---

---

# 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, 2005

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, 2005:

# 18,169,089 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.

oYes   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 oItem 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



---

---



TABLE OF CONTENTS

|       |          |                                                       |   
|------ | -------- | ----------------------------------------------------- | --
|
|
|
|
|PART I |          |                                                       | 5 
|       | Item 1.  | Identity Of Directors, Senior Management And Advisers | 5 
|       | Item 2.  | Offer Statistics and Expected Timetable               | 5 
|       | Item 3.  | Key Information                                       | 5 
|       |          | A. Selected Financial Data                            | 5 
|       |          | B. Capitalization and Indebtedness                    | 7 
|       |          | C. Reasons for the Offer and Use of Proceeds          | 7 
|       |          | D. Risk Factors                                       | 7 
|       | Item 4.  | Information on the Company                            | 18
|       |          | A. History and Development of the Company             | 18
|       |          | B. Business Overview                                  | 18
|       |          | C. Organizational Structure                           | 26
|       |          | D. Property, Plants and Equipment                     | 26
|       | Item 4A. | Unresolved Staff Comments                             | 26
|       | Item 5.  | Operating and Financial Review and Prospects          | 26
|       |          | A. Operating Results                                  | 26
|       |          | B. Liquidity and Capital Resources                    | 35
|       |          | C. Research and Development, Patents and Licenses     | 38
|       |          | D. Trend Information                                  | 39
|       |          | E. Off-Balance Sheet Arrangements                     | 39
|       |          | F. Tabular Disclosure of Contractual Obligations      | 39
|       | Item 6.  | Directors, Senior Management and Employees            | 40
|       |          | A. Directors and Senior Management                    | 40
|       |          | B. Compensation                                       | 42
|       |          | C. Board Practices                                    | 42
|       |          | D. Employees                                          | 45
|       |          | E. Share Ownership                                    | 46
|       | Item 7.  | Major Shareholders and Related Party Transactions     | 47
|       |          | A. Major Shareholders                                 | 47
|       |          | B. Related Party Transactions                         | 48
|       |          | C. Interests of Experts and Counsel                   | 49



---

---



|        |           |                                                                              |   
|------- | --------- | ---------------------------------------------------------------------------- | --
|
|
|
|
|        | Item 8.   | Financial Information                                                        | 49
|        |           | A. Consolidated Statements and Other Financial Information                   | 49
|        |           | B. Significant Changes                                                       | 50
|        | Item 9.   | The Offer and Listing                                                        | 50
|        |           | A. Offer and Listing Details                                                 | 50
|        |           | B. Plan of Distribution                                                      | 51
|        |           | C. Markets                                                                   | 51
|        |           | D. Selling Shareholders                                                      | 51
|        |           | E. Dilution                                                                  | 51
|        |           | F. Expenses of the Issue                                                     | 51
|        | Item 10.  | Additional Information                                                       | 51
|        |           | A. Share Capital                                                             | 51
|        |           | B. Memorandum and Articles of Association                                    | 51
|        |           | C. Material Contracts                                                        | 56
|        |           | D. Exchange Controls                                                         | 58
|        |           | E. Taxation                                                                  | 58
|        |           | F. Dividends and Paying Agents                                               | 66
|        |           | G. Statement by Experts                                                      | 66
|        |           | H. Documents on Display                                                      | 66
|        |           | I. Subsidiary Information                                                    | 66
|        | Item 11.  | Quantitative and Qualitative Disclosures about Market Risk                   | 66
|        | Item 12.  | Description of Securities other than Equity Securities                       | 69
|PART II |           |                                                                              | 69
|        | Item 13.  | Defaults, Dividend Arrearages and Delinquencies                              | 69
|        | Item 14.  | Material Modifications to the Rights of Security Holders and Use of Proceeds | 69
|        | Item 15.  | Controls and Procedures                                                      | 69
|        | Item 16A. | Audit Committee Financial Expert                                             | 69
|        | Item 16B. | Code of Ethics                                                               | 69

3

---

---



|         |           |                                                                       |   
|-------- | --------- | --------------------------------------------------------------------- | --
|
|
|
|
|         | Item 16C. | Principal Accountant Fees and Services                                | 69
|         | Item 16D. | Exemptions from Listing Standards for Audit Committees                | 70
|         | Item 16E. | Purchase of Equity Securities by the Issuer and Affiliated Purchasers | 70
|PART III |           |                                                                       | 70
|         | Item 17.  | Financial Statements                                                  | 70
|         | Item 18.  | Financial Statements                                                  | 70
|         | Item 19.  | Exhibits                                                              | 71

4

---

---



# 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.

On
March 31, 2004, we sold our government surveillance business to Verint Systems Ltd.
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.

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, 2005 and 2004 and the
selected consolidated statements of operations data for each of the three years in the
period ended December 31, 2005 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, Registered Public Accountants, a member firm of KPMG
International, independent public accountants in Israel.  Its report appears
elsewhere in this annual report.The selected consolidated balance
sheet data as of December 31, 2003, 2002 and 2001 and the selected consolidated
statements of operations data for the years ended December 31, 2002 and 2001 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 and the notes thereto included elsewhere in this annual
report. These data should not be construed as indicative of our future operating results
or financial position.

In
March 2004, we sold our government surveillance business to Verint Systems pursuant to an
asset purchase agreement, which is described below under Item 10.C Additional
InformationMaterial Agreements.  The results of operations of this
business for each of the four 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.

On
December 29, 2005, we acquired all of the outstanding shares of Elron Telesoft Ltd. and
Elron Telesoft Export 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.

5

---

---



|                                              | 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           |                        
|In process research and development costs     |                        
|Restructuring and related impairment costs    |                        
|Goodwill impairment                           |                        
|                                              |                        
|Total operating expenses                      |                        
|                                              |                        
|Operating (loss) income                       |                        
|Financial income, net                         |                        
|Other income (expenses), net                  |                        
|                                              |                        
|                                              |                        
|Loss from continuing operations before taxes  |                        
|on income                                     |                        
|Income tax benefit (expense)                  |                        
|                                              |                        
|                                              |                        
|Net (loss) income from continuing operations  |                        
|before cumulative effect of change in         |                        
|accounting principles                         |                        
|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                         |                        
|Cumulative effect of change in accounting     |                        
|principles                                    |                        
|Discontinued operations                       |                        
|                                              |                        
|                                              |                        
|                                              |                        
|                                              |                        
|Weighted average number of shares outstanding |                        
|Diluted earnings (loss) per ordinary share:   |                        
|Continuing operations                         |                        
|Cumulative effect of change in accounting     |                        
|principles                                    |                        
|Discontinued operations                       |                        
|                                              |                        
|                                              |                        
|                                              |                        
|                                              |                        
|Weighted average number of shares outstanding |                        

---

|(*) | Represent
an amount of less than $0.01
|--- | --------------------------------------

6

---

---



|                                   | 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.

# Risks Related to Our
Business and Our Industry

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.

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 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.

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 us.

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 ourproducts. 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. Although we
generally maintain an inventory for some of our components and subassemblies to limit the
potential for an interruption and we believe that we can obtain alternative sources of
supply in the event our suppliers are unable to meet our requirements or fail to do so in
a timely manner, 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. In particular, ECI Telecom Ltd., our supplier of critical
hardware components for our legacy probing devices, has special expertise in engineering
these components. ECI has informed us that it will stop manufacturing some of these
components as of August 2006. Accordingly, we need to arrange for the manufacture of
these components directly through a contractor. We have initiated discussions with an
alternative supplier that has performed manufacturing services for ECI in relation to
these components. However, we may not be able to come to terms acceptable to us with such
alternative supplier or any other suitable manufacturer of these components on a timely
basis. If we are unable to locate and agree upon terms with a suitable alternative
supplier for ECI on a timely basis or, even if we agree on terms, and such contractor is
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 to pay the alternative supplier
higher price for these components than the prices currently charged by ECI.

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

7

---

---



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.

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 return to, 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. In addition, we could
lose sales to our competitors. Lower prices and reduced demand for our products would
reduce our ability to generate revenue, which would harm our business.

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.

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 59.1% of our revenues
in 2005, with sales to three customers in Eastern Europe accounting for 26.0% of our
revenues and sales to three customers in Latin America accounting for 16.6% of our
revenues. Sales to our top ten customers accounted for 74.8% of our revenues in 2004,
with sales to three customers in Eastern Europe accounting for 39.7% of our revenues and
sales to a customer in Latin America accounting for 10.4% 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.

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 recently 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.

We have entered into a
Distribution Agreement with ECI Telecom Ltd. under which we appointed ECI as our exclusive
distributor in significant portions of the former Soviet Union, which we expect to be
important markets for us.  Accordingly, we are 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.  Under this agreement, ECI, among other things,
maintains a business and sales organization in these territories to promote and/or effect
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. However, 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 prospects for
achieving our business plan and growth targets may be harmed.

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 are conducting a more stringent and detailed evaluation of
our products, and decisions are subject to additional levels of internal review. As a
result, the evaluation process has significantly lengthened. This evaluation process is
currently taking between six and 18 months. The following factors, among others,
affect the length of the approval process:

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

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

| |  | the
complexity of the products involved;
| | - | ----------------------------------------

| |  | the
technological priorities and budgets of our customers; and
| | - | --------------------------------------------------------------

| |  | the
need for our customers to obtain or comply with any required regulatory approvals.
| | - | --------------------------------------------------------------------------------------

Delays
in project approval have significantly decreased our revenues in the past. If customers
continue to subject our products to lengthy evaluation processes, if they continue to
delay project approval, if 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.

We increased our 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
quarter of our revenues from these sales channels. When a sale is directed through a
distribution channel and not directly by us, if the sales effort 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 were to deteriorate or if the financial condition of our channel
partners were to weaken.

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

Our
revenues for 2005 were $23.2 million, compared to $12.6 million for 2004. Our net loss
from continuing operations for 2005 was $1.4 million, compared with a net loss from
continuing operations of $25.7 million for 2004, which excludes $12.3 million in income
that was attributable to our discontinued government surveillance business.  We
implemented a comprehensive recovery plan in 2004 aimed at rebuilding our business in
response to the significant decrease in our revenues.  Although the plan involved
significant expense reductions in 2004 and 2005 in order to bring expenses more into line
with revenues, it also involved increasing our focus on sales execution, project delivery
and customer support.   We expect to increase our investment in our sales and
marketing and research and development activities in order to support our growth plan,
which is aimed at increasing our revenues. In addition, we recently acquired Telesoft and
have absorbed 28 of their employees as part of this acquisition. Accordingly, we expect
our operating expenses to increase in 2006 in relation to 2005. If our revenues do not
increase proportionately to our operating expenses, or if revenues decrease or do not
meet expectations for a particular period, and we are not able to reduce our expenses in
the short term, or at all, our business, financial condition and results of operations
will be adversely affected.

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 ourproducts.
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.

8

---

---



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.
While recovery of the telecommunication market was evident in 2004, the two principal
markets in which we compete, the fraud prevention solution market and the revenue
assurance market both continued to suffer the lasting impact of the changes to the market
between 2000 and 2003.  If the recovery in our principal markets continues to
progress at a slow pace such that current and potential customers postpone or
decrease further capital investment, our revenues may fail to grow significantly or may
decline, either of which would have a continued material adverse effect on our operating
results. 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, a recurrence of the slowdown in the buying decisions of telecommunications
service providers could extend our sales cycle period and limit our ability to forecast
our flow of new contracts.

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 and 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.

9

---

---



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 again be
below our expectations, or the expectations of public market analysts or investors, which
may cause our share price to drop.

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.

10

---

---



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.

11

---

---



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

Several
of our newer products are designed to meet the specific requirements of new value-added
services being made available by packet-switched technology (VoIP) and third generation
wireless networks (3G). The markets for VoIP and 3G are currently developing.  We
cannot be sure that the delivery of telephone, other communication or new value-added
services through VoIP or 3G networks rather than over traditional telephone networks will
expand.  If third generation networks and VoIP services are not fully developed and
accepted in the marketplace, the market for some of our newer products may not develop or
be sustainable. In that case, our business would be adversely affected.

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

New
technologies, such as VoIP, are facilitating the use of cheaper communications media and
new pricing schemes, such as flat rates, by some telecom service providers. Such service
providers may be less inclined to invest in high-end solutions like ours. Moreover, since
these technologies enable the service providers to offer relatively low calling rates to
subscribers, this may reduce the incentive to commit telecom fraud or 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.

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

In
addition, we recently outsourced a portion of our professionalservices and
operations in Europe to a subcontractor in Bulgaria. Bulgaria is still economically and
politically unstable, suffers from exchange rate and inflation fluctuations, political
and criminal corruption, and lack of commercial experience and unpredictability of the
civil justice system. There can be no assurances that one or more of such factors will
not have a material adverse effect on our Bulgarian operations and, consequently, on our
business, financial condition or results of operations. We may be unable to adequately
protect our proprietary rights, which may limit our ability to compete effectively. In
addition, our ability to adequately protect our proprietary rights in Bulgaria is further
unclear due to its political instability and the fact that the protection of intellectual
properties in eastern European countries has traditionally been difficult to achieve. If
we fail to overcome the challenges we encounter in our international operations, our
business will be materially adversely affected.

12

---

---



Currency fluctuations could cause
customers to default on payment.

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

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

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

Our
customers generally operate their networks using a wide variety of software applications,
network equipment and software and hardware platforms. If our customers do not agree to
use the technology platforms designated by us or if our products fail to integrate
properly with our customers equipment, our ability to generate future sales will be
harmed. For example, a portion of our FraudView® application platform uses the
Win-Tel operating system. Most companies in the telecommunications industry currently use
UNIX and may not be willing to implement a solution which is partially based on Win-Tel.
If service providers are unwilling to accept a Win-Tel partially based solution, our
business will be harmed.

Breaches in the security of the
data collected by systems that we have sold and still support could adversely affect our
reputation and results of operations.

Our
customers rely on third-party security features to protect the privacy and integrity of
customer data. Our products may be vulnerable to breaches in security due to defects
in the security mechanisms, the operating system, the hardware platform or the networks
linked to the platform. OurQualiWeb®product, which we ceased to produce
and to actively market in 2004, but which will still support, provides information using
Web access, presents additional security issues for our customers. Exploitation of
any vulnerability could jeopardize the security of information stored in and transmitted
through the computer systems of our customers. If the security of our products were
compromised, our reputation would be significantly harmed, which would cause our business
to suffer. In addition, we may be liable to our customers for any breach in security. We
may be required to expend significant capital and other resources to further protect
against security breaches or to correct problems caused by any breach.

We 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.

13

---

---



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 senior 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.

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. There is a           substantial risk
that we are a passive foreign investment company, commonly           referred to as PFIC.
Our treatment as a PFIC could result in a reduction in the           after-tax return to
the holders of our ordinary shares and would likely cause a           reduction in the
value of such shares. For U.S. Federal income tax           purposes, we will be
classified as a PFIC for any taxable year in which either           (i) 75% or more of
our gross income is passive income, or (ii) at least 50% of           the average value
of all of our assets for the taxable year produce or are held           for the
production of passive income. For this purpose, cash is considered           to be
an asset which produces passive income. As a result of our substantial           cash
position and the decline in the value of our stock in prior years, we would           be
classified as a PFIC if the asset test described above were 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.

14

---

---



# Risks Related to
Operations in Israel

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

Our
principal offices and manufacturing facilities and many of our suppliers are located in
Israel. Accordingly, political, economic and military conditions in Israel directly
affect our operations. Since the establishment of the State of Israel in 1948, a
number of armed conflicts have taken place between Israel and its Arab neighbors. A
state of hostility, varying in degree and intensity, has led to security and economic
problems for Israel. From October 2000 until recently, there was a high level of
violence between Israel and the Palestinians, which led to a breakdown of the entire
peace process and has affected Israels relationship with its Arab citizens and
several Arab countries. In addition, in January 2006, Hamas, the Islamic Resistance
Movement, won the majority of the seats in the Parliament of the Palestinian Authority.
The election of a majority of Hamas-supported candidates is expected to be a major
obstacle to relations between Israel and the Palestinian Authority. Hamas does not
recognize Israels right to exist as a state and Israel considers Hamas to be a
terrorist organization. Therefore, there can be no assurance that the recent relative
calm and renewed discussions with Palestinian representatives will continue. Furthermore,
several countries restrict business with Israel and Israeli companies, and additional
companies may restrict doing business with Israel and Israeli companies as the result of
the recent increase in hostilities. These restrictive policies have had and may continue
to have an adverse impact on our business. We could be adversely affected by any
major hostilities involving Israel, the interruption or curtailment of trade between
Israel and its trading partners or a significant downturn in the economic conditions in
Israel.

