could result in potentially dilutive issuances of equity securities as part of
the consideration for such acquisitions or investments, the incurrence of debt and
contingent liabilities, and amortization expenses related to intangible assets, any of
which could have a material adverse effect on our operating results and financial
condition. In addition, we have limited experience with respect to operating acquired
businesses. There can be no assurance that we will be successful in making additional
acquisitions or effective in integrating such acquisitions into our existing business. If
the operation of the business of any future acquisitions disrupts our operations, our
business may suffer.

Consolidation of competitors may
adversely affect our sales and operating results.

In
recent years, our industry has experienced consolidation of solution providers, including
consolidation of some of our direct competitors. This may result in the creation of one or
more competitors possessing more significant market share than we possess. Competing
vendors who dominate the market or have a significantly larger market share can adversely
affect our business and operating results as operators may prefer to transact with these
consolidated solution providers for various reasons such as their larger customers base
and references sites, a larger sales, marketing and support organizations, and their
ability to educate and influence the market.

Developments affecting
telecommunication service providers, such as mergers, can adversely affect us.

Developments
in the telecommunications industry, such as the impact of general global economic
conditions, continued industry consolidation, the formation of alliances among network
operators and service providers, and changes in the regulatory environment have had, and
could continue to have, a material adverse effect on our existing or potential customers.
These conditions have reduced the high growth rates that the telecommunications industry
had previously experienced, and have caused the market value, financial results and
prospects, and capital spending levels of many telecommunications companies to decline or
degrade. In recent years, the telecommunications industry has experienced significant
financial pressures that have caused many in the industry to cut expenses and limit
investment in capital-intensive projects and have led to numerous restructurings and
bankruptcies. Recent telecommunications company mergers may have a material adverse effect
on our results of operations, as existing or potential customers may be purchased or two
customers may combine operations in a manner that results in a decline in repeat sales by
us, reduces the number of licenses we can sell to the combined entity or cause us to have
to repeat significant pre-sale efforts in respect of one or more of the merger parties.

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

New
technologies, such as VoIP, are facilitating the use of cheaper communications media and
new and reduced pricing schemes which are not entirely based on usage level and records,
such as flat rates, by some telecom operators. Such operators may be less inclined to
invest in high-end solutions like ours, which by their nature monitor the usage records.
Moreover, since these technologies enable service providers to offer relatively low
calling rates to subscribers, this may reduce the incentive to commit telecom fraud. This,
in turn, would reduce the need among service providers to constantly monitor revenue
related processes and thereby reduce the demand for anti-fraud and revenue assurance
solutions like ours. This trend may harm our revenues and results of operation.

4

---

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

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

| |  | the
time involved for our customers to determine and announce their specifications;
| | - | -----------------------------------------------------------------------------------

| |  | the
time required for our customers to process approvals for purchasing decisions;
| | - | ----------------------------------------------------------------------------------

| |  | 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.
| | - | --------------------------------------------------------------------------------------

If
customers continue to subject our products to lengthy evaluation processes, continue to
delay project approval, delays lengthen further, or if such continued delays result in the
eventual cancellation of any sale opportunities, it could harm our business and results of
operations.

Increased expense levels will harm
our business if our revenues do not grow.

Our
revenues for 2006 were $28.8 million, compared to $23.2 million for 2005. Our net
operating loss for 2006 was $3.5 million, compared with a net operating loss of $2.9
million for 2005. The increase in our operating loss in 2006 was mostly due to
non-recurring repayment of royalties to the Office of Chief Scientist and expenses for a
due-diligence process of potential acquisition. Our operating loss in 2006 was also
affected by the significant amount of compensation expense we recorded due to the impact
of a new accounting rule that required expensing of share-based awards  SFAS 123 (R)
Share-based payment. We expect costs relating to share-based compensation to
continue to have an adverse impact on our results of operations.

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

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

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

We
utilize single suppliers for some of our product components, including critical components
needed for some of our products. We cannot control the delivery schedule for these
components. In the event that any of these suppliers are unable to meet our requirements,
or fail to do so in a timely manner, we may experience an interruption in production until
an alternative source of supply can be obtained. Any disruption, or any other interruption
of a suppliers ability to provide components to us, could result in delays in making
product shipments, which could have a material adverse effect on our business, financial
condition and results of operations. Furthermore, as suppliers discontinue their products,
or modify them in manners incompatible with our current use, or use manufacturing
processes and tools that cannot be easily migrated to other vendors, we could have
significant delays in product availability, which would have a significant adverse impact
on our results of operations and financial condition. We cannot assure you that our
inventory and alternative sources of supply would be sufficient to avoid a material
interruption or delay in production and in availability of spare parts.

ECI,
our supplier of critical hardware components for our legacy probing devices, stopped
manufacturing some of these components as of August 2006. Accordingly, we contracted with
an alternative supplier for the performance of manufacturing services instead of ECI in
relation to these components. We are currently in the process of developing prototypes for
the components with the new supplier and will enter into serial production only after
successful completion of this process. If we are unable to satisfactorily complete the
creation of a suitable prototype and enter into serial production, or if the alternative
supplier becomes unable or unwilling to provide these components at some point in the
future, we may experience substantial delays in the manufacturing of certain of our
products and our business may suffer. In addition, we may be required, in the future, to
pay the alternative supplier higher prices for these components than the prices ECI
charged.

In
addition, in connection with our sale to Verint Systems of our government surveillance
business, we agreed to supply some of these components to Verint Systems for a period of
seven years. Any problems with our supplier that cause us to breach our obligations to
Verint Systems, which problems may not be under our control, could expose us to claims by
Verint Systems. Such claims could materially harm our financial condition.

5

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We depend upon subcontracted
outsourcers for the performance of certain of our European professional services and
operations. The failure of these outsourcers to meet our quality or performance
requirements may have a material adverse effect on our business, results of operations and
financial condition.

We
have outsourced a portion of our professional services and operations in Europe to a
subcontractor in Bulgaria. We believe that our future success will depend in part on our
ability to continue, expand and manage the use of outsourced subcontracting resources in
these and other respects. There are certain risks entailed in these practices, including
but not limited to: the continued availability of these resources is not assured; the
potential for migration of some expertise to a contractor outside of our organization; and
our policies relating to protection of intellectual property rights may be harder or not
possible to institute, manage or enforce in a subcontractor organization. In addition, as
Bulgaria joined the European Market on January 1, 2007, it is likely that the cost of our
Bulgarian outsourced operations would increase over time, as was the case with other
countries joining the European Market.

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

Because
of the global nature of our business, we are exposed to the risk of economic or political
instability in countries where our customers are located, particularly in developing
countries. In addition, there are often longer sales and payment cycles in developing
countries, as well as greater difficulties in collecting accounts receivable.

We
face additional risks from our international operations including:

| |  | difficulties
of obtaining licenses, the imposition of tariffs and the effects of other trade barriers;
| | - | ------------------------------------------------------------------------------------------------------

| |  | difficulties
in staffing and managing foreign operations;
| | - | ---------------------------------------------------------

| |  | potentially
adverse tax consequences;
| | - | -------------------------------------

| |  | laws
and business practices favoring local competitors;
| | - | -------------------------------------------------------

| |  | costs
and difficulties of customizing products for foreign countries;
| | - | ---------------------------------------------------------------------

| |  | compliance
with a wide variety of complex foreign laws and treaties;
| | - | --------------------------------------------------------------------

| |  | political
instability; and
| | - | --------------------------

| |  | variance
and unexpected changes in local laws and regulations.
| | - | --------------------------------------------------------------

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

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

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

We
are subject to the risk of adverse claims and litigation alleging infringement by us of
the intellectual property rights of others. Many participants in the telecommunications
industry have an increasing number of patents and patent applications and have frequently
demonstrated a readiness to pursue litigation based on allegations of patent and other
intellectual property infringement. All of our products rely on technology that could be
the subject of existing patents or patent applications of third parties. We have agreed to
indemnify our customers with respect to infringement by our products of the proprietary
rights of third parties. Third parties may assert infringement claims in the future with
respect to our current or future products. These claims may require us to enter into
license arrangements or result in protracted and costly litigation, regardless of the
merits of these claims. Any necessary licenses may not be available or, if available, may
not be obtainable on commercially reasonable terms. If we cannot obtain all necessary
licenses on commercially reasonable terms, we may be forced to stop selling our products
in some or all countries, and our business would be seriously harmed.

We are dependent upon Verint
Systems to perform our remaining obligations under certain contracts with government
customers on which we remained the named party.

In
connection with the sale to Verint Systems of our government surveillance business, we
remained the named party on a number of contracts which required additional performance,
including for warranty and other remaining services. With respect to these contracts, the
customers consented to the performance by Verint of all the remaining obligations of ECtel
under the contracts. The customers also agreed to communicate directly with Verint in
connection with the performance of the contracts by Verint. However, we still may be
liable to the customer in the event that Verint does not perform as required under these
agreements and our financial condition and results of operations may suffer if these
customers pursue claims against us. In the event that we suffer damages as a result of
Verints non-performance, we may pursue our indemnification rights against Verint.

6

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Volatility experienced by
telecommunications service providers may adversely affect our sales and operating results.

The
telecommunications service provider market to which we sell historically has been
volatile. From time to time this industry has experienced significant downturns. For
instance, beginning in late 2000 and continuing into 2003, the deterioration of the global
economy in general and economic uncertainty in the telecommunications market in particular
resulted in a decline of capital investment by telecommunications service providers. This
decline in capital expenditures significantly reduced our sales and also resulted in
pressure on the prices we charge for our products. Similarly, adverse market conditions in
the future could have a negative impact on our business by reducing the number and the
value of new contracts we are able to sign.

In addition to our software, our
products also contain certain hardware components. We must maintain sufficient inventory
levels of these components to meet anticipated demand. If we cannot predict orders
accurately, our inventory may become obsolete and our financial performance may be harmed.

Our
solutions consist of both software and hardware components. The timing and volume of our
customers orders are generally difficult to forecast for each quarter, as a
substantial majority of our sales are booked and shipped in the same quarter pursuant to
purchase orders. We purchase the hardware components of our solutions from a small number
of manufacturers, some of which may not always timely fill our orders. We must therefore
maintain or have available sufficient inventory levels to satisfy anticipated demand on a
timely basis. Maintaining sufficient inventory levels to assure prompt delivery of our
products increases the risk of inventory obsolescence and associated write-offs. A shift
in demand could also result in inventory write-offs, which could harm our financial
performance. For example, during the first half of 2004, we recorded an inventory
write-off of approximately $915 thousand in connection with inventory that became obsolete
or that we estimated that we would not be able to sell.

The payment cycle for our
receivables may reduce the cash we have available to operate and expand our business.

As
is typical in the telecommunications industry, our contracts may provide for payments
under a variety of payment schedules. For example, we may receive a deposit prior to
shipment, a partial payment upon delivery and final payment after 180 or 360 days from
delivery. Also, we may collect payments due to specific project milestones, upon specific
customization and development progress. Such payment cycles may adversely affect the cash
resources available to operate and expand our business.

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

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

We are subject to new European
regulations that will require us to use components consisting of environmentally friendly
materials. Compliance with these regulations may increase our costs and adversely affect
our results of operations.

We
are subject to new European telecommunications industry regulations requiring the use of
environmentally-friendly materials in telecommunications equipment. For example, pursuant
to a European Community directive, telecom equipment suppliers are required to cease using
specified materials that are not environmentally friendly by July 1, 2006. In
addition, telecom equipment suppliers are required under this directive to eliminate the
lead solders from their products by 2010. Compliance with these directives may require us
to undertake significant expenses with respect to the re-design of certain of our hardware
products or find other complying alternatives. In addition, we may be required to pay
higher prices for third party components that comply with this directive. Our inability or
failure to comply with these regulations could harm our ability to sell our products in
Europe and in any other countries that may adopt this directive, and may have an adverse
effect on our results of operations.

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

Our
business and future growth and success largely depend on the managerial and technical
skills of members of our management. If one or more of the members of the senior
management team are unable or unwilling to continue in our employ, our results of
operations could be materially and adversely affected.

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

7

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Under the terms of our acquisition
of Telesoft, we may be liable for Telesofts pre acquisition liabilities. These
liabilities may be in excess of amounts we reserved.

In
December 2005, we acquired all the shares of Telesoft and agreed to assume all of the
liabilities of Telesoft at the time of the acquisition. These liabilities might result in
us having to make cash payments. In addition, if such liabilities exceed the liabilities
we are aware of and have provided for in our financial statements or if there are
liabilities that we were not aware of at the time of the acquisition and for which we are
not indemnified, this could have an adverse affect on our financial condition and results
of operations.

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

U.S.
          holders of our ordinary shares face income tax risks. We believe that we were
          not a passive foreign investment company, commonly referred to as PFIC, for
          2006. There is a substantial risk that we may be classified as PFIC in 2004 and
          2005 as a result of our substantial cash position and the performance of our
          ordinary shares during those taxable years. If we would be classified as a PFIC
          for the years 2004 or 2005, U.S. holders who acquired or held our ordinary
          shares during those taxable years will be subject to the PFIC rules as described
          in Item 10 Additional Information  U.S. Federal Income Tax
          Considerations, regardless of whether we were a PFIC for 2006 or not. Our
          treatment as a PFIC could result in a reduction in the after-tax return to the
          holders of our ordinary shares and would likely cause a reduction in the value
          of such shares. For U.S. Federal income tax purposes, we will be classified as a
          PFIC for any taxable year in which either (i) 75% or more of our gross income is
          passive income, or (ii) at least 50% of the average value of all of our assets
          for the taxable year produce or are held for the production of passive income.
          For this purpose, cash is considered to be an asset which produces passive
          income. We would be classified as a PFIC, if the asset test described above was
          applied on the basis of our market capitalization. There is a possibility that
          the application of the asset test based on an alternative valuation of our total
          assets would also result in our being classified as a PFIC. If we are a PFIC for
          U.S. federal income tax purposes, highly complex rules would apply to U.S.
          Holders owning our ordinary shares. Accordingly, you are urged to consult your
          tax advisors regarding the application of such rules. United States Holders
          should carefully read Taxation  United States Federal Income Tax
          Consequences for a more complete discussion of the U.S. federal income tax
          risks related to owning and disposing of our ordinary shares.

# Risks Related to
Operations in Israel

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

Our
principal offices and manufacturing facilities and many of our suppliers are located in
Israel. Accordingly, political, economic and military conditions in Israel may directly
affect our business. Since the establishment of the State of Israel in 1948, a number of
armed conflicts have taken place between Israel and its Arab neighbors, as well as
incidents of civil unrest. Israel was recently engaged in an armed conflict with
Hezbollah, a Lebanese Islamist Shiite militia group and political party. In addition,
Israel and companies doing business with Israel have, in the past, been the subject of an
economic boycott. Although Israel has entered into various agreements with Egypt, Jordan
and the Palestinian Authority, Israel has been and is subject to civil unrest and
terrorist activity, with varying levels of severity, since September 2000. The recent
election of representatives of the Hamas movement to a majority of seats in the
Palestinian Legislative Council has created and may further create additional unrest and
uncertainty. In addition, the recent armed conflict with Hezbollah negatively affected
business conditions in Israel. Any future armed conflicts or political instability in the
region may negatively affect business conditions and adversely affect our results of
operations. In addition, the political and security situation in Israel may result in
parties with whom we have agreements involving performance in Israel claiming that they
are not obligated to perform their commitments under those agreements pursuant to force
majeure provisions in the agreements.

We
can give no assurance that security and political conditions will have no impact on our
business in the future. Hostilities involving Israel or the interruption or curtailment of
trade between Israel and its present trading partners could adversely affect our
operations and could make it more difficult for us to raise capital. While we did not
sustain damages from the recent conflict with Hezbollah referred to above, the operations
of manufacturers or other suppliers that are located in northern Israel, are within range
of Hezbollah missiles and may sustain damages in any future missile attack, which could
adversely affect our operations.

In
addition, our business insurance does not cover losses that may occur as a result of
events associated with the security situation in the Middle East. Although the Israeli
government currently covers the reinstatement value of direct damages that are caused by
terrorist attacks or acts of war, we cannot assure you that this government coverage will
be maintained. Any losses or damages incurred by us could have a material adverse effect
on our business.

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

Currently
our revenues are denominated primarily in U.S. dollars. Accordingly, devaluation in the
local currencies of our customers relative to the U.S. dollar could cause customers to
default on payment. An increasing portion of our revenues is now denominated in Euros, and
in the future additional revenues may be denominated in currencies other than U.S.
dollars, thereby exposing us to gains and losses on non-U.S. currency transactions.

A
significant portion of our expenses in New Israeli Shekels, commonly referred to as NIS.
As a result, we are exposed to risk to the extent that the rate of inflation in Israel
exceeds the rate of devaluation of the NIS in relation to the dollar or if the timing of
such devaluation lags behind inflation in Israel. In either event, the dollar cost of our
operations in Israel will increase and our dollar-measured results of operations will be
adversely affected.

8

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Our
operations also could be adversely affected if we are unable to hedge against currency
fluctuations in the future. Accordingly, we may enter into currency hedging transactions
to decrease the risk of financial exposure from fluctuations in the exchange rate of the
dollar against the NIS. These measures, however, may not adequately protect us from
material adverse effects due to the impact of inflation in Israel.

The tax benefits to which we are
currently entitled from the Investment Center of the Israeli Ministry of Industry, Trade
and Labor require us to meet several conditions and may be terminated or reduced in the
future, which would increase our taxes.

We
are entitled to tax benefits under Israeli law for capital investments that are designated
as approved enterprises. To maintain our eligibility for these tax benefits, we must
continue to meet conditions stipulated in applicable law and in our specific approvals,
including making specified investments in fixed assets. If we fail to comply with these
conditions, in whole or in part, with respect to any approved enterprise program we
establish, we may be required to pay additional taxes for the period in which we benefited
from the tax exemption or reduced tax rates and we would likely be denied these benefits
in the future. From time to time, we submit requests for expansion of our approved
enterprise programs or for new programs to be designated as approved enterprises. These
requests might not be approved, particularly in light of difficult economic conditions in
Israel. In addition, in March 2005, the law governing these tax benefits was amended to
revise the criteria for investments that qualify for tax benefits as an approved
enterprise. We cannot assure you that we will, in the future, be eligible to receive
additional tax benefits under this law. In addition, if we fail for any reason to meet the
conditions of an approved investment program, our future tax benefits under the Israeli
law for capital investments will be materially reduced. In light of our carry loss
forward, we are currently not in a taxable position.

We
received an approval in principle from the Investment Center with respect to the sale of
our government surveillance business to Verint Systems in March 2004. If the Investment
Center declines, for any reason, to grant us the final approval, our tax benefits under
Israeli law will be materially reduced, see Item 10 Additional Information 
Israeli Taxation. The termination or reduction of these tax benefits could seriously
harm our financial condition and results of operations.

Because we received grants from
the Office of the Chief Scientist, we are subject to ongoing restrictions, and certain of
our large shareholders are required to undertake to observe such restrictions.

We
received royalty-bearing grants from the Office of the Chief Scientist of the Israeli
Ministry of Industry Trade and Labor, or the Office of the Chief Scientist (OCS), for
research and development programs that meet specified criteria. According to Israeli law,
any products developed with grants from the OCS are required to be manufactured in Israel,
unless we obtain prior approval of a governmental committee. As a condition to obtaining
this approval, we may be required to pay the Office of the Chief Scientist up to 300% of
the grants we received and to repay such grants at a quicker rate. Furthermore, the
transfer to a non-Israeli entity of technology developed with OCS funding, including
pursuant to a merger or similar transaction, and the transfer of rights related to the
manufacture of more than 10% of a product developed with OCS funding are subject to
approval by an OCS committee and to various conditions, including payment by us to the OCS
of a percentage of the consideration paid to us or our shareholders in the transaction in
which the technology is transferred. In connection with a merger or similar transaction,
the amount payable would be a fraction of the consideration equal to the relative amount
invested by the OCS in the development of the relevant technology compared to the total
investment in our company, net of financial assets that we have at the time of the
transaction, but in no event less than the amount of the grant. In addition, in the event
that the committee believes that the consideration to be paid in a transaction requiring
payment to the OCS pursuant to the provisions of the law described above does not reflect
the true value of the technology or the company being acquired, it may determine an
alternate value to be used as the basis for calculating the requisite payments. These
restrictions may impair our ability to enter into agreements for those products or
technologies, without OCS approval.

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

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

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

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

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

| |  | adequate
 service of process has been effected and the defendant  has had a reasonable
 opportunity  to be               heard;
| | - | -------------------------------------------------------------------------------------------------------------------------------

| |  | the
judgment and its enforcement  are not contrary to the law,  public policy,  security or
sovereignty of               the State of Israel;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
judgment  was obtained  after due process  before a court of competent  jurisdiction
 according to the               rules of private international law prevailing in Israel;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

9

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| |  | the
judgment was not obtained by fraudulent  means and does not conflict with any other valid
 judgment in               the same matter between the same parties;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | an
action  between the same  parties in the same  matter is not  pending in any Israeli
 court at the time               the lawsuit is instituted in the U.S. court; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
U.S. court is not prohibited from enforcing judgments of Israeli courts.
| | - | ----------------------------------------------------------------------------

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

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

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

# Risks Related to the
Market for Our Ordinary Shares

We are currently a party to a
securities litigation class action lawsuit, which, if determined adversely, could
negatively affect our business and results of operations.

On
October 19, 2004, a class action complaint (the Class Action Complaint), Leumi
Gemel Ltd. v. ECtel Ltd., et al., Case No. 8:04-CV-03380-RWT, was filed in the United
States District Court for the District of Maryland. Named as defendants are ECtel Ltd.,
ECI Telecom Ltd., and certain of ECtels directors and officers. The Class Action
Complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934, and Rule 10b-5 promulgated thereunder, by making false and
misleading statements in the Companys SEC filings and press releases during a period
beginning April 24, 2001, and lasting through April 2, 2003. The claims are purportedly
brought on behalf of all persons who purchased our stock during that period. The
plaintiffs seek unspecified compensatory damages against the defendants, as well as
attorneys fees and costs.

The
Company filed a motion to dismiss the class action complaint. At a hearing on this motion
held on July 17, 2006, the Court granted our motion to dismiss the class action complaint.
Following the dismissal, the plaintiff filed a motion to further amend the class action
complaint. We responded by requesting that the Court deny the motion to amend. On March 6,
2007 the Court denied the plaintiffs motion to further amend the class-action.
Plaintiff notified us of their intention to appeal the lowers Courts ruling.
The Court of Appeal for the Fourth Circuit issued a briefing schedule for the appeal.
However, the parties have agreed to file a motion to postpone the appeal schedule pending
the decision of the United States Supreme Court in a case entitled Tellabs, Inc. v. Makor
Issues & Rights, Ltd., which is expected in June or July 2007. The issue to be decided
in the Tellabs case is arguably relevant to the instant case.

Litigation
of this sort could result in significant costs and a diversion of managements
attention and resources.

Our stock price has decreased
significantly in the past and could continue to fluctuate significantly in the future.

The
market price for our ordinary shares, as well as the prices of shares of other technology
companies, has been volatile. Our share price has decreased significantly since the first
quarter of 2003. Recently, following an announcement that our 2007 first quarter revenues
were lower than our internal work plan, our share price decreased significantly. Other
than the above mentioned recent decline, our share price increased during the last year.
Numerous factors, many of which are beyond our control, have caused and may continue to
cause the market price of our ordinary shares to fluctuate significantly, such as:

| |  | shortfalls
in our operating results from levels forecast by securities analysts and by us;
| | - | ------------------------------------------------------------------------------------------

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

| |  | announcements
concerning us, our affiliates, or our competitors;
| | - | ----------------------------------------------------------------

| |  | the
introduction of new telecommunications services;
| | - | ----------------------------------------------------

| |  | changes
in pricing policies by us or our competitors;
| | - | -----------------------------------------------------

| |  | failure
to successfully execute our growth strategy through the acquisition of other businesses;
| | - | ------------------------------------------------------------------------------------------------

| |  | market
conditions in our industry and the global economy in general; and
| | - | ------------------------------------------------------------------------

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

10

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

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

| | A. | History
and Development of the Company
| | -- | --------------------------------------

ECtel
Ltd. is our legal and commercial name. Until April 1998, we operated under the name ECI
Telesystems Ltd. We were incorporated as a wholly-owned subsidiary of ECI Telecom Ltd. on
April 4, 1990, under the laws of the State of Israel. Our principal executive offices are
located at 10 Haamal Street, Rosh Haayin, Israel and our telephone number is
(972-3) 900-2115. Our agent in the United States, ECtel Inc., is located at 8211 W.
Broward Blvd., Suite 460, Fort Lauderdale, FL.

On
December, 29, 2005, we acquired all of the outstanding shares of Telesoft. Telesoft is
engaged in the development and marketing of software solutions for the management of large
communications and internet networks, including its Revenue Assurance solution for
telecommunication services providers, which effectively complements our Integrated Revenue
Management solution. We believe that the acquisition of Telesoft has allowed us to provide
telecommunications service providers with a flexible solution that addresses all of their
revenue assurance needs.

# Principal Capital
Expenditures

Our
principal capital expenditures in the past three years (aside from the acquisition of
Telesoft) have been the purchase of equipment and other fixed assets used in our business
(mainly in Israel). Also, during 2005 we acquired Telesoft. The aggregate purchase price
was $2.5 million, consisting of $2.1 million in cash paid to Elron Electronic Industries
Ltd., as the seller, at the closing and $0.4 million in direct transaction costs
consisting primarily of professional fees.

Capital
equipment purchases totaled approximately $0.5 million in 2006, approximately $0.6 million
in 2005, and approximately $0.9 million in 2004. Our capital expenditures in 2006 were
primarily for the procurement of test and production equipment computers. We use internal
working capital to finance these capital expenditures.

| | B. | Business
Overview
| | -- | -----------------

# General

We
develop and market our Integrated Revenue Management®, or
IRM®, solutions. IRM enables communications service providers to deploy,
execute, and oversee multiple revenue management programs, such as our fraud prevention
and revenue assurance products, on the same platform. As a result, communications service
providers moving towards integrating all existing and future revenue management programs
can, initially, implement any part of the IRM, while gradually migrating to a
comprehensive IRM solution. Our solutions equip telecommunications service providers
with comprehensive data gathering, monitoring, control and analysis capabilities to
improve their operational efficiency and profitability by:

| |  | detecting
and preventing fraud;
| | - | -------------------------------

| |  | monitoring
and controlling revenue related processes;
| | - | -----------------------------------------------------

| |  | detecting
revenue leakage,  (i.e. failure of a telecommunications  service provider to correctly
and fully               bill and collect  revenues  for  services  provided by it), as
part of a revenue  assurance  process,               including leakage of billing events;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | helping
to settle interconnect disputes between operators.
| | - | ----------------------------------------------------------

# Industry Overview

Changes
in the Telecommunications Industry

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

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

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

11

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Increased
Focus on Operational Improvements and Revenue Assurance. Due to competitive industry
conditions, service providers have often been forced to lower the prices they charge for
value added services. In turn, lower prices have resulted in lower profit margins for the
service providers with respect to these value-added services. Operators seeking greater
profitability per subscriber are looking internally to improve business efficiency to
ensure that they capture as much of the revenues associated with these value added
services as possible. In addition, the recent increase in regulatory scrutiny by US
security laws and other countries regulationserve as an incentive for our
potential customers to implement advanced revenue assurance systems, thereby improving the
quality of their internal controls.

On
the other hand, new technologies, such as VoIP, are facilitating the use of cheaper
communications media and new and reduced pricing schemes which are not entirely based on
usage level and records, such as flat rates, by some telecom operators. Such operators may
be less inclined to invest in high-end solutions like ours, which by their nature monitor
the usage records. Moreover, since these technologies enable service providers to offer
relatively low calling rates to subscribers, this may reduce the incentive to commit
telecom fraud. This, in turn, may reduce the need among service providers to constantly
monitor revenue related processes and thereby reduce the demand for anti-fraud and revenue
assurance solutions like ours.

Service
Provider Challenges

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

Fraud
and Revenue Leakage Prevention. Fraud and revenue leakage typically represent a
significant loss of revenues for service providers. We believe that there are several
significant reasons telecommunications service providers invest in fraud and revenue
leakage prevention:

| |  | The
complexities of telecommunications networks, and the large number of interconnected
billing systems, operations support systems (OSS) and business support systems, present
an environment in which failures and errors of such networks and systems, their
interconnectivity or the lack of such interconnectivity, as well as human errors, are
likely to occur. Such failures might affect the revenues and the profitability of the
service providers. Operators are seeking solutions such as ours to monitor and supervise
their revenue-affecting processes in order to minimize the effect of such failures and
errors;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Product
improvements, increased maturity of the revenue assurance market, and market education by
independent software vendors and consultants, is increasing the willingness of operators
to shift some of their investments in outsourced revenue assurance services towards
internally-deployed revenue assurance software products;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
current competitive business environment in the communications markets drives operators
to increase their focus on profitability per customer in addition to number of customers
and average revenue per customer. Operators must therefore look internally to improve
execution and internal operations, such as with respect to fraud and revenue leakage
prevention;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Immature
systems, products, and processes that result from adoption of emerging technologies, such
as Next Generation, VoIP, and 3G, and innovative services, including high value
transactions such as on-line banking, mobile commerce, and content, as well as from the
integration of operators systems after mergers and consolidations among operators
and internal changes in operators organizational structure, increase vulnerability
to errors, faults, leakage and fraud; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | In
some countries, pirate services providers have begun providing international
voice service on data lines which they lease from the network operator. 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 fraud prevention and revenue assurance
solutions in order to overcome these challenges and effectively detect and prevent fraud
in modern telecommunications networks.

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

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

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# The ECtel Solution

We
develop and market our Integrated Revenue Management®, (or IRM®), framework. IRM
enables communications service providers of both wireline, wireless, IP and converged
networks to deploy, execute, and oversee multiple revenue management products such as our
fraud prevention and revenue assurance products, on the same platform. As a result,
communications service providers moving towards integrating all existing and future
revenue management programs can, initially, implement any part of the IRM, while gradually
migrating to comprehensive IRM solutions. Our products consist of proprietary
software and hardware components, as well as off-the-shelf hardware and software
components.

We
believe that our solutions provide our customers with the following benefits:

| |  | Comprehensive
View of the Network. Modern international communications networks function on a
variety of transmission protocols. For example, transmission protocols for
circuit-switched networks are different from those used in packet-switched networks. Our
solutions have the capability to view and analyze many of the transmission protocols used
in converged networks. In addition, our solutions are capable of viewing and analyzing
not only the signaling information, but also the embedded session information. Signaling
information consists of basic information, such as time and place of origin and
destination of the message. Embedded session information includes the classification of
message type (e.g., voice, fax or data) and information regarding the message content,
such as touch tones initiated during a call. Most alternative solutions provided by our
competitors only analyze the signaling information. Moreover, our solutions perform the
crucial mediation function, which is necessary in order to analyze and correlate data
from a wide variety of information sources in a packet-switched network. These
information sources include specialized probes that provide value-added services and
other applications. As a result, our solutions are generally able to provide a more
comprehensive view of modern, interconnected networks than those of our competitors.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Real-Time
Functionality. Our system 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. Based on
this information, the provider can reroute traffic and initiate maintenance on its
network within minutes.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Flexible,
Scalable, Multi-Application Platform. Our system platform has been designed to meet
the continually evolving requirements of service providers. Our platform is based on a
modular architecture, which enables our customers to easily and cost-effectively add
capacity and network coverage. In addition, because all of our applications run on the
same platform, our customers can easily add new functionalities to their installed
solution. Our solutions can also be easily upgraded to keep up with the rapid
introduction of new technologies and services.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Vendor
Independent Solutions. Our probing solutions analyze raw signaling information and
embedded session information, each captured directly from the network. These solutions do
not rely on information provided in vendor-specific format such as data that is processed
and formatted for billing systems. By analyzing raw information, our fraud prevention
system enables our customers to detect types of fraud that would not be detected by
analyzing only processed data. For example, our solutions capture and analyze information
about unsuccessful call attempts, which is not usually registered with billing systems,
and which is important in detecting some types of fraud and implementing a proactive
approach for fraud prevention.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Sophisticated
Algorithms. We have developed sophisticated proprietary algorithms to enable our
products to perform comprehensive session analyses. Using these algorithms and supporting
hardware, our solutions can analyze signaling information and embedded session
information on multiple channels simultaneously. For example, our powerful data-mining
algorithm uses neural networks and decision tree techniques that enable our fraud
prevention solutions to detect types of fraud that the rule-based solutions of many of
our competitors are unable to detect. We have also developed proprietary digital signal
processing algorithms to enable our products to perform comprehensive session signal
analysis.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Personalized
Dashboards. Our system 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 revenue
assurance professional may use our revenue assurance products to view a bar graph showing
revenue leakages for various products offered by the service provider. At the same time,
its marketing professional may use the same product to view usage information. Using a
standard personal computer, each user can generate customized reports and easily select,
organize and analyze the data relevant to the user.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Business Strategy

Our
objective is to be a leading provider of integrated revenue management solutions
worldwide. Currently our IRM® suite of integrated revenue management solutions
includes fraud prevention solutions and revenue assurance solutions. The following are
key elements of our strategy:

13

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| |  | Offer
Comprehensive Fraud Prevention and Revenue Assurance Solutions within our IRM suite.
We offer our service provider customers comprehensive fraud prevention and revenue
assurance solutions to meet their fraud prevention and revenue assurance needs. We also
seek to regularly add new functionality and applications to our products to enable our
customers to meet the full range of fraud prevention and revenue assurance challenges
that exist in converged networks. We continually seek to adapt our existing fraud
prevention and revenue assurance solutions to be compatible with emerging technologies
and services.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Pursue
Organic and Non-Organic Growth.We plan to grow our business by increasing our
installed base of customers and by offering additional solutions to telecom operators in
fields related to our current business. By doing so, we will be able to leverage our
sales channels and customers base for the sale of additional solutions. In order to
execute such growth plan we pursue Mergers & Acquisitions with other suppliers. We
consider acquisition of companies that provide us with additional products, with
complementary sales channels and customers, and that will increase the overall
shareholder value.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Maintain
and Enhance Our Technological Leadership. We believe that our technology platform
provides us with a competitive advantage in developing revenue assurance solutions to
meet the rapidly changing needs of service providers. We have invested significant
resources over the years in both internal development and selective acquisitions. We
intend to continue to invest in our technology, through internal development and
selective acquisitions, to maintain our position as a technological leader in revenue
assurance solutions.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 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. We have sold our solutions to many of
the worlds largest telecommunications service providers, including Hutchison H3G,
O2, Portugal Telecom, MCI, Telenor (Vodafone Sweden), Kyivstar, Qwest Communications
International, Swisscom, the Telefonica Group, Serbia Telecom and Rostelecom. We believe
that sales to market leaders will assist our marketing efforts to establish our brand
name and industry position.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Maintain
Direct and Interactive Relationships With Our Customers. We work closely with our
existing customers, both to support the solutions already sold to them, and to provide
additional products through cross sales and professional services to help them 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 evolving needs of the
marketplace.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Products

Fraud
Prevention Solutions

Our
fraud prevention solutions enable communication service providers (CSPs) to detect,
prevent and manage the treatment of suspected fraudulent activities. The system gathers
information about calls both in real-time and offline and compares it to fraudulent
scenarios established within user-specified filter parameters, subscriber profiles and
thresholds. When defined thresholds are reached, an alert is automatically generated and
appropriate intervention can take place according to the users chosen parameters.
Our FraudView® system provides comprehensive fraud detection and prevention solution
for wireline, wireless and next generation networks.