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

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

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

We
generate most of our revenues in U.S. dollars but incur a significant portion of our
expenses in New Israeli Shekels, commonly referred to as NIS. As a result, we are
exposed to risk to the extent that the rate of inflation in Israel exceeds the rate of
devaluation of the NIS in relation to the dollar or if the timing of such devaluation
lags behind inflation in Israel. In either event, the dollar cost of our operations
in Israel will increase and our dollar-measured results of operations will be adversely
affected. Our operations also could be adversely affected if we are unable to guard
against currency fluctuations in the future. Accordingly, we may enter into currency
hedging transactions to decrease the risk of financial exposure from fluctuations in the
exchange rate of the dollar against the NIS. These measures, however, may not
adequately protect us from material adverse effects due to the impact of inflation in
Israel.

The tax benefits 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.  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.

15

---

---



Because we receive grants from the
Office of the Chief Scientist, we are subject to ongoing restrictions, and certain of our
large shareholders are required to undertake to observe such restrictions. Also, if we
choose not to submit any new requests for grant programs, or, if the grants under requests
we have made are decreased or terminated, our costs would increase.

We
receive royalty-bearing grants from the Office of the Chief Scientist of the Israeli
Ministry of Industry Trade and Labor, or the 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 ten percent 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.

We
recorded grant participations of approximately $0.5 million in 2005 and approximately
$1.4 million in 2004. As of December 31, 2005, our contingent liability to the
Office of the Chief Scientist with respect to grants received was approximately $2.7
million. The Israeli government has reduced the benefits available under these programs
in recent years and has indicated that it may reduce or eliminate these benefits in the
future. These programs may not continue in the future at their current levels or at any
level. From time to time, we decide to submit requests for new OCS grants. There can
be no assurance that we will receive any grants in the future, if we submit grant
requests, or that, if we are approved for a grant, that there will not be a subsequent
reduction in the amounts granted by the OCS. A failure to receive a grant applied
for, reduction in the amount of an approved grant or the termination of the OCS grant
program would increase our operational costs.

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;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 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.

16

---

---



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.

On
December 15, 2005, plaintiffs filed an amended complaint (the Amended Class Action
Complaint), and defendants, subsequently filed motions to dismiss the Amended Class
Action Complaint.  The hearing on our motion to dismiss has been scheduled for May
22, 2006.  We believe that the plaintiffs claims are without merit and intend
to defend the case vigorously.  In doing so, we may incur substantial costs.
 In addition, the litigation has been, and may continue to be, time-consuming and
costly and could divert the attention of our senior management.  These lawsuits
or any future lawsuits filed against us could seriously harm our business.

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. Even though 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;
| | - | -----------------------------------------------------

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

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

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

17

---

---



|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 48092, 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 Elron Telesoft Ltd. and
Elron Telesoft Export (98) Ltd., two sister companies held by Elron Electronic Industries
Ltd., which we refer to as 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 will allow us to
provide telecommunications service providers with a flexible solution that addresses all
of their revenue assurance needs.

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.  Our Chief Executive Officer resigned in
January 2004 and this was followed by the resignation of six Vice Presidents during the
balance of the first half of 2004, either in connection with the transaction with Verint
Systems or for personal or professional reasons. In mid-February 2004, Eitan Naor
assumed the position of President and Chief Executive Officer. Mr. Naor assembled a
new management team which has led our efforts in formulating a comprehensive recovery
plan and its implementation.

The
plan, which was launched during the second quarter of 2004 and the implementation of
which continued through most of 2005, was aimed at rebuilding our core telecom business. To
this end, the plan involved increasing our focus on sales execution, project delivery and
customer support, with an emphasis on improving existing customer relationships,
expanding the sales pipeline and closing pending deals. As part of these efforts, we
established, in June 2004, a new department we refer to as the PSO (Professional Services
Organization & Operations). The PSO is responsible for project development, field
engineering, customer support, expert guidance and training.

The
recovery plan also included measures to further reduce our cost structure. Specifically,
it included steps intended to align our costs and revenues, including a material
reduction of our global workforce and the consolidation of several of our activities,
such as the closing of our main U.S. office and the elimination of our quality-assurance
products research and development team located in that office.  In connection
with the implementation of the plan, we recorded $3.4 million in reorganization expenses
associated with payroll expenses, disposal of fixed assets and rent contracts,
termination penalty expenses and other costs. See Note 17 to our consolidated financial
statements for the year ended December 31, 2005, included elsewhere in this annual
report.

# Principal Capital
Expenditures

Our
principal capital expenditures in the past three years have been the purchase of equipment
and other fixed assets used in our business (mainly in Israel). Also, 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. In
addition, in the event that over a period of 12 months following the closing date of this
transaction, certain milestones will be met, we will be obligated to pay an additional
$0.4 million in cash to Elron Electronic Industries Ltd., in two deferred installments.

Capital
equipment purchases totaled approximately $0.6 million in 2005, approximately $0.9 million
in 2004, and approximately $1.8 million in 2003. Our capital expenditures in 2005 were
spent primarily for the procurement of test and production equipment computers, as well as
for new furniture and office equipment, due to our Israeli office relocation in July
2005. We used internal working capital to finance these capital expenditures.

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

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

# General

We
develop and market our Integrated Revenue Management, or IRM, solutions. The
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. The IRM features scalability. 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 providers 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;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | supporting
revenue assurance, including call leakage detection; and
| | - | -------------------------------------------------------------------

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

18

---

---



# 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. The emerging third generation
wireless (3G) technology will enable the wireless provisioning of an even broader range
of services, including full Internet access, downloading music and video, video
conferencing and mobile banking, trading and online games.

Increased
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, therefore an increased need for service providers 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 securities law and other
regulators serve as an incentive for our potential customers to implement advanced
revenue assurance systems, thereby improving the quality of their internal controls.

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:

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

19

---

---



| |  | 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; 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.

# The ECtel Solution

We
develop and market our Integrated Revenue Management, (or IRM), framework.
The IRM enables communications service providers of both wireline and wireless networks
to deploy, execute, and oversee multiple revenue management products such as our fraud
prevention and revenue assurance products, on the same platform. The IRM features
scalability. 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 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.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

20

---

---



| |  | 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:

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

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

| |  | 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 Austria Telekom, , Cable & Wireless Group, Hutchison H3G, O2, Portugal
Telecom, MCI, Vodafone Sweden, Kievstar, 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.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

21

---

---



# Products

Integrated Revenue
Management Framework

Our Integrated Revenue Management
(IRM) framework consists of a single software and hardware platform that can be leveraged
for our fraud prevention and revenue assurance solutions.

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.
OurFraudView® system provides comprehensive fraud detection and prevention
solution for wireline, wireless and next generation networks.

Revenue
Assurance Solutions

Our
revenue assurance solutions enable wireline, wireless, and next-generation Communications
Service Providers (CSPs) to implement automated revenue assurance processes. 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.

The
IRM Platform

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

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

In
December 2005, we acquired Telesoft, a company engaged in the development and marketing of
software solutions for the management of large communications networks. We believe that
its line of products, including its Revenue Assurance solution, combined with our fraud
prevention solutions will enable us to provide communications services providers with a
comprehensive solution for their IRM requirements.

# Sales and Marketing

As
of March 31, 2006, our direct sales force and marketing staff consisted of 27 employees
worldwide. We market our fraud prevention and revenue assurance solutions to service
providers worldwide, primarily through a direct sales force. Our sales staff operates out
of our offices in Israel, the United States and Germany, and in addition we engage local
sales representatives, distributors and sales consultants.  In some territories we
engage full time sales consultants for management of sales activities in adjacent
territories.

22

---

---



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 revenue
assurance solutions is an average of between six and 18 months. Our primary marketing
activities include raising awareness among existing and potential customers of the
benefits provided by the features of our products. 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 sold our solutions to leading CSPs worldwide, including the following:

|                       |                 
|---------------------- | ----------------
|
|
|
|
|Rostelecom             | Telefonica Group
|                       |                 
|BellSouth group        | MCI             
|                       |                 
|Cable & Wireless Group | 02              
|                       |                 
|Cellcom                | Portugal Telecom
|                       |                 
|Embratel               | Qwest           
|                       |                 
|Hutchison H3G          | Swisscom        
|                       |                 
|Kievstar               | Vodafone Sweden 
|                       |                 
|Serbia Telecom         | CTBC            
|                       |                 
|Iusacell               | Kazakhtelecom   
|                       |                 
|T-Com Croatia         

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 and sales to three
customers in Latin America accounting for 16.6% of our revenues. In 2004, our top ten
customers accounted for 74.8% of our revenues, with sales to three customers in Eastern
Europe accounting for 39.7% of our revenues and sales to one customer in Latin America
accounting for 10.4% of our revenues.

23

---

---



The
following table shows a breakdown of our sales of products by geographical region during
2005, 2004 and 2003 ($ in thousands):

|                          | 2005 | 2004 | 2003
|------------------------- | ---- | ---- | ----
|
|
|
|
|Israel                    |      |      |     
|Asia Pacific              |      |      |     
|North America             |      |      |     
|Europe                    |      |      |     
|Central and Latin America |      |      |     
|Rest of the World         |      |      |     
|                          |      |      |     
|                          |      |     
|                          |      |      |     
|                          |      |      |     

# 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 comprehensive consulting
services, project management, training and on-going support, thereby maximizing the value
of our Integrated Revenue Management solution to our customers. We have recently
outsourced a portion of our technical activities in Europe to a subcontractor in
Bulgaria.

We
have focused on building a strong service and support organization for our systems. Our
customers are primarily responsible for supporting the day-to-day requirements of the
end-users, while we provide technical support to our customers.  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 maintenance and support
revenues. This, we believe, is a result of 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.

# 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
Telecom, our supplier of modules and components for our legacy probing devices, has
informed us that it will stop manufacturing some of these components as of August 2006.
Accordingly, we need to arrange for the manufacture of these components directly through
a contractor. We may be required to pay such contractor higher prices for these
components than the prices currently charged by ECI. We have initiated discussions with a
candidate that has performed manufacturing services for ECI in relation to 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 to
Quality Standard ISO 9001:2000. ISO 9001:2000 is an international standard of quality
assurance for companies involved in the design, development, manufacturing, installation
and servicing of products or services. This standard is set by the International
Organization for Standardization (ISO), an international federation of national standards
bodies. To be recommended for ISO 9001:2000 certification, a company must be audited
by an ISO-accredited auditing company and must meet or surpass the ISO standards. We
believe that our customers value the process, control and traceability that are required
to achieve ISO 9001:2000 certification.

# Research and Development

In
order to accommodate the rapidly changing needs of our markets, we place considerable
emphasis on research and development projects designed to improve our existing product
lines, develop new product lines and customize our products to meet our customersneeds. As
of March 31, 2006, 42 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.

24

---

---



As
a recipient of grants from the Office of the Chief Scientist, 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 Office of the Chief Scientist. Approval is not required for the export of any
products resulting from the research and development based on these grants. For
further information regarding the Office of the Chief Scientist of the Israeli Ministry
of Industry, Trade and Labor, see Item 5C  Research and Development, Patents
and Licenses  Grants from the Office of the Chief Scientist.

# Competition

The
telecommunications industry is characterized by intense competition. Many of the
companies that compete with us 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 new vendors, and we expect this trend to
continue in the future. Some of our customers are developing their own solutions
internally or through strategic alliances.

Our
main competitors in the fraud prevention market are Hewlett-Packard,Neural
Technologies Limited, FairIsaac Corp., Subex-Azure Limited (result of an announced merger
of Subex Systems Limited and Azure Solutions Limited). Our main competitors in the
revenue assurance solutions market include Cape Technologies Limited, Subex Azure
Limited, Martin Dawes Systems WeDo Consultin and Hewlett-Packard.

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. Various trademarks have already been
registered in certain countries.

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

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

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, X-PERTVIEW, INTERPROBE, NGN FRAUDVIEW, HAWKEYE, QUALIVOIP,
QUALIMOBILE, PRE-VIEW, VALUEROUTE, BILLGUARD, FLOWGUARD and SERVGUARD. Our pending
trademarks include 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.

25

---

---



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

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

Prior
to May 10, 2004, ECI held of record 10,490,325, or approximately 57.9%, of our
outstanding ordinary shares. On May 10, 2004 ECI distributed 7,600,000 ordinary shares to
its shareholders. As a result, ECI holds 2,890,325, or 15.9%, of our outstanding ordinary
shares.

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; and
| | - | ------------------------------------------------------------------------------------------------------

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

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

We
have recently entered into a lease agreement for our new 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 making 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 July 31, 2007.

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, including in filings with the United States Securities
and Exchange Commission, in this annual report. 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 Ltd.s 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.

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

26

---

---



# 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.
| | - | -------------------------------------------------------------

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

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

In
mid-February 2004, Eitan Naor assumed the position of our President and Chief Executive
Officer. Mr. Naor assembled a new management team and led our efforts in formulating a
comprehensive recovery plan.

The
plan, which was launched during the second quarter of 2004 and the implementation of
which continued through the balance of 2005, was aimed at rebuilding our core telecom
business.  It also included measures to further reduce our cost structure.
Specifically, it included steps intended to align our costs and revenues, including a
material reduction of our global workforce and the consolidation of several of our
activities, such as the closing of our main U.S. office in Maryland and the elimination
of our quality assurance product research and development team located in that office. In
connection with the implementation of the plan, we recorded $3.4 million in
reorganization and related expenses associated with payroll expenses, disposal of fixed
assets, early termination penalties with respect to certain leases and other costs.

The
sale of our government surveillance business generated proceeds of approximately $35
million, leaving us in a strong cash position that enabled us to fully implement the
recovery plan. At March 31, 2006, we had cash and cash equivalents, short-term and
long-term marketable securities of approximately $50 million.

We
believe that our results of 2005, in which we recorded revenues of $23.2 million and a
net loss from continuing operations of $1.4 million, compared with revenues of $12.6
million and a net loss from continuing operations of $25.8 million in 2004 indicate that
to date our plan has succeeded, although, as detailed in Item 3.D  Risk
Factors, there are still significant challenges to our plans to maintain our growth
and there can be no assurance that we will succeed in the future. We also believe that
our revenue growth in 2005 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.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Acquisitions and
Dispositions

Over
the past few years, our business and financial position have been influenced by a number
of acquisitions and dispositions. The acquisitions we have made were accounted for as
purchases, and, accordingly, the purchase price for each acquisition was allocated to the
assets acquired and liabilities assumed based on their respective fair values. The results
of operations related to each acquisition are included in our consolidated statement of
operations from the date of acquisition.  The following are details for each of these
acquisitions:

| |  | On
December 29, 2005, we acquired all of the outstanding shares of Elron Telesoft Ltd. and
Elron Telesoft Export (98) Ltd., two sister companies which we refer to collectively as
Telesoft, owned by 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, in the event that over a period of 12 months
following the closing date of this transaction, certain milestones are met, we will be
obligated to pay and additional $0.4 million in cash to Elron Electronic Industries Ltd.,
in two deferred installments.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Telesoft
engages in the development and marketing of software solutions for the management of
large communications and internet networks, and developed its line of products, including
its Revenue Assurance solution, for communications services providers. We believe that
this acquisition will enable us to provide communications services providers with a
comprehensive solution for their IRM needs.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | On
March 31, 2004, we sold our government surveillance business to Verint Systems.
Accordingly, our statements of operations, including those of prior periods, reflect the
results of operations of this business in the line item called income (loss) from
discontinued operations. All data in this Annual Report derived from statements
from our statements of operations, unless otherwise specified, exclude our government
surveillance business. 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. Under Israeli law, the repurchase is subject to us
obtaining an approval from the Tel-Aviv District Court in Israel, which we are
currently seeking.

27

---

---



# Results of Operations

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

|                                                       | Year ended December 31,
|------------------------------------------------------ | -----------------------
|
|
|
|
|Revenues                                               |                        
|Cost of revenues                                       |                        
|                                                       |                        
|Gross profit                                           |                        
|Research and development costs, net                    |                        
|Selling and marketing expenses                         |                        
|General and administrative expenses                    |                        
|Restructuring and related impairment costs             |                        
|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 (loss) from discontinued operations         |                        
|                                                       |                        
|Net loss                                               |                        

---

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

Comparison of 2005, 2004 and 2003

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.

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." In addition, we benefited from the improvement
in economic conditions generally and in the telecommunication service industry
specifically. As we expected, revenues generated from maintenance and other related
services increased in 2005 in relation to 2004, both on an aggregate basis and as a
percentage of revenues. We believe this increase was primarily due to our introduction of
our PSO, our increased sales and marketing efforts and our efforts at improving our
customer relationships.

28

---

---



2004
vs. 2003

Total
revenues decreased by 56% from $28.9 million in 2003 to $12.6 million in 2004 due to the
continued effects of the extended negotiations with Verint Systems during the first
quarter of 2004, the heavy turnover in senior management and the resultant transition, as
well as the  effects of implementing our recovery plan. These were slightly offset by an
increase in revenues in the fourth quarter due to our recovery plan starting to take
effect. Revenues were also slightly impacted by continued industry-wide price erosion
resulting from an enhanced competitive environment and global economic conditions.

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, installation and
support of our products, changes in inventory and royalties to the Office of the Chief
Scientist in Israel.

2005
vs. 2004

Cost
of revenues increased from $10.3 million in 2004 to $11.0 million in 2005, as our
increased revenues and the corresponding 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.

2004
vs. 2003

Cost
of revenues decreased from $17.5 million in 2003 to $10.3 million in 2004. Gross profit
decreased by 79.5% from $11.4 million in 2003 to $2.3 million in 2004. Our gross profit
margin decreased from 39.5% in 2003 to 18.5% in 2004.  This decrease derives primarily
from the following:

| | (1)       Our
low volume of revenues in 2004 compared with 2003, together with high fixed costs,
reduced gross margins        significantly, especially in the first half of 2004, which
was prior to our implementation of the cost cutting measures of        our recovery plan.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2)       As
a part of the sale of our governmental surveillance business to Verint Systems and the
recovery plan we        subsequently implemented, we made a one-time write-off in the
amount of $0.9 million relating to inventory of certain        components which we
believed could not be used in the future
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

29

---

---



Operating Expenses

|($ in millions)                            | Year ended December 31, | % Change2005 vs.2004 | % Change2004 vs.2003
|------------------------------------------ | ----------------------- | -------------------- | --------------------
|
|
|
|
|Research and development costs, net        |                         |                      |                     
|Selling and marketing expenses             |                         |                      |                     
|General and administrative expenses        |                         |                      |                     
|Restructuring and related impairment costs |                         |                      |                     
|Goodwill impairment                        |                         |                      |                     
|Total operating expenses                   |                         |                      |                     

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 Office of the Chief Scientist in Israel are deducted
from gross research and development expenses to determine net research and development
expenses.

2005
vs. 2004

Research
and development costs, net decreased by 32.5% from $5.4 million in 2004 to $3.7 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 Office of the Chief Scientist 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.

2004
vs. 2003

Research
and development costs, net decreased by 46% from $10.0 million in 2003 to $5.4 million in
2004. This decrease reflected a decrease in gross research and development costs from
$10.9 million in 2003 to $6.8 million in 2004, which decrease was primarily due to a
reduction in headcount due to implementation of our recovery plan. Grants from the Office
of the Chief Scientist increased by 61.9% from approximately $0.8 million in 2003 to $1.4
million in 2004.

Selling and Marketing
Expenses

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

30

---

---



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.

2004
vs. 2003

Selling
and marketing expenses decreased by 36.6% from $14.3 million in 2003 to $9.1 million in
2004.  The decrease was due to reduced headcount, reductions in related expenses
during 2004 and the decrease in agent commissions due to the reduction in revenues.

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.

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.

2004
vs.2003

General
and administrative expenses decreased by 49.9% from $17.0 million in 2003 to $8.5 million
in 2004. The decrease was primarily due to decrease in expenses for doubtful debts
from $13.2 million in 2003 to $4.7 million in 2004 due both to reduced sales in the
second half of 2003 and during 2004 and due to improved creditworthiness in the
telecommunication industry.

Restructuring and related
impairment costs

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 amount of $0.2
million, as our management decided that the recovery plan had concluded by that time.

2004
vs. 2003

As
part of our Boards June 2004 decision to focus on our core products and to abandon
certain products as well as engage in overall cost reductions, in 2004 we recorded $3.4
million in reorganization expenses associated with payroll expenses, disposal of fixed
assets, rental contract termination penalties and related expenses.

Goodwill impairment

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

In
June 2003 and 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 and $6.0 million
in 2003 to its fair value in the amount of $8.1 million as at December 31, 2004. In 2005,
no goodwill was impaired. Please see Note 7A to our consolidated financial statements
appearing elsewhere in this annual report.

Operating loss

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.

2004
vs.2003

Operating
loss decreased from $36.0 million in 2003 to $26.2 million in 2004. This decrease was
primarily due to a decrease in all components of operating expenses, as a result of the
implementation of our recovery plan. In addition, while goodwill impairment expenses amounted to
$6.0 million in 2003, in 2004 we had goodwill impairment expenses of $2.2 million and
restructuring expense of $3.4 million.

31

---

---



Financial income, net

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; and (ii) our investment practices which
yield higher returns, and the higher rates on investments generally available in the
market during 2005.

2004
vs. 2003

Financial
income, net increased by 128.1% from $0.2 million in 2003 to $0.4 million in 2004. This
increase was primarily due to our increased investments in marketable securities enabled
by receipt of the proceeds from the sale of our government surveillance business.

Net loss from continuing
operations

Net
loss from continuing operations was $1.4 million in 2005, compared with the loss of $25.8
million in 2004 and a net loss of $35.8 million in 2003. The decrease in 2005 compared
with 2004 was primarily due to the significant increase in revenues and the reduction in
all elements of our operating expenses due to implementation of our recovery plan. The
decrease in net loss from continuing operations in 2004 as compared with 2003 is
primarily attributable to a reduction in both doubtful accounts expenses and goodwill
impairment.

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

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 and reduction in all elements of operating
expenses, as a result of implementation of recovery plan.

32

---

---



2004
vs. 2003

Net
loss was $13.5 million in 2004 compared with net loss of $40.7 million in 2003. This
change was due to the decrease in net loss from continuing operations, as a result of
implementation of our recovery plan, which resulted in a decrease in expenses during
2004, and from income from the sale of our government surveillance business.

# 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
| | - | -------------------

| |  | Inventory
valuation
| | - | -------------------

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

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

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

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

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

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

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

For
arrangements with multiple elements, we allocate revenue to each component of the
arrangement using the residual value method based on Vendor Specific Objective Evidence (VSOE)
of the undelivered elements. This means that we defer the arrangement fee equivalent to
the fair value of the undelivered elements until these elements are delivered.

To
assess the probability of collection for revenue recognition, we have a credit policy that
evaluates payment history, the level of open account, collaterals and other guarantees.
These credit limits are reviewed and revised periodically on the basis of each customer
and payment performance.

Service
revenues from product maintenance contracts and separately priced extended warranty
contracts are recognized ratably over the contract period.

Revenues
from contracts for products 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. 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.

Inventory valuation

Inventories
are stated at the lower of cost or market. Cost is determined using the moving average
method. We evaluate inventory value in connection with damaged, obsolete, excess and
slow-moving inventory based on inventory aging reports and specific identification. If
actual market conditions are less favorable than those projected by us or if there is no
future demand for part or all of our inventories, we will need to write off the affected
inventories. This would result in an increase in our operating expenses. For example, in
the first half of 2004, we recorded an inventory write off of approximately $0.9 million
in connection with inventory that became obsolete or that we estimate that we will not be
able to sell.

33

---

---



Allowance for Doubtful
Accounts

Our
financial statements include an allowance, which we believe reflects adequately the loss
inherent in receivables for which collection is in doubt. In determining the fairness of
the allowance, we review and consider information at hand about debtors financial
situation, the volume of their operations, aging of the balance and evaluation of the
security received from them or their guarantors. 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.

Goodwill and other
intangible assets

We
adopted SFAS No. 142 requirements regarding goodwill and other intangible assets with
indefinite useful lives. In June 2003 and 2004, due to significant reduction in our
revenues, it was determined that goodwill had been impaired.  We obtained an
independent appraisal to assess whether goodwill carried on the 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. In 2005, no goodwill was
impaired, since the fair value of our reporting unit exceeded its carrying amount,
including goodwill.

We
impaired the goodwill to its fair value by $2.2 million and $6.0 million as at June 30,
2004 and 2003, respectively.

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.

34

---

---



Valuation
allowances are established when necessary to reduce deferred tax assets to the amount
expected to be realized. We have decided not to recognize deferred tax benefits based on
our expectation that future taxable earnings will not be achieved. 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 of these assets may cause the value of these assets to change.

We
account for long-lived assets under the provisions of FAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. SFAS 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144
requires that long-lived assets be reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the carrying
amount of an asset to future net cash flows expected to be generated by the asset. If the
carrying amount of an asset exceeds its estimated future cash flows, an impairment charge
is recognized by the amount by which the carrying amount of the asset exceeds the fair
value of the asset. SFAS 144 requires companies to separately report discontinued
operations and extends that reporting to a component of an entity that either has been
disposed of (by sale, abandonment, or in a distribution to owners) or is classified as
held for sale. See also Note 18 to our consolidated financial statements appearing
elsewhere in this annual report.

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 estimates 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.

Stock-based compensation

We
apply 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 is 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
adopted the disclosure provisions of SFAS 123 Accounting for Stock-Based
Compensation but opted to remain under the expense recognition provisions of APB 25.
See also Note 11B to our consolidated financial statements appearing elsewhere in this
annual report.

In
December 2004, FASB issued SFAS No. 123 (revised 2004), Share-Based Payments
(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. SFAS 123R is effective for public entities that do not file
as small business issuers as of the beginning of the first annual reporting period that
begins after June 15, 2005. Accordingly, we are required to adopt SFAS 123R effective
January 1, 2006.

We
will implement SFAS 123R using the modified prospective method starting January 1, 2006,
and we will begin recognizing compensation cost for all new awards and for awards
modified, repurchased or canceled after January 1, 2006. Furthermore, we will be required
to recognize compensation cost for unvested options as of January 1, 2006 based on the
grant date fair value of these awards.

We
expect that implementation of SFAS 123R in future years would result in an increase in our
operating expenses and to be approximately $0.5 million, $0.5 million, $0.2 million and
$0.1 million in fiscal 2006, 2007, 2008, and 2009, respectively based on options currently
outstanding. In addition, we expect to grant additional stock-based awards in future years
which will result in additional stock-based compensation expense.

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

As
of December 31, 2005, we had $24.9 million in cash and cash equivalents, compared to
$34.4 million in cash and cash equivalents as of December 31, 2004. As of December 31,
2005, we had $14.4 million in short-term investments and $12.0 million in long-term
marketable securities compared to $4.0 million in short-term investments and $ 10.8
million in long-term marketable securities, as of December 31, 2004.

A
significant part of our capital resources as of December 31, 2005 was comprised of $35
million of proceeds from the sale of our government business to Verint Systems during
2004. In addition, during 2005, we generated positive cash flow from operating
activities. Generally, we invest our excess cash in instruments that are liquid and
generate yields, with conservative and low risk.

Net
Cash Provided by/Used in Operating Activities.  Net cash provided by our
operating activities was approximately $4.4 million in 2005. Cash provided by operations
for 2005 was primarily attributable to higher revenues and actions we took to cut our
costs.

Net
cash used in our operating activities was approximately $21.5 million in 2004. Cash used
in operations for 2004 was primarily attributable to net loss of $13.5 million plus a
decrease in trade payables and other payables and accrued liabilities, which was offset
by a decrease in trade receivables. The decrease in trade and other payables was
primarily attributable to the reduction in our revenues generating a decrease in our
receivables balance, our slight decrease in activity and costs incurred in connection
with employee layoffs during 2004. The decrease in trade receivables was primarily
attributable to a decrease in revenues recorded during 2004 and an increase in the net
balance of provision for doubtful debts from $14.6 million in 2003 to $20.6 million in
2004 reflecting provisions made in 2004 in respect of revenues recorded in prior years.

35

---

---



From
time to time, we enter into accounts receivables factoring agreements with unaffiliated
financial institutions. During 2005 we sold trade account receivables aggregating $0.4
million. Our ability to sell such receivables 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 2005, $1.0 million in
2004 and $1.8 million in 2003. 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.

We
invest in capital expenditures pursuant to the requirements applicable to our approved
enterprise programs. As of December 31, 2005, $0.9 million remains to be invested in
order to comply with the current approved program. Such investment should be made by
December 26, 2006.  This program will provides us with tax benefits in the future;
however, if we will not comply with such investment requirements, all current and future
benefits from this program will be cancelled.

Net
Cash Provided by Financing Activities. Our financing activities provided $0.05
million, $0.2 million in 2004 and $0.2 million in 2003, 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, 2005, outstanding bank guarantees totaled approximately $2.6 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.

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. Under the repurchase program, share purchases may be
made from time to time depending on market conditions, share price, trading volume and
other factors. The repurchase program is for one year and may be suspended from time to
time or discontinued. The share repurchases will be funded from available working
capital. Under Israeli law, the repurchase is subject to us obtaining an approval from
the Court in Israel, which we are currently seeking.  We believe our cash and cash
equivalents reserve, after giving effect to the repurchase, will be sufficient to meet
our anticipated cash needs for working capital and capital expenditures for the next
twelve months. However, if we carry out acquisitions of other companies or new
technologies by paying cash, there may be a need to raise additional capital by issuing
debt or equity during the year.

# Impact of Related Party
Transactions

We
have entered into several agreements with ECI. Of these agreements, only the agreement
for the supply of certain components by ECI has been material to our operations.  We
reviewed the pricing of the agreements and believed that they were not less favorable to
us than could have been obtained from unaffiliated third parties. However, ECI has
informed us that it intends to stop manufacturing some of these components as of August
2006. Accordingly, we need to arrange for the manufacture of these components directly
through a contractor. We have initiated discussions with an alternative supplier that has
performed manufacturing services for ECI in relation to these components. However, we may
not be able to come to terms acceptable to us with such alternative supplier or any other
suitable manufacturer of these components on a timely basis. If we are unable to locate
and agree upon terms with a suitable alternative supplier for ECI on a timely basis or,
even if we agree on terms, and such contractor is 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 to pay the alternative supplier higher price for these components than the
prices currently charged by ECI. Please see Item 3  Risk Factors. 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 for information as to this development.In
addition, please see Item 7  Major Shareholders and Related Party Transactions for
information on our relationship with ECI.

# Corporate Tax Rate

Generally,
Israeli companies are subject to corporate tax at the rate of 31% 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.

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 2016 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,
2005, our effective tax rate for 2005 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, 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

36

---

---



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.

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 Infltion
Adjusted
for
Devaluation
|----------------------- | ---------------------- | ------------------------ | ----------------------------------------
|
|
|
|
|1998                    |                        |                          |                                         
|1999                    |                        |                          |                                         
|2000                    |                        |                          |                                         
|2001                    |                        |                          |                                         
|2002                    |                        |                          |                                         
|2003                    |                        |                          |                                         
|2004                    |                        |                          |                                         
|2005                    |                        |                          |                                         

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.

37

---

---



| | 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 $3.7 million in 2005, $5.4 million in 2004
and $10.1 million in 2003.  As of March 31, 2006, 42 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 programs from the Office of the Chief Scientist of the Ministry of
Industry, Trade and Labor of the Government of Israel, until the end of this year. From
time to time we may decide to apply for a new program.

We
recorded grant participations from the Office of the Chief Scientist totaling $0.5 million
in 2005, $1.4 million in 2004 and $0.8 million in 2003. Pursuant to the terms of these
grants we are obligated to pay royalties of 3.5% of revenues derived from sales of
products funded with these grants. As of December 31, 2005, our contingent liability to
the Office of the Chief Scientist in respect of grants received was approximately $2.7
million, including liabilities to the Office of the Chief Scientist that we assumed as
part of the Telesoft acquisition. Recently, we applied to the Office of the Chief
Scientist to seek a dismissal all Telesofts liabilities.

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

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

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

The
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.

38

---

---



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

The
funds available for Office of the Chief Scientist grants out of the annual budget of the
State of Israel were reduced in 1998 and again in 2004, and the Israeli authorities have
indicated in the past that the government may further reduce or abolish Office of the
Chief Scientist grants in the future.  Even if these grants are maintained, we
cannot presently predict what would be the amounts of future grants, if any, that we
might receive.

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

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

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

In the ordinary course of business,
we have various commercial commitments that amounted, at December 31, 2005, in the
aggregate to approximately $2.6 million. These consisted 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, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures or capital resources that
is material to investors.

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

The
following table sets forth, as of December 31, 2005, our known contractual obligations by
type of obligation and for the periods indicated (in $ thousands):

|                                      | Payments due by period (in thousands)
|------------------------------------- | -------------------------------------
|
|
|
|
|Operating lease obligations (vehicles |                                      
|and facilities)                       |                                      
|                                      |                                      
|Total                                 |                                      

39

---

---



As to our royalty obligations and
outstanding guarantees as at December 31, 2005, see Note 10 to our consolidated financial
statements included elsewhere in this annual report.

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

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

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

|Name                      | Age | Position                                                    
|------------------------- | --- | ------------------------------------------------------------
|
|
|
|
|Eitan Naor                | 43  | President, Chief Executive Officer and Director             
|Ron Fainaro               | 38  | Senior Vice President and Chief Financial Officer           
|Itzik Weinstein           | 47  | Senior Vice President for Professional Services & Operations
|Benny Glazer              | 56  | Senior Vice President, Worldwide Sales                      
|David Ronen               | 32  | Senior Vice President, Marketing and Strategy               
|Benny Yehezkel            | 39  | Senior Vice President of Telesoft                           
|Hadar Solomon             | 49  | Vice President, General Counsel and Corporate Secretary     
|Harel Beit-On (1) (3)     | 46  | Chairman of the Board of Directors                          
|Prof. Gil Epstein (1) (2) | 41  | Director                                                    
|Giora Bitan (1) (3)       | 52  | Director                                                    
|Rami Entin (2) (3)        | 54  | Director                                                    
|Talia Livni (1) (2) (3)   | 63  | Director                                                    

---

|(1) | Member
of the compensation committee
|--- | ------------------------------------

|(2) | Member
of the audit committee
|--- | -----------------------------

|(3) | Member
of the investment committee
|--- | ----------------------------------

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

Ron
Fainaro has served as our Senior Vice President and Chief Financial Officer since
June 1, 2005.  Prior to joining us, Mr. Fainaro served as CFO and Vice President of
the American operations of Tecnomatix Technologies Ltd., a global software company. Prior
to his position at Tecnomatix, Mr. Fainaro served as the CFO of Lucent Technologies
(Waveaccess), a former division of Lucent Technologies and as the CFO of Habas Group. Mr.
Fainaro is a Certified Public Accountant.  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.