During
2006 we launched a new version of our fraud prevention solution, FraudView 8. This new
release features an array of fraud detection and prevention technologies, enabling large
amount of anti-fraud checks and controls for the protection of operators business.
In addition, it enables and facilitates a subscriber-centric fraud management process, in
which a fraud analyst can evaluate the behavior of its subscribers by reviewing
information obtained from various sources, which was consolidated and analyzed by the
FraudView® system.

Revenue
Assurance Solutions

Our
revenue assurance solutions enable wireline, wireless, and next-generation communications
service providers (CSPs) to implement automated revenue assurance processes which
facilitate auditing the accuracy of billing processes, including revenue leakage
detection, help settling of interconnect disputes between operators, monitor network usage
and provide traffic trend reports. Our solution gathers information such as call and
customer details as well as trends and balances from several sources, and compares the
information in order to discover discrepancies and generate Key Performance Indicators
(KPIs), which are metrics that help the user quantify the level of leakage and level of
performance of a certain revenue-related process. Each user can build, revise and add KPIs
according to its organizational needs. Through its top-down viewing approach, it empowers
users to locate risk points, validate revenue assurance processes, prioritize repair
actions and fix leakages. Our RAP product is an automated revenue assurance product
that facilitates cost-effective assurance of revenues and processes.

Integrated
Revenue Management (IRM) Platform for both Solutions

Our
IRM platform can be leveraged  for both our fraud  prevention  and revenue  assurance
 solutions.  The platform includes the following components

| |  | Probes;
| | - | -------

| |  | Data
Management Layer or data loaders; and
| | - | ------------------------------------------

| |  | Dashboard.
| | - | ----------

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

Data
Management Layer or data loaders software component. Our software solutions perform
the crucial data loading and data preparation functions. This consists of extracting,
collecting, re-formatting, filtering and enriching raw data from various network elements
and management systems, including switches, soft switches, billing systems, mediation
systems, CRM systems, routers, authentication servers, VoIP gateways and other information
systems. This information can be combined with information obtained from probes to create
complete data records relating to sessions passing through the network.

DashBoard.
          Our solutions include installed software with a central display that provides an
          overview of key information and KPIs. It is fully configurable and provides
          enterprise-wide visibility across all monitored revenue and cost streams. It
          enables users to drill down to the raw data level of each KPI. It also provides
          users and managers with a wide range of analytical and statistical reports,
          including multi-level reports with drill-down capabilities.

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

| |  | Scale
the capacity and processing power of our products;
| | - | --------------------------------------------------------

| |  | Add
new applications to an installed system; and
| | - | ------------------------------------------------

| |  | Assimilate
new and emerging network standards, devices and applications.
| | - | ------------------------------------------------------------------------

# Sales and Marketing

As
of March 31, 2007, our direct sales force and marketing staff consisted of 26 employees
worldwide. We market our fraud prevention and revenue assurance solutions to service
providers worldwide, through a direct sales force, as well as indirect. Our sales staff
operates out of our offices in Israel and the United States. In addition, we engage local
sales representatives, distributors and sales consultants worldwide. In some territories,
we engage full time sales consultants for management of sales activities in those
territories.

Sales
of our fraud prevention and revenue assurance solutions are made predominantly to large
service providers and involve lengthy evaluation processes before the customers issue
purchase orders. Because the purchase of our products is a relatively significant capital
expenditure, prospective customers generally commit substantial resources to an evaluation
of our solutions and require us to expend significant time, effort and money educating
them about the value of our solutions. This sales cycle for our solutions is an average of
between 6 and 18 months. Our primary marketing activities include raising awareness among
existing and potential customers of the benefits provided by the features of our products.
We utilize the sales and marketing services of local sales representatives for such
activities. We also participate in exhibitions and industry trade shows in an effort to
promote our products.

# Customers

Our
customers are communications service providers, of both fixed and wireless services. We
have recently sold our solutions to leading CSPs worldwide, including the following:

| |                  |                 
| | ---------------- | ----------------
|
|
|
|
| | Rostelecom       | Kyivstar        
| | Telefonica Group | Serbia Telecom  
| | 02               | T-Com Croatia   
| | Cellcom          | Namibia Telecom 
| | Embratel         | Portugal Telecom
| | Hutchison H3G   

In
2006, our top ten customers accounted for 59.24% of our revenues, with sales to three
customers in Eastern Europe accounting for 28.9% of our revenues, one of which accounted
for 16.0% of our revenues. In 2005, our top ten customers accounted for 59.1% of our
revenues, with sales to three customers in Eastern Europe accounting for 26.0% of our
revenues, one of which accounted for 10.1% of our revenues, and sales to three customers
in Latin America accounting for 16.6% of our revenues.

15

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The
following table shows a breakdown of our revenues by geographical region during 2006, 2005
and 2004 ($ in thousands):

|                        | 2006 | 2005 | 2004
|----------------------- | ---- | ---- | ----
|
|
|
|
|Europe                  |      |      |     
|Americas                |      |      |     
|Middle East and Africa  |      |      |     
|Asia Pacific and others |      |      |     
|                        |      |      |     
|                        |      |      |     
|                        |      |      |     

# PSO (Professional
Services Organization)

In
the summer of 2004, we formed a professional services organization (PSO). This
organization consists of technical personnel possessing an in-depth understanding of
customers business environments. The PSO provides to our customers comprehensive
technical services, including consulting services, project management, training and
on-going support, thereby maximizing the value of our Integrated Revenue Management
solution to our customers. In addition, we have outsourced a portion of our technical
services and activities in Europe to a subcontractor in Bulgaria.

We
have focused on building a strong service and support organization for our systems. We
maintain at our headquarters in Israel a staff of highly skilled customer service
engineers that offer support to our dealers or partners that offer direct support to our
customers. These service engineers, as well as additional service engineers located in our
offices in the United States and Europe, provide first class field services and support.
We maintain training and expert guidance services for our customers, as well.

Following
the establishment of our PSO in 2004, we have increased our revenues from maintenance and
support. This, we believe, is mainly attributable to our increased emphasis on customer
satisfaction.

Our
products are generally sold with a warranty for repairs of hardware and software defects
and malfunctions, the term of which is usually one year after acceptance of the system.
Post-warranty support and maintenance services are made available to customers on a
contractual basis for an additional charge. The maintenance agreements generally provide
for remote support and maintenance as well as updates to correct minor bugs or errors in
the software. Upgrades and enhancements to the software may be purchased as part of the
support and maintenance services for additional consideration and subject to additional
specific terms.

# Manufacturing

We
purchase some hardware, such as servers and storage devices, from third party vendors such
as IBM and Hewlett Packard. Our manufacturing operations consist primarily of integration,
final assembly and testing, involving the application of extensive testing and quality
control procedures to materials, modules, subassemblies and systems. ECI, our supplier of
modules and components for our legacy probing devices, stopped manufacturing some of these
components as of August 2006. Accordingly, we contracted with an alternate supplier for
the manufacture of these components.

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

# Research and Development

In
order to accommodate the rapidly changing needs of our markets, we place considerable
emphasis on research and development projects designed to improve our existing product
lines, develop new product lines and customize our products to meet our customers
needs. As of March 31, 2007, 37 of our employees were engaged primarily in product
development activities. We expect that we will continue to commit substantial resources to
product development in the future.

As
a recipient of grants from the OCS, we are obligated to perform, in Israel, all
development activities related to products under these grants, unless we receive an
exemption. Know-how from the research and development used to produce these products may
not be transferred to third parties without the approval of the OCS. Approval is not
required for the export of any products resulting from the research and development based
on these grants. Also, during the fourth quarter of 2006, we committed to repay in full
all the grants related to programs connected to our FraudView® solution. For further
information regarding the OCS of the Israeli Ministry of Industry, Trade and Labor, see
Item 5C  Research and Development, Patents and Licenses  Grants from the
OCS.

16

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# Competition

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

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

Our
main competitors in the fraud prevention and revenue assurance markets are Subex-Azure
Limited, Hewlett-Packard, Cape Technologies Limited, WeDo Consulting, FairIsaac Corp.,
Martin Dawes Systems and Neural Technologies Limited.

In
recent years, our industry has experienced consolidation of solution providers, including
consolidation of some of our direct competitors. This may result in the creation of one or
more competitors possessing more significant market share than we possess. We believe that
the principal competitive factors in the markets in which we compete are product
functionality, the ability to provide effective and comprehensive solutions,
recommendations and references of other customers, pricing, timely introduction of new
products, especially products of next generation networks, and responsive customer
support.

# Intellectual Property
and Proprietary Rights

The
telecommunications industry is characterized to a great extent by its reliance on
proprietary technology. We believe that we own or have the license to use the technologies
used in our products. We depend on a combination of technical innovations, trade secrets,
and non-disclosure agreements for the protection of this technology. Also, we are filing
patent applications to protect our technology and trademark applications to register our
trademarks. We have nine registered patents, of which 6 were granted in 2006, and 2
pending patent applications. Various trademarks of ours have already been registered in
certain countries.

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

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

Our
registered trademarks include QUALIVIEW, FRAUDVIEW, TRP, VOICEMATE, QUALINET, QUALIPHONE,
QUALIWEB, QUALICELL, SS7COUNTER, CASHVIEW, IC-GUARD, PROFEDGE, NETRACE, I-PROBE, SIGVIEW,
X-ELLENCE, X-PERTVIEW, INTERPROBE, NGN FRAUDVIEW, HAWKEYE, QUALIVOIP, QUALIMOBILE,
PRE-VIEW, VALUEROUTE, BILLGUARD, FLOWGUARD, SERVGUARD, INTEGRATED REVENUE MANAGEMENT and IRM.

# Government Regulations

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

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

| | C. | Organizational
Structure
| | -- | ------------------------

Prior
to May 10, 2004, ECI held of record 10,490,325, or approximately 57.9%, of our outstanding
ordinary shares. On May 10, 2004 ECI distributed 7,600,000 ordinary shares to its
shareholders and as a result, ECI held 2,890,325, or 15.9%, of our outstanding ordinary
shares. On June 28, 2006 ECI distributed its remaining shares of ECtel as dividend to its
shareholders. As a result, ECI is no longer a shareholder of ECtel.

As
of March 31, 2007, IDB beneficially held approximately 31% of our outstanding shares as
well as approximately 40% of ECIs outstanding shares.

17

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In
December 2006, we established a wholly owned subsidiary in Bulgaria named ECtel Bulgaria
EOOD.

We
own all the outstanding shares of

| |  | ECtel
Inc., a Maryland corporation;
| | - | -----------------------------------

| |  | ECtel
(2000) U.K. Ltd., a U.K. company;
| | - | ---------------------------------------

| |  | ECtel
Telesoft Ltd, an Israeli company;
| | - | ---------------------------------------

| |  | ECtel
Telesoft Export (98) Ltd, an Israeli company;
| | - | ---------------------------------------------------

| |  | ECtel
BV, a Dutch company which, in turn, holds all of the shares of ECtel GmbH, a German
company;
| | - | --------------------------------------------------------------------------------------------------

| |  | ECtel
Bulgaria EOOD, a Bulgarian company; and
| | - | ---------------------------------------------

| |  | Telrad
Hawk Net - I Ltd. (in voluntary liquidation), an Israeli company
| | - | -----------------------------------------------------------------------

| | D. | Property,
Plants and Equipment
| | -- | ------------------------------

We
lease our headquarters and main facilities located in Rosh Haayin, Israel. The
facilities occupy approximately 37,232 square feet. We lease these facilities pursuant to
an agreement and the lease period commenced on July 10, 2005 and runs through June 30,
2015. We are entitled to shorten the term of the lease at any time following its fifth or
sixth anniversary, subject to certain penalty payments. We are further entitled to
discontinue the lease on the seventh, eight, or ninth anniversaries, upon providing six
months written notice, without any penalty payments.

ECtel
Inc., our U.S. subsidiary, leases approximately 1,500 square feet of office space in
Florida. The term of the Florida lease is through February 29, 2008.

ECtel
GmbH leases approximately 970 square feet of office space from ECI Telecom GmbH in
Oberrursel, Germany, on an ongoing basis. This lease will continue, unless either party
notifies the other party of its wish to terminate it.

We
believe that our existing facilities are adequate to meet our current and foreseeable
needs.

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

Not
Applicable.

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

| | A. | Operating
Results
| | -- | -----------------

We
make forward-looking statements in this annual report and in other filings with the United
States Securities and Exchange Commission. You can identify these forward-looking
statements by use of words such as strategy, expects,
continues, plans, anticipates, believes,
may, estimates, intends, projects,
goals, targets, and other words of similar meaning. You can also
identify them by the fact that they do not relate strictly to historical or current facts.

We
cannot assure you that any forward-looking statement will be realized, although we believe
we have been prudent in our plans and assumptions. Achievement of future results is
subject to risks, uncertainties and inaccurate assumptions. Should known or unknown risks
or uncertainties materialize, or should underlying assumptions prove inaccurate, actual
results could vary materially from those anticipated, estimated or projected. Investors
should bear this in mind as they consider forward-looking statements and whether to invest
or remain invested in ECtel securities. The forward-looking statements relate to, among
other things: revenues, operating results; anticipated cash flows; gross margins; and the
markets acceptance of our technologies, products and solutions.

In
connection with the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, we are identifying important factors that, individually or
in the aggregate, could cause actual results and outcomes to differ materially from those
contained in any forward-looking statements made by us; any such statement is qualified by
reference to the following cautionary statements. Please read the section above entitled
Risk Factors to review conditions that we believe could cause actual results
to differ materially from those contemplated by the forward-looking statements. You should
understand that it is not possible to predict or identify all risk-factors. Consequently,
you should not consider the factors discussed in Risk Factors to be a complete
discussion of all potential risks or uncertainties. Readers are cautioned not to place
undue reliance on these forward-looking statements, which reflect our view only as of the
date of this annual report. Except as required by law, we undertake no obligation to
update these forward-looking statements to reflect future events or circumstances or the
occurrence of unanticipated events.

18

---

---



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

# Overview

We
develop and market Integrated Revenue Management® (IRM®) solutions for wireline,
wireless, converged and next-generation operators. Our solutions equip telecommunications
service providers with comprehensive data gathering and analysis capabilities to improve
their operational efficiency and profitability by:

| |  | Detecting
and preventing fraud;
| | - | -------------------------------

| |  | Supporting
revenue assurance, including call leakage detection;
| | - | ---------------------------------------------------------------

| |  | Helping
to settle interconnect disputes between operators; and
| | - | --------------------------------------------------------------

| |  | Monitoring
network usage and providing traffic trend reports.
| | - | -------------------------------------------------------------

During
the last two quarters of 2004 andthroughout 2005, our efforts were aimed at
rebuilding our core telecom business, which had deteriorated in 2003. Our business plan
for that time period included measures to reduce our cost structure and steps intended to
align our costs and revenues, including a material reduction of our global workforce and
the consolidation of several of our activities. In connection with the implementation of
the plan, we recorded $3.4 million in reorganization and related expenses in June 2004,
associated with payroll expenses, disposal of fixed assets, early termination penalties
with respect to certain leases and other costs.

In
December 2005, we acquired Telesoft, comprised of two sister companies engaged in the
development and marketing of software solutions for the management of large communications
and internet networks, for $2.5 million. We believe that this acquisition enables us to
provide communications services providers with a comprehensive Integrated Revenue
Management solution.

During
2005 we increased our revenues and we believe that the revenue growth was primarily due
to:

| |  | The
intensified focus of our organization on the telecom market and on improving our
performance, a focus enabled by our disposition of our government surveillance business
and the reengagement of senior management in our core business.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
increase in our maintenance revenues comprised largely of renewals and extensions from
our installed customer base, including customers that had previously declined or
hesitated to purchase maintenance contracts from us. We believe that the growth in
maintenance revenues, in turn, resulted from our formation, in 2004, of a professional
services organization, which we refer to as our PSO. Our PSO provides comprehensive
consulting services, project management, training and on-going support to our customers,
thereby maximizing the value of our products to our customers and evidencing renewed
dedication to our customer base.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Recognition
of revenues from new customers wins, including orders for our FraudView product suite
from major telecommunication carriers in Eastern Europe and Latin America.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

During
2006 we increased our revenues, both by winning new accounts, including orders for our
FraudView and RAP solutions from major telecommunication carriers in various geographic
regions, and by making sales to existing customers including sales of a new version of our
FraudView product. We kept increasing our maintenance and support revenues largely through
renewals and extensions from our installed customer base. We also believe that our larger
installed customer base resulting from the acquisition of Telesoft may further increase
our revenues from maintenance and support and allow for cross-sales opportunities.

Although
our operating and net loss for 2006 increased compared to 2005, the increase was largely
due to several factors, which we do not anticipate recurring in the foreseeable future.
These factors include: (a) a provision for royalties to the OCS in the amount of
approximately $2.8 million (comprised of $2.2 million for royalties and $0.6 for financial
interest) which amount is to be paid during 2007, and which represents substantially full
repayment of prior funding to the OCS arising from its participation plan with respect to
our FraudView solution and (b) acquisition-related expenses in connection with a potential
acquisition that was not completed in the amount of $0.6 million.

Provision
for repayment of royalties to the OCS was made based on the reduced economic benefit that
we can gain from participating in the OCS programs, due to recent increase in revenues as
well as internal revenues growth projections from the launch of new version of our fraud
prevention solution, FraudView 8.

Our
loss in 2006 was also affected by an amount of approximately $1 million for share-based
compensation expense. We expect costs relating to share-based compensation to continue to
have an adverse impact on our results of operations.

On
March 19, 2007 we announced that Eitan Naor, will step down as President and CEO of the
Company at the end of June 2007.

19

---

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On
April 12, 2007, we announced that our revenues for the first quarter of 2007 declined and
we did not meet our internal plans due, in part, to slower than anticipated orders, mainly
from countries within the Former Soviet Union carried out through our exclusive reseller
in said region as well as a delay in a large order from a long-standing European
customers.

On
April 16, 2007 we announced that the Company has promoted Itzik Weinstein, our Executive
Vice President of Professional Services & Operations, to serve as our new President
and Chief Executive Officer, commencing May 1, 2007 and that Itzik Weinstein will replace
Eitan Naor who will be working with Itzik until June 30th, 2007 to facilitate a
smooth transition and assumption of responsibilities.

On
May 7, 2007, we announced that Ron Fainaro, our Executive Vice President and Chief
Financial Officer, has decided to leave the Company to pursue other business
opportunities. Mr. Fainaros resignation will become effective during the third
quarter of 2007. ECtels CEO immediately launched a search to locate a qualified
successor.

# Acquisitions and
Dispositions

Our
business and financial position during the three years ended December 31, 2006 were
influenced by an acquisitions and disposition, as well as by potential acquisition
opportunity which was not completed. The acquisitions were accounted for as purchase, and,
accordingly, the purchase price for the acquisitions were allocated to the assets acquired
and liabilities assumed based on their respective fair values. The results of operations
related to acquisitions are included in our consolidated statements of operations from the
date of acquisitions. The following are details for each of these acquisitions and
disposition:

| |  | On
December 29, 2005, we acquired Telesoft, from Elron Electronic Industries Ltd. The
aggregate purchase price was $2.5 million consisting of $2.1 million in cash paid to
Elron Electronic Industries Ltd., as the seller at the closing and $0.4 million in direct
transaction costs consisting primarily of professional fees. In addition to the purchase
price, we were obligated to pay to Elron Electronic Industries an amount of up to $0.4
million in connection with an earn outif certain milestones were met, in
accordance with purchase agreement. The earn-outwas over the period of 12 months
following the closing date. As of December 31, 2006, no such earn-out had been paid as
the milestones had not been met.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | On
March 31, 2004, we sold our government surveillance business to Verint Systems.
Accordingly, our statements of operations, including those of prior periods, reflect the
results of operations of this business in the line item called income (loss) from
discontinued operations. All data in this Annual Report derived from our statements
of operations, unless otherwise specified, exclude our government surveillance business.
Pursuant to the asset purchase agreement, Verint Systems purchased certain assets and
assumed certain liabilities relating to the government surveillance business for $35
million in cash. The transferred assets included certain intellectual property rights (as
more fully described below), fixed assets, backlog contracts, agreements with
subcontractors and suppliers, third-party software licenses and outstanding customer
proposals. The assumed liabilities included employment-related liabilities in respect of
our employees who were hired by Verint including retention bonuses, severance and
compensation liabilities with respect to the termination of certain of our officers, and
an accrual for certain research and development and customization expenses, see Item
10 Additional Information  Material Contracts.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | On
October 1, 2001, we acquired all of the outstanding shares of Telrad Hawk Net-I Ltd., or
Net-I. As a result of the purchase of Net-I, goodwill in amount of $16.3 million was
created (as at the date of purchase). On December 29, 2004, we resolved to voluntarily
liquidate it and appointed an attorney to serve as its liquidator. This liquidation
process has not had a significant effect on our consolidated financial statements.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Share Repurchase Plan

In
April 2006 we announced a plan to repurchase our ordinary shares on the open market in an
amount in cash of up to $15 million. Since we adopted the plan, we repurchased an amount
of 2,304,794 of our ordinary shares for total consideration of $11.5 million. As of
December 31, 2006, our total cash, subsequent to the share repurchase, was approximately
$37.1 million. See also Liquidity and Capital Resources in connection with our
cash position.

# Results of Operations

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

20

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|                                                       | Year ended December 31,
|------------------------------------------------------ | -----------------------
|
|
|
|
|Revenues                                               |                        
|Cost of revenues                                       |                        
|                                                       |                        
|                                                       |                        
|Gross profit                                           |                        
|Research and development costs, net                    |                        
|Selling and marketing expenses                         |                        
|General and administrative expenses                    |                        
|Restructuring and related impairment costs             |                        
|Amortization of acquisition-related intangible assets  |                        
|Acquisition-related expenses                           |                        
|Goodwill impairment                                    |                        
|                                                       |                        
|                                                       |                        
|Total operating expenses                               |                        
|                                                       |                        
|                                                       |                        
|Operating loss                                         |                        
|Financial income, net                                  |                        
|Other income (expenses), net                           |                        
|                                                       |                        
|                                                       |                        
|Loss from continuing operations before taxes on income |                        
|Income tax benefit (expense)                           |                        
|                                                       |                        
|Net loss from continuing operations                    |                        
|                                                       |                        
|Net income from discontinued operations                |                        
|                                                       |                        
|                                                       |                        
|Net loss                                               |                        

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

Comparison of 2006, 2005
and 2004

Revenues

Our
revenues consist of fees from the sale of our solutions, which include software and
hardware, as well as licenses of software and hardware of third parties, to
telecommunications services providers, and from fees for maintenance and other related
services.

2006
vs. 2005

Total
revenues increased by 24% from $23.2 million in 2005 to $28.8 million in 2006, for the
reasons discussed above in the Overview of this section.

2005
vs. 2004

Total
revenues increased by 84% from $12.6 million in 2004 to $23.2 million in 2005, for the
reasons discussed above in Overview of this section. In addition, we benefited
from the improvement in economic conditions generally and in the telecommunication service
industry specifically.

Cost of Revenues

Cost
of revenues consists primarily of the direct cost of materials, employee compensation
expenses, payments to subcontractors and outsourcers, payments to consultants,
depreciation related to manufacturing facilities, allocated overhead, maintenance and
support of our products, changes in inventory and royalties to the OCS.

2006
vs. 2005

Cost
of revenues increased from $11.0 million in 2005 to $13.6 million in 2006, as a result of
increase in revenues, but primarily due to a provision of $2.2 million in royalties to the
OCS, as discussed in Overview, which was recorded in the fourth quarter of
2006. Our gross profit margin was 53%, which was similar to our gross profit margin in
2005. Gross profit margins remained essentially unchanged despite the increase in our
gross profit from $12.2 million in 2005 to $15.2 million in 2006, which increase was due
primarily to our higher sales in 2006 compared with 2005, and as a result of the $2.2
million OCS royalties charge which we provided for in December 2006, as discussed in
Overview.

21

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2005
vs. 2004

Cost
of revenues increased from $10.3 million in 2004 to $11.0 million in 2005, as our increase
in cost of revenues was offset by our maintaining operational efficiencies we instituted
in connection with the 2004 restructuring plan. In addition, our cost of revenues in 2004
was effected by the sale of our governmental surveillance business to Verint Systems as we
made a one-time write-off in the amount of $0.9 million related to inventory of certain
components which we believed could not be used by us in the future. Furthermore, part of
our 2004 cost of revenues included expenses that were reduced as part of the
implementation of our recovery plan in the middle of that year. Gross profit increased by
421.3% from $2.3 million in 2004 to $12.2 million in 2005 and gross profit margin
increased from 18.5% in 2004 to 52.6% in 2005. This increase in margins derives primarily
from our higher sales in 2005 compared with 2004 as well as the implementation of our
recovery plan which resulted in lower expenses level.

Operating Expenses

($ in millions)

|                                                      | Year ended December 31, | % Change 2006 vs. 2005 | % Change 2005 vs. 2004
|----------------------------------------------------- | ----------------------- | ---------------------- | ----------------------
|
|
|
|
|Research and development costs, net                   |                         |                        |                       
|Selling and marketing expenses                        |                         |                        |                       
|General and administrative expenses                   |                         |                        |                       
|Restructuring and related impairment costs            |                         |                        |                       
|Amortization of acquisition-related intangible assets |                         |                        |                       
|Acquisition-related expenses                          |                         |                        |                       
|Goodwill impairment                                   |                         |                        |                       
|Total operating expenses                              |                         |                        |                       

|(*) | Represent
a percentage less than 0.1 million
|--- | --------------------------------------------

Research and Development
Costs, Net

Research
and development costs consist primarily of employee compensation expenses, payments to
subcontractors and consultants and allocated overhead, costs of materials and software and
amortization of purchased technologies associated with our research and development
activities. Grants received from the OCS are deducted from gross research and development
expenses to determine net research and development expenses.

2006
vs. 2005

Research
and development costs, net increased by 18.1% from $3.6 million in 2005 to $4.3 million in
2006. This increase reflected an increase in gross research and development costs from
$4.1 million in 2005 to $4.5 million in 2006, which was primarily due to increase in the
number of research and development personnel in 2006 as a result of our acquisition of
Telesoft and decrease in OCS grants participation. Grants from the OCS that we recorded in
our books decreased by 49.6% from approximately $0.5 million in 2005 to $0.2 million in
2006, as we were entitled to a lower OCS participation rate and did not request any grants
or participation in any new programs.

2005
vs. 2004

Research
and development costs, net decreased by 32.8% from $5.4 million in 2004 to $3.6 million in
2005. This decrease reflected a decrease in gross research and development costs from $6.8
million in 2004 to $4.1 million in 2005, which was primarily due to maintaining the
reduced headcount as of the end of 2004, which we implemented as part of our recovery
plan. Grants from the OCS that we recorded in our books decreased by 66.3% from
approximately $1.4 million in 2004 to $0.5 million in 2005, as we were entitled to a lower
OCS participation rate.

Selling and Marketing
Expenses

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

2006
vs. 2005

Selling
and marketing expenses increased by 37.4% from $6.9 million in 2005 to $9.5 million in
2006. The increase in selling and marketing expenses in 2006 was due to higher expense for
agents commissions than we incurred in the previous year, resulting from increased
sales in 2006, and due to adoption of SFAS 123 (R) Share-based payment,
under which we recorded an expense in the amount for approximately $0.5 million
share-based compensation we granted to sales and marketing personnel.

2005
vs. 2004

Selling
and marketing expenses decreased by 23.8% from $9.1 million in 2004 to $6.9 million in
2005. The decrease was due to maintaining the reduced headcount as of the end of 2004,
which we implemented as part of our recovery plan, reduction in agent commission expenses
and better budgetary management instituted in connection with the recovery plan. The
reduction in agent commissions resulted both from our renegotiation of agent commission
rates and from increased cooperation with distributors and system integrators in an effort
to broaden our penetration in various markets. Sales through distributors and system
integrators generally do not involve payment by us of agent commissions.

22

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General and
Administrative Expenses

General
and administrative expenses consist primarily of employee compensation expenses,
professional fees, including legal and accounting fees, recruiting costs, allocated
overheads and changes in the balance of provision for doubtful accounts.

2006
vs.2005

General
and administrative expenses decreased by 7.0% from $4.1 million in 2005 to $3.8 million in
2006. The decrease was primarily due to a reduction in certain overhead allocation costs.
In addition, we succeeded in collecting $0.6 million in debt which we had recorded as
doubtful debt in previous years, primarily due to improved creditworthiness in the
telecommunication industry and our improved collection efforts.

2005
vs.2004

General
and administrative expenses decreased by 51.8% from $8.5 million in 2004 to $4.1 million
in 2005. The decrease was primarily due to the change in our balance of provision for
doubtful accounts, as we charged $1.9 million to doubtful accounts in 2005 and recovered
$2.5 million of amounts previously charged to doubtful accounts, as opposed to a charge in
the amount of $ 4.7 million in 2004. The change in the balance of provision for doubtful
accounts was due to improved creditworthiness in the telecommunication industry and our
improved collection efforts.

Amortization of
acquisition-related intangible assets

In
2006, due to our acquisition of Telesoft, we recorded amortization of acquisition-related
intangible assets in theamount of $0.5 million, which consists of amortization
expense related to intangible assets recorded in connection with acquisition accounted for
by the purchase method of accounting. These intangible assets, consisting primarily of
core technology, third party relations, customer contracts and relationships, are being
amortized using the straight-line method and based on forecasted cash flows associated
with the assets over periods ranging from one to five years. In 2005 and 2004, the
amortization of acquired-related intangible assets are related to the amortization of
intangible assets acquired in NetI acquisition.

Restructuring and related
impairment costs

2006
vs.2005

We
recorded no restructuring expenses during the year 2006.

2005
vs.2004

As
part of our acquisition of Telesoft in December 2005, we included in our results of
operations for 2005 costs of approximately $0.5 million, which related primarily to
involuntary termination of some employees. In addition, during the third quarter of the
year, we reversed a reserve made in 2004 for our restructuring plan in theamount
of $0.2 million, as our management decided that the recovery plan had concluded by that
time.

Acquisition-related
expenses

During
2006, we incurred expenses in the amount of $0.6 million in connection with a
due-diligence process and legal work for a potential acquisition. During the third quarter
of 2006 we decided, after evaluating all the relevant parameters, not to conclude the
negotiations, and therefore, we released all incurred expenses to our statements of
operations. These expenses consist principally of third-party legal, accounting and other
professional fees.

Goodwill impairment

On
October 1, 2001, we acquired all of the outstanding shares of Telrad Hawk Net-I Ltd., or
Net-I. As a result of the purchase of Net-I, goodwill in the amount of $16.3 million was
created as at the date of purchase. Goodwill is subject to evaluation for impairments in
accordance with SFAS No. 142, which provides that goodwill and other intangible assets
with indefinite lives are no longer amortized, but instead are to be tested for impairment
at least annually in accordance with the provisions of SFAS No. 142. In June 2004, due to
significant reductions in our revenues, goodwill was impaired. We obtained an independent
appraisal to assess whether the goodwill carried on our books must be written down. We
impaired the goodwill by $2.2 million in 2004 to its fair value in the amount of $8.1
million as at December 31, 2004.

In
2005 and 2006, no goodwill was impaired.

23

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Operating loss

2006
vs.2005

Operating
loss increased from $2.9 million in 2005 to $3.5 million in 2006. This increase was
largely due to several factors, which we do not anticipate to recur in foreseeable future.
These factors include a provision for the repayment of prior funding to the OCS in the
amount of approximately $2.2 million, as substantially full repayment of our obligations
to the OCS arising from its participation plan with respect to FraudView solution and
acquisition-related expenses in connection with the negotiation of a potential acquisition
in the amount of $0.6 million. Also, our operating results for 2006 were affected by
the adoption of SFAS 123 (R) Share-based payment, under which we
recorded an expense in the amount of approximately $1 million. We anticipate this
share-based compensation expense to recur in near future.

2005
vs.2004

Operating
loss decreased from $26.2 million in 2004 to $2.9 million in 2005. This decrease was
primarily due to increased revenues and continuing decrease in all components of operating
expenses, as a result of the implementation of our recovery plan, and reduction in other
special charges in amount of $5.2 million, such as restructuring costs and goodwill
impairment.