Itzik
Weinstein has served as our Senior Vice President for Professional Services &Operations
since July 2004. Prior to that he was Vice President  Customer Services and Product
Management at VocalTec since the year 2000. Prior to this position, 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.

40

---

---



Benny
Glazerhas served as our Senior Vice President of Worldwide Sales since January 2006.
Prior to joining us, he led the worldwide sales team of Alvario Ltd., a provider of
Broadband Wireless Access & WiMAX products (NASDAQ: ALVR), where he served as Senior
Vice President of Corporate Sales. Prior to that, Mr. Glazer served as Director of
Business Development for ESC Medical Systems Ltd., now known as Lumenis Ltd., a
manufacturer of light-based medical and aesthetic devices.  Prior to ESC, Mr. Glazer
served as the President and CEO of North Hills, a provider of cabling systems, internet
and token-rings products, and later of NuLAN Technologies, a provider of video conference
products.  Previously, Mr. Glazer served as VP International Sales of Fibronics, a
manufacturer of data communication equipment. Mr. Glazer holds a B.Sc. degree in
Electrical Engineering from Ben Gurion University and an M.B.A. degree from Tel Aviv
University.

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. He holds a BA in
Computer Science from The Open University in Tel Aviv, with honors.

Benny
Yehezkeljoined 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. a provider of automatic negotiation platforms. 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.

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

Harel
Beit-On has served as Chairman of our Board of Directors since June 21, 2004. Mr.
Beit-On is a partner in several high-tech venture capital funds including Carmel Software
Funds. Mr. Beit-On served as Chairman of the Board of Directors of Tecnomatix
Technologies Ltd. from December 2001 and as a director from 1999 until the acquisition of
Tecnomatix in March 2005 by UGS Corp. From 1996 until February 2004 Mr. Beit-On served as
the CEO of Tecnomatix. Mr. Beit-On also served as the President of Tecnomatix from 1995
until October 2002. From 1985 to 1999, Mr. Beit-On served in various positions with
Tecnomatix and its U.S. subsidiary. Mr. Beit-On holds a B.A. degree in Economics from the
Hebrew University and an M.B.A. degree from MIT.

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

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

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 a director of
Maccabee-Dent, which is engaged in the management and operation of dental clinics, and is
an external director of Solomon Holdings Ltd., an Israeli publicly traded construction
company. 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.

41

---

---



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 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 director or senior manager.

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

The
aggregate direct remuneration paid during 2005 to executive officers and directors as a
group (15 persons), as well as remuneration paid to former executives in connection with
their services during 2005 and payments made in connection with their termination, was
approximately $2.7 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. Employee directors do
not receive additional fees for their services as directors, and our other directors do
not receive any fees except as described below.

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

# Board of Directors

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

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

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 new 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.

42

---

---



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.

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 Prof. Gil Epstein and 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.

43

---

---



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.

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 recently 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.

The
new 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 an 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 serves as our internal auditor.

# Nasdaq Listing
Requirements

Nasdaq
rules enable foreign private issuers, such as ourselves, 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.

44

---

---



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

Number.
The following table describes the number of our employees as of March 31, 2006 and
December 31 of each of the indicated years:

|                                                                     | March 31,
2006 * | 2005 * | 2004 | 2003
|-------------------------------------------------------------------- | ---------------- | ------ | ---- | ----
|
|
|
|
|Approximate numbers of employees by geographic location:             |                  |        |      |     
|                                                                     |                  |       
|Israel                                                               |                  |        |      | 155 
|                                                                     |                  |       
|United States                                                        |                  |        |      | 9   
|                                                                     |                  |       
|Europe and elsewhere                                                 |                  |        |      | 19  
|                                                                     |                  |       
|Total workforce                                                      |                  |        |      | 183 
|                                                                     |                  |       
|Approximate numbers of employees by category of activity:            |                  |       
|                                                                     |                  |       
|Management and administration                                        |                  |        |      | 24  
|                                                                     |                  |       
|Research and development (including Testing + Customization in 2003) |                  |        |      | 43  
|                                                                     |                  |       
|Professional services and operations                                 |                  |        |      | 86  
|                                                                     |                  |       
|Sales and marketing                                                  |                  |        |      | 30  
|                                                                     |                  |       
|Total workforce                                                      |                  |        |      | 183 

| | * | Including
employees of Telesoft
| | - | -------------------------------

| | ** | Including
Testing and Customization employees which are now classified as PSO employees.
| | -- | ----------------------------------------------------------------------------------------

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.

45

---

---



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

Security
Ownership of Our Directors and Executive Officers

Other
than Harel Beit On and Giora Bitan, as of May 31, 2006, none of our directors or
executive officers beneficially owns shares, including options to acquire our ordinary
shares that are vested or vest within 60 days, which represent more than 1% of our
outstanding ordinary shares. Mr. Beit On, in the capacity of his position as General
Partner of Carmel V.C. Ltd., may be deemed to beneficially own options to purchase
362,308 of our ordinary shares, and Mr. Bitan, in his capacity as Executive Vice
President and Chief Financial Officer of ECI, may be deemed to beneficially own the
2,890,325 shares of our company owned by ECI. As of May 31, 2006, our officers and
directors as a group held 5,944 of our ordinary shares and options to purchase
additional 362,308 of our ordinary shares. The following table sets forth detailed
information about the granted options, for the periods indicated:

|Grant date | Exercise price | Grantedamount | Vestedoptions | Non-vestedoptions | Options whichwere exercised
|---------- | -------------- | ------------- | ------------- | ----------------- | ---------------------------
|
|
|
|
|2001       |                |               | $             | 11.55             |                            
|2003       |                |               | $             | 4.67              |                            
|2004       |                |               | $             | 2.63-3.14         |                            
|2005       |                |               | $             | 3.64-4.97         |                            
|           |                |               |               |                   |                            
|           |                |               |               |                   |                            

---

All these options expire 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, 2006, options to purchase a total of 3,190,239 of our ordinary shares were
outstanding. As of March 31, 2006, options to purchase an aggregate of 1,246,193 ordinary
shares granted under the plans have been exercised. No options have been granted during
2006 prior to the date of the filing of this Annual Report.

46

---

---



|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 May 31, 2006, to beneficially own more than 5% of our
outstanding ordinary shares. As of that date,  18,215,164 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.

|                                     | Shares Beneficially Owned
|------------------------------------ | -------------------------
|
|
|
|
|ECI Telecom Ltd. (1)                 |                          
|Koor Industries Ltd. (2)             |                          
|FMR Corp. (3)                        |                          
|Merrill Lynch & Co., Inc. (4)        |                          
|Clal Electronics Industries Ltd. (5) |                          
|Stichting Pensioenfonds ABP (6)      |                          
|Kingdon Capital Management, LLC (7)  |                          

(1) Based upon a Schedule 13G/A filed with the SEC in August 2004. We were initially
a wholly-owned subsidiary of ECI. After the completion of our initial public offering in
October 1999, ECI owned approximately 74% of our ordinary shares. In March 2002, ECI sold
1,572,175 ordinary shares to institutional investors in a private placement, which reduced
its interest in us to approximately 59%.  In May 2004, ECI distributed 7,600,000
ordinary shares to its shareholders, of which 544,054 shares, which were withheld by ECI
pursuant to Israeli tax law, were placed in an irrevocable trust with instructions to sell
on the Nasdaq Stock Market to reimburse the tax payable by ECI to the Israeli government,
subject to the terms of the trust and applicable securities laws. As of March 31,
2006, none of these shares were still held in the trust. Mr. Bitan, who serves as our
director and also as an officer of ECI, may be deemed to beneficially own the shares held
by ECI by virtue of his position in ECI. However, he disclaims beneficial ownership of
these shares.

(2) Based upon a notice from Koor Industries Ltd (Koor). Includes
          364,497 shares held directly by Koor and 2,318,415 ordinary shares held by
          M.A.G.M. Chemistry Holdings Ltd., which is a subsidiary of Koor. M.A.G.M. is a
          shareholder of ECI and acquired its ECtel shares in ECIs share
          distribution in May 2004. Koor is an Israeli corporation whose ordinary shares
          are traded on the Tel Aviv Stock Exchange and whose ADRs (American depositary
          shares) are traded on the New York Stock Exchange. Also outstanding are
          exercisable warrants to purchase 1,000,000 ordinary shares at an exercise price
          of $24 per share and 250,000 ordinary shares at an exercise price of $28 per
          share which were granted to Telrad Networks Ltd., which is a subsidiary of Koor
          Industries Ltd.

(3)
          Based upon a Schedule 13D filed with the SEC in February 2006. 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
          distribution in May 2004. 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.

(4)
          Based upon a Schedule 13D filed with the SEC in February 2006, containing
          information as of December 31, 2005. Merrill Lynch & Co., Inc.
          (ML&Co.) is a parent holding company. Merrill Lynch Investment
          Managers is an operating division of ML&Co. consisting of ML&Co.s
          indirectly-owned asset management subsidiaries. The following asset management
          subsidiaries hold certain shares of our ordinary shares: Transamerica Fund
          Advisors; Merrill Lynch Investment Managers Ltd; Fund Asset Management, L.P;
          Merrill Lynch Investment Managers, L.P.

(5)
          Based upon notice from Clal Electronics Industries Ltd. . Clal Electronics
          Industries Ltd. is a wholly owned subsidiary of Clal Industries and Investments
          Ltd. Both Clal Electronics Industries Ltd., or CEI, and Clal
          Industries and Investments Ltd., or Clal, are Israeli corporations.
          Clal is controlled by IDB Development Corporation Ltd., or IDBD,
          which, in turn, is controlled by IDB Holding Corporation, or IDBH.
          In addition to CEIs holdings, the following entities within the IDB group
          beneficially own ordinary shares, as follows: IDBD (7,015.25 shares); Badal
          Securities Ltd., or Badal, a wholly owned subsidiary of IDBH
          (7,015.25 shares); and Clal Insurance Enterprises Holdings Ltd., or Clal
          Insurance,  a majority-owned subsidiary of IDBD (2,927 shares).
          IDBD, IDBH, Clal and Clal Insurance are all Israeli corporations whose shares
          are listed on The Tel Aviv Stock Exchange. The address of CEI is 3 Azrieli
          Center, 45th floor, Tel Aviv 67023, Israel. IDBD is a beneficial owns of
          approximately 10.00% of the shares of Koor. On May 1, 2006 Discount Investment
          Corporation Ltd. (DIC), a subsidiary of IDBD, entered in to an
          agreement to purchase approximately 35.38% of the outstanding shares of Koor
          from its principal shareholders. The agreement is subject to regulatory
          approvals and certain consent of third parties (the Purchase
          Agreement).

47

---

---



As of March 31, 2006, IDBH was
controlled by a group comprised of: (i) Ganden Investments I.D.B. Ltd., or
Ganden, a private Israeli company controlled by Nochi Dankner (who is the
Chairman of IDBH, IDBD and Clal and a director of Clal Insurance) and his sister Shelly
Bergman, which holds 31.02% of the equity of and voting power in IDBH; (ii) Manor
Investments  IDB Ltd., or Manor, a private Israeli company controlled by
Ruth Manor (whose husband, Isaac Manor, and their son, Dori Manor, are directors of IDBH,
IDBD and Clal and Isaac Manor is a director of Clal Insurance), which holds 10.34% of the
equity of and voting power in IDBH; and (iii) Avraham Livnat Investments (2002) Ltd., or
Livnat, a private Israeli company controlled by Avraham Livnat (one of whose
sons, Zvi Livnat, is a director and Executive Vice President of IDBH, Deputy Chairman of
IDBD and Co-Chief Executive Officer of Clal, and another son, Shay Livnat, is a director
of IDBD, Clal and Clal Insurance), which holds 10.34% of the equity of and voting power in
IDBH. Ganden, Manor and Livnat, owning in the aggregate approximately 51.70% of the equity
of and voting power in IDBH, entered into a Shareholders Agreement relating, among other
things, to their joint control of IDBH, the term of which is until May 19, 2023. In
addition, (a) Ganden Holdings Ltd., the parent company of Ganden, holds 11.35% of the
equity of and voting power in IDBH; (b) Ganden holds a further 6.71% of the equity of and
voting power in IDBH; (c) Manor Holdings B.A. Ltd., the parent company of Manor, holds
0.03% of the equity of and voting power in IDBH; (d) Avraham Livnat Ltd., the parent
company of Livnat, holds 0.04% of the equity of and voting power in IDBH; and (e) Ms.
Bergman owns, through a private company which is wholly owned by her, approximately 7.23%
of the equity and voting power of IDBH.

Based on the foregoing IDBH (by
reason of its control of IDBD), Ganden, Manor and Livnat (by reason of their control of
IDBH), Mr. Dankner, Ms. Bergman, Ms. Manor and Mr. A. Livnat (by reason of their control,
respectively, of Ganden, Manor and Livnat) may be deemed to share the power to vote and
dispose: (i) with IDBD (by reason of its control of Clal and CEI), Clal, CEI and DIC (if
the Purchase Agreement shall be concluded) , of our ordinary shares held by CEI; (ii) with
Badal, of our ordinary shares held by Badal; (iii) with IDBD, of our ordinary shares held
by IDBD; and (iv) with IDBD and Clal Insurance, of our ordinary shares held by Clal
Insurance.

(6)
          Based upon a Schedule 13G filed with the SEC in February 2006.

(7)
          Based upon a Schedule 13D filed with the SEC in March 2006, containing
          information as of December 31, 2005 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.

Record Holders

As
of May 31, 2006, there were 331 holders of record of our ordinary shares. 268 record holders, holding
approximately 6,180,958, or 33.93%, of our outstanding ordinary shares, were located in the United States. These
numbers are not representative of the number of beneficial holders of our shares nor is it representative of
where such beneficial holders reside since many of these ordinary shares were held of record by brokers or other
nominees.

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

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

# Commercial Agreements

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

Services
Arrangements

Until
our relocation in July, 2005 to our current offices, various services arrangements
existed with ECI according to which ECI provided communication services, internal audit
services, intellectual property management assistance, and other miscellaneous services
such as security and limited human resources related services. Such arrangements were
terminated following our relocation.

48

---

---



Supply
Agreement

In
February 2004, we executed a new supply agreement with ECI, which replaced an earlier
supply agreement entered into in October 1999. Under the terms of the new supply
agreement, ECI supplies us with the components (modules) for use in our
products. We agreed on the prices for these modules after intense negotiations with ECI.
In accordance with its right under the Supply Agreement, ECI has informed us that it will
stop manufacturing some of these components as of August 2006. ECI is obligated to
provide us with all necessary information for us to manufacture the modules ourselves and
integrate them into our products, as well as to supply us with spare parts for such
modules. We have initiated discussions with a candidate that has performed manufacturing
services for ECI in relation to these components. We may be required to pay such
contractor higher prices for these components than the prices currently charged by ECI.
In addition, under the terms of the supply agreement, ECI has granted us (i) a
non-exclusive, non-transferable license to use the software embedded in the modules that
are incorporated in our products in the course of our regular business, (ii) the right to
develop and change the modules software and (iii) the right to sub-license the
software to third parties for use solely with our products. ECtel has undertaken not to
sell certain ECI components, other than for use and incorporation into final products of
ECtel. Under the Supply Agreement we are allowed to sell these modules to Verint Systems
under similar terms. The supply agreement has an initial period of seven years and may be
extended subject to a written agreement of the parties. Either party may terminate the
agreement at any time upon a material breach by the other party or in the event of
liquidation or similar consequences of the other party. In addition, ECI has the right to
terminate the agreement with us in the event that (i) we shall have new controlling
shareholder, which is a company that directly competes with ECI with respect to the ECI
modules, or (ii) the final product in which the ECI modules are to be used is in direct
competition with ECIs DCME products.

Please
see Item 10.C  Material Contracts for a description of certain
agreements we entered into with ECI in 2002.

| | 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.

On
December 15, 2005, plaintiffs filed an amended complaint (the Amended Class Action
Complaint), and we subsequently filed motions to dismiss the Amended Class Action
Complaint.  The hearing on our motion to dismiss is currently scheduled for July 17,
2006.  We believe that the plaintiffs claims are without merit and intend to
defend the case vigorously.