Financial income, net

2006
vs. 2005

Financial
income, net decreased by 17.5% from $1.5 million in 2005 to $1.2 million in 2006. This
decrease was solely due to the decision to repay prior funding to OCS which bore interest
in the amount of $0.6 million.

2005
vs. 2004

Financial
income, net increased by 241.1% from $0.4 million in 2004 to $1.5 million in 2005. This
increase was primarily due to the following two factors: (i) increase in the average cash
available for investment during 2005 compared to 2004 resulting from the receipt of
proceeds from the sale of our government surveillance business to Verint Systems on March
31, 2004 and the cash generated during 2005 from operations; and (ii) our investment
practices which yielded higher returns, and the higher rates on investments generally
available in the market during 2005.

Net income (loss) from
discontinued operations

As
discussed above under Acquisitions and Dispositions, on March 31, 2004 we sold
our Government Surveillance business. Net income from these discontinued operations was
approximately $12.2 million for 2005 (including gain on disposition), and net loss of $4.8
million for 2004.

Net loss

2006
vs. 2005

Net
loss was $2.3 million in 2006 compared with net loss of $1.4 million in 2005. This
increase was primarily due to the several non-recurring expense items as mentioned in
Operating Loss above.

2005
vs. 2004

Net
loss was $1.4 million in 2005 compared with net loss of $13.5 million in 2004. This change
was due to the significant increase in revenues, reduction in all elements of operating
expenses, as a result of implementation of recovery plan, and increase in our financial
income, net.

# Critical Accounting
Policies

The
preparation of our financial statements in conformity with generally accepted accounting
principles in the United States requires our management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period, which could potentially result in
materially different results under different assumptions and conditions. These are our
managements best estimates based on experience and historical data; however, actual
results could differ materially from these estimates. Our significant accounting
principles are presented within Note 2 to our consolidated financial statements appearing
elsewhere in this annual report. While all the accounting policies impact the financial
statements, certain policies may be viewed to be critical. Management believes that the
following policies are those that are most important to the portrayal of our financial
condition and results of operations and are the most critical to aid in fully
understanding and evaluating our reported results:

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

24

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| |  | Allowance
for doubtful accounts
| | - | -------------------------------

| |  | Goodwill
and other intangible assets
| | - | ------------------------------------

| |  | Deferred
taxes
| | - | --------------

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

| |  | Contingencies
| | - | -------------

| |  | Share-based
compensation
| | - | ------------------------

Revenue Recognition

Our
revenue recognition policy is significant because our revenue is a key component of our
results of operations. We follow very specific and detailed guidelines in measuring
revenues, as discussed below. However, such guidelines may require the exercise of certain
judgments, estimates and assumptions.

We
have adopted the requirements of SOP 97-2 Software Revenue Recognition.
Therefore we recognize revenue from product sales (which include software) when the
following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery
has occurred; (3) the fee is fixed or determinable and (4) collectibility is probable.

We
include post contract customer support, or PCS, within the price of the product sale. This
PCS is for a one-year period and includes a standard product warranty and upgrades and
enhancements to correct minor bugs or errors in the software. The cost of providing the
PCS is insignificant and the warranty and bug fixes have been infrequent. Therefore, the
PCS revenue is recognized upon delivery of the product, in accordance with SOP 97-2.

We
use the residual method to recognize revenue when an arrangement includes one or more
elements to be delivered at a future date and vendor-specific objective evidence of the
fair value (VSOE) of all undelivered elements exists. Such VSOE is based on
the normal pricing practices for those products and services when sold separately. Under
the residual method, the fair value of the undelivered elements is deferred and the
remaining portion of the arrangement fee is recognized as revenue. If evidence of the fair
value of one or more undelivered elements does not exist, the revenue is deferred and
recognized when delivery of those elements occurs or when fair value can be established.

When
a software product is sold together with implementation or consulting services, product
fees are recognized upon delivery, provided that the above criteria are met, payment of
the license fees is not dependent upon the performance of the services, and the services
do not provide significant customization or modification of the software products and are
not essential to the functionality of the software that was delivered.

If,
at the outset of an arrangement, the arrangement fee is determined as not fixed or
determinable, revenue is deferred until the arrangement fee becomes due. If, at the outset
of the arrangement, collectibility is determined to be not probable, revenue is deferred
until the earlier of when collecitibility becomes probable or the receipt of payment. If
an arrangement provides for customer acceptance, revenue is not recognized until the
earlier of receipt of customer acceptance or expiration of the acceptance period.

Revenues
from product maintenance and support contracts are recognized on a straight-line basis
over the term of the support period. The majority of our maintenance agreements provide
technical support as well as unspecified software product upgrades and releases when and
if made available by us during the term of the support period.

Revenues
from contracts that require significant design, development, modification and
customization are recognized using the percentage of completion method, which is in
accordance with SOP 81-1, Accounting for performance of construction type and
certain production type contracts. The percentage of completion is determined as a
ratio of the extent of the progress toward completion of the contract, using an input
measure method of labor hours performed. In the event that management anticipates a loss
on a particular contract, such anticipated loss is provided for in full in the period when
the loss is first anticipated. If collectibility is determined as not being probable, we
recognize revenues from contracts with significant design, development, modification and
customization, using the completed-contract method.

Allowance for Doubtful
Accounts

Our
financial statements include an allowance, which we believe reflects adequately the loss
inherent in our accounts receivables portfolio. In establishing the required allowance,
our management bases its determination, among other factors, on information available
about the debtors financial situation, the volume of their operations and evaluation
of the security received from them. We use our best estimate to assess the recoverability
of open accounts. If there is a major deterioration in a major customers credit
worthiness or actual defaults are higher than our historical experience, our estimates of
the recoverability of amounts due to us could be adversely affected. This would result in
an increase in our general and administrative expenses by increasing the allowance for bad
and doubtful debts and would decrease the amount of our trade receivables.

Business Acquisitions;
Goodwill and other intangible assets

Our
business acquisitions may result in the recognition of goodwill and other intangible
assets, and in certain cases non-recurring charges associated with the write-off of
in-process research and development (IPR&D), which may affect the amount
of current and future period charges and amortization expense. Goodwill represents the
excess of the purchase price over the fair value of net assets acquired, including
identified intangible assets, in connection with our business combinations accounted for
by the purchase method of accounting. We amortize our acquisition-related intangible
assets using the straight-line method and based on forecasted cash flows associated with
the assets over the estimated useful lives. We adopted SFAS No. 142 requirements regarding
goodwill and other intangible assets with indefinite useful lives. Such goodwill is not
amortized, but rather is periodically assessed for impairment.

25

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The
determination of the value of these components of a business combination, as well as
associated asset useful lives, requires management to make various estimates and
assumptions. Critical estimates in valuing certain of the intangible assets include but
are not limited to: future expected cash flows from product sales, maintenance agreements,
customer contracts, and acquired developed technologies; expected costs to develop the
IPR&D into commercially viable products and estimating cash flows from the projects
when completed; assumptions about the period of time the acquired products and will
continue to be used in our product portfolio; and discount rates. Managements
estimates of fair value and useful lives are based upon assumptions believed to be
reasonable, but which are inherently uncertain and unpredictable. Unanticipated events and
circumstances may occur and assumptions may change. Estimates using different assumptions
could also produce significantly different results.

We
continually review the events and circumstances related to our financial performance and
economic environment for factors that would provide evidence of the impairment of our
intangible assets. When impairment indicators are identified with respect to our
previously recorded intangible assets, then we test for impairment using undiscounted cash
flows. If such tests indicate impairment, then we measure the impairment as the difference
between the carrying value of the asset and the fair value of the asset, which is measured
using discounted cash flows. Significant management judgment is required in forecasting of
future operating results, which are used in the preparation of the projected discounted
cash flows and should different conditions prevail, material write downs of net intangible
assets and other long-lived assets could occur. We periodically review the estimated
remaining useful lives of our acquired intangible assets. A reduction in our estimate of
remaining useful lives, if any, could result in increased amortization expense in future
periods.

In
June 2003 and 2004, due to significant reduction in our revenues, we determined that
goodwill had been impaired. We obtained an independent appraisal to assess whether
goodwill carried on our books needed to be written down.

The
independent appraisal was conducted in accordance with paragraphs 19-22 of SFAS 142, which
requires a two-step analysis. The first step used the discounted cash flow approach to
measure the fair value of our reporting unit, the result of which indicated that the
carrying amount of such reporting unit, including goodwill, exceeded its fair value. The
second step was then conducted in order to measure the amount of impairment loss, by means
of a comparison between the implied fair value of the goodwill and the carrying amount of
the goodwill. In the second step, the appraisal assigned the fair value of our reporting
unit, as determined in the first step, to the reporting units individual assets and
liabilities. The excess of the fair value of the reporting unit over the amounts assigned
to its assets and liabilities represented the implied fair value of the goodwill.

We
conduct our annual goodwill impairment test as of June 30 every year. We performed annual
impairment tests during 2006 and 2005 and did not identify any impairment.

We
impaired goodwill to its fair value by $2.2 million as at June 30, 2004.

We will
continue to perform an impairment test at least annually and on an interim basis should
circumstances indicate that an impairment loss may exist. The outcome of such testing may
lead to the recognition of an impairment loss.

The
estimated useful life of other purchased technology was changed as of April 2004 from 5
years to 2.5 years. The change was based on our managements estimation with regard
to the useful life of this technology and the development of a replacement solution for
the year 2006 and beyond. Therefore, the amortization period has been adjusted for this
change.

Deferred Taxes

We
account for income taxes under SFAS 109, Accounting for Income Taxes. Under
SFAS 109, deferred tax assets or liabilities are recognized in respect of temporary
differences between the tax bases of assets and liabilities and their financial reporting
amounts as well as in respect of tax losses and other deductions which may be deductible
for tax purposes in future years, based on tax rates applicable to the periods in which
such deferred taxes will be realized. Deferred tax assets for future tax benefits from
realization, are included in the balance sheets, when, in our estimation, their
realization is more likely than not.

Valuation
allowances are established when necessary to reduce deferred tax assets to the amount
expected to be realized. A valuation allowance has been made for all of our deferred tax
assets and those of our subsidiary companies, since we believe that it is more likely than
not that the deferred tax assets will not be realized, as we are uncertain as to whether
loss carry forwards will be utilizable in the foreseeable future.

Impairment of long-lived
assets

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

We
account for long-lived assets under the provisions of SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. SFAS 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144
requires that long-lived assets be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the carrying
amount of an asset to future net cash flows expected to be generated by the asset. If the
carrying amount of an asset exceeds its estimated future cash flows, an impairment charge
is recognized by the amount by which the carrying amount of the asset exceeds the fair
value of the asset. SFAS 144 requires companies to separately report discontinued
operations and extends that reporting to a component of an entity that either has been
disposed of (by sale, abandonment, or in a distribution to owners) or is classified as
held for sale.

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Contingencies

From
time to time, we are defendant or plaintiff in various legal actions, which arise in the
normal course of business. We are required to assess the likelihood of any adverse
judgments or outcomes to these matters as well as potential ranges of probable losses.
When we believe that it is probable that we will not prevail in a particular matter, we
then estimate the amount of the liability based in part on advice of legal counsel. See
Note 10I to our consolidated financial statements appearing elsewhere in this annual
report and Item 8.A  Legal Proceedings in relation to the class action
filed against us in January 2005.

Share-based compensation

Prior
to January 1, 2006, we applied the intrinsic value-based method of accounting prescribed
by Accounting Principles Board (APB) Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations, in accounting for its fixed
plan stock options. As such, compensation expense was determined on the date of grant only
if the current market price of the underlying stock exceeded the exercise price and
amortized over the vesting period.

We
also adopted the disclosure provisions of SFAS 123 Accounting for Stock-Based
Compensation that were in force until December 31, 2005, but opted to remain under
the expense recognition provisions of APB 25.

In
December 2004, FASB issued SFAS No. 123 (revised 2004), Share-Based Payment
(SFAS 123R), which requires entities to measure the cost of employee services
received in exchange for an award of equity instruments based on the grant-date fair value
of the award and recognize the cost over the period during which an employee is required
to provide service in exchange for the award. SFAS 123R does not change the accounting
guidance for share-based payment transaction with parties other than employees provided in
SFAS 123 as originally issued. In March 2005, the U.S. Securities and Exchange Commission
(SEC) issued Staff Accounting Bulletin No. 107 (SAB 107), which
expressed views of the SEC staff regarding the application of SFAS No. 123R. Among other
things, SAB 107 provides interpretive guidance related to the interaction between SFAS
123R and certain SEC rules and regulations, as well as providing the SEC staffs
views regarding the valuation of share-based payment arrangements for public companies.

We
implemented SFAS 123R using the modified prospective method starting January 1, 2006. We
have selected the Black-Scholes option-pricing model to determine the fair value of our
awards on the date of grant and recognizing compensation cost on a straight-line basis
over our awards vesting period for all unvested and new granted awards as of January
1, 2006, based on the grant date fair value of these awards.

An
implementation of SFAS 123R resulted in increase in our operating expenses in amount of
approximately $1 million. We expect to grant additional stock-based awards in future years
which will result in additional share-based compensation expense.

| | B. | Liquidity
and Capital Resources
| | -- | -------------------------------

As
of December 31, 2006, we had $14.4 million in cash and cash equivalents, compared to $24.9
million in cash and cash equivalents as of December 31, 2005. As of December 31, 2006, we
had $11.4 million in short-term investments and $11.3 million in long-term marketable
securities compared to $14.4 million in short-term investments and $12.0 million in
long-term marketable securities, as of December 31, 2005.

A
significant part of our capital resources are derived from the $35 million in proceeds we
received as consideration for the sale of our government business to Verint Systems during
2004. In addition, during 2005, we generated positive cash flow from operating activities
in the amount of $4.4 million. In 2006, cash flow used in operating activities was $2.1
million. This decrease is primarily due to payments made in the fourth quarter of 2006 for
costs generated with regard to investigating and potentially executing an M&A
transaction in the third quarter of 2006, as well as slight delays in some end-of-year
collections from large customers.

In
April 2006 we announced a plan to repurchase our ordinary shares on the open market in an
amount in cash of up to $15 million and, ultimately during 2006, we purchased an amount of
2,304,794 of our ordinary shares for total consideration of $11.5 million. The repurchase
of our ordinary shares was the primary reason for the decrease in the amount of our cash
and cash equivalents as of December 31, 2006 as compared with December 31, 2005.

Generally,
we invest our excess cash in instruments that are liquid and generate yields, with
conservative and low risk.

We
believe that our current cash and cash equivalents, together with our short-term
investments and long-term marketable securities, including interest to be earned thereon,
will be sufficient to fund our working and other capital requirements over the course of
the next twelve months. In the normal course of business, we evaluate the merits of
acquiring technology or businesses. We may elect to use available cash and cash
equivalents and marketable security investments to fund such activities in the future. In
the event additional needs for cash arise, we may raise additional funds from a
combination of sources, including the potential issuance of debt or equity securities.
Additional financing might not be available on terms favorable to us, or at all. If
adequate funds were not available or were not available on acceptable terms, our ability
to take advantage of unanticipated opportunities or respond to competitive pressures could
be limited.

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Net
Cash Provided by/Used in Operating Activities. Net cash used in our operating
activities was approximately $2.1 million in 2006. Cash used in operations for 2006 was
primarily due to a longer collection cycle in the fourth quarter of 2006 which was
reflected by a decrease in operating cash flow during fourth quarter and which resulted in
negative cash flow used in operating activities for 2006. Net cash provided by operating
activities of $4.4 in 2005 was primarily attributable to higher revenues and cost cutting
measures we adopted as part of our restructuring plan.

From
time to time, we enter into accounts receivables factoring agreements with unaffiliated
financial institutions. During 2006 we sold no trade account receivables (2005  $0.4
million). Our ability to sell such receivables, if any, to these financial institutions on
current terms and conditions is uncertain and is dependent on the creditworthiness of the
customers involved, the credit risks in the specific countries concerned and the
institutions policies from time to time.

Capital
Expenditures. Our capital expenditures were $0.6 million in 2006, $0.6 million in 2005
and $1.0 million in 2004. Our capital expenditures in each of these periods related
primarily to the purchase of testing and computer equipment, and investment in back-office
equipment. In addition, in 2005 we invested $1.8 million in the acquisition of newly
consolidated subsidiaries (net of cash acquired), as a result of the Telesoft transaction.
Following the acquisition, we had additional expenses in amount of $1.2 million, which
were incurred mostly in connection with termination plan of the employees of the acquired
company and repayment of certain liabilities. We expect our capital expenditures to
increase in 2007 due to our anticipated implementation of new enterprise resource software
platform.

In
addition, we invest in capital expenditures pursuant to the requirements applicable to us
under our approved enterprise programs. As of December 31, 2006, no amounts remain to be
invested in order to comply with our current approved program. This program was conducted
and filed to the Investment Center on 2007. This program will provide us with tax benefits
in the future; however, if we do not comply with applicable requirements of our approved
programs, all current and future benefits from this program will be cancelled.

Net
Cash Used in/Provided by Financing Activities. Net cash used in our financing
activities in 2006 was approximately $10.1 million. This was mostly due to the repurchase
of our shares during the second half of 2006 in an amount of $11.5 million. Our financing
activities provided $0.05 million in 2005 and $0.2 million in 2004, due to the issuance of
our ordinary shares to employees upon the exercise of share options.

Bank
Credit. In September 2002, we entered into an arrangement with an Israeli bank which
supplies us with various credit facilities and/or banking services, such as bank
guarantees to our customers to guarantee our contractual obligations to such customers. As
of December 31, 2006, outstanding bank guarantees totaled approximately $2.3 million. In
connection with this arrangement, we executed a negative pledge in favor of the bank, in
which we undertook not to perform the following without the banks prior written
consent:

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

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

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

# Impact of Related Party
Transactions

Prior
to June 28, 2006, we accounted for transactions with ECI as related party
transactions based on ECIs holdings in our shares. On June 28, 2006, ECI
distributed its remaining shares of ECtel as dividend to its shareholders and as a result,
ECI is no longer a shareholder of ECtel, however, ECI and ECtel may still be deemed
related parties as since December 31, 2006, IDB beneficially held approximately 31% of our
outstanding shares as well as approximately 40% of ECIs outstanding shares. In our
ordinary course of business we have entered into few agreements with ECI which are
material to our operations:

Supply
Agreement. In February 2004, we executed a new supply agreement with ECI, which
replaced an earlier supply agreement entered into in October 1999. Under the terms of the
new supply agreement, ECI supplies us with the components (modules) for use in
our products. We agreed on the prices for these modules after negotiations with ECI. In
accordance with its right under the Supply Agreement, ECI stopped manufacturing some of
these components as of August 2006. Accordingly, we contracted with an alternate supplier
for the manufacture of these components.

Distribution
Agreement. In June 2005 we entered into a distribution agreement with ECI under which
we appointed ECI as our exclusive distributor in the Russian Federation, Ukraine and
Kazakhstan, territories. Under this agreement, ECI, among other things, maintains a
business and sales organization in these territories to promote and/or affect the sale of
those of our products and services covered by the agreement. The agreement is subject to
termination by either party upon three months notice. In addition, either party may
terminate the agreement at any time upon a material breach by the other party or in the
event of liquidation or similar consequences of the other party.

# Corporate Tax Rate

Generally,
Israeli companies are subject to corporate tax at the rate of 29% on taxable income and
are subject to capital gains tax at a rate of 25% on capital gains (other than gains
derived from the sale of listed securities that are taxed at the prevailing corporate tax
rates) derived after January 1, 2003. Also, 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.
The corporate tax rate was reduced in July 2005, from 34% to 31% for the 2006 tax year,
29% for the 2007 tax year, 27% for the 2008 tax year, 26% for the 2009 tax year and 25%
for the 2010 tax year and thereafter. However, the effective tax rate payable by a company
that derives income from an approved enterprise (as discussed below) may be considerably
less.

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Our
manufacturing facilities in Rosh Haayin have been granted approved enterprise status
under the Law for the Encouragement of Capital Investments, 1959. Consequently, these
facilities are eligible for tax benefits. We have derived, and expect to continue to
derive, a substantial portion of our income from our approved enterprise facilities.
Subject to compliance with applicable requirements, the income derived from our approved
enterprise facilities will be subject through 2018 to a reduced tax rate of a maximum of
25%. The actual tax rate will depend upon the percentage of non-Israeli holders of our
share capital. Based on our information as to share ownership as at December 31, 2006, our
effective tax rate for 2006 applicable to our taxable income derived from approved
enterprises would be between 0% to 25%. In light of our carry loss forward, we are
currently not in a taxable position. However, according to the Law for the Encouragement
of Capital Investments, prior to its amendment in 2005 (see Israeli
TaxationTax Benefits under the Law for the Encouragement of Capital Investments,
1959.), the tax benefits of the law require us to invest in qualifying assets. To
the extent that we invest in non-qualifying assets, we would not be entitled to the tax
benefits under the law for a portion of our taxable income reflecting the ratio of our
qualifying to non-qualifying assets, for those programs which are subject to the old
provisions of the law.

The
above benefits are conditioned upon our fulfillment of conditions stipulated by the Law
for the Encouragement of Capital Investments, the regulations promulgated thereunder and
the instruments of approval for the specific investments in approved enterprises. If we
fail to comply with these conditions, our benefits may be canceled and we may be subject
to higher corporate tax rate.

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

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

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

29

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

|Year Ended December 31, | Israeli
Inflation
Rate | Israeli
Devaluation
Rate | Israel Inflation
Adjusted for
Devaluation
|----------------------- | ---------------------- | ------------------------ | -----------------------------------------
|
|
|
|
|1998                    |                        |                          |                                          
|1999                    |                        |                          |                                          
|2000                    |                        |                          |                                          
|2001                    |                        |                          |                                          
|2002                    |                        |                          |                                          
|2003                    |                        |                          |                                          
|2004                    |                        |                          |                                          
|2005                    |                        |                          |                                          
|2006                    |                        |                          |                                          

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

# Market Risk

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

| | C. | Research
and Development, Patents and Licenses
| | -- | ----------------------------------------------

In
order to accommodate the rapidly changing needs of our markets, we place considerable
emphasis on research and development projects designed to improve our existing product
lines and to develop new product lines to meet the changing needs of our market. Our
research and development expenses, net were $4.3 million in 2006, $3.6 million in 2005 and
$5.4 million in 2004. As of March 31, 2007, 37 of our employees were engaged primarily in
research and development activities. We expect that we will continue to commit substantial
resources to research and development in the future.

# Grants from the Office
of the Chief Scientist

We
received grants under several programs from the OCS, until the end of this year. From time
to time we may decide to apply for new programs.

We
recorded grant participations from the OCS totaling $0.2 million in 2006, $0.5 million in
2005 and $1.4 million in 2004. Pursuant to the terms of these grants we are obligated to
pay royalties of 3%-3.5% of revenues derived from sales of products funded with these
grants. As of December 31, 2006, our contingent liability to the OCS for remaining
programs, after repayment of some of the programs as mentioned above, in respect of grants
received was approximately $0.4 million.

In
April 2006, we repaid to the OCS an amount of $0.4 million, which represents the entire
obligation of Telesoft, in connection with grants received by Telesoft in prior years.

During
the fourth quarter of 2006, we committed to repay in full all the grants related to
programs connected to our FraudView® solution. Pursuant to an agreement entered into
with the OCS, the OCS agreed to conclude its participation in the OCS sponsored research
and development programs relating to FraudView. As part of this agreement, we agreed to
pay during 2007 to the OCS approximately $3 million, which includes interest accrued on
the outstanding balance of the royalties. Such royalties are presented in our cost of
revenues, see also Note 14E of our financial statements.

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

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

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

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The
State of Israel does not own proprietary rights in technology developed with OCS funding
and there is no restriction on the export of products manufactured using technology
developed with OCS funding. The technology is, however, subject to transfer restrictions,
as described below. These restrictions may impair our ability to sell our technology
assets or to outsource manufacturing and the restrictions continue to apply even after we
have paid the full amount of royalties payable for the grants. In addition, the
restrictions may impair our ability to consummate a merger or similar transaction in which
the surviving entity is not an Israeli company.

The
transfer to a non-Israeli entity of technology developed with OCS funding, including
pursuant to a merger or similar transaction, and the transfer of rights related to the
manufacture of more than ten percent of a product developed with OCS funding are subject
to approval by an OCS committee and to the following conditions:

| |  | Transfer
of Technology. If the committee approves the transfer of OCS-backed technology, such
a transfer would be subject to the payment to the OCS of a portion of the consideration
we receive for such technology. The amount payable would be a fraction of the
consideration equal to the relative amount invested by the OCS in the development of such
technology compared to our total investment in the technology, but in no event less than
the amount of the grant. However, in the event that in consideration for our transfer of
technology out of Israel we receive technology from a non-Israeli entity for use in
Israel, we would not be required to make payments to the OCS if the approval committee
finds that such transfer of non-Israeli technology would significantly increase the
future return to the OCS.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Transfer
of Manufacturing Rights. The committee is authorized to approve transfers of
manufacturing rights only if the transfer is conditioned upon either (1) payment of
increased aggregate royalties, ranging from 120% to 300% of the amount of the grant plus
interest, depending on the percentage of foreign manufacture or (2) a transfer of
manufacturing rights into Israel of another product of similar or more advanced
technology.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Merger
or Acquisition. If the committee approves a merger or similar transaction in which
the surviving entity is not an Israeli company, such a transaction would be subject to
the payment to the OCS of a portion of the consideration paid. The amount payable would
be a fraction of the consideration equal to the relative amount invested by the OCS in
the development of such technology compared to the total investment in the company, net
of financial assets that the company has at the time of the transaction, but in no event
less than the amount of the grant.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In the event that the committee
believes that the consideration to be paid in a transaction requiring payment to the OCS
pursuant to the provisions of the law described above does not reflect the true value of
the technology or the company being acquired, it may determine an alternate value to be
used as the basis for calculating the requisite payments.

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

The
funds available for OCS grants out of the annual budget of the State of Israel were
reduced in the past, and the Israeli authorities have indicated that the government may
further reduce or abolish OCS grants in the future. Even if these grants are maintained,
we cannot predict what would be the amounts of future grants, if any, which we might
receive if we decide to apply for new grants participation programs.

| | D. | Trend
Information
| | -- | -----------------

Beginning
in late 2000 and continuing into 2003, the deterioration of the global economy in general
and economic uncertainty in the telecommunications market in particular, resulted in a
decline of capital investment by telecommunications service providers. This decline in
capital expenditures had a negative impact on our sales and adversely affected the pricing
of our products.

Recovery
of the telecommunication market was evident in 2004 and 2005. However, of the two
principal markets in which we compete, (a) the fraud prevention solution market remained
highly competitive with revenue levels still not rising to their pre-crisis levels and (b)
the revenue assurance market is still developing and fragmented, consisting of quite a few
smaller sized participants and lacking major software vendors.

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

31

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Our
business depends on the purchases by large telecom companies. Since some of these telecom
providers operate according to annual budgets, their tendency is to approve budgets toward
the beginning of the fiscal year and utilize the budgets toward the end of the fiscal
year. This mode of operation may affect our results of operations throughout the year and
may cause certain seasonality in our financial results.

Currently,
the demand for revenue assurance and fraud prevention technologies is solid, especially in
large telecom providers. We expect the demand for revenue assurance and fraud prevention
technologies to remain solid in the near future. However, internal processes at our
prospective customers and resellers as well as competition, may affect our ability to
close deals and maintain profitability at current levels. In addition, the above factors
may cause fluctuations in our quarterly and annual results of operations. For example, in
April 2007 we announced that our first quarter revenues were lower than our internal work
plan following both a delay in the receipt of previously anticipated orders and a delay in
receiving acceptance for certain customer projects that were part of our backlog.

| | E. | Off-Balance
Sheet Arrangements
| | -- | ------------------------------

In
the ordinary course of business, we have various commercial commitments that amounted, at
December 31, 2006, in the aggregate to approximately $2.3 million. These consist of
primarily performance bonds and other bonds and guarantees, such as tender guarantees.

We
do not believe that these commitments have or are reasonably likely to have a current or
future effect on our financial condition.

| | F. | Tabular
Disclosure of Contractual Obligations
| | -- | ---------------------------------------------

The
following table sets forth, as of December 31, 2006, our known contractual obligations by
type of obligation and for the periods indicated (in $ thousands):

|                                                      | Payments due by period (in thousands)
|----------------------------------------------------- | -------------------------------------
|
|
|
|Repayment of prior funding to the OCS                 |                                      
|Operating lease obligations (vehicles and facilities) |                                      

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

| | A. | Directors
and Senior Management
| | -- | -------------------------------

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

|Name                   | Age | Position                                                   
|---------------------- | --- | -----------------------------------------------------------
|
|
|
|
|Itzik Weinstein        | 48  | President and Chief Executive Officer                      
|Ron Fainaro            | 39  | Executive Vice President and Chief Financial Officer       
|Benny Yehezkel         | 40  | Executive Vice President, Worldwide Sales                  
|David Ronen            | 33  | Senior Vice President, Marketing and Strategy              
|Dr. Hanun Dvey-Aharon  | 60  | Senior Vice President of Products and Professional Services
|Hadar Solomon          | 50  | Vice President, General Counsel and Corporate Secretary    
|Yoav Geva              | 42  | Vice President, Corporate Development                      
|Yair Cohen (1) (3)     | 52  | Chairman of the Board                                      
|Jonathan Kolber        | 45  | Director                                                   
|Sami Totah (1) (2) (3) | 49  | Director                                                   
|Rami Entin (1) (2) (3) | 55  | Director                                                   
|Talia Livni (1) (2)    | 64  | Director                                                   

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

Itzik
Weinstein has served as our President & CEO since May 1, 2007. Previously, he
served as our Executive Vice President for Professional Services & Operations since
July 2004. Prior to this position, he was Vice President  Customer Services and
Product Management at VocalTec since the year 2000. Prior to that, Mr. Weinstein served as
Engineering Site Manager at NetManage since the year 1999, and Software Engineering
Manager of KLA-Tencor Corporations optical metrology division since the year 1995.
Mr. Weinstein holds an MBA from the Kellogg-Recanati Executive MBA Program of Tel Aviv
University and a B.Sc. in Computer Engineering from the Technion  Israel Institute
of Technology.

32

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Ron
Fainaro has served as our Executive Vice President and Chief Financial Officer since
June 2005. Prior to joining us, Mr. Fainaro served as CFO and Vice President of the
American operations of Tecnomatix Technologies Ltd., from 2001 to 2005. From 2000 to 2001,
Mr. Fainaro served as the CFO of Lucent Technologies (Waveaccess) and from 1998 to 2000 as
the CFO of Habas Group. Mr. Fainaro is a Certified Public Accountant in Israel. He holds a
B.A in Accounting from Tel-Aviv University and a B.Sc in Physics and Materials Engineering
from the Technion  Israels Institute of Technology, both with honors.

Benny
Yehezkel has served as our Executive Vice President of Worldwide Sales since September
2006. He joined us as the Senior Vice President of Telesoft following our December 2005
acquisition of TeleSoft, where he had served as CEO since November 2002. Prior to
Telesoft, Mr. Yehezkel served in various executive positions in the Elron Electronic
Industries Group, including VP of Business Development of Elbit Ltd, CEO of Dealigence
Inc. Previously, Mr. Yehezkel was the CEO of Sintec Call Centers (SCC). Mr. Yehezkel holds
an MBA from Tel-Aviv University and a B.Sc. in Computer Science from the Technion 
Israel Institute of Technology.

David
Ronen has served as our Senior Vice President for Marketing & Strategy since
December 2005. Prior to that, he served in various Business Development positions at ECtel
Inc. (since February 2003) and ECtel Ltd. (since October 2001). Prior to joining ECtel,
David served as the CTO of NetEye Corp., a 3G Fraud and Security Management solutions
vendor, which was later acquired by us. Prior to that, he served in various Research and
Development management positions at Telrad Networks Ltd. Mr. Ronen holds a BA in Computer
Science from The Open University in Tel Aviv, with honors.

Hanun
Dvey-Aharon was appointed as Senior Vice President of Products and Professional
Services on May 1, 2007. Prior to joining ECtel, he served as Vice President of Products,
Development and Projects Delivery at TTI Telecom. Previously, Dr. Dvey-Aharon served as
AVP Technology at Ofek New World, Director of Network Management at Telrad Networks, and
Software Development Director at Elbit Systems. Dr. Dvey-Aharon has a D.Sc. in Physics
from the Technion Institute of Technology and a M.Sc. in Computer Sciences from Case
Western Reserve University.

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

Yoav
Geva has served as our Vice President Corporate Development since January 2007. Previously, he
served as our Commercial Director since December 2004 and as our Financial Sales Support
Manager since January 2001. Previously, he served as a Sales Manager in the International
Marketing Division at Rotem Amfert Negev of the ICL Group since 1999. Prior to that, he
served as the Manager of the Guarantees Division at the Israel Foreign Trade Risks
Insurance Corporation since 1998 and as the Manager of the Short Term Credit Insurance
Division at the Israel Foreign Trade Risks Insurance Corporation since 1994. Mr. Geva
holds an MBA from the Executive MBA program of Bar Ilan University and a BA in Economics
from Tel Aviv University.

Yair
Cohen has served as the Chairman of our Board since August 2006. Mr. Cohen has served
as a Vice President of Elron Electronic Industries Ltd. (Elron) since July
2005. From 2000 until joining Elron, Mr. Cohen served as a Brigadier General in Unit 8200,
the central military intelligence unit of the Israeli Defense Force, engaged in the
development of advanced technology. Mr. Cohen serves on the Boards of Directors of
RDC-Rafael Development Corporation Ltd., Galil Medical Ltd., and other Elron group
companies. Mr. Cohen holds a BA degree in History and Arabic (Summa cum laude) from
Bar-Ilan University, Israel, and a MA degree in Management of National Resources (Summa
cum laude) from Industrial College (NDU), Washington D.C., U.S.

Jonathan
Kolber has served as one of our directors since September 2006. Mr. Kolber served as
the Chief Executive Officer of Koor Industries Ltd. since 1998 until the recent sale of
Koor to the IDB Group. He has recently been nominated to serve as Chairman of the Board of
Directors of Koor. From 1985 until 1998 Mr. Kolber has worked for the Claridge Group,
serving as president and Chief Executive Officer of Claridge Israel from 1988 until 1998.
From 1983 to 1985 Mr. Kolber worked as financial analyst in the Canadian finance group at
Salomon Brothers Inc. Mr. Kolber is a member of the Board of Directors of a number of
Israeli companies including ECI Telecom Ltd., Makhteshim-Agan Industries Ltd.,
Sheraton-Moriah Israel Ltd., Telrad Networks Ltd. and Epsilon Investment Bank. Mr. Kolber
holds a bachelor degree in Near eastern Languages and Civilizations from Harvard
University.

Sami
Totah has served as one of our directors since September 2006. Mr. Totah has served as
Chairman of the Board of Directors of several Israeli start-up companies since 2003,
including Pilat Media, Sheer networks, Red Bend, and Flash Networks. From 1984 until 2002
Mr. Totah served in various positions at Amdocs including the position of Chief Operations
Officer. Mr. Totah is a practical software engineer and participated in professional
courses over the years, including courses of the Executive MBA program of the Hebrew
University Business School.

Rami
Entin has served as one of our directors since June 2004. From 2001 until 2003, Mr.
Entin was the chairman of the Hashavim Group, a data center for direct taxation and
employment laws and a processor of wages and personnel data. From 1999 until 2001, Mr.
Entin was Co-Chief Executive Officer and a director of Hilan-Tech Ltd., where he was in
charge of financial, personnel, sales and marketing and Lotus Notes operations. From 1985
until 1999 he was financial manager and a director of Hilan Ltd., where he was in charge
of financial and personnel operations. From 1981 until 1985, Mr. Entin worked for
Kesselman & Kesselman, an accounting firm, where he served various publicly traded
companies engaged in the services and industry fields. Mr. Entin is an external director
of Solomon Holdings Ltd., Cimatron Ltd and of BSP Ltd., and is director of Hilan Tech Ltd.
and of Gilon BI Limited. Mr. Entin holds a B.A. degree in accounting and economics and an
M.B.A. degree from the Tel Aviv University, and is a certified accountant in Israel. He is
also a graduate of the Advanced Management Program at Harvard University.

33

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Talia
Livni has served as one of our directors since June 2004. Since 2002, Ms. Livni has
served as president of Naamat  The Movement for the Advancement of Status of Women.
From 1997 until 2001, she served as the legal advisor of the Israeli General Federation of
Labor. From 1992 until 1997, she served as Head of the Human Resources Division of the
Israeli Ministry of Defense. From 1975 until 1992, Ms. Livni served as Senior Deputy Legal
Advisor to the Israeli Ministry of Defense. From 1973 until 1975, Ms. Livni served as
Legal Adviser to RAFAEL Israel Armament Development Authority Ltd. Ms. Livni serves as
external director of Lumenis Ltd. since December 2006. Ms. Livni also served as an
external director of Tecnomatix from August 2000 until its acquisition by UGS Corp. in
March 2005. Ms. Livni holds an L.L.B degree from the Hebrew University and an M.A. degree
in Social Sciences from the Haifa University. She is also a graduate of the National
Security Academy.

There
are no family relationships between any directors or senior managers.

| | B. | Compensation
| | -- | ------------

The
aggregate direct remuneration paid during 2006 to executive officers and directors as a
group (14 persons), as well as remuneration paid to former executives in connection with
their services during 2006 and payments made in connection with their termination, was
approximately $2.6 million. This does not include amounts expended by us for automobiles
made available to our officers, expenses (including business, travel, professional and
business association dues and expenses) reimbursed to officers and other fringe benefits
commonly reimbursed or paid by companies in Israel. In addition, we recorded an amount of
$0.9 million of share-based compensation expenses, in accordance with SFAS 123R, which
relate to our executive officers and directors.

Our
board of directors granted options to executive officers and directors to purchase an
aggregate of 810,000 ordinary shares, at exercise prices ranging $4.474.86 per
share, during 2006. The exercise price was equal to the fair market value of our ordinary
shares on the date of grant. The vesting of these options is spread over various periods
commencing on various dates from January 2007 and ending November 2010, unless terminated
sooner, in accordance with their terms.

| | C. | Board
Practices
| | -- | ---------------

# Board of Directors

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

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

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

# Audit Committee

Nasdaq
Requirements

Our
ordinary shares are listed for quotation on the Nasdaq National Market and we are subject
to the rules of Nasdaq applicable to listed companies. Pursuant to the current listing
requirements of the Nasdaq National Market, we are required to have at least three
independent directors on our audit committee. We have appointed such directors to our
audit committee. Pursuant to the Sarbanes-Oxley Act of 2002, the Nasdaq National Market
has introduced listing standards requiring all members of an audit committee to comply
with tightened independence requirements. All members of our audit committee currently
comply with those requirements.

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

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

34

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Companies
Law Requirements

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

| |  | The
chairman of the board of directors;
| | - | ---------------------------------------

| |  | any
controlling shareholder or any relative of a controlling shareholder; and
| | - | -----------------------------------------------------------------------------

| |  | any
director employed by the company or providing services to the company on a regular basis.
| | - | ---------------------------------------------------------------------------------------------

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

# Outside Directors

Under
the Companies Law,  public  companies are required to have at least two outside
 directors. Our outside directors are Mr. Sami Totah and Ms. Talia Livni.

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

| |  | the
company;
| | - | ------------

| |  | any
entity controlling the company; or
| | - | --------------------------------------

| |  | any
entity controlled by the company or by its controlling entity.
| | - | ------------------------------------------------------------------

The
term affiliation includes:

| |  | an
employment relationship;
| | - | ---------------------------

| |  | a
business or professional relationship maintained on a regular basis;
| | - | ----------------------------------------------------------------------

| |  | control;
and
| | - | ------------

| |  | service
as an office holder.
| | - | ----------------------------

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

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

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

| |  | at
least one third of the shares of  non-controlling  shareholders  voted at the meeting
 vote in               favor of the election; or
| | - | -----------------------------------------------------------------------------------------------------------------------------------------

| |  | the
total number of shares voted against the election of the outside director does not exceed
one percent of the aggregate voting rights in the company.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------

The
initial term of an outside director is three years and may be extended for an additional
three years. Outside directors may be removed from office only by the same percentage of
shareholders as is required for their election, or by a court, and then only if the
outside directors cease to meet the statutory qualifications for their appointment or if
they violate their duty of loyalty to the company. If all directors are of the same
gender, the next new outside director elected must be of the other gender.

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Each
committee of a companys board of directors is required to include at least one
outside director, except for the audit committee, which is required to include all outside
directors. Pursuant to regulations promulgated under the Companies Law, each public
company must have one outside director who has financial and accounting expertise and any
other external directors must either have such financial and accounting expertise or meet
certain professional qualifications. A director with financial and accounting expertise is
a director who, due to his/her education, experience, and skills, possesses capabilities
relating to, and an understanding of, business and accounting matters and financial
statements, which enable him/her to understand in depth the companys financial
statements and to initiate a debate regarding the manner in which the companys
financial information is presented. A director who meets certain professional
qualifications is a director who satisfies one of the following requirements: (i) the
director holds an academic degree in either economics, business administration,
accounting, law or public administration, (ii) the director either holds another academic
degree or has obtained other high education in the companys primary field of
business or in an area that is relevant to his position, or (iii) the director has at
least five (5) years of experience serving in one of the following capacities or an
aggregate of at least five (5) years of experience in two or more of the following
capacities: (a) a senior business management position of a company with a substantial
scope of business, (b) a senior position in the primary field of business of the company
or (c) a senior public administration position.

The
determination as to whether a director possesses accounting and financial expertise or
meets one of the required professional qualifications is made by the board of directors.
In making the determination as to a directors accounting and financial expertise,
the board of directors is required to consider, among other things, the education,
experience and knowledge of such person with respect to (i) accounting and internal
controls matters that are typical to the industry in which the company engages and to
companies of similar size and complexity to those of the company, (ii) the
responsibilities of the companys auditor and (iii) the preparation and approval of
financial statements under the Companies Law and the Israeli Securities Law.

These
regulations further provide that the declaration submitted by a proposed external director
to the company pursuant to the Companies Law (in which such person declares that he meets
all of the requirements for his appointment as an external director) will include a
declaration as to such persons education and experience, to the extent relevant to
examining whether such person meets the requirements set forth in the new regulations.
Such declaration shall be accompanied by documents and certifications supporting the
declaration.

# Other Committees

Subject
to the provisions of the Companies Law, our board of directors may delegate its powers to
committees consisting of board members. In addition to our audit committee, which is
described above, our board of directors has also appointed a compensation committee, which
reviews and handles certain compensation matters and investment committee, which reviews
and approves our investment policy.

# Internal Auditor

Under
the Companies Law, our board of directors is also required to appoint an internal auditor
proposed by the audit committee. The role of the internal auditor is to examine, among
other things, whether our activities comply with the law and orderly business procedure.
The internal auditor may not be an interested party or office holder, or a relative of any
interested party or office holder, nor a member or representative of our independent
accounting firm. The Companies Law defines the term interested party to
include a person who holds 5% or more of the companys outstanding share capital or
voting rights, a person who has the right to appoint one or more directors or the general
manager, or any person who serves as a director or as the general manager. Mr. Meir
Schweitzer served as our internal auditor until November 9, 2006 when he was replaced by
Chaikin, Cohen, Rubin & Gilboa, an Israeli auditing firm.

# Nasdaq Listing
Requirements

Nasdaq
rules enable foreign private issuers, such as us, to comply with the prevalent practice in
our jurisdiction of incorporation in place of certain Nasdaq listing requirements. To the
extent that we choose to do so, we are required to disclose in our annual reports filed
with the Commission each Nasdaq listing requirement that we do not follow and describe the
home country practice we follow in lieu of such requirement. Pursuant to the Companies
Law, the quorum requirement for general meetings of our shareholders is 25% of the voting
power in our company, rather than 33%, as is otherwise required by Nasdaq rules.

36

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| | D. | Employees
| | -- | ---------

The
following table describes the number of our employees as of March 31, 2007 and December 31
of each of the indicated years:

|                                                          | March 31, 2007 | 2006 | 2005 * | 2004
|--------------------------------------------------------- | -------------- | ---- | ------ | ----
|
|
|
|
|Approximate numbers of employees by geographic location:  |                |      |        |     
|Israel                                                    |                |      |        | 125 
|United States                                             |                |      |        | 10  
|Europe and elsewhere                                      |                |      |        | 31  
|Total workforce                                           |                |      |        | 166 
|Approximate numbers of employees by category of activity: |                |     
|Management and administration                             |                |      |        | 25  
|Research and development                                  |                |      |        | 37  
|Professional services and operations                      |                |      |        | 78  
|Sales and marketing                                       |                |      |        | 26  
|                                                          |                |      |        |     
|Total workforce                                           |                |      |        | 166 

* Including employees of
Telesoft

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

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

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

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

| | E. | Share
Ownership
| | -- | ---------------

# Security Ownership of
Our Directors and Executive Officers

Other
than Jonathan Kolber, as of March 31, 2007, none of our directors or executive officers
beneficially owns shares, including options to acquire our ordinary shares that are vested
or will vest within 60 days and which represent more than 1% of our outstanding ordinary
shares. Mr. Jonathan Kolber, as Chairman of the Board of Directors of Koor Industries Ltd.
may be deemed to beneficially own 3,498,835 shares of our Company owned by Koor.As
of March 31, 2007, our officers and directors as a group held 9,485 of our ordinary shares
and options to purchase additional 1,334,184 ordinary shares. The following table sets
forth detailed information about the granted options, for the periods indicated:

|Grant date | Exercise price | Granted amount | Vested options | Non-vested
options | Options which were
exercised
|---------- | -------------- | -------------- | -------------- | ------------------ | ----------------------------
|
|
|
|
|2003       |                |                | $              | 4.67               |                             
|2004       |                |                | $              | 2.63-3.14          |                             
|2005       |                |                | $              | 3.64-4.97          |                             
|2006       |                |                | $              | 4.47-4.86          |                             
|           |                |                |                |                    |                             
|           |                |               
|           |                |                |                |                    |                             
|           |                |                |                |                    |                             

37

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All these options expire in period of
six and ten years after the date of grant, unless terminated sooner in accordance with
their terms. No such options were granted in 2002.

# Options to Purchase Our
Ordinary Shares

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

In
2003, our board of directors adopted the ECtel Ltd. 2003 Share Option Plan for
our officers, directors and consultants who are Israeli residents. Pursuant to the Israeli
tax reform (described below under Item 10E  Taxation-Israeli Taxation),
our board of directors resolved to elect the capital gains route. Accordingly,
subject to the fulfillment of certain conditions, gains realized by Israeli residents from
the sale of shares issued upon exercise of options will be taxed at a rate of only 25% and
not at the marginal income tax rate applicable to the grantee (up to 50%). Also in 2003,
our board of directors adopted the ECtel Ltd. U.S. Employee Stock Option Plan
for residents of the United States to enable eligible grantees to benefit from favorable
U.S. federal income tax treatment of options that qualify as incentive stock options.
These plans were approved by our shareholders and currently have pools of 1,700,000 shares
and 50,000 ordinary shares, respectively. Terms of the options granted under the plans,
such as length of term, exercise price, vesting and exercisability, are determined by our
board of directors.

In
September 2004, our shareholders resolved to increase the number of Ordinary Shares
underlying our 2003 Share Option Plan from 200,000 Ordinary Shares to 1,700,000 Ordinary
Shares and to decreases the number of Ordinary Shares underlying our other share option
plans (other than the 2003 U.S. Stock Option Plan) by an aggregate of (i) 490,266 Ordinary
Shares as of the date of said resolution and (ii) 437,933 Ordinary Shares underlying the
then outstanding options, which were scheduled to expire within 30 days following the date
of said resolution.

In
April 2006, our shareholders resolved to approve an amendment to our 2003 Share Option
Plan (the 2003 Plan and as amended by such amendment, the Amended
Plan) intended to, among other things, increase the number of shares reserved for
issuance under the Amended Plan by 2,000,000 shares, from 1,700,000 shares to 3,700,000
shares, add Restricted Stock Units and Stock Appreciation Rights to the types of awards
available for issuance under the Amended Plan, terminate our ECtel Ltd. 2003 U.S. Employee
Stock Option Plan and consolidate its terms into the Amended Plan so that we will have
only one equity incentive plan under which we make awards.

As
of March 31, 2007, options to purchase a total of 1,987,712 of our ordinary shares were
outstanding. During 2006 and up to the date of the filing of this Annual Report, 785,110
options to purchase an aggregate of ordinary shares granted under the plans have been
exercised. During 2006, 810,000 options have been granted. In May, 2007, 580,000 options
were granted to a group of officers and employees.

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

| | A. | Major
Shareholders
| | -- | ------------------

The
following table shows the number of our ordinary shares beneficially owned by the only
shareholders known to us as of March 31, 2007 to beneficially own more than 5% of our
outstanding ordinary shares. As of that date, 16,649,405 of our ordinary shares were
issued and outstanding. In accordance with the rules of the Securities and Exchange
Commission, the number of ordinary shares used in calculating the percentage for each
person listed below includes the shares underlying options or warrants held by such person
that are exercisable within 60 days, but excludes the shares underlying any other options
or warrants held by these persons.

|                                                      | Shares Beneficially Owned
|----------------------------------------------------- | -------------------------
|
|
|
|
|IDB Holding Corporation Ltd. and its subsidiaries (1) |                          
|FMR Corp. (2)                                         |                          
|Kingdon Capital Management, LLC (3)                   |                          

(1)
          Based upon notification from Clal Industries and Investments Ltd. dated January
          21, 2007. This number of shares includes: (a) 364,497 of our ordinary shares
          held directly by Koor Industries Ltd (Koor) and 3,134,338 of our
          ordinary shares held by M.A.G.M. Chemistry Holdings Ltd. (M.A.G.M.),
          which is a wholly owned subsidiary of Koor. Koor and M.A.G.M. are Israeli
          corporations. Koors ordinary shares are traded on the Tel Aviv Stock
          Exchange (TASE) and Koors ADRs (American depositary shares)
          are traded on the New York Stock Exchange. (b) 1,443,254 of our ordinary shares
          held directly by Clal Electronics Industries Ltd. (CEI), which is a
          wholly owned subsidiary of Clal Industries and Investments Ltd.
          (Clal). CEI and Clal are Israeli corporations. Clals shares
          are traded on TASE. (c) 9,483 of our ordinary shares held directly by IDB
          Development Corporation Ltd. (IDBD), and 4,004 of our ordinary
          shares held by subsidiaries of Clal Insurance Enterprises Holdings Ltd
          (Clal Insurance), a majority-owned subsidiary of IDBD, for their own
          account (but does not include 1,993 of our ordinary shares held for members of
          the public through insurance policies managed by subsidiaries of Clal Insurance,
          and 735 of our ordinary shares held by unaffiliated third-party client accounts
          managed by subsidiaries of Clal Insurance as portfolio managers). IDBD and Clal
          Insurance are Israeli corporations, whose shares are traded on TASE. (d) 9,483
          of our ordinary shares held by Badal Securities Ltd. (Badal), a
          wholly owned subsidiary of IDB Holding Corporation Ltd. (IDBH).
          Badal and IDBH are Israeli corporations. IDBHs shares are traded on TASE.

38

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Approximately 42% of Koors
ordinary shares are held by Discount Investment Corporation Ltd. (DIC), and
approximately 10% of Koors ordinary shares are held directly by IDBD. DIC is an
Israeli corporation whose shares are traded on TASE. Clal and DIC are controlled by IDBD.
IDBD is control by IDBH.

IDBH is controlled as follows: Ganden
Holdings Ltd. (Ganden), a private Israeli company controlled by Nochi Dankner
and his sister Shelly Bergman, holds, directly and through a wholly-owned subsidiary,
approximately 44.88% of the outstanding shares of IDBH; Shelly Bergman, through a
wholly-owned company, holds approximately 7.23% of the outstanding shares of IDBH; Avraham
Livnat Ltd ({Livnat), a private Israeli company controlled by Avraham Livnat
holds, directly and through a wholly-owned subsidiary, approximately 10.38% of the
outstanding shares of IDBH; and Manor Holdings BA Ltd., or Manor, a private company
controlled by Ruth Manor holds, directly and through a majority-owned subsidiary,
approximately 10.37% of the outstanding shares of IDBH.

Subsidiaries of Ganden, Livnat and
Manor have entered into a shareholders agreement with respect to shares of IDBH
constituting 31.02%, 10.34% and 10.34%, respectively, of the outstanding shares of IDBH
for the purpose of maintaining and exercising control of IDBH as a group. Their additional
holdings in IDBH are not subject to the shareholders agreement. The term of the
shareholders agreement expires in May 2023.

Based on the foregoing, IDBH (by
reason of its control of Badal and IDBD, and by reason of IDBDs control of Clal,
CEI, Clal Insurance, DIC, Koor and M.A.G.M.), Ganden, Manor and Livnat (by reason of their
control of IDBH) and Nochi Dankner, Shelly Bergman, Ruth Manor, and Avraham Livnat (by
reason of their control of Ganden, Manor and Livnat, respectively) may be deemed to share
with Badal, IDBD, Clal, CEI, Clal Insurance. DIC, Koor and M.A.G.M. the power to vote and
dispose of our ordinary shares held by these entities.

(2)
          Based upon a Schedule 13D filed with the SEC in February 14, 2007. FMR Corp.
          owns Fidelity Management & Research Company, an investment adviser
          registered under Section 203 of the Investment Advisers Act of 1940 that manages
          various registered investment companies that own some of our shares. One such
          investment company is a shareholder of ECI and acquired ECtel shares in
          ECIs share distributions in May 2004 and July 2006. FMR Corp. also owns
          Fidelity Management Trust Company, a bank that owns some of our shares. Edward
          C. Johnson 3rd and other members of his family are the predominate owners of,
          and may be deemed to form a controlling group of, FMR Corp.

(3)
          Based upon a Schedule 13D filed with the SEC in February 12, 2007, containing
          information as of December 31, 2006 with respect to beneficial ownership of our
          Ordinary Shares held for the accounts of Kingdon Associates, a New York limited
          partnership (Kingdon Associates), M. Kingdon Offshore Ltd., a Cayman
          Islands exempted company (Kingdon Offshore), and Kingdon Family
          Partnership, L.P., a New York limited partnership (Kingdon Family
          Partnership). Kingdon Capital Management serves as investment manager to
          each of Kingdon Associates, Kingdon Offshore and Kingdon Family Partnership. In
          such capacity, Kingdon Capital Management may be deemed to have voting and
          dispositive power over the Ordinary Shares held for the accounts of each of
          Kingdon Associates, Kingdon Offshore and Kingdon Family Partnership. Mark
          Kingdon is the managing member and president of Kingdon Capital Management.

On June 28, 2006, ECI distributed its
remaining shares of ECtel as dividend to its shareholders and as a result, ECI is no
longer a shareholder of ECtel. Accordingly ECI has been removed from the above table.

Based upon a Schedule 13G/A filed
with the SEC on November 1, 2005, Royce & Associates, LLC held 184,700 of our ordinary
shares as of such date, constituting 1.03% of our then outstanding share capital.
Accordingly Royce & Associates, LLC has been removed from the above table.

Based upon notification from the
BlackRock Group dated January 26, 2007, the BlackRock Group held 591,121of our ordinary
shares as of such date, constituting 3.61% of our then outstanding share capital.
Accordingly Merrill Lynch & Co., Inc. has been removed from the above table.

Based upon a Schedule 13G filed with
the SEC on February 13, 2007, Stichting Pensioenfonds ABP held 257,930 of our ordinary
shares as of such date, constituting 1.58% of our outstanding share capital. Accordingly
Stichting Pensioenfonds ABP has been removed from the above table.

Record Holders

As
of March 31, 2007, there were 359 holders of record of our ordinary shares. Two hundred
sixty one record holders, holding approximately 14,643,923 shares, or 77.26%, of our
outstanding ordinary shares, were located in the United States. These numbers are not
representative of the number of beneficial holders of our shares nor is it representative
of where such beneficial holders reside since many of these ordinary shares were held of
record by brokers or other nominees.

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

39

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| | B. | Related
Party Transactions
| | -- | --------------------------

Supply
Agreemen with ECI

In
February 2004, we executed a new supply agreement with ECI, which replaced an earlier
supply agreement entered into in October 1999. Under the terms of the new supply
agreement, ECI supplies us with the components (modules) for use in our
products. We agreed on the prices for these modules after negotiations with ECI. In
accordance with its right under the Supply Agreement, ECI stopped manufacturing some of
these components as of August 2006. Accordingly, we contracted with an alternate supplier
for the manufacture of these components.

Distribution
Agreement with ECI

In
June 2005 we entered into a distribution agreement with ECI under which we appointed ECI
as our exclusive distributor in the Russian Federation, Ukraine and Kazakhstan,
territories. Under this agreement, ECI, among other things, maintains a business and sales
organization in these territories to promote and/or affect the sale of those of our
products and services covered by the agreement. The agreement is subject to termination by
either party upon three months notice. In addition, either party may terminate the
agreement at any time upon a material breach by the other party or in the event of
liquidation or similar consequences of the other party.

| | C. | Interests
of Expert and Counsel
| | -- | -------------------------------

Not
Applicable.

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

| | A. | Consolidated
Financial Statements and Other Financial Information
| | -- | -----------------------------------------------------------------

# Financial Statements

See
Item 18.

# Legal Proceedings

On
October 19, 2004, a class action complaint (the Class Action Complaint), Leumi
Gemel Ltd. v. ECtel Ltd., et al., Case No. 8:04-CV-03380-RWT, was filed in the United
States District Court for the District of Maryland. Named as defendants are ECtel Ltd.,
ECI Telecom Ltd., and certain of ECtels directors and officers. The Class Action
Complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934, and Rule 10b-5 promulgated thereunder, by making false and
misleading statements in the Companys SEC filings and press releases during a period
beginning April 24, 2001, and lasting through April 2, 2003. The claims are purportedly
brought on behalf of all persons who purchased our stock during that period. The
plaintiffs seek unspecified compensatory damages against the defendants, as well as
attorneys fees and costs.

The
Company filed a motion to dismiss the amended class action complaint. At a hearing on this
motion held on July 17, 2006, the Court granted our motion to dismiss the amended class
action complaint. Following the dismissal, the plaintiff filed a motion to further amend
the amended class action complaint and we responded by requesting the Court to deny the
motion to amend. On March 6, 2007 the Court denied the plaintiffs motion to further
amend the amended class-action. The plaintiffs have 30 days in which they can appeal this
decision to an Appellate Court. The Company believes that the plaintiffs class
action claims are without merit and intends to continue defending the case vigorously.

Other
than this lawsuit, we are not party to any material legal proceedings.

# Dividend Policy

We
do not expect to pay cash dividends in the foreseeable future.

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

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

| | B. | Significant
Changes
| | -- | -------------------

There
has been no significant change in our financial position since December 31, 2006 other than as stated in Item 5(A), Overview.

40

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

| | A. | Offer
and Listing Details
| | -- | -------------------------

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

|                  | High | Low
|----------------- | ---- | ---
|
|
|
|
|Calendar Year:    |      |    
|                  |      |    
|2002              |      |    
|2003              |      |    
|2004              |      |    
|2005              |      |    
|2006              |      |    
|                  |      |    
|Calendar Quarter: |      |    
|                  |      |    
|2005:             |      |    
|First Quarter     |      |    
|Second Quarter    |      |    
|Third Quarter     |      |    
|Fourth Quarter    |      |    
|                  |      |    
|2006:             |      |    
|First Quarter     |      |    
|Second Quarter    |      |    
|Third Quarter     |      |    
|Fourth Quarter    |      |    
|                  |      |    
|Calendar Month    |      |    
|                  |      |    
|November 2006     |      |    
|December 2006     |      |    
|January 2007      |      |    
|February 2007     |      |    
|March 2007        |      |    
|April 2007        |      |    

| | B. | Plan
of Distribution
| | -- | --------------------

Not
Applicable.

| | C. | Markets
| | -- | -------

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

| | D. | Selling
Shareholders
| | -- | --------------------

Not
Applicable.

| | E. | Dilution
| | -- | --------

Not Applicable.

| | F. | Expenses
of the Issue
| | -- | ---------------------

Not Applicable.

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

| | A. | Share
Capital
| | -- | -------------

Not
Applicable.

41

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| | B. | Memorandum
and Articles of Association
| | -- | --------------------------------------

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

# Objects and Purposes

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

The
following sections, to the extent they refer to our articles of association are qualified
in their entirety by the articles themselves, filed as an exhibit to our annual report
submitted for 2005.

# Transfer and Ownership
of Shares; Notices

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

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

# Dividend and Liquidation
Rights

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

# Voting,
Shareholders Meetings and Resolutions

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

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

The
quorum required for a meeting of shareholders consists of at least two shareholders
present in person or by proxy who hold or represent in the aggregate at least 25% of the
outstanding voting shares. A meeting adjourned for lack of a quorum generally is adjourned
to the same day in the following week at the same time and place or any time and place as
the chairman may designate with the consent of the holders of a majority of the voting
power represented at the meeting and voting on the matter adjourned.

# Mergers and Acquisitions
under Israeli Law

The
Israeli Companies Law includes provisions that allow a merger transaction and requires
that each company that is a party to a merger have the transaction approved by its board
of directors and a vote of the majority of its shares, at a shareholders meeting
called on at least 21 days prior notice. For purposes of the shareholder vote,
unless a court rules otherwise, the merger will not be deemed approved if a majority of
the shares held by parties other than the other party to the merger, or by any person who
holds 25% or more of the shares or the right to appoint 25% or more of the directors of
the other party, vote against the merger. Upon the request of a creditor of either party
to the proposed merger, the court may delay or prevent the merger if it concludes that
there exists a reasonable concern that as a result of the merger, the surviving company
will be unable to satisfy the obligations of any of the parties to the merger. In
addition, a merger may not be completed unless at least 50 days have passed from the date
that a proposal of the merger was filed with the Israeli Registrar of Companies by each
merging company and 30 days from the date that shareholder approval of both merging
companies was obtained. The request for the approval of a merger may be filed once a
shareholder meeting has been called to approve the merger.

42

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The
Companies Law also provides that an acquisition of shares of a public company must be made
by means of a tender offer if as a result of the acquisition the purchaser would become a
25% shareholder of the company and there is not any other existing shareholder who holds
25% or more of the company. In addition, an acquisition of shares of a public company must
be made by means of a tender offer if as a result of the acquisition the purchaser would
become a 45% shareholder of the company unless there already is another 45% shareholder in
the company. If following any acquisition of shares, the acquiror will hold 90% or more of
the companys shares, the acquisition may not be made other than through a tender
offer to acquire all of the shares of such class. If more than 95% of the outstanding
shares are tendered in the tender offer, all the shares that the acquirer offered to
purchase will be transferred to it. However, the remaining minority shareholders may seek
to alter the tender offer consideration by court order.

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

# Modification of Class
Rights

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

# Fiduciary Duties of
Office Holders

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

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

| |  | Information
 on the  advisability  of a given action brought for his approval or performed by him
              by virtue of his position; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------

| |  | all
other important information pertaining to these actions.
| | - | ------------------------------------------------------------

The duty of loyalty of an office
holder includes a duty to:

| |  | refrain
from any conflict of interest between the performance of his duties in the company and
the performance of his other duties or his personal affairs;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | refrain
from any activity that is competitive with the company;
| | - | ---------------------------------------------------------------

| |  | refrain
from  exploiting  any business  opportunity of the company to receive a personal gain for
              himself or others; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------

| |  | disclose
to the company any information or documents relating to the companys affairs which
the office holder has received due to his position as an office holder.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Approval of
Related-Party Transactions under Israeli Law

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

| |  | the
office holder's spouse, siblings, parents,  grandparents,  descendants,  spouse's
descendants               and the spouses of any of these people; or
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | any
corporation in which the office holder is a 5% or greater shareholder, director or
general manager or in which he has the right to appoint at least one director or the
general manager.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Under the Companies Law, an
extraordinary transaction is a transaction:

| |  | other
than in the ordinary course of business;
| | - | ----------------------------------------------

| |  | otherwise
than on market terms; or
| | - | ----------------------------------

| |  | that
is likely to have a material impact of the company's profitability, assets or liabilities.
| | - | -----------------------------------------------------------------------------------------------

43

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

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

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

# Duties of Shareholders

Disclosure
of Personal Interests of a Controlling Shareholder

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

| |  | at
 least  one-third  of the  shares  of  shareholders  who  have  no  personal  interest
 in the               transaction and who vote on the matter vote in favor thereof; or
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
shareholders who have no personal interest in the transaction who vote against the
transaction do not represent more than one percent of the voting rights in the company.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

Duties
of Good Faith and Fairness

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

# Indemnification of
Directors and Officers

Exculpation
of Office Holders

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

Insurance
Relating to Office Holders

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

| |  | A
breach of his duty of care to 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
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

44

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| |  | A
financial liability imposed upon him in favor of another person.
| | - | ------------------------------------------------------------------

We
have obtained liability insurance covering our officers and directors.

Indemnification
of Office Holders

An
Israeli company may indemnify an office holder in respect of certain liabilities following
an event or in advance of an event, provided that a provision authorizing such
indemnification is inserted in its articles of association and that the companys
undertaking to indemnify an office holder is limited to such events which the board of
directors shall deem to be likely to occur in light of the operations of the company at
the time that the undertaking is made and for such amounts or criteria which the board of
directors may, at the time, deem to be reasonable under the circumstances. Our articles of
association were amended on September 2005 to contain such an authorization. An
undertaking by an Israeli company to indemnify an office holder with respect to a
financial liability for acts performed as an office holder imposed on him or her in favor
of another person pursuant to a judgment, settlement or arbitrators award approved
by court must be limited to foreseeable liabilities and reasonable amounts determined by
the board of directors. In addition, a company may indemnify an office holder against the
following liabilities incurred for acts performed as an office holder:

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

| |  | a
 financial  obligation  imposed on him or her in favor of another  person by a court
 judgment,               including a compromise judgment or an arbitrator's award
approved by court; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | reasonable
litigation expenses, including attorneys fees, expended by the office holder or
charged to him by a court in connection with:
| | - | -----------------------------------------------------------------------------------------------------------------------------------------

| |  | Proceedings
we institute against him or that are instituted on our behalf or by another person;
| | - | -----------------------------------------------------------------------------------------------

| |  | a
criminal charge from which he is acquitted; or
| | - | ------------------------------------------------

| |  | a
criminal  proceeding  in which he is  convicted  of an offense  that does not require
 proof of               criminal intent.
| | - | --------------------------------------------------------------------------------------------------------------------------------

| |  | Our
articles of association also include provisions:
| | - | ----------------------------------------------------

| |  | authorizing
us to undertake to indemnify an office holder as described above, and
| | - | ---------------------------------------------------------------------------------

| |  | setting
 forth  such  events  which  our  board of  directors  deems to be  anticipated  when the
              undertaking is given and such
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------

| |  | amounts
 and/or  criteria  determined  by our  board of  directors  to be  reasonable  under  the
              circumstances; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------

| |  | authorizing
us to retroactively indemnify an officer or director.
| | - | -----------------------------------------------------------------

Limitations
on Exculpation, Insurance and Indemnification

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

| |  | a
breach by the office holder of his duty of loyalty unless, with respect to insurance
coverage, the office holder acted in good faith and had a reasonable basis to believe
that the act would not prejudice the company;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
prohibited dividend or distribution to shareholders;
| | - | ------------------------------------------------------

| |  | a
breach by the office holder of his duty of care if the breach was committed intentionally
or recklessly (excluding a breach arising out of negligent conduct of the office holder);
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | any
act or omission committed with the intent to derive an illegal personal benefit; or
| | - | ---------------------------------------------------------------------------------------

| |  | any
fine imposed on the office holder;
| | - | --------------------------------------

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

45

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

| | C. | Material
Contracts
| | -- | ------------------

For
a description of material agreements other than the ones described below that we entered
into with ECI, please refer to Item 7B  Related Party Transactions.