49

---

---



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

# Dividend Policy

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

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

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

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

There
has been no significant change in our financial position since December 31, 2005,
although, 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. See Item 16.E  Purchases
of Equity Securities by the Issuer and Affiliated Purchasers for additional
information.

|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:    |      |    
|                  |      |    
|2001              |      |    
|2002              |      |    
|2003              |      |    
|2004              |      |    
|2005              |      |    
|                  |      |    
|Calendar Quarter: |      |    
|                  |      |    
|2004:             |      |    
|First Quarter     |      |    
|Second Quarter    |      |    
|Third Quarter     |      |    
|Fourth Quarter    |      |    
|                  |      |    
|2005:             |      |    
|First Quarter     |      |    
|Second Quarter    |      |    
|Third Quarter     |      |    
|Fourth Quarter    |      |    
|                  |      |    
|Calendar Month    |      |    
|                  |      |    
|December 2005     |      |    
|January 2006      |      |    
|February 2006     |      |    
|March 2006        |      |    
|April 2006        |      |    
|May 2006          |      |    

50

---

---



| | 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.

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

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

# Objects and Purposes

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

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

# Transfer and Ownership
of Shares; Notices

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

51

---

---



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.

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
acquiror offered to purchase will be transferred to it. However, the remaining minority
shareholders may seek to alter the tender offer consideration by court order.

52

---

---



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;
| | - | ----------------------------------------------

53

---

---



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

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

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

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

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.

54

---

---



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

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

55

---

---



| |  | 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.

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.

56

---

---



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.

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.

As
part of the transactions, we entered into extensive non-compete undertakings which
prohibit us from engaging in the disposed business. We did retain potential liability
under certain of the customer contracts, for which we should be fully indemnified by
Verint as noted above.

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.

Based
on the foregoing, we excluded the government surveillance business from continuing
operations and included it in discontinued operations in the statement of operations.

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.

In
addition, we agreed to cover certain expenses of up to $1.4million plus 17% Value Added
Tax, related to the government surveillance business in 2004.

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.

Verint
Systems hired most of our employees who worked in our government surveillance business.
We and Verint Systems mutually agreed to make our engineering employees available to the
other, primarily for support and bug fixing, for a period of 18 months, at fixed hourly
rates. As stated above, under the additional agreement we entered into with Verint
Systems in December 2005, the parties agreed on certain modifications to their mutual
engineering support obligations, and further agreed to extend the term of such mutual
engineering support until the end of 2006.

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. We also mutually agreed, for a period of one
year, not to solicit one anothers employees, customers or suppliers.

Acquisition of Elron
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. In
addition, in the event that over a period of 12 months following the closing date of this
transaction, certain milestones are met, we will be obligated to pay an additional $0.4
million in cash to Elron Electronic Industries Ltd., in two deferred installments. The
acquisition closed in January 2006.

As
part of the agreement, Elron Electronic Industries Ltd., on behalf of itself and its
controlled affiliates, made certain commitments to refrain 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.

57

---

---



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

# Exchange Controls and
Other Limitations Affecting Security Holders

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

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

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

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

# U.S.
FEDERAL INCOME TAX CONSIDERATIONS

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

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

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

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

| |  | a
trust (i) if, in general, a court within the United States is able to exercise primary
supervision over its               administration and one or more U.S. persons have the
authority to control all of its substantial decisions, or               (ii) that has in
effect a valid election under applicable U.S. Treasury regulations to be treated as a
U.S. person.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

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

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

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

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

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

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

| |  | are,
or hold their shares through, partnerships or other pass-through entities,
| | - | -------------------------------------------------------------------------------

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

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

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

58

---

---



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

Taxation of Dividends
Paid on Ordinary Shares

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

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

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

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

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

| |  | if
the U.S. holder has not held the ordinary shares for at least 16 days of the 30-day
period beginning on the date               which is 15 days before the ex-dividend date
with respect to such dividend; or
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

59

---

---



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

Taxation of the
Disposition of Ordinary Shares

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

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

Tax Consequences if we
are a Passive Foreign Investment Company

There
is a substantial risk that we are 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. As a result of our substantial cash position and the decline in
the value of our stock in prior years, we would be a PFIC if the asset test described
above were 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, 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.

60

---

---



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

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

| |  | the
item is effectively connected with the conduct by the non-U.S. holder of a trade or
business in the United States and:
| | - | --------------------------------------------------------------------------------------------------------------------------

| |  | in
the case of a resident of a country which has a treaty with the United States, the item
is attributable to a               permanent establishment; or
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | in
the case of an individual, the item is attributable to a fixed place of business in the
United States;
| | - | ---------------------------------------------------------------------------------------------------------

| |  | the
non-U.S. holder is an individual who holds the ordinary shares as a capital asset and is
present in the United               States for 183 days or more in the taxable year of
the disposition and does not qualify for an exemption; or
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
non-U.S. holder is subject to tax under the provisions of U.S. tax law applicable to U.S.
expatriates.
| | - | ----------------------------------------------------------------------------------------------------------

Information Reporting and
Back-up Withholding

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

Non-U.S.    holders
generally are not subject to information reporting or back-up           withholding with
respect to dividends paid on, or proceeds from the disposition           of, our ordinary
shares, provided that the non-U.S. holder provides 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.

# Tax Reform

Israel
tax law has undergone two significant reforms in recent years. The first of these reforms
came into effect on January 1, 2003, and was aimed at broadening the categories of
taxable income and reducing the tax rates imposed on employment income. The second of
these reforms came into effect on January 1, 2006 and further refined the changes to
capital gains taxation introduced by the January 2003 reform. Cumulatively, these reforms
introduced, among other things, the following provisions:

| |  | Reduction
of the tax rate levied on capital gains (other than gains from the sale of listed
securities) derived after January 1, 2003, to a general rate of 25% for corporations and
since January 1, 2006, to a rate of 20% for an individual shareholder holding less than
10% of the means of control in a company during a 12 month period prior to the sale and
to a rate of tax of up to 25% for an individual shareholder holding10% or more of the
means of control in a company during such period. Regarding assets acquired prior to
January 1, 2003, the reduced tax rate will apply to a proportionate part of the gain, in
accordance with the holding periods of the asset, before or after January 1, 2003, on a
linear basis;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Imposition
of Israeli tax on all income of Israeli residents, individuals and corporations,
regardless of the territorial source of income, including income derived from passive
sources such as interest, dividends and royalties;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

61

---

---



| |  | Introduction
of controlled foreign corporation (CFC) rules into the Israeli tax structure. Generally,
under such rules, an Israeli resident who holds, directly or indirectly, 10% or more of
the rights in a foreign corporation whose shares are not publicly traded (or which has
offered less than 30% of its shares or any rights to its shares to the public), in which
more than 50% of the rights are held directly or indirectly by Israeli residents, and a
majority of whose income in a tax year is considered passive income, and the rate at
which such passive income is taxed in the jurisdiction of such foreign corporation
exceeds 20%, will be liable for tax on the portion of such income attributed to his
holdings in such corporation, as if such income were distributed to him as a dividend;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Imposition
of capital gains tax on capital gains realized as of January 1, 2003 by individuals
who are Israeli residents, from the sale of shares of publicly traded companies on the
Tel Aviv Stock Exchange and from the sale of shares of publicly traded Israeli companies
on certain other stock exchanges (such gain was previously exempt from capital gains tax
in Israel in certain cases). For information with respect to the applicability of Israeli
capital gains taxes on the sale of ordinary shares, see Capital Gains Tax below;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Effectuation
of a new regime for the taxation of shares and options
                                    issued to employees, officers and directors; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Introduction
of tax at a rate of 25% on dividends paid by one Israeli company to another (which are
generally not subject to tax), if the source of such dividends is income that was derived
outside of Israel;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Elimination
of the seven-year limit to carry forward capital losses with respect to capital losses
arising from and after 1996.
| | - | -------------------------------------------------------------------------------------------------------------------------------

# General Corporate Tax
Structure

Generally,
Israeli companies are subject to corporate tax at the rate of 34% 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 2006, companies will
be taxed at a rate of 31%, in 2007 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.

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.

62

---

---



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

We
received an approval in principle from the Investment Center with respect to the sale of
our government surveillance business to Verint Systems in March 2004. If the Investment
Center declines, for any reason, to grant us the final approval, our tax benefits under
the Law for the Encouragement of Capital Investments will be materially reduced. In light
of our carry loss forward, we are currently not in a taxable position.

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

63

---

---



| | 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:
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

64

---

---



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

# Special Provisions
Relating to Taxation Under Inflationary Conditions

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

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

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

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

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

# Capital Gains Tax

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

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.

65

---

---



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%.

| | 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.

65

---

---



# Presentation of interest
rate risk (position as of December 31, 2004)

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 value as 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     |             |                 |                 

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.

67

---

---



As
at December 31, 2005, we had entered into currency forward contracts, ending March 2006,
as a hedge against sales contracts receivable as follows:

| |  | Obligation
to sell EUR 361,000 for a total amount of $ 452,189.
| | - | ---------------------------------------------------------------

| |  | Obligation
to sell EUR 259,000 for a total amount of $ 307,562; and.
| | - | --------------------------------------------------------------------

| |  | Obligation
to sell EUR 443,000 for a total amount of $ 555,876.
| | - | ---------------------------------------------------------------

# Presentation of foreign
currency-denominated assets and liabilities(position as of December 31, 2005)

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

|                      | Total as of | Settlement Date | Fair value as 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                   |             |                 |                 

68

---

---



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

Not
applicable.

# PART  II

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

Not
applicable.

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

# Modification of Rights

Not
applicable.

Use
of Proceeds

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

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

(a)
          Disclosure Controls and Procedures.

Our
chief executive officer, or CEO, and chief financial officer, or CFO, are responsible for
establishing and maintaining our disclosure controls and procedures as defined in Rule
13a-15(e) and 15d-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, 2005. 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, 2005, 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, 2005 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 26, 2005, our shareholders re-appointed Somekh
Chaikin, a member firm of KPMG International, to serve as our independent auditors.

Somekh
Chaikin, a member firm of KPMG International billed the following fees to us for
professional services in each of the last two fiscal years ($ in thousands):

69

---

---



|                   | Year Ended December 31,
|------------------ | -----------------------
|
|
|
|
|Audit Fees         |                        
|Audit-Related Fees |                        
|Tax Fees           |                        
|All Other 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
|--------- |  | ----------------------------------------------------------------------

Not
applicable.

# 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-51, incorporated
herein by reference.

70

---

---



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

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

|1.1 |  | Memorandum
of Association*
|--- |  | --------------------------

|1.2 |  | Amended
and Restated Articles of Association (as amended on September 26, 2005)
|--- |  | -------------------------------------------------------------------------------

|4.1 |  | ECtel
Managers and Employees Option Allotment Plan, as amended**(1)
|--- |  | -------------------------------------------------------------------

|4.2 |  | ECtel
International Employee Stock Option Plan, as amended**
|--- |  | ------------------------------------------------------------

|4.3 |  | ECtel
Director Share Option Plan 1999*
|--- |  | --------------------------------------

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

|4.6 |  | Form
of Non-Exclusive Sales Agency Agreement (Germany)*
|--- |  | -------------------------------------------------------

|4.8 |  | Share
and Asset Purchase Agreement, dated August 7, 2001, by and among Telrad Networks Ltd.,
Telrad Hawk Net-I Ltd.               and the Registrant****
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------

|4.9 |  | Form
of Warrants issued to Telrad Networks Ltd. on October 1, 2001****
|--- |  | ----------------------------------------------------------------------

|4.10 |  | Registration
Rights Agreement, dated January 22, 2002, by and between ECI Telecom Ltd. and the
Registrant****
|---- |  | -------------------------------------------------------------------------------------------------------------

|4.11 |  | Share
Purchase Agreement, dated February 6, 2002, by and among ECI Telecom Ltd., the Registrant
and certain               investors****
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------

|4.12 |  | Registration
Rights Agreement, dated February 6, 2002, by and among certain investors and the
Registrant****
|---- |  | ------------------------------------------------------------------------------------------------------------

|4.13 |  | ECtel
2003 Share Option Plan*****
|---- |  | ---------------------------------

|4.14 |  | ECtel
2003 U.S. Employee Stock Option Plan*****
|---- |  | -----------------------------------------------

|4.15 |  | Asset
Purchase Agreement, dated February 9, 2004, by and between Verint Systems Ltd. and the
Registrant*****
|---- |  | ------------------------------------------------------------------------------------------------------------

|4.16 |  | Joint
Intellectual Property Agreement, dated March 31, 2004, by and between Verint Systems Ltd.
and the               Registrant*****
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------

|4.17 |  | Patent
License-Back Agreement, dated March 31, 2004, by and between Verint Systems Ltd. and the
Registrant*****
|---- |  | ---------------------------------------------------------------------------------------------------------------

|4.18 |  | Summary
Translation of Lease Agreement between the Registrant and Hevrat Mivney Ta'asiya, dated
March 2005******
|---- |  | ----------------------------------------------------------------------------------------------------------------

|4.19 |  | 2003
Equity Incentive Plan
|---- |  | --------------------------

|4.20 |  | Form
of Indemnification Letter
|---- |  | ------------------------------

|8.1 |  | List
of Significant 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
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------

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

---

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

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

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

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

|***** |  | Incorporated
by reference to our Annual Report on Form 20-F for the fiscal year ended December 31,
2003, filed June 28, 2004  (File No. 000-30348)
|----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------

|****** |  | Incorporated
by reference to our Annual Report on Form 20-F for the fiscal year ended December 31,
2004, filed June 28, 2005 (File No. 000-30348)
|------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------

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

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

71

---

---



# 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/ Eitan Naor
Eitan NaorPresident and Chief Executive Officer
| |  | ------------------------------------------------------------------------------------------------------

Date: June 15, 2006

72

---

---

# ECtel Ltd. and
Subsidiaries

# Consolidated Financial
StatementsAs at December 31, 2005



---

---



|ECtel Ltd. and subsidiaries                              
|---------------------------------------------------------
|                                                         
|Consolidated Financial Statements as at December 31, 2005
|                                                         
|                                                         

# Contents

|                                                                   | Page
|------------------------------------------------------------------ | ----
|
|
|
|
|Report of Independent Registered Public Accounting Firm            | F-2 
|                                                                  
|Consolidated Balance Sheets as at                                 
|December 31, 2005 and 2004                                         | F-3 
|                                                                  
|Consolidated Statements of Operations for the                     
|years ended December 31, 2005, 2004 and 2003                       | F-4 
|                                                                  
|Consolidated Statements of Changes in Shareholders' Equity for the
|years ended December 31, 2005, 2004 and 2003                       | F-5 
|                                                                  
|Consolidated Statements of Cash Flows for the                     
|years ended December 31, 2005, 2004 and 2003                       | F-6 
|                                                                  
|Notes to the Consolidated Financial Statements                     | F-9 



---

---



# 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. (an Israeli corporation) and its consolidated subsidiaries
(the Company), as at December 31, 2005 and 2004 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, 2005. These consolidated financial
statements are the responsibility of the Companys Board of Directors and of its
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 Board of Directors and by 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, 2005 and 2004, and the results of their
operations and their cash flows for each of the years in the three-year period ended
December 31, 2005 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.