Transactions
with ECI

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

# Registration Rights
Agreement

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

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

# ECI Share Purchase
Agreement

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

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

Transaction with Verint
Systems

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

Pursuant
to the asset purchase agreement, Verint Systems purchased certain assets and assumed
certain liabilities relating to our government surveillance business for $35 million in
cash. The divestiture of our government surveillance business entailed the legal transfer
of technology required for the segment, transfer or termination of employees involved in
the segment, transfer of fixed assets required for the performance of the business and
transfer of inventory related to the business.

As
part of the transaction, we remained the named party on a number of contracts which
required additional performance, including for warranty and other remaining services. With
respect to these contracts, the customers consented to the performance by Verint Systems
of all the remaining obligations of ECtel under the contracts. The customers also agreed
to communicate directly with Verint in connection with the performance of the contracts by
Verint. However, we may be liable to the customer in the event that Verint does not
perform as required under these agreements. In the event that we suffer damages as a
result of Verints non-performance, we would have indemnification rights against
Verint.

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We
and Verint Systems have made mutual non-competition covenants in favor of each other not
to engage in the respective businesses of the other (i) generally, for a period of three
years and (ii) using our respective technologies as they existed as of the closing of the
transaction, for a period of ten years.

As
a result of the transactions described above, we did not retain any interest or any active
involvement in the government surveillance business. We have no veto, managerial or other
control over the disposed business, the performance of customer contracts or the
relationships with the customers. Under the sale agreement, we have no right to influence,
in any way, the disposed segment activities, and have not been, nor do we have any plans
to be, involved in the disposed business.

Since
the time of the sale of the business to Verint, we have not generated any revenue or
incurred any costs that would otherwise have been generated or incurred by the disposed
unit. All revenues and related costs under the disposed component are generated and
incurred by Verint. Also, there is no continuation of the business through sales of
similar products or services through any related party. This would be prohibited by our
non-compete obligations entered into in connection with the sale of the business. As
described above, we have no continued involvement in the operation of the disposed
component.

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

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

On
December 25, 2005 we entered into an agreement with Verint Systems in order to modify
certain terms of the asset purchase agreement and other related agreements. According to
this additional agreement, all monetary obligations under the agreements between the
parties were settled and terminated (except for certain specifically excluded
obligations), some of the projects that had been retained by us, the performance of which
was subcontracted to Verint, were terminated, and the parties agreed on certain
modifications to their mutual engineering support obligations. Such mutual obligations
expired at the end of 2006.

Acquisition of Telesoft

On
December 29, 2005, we entered into a Share Sale and Purchase Agreement with Elron Telesoft
Ltd., Elron Telesoft Export Ltd., and Elron Electronic Industries Ltd. Pursuant to the
agreement, we purchased all of the outstanding share capital of Elron Telesoft Ltd. and
Elron Telesoft Export Ltd. from their parent company, Elron Electronic Industries Ltd., as
well as all of Elron Electronic Industries Ltd.s interest under certain notes and
inter-company loan agreements and arrangements between the parent and these subsidiaries.
The aggregate purchase price was $2.5 million consisting of $2.1 million in cash paid to
Elron Electronic Industries Ltd., as the seller at the closing and $0.4 million in direct
transaction costs consisting primarily of professional fees. The acquisition closed in
January 2006.

In
addition to the purchase price as mentioned above, we were obligated to pay to Elron
Electronic Industries Ltd. an earn-out in the amount of $0.4 million, in accordance with
the purchase agreement, which is payable in two deferred installments if certain
milestones are met. The earn-out was payable over the period of 12 months following the
closing date and as of December 31, 2006, no such earn-out was paid since the aforesaid
milestones were not met.

As
part of the agreement, Elron Electronic Industries Ltd., on behalf of itself and its
controlled affiliates, made certain commitments to refrain from engaging in any business
conducted by its subsidiaries immediately prior to the closing of the Share Sale and
Purchase Agreement in the field of revenue assurance.

| | D. | Exchange
Controls
| | -- | -----------------

# Exchange Controls and
Other Limitations Affecting Security Holders

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

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

47

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| | E. | Taxation
| | -- | --------

The
following is a general summary only and should not be considered as income tax advice or
relied upon for tax planning purposes. Holders of our ordinary shares should consult their
own tax advisors as to the United States, Israeli or other tax consequences of the
purchase, ownership and disposition of ordinary shares, including, in particular, the
effect of any foreign, state or local taxes.

# CERTAIN U.S. FEDERAL
INCOME TAX CONSIDERATIONS

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

| |  | an
individual citizen or resident of the United States,
| | - | -------------------------------------------------------

| |  | a
corporation  (or other entity  taxable as a corporation  for U.S.  federal income tax
purposes)               created  or  organized  in the United  States or under the laws
of the United  States or any               political subdivision thereof,
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | an
estate,  the income of which is subject to U.S.  federal  income tax regardless of its
source,               or
| | - | ------------------------------------------------------------------------------------------------------------------

| |  | a
trust if, in  general,  (i) 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.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

If
a partnership (or any other entity treated as a partnership for U.S. Federal income tax
purposes) holds our ordinary shares, the tax treatment of the partnership and a partner in
such partnership will generally depend on the status of the partner and the activities of
the partnership. Such a partner or partnership should consult its tax advisor as to its
tax consequences.

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

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

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

| |  | are
broker-dealers or insurance companies,
| | - | ------------------------------------------

| |  | have
elected mark-to-market accounting,
| | - | ---------------------------------------

| |  | are
tax-exempt organizations or retirement plans,
| | - | -------------------------------------------------

| |  | granter
trusts,
| | - | ---------------

| |  | certain
former citizens or long term residents of the United States,
| | - | --------------------------------------------------------------------

| |  | are
financial institutions or financial services entities,
| | - | ----------------------------------------------------------

| |  | hold
 ordinary  shares  as part  of a  straddle,  hedge  or  conversion  transaction  with
 other               investments,
| | - | ----------------------------------------------------------------------------------------------------------------------------

| |  | acquired
 their  ordinary  shares upon the  exercise of employee  stock  options or  otherwise as
              compensation,
| | - | -----------------------------------------------------------------------------------------------------------------------------

| |  | real
estate investment trusts or regulated investment companies,
| | - | ----------------------------------------------------------------

| |  | own
directly, indirectly or by attribution at least 10% of our voting power, or
| | - | -------------------------------------------------------------------------------

| |  | have
a functional currency that is not the U.S. dollar.
| | - | -------------------------------------------------------

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

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

Taxation of Dividends
Paid on Ordinary Shares

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

Dividends
that are received by U.S. holders that are individuals, estates or trusts will be taxed at
the rate applicable to long-term capital gains currently (a maximum rate of 15% for
taxable years beginning on or before December 31, 2010), provided that such dividends meet
the requirements of qualified dividend income. Dividends that fail to meet
such requirements, and dividends received by corporate U.S. holders, are taxed at ordinary
income rates. No dividend received by a U.S. holder will be a qualified dividend (1) if
the U.S. holder held the ordinary share with respect to which the dividend was paid for
less than 61 days during the 121-day period beginning on the date that is 60 days before
the ex-dividend date with respect to such dividend, excluding for this purpose, under the
rules of Code Section 246(c), any period during which the U.S. holder has an option to
sell, is under a contractual obligation to sell, has made and not closed a short sale of,
is the grantor of a deep-in-the-money or otherwise nonqualified option to buy, or has
otherwise diminished its risk of loss by holding other positions with respect to, such
ordinary share (or substantially identical securities) or (2) to the extent that the U.S.
holder is under an obligation (pursuant to a short sale or otherwise) to make related
payments with respect to positions in property substantially similar or related to the
ordinary share with respect to which the dividend is paid. If we were to be a
passive foreign investment company, (as such term is defined in the Code) for
any year, dividends paid on our ordinary shares in such year or in the following year
would not be qualified dividends. In addition, a non-corporate U.S. holder will be able to
take a qualified dividend into account in determining its deductible investment interest
(which is generally limited to its net investment income) only if it elects to do so; in
such case the dividend will be taxed at ordinary income rates.

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

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

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

| |  | If
the U.S. holder has not held the ordinary shares for at least 16 days of the 31day
period beginning on the date which is 15 days before the ex-dividend date with respect to
such dividend; or
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

Taxation of the
Disposition of Ordinary Shares

Subject
to the discussion below under Tax Consequences if We are a Passive Foreign
Investment Company, upon the sale, exchange or other disposition of our ordinary
shares, a U.S. holder will recognize capital gain or loss in an amount equal to the
difference between the U.S. holders basis in the ordinary shares, which is usually
the cost to the U.S. holder of the ordinary shares, and the amount realized on the
disposition. A disposition of ordinary shares will be considered to occur on the trade
date, regardless of the holders method of accounting. Capital gain from the sale,
exchange or other disposition of ordinary shares held more than one year will be long-term
capital gain and may, in the case of individual U.S. holders, be subject to a reduced rate
of taxation (long term capital gains are currently taxable at a maximum rate of 15% for
taxable year beginning in or before December 31, 2010). Gain or loss recognized by a U.S.
holder on a sale, exchange or other disposition of ordinary shares will generally be
treated as U.S. source income for U.S. foreign tax credit purposes. The deductibility of a
capital loss recognized on the sale, exchange or other disposition of ordinary shares is
subject to limitations.

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

Tax Consequences if we
are a Passive Foreign Investment Company

There
is a risk that we may be a passive foreign investment company, or PFIC, for U.S. federal
income tax purposes. As described more fully below, our treatment as a PFIC could result
in a reduction in the after-tax return to the U.S. Holders of our ordinary shares and may
cause a reduction in the value of such shares.

For
U.S. federal income tax purposes, we will be classified as a PFIC for any taxable year in
which either (i) 75% or more of our gross income is passive income, or (ii) at least 50%
of the average value of all of our assets for the taxable year produce or are held for the
production of passive income. For this purpose, cash is considered to be an asset which
produces passive income. Passive income includes dividends, interest, royalties, rents,
annuities and the excess of gains over losses from the disposition of assets which produce
passive income.

We
believe that we were not a PFIC for 2006. However, we could be a PFIC for 2006, if (i)
certain of our assets were determined to produce or to be held for the production of
passive income or (ii) our conclusions, regarding the value of certain assets or our
ordinary shares were challenged, by the United States Internal Revenue Service
(IRS). In addition, we believe there is a substantial risk that we were a PFIC
in 2004 and 2005 as a result of our substantial cash position and the performance of our
ordinary shares during those taxable years. If we were a PFIC during 2004 or 2005, U.S.
holders who acquired or held our ordinary shares during those taxable years will be
subject to the PFIC rules described below regardless of whether we were a PFIC for 2006.
However, if we were not a PFIC for 2006, U.S. holders who acquired our ordinary shares in
2006 will not be subject to the PFIC rules, unless we are classified as a PFIC in future
years.

If
we are a PFIC, a U.S. holder of our ordinary shares could be subject to increased tax
liability upon the sale or other disposition (including gifts) of its ordinary shares or
upon the receipt of amounts treated as excess distributions, which could
result in a reduction in the after-tax return to such U.S. holder. In general, an excess
distribution is the amount of distributions received during a taxable year that exceed
125% of the average amount of distributions received by the taxpayer in respect of the
ordinary shares during the preceding three taxable years, or if shorter, during the U.S.
holders holding period prior to the taxable year of the distribution. Under these
rules, the excess distribution and any gain on the disposition of ordinary shares would be
allocated ratably over the U.S. holders holding period for the ordinary shares. The
amount allocated to the current taxable year and any taxable year prior to the first
taxable year in which we were a PFIC would be taxed as ordinary income. The amount
allocated to each of the other taxable years would be subject to tax at the highest
marginal rate in effect for the applicable class of taxpayer for that taxable year, and an
interest charge for the deemed deferral benefit would be imposed on the resulting tax
allocated to such other taxable years. The tax liability with respect to the amount
allocated to taxable years prior to the year of the disposition or distribution cannot be
offset by net operating losses. In addition, holders of stock in a PFIC may not receive a
step-up in basis on shares acquired from a decedent.

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

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

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

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

| |  | the
item is effectively connected with the conduct by the non-U.S. holder of a trade or
business in the United States and in the case of a resident of a country which has a
treaty with the United States, the item is attributable to a permanent establishment; or
in the case of an individual, the item is attributable to a fixed place of business in
the United States; or
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

50

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| |  | 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 certain other conditions are met does not qualify for an exemption.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Information Reporting and
Back-up Withholding

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

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

# ISRAELI TAXATION

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

# Transfer Pricing

In
accordance with Section 85A of the Israeli Tax Ordinance, if, in an international
transaction, (whereby at least one party is a foreigner or all or part of the income from
such transaction is to be taxed abroad as well as in Israel) there is a special
relationship (including, but not limited to family relationship or a relationships of
control between companies) between the parties, and due to this relationship the price set
for an asset, right, service or credit was determined or other conditions for the
transaction were set such that a smaller profit was realized then what would have been
expected to be realized from a transaction of this nature, then such transaction shall be
reported in accordance with customary market conditions and tax shall be charged
accordingly. This Section shall apply solely to transactions which transpire after
November 29, 2006 at which time regulations with respect to this section were legislated.
The assessment of whether a transaction falls under the aforementioned definition shall be
implemented in accordance with one of the procedures mentioned in the regulations and is
based, among others, on comparisons of characteristics which portray similar transactions
in ordinary market conditions, such as profit, the area of activity, nature of the asset,
the contractual conditions of the transaction and according to additional terms and
conditions specified in the regulations.

# General Corporate Tax
Structure

Generally,
Israeli companies are subject to corporate tax at the rate of 29% on taxable income and
are subject to capital gains tax at a rate of 25% on capital gains (other than gains
derived from the sale of listed securities that are taxed at the prevailing corporate tax
rates) derived after January 1, 2003. Also, 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.
The corporate tax rate was reduced in July 2005 such that in 2007, companies will be taxed
at a rate of 29%, in 2008  at a rate of 27%, in 2009  at a rate of 26% and
following 2010 at a rate of 25%. However, the effective tax rate payable by a company that
derives income from an approved enterprise (as discussed below) may be considerably less.

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

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

The
law was amended in 2005, although we are subject to both the new provisions of the law as
well as the old provisions, as certain of our approved enterprises were approved by the
Israeli government prior to the amendment of the law, while other approved enterprises
were approved by the government following the amendment.

51

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Under
the old law, taxable income of a company derived from an approved enterprise (including
income generated by a company from the grant of a usage right with respect to know-how
developed by the approved enterprise, income generated from royalties and income derived
from a service which is auxiliary to such usage right or royalties, provided that such
income is generated within the approved enterprises ordinary course of business) is
subject to company tax at the maximum rate of 25%, rather than the usual rate of 34%, for
the Benefit Period. The Benefit Period is seven years (and under certain
circumstances, as further detailed below, ten years), commencing with the year in which
the approved enterprise first generates taxable income, and is limited to 12 years from
commencement of production or 14 years from the date of approval, whichever is earlier.

A
company that has an approved enterprise program is eligible for further tax benefits if it
qualifies as a foreign investors company. A foreign
investors company is a company more than 25% of whose shares of capital stock
and combined share capital and loan, without interest charge, is owned by non-Israeli
residents. A company that qualifies as a foreign investors company and has an
approved enterprise program is eligible for tax benefits for a ten-year benefit period and
to a reduced tax rate of 10% to 20% depending on the level of foreign investment in each
year.

A
company owning an approved enterprise may elect (as we have done) to forego certain
government grants extended to approved enterprises in return for an alternative package of
benefits. Under the alternative package, the companys undistributed income derived
from an approved enterprise will be exempt from tax for a period of between two and ten
years from the first year of taxable income, depending on the geographic location of the
approved enterprise within Israel, and the company will be eligible for the reduced tax
benefits under the law for the remainder of the benefit period.

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

A
major portion of our production facilities have been granted the status of approved
enterprises. Income arising from our approved enterprises facilities is tax-free under the
alternative package of benefits described above for the period in which such alternative
package is in effect and thereafter, entitled to reduced tax rates based on the level of
foreign ownership for specified periods. We have derived, and expect to continue to
derive, a substantial portion of our income from our approved enterprises facilities.
Subject to compliance with applicable requirements, the benefits for most of our
production facilities in Israel will continue until termination between the years 2001 and
2008. Our current investments in development facilities are made under new approvals. If
we fail for any reason to meet the conditions of the approved revised investment program,
our future tax benefits under the Law for the Encouragement of Capital Investments will be
materially reduced. In light of our carry loss forward, we are currently not in a taxable
position.

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

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

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

In
March 2005, the government of Israel passed an amendment to the Investment Law in which it
revised the criteria for investments qualified to receive tax benefits as an approved
enterprise. Among other things, companies that meet the criteria of the alternate package
of tax benefits will receive those benefits without prior approval. However, no assurance
can be given that we will in the future be eligible to receive additional tax benefits
under this law.

The
reform primarily included the following provisions:

| | n | Companies
that meet the criteria of the Alternate Path will receive its benefits
without need for prior approval. In addition, such companies will not be required to file
reports with the Investment Center. Audits will take place via the Income Tax Authority
within the framework of general tax audits. Such companies will be able to request to
obtain pre-rulings.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | n | Tax
benefits of the Alternate Path include lower tax rates or exemptions, depending upon the
field in which a company engages and the path chosen, as well as lower tax
rates on dividends and accelerated depreciation.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | n | In
order to receive benefits within the framework of the Grant Path, under which a company
may elect to receive certain grants instead of being eligible for tax reductions or
exemptions, or the Alternate Path, the Industrial Enterprise must be deemed to contribute
to the economic independence of the State of Israels economy in one of
the following manners:
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

52

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| | (i) | its
primary activity involves the biotechnology or nanotechnology fields and
               pre-approval is received from the head of research and development at the
Office                of the Chief Scientist;
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (ii) | its
revenue derived from activity within a specific country does not exceed 75%
               of its total revenues in such year;
| | ---- | ----------------------------------------------------------------------------------------------------------------------------------

| | (iii) | 25%
or more of its revenues are derived from a specific market of at least 12
               million residents.
| | ----- | ---------------------------------------------------------------------------------------------------------------

| | n | Upon
the establishment of an approved enterprise, an investment, within three years, of at
least NIS 300,000 in production machinery and equipment within is required.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | n | In
order to be eligible for increased tax benefits under an expansion of the Industrial
Enterprise, a company is required to invest, within three years of the establishment of
an approved enterprise, the greater of NIS 300,000 in production machinery and equipment
or a certain percentage of its existing production machinery and equipment as follows:
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Production assets         | % of required investment | Required investment       
|------------------------- | ------------------------ | --------------------------
|
|
|
|
|Up to NIS140 million      | 12%                      | Up to NIS 16.8 million    
|From NIS140 - 500 million | 7%                       | From NIS 16.8 - 42 million
|Over NIS 500 million      | 5%                       | From NIS 42 million       

# Tax Benefits for
Research and Development

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

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

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

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

| |  | deduction
of purchases of know-how and patents over an eight-year period for tax purposes;
| | - | ------------------------------------------------------------------------------------------

| |  | deduction
over a three-year  period of expenses  involved with the issuance and listing of shares
              on a stock exchange;
| | - | ------------------------------------------------------------------------------------------------------------------------------------

| |  | the
right to elect, under certain conditions, to file a consolidated tax return with related
Israeli Industrial Companies that satisfy conditions set forth in the law;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

# Special Provisions
Relating to Taxation Under Inflationary Conditions

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

| |  | A
special tax adjustment for the preservation of equity whereby certain corporate assets
are classified broadly into fixed (inflation immune) assets and non-fixed (soft) assets.
Where a companys equity, as defined in the law, exceeds the depreciated cost of its
fixed assets, as defined in the law, the company may take a deduction from taxable income
that reflects the effect of multiplication of the annual rate of inflation on such
excess, up to a ceiling of 70% of taxable income in any single tax year, with the unused
portion carried forward, linked to the increase in the consumer price index. If the
depreciated cost of fixed assets exceeds a companys equity, then the excess
multiplied by the annual rate of inflation is added to taxable income.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

53

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

| |  | Taxable
gains on certain traded securities, which are taxed at a reduced tax rate with respect to
individuals following the Tax Reform (and which were previously exempt from tax), are
taxable at the companys tax rate in certain circumstances.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

# Capital Gains Tax

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

Pursuant
to the Tax Reforms, generally, capital gains tax is imposed on Israeli individual
residents at a rate of 20%, 25% for individual shareholders holding more than 10% of the
means of control in a company during a 12 month period prior to the sale, and at the
corporate tax rate for Israeli corporations on real gains derived on or after January 1,
2003, from the sale of shares in (i) companies publicly traded on the Tel Aviv Stock
Exchange (TASE), or (ii) Israeli companies publicly traded on Nasdaq or on a
recognized stock exchange or regulated market in a country that has a treaty for the
prevention of double taxation with Israel (such as our company), or (iii) companies dually
traded on both the TASE and Nasdaq or on a recognized stock exchange or a regulated market
outside of Israel. This tax rate is contingent upon the shareholder not claiming a
deduction for financing expenses, and does not apply to: (i) the sale of shares to a
relative (as defined in the Tax Reform); (ii) the sale of shares by dealers in securities;
(iii) the sale of shares by shareholders that report in accordance with the Inflationary
Adjustment Law; or (iv) the sale of shares by shareholders who acquired their shares prior
to an initial public offering (that are subject to a different tax arrangement). The tax
basis of shares acquired prior to January 1, 2003 will be determined in accordance with
the average closing share price in the three trading days preceding January 1, 2003.
However, a request may be made to the tax authorities to consider the actual adjusted cost
of the shares as the tax basis if it is higher than such average price.

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

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

Pursuant
to a treaty between the governments of the United States and Israel, the sale of shares by
a person who qualifies as a resident of the United States within the meaning of the treaty
and who is entitled to claim the benefits afforded to a resident by the treaty will not be
subject to Israeli capital gains tax. This exemption does not apply if (i) the person
holds, directly or indirectly, shares representing 10% or more of our voting power during
any part of the 12-month period preceding the applicable sale, or (ii) the capital gains
from such sale can be allocated to a permanent establishment in Israel. Also, no
withholding tax applies if the purchase of shares was made trough a financial institution.
However, the person would be permitted to claim a credit for the capital gains tax paid in
Israel against the U.S. income tax imposed with respect to the applicable sale, subject to
the limitations in U.S. laws applicable to foreign tax credits.

# Taxation of Dividends

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

54

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| | F. | Dividends
and Paying Agents
| | -- | ---------------------------

Not
Applicable.

| | G. | Statement
by Experts
| | -- | --------------------

Not Applicable.

| | H. | Documents
on Display
| | -- | --------------------

We
are subject to the informational requirements of the Securities Exchange Act of 1934, as
amended, applicable to foreign private issuers and fulfill the obligations with respect to
such requirements by filing reports with the Securities and Exchange Commission, or SEC.
You may read and copy any document we file, including any exhibits, with the SEC without
charge at the SECs public reference room at 100 F Street, N.E., Washington, D.C.
20549. Copies of such material may be obtained by mail from the Public Reference Branch of
the SEC at such address, at prescribed rates. Please call the SEC at 1-800-SEC-0330 for
further information on the public reference room. Certain of our SEC filings are also
available to the public at the SECs website at http://www.sec.gov.

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

| | I. | SUBSIDIARY
INFORMATION
| | -- | ----------------------

Not
applicable.

|Item 11. |  | Quantitative and Qualitative Disclosures about Market Risk
|-------- |  | ----------------------------------------------------------

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

# Presentation of interest
rate risk (position as of December 31, 2006)

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

|                                   | Total as of | Settlement Date | Fair valueas of
|---------------------------------- | ----------- | --------------- | ---------------
|
|
|
|
|Assets that incur interest         |             |                 |                
|A. Cash and cash equivalents       |             |                
|U.S. dollars                       |             |                 |                
|Weighted-average interest rate     |             |                 |                
|NIS                                |             |                 |                
|Weighted-average interest rate     |             |                 |                
|EUR                                |             |                 |                
|Weighted-average interest rate     |             |                 |                
|B. Short-term investments          |             |                
|U.S. dollars                       |             |                 |                
|Weighted-average interest rate     |             |                 |                
|C. Long-term marketable securities |             |                
|U.S. dollars                       |             |                 |                
|Weighted-average interest rate     |             |                 |                

55

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Exchange Rate Risk
Management

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

As
at December 31, 2006, we had entered into currency forward contracts, ending June 2007, as
a hedge against sales contracts receivable as follows:

| |  | Obligation
to sell EUR 280,000 for a total amount of $ 361,746;
| | - | ---------------------------------------------------------------

| |  | Obligation
to sell EUR 350,000 for a total amount of $ 451,203; and
| | - | -------------------------------------------------------------------

| |  | Obligation
to sell EUR 369,000 for a total amount of $ 475,088.
| | - | ---------------------------------------------------------------

# Presentation of foreign
currency-denominated assets and liabilities(position as of December 31, 2006)

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

|                      | Total as of | Settlement Date | Fair valueas of
|--------------------- | ----------- | --------------- | ---------------
|
|
|
|
|Current Assets        |             |                 |                
|NIS                   |             |                 |                
|U.K. pound sterling   |             |                 |                
|Euro                  |             |                 |                
|Other                 |             |                 |                
|Total                 |             |                 |                
|Long-term assets      |             |                
|NIS                   |             |                 |                
|Current liabilities   |             |                
|NIS                   |             |                 |                
|U.K. pound sterling   |             |                 |                
|Euro                  |             |                 |                
|Other                 |             |                 |                
|Total                 |             |                 |                
|Long-term liabilities |             |                
|NIS                   |             |                 |                

|Item 12. |  | Description of Securities Other Than Equity Securities
|-------- |  | ------------------------------------------------------

Not
applicable.

56

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# PART II

|Item 13. |  | Defaults, Dividend Arrearages and Delinquencies
|-------- |  | -----------------------------------------------

Not
applicable.

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

# Modification of Rights

Not
applicable.

Use of
Proceeds

The
net proceeds of our initial public offering were $43.2 million. Of the net proceeds, we
used $3.0 million to repay a portion of our indebtedness to ECI. The remaining proceeds
were invested in cash equivalents and are used for general corporate purposes and funding
our current activities.

In
April 2006 we announced a plan to repurchase our ordinary shares on the open market in an
amount in cash of up to $15 million. Since we adopted the plan, we repurchased an amount
of 2,304,794 of our ordinary shares for total consideration of $11.5 million. As of
December 31, 2006, our total cash, subsequent to the share repurchase, was approximately
$37.1 million.

|Item 15. |  | Controls and Procedures
|-------- |  | -----------------------

(a)
          Disclosure Controls and Procedures.

Our
chief executive officer, or CEO, and chief financial officer, or CFO, are responsible for
establishing and maintaining our disclosure controls and procedures as defined in Rule
13a-15(e) of the Securities and Exchange Act of 1934. These controls and procedures were
designed to ensure that information required to be disclosed in the reports that we file
or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed,
summarized and reported within the time periods specified in the rules and forms of the
SEC. Our management evaluated these disclosure controls and procedures under the
supervision of our CEO and CFO as of December 31, 2006. Based on this evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls
and procedures are effective as of December 31, 2006, to provide reasonable assurance that
the information required to be disclosed in filings and submissions under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported within
the time periods specified by the SECs rules and forms, and that material
information related to us and our consolidated subsidiaries is accumulated and
communicated to management, including the Chief Executive Officer and Chief Financial
Officer, as appropriate to allow timely decisions about required disclosure.

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

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

Our
board of directors has determined that Mr. Rami Entin qualified as our Audit Committee
financial expert. Our board has determined that Mr. Entin is independent as
defined by Nasdaq Rule 4200(a)(15).

|Item 16B. |  | Code of Ethics
|--------- |  | --------------

Our
board of directors has adopted our Code of Ethics and Business Conduct, a code that
applies to all of our directors and employees. A copy of our Code of Ethics and Business
Conduct may be obtained, free of charge, by writing to ECtel Ltd., Attention: Corporate
Secretary, 10 Haamal Street, Rosh Haayin, Israel.

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

At
the annual meeting held in September 21, 2006, our shareholders re-appointed Somekh
Chaikin, a member firm of KPMG International, to serve as our independent auditors.

57

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The
following table presents fees for professional audit services rendered by Somekh Chaikin
for the audit of the Companys annual financial statements for 2006 and 2005 and for
certain taxation matters:

|           | Year Ended December 31,
|---------- | -----------------------
|
|
|
|
|Audit Fees |                        
|Tax Fees   |                        
|           |                        
|           |                        
|Total      |                        

Audit
Fees are the aggregate fees billed for the audit of our annual financial statements.
This category also includes services that generally the independent accountant provides,
such as statutory audits (including audits required by the Office of the Chief Scientist
and other Israeli government institutes), and consents and assistance with and review of
documents filed with the SEC.

Tax
Fees are the aggregate fees billed for professional services rendered for tax
compliance, other than in connection with the audit.

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

|Item 16D. |  | Exemptions from Listing Standards for Audit Committees
|--------- |  | ------------------------------------------------------

Not
applicable.

|Item 16E: |  | Purchases of Equity Securities by the Issuer and Affiliated Purchasers
|--------- |  | ----------------------------------------------------------------------

In
April 2006 we announced a plan to repurchase our ordinary shares on the open market in an
amount in cash of up to $15 million. Since we adopted the plan, we repurchased an amount
of 2,304,794 of our ordinary shares for total consideration of $11.5 million.

|Purchasing period | The total number of shares purchasedas a part of the plan | Average price paidper share | Maximum amount remaining for repurchasesunder the plan
|----------------- | --------------------------------------------------------- | --------------------------- | ------------------------------------------------------
|
|
|
|
|September 2006    |                                                           |                             |                                                       
|                  |                                                           |                            
|October 2006      |                                                           |                             |                                                       
|                  |                                                           |                            
|November 2006     |                                                           |                             |                                                       
|                  |                                                           |                            
|Total             |                                                           |                             |                                                       

# PART III

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

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

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

See
pages F-1 through F-50, incorporated herein by reference.

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

|Exhibit No. |  | Exhibit
|----------- |  | -------

|1.1 |  | Memorandum
of Association (previously filed as Exhibit to our Registration Statement on Form F-1,
and incorporated herein by                           reference).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

|1.2 |  | Amended
and Restated Articles of Association (as amended on September 26, 2005) (previously filed
as Exhibit to our Annual                           Report on Form 20-F for the fiscal
year ended December 31, 2005, filed June 15, 2006, and incorporated herein by reference).
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.1 |  | ECtel
Managers and Employees Option Allotment Plan, as amended (previously filed as Exhibit to
our Annual Report on Form 20-F                           for the fiscal year ended
December 31, 1999, filed June 30, 2000, and incorporated herein by reference) (1)
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

58

---

---



|4.2 |  | ECtel
International Employee Stock Option Plan, as amended (previously filed as Exhibit to our
Annual Report on Form 20-F for                           the fiscal year ended December
31, 1999, filed June 30, 2000, and incorporated herein by reference)
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.3 |  | ECtel
Director Share Option Plan 1999 (previously filed as Exhibit to our Registration
Statement on Form F-1, and incorporated                           herein by reference).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.5 |  | Supply
Agreement, dated February 9, 2004, by and between ECI Telecom Ltd. and the Registrant
|--- |  | --------------------------------------------------------------------------------------------

|4.6 |  | Form
of Non-Exclusive Sales Agency Agreement (Germany) (previously filed as Exhibit to our
Registration Statement on Form F-1,                           and incorporated herein by
reference).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.8 |  | Share
and Asset Purchase Agreement, dated August 7, 2001, by and among Telrad Networks Ltd.,
Telrad Hawk Net-I Ltd. and the                           Registrant  (previously filed as
Exhibit to our Annual Report on Form 20-F for the fiscal year ended December 31, 2001,
filed                           February 28, 2002, and incorporated herein by reference).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.9 |  | Registration
Rights Agreement, dated January 22, 2002, by and between ECI Telecom Ltd. and the
Registrant (previously filed as                           Exhibit to our Annual Report on
Form 20-F for the fiscal year ended December 31, 2001, filed February 28, 2002, and
                          incorporated herein by reference).
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.10 |  | Share
Purchase Agreement, dated February 6, 2002, by and among ECI Telecom Ltd., the Registrant
and certain investors                           (previously filed as Exhibit to our
Annual Report on Form 20-F for the fiscal year ended December 31, 2001, filed February
28,                           2002 and incorporated herein by reference).
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.11 |  | Registration
Rights Agreement, dated February 6, 2002, by and among certain investors and the
Registrant (previously filed as                           Exhibit to our Annual Report on
Form 20-F for the fiscal year ended December 31, 2001, filed February 28, 2002, and
                          incorporated herein by reference).
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.12 |  | ECtel
2003 Share Option Plan (previously filed as Exhibit to our Annual Report on Form 20-F for
the fiscal year ended December                           31, 2003, filed June 28, 2004
and incorporated herein by reference).
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.13 |  | ECtel
2003 U.S. Employee Stock Option Plan (previously filed as Exhibit to our Annual Report on
Form 20-F for the fiscal year                           ended December 31, 2003, filed
June 28, 2004 and incorporated herein by reference).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.14 |  | Asset
Purchase Agreement, dated February 9, 2004, by and between Verint Systems Ltd. and the
Registrant (previously filed as                           Exhibit to our Annual Report on
Form 20-F for the fiscal year ended December 31, 2003, filed June 28, 2004 and
incorporated                           herein by reference).
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.15 |  | Joint
Intellectual Property Agreement, dated March 31, 2004, by and between Verint Systems Ltd.
and the Registrant (previously                           filed as Exhibit to our Annual
Report on Form 20-F for the fiscal year ended December 31, 2003, filed June 28, 2004 and
                          incorporated herein by reference).
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.16 |  | Patent
License-Back Agreement, dated March 31, 2004, by and between Verint Systems Ltd. and the
Registrant
|---- |  | ----------------------------------------------------------------------------------------------------------

|4.17 |  | Summary
Translation of Lease Agreement between the Registrant and Hevrat Mivney Ta'asiya, dated
March 2005 (previously filed                           as Exhibit to our Annual Report on
Form 20-F for the fiscal year ended December 31, 2004, filed June 28, 2005 and
incorporated                           herein by reference).
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.18 |  | 2003
Equity Incentive Plan (previously filed as Exhibit to our Annual Report on Form 20-F for
the fiscal year ended December                           31, 2005, filed June 15, 2006,
and incorporated herein by reference).
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.19 |  | Form
of Indemnification Letter
|---- |  | ------------------------------

|8.1 |  | List
of Subsidiaries
|--- |  | --------------------

|12.1 |  | Certification
of Principal Executive Officer pursuant to 17 CFR 240.13a-14(a), as adopted pursuant
toss.302 of the                           Sarbanes-Oxley Act
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

|12.2 |  | Certification
of Principal Financial Officer pursuant to 17 CFR 240.13a-14(a), as adopted pursuant
toss.302 of the                           Sarbanes-Oxley Act
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

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

59

---

---



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

|14(a) |  | Consent
of Independent Registered Public Accounting Firm
|----- |  | --------------------------------------------------------

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

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

60

---

---



SIGNATURES

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

| |  | ECTEL LTD.(Registrant)By: /s/ Itzik Weinstein
Itzik WeinsteinPresident and Chief Executive Officer
| |  | ----------------------------------------------------------------------------------------------------------------

Date: May 16, 2007

61

---

---

# ECtel Ltd. and
Subsidiaries

Consolidated
Financial Statements
as
at and for the year ended December 31, 2006



---

---



|                                                                                
|--------------------------------------------------------------------------------
|ECtel Ltd. and Subsidiaries                                                     
|Consolidated Financial Statements as at and for the year ended December 31, 2006
|                                                                                

# Contents

|                                                                                                                | Page  
|--------------------------------------------------------------------------------------------------------------- | ------
|
|
|
|
|Report of Independent Registered Public Accounting Firm                                                         | F - 2 
|                                                                                                               
|Consolidated Balance Sheets as at December 31, 2006 and 2005                                                    | F - 3 
|                                                                                                               
|Consolidated Statements of Operations for the years ended December 31, 2006, 2005 and 2004                      | F - 5 
|                                                                                                               
|Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2006, 2005 and 2004 | F - 6 
|                                                                                                               
|Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004                      | F - 7 
|                                                                                                               
|Notes to the Consolidated Financial Statements                                                                  | F - 10



---

---





| |                                 |           |                 
| | ------------------------------- | --------- | ----------------
| | Somekh Chaikin                  | Telephone | 972 3  684  8000
| | KPMG Millennium Tower           | Fax       | 972 3  684  8444
| | 17 Ha'arba'a Street, PO Box 609 | Internet  | www.kpmg.co.il  
| | Tel Aviv 61006 Israel           |           |                 

Report
of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders
ECtel Ltd.:

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

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

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

As discussed in Note 10I to the
consolidated financial statements, a class action lawsuit has been filed against the
Company.

As discussed in Note 2N to the
consolidated financial statements, effective January 1, 2006, the Company adopted the fair
value method of accounting for stock-based compensation as required by Statement of
Financial Accounting Standards No. 123(R), Share-Based Payment.

Somekh Chaikin
Certified Public Accountants (Israel)
Member Firm of KPMG International
Tel Aviv, Israel
May 16, 2007

F - 2

---

---



|                                             
|---------------------------------------------
|Consolidated Balance Sheets as at December 31
|                                             

|                                              |  | 2006 | 2005
|--------------------------------------------- |  | ---- | ----
|
|
|
|
|Assets                                        |  |      |     
|                                              |  |     
|Current assets                                |  |     
|Cash and cash equivalents                     |  |      |     
|Short-term investments                        |  |      |     
|Receivables:                                  |  |     
|Trade, net of allowance for doubtful accounts |  |      |     
|Other                                         |  |      |     
|Related parties                               |  |      |     
|Work in progress                              |  |      |     
|Inventories                                   |  |      |     
|                                              |  |      |     
|                                              |  |     
|Total current assets                          |  |      |     
|                                              |  |      |     
|                                              |  |     
|Long-term marketable securities               |  |      |     
|                                              |  |      |     
|                                              |  |     
|Long-term other assets                        |  |      |     
|                                              |  |      |     
|                                              |  |     
|Property, plant and equipment, net            |  |      |     
|                                              |  |      |     
|                                              |  |     
|Goodwill                                      |  |      |     
|                                              |  |      |     
|                                              |  |     
|Other intangible assets, net                  |  |      |     
|                                              |  |      |     
|                                              |  |     
|Total assets                                  |  |      |     
|                                              |  |      |     

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

F - 3

---

---



ECtel Ltd and
Subsidiaries

---

|                                                          |  | 2006 | 2005
|--------------------------------------------------------- |  | ---- | ----
|
|
|
|
|Liabilities and Shareholders' equity                      |  |      |     
|                                                          |  |     
|Current liabilities                                       |  |     
|Trade payables                                            |  |      |     
|Related parties                                           |  |      |     
|Advances from customers                                   |  |      |     
|Other payables and accrued liabilities                    |  |      |     
|                                                          |  |      |     
|                                                          |  |     
|Total current liabilities                                 |  |      |     
|                                                          |  |      |     
|                                                          |  |     
|Long-term liabilities                                     |  |     
|Liability for employee severance benefits                 |  |      |     
|                                                          |  |      |     
|                                                          |  |     
|Total liabilities                                         |  |      |     
|                                                          |  |      |     
|                                                          |  |     
|Commitments and contingencies                             |  |      |     
|                                                          |  |     
|Shareholders' equity                                      |  |      |     
|Ordinary shares NIS 0.04 par value per share, Authorized  |  |     
|125,000,000 shares; issued and outstanding 16,364,668     |  |     
|shares as at December 31, 2006 and 18,169,089 shares      |  |     
|as at December 31, 2005                                   |  |      |     
|Treasury shares at cost - 2,304,794 ordinary shares as at |  |     
|December 31, 2006                                         |  |      |     
|Capital surplus                                           |  |      |     
|Accumulated loss                                          |  |      |     
|                                                          |  |      |     
|                                                          |  |     
|Total shareholders' equity                                |  |      |     
|                                                          |  |      |     
|                                                          |  |     
|Total liabilities and shareholders' equity                |  |      |     
|                                                          |  |      |     

F - 4

---

---



|                                                                     
|---------------------------------------------------------------------
|ECtel Ltd. and Subsidiaries                                          
|Consolidated Statements of Operations for the years ended December 31
|                                                                     

|                                             |  | 2006 | 2005 | 2004   
|-------------------------------------------- |  | ---- | ---- | -------
|
|
|
|
|Revenues                                     |  |      |      | 14D    
|Cost of revenues                             |  |      |      | 13, 14E
|                                             |  |      |      |        
|                                             |  |     
|Gross profit                                 |  |      |      |        
|Research and development costs, net          |  |      |      | 13, 14F
|Selling and marketing expenses               |  |      |      | 13, 14G
|General and administrative expenses          |  |      |      | 13, 14H
|Restructuring and related impairment costs   |  |      |      | 17     
|Acquisition-related expenses                 |  |      |      | 18     
|Amortization of acquisition-related          |  |     
|intangible assets                            |  |      |      | 7      
|Goodwill impairment                          |  |      |      | 7C     
|                                             |  |      |      |        
|                                             |  |     
|Operating loss                               |  |      |      |        
|Financial expenses                           |  |      |      | 13, 14I
|Financial income                             |  |      |      | 14I    
|Other expenses, net                          |  |      |      |        
|                                             |  |      |      |        
|                                             |  |     
|Loss from continuing operations              |  |     
|before taxes on income                       |  |      |      |        
|Income tax (expense) benefit                 |  |      |      | 12     
|                                             |  |      |      |        
|                                             |  |     
|Net loss from continuing operations          |  |      |      |        
|Income from discontinued operations, nil tax |  |      |      | 19B    
|                                             |  |      |      |        
|                                             |  |     
|Net loss                                     |  |      |      |        
|                                             |  |      |      |        
|                                             |  |     
|Loss per ordinary share                      |  |     
|Basic and diluted loss per ordinary          |  |     
|share from:                                  |  |     
|Continuing operations                        |  |      |      |        
|Discontinued operations                      |  |      |      |        
|                                             |  |      |      |        
|                                             |  |      |      |        
|                                             |  |      |      |        
|                                             |  |     
|Weighted average number  of                  |  |     
|shares outstanding                           |  |      |      |        
|                                             |  |      |      |        

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

F - 5

---

---



|                                                                                                               
|---------------------------------------------------------------------------------------------------------------
|ECtel Ltd. and Subsidiaries                                                                                    
|Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 2006, 2005 and 2004
|                                                                                                               

|                                                | Ordinary
shares | Share
capital | Treasury
shares | Capital
surplus | Accumulated
(loss)
earnings | Total
Shareholders'
equity
|----------------------------------------------- | --------------- | ------------- | --------------- | --------------- | --------------------------- | --------------------------
|
|
|
|
|Balance at December 31, 2003                    |                 |               |                 | 17,995,628      |                             |                           
|                                                |                 |              
|Stock options exercised and paid (see Note 11B) |                 |               |                 | 155,544         |                             |                           
|                                                |                 |              
|Net loss                                        |                 |               |                 | -               |                             |                           
|                                                |                 |               |                 |                 |                             |                           
|                                                |                 |              
|Balance at December 31, 2004                    |                 |               |                 | 18,151,172      |                             |                           
|                                                |                 |              
|Stock options exercised and paid (see Note 11B) |                 |               |                 | 17,917          |                             |                           
|                                                |                 |              
|Net loss                                        |                 |               |                 | -               |                             |                           
|                                                |                 |               |                 |                 |                             |                           
|                                                |                 |              
|Balance at December 31, 2005                    |                 |               |                 | 18,169,089      |                             |                           
|                                                |                 |              
|Stock options exercised and paid (see Note 11B) |                 |               |                 | 500,373         |                             |                           
|                                                |                 |              
|Share-based compensation                        |                 |               |                 | -               |                             |                           
|                                                |                 |              
|Repurchase of shares (see Note 11C)             |                 |               |                 | (2,304,794      | )                           |                           
|                                                |                 |              
|Net loss                                        |                 |               |                 | -               |                             |                           
|                                                |                 |               |                 |                 |                             |                           
|                                                |                 |              
|Balance at December 31, 2006                    |                 |               |                 | 16,364,668      |                             |                           
|                                                |                 |               |                 |                 |                             |                           

* Represents an amount less than $1
thousand.

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

F - 6

---

---



|                                                                     
|---------------------------------------------------------------------
|ECtel Ltd. and Subsidiaries                                          
|Consolidated Statements of Cash Flows for the years ended December 31
|                                                                     

|                                                              | 2006 | 2005 | 2004
|------------------------------------------------------------- | ---- | ---- | ----
|
|
|
|
|Cash flows from operating activities                          |      |      |     
|Net loss                                                      |      |      |     
|                                                              |      |     
|Adjustments to reconcile net loss to                          |      |     
|cash (used in) provided by operating activities:              |      |     
|                                                              |      |     
|Depreciation and amortization                                 |      |      |     
|Accrued severance pay                                         |      |      |     
|Decrease in deferred tax                                      |      |      |     
|(Gain) loss on sale of property, plant and equipment          |      |      |     
|Gain from sale of operations                                  |      |      |     
|Premium amortization of long-term marketable securities       |      |      |     
|Impairment of fixed assets                                    |      |      |     
|Goodwill impairment                                           |      |      |     
|Inventory write-off                                           |      |      |     
|(Increase) decrease in trade receivables, net                 |      |      |     
|Share-based compensation expenses                             |      |      |     
|Decrease (increase) in other receivables                      |      |      |     
|Decrease in recoverable costs and estimated                   |      |     
|earnings - not yet billed                                     |      |      |     
|Decrease in inventories                                       |      |      |     
|Increase in work in progress                                  |      |      |     
|(Decrease) increase in trade payables                         |      |      |     
|(Decrease) increase in advances from customers                |      |      |     
|Changes in related parties, net                               |      |      |     
|Increase (decrease) in other payables and accrued liabilities |      |      |     
|(Decrease) increase in liability for employee                 |      |     
|severance benefits                                            |      |      |     
|                                                              |      |      |     
|                                                              |      |     
|Net cash (used in) provided by operating activities           |      |      |     
|                                                              |      |      |     

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

F - 7

---

---



|                                                                              
|------------------------------------------------------------------------------
|ECtel Ltd. and Subsidiaries                                                   
|Consolidated Statements of Cash Flows for the years ended December 31 (cont'd)
|                                                                              

|                                                            | 2006 | 2005 | 2004
|----------------------------------------------------------- | ---- | ---- | ----
|
|
|
|
|Cash flows from investing activities                        |      |      |     
|Changes in short-term investments, net                      |      |      |     
|Capital expenditure on property, plant and equipment        |      |      |     
|Acquisition of newly consolidated subsidiaries, less cash   |      |     
|acquired (see A below)                                      |      |      |     
|Remaining
payments in consideration of acquisition of newly |      |     
|consolidated subsidiaries                                   |      |      |     
|Long-term (funding) deposits withdrawal                     |      |      |     
|Proceeds from sale of property, plant and equipment         |      |      |     
|Proceeds from disposal of discontinued operations           |      |      |     
|Proceeds from maturity of long-term marketable securities   |      |      |     
|Investment in long-term marketable securities               |      |      |     
|                                                            |      |      |     
|                                                            |      |     
|Net cash provided by (used in) investing activities         |      |      |     
|                                                            |      |      |     
|                                                            |      |     
|Cash flows from financing activities                        |      |     
|Repurchase of shares                                        |      |      |     
|Issuance of ordinary shares                                 |      |      |     
|                                                            |      |      |     
|                                                            |      |     
|Net cash (used in) provided by financing activities         |      |      |     
|                                                            |      |      |     
|                                                            |      |     
|Net (decrease) increase in cash and cash equivalents        |      |      |     
|                                                            |      |     
|Cash and cash equivalents at beginning of the year          |      |      |     
|                                                            |      |      |     
|                                                            |      |     
|Cash and cash equivalents at end of the year                |      |      |     
|                                                            |      |      |     
|                                                            |      |     
|Supplemental disclosures:                                   |      |     
|                                                            |      |     
|Income taxes (received) paid, net                           |      |      |     
|                                                            |      |      |     

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

F - 8

---

---



|                                                                              
|------------------------------------------------------------------------------
|ECtel Ltd. and Subsidiaries                                                   
|Consolidated Statements of Cash Flows for the years ended December 31 (cont'd)
|                                                                              

|                                                                  | 2005
|----------------------------------------------------------------- | ----
|
|
|
|
|A.       Acquisition of newly consolidated subsidiaries (Note 7B) |     
|                                                                  |     
|Trade receivables                                                 |     
|Inventory                                                         |     
|Other receivables                                                 |     
|Trade payables                                                    |     
|Other payables and accrued liabilities                            |     
|Property, plant and equipment, net                                |     
|Goodwill                                                          |     
|Third party relations                                             |     
|Core technology                                                   |     
|Customer contracts                                                |     
|Contractual customer relations                                    |     
|Long-term assets                                                  |     
|Liability for employees severance benefits                        |     
|                                                                  |     
|                                                                  |     
|Cash paid for net assets acquired                                 |     
|                                                                  |     

# B.       Non-cash transactions

|                                                       | 2006 | 2005 | 2004
|------------------------------------------------------ | ---- | ---- | ----
|
|
|
|
|Purchase of property, plant and equipment not yet paid |      |      |     
|                                                       |      |      |     

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

F - 9

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 1  General

| | ECtel
Ltd. and its subsidiaries (hereinafter  the Company) provide Integrated
Revenue Management (IRM) solutions for communications services providers. ECtel Ltd. was
established and commenced operations in April 1990. In October 1999, the Company
completed an initial public offering of its ordinary shares on the Nasdaq National
Market.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
February 9, 2004, the Company sold its Government Surveillance Business to Verint Systems
(see Note 19).
| | -----------------------------------------------------------------------------------------------------------

| | On
December 29, 2005, ECtel Ltd. acquired all of the outstanding shares of Elron Telesoft
Ltd. and Elron Telesoft Export Ltd., two sister companies held by Elron Electronic
Industries Ltd., (see Note 7B).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ECtel
Ltd.s eight subsidiaries are ECtel Inc., ECtel (2000) UK Limited, ECtel B.V, ECtel
GmbH, Telrad Hawk Net-I Ltd. (in voluntary liquidation  see Note 7A(2)), ECtel
Telesoft Ltd., ECtel Telesoft Export (98) Ltd. and ECtel EOOD Bulgaria, which was
incorporated in December 2006.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 2 
Significant Accounting Policies

| | The
 financial  statements  have  been  prepared  in  conformity  with  U.S.  generally
 accepted          accounting principles (U.S. GAAP).
| | ---------------------------------------------------------------------------------------------------------------------------------------------

| | A. | Principles
of consolidation
| | -- | ---------------------------

| | The
consolidated financial statements include the accounts of the Company and its
subsidiaries, all of which are wholly owned. All intercompany transactions and balances
have been eliminated in consolidation.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Financial
statements in U.S. dollars
| | -- | ------------------------------------

| | The
currency of the primary economic environment in which the operations of the Company and
its subsidiaries are conducted is the U.S. dollar (dollar).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| | Most
of the Companys sales are made outside of Israel (see Note 14D regarding
geographical distribution) and are made primarily in dollars. Most purchases of materials
and components, as well as most selling and other expenses incurred outside Israel, are in
dollars. In view of the foregoing, the dollar has been determined to be the Companys
functional currency.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Transactions
and balances denominated in dollars are presented at their original amounts. Non-dollar
transactions and balances have been translated into dollars in accordance with the
principles set forth in Statement of Financial Accounting Standards (SFAS) No.
52, Foreign Currency Translation, of the Financial Accounting Standards Board
(FASB) of the United States.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | All
exchange gains and losses resulting from monetary balance sheet items denominated in
non-dollar currencies are reflected in the statement of operations when they arise. Such
exchange gains and losses are included in the same statement of operations items in which
the related transactions are included.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 10

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | C. | Cash
and cash equivalents
| | -- | -------------------------

| | The
Company considers all highly liquid investments with original maturity of three months or
less at date of purchase, to be cash equivalents. Marketable securities that have an
original maturity of three months or less are considered to be cash equivalents.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Short-term
investments
| | -- | ----------------------

| | Short-term
deposits and marketable securities with maturity dates between 91 to 365 days, are
considered to be short-term investments (see also Note 2G).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| | E. | Doubtful
accounts
| | -- | -----------------

| | The
Company maintains an allowance for doubtful accounts for estimated losses inherent in its
accounts receivable portfolio. In establishing the required allowance, management bases
its determination, among other factors, on information available about the debtors
financial situation, the volume of their operations and evaluation of the security
received from them. Account balances are charged against the allowance after all means of
collection have been exhausted and the potential for recovery is considered remote (see
Note 14B).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | F. | Inventories
| | -- | -----------

| | Inventories
are stated at the lower of cost or market. Cost is determined using the moving average
method.
| | ----------------------------------------------------------------------------------------------------------

| | G. | Long-term
marketable securities
| | -- | -------------------------------

| | Long-term
marketable securities consist of Corporate bonds and U.S. Government Agencies debt
securities. The Company classifies its debt securities as held-to-maturity.
Held-to-maturity securities are those securities in which the Company has the ability and
intent to hold the security until maturity.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Held-to-maturity
securities are recorded at amortized cost, adjusted for the amortization or accretion of
premiums or discounts.
| | --------------------------------------------------------------------------------------------------------------------------------

| | Any
decline in the market value of any held-to-maturity security below cost, that is deemed to
be other than temporary, results in a reduction in the carrying amount to fair value. The
impairment is charged to earnings and a new cost basis for the security is established.
Premiums and discounts are amortized or accreted over the life of the related
held-to-maturity security as an adjustment to yield using the straight-line method.
Interest income is recognized when earned.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 11

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---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | H. | Property, plant and equipment
| | -- | -----------------------------

| | 1. | These assets are stated at cost less accumulated depreciation.
| | -- | --------------------------------------------------------------

| | 2. | Depreciation is computed using the straight-line method, over the estimated
               useful life of the assets as estimated by the Company.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------

| | Annual
rates of depreciation are as follows:
| | --------------------------------------------

| |                                | 
| | ------------------------------ | 
|
|
|
|
| | Machinery and equipment        | 
| | Office furniture and equipment | 

| | 3. | Major renewals and improvements are capitalized, while repairs and maintenance
               are expensed as incurred.
| | -- | -----------------------------------------------------------------------------------------------------------------------

| | 4. | Upon the sale or retirement of equipment, the cost and related accumulated
               depreciation and amortization are eliminated from the respective accounts and
               the resulting gain or loss is reflected in the consolidated statement of
               operations.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | I. | Goodwill and other intangible assets
| | -- | ------------------------------------

| | Goodwill
represents the excess of the aggregate purchase price over the fair value of the net
assets acquired in a purchase businesses combination. Goodwill is reviewed for impairment
at least annually in accordance with the provisions of SFAS No. 142, Goodwill and
Other Intangible Assets. The goodwill impairment test is a two-step test. Under the
first step, the fair value of the reporting unit is compared with its carrying value
(including goodwill). If the fair value of the reporting unit is less than its carrying
value, an indication of goodwill impairment exists for the reporting unit and the
enterprise must perform step two of the impairment test (measurement). Under step two, an
impairment loss is recognized for any excess of the carrying amount of the reporting
units goodwill over the implied fair value of that goodwill. Fair value of the
reporting unit is determined using a discounted cash flow analysis. If the fair value of
the reporting unit exceeds its carrying value, step two does not need to be performed.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
2006 and 2005, the Company performed its annual impairment review of goodwill and
concluded that there was no impairment in either year.
| | -----------------------------------------------------------------------------------------------------------------------------------------------

| | Intangible
assets that have finite useful lives are amortized over their expected useful lives.
| | -----------------------------------------------------------------------------------------------

| | J. | Revenue
recognition
| | -- | -------------------

| | 1. | Revenues from product sales (which include software) are recognized, in
               accordance with Statement of Position (SOP) 97-2, Software
               Revenue Recognition, when all the following criteria are met: (1)
               persuasive evidence of an arrangement exists, (2) delivery has occurred, (3) the
               vendors fee is fixed or determinable and (4) collectibility is probable.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company includes post contract customer support (PCS) within the price of the product
sale. This PCS is for a one-year period and includes a standard product warranty and
upgrades and enhancements to correct minor bugs or errors in the software. The cost of
providing the PCS is insignificant and the warranty and bug fixes have been infrequent.
Therefore, the PCS revenue is recognized upon delivery of the product in accordance with
SOP 97-2.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | J. | Revenue
recognition (contd)
| | -- | ----------------------------

| | The
Company uses the residual method to recognize revenue when an arrangement includes one or
more elements to be delivered at a future date and vendor-specific objective evidence of
the fair value of all undelivered elements exists. Vendor-specific objective evidence of
fair value is based on the normal pricing practices for those products and services when
sold separately. Under the residual method, the fair value of the undelivered elements is
deferred and the remaining portion of the arrangement fee is recognized as revenue. If
evidence of the fair value of one or more undelivered elements does not exist, the revenue
is deferred and recognized when delivery of those elements occurs or when fair value can
be established.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | When
a software product is sold together with implementation or consulting services, product
fees are recognized upon delivery, provided that the above criteria are met, payment of
the license fees is not dependent upon the performance of the services, and the services
do not provide significant customization or modification of the software products and are
not essential to the functionality of the software that was delivered.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | If,
at the outset of an arrangement, the arrangement fee is determined as not fixed or
determinable, revenue is deferred until the arrangement fee becomes due. If, at the outset
of the arrangement, collectibility is determined to be not probable, revenue is deferred
until the earlier of when collectibility becomes probable or the receipt of payment. If an
arrangement provides for customer acceptance, revenue is not recognized until the earlier
of receipt of customer acceptance or expiration of the acceptance period.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Revenues from product maintenance and support contracts are recognized on a
               straight-line basis over the term of the support period. The majority of the
               Companys maintenance agreements provide technical support as well as
               unspecified software product upgrades and releases when and if made available by
               the Company during the term of the support period.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Revenues from contracts requiring significant design, development, modification
               and customization are recognized using the percentage of completion method,
               which is in accordance with SOP 81-1, Accounting for performance of
               construction type and certain production type contracts. The percentage of
               completion is determined as a ratio of the extent of the progress toward
               completion of the contract, using an input measure method of labor hours
               performed. In the event that management anticipates a loss on a particular
               contract, such anticipated loss is provided for in full in the period when the
               loss is first anticipated.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | If
collectibility is determined as not being probable, the Company recognizes revenues from
contracts with significant design, development, modification and customization of the
software, using the completed-contract method.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | Value added taxes applied on sales collected from customers and remitted to
               governmental authorities are accounted for on a net basis, and therefore, are
               excluded from revenues, in accordance with Emerging Issues Task Force
               (EITF) Issue No. 06-3, How taxes collected from customers and
               remitted to Governmental Authorities should be presented in the Income
               Statement. The Company has historically presented such taxes on a net
               basis.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 13

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | K. | Research and development costs
| | -- | ------------------------------

| | 1. | Research and development costs, are charged to the consolidated statements of
               operations as incurred. The Company records grants received from the Office of
               the Chief Scientist of the Israeli Ministry of Industry Trade and Labor, (the
               OCS) as a reduction of research and development expenses. Royalties
               payable to OCS are recognized pursuant to sale of related products and are
               classified as cost of revenues.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Software development costs are expensed as incurred until the phase where
               technological feasibility has been established, at which time subsequent costs
               are capitalized until the product is available for general release to customers.
               To date, either the establishment of technological feasibility of the
               Companys products and their general release has substantially coincided or
               costs incurred subsequent to the achievement of technological feasibility have
               not been material. Accordingly, no software development costs have been
               capitalized by the Company.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | L. | Liability for employee severance benefits, net
| | -- | ----------------------------------------------

| | The
Companys liability for severance pay for its Israeli employees is calculated
pursuant to Israeli severance pay law based on the most recent salary of the employees
multiplied by the number of years of employment, as of the balance sheet date. Employees
are entitled to one months salary for each year of employment or a portion thereof.
Certain senior executives are entitled to receive additional severance pay. The
Companys liability for all of its Israeli employees is partly provided for by
monthly deposits for insurance policies and by an accrual. The value of these policies is
recorded as an asset in the Companys balance sheet.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Assets
held for employees severance benefits represent contributions to severance pay funds and
cash surrender value of life insurance policies that are recorded at their current
redemption value.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | M. | Income
taxes
| | -- | ------------

| | The
Company accounts for income taxes under SFAS No. 109 Accounting for Income Taxes.
| | ---------------------------------------------------------------------------------------

| | Under
SFAS 109 deferred tax assets and liabilities are recognized in respect of temporary
differences between the tax bases of assets and liabilities and their financial reporting
amounts as well as in respect of tax losses and tax credit carryforwards which may be
deductible for tax purposes in future years, based on statutory tax rates as these will be
applicable to the periods in which such deferred taxes will be realized. The Company
provides a valuation allowance to reduce deferred tax assets to the extent it believes it
is more likely than not that such assets will not be realized.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 14

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | M. | Income
taxes (contd)
| | -- | ---------------------

| | Deferred
taxes were not recorded in respect of the following matters 
| | ----------------------------------------------------------------------

| | 1. | Differences between the rate of change in the Israeli Consumer Price Index
               (which serves as a basis for measurement for tax purposes) and the rate of
               change in the NIS/US dollar exchange rate. This is in accordance with SFAS 109.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Certain undistributed earnings of a foreign consolidated subsidiary, which are
               taxable upon distribution by way of dividend, as no such dividend distribution
               intention exists.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Income
tax benefit (expense) represents the tax for the period and the change during the period
in deferred tax assets and liabilities.
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | N. | Share
incentive plans
| | -- | ---------------------

| | Prior
to January 1, 2006, the Company applied the intrinsic value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations, in
accounting for its fixed plan stock options as permitted by SFAS No. 123, Accounting
for Stock-Based Compensation. As such, compensation expense was determined on the
date of grant only if the current market price of the underlying stock exceeded the
exercise price and amortized over the vesting period.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Effective
January 1, 2006, the Company adopted SFAS No. 123(R), Share-Based
Payment. This statement replaces SFAS No. 123, and supersedes APB No. 25. SFAS
123(R) requires that all stock-based compensation be recognized as an expense in the
financial statements and that such cost be measured at the fair value of the award on the
date of grant. This statement was adopted using the modified prospective method of
application, which requires the Company to recognize compensation cost on a prospective
basis. In March 2005, the Securities and Exchange Commission (SEC) issued Staff Accounting
Bulletin No. 107 (SAB 107) relating to SFAS 123(R). The Company has applied
the provisions of SAB 107 in its adoption of SFAS 123(R).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
this method, the Company recorded stock-based compensation expense for awards granted
prior to, but not yet vested, as of January 1, 2006, using the fair value amounts
determined for pro forma disclosures under SFAS 123. For stock-based awards granted after
January 1, 2006, the Company recognizes compensation expense based on estimated grant
date fair value using the Black Scholes option-pricing model. The value of
stock options as noted, is recognized as compensation expense over the requisite service
period of the entire award.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
a change from previous standards, SFAS 123(R) also requires that excess tax benefits
related to stock option exercises be reflected as financing cash inflows. Therefore,
excess tax benefits related to stock option exercises in 2006 should be reflected in
operating activities. Since the Company recorded a valuation allowance in respect of the
entire deferred taxes, no excess tax benefits related to stock option exercises in 2006
are reflected in operating activities.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 15

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | N. | Share
incentive plans (contd)
| | -- | ------------------------------

| | Stock-based
compensation expense recognized during the period is based on the value of the portion of
share-based payment awards that is ultimately expected to vest during the period.
Stock-based compensation expense recognized in the Companys Consolidated Statement
of Operations for the year ended December 31, 2006 includes compensation expense for
share-based payment awards granted prior to, but not yet vested as of December 31, 2005
based on the grant date fair value, estimated in accordance with the pro forma disclosure
provisions of SFAS 123, and compensation expense for the share-based payment awards
granted subsequent to December 31, 2005 based on the grant date fair value estimated
in accordance with the provisions of SFAS 123(R). SFAS 123(R) requires forfeitures to be
estimated at the time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates. In the Companys pro forma information
required under SFAS 123 for the periods prior to fiscal 2006, the Company accounted for
forfeitures as they occurred.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Share-based
compensation cost that has been included in loss from continuing operations and net loss
amounted to $995 thousand for the year ended December 31, 2006, and reduced the
Companys basic and diluted earnings per share by $ 0.06.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | No
pro forma disclosure has been made for periods subsequent to January 1, 2006 as all
stock-based compensation has been recognized in net loss. For purposes of the pro forma
disclosure relating to years ended December 31, 2005 and 2004 the value of the options is
estimated using a Black-Scholes option-pricing model and amortized to expense
over the options service periods with forfeitures recognized as they occurred. The
following table illustrates the effect on net loss for the years ended December 31,
2005 and 2004 as if the Company had applied the fair value recognition provisions of
Statement 123 to options granted under the Companys stock plans prior to adoption of
SFAS No. 123(R) on January 1, 2006.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                | Year ended December 31
| | ---------------------------------------------- | ----------------------
|
|
|
|
| | Net loss as reported                           |                       
| | Less: Application of Stock-Based compensation  |                       
| | expense according to SFAS 123                  |                       
| |                                                |                       
| |                                                |                       
| | Net loss - pro forma                           |                       
| |                                                |                       
| |                                                |                       
| | Basic and diluted loss per ordinary share ($): |                       
| | As reported                                    |                       
| |                                                |                       
| |                                                |                       
| | Pro forma                                      |                       
| |                                                |                       

F - 16

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | O. | Derivative
financial instruments
| | -- | --------------------------------

| | The
Company accounts for derivative financial instruments according to SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. The Company
utilizes derivative financial instruments principally to manage market risks and reduce
its exposure resulting from fluctuations in foreign currency exchange rates. Derivative
instruments include forward exchange and purchase contracts. Under SFAS 133, the Company
is required to recognize all derivatives on the balance sheet at fair value. Derivatives
that are not hedges must be adjusted to fair value through income. If the derivative is a
hedge, depending on the nature of the hedge, changes in the fair value of derivatives will
either be offset against the change in fair value of the hedged assets, liabilities or
firm commitments through earnings or recognized in other comprehensive income under
shareholders equity until the hedged item is recognized in earnings. The ineffective
portion of a derivatives change in fair value will be immediately recognized in
earnings.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company does not utilize derivative financial instruments for trading or other speculative
purposes. The Company actively evaluates the creditworthiness of the financial
institutions that are counter parties to derivative financial instruments, and does not
expect counter parties to fail to meet their obligations.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | P. | Earnings
(loss) per Ordinary Share
| | -- | ----------------------------------

| | Basic
and diluted earnings (loss) per ordinary share are presented in conformity with SFAS No.
128, Earnings Per Share, for all years presented. Basic earnings (loss) per
ordinary share are calculated by dividing the net earnings (loss) attributable to ordinary
shares, by the weighted average number of ordinary shares outstanding. Diluted earnings
(loss) per share is the same as basic earnings (loss) per share as the inclusion of
2,351,914, 3,260,493 and 3,072,271 common stock equivalents in 2006, 2005 and 2004
respectively, would be anti dilutive.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Q. | Estimations
and assumptions in the financial statements
| | -- | -------------------------------------------------------

| | The
preparation of financial statements in conformity with United States generally accepted
accounting principles requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
estimates and assumptions used are managements best estimates based on experience
and historical data, however actual results could differ from these estimates.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | R. | Transfer
of financial assets
| | -- | ----------------------------

| | The
Company accounts for transfer of financial assets in accordance with the provisions of
SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets.
The Standard requires recognizing the sale of financial instruments when the control over
the financial assets transferred and the consideration from the sale does not include any
beneficial interests in the transferred asset.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 17