Somekh Chaikin 
Certified Public Accountants (Israel) 
Member Firm of KPMG International

Tel Aviv, Israel 
June 7,
2006



---

---



|ECtel Ltd. and subsidiaries                  
|---------------------------------------------
|                                             
|Consolidated Balance Sheets as at December 31
|                                             
|                                             

|                                   |  | 2005 | 2004
|---------------------------------- |  | ---- | ----
|
|
|
|
|Assets                             |  |      |     
|                                   |  |     
|Current assets                     |  |     
|Cash and cash equivalents          |  |      | 14A 
|Short-term investments             |  |      | 4   
|Receivables:                       |  |     
|Trade, net                         |  |      | 14B 
|Other                              |  |      |     
|Related parties                    |  |      | 13C 
|Inventories                        |  |      | 3   
|                                   |  |      |     
|                                   |  |     
|Total current assets               |  |      |     
|                                   |  |      |     
|                                   |  |     
|                                   |  |     
|Long-term marketable securities    |  |      | 4   
|                                   |  |      |     
|                                   |  |     
|Long-term other receivables        |  |      | 5   
|                                   |  |      |     
|                                   |  |     
|Property, plant and equipment, net |  |      | 6   
|                                   |  |      |     
|                                   |  |     
|Goodwill                           |  |      | 7C  
|                                   |  |      |     
|                                   |  |     
|Other assets, net                  |  |      | 8   
|                                   |  |      |     
|                                   |  |     
|                                   |  |     
|Total assets                       |  |      |     
|                                   |  |      |     

|
Eitan NaorChief Executive Officer and Director | 
Ron FainaroChief Financial Officer
|------------------------------------------------------------- | -------------------------------------------------

Rosh Haayin, June 7,
2006

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



---

---



|ECtel Ltd and its subsidiaries.              
|---------------------------------------------
|                                             
|Consolidated Balance Sheets as at December 31
|                                             
|                                             

|                                                         |  | 2005 | 2004
|-------------------------------------------------------- |  | ---- | ----
|
|
|
|
|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 18,169,089    |  |     
|shares as at December 31, 2005 and 18,151,172 shares     |  |     
|as at December 31, 2004                                  |  |      |     
|Capital surplus                                          |  |      |     
|Accumulated loss                                         |  |      |     
|                                                         |  |      |     
|                                                         |  |     
|Total shareholders' equity                               |  |      |     
|                                                         |  |      |     
|                                                         |  |     
|                                                         |  |     
|Total liabilities and shareholders' equity               |  |      |     
|                                                         |  |      |     

F - 3

---

---



|ECtel Ltd. and subsidiaries                                          
|---------------------------------------------------------------------
|                                                                     
|Consolidated Statements of operations for the years ended December 31
|                                                                     
|                                                                     

|                                            |  | 2005 | 2004 | 2003        
|------------------------------------------- |  | ---- | ---- | ------------
|
|
|
|
|Revenues                                    |  |      |      | 14D         
|Cost of revenues                            |  |      |      | 10B, 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          
|Goodwill impairment                         |  |      |      | 7C          
|                                            |  |      |      |             
|                                            |  |     
|Operating loss                              |  |      |      |             
|Financial expenses                          |  |      |      | 13, 14I     
|Financial income                            |  |      |      | 14I         
|Other (expenses) income, net                |  |      |      |             
|                                            |  |      |      |             
|                                            |  |     
|Loss from continuing operations             |  |     
|before taxes on income                      |  |      |      |             
|Income tax benefit (expense)                |  |      |      | 12          
|                                            |  |      |      |             
|                                            |  |     
|Net loss from continuing operations         |  |      |      |             
|Discontinued operations:                    |  |     
|Income (loss) from discontinued operations, |  |     
|nil of tax                                  |  |      |      | 18B         
|                                            |  |      |      |             
|                                            |  |     
|Net loss for the year                       |  |      |      |             
|                                            |  |      |      |             
|                                            |  |     
|Earnings (loss) per ordinary share          |  |     
|Basic and diluted earnings (loss) per       |  |     
|ordinary share for:                         |  |     
|Continuing operations                       |  |      |      |             
|Discontinued operations                     |  |      |      |             
|                                            |  |      |      |             
|                                            |  |      |      |             
|                                            |  |      |      |             
|                                            |  |     
|Weighted average number of                  |  |     
|shares outstanding                          |  |      |      |             
|                                            |  |      |      |             

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

F - 4

---

---



|ECtel Ltd. and subsidiaries                                                                       
|--------------------------------------------------------------------------------------------------
|                                                                                                  
|Statements of Changes in Shareholders' Equity for the years ended December 31, 2005, 2004 and 2003
|                                                                                                  
|                                                                                                  

|                        | Ordinary
shares | Share
capital | Capital
surplus | Accumulated
(loss) earnings | Total
Shareholders'
equity
|----------------------- | --------------- | ------------- | --------------- | --------------------------- | --------------------------
|
|
|
|
|Balance at              |                 |               |                 |                             |                           
|December 31, 2002       |                 |               |                 | 17,917,848                  |                           
|                        |                 |              
|Employees stock options |                 |              
|exercised and paid      |                 |              
|(see Note 11B)          |                 |               |                 | 77,780                      |                           
|Net loss for the year   |                 |               |                 | -                           |                           
|                        |                 |               |                 |                             |                           
|                        |                 |              
|Balance at              |                 |              
|December 31, 2003       |                 |               |                 | 17,995,628                  |                           
|                        |                 |              
|Employees stock options |                 |              
|exercised and paid      |                 |              
|(see Note 11B)          |                 |               |                 | 155,544                     |                           
|Net loss for the year   |                 |               |                 | -                           |                           
|                        |                 |               |                 |                             |                           
|                        |                 |              
|Balance at              |                 |              
|December 31, 2004       |                 |               |                 | 18,151,172                  |                           
|                        |                 |              
|Employees stock options |                 |              
|exercised and paid (see |                 |              
|Note 11B)               |                 |               |                 | 17,917                      |                           
|                        |                 |              
|Net loss for the year   |                 |               |                 | -                           |                           
|                        |                 |               |                 |                             |                           
|                        |                 |              
|Balance at              |                 |              
|December 31, 2005       |                 |               |                 | 18,169,089                  |                           
|                        |                 |               |                 |                             |                           

* Represents an amount less than $ 1
thousand.

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

F - 5

---

---



|ECtel Ltd. and its subsidiaries                                      
|---------------------------------------------------------------------
|                                                                     
|Consolidated Statements of Cash Flows for the years ended December 31
|                                                                     
|                                                                     

|                                                        | 2005 | 2004 | 2003
|------------------------------------------------------- | ---- | ---- | ----
|
|
|
|
|Cash flows from operating activities                    |      |      |     
|                                                        |      |     
|Net loss for the year                                   |      |      |     
|                                                        |      |     
|Adjustments to reconcile net loss to                    |      |     
|cash provided by (used in) operating activities:        |      |     
|                                                        |      |     
|Depreciation and amortization                           |      |      |     
|Decrease (increase) in deferred tax                     |      |      |     
|Loss (gain) 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                                     |      |      |     
|Decrease in trade receivables                           |      |      |     
|Decrease (increase) in other receivables                |      |      |     
|Decrease in recoverable costs and estimated             |      |     
|earnings - not yet billed                               |      |      |     
|Decrease (increase) in inventories                      |      |      |     
|Decrease in long-term receivables                       |      |      |     
|Increase (decrease) in trade payables                   |      |      |     
|Increase (decrease) in advances from customers          |      |      |     
|Related parties, net                                    |      |      |     
|Decrease in other payables and accrued liabilities      |      |      |     
|Increase (decrease) in liability for employee severance |      |     
|benefits                                                |      |      |     
|                                                        |      |      |     
|                                                        |      |     
|Net cash provided by (used in) operating activities     |      |      |     
|                                                        |      |      |     

|* | The consolidated cash flow statement for the year ended December 31, 2004 has been revised
to combine cash flows from discontinued operations with cash flows from continuing
operations within each category (previously, income from discontinued operations was
presented, net in one line, within the operating cash flows category).
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 (cont'd)
|                                                                              
|                                                                              

|                                                             | 2005 | 2004 | 2003
|------------------------------------------------------------ | ---- | ---- | ----
|
|
|
|
|Cash flows from investing activities                         |      |      |     
|                                                             |      |     
|Investment in short-term investments, net                    |      |      |     
|Capital expenditure on property, plant and equipment         |      |      |     
|Acquisition of newly consolidated subsidiaries, less of cash |      |     
|acquired (see A below)                                       |      |      |     
|Investment in technology                                     |      |      |     
|Long-term deposits withdrawal (funding)                      |      |      |     
|Proceeds from sale of property, plant and equipment          |      |      |     
|Proceeds from disposal of discontinued operations            |      |      |     
|Employee severance rights (funding) withdrawal               |      |      |     
|Proceeds from maturity of long-term marketable securities    |      |      |     
|Investment in long-term marketable securities                |      |      |     
|                                                             |      |      |     
|                                                             |      |     
|Net cash (used in) provided by investing activities          |      |      |     
|                                                             |      |      |     
|                                                             |      |     
|                                                             |      |     
|Cash flows from financing activities                         |      |     
|                                                             |      |     
|Issuance of ordinary shares                                  |      |      |     
|                                                             |      |      |     
|                                                             |      |     
|Net cash 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 of tax refunds             |      |      |     
|                                                             |      |      |     

|* | The consolidated cash flow statement for the year ended December 31, 2004 has been revised
to combine cash flows from discontinued operations with cash flows from continuing
operations within each category (previously, income from discontinued operations was
presented, net in one line, within the operating cash flows category).
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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)
|                                                                              
|                                                                              

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

|                                          | 2005 | 2004 | 2003
|----------------------------------------- | ---- | ---- | ----
|
|
|
|
|Purchase of property, plant and equipment |      |      |     
|not yet paid                              |      |      |     
|                                          |      |      |     

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

F - 8

---

---



|ECtel Ltd.                                                            
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 1 |  | General
|------ | - | -------

| | ECtel
Ltd. and its subsidiaries (hereinafter  the Company) provide Integrated
Revenue Management (IRM) solutions for communications services providers. The Company 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 18).
| | -----------------------------------------------------------------------------------------------------------

| | The
Companys seven 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. and ECtel Telesoft Export (98) Ltd., (see Note 20).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
December 29, 2005, the Company 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 and Note 20).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 all of its
wholly owned subsidiaries. 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 Standard (SFAS)
Statement No. 52, Foreign Currency Transaction, 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 - 9

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|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 are with maturity date between 91 to 365 days, (see
also Note 2F).
| | ----------------------------------------------------------------------------------------------------------------

| | E. | Inventories
| | -- | -----------

| | Inventories
are stated at the lower of cost or market. Cost is determined using the moving average
method.
| | ----------------------------------------------------------------------------------------------------------

| | F. | Long-Term
marketable securities
| | -- | -------------------------------

| | Long-term
marketable securities at December 31, 2005 consist of corporate and 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.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | G. | 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        | 10% - 33% (mainly 20%)
| | Office furniture and equipment | 6%                    

| | Leasehold
improvements are amortized by the straight-line method over the shorter of the useful
lives or the terms of the leases.
| | ---------------------------------------------------------------------------------------------------------------------------------

F - 10

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 2 |  | Significant
Accounting Policies (contd)
|------ | - | ----------------------------------------

| | G. | Property, plant and equipment (contd)
| | -- | --------------------------------------

| | 3. | Major
renewals and improvements are capitalized, while repairs and maintenance           are
expensed as incurred.
| | -- | ------------------------------------------------------------------------------------------------------------------

| | 4. | Upon
the sale or retirement of equipment and leasehold improvements, 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.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | H. | Allowance for doubtful accounts receivable
| | -- | ------------------------------------------

| | The
financial statements include an allowance which management believes reflects adequately
the loss inherent in receivables for which collection is in doubt. In determining the
fairness of the allowance management bases its determination, among other factors, on
information available about the debtors financial situation, the volume of their
operations and evaluation of the security received from them.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | I. | Goodwill
and other intangible assets
| | -- | ------------------------------------

| | According
to SFAS No. 142, Goodwill and Other Intangible Assets, goodwill is not
amortized, but instead tested for impairment at least annually.
| | --------------------------------------------------------------------------------------------------------------------------------------------------

| | SFAS
No. 142 also requires that intangible assets with definite useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and reviewed
for impairment in accordance with SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Change
in basis of valuation
| | ----------------------------

| | The
basis of valuation of the useful life of other purchased technology was accelerated as of
April 2004 from 5 years to 2.5 years. The acceleration was based on managements
decision regarding the development of a replacement solution for the year 2006 and
beyond. Therefore, an amortization period has been adjusted for this change.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | J. | Revenue
recognition
| | -- | -------------------

| | 1. | Revenues
from product sales (which include software) are recognized, in           accordance with
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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
certain cases, when the sale contract includes customer acceptance provisions
          with respect to performance guarantees, i.e. installation, revenue is
recognized           when the Company has demonstrated that the criteria specified in the
provisions           have been satisfied.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Revenues
from product maintenance and support contracts and separately priced           extended
warranty contracts are recognized ratably over the contract period.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 11

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 2 |  | Significant
Accounting Policies (contd)
|------ | - | ----------------------------------------

| | J. | Revenue
recognition (contd)
| | -- | ----------------------------

| | 4. | Revenues
from contracts 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. 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.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to managements evaluations and assumptions, see Note 2Q below.
| | ------------------------------------------------------------------

| | K. | Research and development costs
| | -- | ------------------------------

| | 1. | Research
and development costs, net of any grants, are charged to the statement           of
operations as incurred. Royalties paid and accrued in respect of the said
          grants 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 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Severance
pay deposits fund represent contributions to severance pay funds and cash surrender value
of life insurance policies that are recorded at their current redemption value.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | M. | Taxes
on income
| | -- | ---------------

| | 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 other deductions 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. Deferred tax
assets do not include future tax benefits for which the realization of the benefit is
less than more likely than not. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be realized. Deferred
tax assets and liabilities are presented as current or long-term items in accordance with
the nature of assets or liabilities to which they relate, according to the date of their
realization.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 2 |  | Significant
Accounting Policies (contd)
|------ | - | ----------------------------------------

| | M. | Taxes
on income (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. | Stock
option plans
| | -- | ------------------

| | The
Company applies 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 is 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
October 1995 the Financial Accounting Standards Board (FASB) issued SFAS No. 123, Accounting
for Stock-based Compensation (SFAS 123), which establishes financial
accounting and reporting standards for stock-based compensation plans. The statement
defines a fair value based method of accounting for an employee stock option. The Company
adopted the disclosure provisions of SFAS 123 but opted to remain under the expense
recognition provisions of APB 25.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following table illustrates the effect on net loss if the Company had applied the fair
value recognition provisions of SFAS 123 ($ in thousands, except per share data):
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                            | Year ended December 31
| | ------------------------------------------ | ----------------------
|
|
|
|
| | Net loss as reported                       |                       
| | Add: Compensation expenses recorded in     |                       
| | statements of operations                   |                       
| | Less: Compensation expenses                |                       
| | according to SFAS 123                      |                       
| |                                            |                       
| |                                            |                       
| | Pro forma net loss                         |                       
| |                                            |                       
| |                                            |                       
| |                                            |                       
| | Basic and diluted loss per ordinary share: |                       
| | As reported                                |                       
| |                                            |                       
| | Pro forma                                  |                       

F - 13

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 2 |  | Significant
Accounting Policies (contd)
|------ | - | ----------------------------------------

| | O. | Derivative
financial instruments
| | -- | --------------------------------

| | The
Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, as amended (SFAS 133), effective January 1, 2001. 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 Statement
of Financial Accounting Standard 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 ordinary share calculation is
similar to basic earnings per share except that the weighted average of common shares
outstanding is increased to include the number of additional common shares that would
have been outstanding if the dilutive potential common shares, such as options, had been
exercised.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | These
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 - 14

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 2 |  | Significant
Accounting Policies (contd)
|------ | - | ----------------------------------------

| | S. | Comprehensive
income
| | -- | --------------------

| | The
Company adopted SFAS No. 130, Reporting Comprehensive Income. It requires
that all items required to be recognized under accounting standards as components of
comprehensive income (loss) be reported in a separate financial statement and displayed
with the same prominence as other financial statements. It requires that an enterprise
(a) classifies items of other comprehensive income (loss) by their nature in a financial
statement and (b) displays the accumulated balance of other comprehensive income (loss)
separately from retained earnings and additional paid in capital in the equity section of
the statement of financial position. In the Companys case, comprehensive loss is
the same as net loss for all periods presented.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | T. | Impairment
of long-lived assets and assets to be disposed of
| | -- | ------------------------------------------------------------

| | 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 cash flows, an impairment charge
is recognized by the amount by which the carrying amount of the asset exceeds the fair
value of the asset. SFAS 144 requires companies to separately report discontinued
operations and extends that reporting to a component of an entity that either has been
disposed of (by sale, abandonment, or in a distribution to owners) or is classified as
held for sale, (see also Note 18).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | U. | Guarantors accounting and disclosure requirements for guarantees,
          including indirect guarantees of indebtedness of others
| | -- | ------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has adopted the provision of FASB Interpretation (FIN) No. 45, Guarantors
Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees or
Indebtedness of Others. FIN No. 45 requires the guarantor to recognize a liability
for the non-contingent component of the guarantee i.e. the obligation to stand ready to
perform in the event that specific triggering events or conditions occur. The initial
measurement of this liability is the fair value of the guarantee at inception. The
recognition of the liability is required even if it is not probable that payments will be
required under the guarantee or if the guarantee was issued with a premium payment or as
part of a transaction with multiple elements. The Company also complies with the
disclosure requirements of FIN No. 45 in regard to its obligations under guarantees.
These disclosure requirements are included in Note 10D to the consolidated financial
statements.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | V. | 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).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | W. | Reclassification
| | -- | ----------------

| | Certain
prior year figures have been reclassified to conform to current year presentation.
| | ------------------------------------------------------------------------------------------

F - 15

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

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

| | The
Company believes that this inventory will not be used in the future.
| | ------------------------------------------------------------------------

|Note 4 |  | Investment
in Marketable Securities and Deposits
|------ | - | ------------------------------------------------

| | Regarding
Companys marketable securities classification, see Note 2F.
| | ----------------------------------------------------------------------

| | The
Companys investments in marketable securities consist primarily of investments in
US Government Agencies and Corporate bonds. Based on that evaluation and the 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, 2005.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (1) | The
following table summarizes the Companys marketable securities and
          deposits at December 31, 2005 and 2004 (regarding assumptions used for
estimated           fair value, see Note 16):
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                 | 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 - 16