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---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 2 
Significant Accounting Policies (contd)

| | S. | Long-lived
assets
| | -- | -----------------

| | The
Company accounts for long-lived assets under the provisions of SFAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS 144
addresses financial accounting and reporting for the impairment or disposal of long-lived
assets. SFAS 144 requires that long-lived assets be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is measured by a comparison
of the carrying amount of an asset to future net cash flows expected to be generated by
the asset. If the carrying amount of an asset exceeds its estimated future undiscounted
cash flows, an impairment charge is recognized to the extent that the carrying amount
value exceeds its fair value. SFAS 144 also requires companies to separately report
discontinued operations and extends that reporting to a component of an entity that either
has been disposed of (by sale, abandonment, or in a distribution to owners) or is
classified as held for sale.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | T. | Accrued
warranty costs
| | -- | ----------------------

| | Accrued
warranty costs are calculated in respect of products sold and work performed (for periods
subsequent to delivery of the products or performance of the work) based on
managements estimation and in accordance with the Companys prior experience,
(see also Note 10G).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | U. | Reclassification
| | -- | ----------------

| | Certain
prior year figures have been reclassified to conform to current year presentation.
| | ------------------------------------------------------------------------------------------

# Note 3  Inventories

| | A. | Inventories
consist of the following:
| | -- | -------------------------------------

| |                              | December 31
| | ---------------------------- | -----------
|
|
|
|
| | Raw materials and components |            
| | Work in process              |            
| | Finished products            |            
| |                              |            
| |                              |            
| |                              |            
| |                              |            

| | B. | Inventory
write-off
| | -- | -------------------

| | Following
the Companys Board of Directors decision to abandon certain products, the
Company wrote off $915 thousand of inventories during the year 2004, (see also Note 14E).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 18

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 4  Investment
in Marketable Securities and Deposits

| | Regarding
the Companys marketable securities classification, see Note 2D and 2G.
| | ---------------------------------------------------------------------------------

| | The
Companys investments in marketable securities consist primarily of investments in US
Government Agencies and Corporate bonds. Based on managements evaluation,
Companys ability and intent to hold these investments for a reasonable period of
time sufficient for a forecasted recovery of fair value, the Company does not consider
these investments to be other-than-temporarily impaired at December 31, 2006.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (1) | The following table summarizes the Companys marketable securities and
               deposits at December 31, 2006 and 2005 (regarding assumptions used for estimated
               fair value, see Note 16):
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                 | December 31, 2006 | 
| | ------------------------------- | ----------------- | 
|
|
|
|
| | Held to maturity securities     |                   | 
| | (carried at amortized cost)     |                   | 
| |                                 |                   | 
| | US Government agencies          |                   | 
| | Corporate bonds                 |                   | 
| |                                 |                   | 
| |                                 |                   | 
| | Short-term investments          |                   | 
| |                                 |                   | 
| |                                 |                   | 
| | US Government agencies          |                   | 
| | Corporate bonds                 |                   | 
| |                                 |                   | 
| |                                 |                   | 
| | Long-term marketable securities |                   | 
| |                                 |                   | 

| |                                 | December 31, 2005 | 
| | ------------------------------- | ----------------- | 
|
|
|
|
| | Short-term deposits             |                   | 
| |                                 |                   | 
| |                                 |                   | 
| | Held to maturity securities     |                   | 
| | (carried at amortized cost)     |                   | 
| |                                 |                   | 
| | US Government agencies          |                   | 
| | Corporate bonds                 |                   | 
| |                                 |                   | 
| |                                 |                   | 
| |                                 |                   | 
| |                                 |                   | 
| | Short-term investments          |                   | 
| |                                 |                   | 
| |                                 |                   | 
| | US Government agencies          |                   | 
| | Corporate bonds                 |                   | 
| |                                 |                   | 
| |                                 |                   | 
| | Long-term marketable securities |                   | 
| |                                 |                   | 

F - 19

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---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 4  Investment
in Marketable Securities and Deposits (contd)

| | (2) | The following table summarizes the Companys marketable securities by
               maturity date as at December 31, 2006:
| | --- | ---------------------------------------------------------------------------------------------------------------------------

| |                                                   | Amortized cost | Fair value
| | ------------------------------------------------- | -------------- | ----------
|
|
|
|
| | Maturity date of long-term marketable securities: |                |           
| | 2008                                              |                |           
| | 2009                                              |                |           
| |                                                   |                |           
| |                                                   |                |           
| |                                                   |                |           
| |                                                   |                |           

| | (3) | The following table shows the gross unrealized losses and fair value of the
               Companys investments in marketable securities with unrealized losses that
               are not deemed to be other-than-temporarily impaired, aggregated by investment
               category and length of time that individual securities have been in a continuous
               unrealized loss position.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006:
| | ------------------------

| |                 | Less than 12 months | 12 months or Greater |  |       
| | --------------- | ------------------- | -------------------- |  | ------
|
|
|
|
| | US Government   |                     |                      |  |       
| | Agencies        |                     |                      |  | 7,248 
| | Corporate bonds |                     |                      |  | 3,491 
| |                 |                     |                      |  |       
| | Total           |                     |                      |  | 10,739
| |                 |                     |                      |  |       

| | As
of December 31, 2005:
| | ------------------------

| |                 | Less than 12 months | 12 months or Greater |  |       
| | --------------- | ------------------- | -------------------- |  | ------
|
|
|
|
| | US Government   |                     |                      |  |       
| | Agencies        |                     |                      |  | 3,562 
| | Corporate bonds |                     |                      |  | 7,230 
| |                 |                     |                      |  |       
| | Total           |                     |                      |  | 10,792
| |                 |                     |                      |  |       

| | The
unrealized losses on the Companys investments in US Government Agencies and
Corporate bonds were caused by interest rate increases. Since the Company has the ability
and intent to hold these investments until a recovery of fair value, which may be
maturity, the Company does not consider these investments to be other-than-temporarily
impaired as of December 31, 2006 and 2005.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 20

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 5  Long-Term
Other Assets

| |                                              | December 31
| | -------------------------------------------- | -----------
|
|
|
|
| | Assets held for employees severance benefits |            
| | Long-term deposits                           |            
| |                                              |            
| |                                              |            
| |                                              |            
| |                                              |            

# Note 6  Property,
Plant and Equipment, net

Property,
plant and equipment consist of the following:

| |                                    | Machinery
and
equipment | Office
furniture and
equipment | Total
| | ---------------------------------- | ----------------------- | ------------------------------ | -----
|
|
|
|
| | Cost                               |                         |                                |      
| | Balance at January 1, 2006         |                         |                                |      
| | Additions                          |                         |                                |      
| | Disposals                          |                         |                                |      
| |                                    |                         |                                |      
| |                                    |                         |                               
| | Balance at December 31, 2006       |                         |                                |      
| |                                    |                         |                                |      
| |                                    |                         |                               
| | Accumulated depreciation           |                         |                               
| | Balance at January 1, 2006         |                         |                                |      
| | Depreciation for the year          |                         |                                |      
| | Disposals                          |                         |                                |      
| |                                    |                         |                                |      
| |                                    |                         |                               
| | Balance at December 31, 2006       |                         |                                |      
| |                                    |                         |                                |      
| |                                    |                         |                               
| | Property, plant and equipment, net |                         |                               
| |                                    |                         |                               
| | Balance at December 31, 2006       |                         |                                |      
| |                                    |                         |                                |      
| |                                    |                         |                               
| | Property, plant and equipment, net |                         |                               
| |                                    |                         |                               
| | Balance at December 31, 2005       |                         |                                |      
| |                                    |                         |                                |      

F - 21

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 7 
Acquisitions

| | A. | Acquisition of Telrad Hawk Net-I Ltd.
| | -- | -------------------------------------

| | 1. | On October 1, 2001, ECtel Ltd. acquired all of the outstanding shares of Telrad
               Hawk Net-I Ltd. (Net-I). As a result of the purchase of Net-I,
               goodwill in the amount of $16,348 thousand was created (as at the date of
               purchase).
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | On December 29, 2004, Net-I shareholders meeting resolved on voluntary
               liquidation process by creditors, under the Companies Law  1983.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, Net-I shareholders appointed an attorney to serve as Net-Is liquidator.
| | -------------------------------------------------------------------------------------

| | There
is no significant effect on the consolidated financial statements by the aforesaid
process.
| | -------------------------------------------------------------------------------------------------

| | 3. | The
following table summarizes the allocation of acquired intangible assets:
| | -- | ----------------------------------------------------------------------------

| |                                               | As at December 31
| | --------------------------------------------- | -----------------
|
|
|
|
| | Amortized intangible assets:                  |                  
| | In process research and development costs (*) |                  
| | Current technology                            |                  
| | Customer contracts                            |                  
| |                                               |                  
| |                                               |                  
| |                                               |                  
| |                                               |                  
| | Less - accumulated amortization               |                  
| |                                               |                  
| |                                               |                  
| | Total                                         |                  
| |                                               |                  

| | (*) | Fully
amortized at date of purchase.
| | --- | ------------------------------------

| | Amortization
expenses were $43 thousand, $49 thousand and $49 thousand for the years ended December 31,
2006, 2005 and 2004, respectively, and were recorded in research and development costs.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 7 
Acquisitions (contd)

| | B. | Acquisition
of Elron Telesoft Ltd. and Elron Telesoft Export Ltd.
| | -- | -----------------------------------------------------------------

| | 1. | On December, 29, 2005, (hereinafter  the closing date) ECtel
               Ltd. acquired all of the outstanding shares of Elron Telesoft Ltd. and Elron
               Telesoft Export (98) Ltd., two sister companies (hereinafter  the
               acquired companies or Telesoft) held by Elron Electronic
               Industries Ltd. (hereinafter  the Seller).
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
acquired companies are engaged in the development and marketing of software solutions for
the management of large communications and internet networks. The acquired companies have
developed a line of products, including Revenue Assurance Solution for communications
services providers. The acquisition of the acquired companies will allow ECtel to provide
Integrated Revenue Management (IRM) solutions for communications services providers.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
 transaction  was accounted for by the purchase  method in accordance  with SFAS No.
                  141, "Business Combinations".
| | ----------------------------------------------------------------------------------------------------------------------------------------

| | The
effect of the acquisition is reflected in the consolidated balance sheet as at December
31, 2005.
| | -----------------------------------------------------------------------------------------------------

| | 2. | The purchase price paid to the Seller was approximately $2,100 thousand in cash,
               plus potential earn-outs based on successful completion of certain milestones,
               according to the purchase agreement, amounting to $400 thousand, in two deferred
               installments, over a period of 12 months following the closing date. As of
               December 31, 2006, no additional payments had been made, as milestones have not
               been met.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
aggregate purchase price is $2,504 thousand and was comprised of the following:
| | -----------------------------------------------------------------------------------

| | (1) | $2,100 thousand in cash paid by the Company to the Seller, according to the
                    purchase agreement.
| | --- | -------------------------------------------------------------------------------------------------------------------

| | (2) | $404 thousand direct transaction costs consisting primarily of professional
                    fees.
| | --- | -----------------------------------------------------------------------------------------------------

| | 3. | As a result of the purchase of Telesoft, goodwill in an amount of $3,558
               thousand was created (as at the date of purchase). During January 2006, the
               Company paid to the Seller an additional amount of $21 thousand for adjustments,
               according to the purchase agreement.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of the date of acquisition, the Company identified a certain pre-acquisition liability
with respect to possible royalty payments to a third party in the amount of $400 thousand,
which was not recorded in Telesofts books. During the year 2006, the Company
reevaluated the liability and decided to reverse it, due to managements assessment
and future estimations. This action, net of the additional payment to the Seller, as
mentioned above, decreased goodwill to the amount of $3,179.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 23

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 7 
Acquisitions (contd)

| | B. | Acquisition of Elron Telesoft Ltd. and Elron Telesoft Export Ltd.
               (contd)
| | -- | -----------------------------------------------------------------------------------------

| | 4. | The following tables summarize the allocation of acquired intangible assets and
               estimated amortization expense:
| | -- | ------------------------------------------------------------------------------------------------------------------------------

| |                                | As at December 31, 2006
| | ------------------------------ | -----------------------
|
|
|
|
| | Amortized intangible assets:   |                        
| | Third party relations          |                        
| | Core technology                |                        
| | Customer contracts             |                        
| | Contractual customer relations |                        
| |                                |                        
| |                                |                        
| | Total                          |                        
| |                                |                        

| | Future
estimated amortization expenses:
| | ---------------------------------------

| |       | Year ended
December 31,
2006
| | ----- | ----------------------------
|
|
|
|
| | 2007  |                             
| | 2008  |                             
| | 2009  |                             
| | 2010  |                             
| |       |                             
| |       |                             
| | Total |                             
| |       |                             

| | C. | Goodwill
| | -- | --------

| |                                                              | Year ended December 31
| | ------------------------------------------------------------ | ----------------------
|
|
|
|
| | Original amount, as adjusted (see also Note 7A(1) and 7B(3)) |                       
| | Goodwill impairment                                          |                       
| |                                                              |                       
| |                                                              |                       
| |                                                              |                       

| | The
Company conducts its annual goodwill impairment test as of June 30 every year.
| | ----------------------------------------------------------------------------------

| | As
at June 2003, the Company impaired the goodwill by $6,019 and as at June 2004, the Company
impaired the goodwill by an additional $2,186.
| | --------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company performed annual impairment tests during 2006 and 2005 and did not identify any
further impairment losses.
| | ----------------------------------------------------------------------------------------------------------------------

F - 24

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 8  Other
Intangible Assets, net

| |                                                       | December 31
| | ----------------------------------------------------- | -----------
|
|
|
|
| | Net I acquisition - original cost (see Note 7A(3))    |            
| | Telesoft acquisition - original cost (see Note 7B(4)) |            
| |                                                       |            
| |                                                       |            
| |                                                       |            
| | Less - accumulated amortization                       |            
| |                                                       |            
| |                                                       |            
| |                                                       |            
| |                                                       |            

| | The
amortization expenses were $466 thousand, $252 thousand and $49 thousand for each of the
years ended December 31, 2006, 2005 and 2004, respectively, and were recorded in
amortization of acquisition-related intangible assets.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 9  Liability
for Employee Severance Benefits

| | A. | Employees
of the Israeli Companies
| | -- | ----------------------------------

| | Under
Israeli law and labor agreements, Israeli companies are required to make severance and
pension payments to its retired or dismissed employees and to employees leaving employment
in certain other circumstances.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | The liability in respect of certain employees is discharged by participating in
               a defined contribution pension plan and making regular deposits with a pension
               fund. The custody and management of the amounts so deposited is independent of
               any control by the Israeli companies and accordingly such amounts funded
               (included in expenses on an accrual basis) and related liabilities are not
               reflected in the balance sheet.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In respect of the liability to other employees, individual insurance policies
               are purchased and deposits are made with recognized severance pay funds.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
liability for severance pay is calculated on the basis of the latest salary paid to each
employee multiplied by the number of years of employment. Withdrawals from the funds may
be made only for the purpose of disbursement of severance pay.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
certain part of the Companys employees, the payments to the pension funds and
insurance policies discharge the Companys obligation to the employees, as required
by the Severance Pay Law, in connection with Section 14.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Accumulated
amounts in the pension funds and with the insurance companies are not under the control or
administration of the Company, and accordingly, neither those amounts nor the
corresponding accrual for severance pay are reflected in the balance sheet. The obligation
of the Company, under law and labor agreements, for termination benefits to employees not
covered by the aforementioned pension or insurance plans are included in the balance
sheet.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Expenses recorded in respect of severance and pension pay for the years ended
               December 31, 2006, 2005 and 2004 are $133 thousand, $124 thousand and $661
               thousand, respectively.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 25

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 9  Liability
for Employee Severance Benefits (contd)

| | B. | Employees
of U.S consolidated subsidiary
| | -- | ----------------------------------------

| | The
U.S consolidated subsidiary sponsors a 401(K) defined contribution plan which permits its
employees to make contributions on a pre-tax basis subject to the limits specified in the
Internal Revenue Code. These contributions are not subject to federal income taxes until
distributed to the employees. The subsidiary matches the employees contribution up
to 5% of the employees earnings.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
subsidiarys matching contributions with respect to this plan were $36 thousand, $42
thousand and $100 thousand in 2006, 2005 and 2004, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 10 
Commitments and Contingencies

| | A. | Lease
commitments
| | -- | -----------------

| | The
Company has entered into operating leases (in respect of premises and motor vehicles) in
Israel and abroad. The agreements expire on various dates from 2007 to 2012 (some have
renewal options) and are in US dollars, local currencies or linked to the US dollar.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Future
minimum annual rental payments which the Company is committed to pay under the above
leases, at rates in effect at December 31, 2006, are as follows:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Year ending December 31: | $ in thousands
| | ------------------------ | --------------
|
|
|
|
| | 2007                     |               
| | 2008                     |               
| | 2009                     |               
| | 2010                     |               
| | 2011 and thereafter      |               

| | As
to rent expense in connection with the Companys leased premises, see Note 14J.
| | ----------------------------------------------------------------------------------

| | B. | Royalty
commitments
| | -- | -------------------

| | The
Company is committed to pay royalties for several approved programs to the Government of
Israel, Ministry of Industry and Commerce and Office of Chief Scientist (hereinafter
 OCS) , on proceeds from sales of products in which the Israeli
Government participated by way of grants for research and development. As at December 31,
2006, the Company had received, for remaining programs after repayment of some of the
programs, as mentioned below, a total of $432 thousand in grants and had paid or accrued a
total of $90 thousand in royalties. The royalties are computed at the rate of 3%-3.5% of
the aggregate proceeds from sale of such products, up to an amount not exceeding 100% of
such grants plus interest at the LIBOR rate. Royalties to the Government of Israel are
presented in cost of revenues, (see Note 14E).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
April 2006, the Company repaid to the OCS an amount of $364 thousand, which represents the
entire obligation of Telesoft, in connection with the grants participation received in
prior years.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
the fourth quarter of 2006, the Company committed to repay in full its primary program,
which the OCS had sponsored during prior years and in the R&D efforts of which the OCS
had participated. The total amount to be paid to the OCS is approximately $3 million,
which includes interest accrued on the outstanding balance of the amounts funded. Such
amounts funded are presented in the cost of revenues (see also Note 14C). The repayment
will be made in five installments during 2007.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 26

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 10 
Commitments and Contingencies (contd)

| | C. | Capital
expenditure commitments
| | -- | -------------------------------

| | The
Company invests in capital expenditures according to Approved Enterprise
programs. As at December 31, 2006, no investments are to be made in current approved
programs (see Note 12A1).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Guarantees
| | -- | ----------

| | At
December 31, 2006, the Company has granted guarantees to third parties in the sum of $2.3
million mainly as performance guarantees that can be demanded in case of material breach
of contracts. The expiration dates of the guarantees are from January 2007 through
December 2007.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | E. | Financial
instruments
| | -- | ---------------------

| | 1. | Forward
exchange contracts
| | -- | --------------------------

| | The
geographical distribution of the Companys operations gives rise to exposure to
market risks mainly from changes in foreign currency exchange rates. Financial instruments
are utilized by the Company to reduce these risks.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company enters into forward exchange contracts to hedge existing non-dollar assets and
liabilities.
| | -------------------------------------------------------------------------------------------------------

| | As
at December 31, 2006, the Company has entered into currency forward contracts, ending June
2007, as a hedge against receivables as follows:
| | ----------------------------------------------------------------------------------------------------------------------------------------------

| | a) | Obligation
to sell EUR 280,000 for a total amount of $361,746.
| | -- | --------------------------------------------------------------

| | b) | Obligation
to                     sell EUR 350,000 for a total amount of $451,203.
| | -- | ----------------------------------------------------------------------------------

| | c) | Obligation
to sell EUR                     369,000 for a total amount of $475,088.
| | -- | ----------------------------------------------------------------------------------

| | Since
the impact of fluctuations in currency exchange rates on foreign exchange contracts
offsets the impact on the underlying items being hedged, these instruments do not expose
the Company to risk that would otherwise result from fluctuations in currency exchange
rates.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Concentrations
of credit risk
| | -- | -----------------------------

| | Financial
instruments, which potentially subject the Company to significant concentrations of credit
risk, consist principally of cash investments and trade accounts receivable. The Company
maintains cash and cash equivalents, marketable securities, forward exchange contracts and
certain other financial instruments with various major financial institutions. These major
financial institutions are located in Israel and the United States, and the Companys
policy is designed to limit exposure to any one institution.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | With
respect to trade account receivables, the Company is subject to a concentration of credit
risk as a majority of its outstanding trade receivables relates to sales to a limited
number of customers.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 10 
Commitments and Contingencies (contd)

| | F. | Commitments
to indemnify directors and office holders
| | -- | -----------------------------------------------------

| | The
Companys Articles of Association include, but are not limited to, the following
provisions in connection with the protection, indemnification and insurance of its
directors and officers:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (1) | The Company may prospectively exculpate an Office Holder from all or some of the
               Office Holders responsibility for damage resulting from the Office
               Holders breach of the Office Holders duty of care to the Company to
               the fullest extent permitted by the Companies Law.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | The Company may indemnify an Officer Holder in respect of an obligation or
               expense imposed on the Office Holder in respect of an act performed in his
               capacity as an Office Holder, to the fullest extent permitted by the Companies
               Law.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | The Company may enter into a contract for the insurance of all or part of the
               liability of any Office Holder imposed on the Office Holder in respect of an act
               performed in his capacity as an Office Holder, to the fullest extent permitted
               by the Companies Law.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
this regard, the Company enters into Indemnification Agreements with its directors and
officers and purchases D&O liability insurance coverage.
| | --------------------------------------------------------------------------------------------------------------------------------------------------

| | G. | Liability
for warranty
| | -- | ----------------------

| | The
Company has made provision for its product warranty to its customers, in accordance with
management judgment and based on past experience, see Note 14C.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                | December 31
2006 | December 31
2005 | December 31
2004
| | ---------------------------------------------- | ---------------- | ---------------- | ----------------
|
|
|
|
| | Balance outstanding at beginning of the year   |                  |                  |                 
| | Warranty expenses                              |                  |                  |                 
| | Warranties for products sold                   |                  |                  |                 
| | Lapsed warranties                              |                  |                  |                 
| | Balance related to the acquisition of Telesoft |                  |                  |                 
| |                                                |                  |                  |                 
| |                                                |                  |                 
| | Balance outstanding at end of the year         |                  |                  |                 
| |                                                |                  |                  |                 

F - 28

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---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 10 
Commitments and Contingencies (contd)

| | H. | Negative
pledge
| | -- | ---------------

| | In
September 2002, the Company executed a negative pledge to an Israeli Bank in which it
undertook not to perform primarily the following without the Banks prior written
consent:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (1) | Mortgage,
or undertake to mortgage, in any manner or form, any of its assets in
               favor of any third party.
| | --- | ------------------------------------------------------------------------------------------------------------------------

| | (2) | Sell
assets (other than in the ordinary course of business) for consideration
               exceeding $1 million in the aggregate, on an annual basis.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
the basis of the above-mentioned negative pledge, the Bank has agreed to grant various
credit facilities and/or banking services to the Company. The credit facilities granted by
the Bank to the Company and outstanding as of December 31, 2006 are approximately $1.2
million for guarantees issued by the Bank in favor of third parties, at the request of the
Company.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | I. | Class
action complaint
| | -- | ----------------------

| | In
January 2005, a class action complaint had been filed in the District Court of the State
of Maryland against the Company, certain officers and directors of the Company who served
in such positions in the years 2001  2003, as well as a major shareholder during the
referenced period. The complaint alleges violation of US Federal Securities laws and
breach of fiduciary duties in connection with disclosure of Companys financial
results between April 2001 and April 2003.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company filed a motion to dismiss the amended class action complaint and a hearing on said
motion was held on July 17, 2006. At said hearing the Court granted ECtels motion to
dismiss the amended class action complaint. Following said dismissal, plaintiff filed a
motion to further amend the amended class action complaint and the Company responded
requesting the Court to deny and strike plaintiffs motion.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
March 6, 2007, the Court denied the plaintiffs motion to further amend the amended
class action. Plaintiff notified the Company of their intention to appeal the lower
Courts ruling. The Court of Appeal for the Fourth Circuit issued a briefing schedule
for the appeal. However, the parties have agreed to file a motion to postpone the appeal
schedule pending the decision of the United States Supreme Court in a case entitled
Tellabs Inc. v. Makor Issues & Rights Ltd., which is expected in June or July 2007.
The issue to be decided in the Tellabs case is arguably relevant to the instant case.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | No
liability has been recorded in these consolidated financial statements.
| | --------------------------------------------------------------------------

# Note 11 
Shareholders Equity

| | A. | Authorized,
issued and outstanding share capital
| | -- | ------------------------------------------------

| |                              | Issued and outstanding shares | Authorized
| | ---------------------------- | ----------------------------- | ----------
|
|
|
|
| | NIS 0.04 par value per share |                               |           
| |                              |                               |           

| | The
Companys shares are traded in the United States and listed on Nasdaq National
Market.
| | ------------------------------------------------------------------------------------------

F - 29

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 11 
Shareholders Equity (contd)

| | B. | Share
incentive (stock options and restricted shares plans)
| | -- | -----------------------------------------------------------

| | 1. | The
Companys Share Option Plan (the ECtel Plan) was adopted by
               the Board of Directors on June 15, 1998.
| | -- | -------------------------------------------------------------------------------------------------------------------------

| | The
ECtel Plan provides that options may be granted to senior employees or managers of the
Company or its subsidiaries pursuant to (a) one or more sub-plans designed to benefit
Israeli employees from the provisions of Section 102 of the Israeli Income Tax Ordinance
(New Version) 1961 and (b) any other share incentive plan approved by the Board of
Directors of the Company.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys 2003 Share Option Plan (the 2003 Share Option Plan) was adopted
by the Board of Directors on August 3, 2003.
| | ----------------------------------------------------------------------------------------------------------------------------

| | The
purpose of the 2003 Share Option Plan is to provide incentives to employees, directors,
consultants and contractors of the Company, or its subsidiary, whether Israeli or
non-Israeli, by providing them with opportunities to purchase Ordinary Shares of the
Company. The 2003 Plan is designed to allow the grantees to benefit from the provisions of
either Section 102 or Section 3(9) of the Israeli Income Tax Ordinance (New Version)
1961, or the Tax Ordinance, as applicable, and the rules and regulations promulgated
thereunder or any other tax ruling provided by the tax authorities to the Company, or,
with respect to non-Israeli grantees, the applicable laws relevant in the country of
residency of such grantees.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
September 2004, the Companys shareholders approved the increase in the number of
ordinary shares underlying the Companys 2003 Share Option Plan for international
grantees from 200,000 ordinary Shares to 1,700,000 ordinary shares and the decrease in the
number of ordinary Shares underlying the Companys other share option plans (other
than the Companys 2003 U.S. stock option plan covering 50,000 ordinary shares) by an
aggregate of (i) 490,266 ordinary shares as of the date of the resolution and (ii) 437,933
ordinary shares underlying the then outstanding options, which were scheduled to expire
within 60 days following the date of the resolution, upon such expiration (unless any of
such options were exercised prior to such expiration).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | The
Company began using Stock Appreciation Rights (SAR) as its
               primary stock-based incentive compensation, in November 2006. Prior to
such                time, stock options were primarily used for stock-based
               incentive compensation.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
April 2006, the Companys shareholders approved an amendment to 2003 Share Option
Plan (hereinafter  2003 Equity Incentive Plan).
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | The
2003 Equity Incentive Plan: (i) increased the number of shares reserved for issuance under
the 2003 Equity Incentive Plan by 2,000,000 shares, from 1,700,000 shares to 3,700,000
shares, (ii) added Restricted Stock Units and Stock Appreciation Rights to the types of
awards available for issuance under the 2003 Equity Incentive Plan, (iii) terminated the
ECtel Ltd. 2003 U.S. Employee Stock Option Plan (the 2003 U.S. Plan) and (iv)
consolidated the terms of the 2003 U.S. Plan into the 2003 Equity Incentive Plan so that
the Company will have only one equity incentive plan under which it makes awards.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 30

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 11 
Shareholders Equity (contd)

| | B. | Share
incentive (stock options and restricted shares plans)           (contd)
| | -- | -------------------------------------------------------------------------------

| | 3. | Stock
option grants during the reporting period
| | -- | -----------------------------------------------

| | 3.1 | In May 2004, the Board of Directors authorized, under the 2003 Share Option Plan, the
grant to employees of options to purchase a total of 480,000 ordinary shares. In May 2004,
the Company granted 480,000 options to employees. The exercise price is $3.14 per share.
These options vest 25% after one year and the rest in 12 equal quarterly installments
commencing May 2005.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.2 | In July 2004, the Board of Directors authorized, under the 2003 Share Option Plan, the
grant to directors of options to purchase a total of 60,000 ordinary shares. In July 2004,
the Company granted 60,000 options to Directors. The exercise price is $2.63-2.77 per
share. The options vest 33% after one year and the rest in 8 equal quarterly installments
commencing July 2005.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.3 | In August 2004, the Board of Directors authorized, under the 2003 Share Option Plan, the
grant to employees and directors of options to purchase a total of 692,808 ordinary
shares. In August 2004, the Company granted 330,500 options to employees and 362,308
options to directors. The exercise price ranges between $2.43 and $2.81 per share. The
employee options vest 25% after one year and the rest in 12 equal quarterly installments,
commencing on various dates from August 2005 to November 2005. The director options vest
33% immediately, 33% after 6 months and the rest over 1 year afterwards.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.4 | In December 2004, the Board of Directors authorized, under the 2003 Share Option Plan, the
grant to employees of options to purchase a total of 50,000 ordinary shares. In December
2004, the Company granted 50,000 options to employees. The exercise price is $3.56 per
share. These options vest 25% after one year and the rest in 12 equal quarterly
installments commencing December 2005.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.5 | In February 2005, the Board of Directors authorized, under the 2003 Share Option Plan, the
grant to employees of options to purchase a total of 120,000 ordinary shares. In February
2005, the Company granted 120,000 options to employees. The exercise price is $3.64 per
share. These options vest in 12 equal quarterly installments commencing May 2005.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.6 | In May 2005, the Board of Directors authorized, under the 2003 Share Option Plan, the
grant to employees of options to purchase a total of 100,000 ordinary shares. In May 2005,
the Company granted 100,000 options to employees. The exercise price is $3.70 per share.
These options vest 25% after one year and the rest in 12 equal quarterly installments
commencing May 2006.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 31

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 11 
Shareholders Equity (contd)

| | B. | Share
incentive (stock options and restricted shares plans)           (contd)
| | -- | -------------------------------------------------------------------------------

| | 3. | Stock
option grants during the reporting period (contd)
| | -- | --------------------------------------------------------

| | 3.7 | In August 2005, the Board of Directors authorized, under the 2003 Share Option Plan, the
grant to employees of options to purchase a total of 45,000 ordinary shares. In August
2005, the Company granted 45,000 options to employees. The exercise price is $4.54 per
share. These options vest 25% after one year and the rest in 12 equal quarterly
installments commencing August 2006.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.8 | In November 2005, the Board of Directors authorized, under the 2003 Share Option Plan, the
grant to employees of options to purchase a total of 75,000 ordinary shares. In November
2005, the Company granted 75,000 options to employees. The exercise price is $4.97 per
share. These options vest 25% after one year and the rest in 12 equal quarterly
installments commencing November 2006.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.9 | In January 2006, the Board of Directors authorized, under the 2003 Share Option Plan, the
grant to employees of options to purchase a total of 170,000 ordinary shares. In January
2006, the Company granted 170,000 options to employees. The exercise price is $4.47 
4.63 per share. These options vest 25% after one year and the rest in 12 equal quarterly
installments commencing January 2007.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3.10 | In November 2006, the Board of Directors authorized, under the 2003 Equity Incentive Plan,
the grant to employees of options to purchase a total of 640,000 ordinary shares. In
November 2006, the Company granted 620,000 options to employees and 20,000 options to
directors. The exercise price is $4.86 per share. These employee options vest 25% after
one year and the rest in 3 equal annually installments commencing November 2007. The
director options vest 33% after one year and the rest in 8 equal quarterly installments
commencing November 2007.
| | ---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
2006, the Company recorded share-based compensation expenses in the amount of $995
thousand, in accordance with SFAS No. 123(R).
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | None
of the above stock options were granted at exercise prices below the market price of the
ordinary shares on the date of the grant.
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | The
total intrinsic value of abovementioned options that vested prior to December 31, 2005 was
zero.
| | ----------------------------------------------------------------------------------------------------

| | The
total intrinsic value of options exercised during the year ended December 31, 2006, was
$ 42 thousand.
| | ----------------------------------------------------------------------------------------------------------

F - 32

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 11 
Shareholders Equity (contd)

| | B. | Share incentive (stock options and restricted shares plans) 
               (contd)
| | -- | -------------------------------------------------------------------------------------

| | 4. | Following is a summary of options activity under the Companys stock-based
               incentive compensation plans during the years ended December 31, 2006, 2005 and
               2004:
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                            | Number of
shares | Weighted
average
exercise price | Weighted
average
remaining
contractual term | Aggregate
intrinsic value
| | -------------------------- | ---------------- | ------------------------------- | ------------------------------------------- | -------------------------
|
|
|
|
| | Balance at January 1, 2004 |                  |                                 |                                             | 2,743,536                
| |                            |                  |                                
| | Granted                    |                  |                                 |                                             | 1,282,808                
| | Exercised                  |                  |                                 |                                             | (155,544                 
| | Forfeited and expired      |                  |                                 |                                             | (798,529                 
| |                            |                  |                                 |                                             |                          
| |                            |                  |                                
| | Balance at                 |                  |                                
| | December 31, 2004          |                  |                                 |                                             | 3,072,271                
| |                            |                  |                                
| | Granted                    |                  |                                 |                                             | 340,000                  
| | Exercised                  |                  |                                 |                                             | (17,917                  
| | Forfeited and expired      |                  |                                 |                                             | (133,861                 
| |                            |                  |                                 |                                             |                          
| |                            |                  |                                
| | Balance at                 |                  |                                
| | December 31, 2005          |                  |                                 |                                             | 3,260,493                
| |                            |                  |                                
| | Granted                    |                  |                                 |                                             | 810,000                  
| | Exercised                  |                  |                                 |                                             | (500,373                 
| | Forfeited and expired      |                  |                                 |                                             | (1,218,206               
| |                            |                  |                                 |                                             |                          
| |                            |                  |                                
| | Balance at                 |                  |                                
| | December 31, 2006          |                  |                                 |                                             | 2,351,914                
| |                            |                  |                                 |                                             |                          
| |                            |                  |                                
| | Exercisable at             |                  |                                
| | December 31, 2006          |                  |                                 |                                             | 1,256,197                
| |                            |                  |                                 |                                             |                          

| | 5. | Following is a summary of non-vested options activity as of December 31, 2006,
               under the Companys stock-based incentive compensation plans:
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                 | Number of
shares | Weighted
average grant
date fair value
| | ------------------------------- | ---------------- | --------------------------------------
|
|
|
|
| | Non-vested at January 1, 2006   |                  |                                       
| | Granted                         |                  |                                       
| | Vested                          |                  |                                       
| | Forfeited                       |                  |                                       
| |                                 |                  |                                       
| | Non-vested at December 31, 2006 |                  |                                       
| |                                 |                  |                                       

| | As
of December 31, 2006, there was $ 2,385 thousand of total unrecognized compensation cost
related to non-vested share-based compensation arrangements under Companys
stock-based incentive compensation plans which is expected to be recognized over the
weighted average period of 3 years. The total fair value of shares vested during the year
ended December 31, 2006 was $ 1,079 thousand.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 33

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 11 
Shareholders Equity (contd)

| | B. | Share
incentive (stock options and restricted shares plans)           (contd)
| | -- | -------------------------------------------------------------------------------

| | 6. | Fair
value method
| | -- | -----------------

| | The
Company has determined the weighted average fair value per option of stock-based
arrangements granted during 2006, 2005 and 2004 to be $2.29, $2.79 and $1.61,
respectively. The fair values of the stock based compensation awards granted were
estimated using the Black Scholes option pricing model with the following
assumptions:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Year of grant             | Expected
dividend yield | Expected
option life | Expected
volatility | Risk free
interest rate | Fair value
$
| | ------------------------- | ----------------------- | -------------------- | ------------------- | ----------------------- | ------------
|
|
|
|
| | May 2004                  |                         |                      |                     | -                       |             
| | July 2004                 |                         |                      |                     | -                       |             
| | August 2004 (employees)   |                         |                      |                     | -                       |             
| | August 2004 (directors)   |                         |                      |                     | -                       |             
| | December 2004             |                         |                      |                     | -                       |             
| | February 2005             |                         |                      |                     | -                       |             
| | May 2005                  |                         |                      |                     | -                       |             
| | August 2005               |                         |                      |                     | -                       |             
| | November 2005             |                         |                      |                     | -                       |             
| | January 2006              |                         |                      |                     | -                       |             
| | January 2006              |                         |                      |                     | -                       |             
| | November 2006 (employees) |                         |                      |                     | -                       |             
| | November 2006 (directors) |                         |                      |                     | -                       |             

| | The
Company has determined the fair value of stock-based arrangements as follows:
| | ---------------------------------------------------------------------------------

| | The
expected option life represents the weighted average period of time that options granted
are expected to be outstanding. The expected life of the options granted to employees and
directors during 2005 and 2006, is calculated based on the Simplified Method as allowed
under SAB 107, giving consideration to the contractual term of the options and their
vesting schedules.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company estimates its expected stock volatility based on its own historical stock
volatility.
| | -------------------------------------------------------------------------------------------------

| | C. | Treasury
Shares
| | -- | ---------------

| | In
April 2006, the Companys Board of Directors authorized a plan for repurchase of the
Companys ordinary shares on the open market in an amount in cash of up to $15
million. Under the repurchase plan, share purchases may be made from time to time
depending on market conditions, share price, trading volume and other factors. The
repurchase plan was for one year and may be suspended from time to time or discontinued.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2006, the Company repurchased 2,304,794 shares of its common stock for
total consideration of $11.5 million, at an average purchase price of $4.98 per share.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
share repurchases were funded from available working capital.
| | -----------------------------------------------------------------

F - 34

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 12  Income
Taxes

| | A. | Tax
programs under various Israeli tax laws:
| | -- | --------------------------------------------

| | Israeli
Companies
| | -----------------

| | (1) | Israeli
income tax is computed on the basis of the Israeli companies               results
in nominal NIS determined for statutory purposes. The Companies are
               assessed for tax purposes under the Income Tax Law (Inflationary
Adjustments                1985), the purpose of which is to prevent taxation on
inflationary profits.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Pursuant
to the Israeli Law for Encouragement of Capital Investments  1959, ECtel Ltd. was
awarded Approved Enterprise status under the government alternative benefits
track. The program is for investments in the development of infrastructure and for
investments in locally produced and imported equipment. The main benefits to which ECtel
Ltd. will be entitled, if it implements all the terms of an approved program, are the
exemption from tax on income deriving from an Approved Enterprise, and reduced tax rates
on dividends originating from this income.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
income derived from an Approved Enterprise will be exempt from tax for a two year period,
commencing on the date that taxable income is first generated by the Approved Enterprise
(limited to the earlier of a maximum period of 12 years from the year of commencement of
operations or 14 years from the year the approval letter was received). At December 31,
2006 approximately 97% of the cost of ECtel Ltd.s production facilities represented
Approved Enterprise facilities (2005  87%; 2004  41%).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Dividend
distributions originating from the income of the Approved Enterprise will be subject to
tax at the rate of 15%, provided that the dividend is distributed during the period
stipulated under Israeli law.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
the event of a dividend distribution (including withdrawals and charges that are deemed to
be dividends) out of the income originating from the Approved Enterprise, and on which
ECtel Ltd. received a tax exemption, the distribution is subject to corporate taxes at
rates varying from 10%  25%, depending on the percentage of foreign investment
holding in ECtel Ltd. as defined by the Law for Encouragement of Capital Investments
 1959.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | If
ECtel Ltd. derives income from sources other than the Approved Enterprise during the
relevant period of benefits, such income will be taxable at regular corporate tax rates
(see Note 12H below).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
March 30, 2005, an amendment to the Law for Encouragement of Capital Investments -1959
became effective. The primary changes are as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------

| |  | Companies
that meet the criteria of the Alternate Path of tax benefits will receive those benefits
without prior approval. In addition there will be no requirement to file reports with the
Investment Center. Audit will take place via the Income Tax Authorities as part of the
tax audits. Request for pre-ruling is possible.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Tax
benefits of the Alternate Path include lower tax rates or not tax depending on area and
the path chosen, lower tax rates on dividends and accelerated depreciation.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 35

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 12  Income
Taxes (contd)

| | A. | Tax
programs under various Israeli tax laws: (contd)
| | -- | -----------------------------------------------------

| | Israeli
Companies (contd)
| | --------------------------

| | (1) | (contd)
| | --- | --------

| |  | In
order to receive benefits in the Grant Path or the Alternate Path, the Industrial
Enterprise must contribute to the economic independence of the Countrys economy in
one of the following ways:
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | Its
primary activity is in the Biotechnology or Nanotechnology fields and
               pre-approval is received from the head of research and development at the
Office                of the Chief Scientist;
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Its
revenue from a specific country is not greater than 75% of its total
               revenues that year;
| | -- | -----------------------------------------------------------------------------------------------------------

| | 3. | 25%
or more of its revenues are derived from a specific market of at least 12
               million residents.
| | -- | ---------------------------------------------------------------------------------------------------------------

| | The
amendments to the Law for Encouragement of Capital Investments  1959 do not
retroactively apply for investment programs having an Approved Enterprise approval
certificate from the Investment Center issued up to December 31, 2004 (even when
investments under these programs are conducted after January 1, 2005). Consequently, the
amendments should not impact an existing Approved Enterprise, which received written
approval. The new tax regime shall apply for a new Approved Enterprise and for an Approved
Enterprise expansion for which the first year of benefits may be as early as 2004.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
at December 31, 2006, ECtel Ltd. has ended its investments in investment programs under
previous approval and currently is subject to the requirements of the law after aforesaid
reform, see also Note 10C.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
light of its current carryforward losses, ECtel Ltd. is currently not in a taxable
position.
| | -----------------------------------------------------------------------------------------------

| | (2) | Tax
benefits under the Law for the Encouragement of Industry (Taxation), 1969.
| | --- | ------------------------------------------------------------------------------

| | ECtel
Ltd. is an Industrial Company as defined by this Law, and as such is entitled,
among other benefits, to claim accelerated depreciation of machinery and equipment as
prescribed by regulations issued under the inflationary adjustments tax law.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (3) | Tax
rates applicable to income from other sources in Israel.
| | --- | ------------------------------------------------------------

| | Income
not eligible for Approved Enterprise benefits as mentioned above is taxed at
the ordinary tax rate of 31%, (also see Note 12H).
| | ----------------------------------------------------------------------------------------------------------------------------------------

F - 36

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 12  Income
Taxes (contd)

| | B. | Non-Israeli
subsidiaries
| | -- | ------------------------

| | The
non-Israeli subsidiaries are taxed based upon tax laws in their countries of domicile.
| | ------------------------------------------------------------------------------------------

| | C. | Taxes
on income
| | -- | ---------------

| | Income
tax (expense) benefit included in the consolidated statements of operations is comprised
as follows:
| | -----------------------------------------------------------------------------------------------------------

| |                                                | Year ended December 31
| | ---------------------------------------------- | ----------------------
|
|
|
|
| | Current and previous years taxes relating to - |                       
| | Israeli operations                             |                       
| | Foreign operations                             |                       
| |                                                |                       
| |                                                |                       
| |                                                |                       
| | Deferred taxes relating to -                   |                       
| | Israeli operations                             |                       
| |                                                |                       
| |                                                |                       
| |                                                |                       
| |                                                |                       
| |                                                |                       

| | D. | Loss
from continuing operations before taxes on income
| | -- | ------------------------------------------------------

| |                                         | Year ended December 31
| | --------------------------------------- | ----------------------
|
|
|
|
| | ECtel Ltd. and its Israeli subsidiaries |                       
| | Foreign subsidiaries                    |                       
| |                                         |                       
| |                                         |                       
| |                                         |                       
| |                                         |                       

F - 37

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 12  Income
Taxes (contd)

| | E. | Reconciliation
of the statutory tax expense to actual tax expense
| | -- | -----------------------------------------------------------------

| | A
reconciliation of the statutory tax (benefit) expense, assuming all income is taxed at the
statutory rate (see Note 12G) applicable to the income of companies in Israel, and the
actual tax (benefit) expense is as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                           | Year ended December 31
| | --------------------------------------------------------- | ----------------------
|
|
|
|
| | Loss from continuing operations before taxes on income    |                       
| | as reported in the consolidated statements of operations: |                       
| |                                                           |                       
| |                                                           |                       
| | Statutory tax rate                                        |                       
| |                                                           |                       
| | Benefit computed at statutory tax rate                    |                       
| | Tax adjustment in respect of foreign subsidiaries         |                       
| | different tax rates                                       |                       
| | Goodwill impairment                                       |                       
| | Decrease in taxes resulting from "Approved                |                       
| | Enterprise" benefit (1)                                   |                       
| | Valuation allowance                                       |                       
| | Taxes in respect of prior years                           |                       
| | Non-deductible expenses                                   |                       
| | Other                                                     |                       
| |                                                           |                       
| | Actual tax (benefit) expense                              |                       
| |                                                           |                       
| |                                                           |                       
| | (1)   Per share amounts                                   |                       
| | (basic and diluted) of the tax benefit                    |                       
| | resulting from the exemption                              |                       

F - 38

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 12  Income
Taxes (contd)

| | F. | Components
of deferred income tax
| | -- | ---------------------------------

| | The
Company recognizes deferred tax benefits based on managements expectation that
future taxable earnings will be achieved. A valuation allowance has been recorded in
respect of the entire balance of deferred tax assets as management concluded that at
December 31, 2006 it is more likely than not that such assets will not be realized.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Deferred
income tax consists of future tax assets attributable to the following:
| | --------------------------------------------------------------------------------

| |                                           | December 31
| | ----------------------------------------- | -----------
|
|
|
|
| | Current deferred tax asset:               |            
| |                                           |            
| | Accrued expenses                          |            
| | Inventory                                 |            
| | Vacation pay accruals                     |            
| | Allowance for doubtful accounts           |            
| | Research and development costs            |            
| |                                           |            
| |                                           |            
| | Gross current deferred tax asset          |            
| |                                           |            
| | Less - valuation allowance                |            
| |                                           |            
| |                                           |            
| | Net current deferred tax asset            |            
| |                                           |            
| |                                           |            
| | Long term deferred tax asset:             |            
| |                                           |            
| | Liability for employee severance benefits |            
| | Operating and capital loss carryforwards  |            
| | Property, plant and equipment             |            
| | Research and development costs            |            
| |                                           |            
| |                                           |            
| | Gross long term deferred tax asset        |            
| |                                           |            
| | Less - valuation allowance                |            
| |                                           |            
| |                                           |            
| | Net long-term deferred tax asset          |            
| |                                           |            

F - 39

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 12  Income
Taxes (contd)

| | G. | Tax
assessments and carryforward tax losses
| | -- | -------------------------------------------

| | Final
tax assessments have been received by the Israeli companies through the 2001 tax year.
| | --------------------------------------------------------------------------------------------

| | The
U.K. and U.S. subsidiaries are currently undergoing examinations by the tax authorities.
In the opinion of management and its tax advisors, at the present time it is too early to
indicate the probable outcome of these examinations.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Israeli Companies have tax loss carryforwards of approximately $99 million which can be
carried forward indefinitely.
| | -------------------------------------------------------------------------------------------------------------------------

| | The
UK subsidiary has a tax loss carryforward of approximately $2 million which can be carried
forward indefinitely. However, starting in 2006, the UK subsidiarys losses cannot be
offset against current income, in accordance with the tax laws of the United Kingdom.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
US subsidiary has a tax loss carryforward of $7 million which will expire between 2023 and
2024.
| | ----------------------------------------------------------------------------------------------------

| | The
German subsidiary has a tax loss carryforward of approximately $0.3 million which can be
carried forward indefinitely.
| | --------------------------------------------------------------------------------------------------------------------------

| | H. | Reduction
in the company tax rate
| | -- | ---------------------------------

| | On
July 25, 2005, the Knesset passed the Law for the Amendment of the Income Tax Ordinance
(No. 147 and Temporary Order)  2005 (hereinafter  the Amendment).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Amendment provides for a gradual reduction in corporate tax rate in the following manner:
in 2007  29%, 2008  27%, 2009  26% and from 2010 onward 25%.
Furthermore, as from 2010, upon reduction of the corporate tax rate to 25%, capital gains
will be subject to tax of 25%.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
change had no effect on the financial statements of the Company.
| | ---------------------------------------------------------------------

# Note 13  Related
Party Transactions

| | A. | Generally, related parties are comprised of principal shareholders (those owning
               10% or more of the Companys share capital) and their subsidiaries and
               affiliates as well as other affiliates of the Company.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Transactions
with related parties are mainly comprised of sales of some of the Companys products
and purchases from related parties in respect of cost of revenues.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | All
transactions with related parties are in the ordinary course of business and at terms
identical to those applied to transactions with other customers or suppliers.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 40

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 13  Related
Party Transactions (contd)

| | B. | In June 2006, ECI Telecom Ltd. (hereinafter ECI), a principal
               shareholder, distributed ECtels shares to ECIs shareholders and,
               therefore, ceased being a principle shareholder. The data in Note 13E represents
               transactions with ECI during 2006 until the date it ceased being a principal
               shareholder, and with others, as mentioned below.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company had various agreements with ECI. The agreements effective throughout 2006 are as
follows:
| | -----------------------------------------------------------------------------------------------------

| | 1. | An administrative agreement for certain services including intellectual property
               services and communication services. For the performance of each service, the
               Company paid ECI amounts as agreed upon in the agreement.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | A supply agreement with ECI, under which ECI supplies the Company with the
               components (hereinafter: modules) for use in its products.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------

| | According
to the supply agreement, ECI has informed the Company that it will stop manufacturing some
of the modules as of August 2006. The Company has initiated discussions with an
alternative supplier that has performed manufacturing services for ECI, in relation to
these modules.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
the performance of this agreement the Company pays ECI agreed prices.
| | -------------------------------------------------------------------------

| | 3. | Effective October 1, 2002, the Company executed an administrative services
               agreement with ECI Telecom GmbH for the provision of certain services to ECtel
               GmbH, including leasing of office space, according to agreed payments.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
term of the agreement was for an initial period of one year, with automatic renewal of
additional periods of one year each.
| | -------------------------------------------------------------------------------------------------------------------------------

| | 4. | In June 2005, the Company entered into a distribution agreement with ECI, under
               which ECI was appointed as Companys exclusive distributor in significant
               portions of the former Soviet Union. Under the agreement, ECI will among other
               things, maintain a business and sales organization in these territories to
               promote and effect the sale of those of the Companys products and services
               covered by the agreement. In addition, the Company will provide services to
               those customers who purchase its products from ECI, subject to a standard
               warranty. The agreement which expired on December 31, 2005, provided that
               subsequent to that date, it continues in full force and effect until such time
               as either party gives the other party three months notice. In addition,
               either party may terminate the agreement at anytime upon a material breach by
               the other party or in the event of liquidation or similar consequences of the
               other party.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | Starting July 2006, and following distribution of ECtels shares by ECI as
               mentioned above, the Company accounts for several commercial agreements with
               certain vendors and customers as transactions with related parties, in
               accordance with disclosure provisions set forth in SFAS No. 57
               Related Parties Disclosures. The agreements existed prior to the
               date when the customers and vendors became related parties. IDB Group, an
               Israeli publicly-traded entity on the Tel Aviv Stock Exchange, is a principal
               shareholder, which holds indirectly and through several intermediaries,
               approximately 31% of the Companys shares.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 41

---

---



|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 13  Related
Party Transactions (contd)

| | C. | (contd)
| | -- | --------

| | Two
of the Companys customers and vendors are accounted for as affiliates of IDB Group.
Related transactions are disclosed as follows:
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | 1. | The
Company has various commercial agreements with Cellcom Ltd., an Israeli
          cellular communications operator. Under some of the agreements the Company acts
          as a vendor, and under other, as a customer. For the performance of the
          aforesaid agreements the Company pays and is paid by Cellcom amounts as agreed
          upon in the commercial agreements.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | The
Company has various commercial agreements with 013 Barak Ltd., an Israeli
          international voice telecommunication services provider. Under some of the
          agreements, the Company acts as a vendor, and under other, as a customer. For
          the performance of the aforesaid agreements, the Company pays and is paid by
013           Barak amounts as agreed upon in the commercial agreements.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Balances
due to or from related parties:
| | -- | ----------------------------------------

| |                        | December 31
| | ---------------------- | -----------
|
|
|
|
| | Assets:                |            
| | Trade receivables, net |            
| |                        |            
| | Liabilities:           |            
| | Trade payables         |            
| | Other payables         |            

| | E. | Income
from and expenses to related parties:
| | -- | --------------------------------------------

| |                                     | Year ended December 31
| | ----------------------------------- | ----------------------
|
|
|
|
| | Sales                               |                       
| | Purchase from related parties       |                       
| | Research and development costs      |                       
| | Selling and marketing expenses      |                       
| | General and administrative expenses |                       
| | Financial (income) expenses         |                       

F - 42

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|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 14 
Supplementary Financial Statement Information

| | Balance
sheet:
| | --------------

| | A. | Cash
and cash equivalents
| | -- | -------------------------

| | Including
short-term deposits and marketable securities in the amount of $11,709 thousand as at
December 31, 2006 (December 31, 2005  $23,847 thousand).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Trade
Receivables
| | -- | -----------------

| | 1. | Net of provision for doubtful accounts of $13,374 thousand as at December 31,
               2006 (December 31, 2005 - $18,051 thousand).
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------

| | The
activity in the allowance for doubtful accounts for the years ended December 31 is as
follows:
| | --------------------------------------------------------------------------------------------------

| |                                            | December 31
| | ------------------------------------------ | -----------
|
|
|
|
| | Allowance for doubtful accounts            |            
| | at the beginning of the year               |            
| | Additions charged to doubtful debt expense |            
| | Write-down charged against the allowance   |            
| | Recoveries of amounts previously reserved  |            
| |                                            |            
| | Allowance for doubtful accounts            |            
| | at the end of the year                     |            
| |                                            |            

| | 2. | A substantial portion of the Companys sales are to large
               telecommunications service providers. In certain cases the Company obtains
               collateral from its customers, such as letters of credit and promissory notes.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | The Company entered into accounts receivable factoring agreements with a number
               of financial institutions (banks). Under terms of the agreements,
               the Company has the option to factor receivables, with the bank on a
               non-recourse basis, provided that the bank approves the receivables in advance.
               The Company continues to be obligated in the event of a commercial dispute,
               (such as product defects) which are not covered under the credit insurance
               policy, unrelated to the credit worthiness of the customer. As of December 2006
               no trade receivables were sold (December 31, 2005  $423 thousand).
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 43

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|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 14 
Supplementary Financial Statement Information (contd)

| | C. | Other
Payables and Accrued Liabilities
| | -- | --------------------------------------

| |                                           | December 31
| | ----------------------------------------- | -----------
|
|
|
|
| | Employees and social benefits             |            
| | Government authorities                    |            
| | Chief Scientist (see also Note 10B)       |            
| | Commissions payable                       |            
| | Product warranty liability (see Note 10G) |            
| | Other payables                            |            
| |                                           |            
| |                                           |            
| |                                           |            
| |                                           |            

| | D. | Disclosures
about segments and related information
| | -- | --------------------------------------------------

| | 1. | Information
on sales by geographic distribution:
| | -- | ------------------------------------------------

| | Revenues
are attributed to geographic distribution based on the location of the customer.
| | -----------------------------------------------------------------------------------------

| |                        | Year ended December 31
| | ---------------------- | ----------------------
|
|
|
|
| | Europe                 |                       
| | Americas               |                       
| | Asia Pacific and other |                       
| | Middle East and Africa |                       
| |                        |                       
| |                        |                       
| |                        |                       
| |                        |                       

| | 2. | Sales
to single customers exceeding 10% of sales:
| | -- | -------------------------------------------------

| |            | Year ended December 31
| | ---------- | ----------------------
|
|
|
|
| | Customer A |                       
| | Customer B |                       
| | Customer C |                       
| |            |                       
| |            |                       
| |            |                       
| |            |                       

F - 44

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|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 14 
Supplementary Financial Statement Information (contd)

| | D. | Disclosures
about segments and related information (contd)
| | -- | -----------------------------------------------------------

| | 3. | Long-lived
assets on a geographical basis:
| | -- | ------------------------------------------

| |                   | Israel | United States | Europe | Total 
| | ----------------- | ------ | ------------- | ------ | ------
|
|
|
|
| | December 31, 2006 |        |               |        | 13,959
| | December 31, 2005 |        |               |        | 14,702
| | December 31, 2004 |        |               |        | 11,195

| | E. | Cost
of revenues:
| | -- | -----------------

| |                                       | Year ended December 31
| | ------------------------------------- | ----------------------
|
|
|
|
| | Materials and components              |                       
| | Salaries, wages and employee benefits |                       
| | Depreciation                          |                       
| | Royalties to Chief Scientist          |                       
| | Share-based compensation              |                       
| | Other manufacturing and service costs |                       
| |                                       |                       
| |                                       |                       
| | Decrease in inventories               |                       
| | Inventory write off                   |                       
| |                                       |                       
| |                                       |                       
| |                                       |                       

| | F. | Research
and development costs, net:
| | -- | ------------------------------------

| |                             |  | Year ended December 31
| | --------------------------- |  | ----------------------
|
|
|
|
| | Expenses incurred           |  |                       
| | Share-based compensation    |  |                       
| | Less - grant participations |  |                       
| |                             |  |                       
| |                             |  |                       
| |                             |  |                       
| |                             |  |                       

| | G. | Selling
and marketing expenses:
| | -- | -------------------------------

| |                                | Year ended December 31
| | ------------------------------ | ----------------------
|
|
|
|
| | Salaries and employee benefits |                       
| | Agents' commissions            |                       
| | Advertising and exhibitions    |                       
| | Domestic and foreign travel    |                       
| | Share-based compensation       |                       
| | Other expenses                 |                       
| |                                |                       
| |                                |                       
| |                                |                       
| |                                |                       

F - 45

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|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

Note 14  Supplementary Financial Statement Information (cont'd)

| | H. | General
and administrative expenses:
| | -- | ------------------------------------

| |                                           | Year ended December 31
| | ----------------------------------------- | ----------------------
|
|
|
|
| | Salaries and employee benefits            |                       
| | Doubtful debt expense (recovery)          |                       
| | Share-based compensation                  |                       
| | Other administrative and general expenses |                       
| |                                           |                       
| |                                           |                       
| |                                           |                       
| |                                           |                       

| | I. | Financial
income and expenses:
| | -- | ------------------------------

| |                                               | Year ended December 31
| | --------------------------------------------- | ----------------------
|
|
|
|
| | Financial expenses:                           |                       
| | Interest and bank charges (see also Note 10B) |                       
| | Exchange rate differences (see Note 2(B))     |                       
| |                                               |                       
| |                                               |                       
| |                                               |                       
| |                                               |                       
| | Financial income:                             |                       
| | Interest, mainly on bank deposits and         |                       
| | marketable securities                         |                       
| | Exchange rate differences (see Note 2(B))     |                       
| |                                               |                       
| |                                               |                       
| |                                               |                       
| |                                               |                       

| | J. | Supplementary
statement of operations information:
| | -- | --------------------------------------------------

| |                                               | Year ended December 31
| | --------------------------------------------- | ----------------------
|
|
|
|
| | Maintenance and repairs                       |                       
| | Depreciation of property, plant and equipment |                       
| | Taxes (other than income taxes)               |                       
| | Rent of premises                              |                       
| | Lease of vehicles                             |                       

F - 46

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|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

Note 15  Balances in Currencies Other Than the U.S Dollar:

| | A. | Comprised
of:
| | -- | -------------

| |                             | December 31, 2006 | December 31, 2005
| | --------------------------- | ----------------- | -----------------
|
|
|
|
| | Assets                      |                   |                  
| | Trade receivables, net      |                   |                  
| | Other current assets        |                   |                  
| | Long-term other receivables |                   |                  
| |                             |                   |                  
| |                             |                   |                  
| |                             |                   |                  
| |                             |                   |                  
| |                             |                   |                  
| | Liabilities                 |                   |                  
| | Trade payables              |                   |                  
| | Other current liabilities   |                   |                  
| | Long-term liabilities       |                   |                  
| |                             |                   |                  
| |                             |                   |                  
| |                             |                   |                  
| |                             |                   |                  

| | (*) | Linked
to the Israeli CPI.
| | --- | --------------------------

| | B. | Aggregate exchange rate (losses) gains for the years ended December 31, 2006,
               2005 and 2004 are $(273) thousand, $123 thousand and $22 thousand, respectively.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
stated in Note 2(B), exchange gains and losses are included in the same statement of
operationsitems in which the related transactions are included.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------

F - 47

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|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 16 
Disclosure Regarding Fair Value of Financial Instruments

| | The
financial instruments of the Company consist mainly of cash and cash equivalents, current
and non-current receivables, short and long-term marketable securities, accounts payable
and accruals, and other long-term liabilities.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
view of their short term nature, the fair value of the financial instruments included in
working capital of the Company is usually identical or close to their carrying value.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of long-term marketable securities also approximate the carrying value since it
bears interest at rates close to the prevailing market rates.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Considerable
judgment is required to develop the estimates of fair value, thus, the estimates provided
herein are not necessarily indicative of amounts that could be realized in a current
market exchange.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 17 
Restructuring and Related Impairment Costs

| | In
June 2004, as part of the Companys Board of Directors decision to abandon
certain products as well as overall cost reductions, the Company recorded $3,358 thousand
in reorganization expenses associated with payroll expenses, disposal of fixed assets and
rent contract termination penalty expenses and others. The restructuring has been
completed and excess accruals have been reversed.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
December 2005, the Company acquired Elron Telesoft Ltd. and Elron Telesoft Export Ltd. As
a result of the acquisition the Company made certain restructuring charges as a result of
redundancies.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following table summarizes the net charges or reversals under the restructuring program:
| | --------------------------------------------------------------------------------------------

| |                                       | December 31
2006 | December 31
2005 | December 31
2004
| | ------------------------------------- | ---------------- | ---------------- | ----------------
|
|
|
|
| | Restructuring costs                   |                  |                  |                 
| | Reversal of prior restructuring costs |                  |                  |                 
| |                                       |                  |                  |                 
| |                                       |                  |                 
| |                                       |                  |                  |                 
| |                                       |                  |                  |                 

| | The
following table summarizes the movements in provision of restructuring costs:
| | ---------------------------------------------------------------------------------

| |                              | Year ended December 31, 2006
| | ---------------------------- | ----------------------------
|
|
|
|
| | At the beginning of the year |                             
| | Paid or reversed             |                             
| |                              |                             
| | At the end of the year       |                             
| |                              |                             

F - 48

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|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 18 
Acquisition-Related Expenses

| | During
2006, the Company carried out a due-diligence process in the framework of an examination
of a potential acquisition opportunity which reached advanced stages in the third quarter
of 2006. Eventually, the Company decided, after evaluating all the relevant parameters,
not to conclude the negotiations, and therefore recorded an amount of $640 thousand as
acquisition-related expenses.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 19 
Discontinuance of the Government Segment Operation

| | A. | On February 9, 2004, the Company sold the Government Surveillance Business to
               Verint Systems, an Israeli subsidiary of Verint Systems Inc., a US corporation
               (Verint Systems). The transaction was consummated on March 31, 2004.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
at December 31, 2006 there are no further obligations to Verint Systems.
| | ---------------------------------------------------------------------------

| | B. | Set
forth below are the results of operations of the discontinued operations:
| | -- | -----------------------------------------------------------------------------

| |                                               | Year ended December 31
| | --------------------------------------------- | ----------------------
|
|
|
|
| | Revenues                                      |                       
| | Expenses                                      |                       
| | Other income*                                 |                       
| |                                               |                       
| |                                               |                       
| | Income of discontinued operations, nil of tax |                       
| |                                               |                       

| | *
Gain from sale of government surveillance business.
| | -----------------------------------------------------

# Note 20  Recently
Enacted Accounting Standards

| | 1. | In September 2006, the FASB issued SFAS No. 157, Fair Value
               Measurement. SFAS 157 defines fair value, establishes a framework for the
               measurement of fair value, and enhances disclosures about fair value
               measurements. The Statement does not require any new fair value measures. The
               Statement is effective for fair value measures already required or permitted by
               other standards for fiscal years beginning after November 15, 2007. The
               Company is required to adopt Statement 157 beginning on January 1,
               2008. Statement 157 is required to be applied prospectively, except for certain
               financial instruments. Any transition adjustment will be recognized as an
               adjustment to opening retained earnings in the year of adoption.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 49

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|                                              
|----------------------------------------------
|ECtel Ltd. and Subsidiaries                   
|Notes to the Consolidated Financial Statements
|                                              

# Note 20  Recently
Enacted Accounting Standards (contd)

| | 2. | In July 2006, the FASB issued FASB Interpretation No. 48,
               Accounting for Uncertainty in Income Taxes, an interpretation of
               FASB Statement 109 (FIN 48). FIN 48 clarifies the accounting for
               uncertainty in income taxes recognized in an enterprises financial
               statements and prescribes a threshold of more-likely-than-not for recognition of
               tax benefits of uncertain tax positions taken or expected to be taken in a tax
               return. FIN 48 also provides related guidance on measurement,
               derecognition, classification, interest and penalties, and disclosure. The
               provisions of FIN 48 will be effective for the Company on January 1,
               2007, with any cumulative effect of the change in accounting principle recorded
               as an adjustment to opening retained earnings. The Company is in the process of
               assessing the impact of adopting FIN 48 on its results of operations and
               financial position.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | In February 2007, the FASB issued Statement No. 159, The Fair Value Option
               for Financial Assets and Financial Liabilities  Including an amendment of
               FASB Statement No. 115", which permits entities to choose to measure many
               financial instruments at fair value. The Statement allows entities to achieve an
               offset accounting effect for certain changes in fair value of certain related
               assets and liabilities without having to apply complex hedge accounting
               provisions, and is expected to expand the use of fair value measurement
               consistent with the Boards long-term objectives for financial instruments.
               This Statement is effective as of the beginning of an entitys first fiscal
               year that begins after November 15, 2007.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 50

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---