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 4 |  | Marketable
Securities (contd)
|------ | - | ------------------------------

| |                                  | December 31, 2004 | 
| | -------------------------------- | ----------------- | 
|
|
|
|
| | Held to maturity securities      |                   | 
| | (carried at amortized cost)      |                   | 
| |                                  |                   | 
| | US Government Agencies           |                   | 
| | Corporate bonds                  |                   | 
| |                                  |                   | 
| |                                  |                   | 
| | Short-term marketable securities |                   | 
| |                                  |                   | 
| |                                  |                   | 
| |                                  |                   | 
| | US Government Agencies           |                   | 
| | Corporate bonds                  |                   | 
| |                                  |                   | 
| |                                  |                   | 
| | Long-term marketable securities  |                   | 
| |                                  |                   | 

| | (2) | The
following table summarizes the Companys marketable securities by           maturity
date:
| | --- | ----------------------------------------------------------------------------------------------

| |                                                  | Amortized Cost | Fair value
| | ------------------------------------------------ | -------------- | ----------
|
|
|
|
| | Maturity date of long-term marketable securities |                |           
| | 2007                                             |                |           
| | 2008                                             |                |           
| |                                                  |                |           
| |                                                  |                |           
| |                                                  |                |           

| | 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, 2005:
| | ------------------------

| |                 | Less than 12 months | 12 months or Greater |  | Total
Unrealized
losses
| | --------------- | ------------------- | -------------------- |  | -----------------------
|
|
|
|
| | US Government   |                     |                      |  |                        
| | Agencies        |                     |                      |  | 3,562                  
| | Corporate bonds |                     |                      |  | 7,230                  
| |                 |                     |                      |  |                        
| | Total           |                     |                      |  | 10,792                 
| |                 |                     |                      |  |                        

F - 17

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 4 |  | Marketable
Securities (contd)
|------ | - | ------------------------------

| | As
of December 31, 2004:
| | ------------------------

| |                 | Less than 12 months | 12 months or Greater |  | Total
Unrealized
losses
| | --------------- | ------------------- | -------------------- |  | -----------------------
|
|
|
|
| | US Government   |                     |                      |  |                        
| | Agencies        |                     |                      |  | 1,995                  
| | Corporate bonds |                     |                      |  | -                      
| |                 |                     |                      |  |                        
| | Total           |                     |                      |  | 1,995                  
| |                 |                     |                      |  |                        

| | The
unrealized losses on the Companys investments in US Government Agencies and
corporate bonds were caused by interest rate increases. Because 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, 2005 and 2004.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Note 5 |  | Long-Term
Other Receivables
|------ | - | ---------------------------

| | Consist
of the following :
| | --------------------------

| |                                               | December 31
| | --------------------------------------------- | -----------
|
|
|
|
| | Employee severance rights funded (see Note 9) |            
| | Long-term deposits                            |            
| |                                               |            
| |                                               |            
| |                                               |            
| |                                               |            

F - 18

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 6 |  | Property,
Plant and Equipment
|------ | - | -----------------------------

| | Property,
plant and equipment consist of the following:
| | -------------------------------------------------------

| |                                    | Machinery
and
equipment | Office
furniture and
equipment | Leasehold
improvements | Total
| | ---------------------------------- | ----------------------- | ------------------------------ | ---------------------- | -----
|
|
|
|
| | Cost                               |                         |                                |                        |      
| | Balance at January 1, 2005         |                         |                                |                        | 5,833
| | Acquisitions                       |                         |                                |                        | 40   
| | Additions                          |                         |                                |                        | 309  
| | Disposals                          |                         |                                |                        | (178 
| |                                    |                         |                                |                        |      
| |                                    |                         |                               
| | Balance at December 31, 2005       |                         |                                |                        | 6,004
| |                                    |                         |                                |                        |      
| |                                    |                         |                               
| | Accumulated depreciation           |                         |                               
| | Balance at January 1, 2005         |                         |                                |                        | 3,349
| | Additions                          |                         |                                |                        | 650  
| | Disposals                          |                         |                                |                        | (161 
| |                                    |                         |                                |                        |      
| |                                    |                         |                               
| | Balance at December 31, 2005       |                         |                                |                        | 3,838
| |                                    |                         |                                |                        |      
| |                                    |                         |                               
| | Property, plant and equipment, net |                         |                               
| |                                    |                         |                               
| | Balance at December 31, 2005       |                         |                                |                        | 2,166
| |                                    |                         |                                |                        |      
| |                                    |                         |                               
| | Property, plant and equipment, net |                         |                               
| |                                    |                         |                               
| | Balance at December 31, 2004       |                         |                                |                        | 2,484
| |                                    |                         |                                |                        |      

|Note 7 |  | Acquisitions
|------ | - | ------------

| | A. | Acquisition
of Telrad Hawk Net-I Ltd.
| | -- | -------------------------------------

| | 1. | On
October 1, 2001, the Company 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).
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 to its fair value in the
amount of $ 10,329 thousand.
| | -------------------------------------------------------------------------------------------------------------------

| | As
at June 2004, the Company impaired the goodwill by $ 2,186 to its fair value in the
amount of $ 8,143 thousand.
| | ------------------------------------------------------------------------------------------------------------------

| | No
goodwill was impaired, since the fair value of the Companys reporting unit exceeded
its carrying amount, including goodwill. Hence, goodwill was considered not impaired.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 19

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 7 |  | Acquisitions
(contd)
|------ | - | ---------------------

| | A. | Acquisition
of Telrad Hawk Net-I Ltd.(contd)
| | -- | ---------------------------------------------

| | 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 Company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.
| | --- | ------------------------------------

| | (**) | As
at December 31, 2005 was fully amortized.
| | ---- | --------------------------------------------

| | Amortization
expenses were $ 49 thousand for each of the years ended December 31, 2005 and 2004,
respectively, as part of research and development costs.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Acquisition
of Elron Telesoft Ltd. and Elron Telesoft Export Ltd.
| | -- | -----------------------------------------------------------------

| | 1. | On
December, 29, 2005, (hereinafter  the closing date) the
          Company acquired all of the outstanding shares of Elron Telesoft Ltd. and Elron
          Telesoft Export (98) Ltd., two sister companies (hereinafter  the
          acquired companies) 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 its line of products, including Revenue Assurance solution for communications
services providers. The acquisition of the acquired companies will allow ECtel to provide
communications services providers comprehensive solution for IRM (Integrated Revenue
Management) framework.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
transaction was accounted for by the purchase method in accordance with Financial
Accounting Standard (SFAS) No. 141 Business Combinations.
| | --------------------------------------------------------------------------------------------------------------------------------------------------

| | The
effect of the acquisition is reflected in the consolidated balance sheet as at December
31, 2005.
| | -----------------------------------------------------------------------------------------------------

F - 20

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 7 |  | Acquisitions
(contd)
|------ | - | ---------------------

| | B. | Acquisition
of Elron Telesoft Ltd. and Elron Telesoft Export Ltd. (contd)
| | -- | --------------------------------------------------------------------------

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

| | In
addition, $ 400 thousand in cash shall be paid by the Company to the Seller, according to
the purchase agreement, in two deferred installments, over a period of 12 months
following the closing date, subject to the successful completion of certain milestones,
according to the purchase agreement.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | The
purchase price of the acquired companies was allocated based on management
          estimates and independent appraisal to the tangible and identifiable intangible
          assets acquired and liabilities assumed respectively based on their estimated
          fair values at the acquisition date.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following table summarizes the estimated fair value of the assets acquired and
liabilities assumed as of the acquisition date:
| | ----------------------------------------------------------------------------------------------------------------------------------

| |                                | As at
December 31
2005
| | ------------------------------ | ----------------------
|
|
|
|
| | Current assets*                |                       
| | Current liabilities            |                       
| | Long-term other assets         |                       
| | Long-term liabilities          |                       
| | Equipment                      |                       
| |                                |                       
| | Intangible Assets              |                       
| | Technology                     |                       
| | Contractual customer relations |                       
| | Third party relations          |                       
| | Existing contracts             |                       
| | Goodwill                       |                       
| |                                |                       
| |                                |                       
| | Net assets                     |                       
| |                                |                       

| | * | Includes
$ 267 thousand cash and cash equivalents.
| | - | --------------------------------------------------

| | Of
the $ 2,504 thousand net assets, $ 349 thousand assigned to core technology that have a
weighted-average useful life of approximately 5 years. $ 159 thousand was assigned to
relationship with a third party equipment supplier of the acquired companies and have a
weighted average useful life of approximately 1 year. $ 171 thousand has been assigned to
existing customer contracts which have a weighted-average useful life of 1 year. $ 130
thousand has been assigned to contractual customer relations which have a
weighted-average useful life of approximately 5 years.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 21

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 7 |  | Acquisitions
(contd)
|------ | - | ---------------------

| | B. | Acquisition
of Elron Telesoft Ltd. and Elron Telesoft Export Ltd. (contd)
| | -- | --------------------------------------------------------------------------

| | The
$ 3,558 thousand of goodwill was derived by applying the Residual Approach.
Under this approach, the purchase price is allocated to tangible assets and to
specifically identifiable intangible assets, with any remainder allocated to goodwill.
The goodwill figure was assigned to existing Telecommunications reporting unit.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company believes that this acquisition resulted in the recognition of goodwill primarily
because acquired companies technology will add significant capabilities to ECtels
IRM framework solution.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Hereafter
are certain unaudited pro forma combined statements of income data for           the
years ended December 31, 2005 and 2004, as if the acquisition of the           acquired
companies occurred on January 1, 2005 and 2004, respectively. The pro           forma
financial information is not necessarily indicative of the combined           results
that would have been attained had the acquisition taken place at the           beginning
of 2005 and 2004, respectively, nor is it necessarily indicative of           future
results.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                            | Year ended December 31
| | ------------------------------------------ | ----------------------
|
|
|
|
| | Sales                                      |                       
| |                                            |                       
| |                                            |                       
| | Net loss                                   |                       
| |                                            |                       
| |                                            |                       
| | Basic and diluted loss per ordinary share: |                       
| |                                            |                       

| | C. | Goodwill
| | -- | --------

| | Consists
of the following:
| | --------------------------

| |                     | Year ended December 31
| | ------------------- | ----------------------
|
|
|
|
| | Original amount     |                       
| | Goodwill impairment |                       
| |                     |                       
| |                     |                       
| |                     |                       
| |                     |                       

F - 22

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 7 |  | Acquisitions
(contd)
|------ | - | ---------------------

| | D. | Acquired
Intangible Assets
| | -- | --------------------------

| | The
following tables summarize the allocation of acquired intangible assets and estimated
amortization expenses ($ in thousands):
| | ---------------------------------------------------------------------------------------------------------------------------------

| |                                | As at December 31, 2005
| | ------------------------------ | -----------------------
|
|
|
|
| | Amortized intangible assets:   |                        
| | Third party relations          |                        
| | Core technology                |                        
| | Customer contracts             |                        
| | Contractual customer relations |                        
| |                                |                        
| |                                |                        
| | Total                          |                        
| |                                |                        

| | Future
estimated amortization expenses:
| | ---------------------------------------

| |                     | Year ended
December 31
2005
| | ------------------- | ---------------------------
|
|
|
|
| | 2006                |                            
| | 2007                |                            
| | 2008                |                            
| | 2009 and afterwards |                            
| |                     |                            
| |                     |                            
| | Total               |                            
| |                     |                            

|Note 8 |  | Other
Assets, net
|------ | - | -----------------

| | Consist | of
the following:
| | ------- | -----------------

| |                                            | December 31
| | ------------------------------------------ | -----------
|
|
|
|
| | Intangible asset arising from:             |            
| | Net I acquisition - original cost          |            
| | Elron Telesoft acquisition - original cost |            
| |                                            |            
| |                                            |            
| |                                            |            
| | Less - accumulated amortization            |            
| |                                            |            
| |                                            |            
| |                                            |            
| |                                            |            

| | The
amortization expenses were $ 252 thousand and $ 48 thousand for each of the years ended
December 31, 2005 and 2004, respectively, as part of research and development costs.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 23

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|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 the relevant 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. The liability is covered by the
amounts deposited including accumulated income thereon as well as by the unfunded
provision.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Withdrawals
from the funds may be made only for the purpose of disbursement of severance pay.
| | ---------------------------------------------------------------------------------------------

| | 3. | Expenses
recorded in respect of severance and pension pay for the years ended           December
31, 2005, 2004 and 2003 are $ 124 thousand, $ 661 thousand and $ 617           thousand,
respectively.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 $ 42 thousand, $
100 thousand and $ 165 thousand in 2005, 2004 and 2003, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 24

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|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 2006 to 2009 (some have
renewal options) and are in US dollar, 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, 2005, are as follows:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Year ending December 31: | $ in thousands
| | ------------------------ | --------------
|
|
|
|
| | 2006                     |               
| | 2007                     |               
| | 2008                     |               
| | 2009                     |               
| | 2010 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, to the Government of Israel, Ministry of Industry
and Commerce and Offices of Chief Scientist, on proceeds from sales of products in which
the Israeli Government participated by way of grants for research and development. As at
December 31, 2005, the Company had received a total of $ 8.4 million in grants and has
paid or accrued a total of $ 5.7 million 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).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | Capital
expenditure commitments
| | -- | -------------------------------

| | The
Company invests in capital expenditures according to Approved Enterpriseprograms.
At December 31, 2005, in order to comply with current approved programs, $ 886 thousand
remain to be invested (see Note 12A1).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Guarantees
| | -- | ----------

| | At
December 31, 2005, the Company has granted guarantees to third parties in the sum of $
2.6 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 2006 through
December 2006.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 25

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 10 |  | Commitments
and Contingencies (contd)
|------- | - | --------------------------------------

| | 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, 2005, the Company has entered into currency forward contracts, ending
March 2006, as a hedge against receivable as follows:
| | ----------------------------------------------------------------------------------------------------------------------------------------------

| | a) | Obligation
to sell EUR 361,000 for a total amount of $ 452,189.
| | -- | ---------------------------------------------------------------

| | b) | Obligation
to sell EUR 259,000 for a total amount of $ 307,562.
| | -- | ---------------------------------------------------------------

| | c) | Obligation
to sell EUR 443,000 for a total amount of $ 555,876.
| | -- | ---------------------------------------------------------------

| | 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. | 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 of 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------

F - 26

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 10 |  | Commitments
and Contingencies (contd)
|------- | - | --------------------------------------

| | 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
2005 | December 31
2004 | December 31
2003
| | -------------------------------------------- | ---------------- | ---------------- | ----------------
|
|
|
|
| | Balance outstanding at beginning of the year |                  |                  |                 
| | Warranty expenses                            |                  |                  |                 
| | Warranties for products sold                 |                  |                  |                 
| | Lapsed warranties                            |                  |                  |                 
| |                                              |                  |                  |                 
| |                                              |                  |                 
| | Balance outstanding at end of the year       |                  |                  |                 
| |                                              |                  |                  |                 

| | 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, 2005 are approximately $ 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
plaintiffs filed an amended complaint (the Amended Class Action Complaint),
on December 15, 2005. The Court set a date for the Company to file its motion to dismiss
the Amended Class Action Complaint for February 21, 2006. The hearing on motion to
dismiss has been scheduled for May 22, 2006.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company, based on its legal counsel, believes that the class action plaintiffsclaims
are without merit and intend to defend the case vigorously.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 11 |  | Shareholders Equity
|------- | - | --------------------

| | A. | Authorized,
issued and outstanding share capital
| | -- | ------------------------------------------------

| |                              | Issued and outstanding shares | Authorized
| | ---------------------------- | ----------------------------- | ----------
|
|
|
|
| | NIS 0.04 par value per share |                               |           
| |                              |                               |           

| | B. | Share
incentive and stock option plans
| | -- | --------------------------------------

| | 1.a | 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 subsidiary 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
Board of Directors initially authorized the Company to grant options for a total of
965,000 shares under the ECtel Plan. The option awards are personal and non-assignable
and terminate automatically upon termination of employment (except for approved
retirement or termination caused by death or disability). The vesting for these options
is in three equal annual installments commencing two years after the date of grant.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
November 1998, the Company granted to employees options to purchase an aggregate of
837,525 ordinary shares. The aggregate amount of compensation expense for this grant was $ 2,604
thousand.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
May 1999, the Company granted to employees options to purchase an aggregate of 127,475
ordinary shares. The aggregate amount of compensation expense for this grant was $ 1,030
thousand.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
exercise price per share under the option awards was determined based on factors
considered by the Board of Directors. The exercise price per share for these stock
options is $ 1.04 per share.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1.b | In
August 1999, the Board of Directors adopted an additional share incentive plan for
non-employee directors. Under the terms of the plan, the Company is authorized to grant
options for a total of 422,200 ordinary shares. In August 1999, the Company granted to
directors options to purchase an aggregate of 422,200 shares. The exercise price is $
4.66 per share. The aggregate amount of compensation expense for this grant was $ 2,581
thousand. These options vest in two equal annual installments commencing March 2001.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, the Board authorized the grant to employees of options to purchase an
additional 180,925 ordinary shares, pursuant to the ECtel Plan. In September 1999, the
Company granted to employees options to purchase an aggregate of 180,925 ordinary shares.
The exercise price is $ 4.66 per share. The aggregate amount of compensation expense for
this grant was $ 1,106 thousand. These options vest in three equal annual installments
commencing September 2001.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 28

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 11 |  | Shareholders Equity
(contd)
|------- | - | -----------------------------

| | B. | Share
incentive and stock option plans (contd)
| | -- | -----------------------------------------------

| | 1.c | In
May 2000, the Board of Directors amended the ECtel Plan (the Amended Plan)
and authorized the Company to grant to employees additional options for a total of
476,760 ordinary shares. In May 2000, the Company granted to employees options to
purchase an aggregate of 476,760 shares. The exercise price is $ 15.75 per share. There
is no compensation expense for this grant as the exercise price was equal to the quoted
market price at the date of the grant. These options vest in two equal annual
installments commencing at May 2002.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1.d | In
January 2001, the Board of Directors authorized, under the above plans, the grant to
employees and directors of options to purchase a total of 832,520 ordinary shares. In
January 2001, the Company granted 812,520 options to employees and 20,000 options to
directors. The exercise price is $ 8.82 per share. There is no compensation expense for
these grants as the exercise price was equal to the quoted market price at the date of
the grant. These options vest in two equal annual installments commencing at January
2002.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1.e | In
October 2001, the Board of Directors authorized, under the above plans, the grant to
employees and directors of options to purchase a total of 498,000 ordinary shares. In
October 2001, the Company granted 408,000 options to employees and 90,000 options to
Directors. The exercise price is $ 11.55 per share. There is no compensation expense for
these grants as the exercise price was equal to the quoted market price at the date of
the grant. The employee options vest in two equal annual installments commencing October
2002. The director options vest in 12 equal quarterly installments, commencing January
2002.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1.f | In
October 2002, the Board of Directors authorized, under the above plans, the grant to
employees of options to purchase a total of 713,400 ordinary shares. In October 2002, the
Company granted 713,400 options to employees. The exercise price is $ 7.90 per share.
There is no compensation expense for this grant as the exercise price was equal to the
quoted market price at the date of the grant. These options vest in three equal annual
installments, commencing in October 2003.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1.g | In August 2003, the Board of Directors, authorized two new share option plans for
international and US grantees covering in the aggregate 250,000 shares. Under said 2003
plans, in December 2003, the Company granted 120,000 options to employees. The exercise
price for said options is $ 4.67 per share. There is no compensation expense for this
grant as the exercise price was equal to the quoted market price at the date of the grant.
These options vest over three years in twelve equal quarterly installments, commencing on
various dates from March 2003 to May 2003.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1.h | 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).
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 29

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 11 |  | Shareholders Equity
(contd)
|------- | - | -----------------------------

| | B. | Share
incentive and stock option plans (contd)
| | -- | -----------------------------------------------

| | 1.i | 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.
There is no compensation expense for this grant as the exercise price was equal to the
quoted market price at the date of the grant. These options vest 25% after one year and
the rest in 12 equal quarterly installments commencing May 2005.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1.j | In
July 2004, the Board of Directors authorized, under the 2003 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. There
is no compensation expense for this grant as the exercise price was equal to the quoted
market price at the date of the grant. The options vest 33% after one year and the rest
in 8 equal quarterly installments commencing July 2005.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1.k | In
August 2004, the Board of Directors authorized, under the 2003 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 to $ 2.81 per share. There is no
compensation expense for these grants as the exercise price was equal to the quoted
market price at the date of the grant. 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.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1.l | In
December 2004, the Board of Directors authorized, under the 2003 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.
There is no compensation expense for this grant as the exercise price was equal was equal
to the quoted market price at the date of the grant. These options vest 25% after one
year and the rest in 12 equal quarterly installments commencing December 2005.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1.m | In
February 2005, the Board of Directors authorized, under the 2003 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.
There is no compensation expense for this grant as the exercise price was equal to the
quoted market price at the date of the grant. These options vest in 12 equal quarterly
installments commencing May 2005.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1.n | In
May 2005, the Board of Directors authorized, under the 2003 Plan, the grant to employees
of options to purchase a total 100,000 ordinary shares. In May 2005, the Company granted
100,000 options to employees. The exercise price is $ 3.70 per share. There is no
compensation expense for this grant as the exercise price was equal to the quoted market
price at the date of the grant. These options vest 25% after one year and the rest in 12
equal quarterly installments commencing May 2006.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 30

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 11 |  | Shareholders Equity
(contd)
|------- | - | -----------------------------

| | B. | Share
incentive and stock option plans (contd)
| | -- | -----------------------------------------------

| | 1.o | In
August 2005, the Board of Directors authorized, under the 2003 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.
There is no compensation expense for this grant as the exercise price was equal to the
quoted market price at the date of the grant. These options vest 25% after one year and
the rest in 12 equal quarterly installments commencing August 2006.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1.p | In
November 2005, the Board of Directors authorized, under the 2003 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.
There is no compensation expense for this grant as the exercise price was equal to the
quoted market price at the date of the grant. These options vest 25% after one year and
the rest in 12 equal quarterly installments commencing November 2006.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Stock
options under all the share incentive and option plans are as follows:
| | -- | ----------------------------------------------------------------------------

| |                                              | Year ended December 31
| | -------------------------------------------- | ----------------------
|
|
|
|
| | Balance outstanding at beginning of the year |                       
| | Changes during the year:                     |                       
| | Granted                                      |                       
| | Exercised *                                  |                       
| | Forfeited                                    |                       
| |                                              |                       
| |                                              |                       
| | Balance outstanding at end of the year       |                       
| |                                              |                       
| |                                              |                       
| | *  Average price of options exercised during |                       
| | the year (in US$)                            |                       
| |                                              |                       

| | 2. | Stock
options under all the share incentive and option plans are as follows:           (contd)
| | -- | -----------------------------------------------------------------------------------------------

| |                                      | Year ended December 31
| | ------------------------------------ | ----------------------
|
|
|
|
| | Options may be exercised as follows: |                       
| | First year or thereafter             |                       
| | Second year or thereafter            |                       
| | Third year or thereafter             |                       
| |                                      |                       
| |                                      |                       
| |                                      |                       
| |                                      |                       

F - 31

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 11 |  | Shareholders Equity
(contd)
|------- | - | -----------------------------

| | B. | Share
incentive and stock option plans (contd)
| | -- | -----------------------------------------------

| | No
compensation expense has been recorded in statements of operations for 2005, 2004 and
2003. The options were granted at market value.
| | ----------------------------------------------------------------------------------------------------------------------------------------

| | Market
value of the ordinary shares, as determined at the time of issuance by the Board of
Directors (subsequent to the October 1999 public offering, based on market price), was $
4.15 per share for the 1998 grants, $ 9.12 per share for the 1999 grants, $ 10.78 per
share for the 1999 plan for directors and the 1999 plan for employees, $ 15.75 for the
2000 grant, $ 8.82 for the January 2001 grant, $ 11.55 for the October 2001 grant, $ 7.90
for the 2002 grant, $ 4.67 for the 2003 grant, $ 2.90 for the 2004 grant and $ 4.07 for
the 2005 grant.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Shares
covered by unexercised options have no voting rights or rights to cash dividends.
| | ----------------------------------------------------------------------------------------

| | 3. | In
October 1995, the Financial Accounting Standards Board issued SFAS 123           Accounting
for Stock Based Compensation which establishes financial           accounting and
reporting standards for stock-based compensation plans. The           statement defines a
fair value based method of accounting for an employee stock           option.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
1998, following the adoption of the ECtel Plan, the Company adopted the disclosure
provisions of SFAS 123 but opted to remain under the expense recognition provisions of
APB No. 25, Accounting for Stock Issued to Employees.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2005, 2,442,894 options are exercisable.
| | -----------------------------------------------------------

| | As
required by SFAS 123 the Company has determined the fair value of stock-based
arrangements as follows:
| | ---------------------------------------------------------------------------------------------------------

| |                           | Fair value
| | ------------------------- | ----------
|
|
|
|
| | 1998                      |           
| | May 1999                  |           
| | August and September 1999 |           
| | 2000                      |           
| | January 2001              |           
| | October 2001 (employees)  |           
| | October 2001 (directors)  |           
| | 2002                      |           
| | 2003                      |           
| | May 2004                  |           
| | July 2004                 |           
| | August 2004 (employees)   |           
| | August 2004 (directors)   |           
| | December 2004             |           
| | February 2005             |           
| | May 2005                  |           
| | August 2005               |           
| | November 2005             |           

F - 32

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 11 |  | Shareholders Equity
(contd)
|------- | - | -----------------------------

| | B. | Share
incentive and stock option plans (contd)
| | -- | -----------------------------------------------

| | The
fair values of stock-based compensation awards granted were estimated using the Black-Scholes pricing
model with the following assumptions:
| | -------------------------------------------------------------------------------------------------------------------------------------------------

| | Year of grant            | Dividend | Expected
option life | Expected
volatility | Risk free
interest rate
| | ------------------------ | -------- | -------------------- | ------------------- | -----------------------
|
|
|
|
| | 1998                     |          |                      |                     |                        
| | 1999                     |          |                      |                     | -                      
| | 1999                     |          |                      |                     | -                      
| | 2000                     |          |                      |                     | -                      
| | January 2001             |          |                      |                     | -                      
| | October 2001 (employees) |          |                      |                     | -                      
| | October 2001 (directors) |          |                      |                     | -                      
| | 2002                     |          |                      |                     | -                      
| | 2003                     |          |                      |                     | -                      
| | May 2004                 |          |                      |                     | -                      
| | July 2004                |          |                      |                     | -                      
| | August 2004 (employees)  |          |                      |                     | -                      
| | August 2004 (directors)  |          |                      |                     | -                      
| | December 2004            |          |                      |                     | -                      
| | February 2005            |          |                      |                     | -                      
| | May 2005                 |          |                      |                     | -                      
| | August 2005              |          |                      |                     | -                      
| | November 2005            |          |                      |                     | -                      

| | As
required by SFAS 123, the Company has determined the weighted average fair value per
option of stock-based arrangements grants during 2005, 2004 and 2003 to be $ 1.67 $ 1.63
and $ 2.30, respectively. The fair values of stock-based compensation awards granted were
estimated using the Black-Scholes option-pricing model with the following
assumptions.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Had
compensation expenses for stock options granted under the ECtel Plans been determined
based on fair value at the grant dates consistent with SFAS 123 requirements, the Companys
net loss and loss per share would have been reduced to the pro forma amounts shown below
($ in thousands, except per share data):
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                            | Year ended December 31
| | ------------------------------------------ | ----------------------
|
|
|
|
| | Net loss as reported                       |                       
| | Add:  Compensation expenses recorded in    |                       
| | statements of operations                   |                       
| | Less: Compensation expenses                |                       
| | according to SFAS 123                      |                       
| |                                            |                       
| |                                            |                       
| | Pro forma loss                             |                       
| |                                            |                       
| |                                            |                       
| | Basic and diluted loss per ordinary share: |                       
| | As reported                                |                       
| |                                            |                       
| | Pro forma                                  |                       

F - 33

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 11 |  | Shareholders Equity
(contd)
|------- | - | -----------------------------

| | B. | Share
incentive and stock option plans (contd)
| | -- | -----------------------------------------------

| | C. | Warrants
| | -- | --------

| | In
October 2001, as part of Net-I acquisition, the Company granted to Telrad Networks Ltd.:
| | -------------------------------------------------------------------------------------------

| | (1) | Warrants
to acquire 1,000,000 ordinary shares for an exercise price of $ 24 per
                    share.
| | --- | ----------------------------------------------------------------------------------------------------------

| | (2) | Warrants
to acquire 250,000 ordinary shares for an exercise price of                     $ 28 per
share.
| | --- | --------------------------------------------------------------------------------------------------------

| | These
warrants were granted for five years expiring October 1, 2006 and were valued at $ 3,922
thousand using the Black  Scholes valuation model with the following
assumptions:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                         |   |          | 
| | ----------------------- | - | -------- | 
|
|
|
|
| | Expected volatility     | - | 60%      | 
| | Risk free interest rate | - | 4.57%    | 
| | Warrants terms          | - | 4 years  | 
| | Dividend                | - | 0        | 
| | Stock price             | - | $ 10.997 | 

|Note 12 |  | Taxes
on Income
|------- | - | ---------------

| | A. | Tax
programs under various Israeli tax laws:
| | -- | --------------------------------------------

| | Israeli
Company
| | ---------------

| | (1) | Israeli
income tax is computed on the basis of the Companys results in           nominal
NIS determined for statutory purposes. The Company is 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 tax law, the Company 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 the Company 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 ten 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,
2005 approximately 87% of the cost of the Companys production facilities
represented approved enterprise facilities (2004  41%; 2003  45%).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 34

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 12 |  | Taxes
on Income (contd)
|------- | - | ------------------------

| | A. | Tax
programs under various Israeli tax laws: (contd)
| | -- | -----------------------------------------------------

| | Israeli
Company (contd)
| | ------------------------

| | 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
the Company 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 the Company as defined by the Law.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | If
the Company 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 (H) below).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
March 30, 2005, the Knesset approved a reform of the Encouragement of Capital Investments
Law  1959. 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.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | 2. | Tax
benefits under the Law for the Encouragement of Industry (Taxation), 1969.
| | -- | ------------------------------------------------------------------------------

| | The
Company 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 34%, (also see Note 12H).
| | ----------------------------------------------------------------------------------------------------------------------------------------

F - 35

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 12 |  | Taxes
on Income (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 benefit (expense) 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                             |                       
| | Foreign operations                             |                       
| |                                                |                       
| |                                                |                       
| |                                                |                       
| |                                                |                       
| |                                                |                       
| |                                                |                       
| |                                                |                       

F - 36

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 12 |  | Taxes
on Income (contd)
|------- | - | ------------------------

| | D. | 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 12H) 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:                                               |                       
| |                                                                         |                       
| |                                                                         |                       
| | Theoretical tax on the above amount (2005 - 34%, 2004 -35%; 2003 - 36%) |                       
| | Tax effect of differences between the statutory rate                    |                       
| | of tax and tax rate relating to foreign operations                      |                       
| | Tax benefit arising from the "Approved Enterprise"                      |                       
| | Differences for which deferred taxes were not                           |                       
| | recorded                                                                |                       
| | Taxes in respect of prior years for which deferred                      |                       
| | taxes were not recorded                                                 |                       
| | Currency revaluation on pre-paid taxes                                  |                       
| | Increase in taxes resulting from permanent                              |                       
| | differences, net (disallowed expenses)                                  |                       
| | Adjustments arising from differences in the                             |                       
| | basis of measurement for tax purposes and                               |                       
| | for financial reporting purposes and other*                             |                       
| |                                                                         |                       
| |                                                                         |                       
| | Taxes (benefit) expense for the reported year                           |                       
| |                                                                         |                       

| | * | Resulting
from the difference between the changes in the Israeli CPI (the basis for computation of
taxable income of the Company  (see Note 12A1 above) and the changes in the
exchange rate of Israeli currency relative to the dollar.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 37

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 12 |  | Taxes
on Income (contd)
|------- | - | ------------------------

| | E. | Components
of deferred income tax
| | -- | ---------------------------------

| | The
Company recognizes deferred tax benefits based on the managements expectation that
future taxable earnings will be achieved. A valuation allowance has been recorded in
respect of the entire deferred tax assets as management concluded that at December 31,
2005 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 benefit:             |            
| |                                           |            
| | Accrued expenses                          |            
| | Inventory                                 |            
| | Vacation pay accruals                     |            
| | Allowance for doubtful debts              |            
| | Research and development costs            |            
| |                                           |            
| |                                           |            
| | Gross current deferred tax benefit        |            
| |                                           |            
| | Less - valuation allowance                |            
| |                                           |            
| |                                           |            
| | Net current deferred tax benefit          |            
| |                                           |            
| |                                           |            
| | Long term deferred tax benefit:           |            
| |                                           |            
| | Liability for employee severance benefits |            
| | Operating and capital loss carryforwards  |            
| | Fixed assets                              |            
| | Research and development costs            |            
| |                                           |            
| |                                           |            
| | Gross long term deferred tax benefit      |            
| |                                           |            
| | Less - valuation allowance                |            
| |                                           |            
| |                                           |            
| | Total net deferred tax benefit            |            
| |                                           |            

F - 38

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 12 |  | Taxes
on Income (contd)
|------- | - | ------------------------

| | F. | Tax
assessments and carryforward tax losses
| | -- | -------------------------------------------

| | Final
tax assessments have been received by the Israeli company through the 2001 tax year.
| | ------------------------------------------------------------------------------------------

| | The
U.K. and U.S. subsidiaries are currently undergoing examinations by the tax authorities
in the UK and the US. 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 Company has a tax loss carryforward of approximately $ 47 million which can be
carryforward indefinitely.
| | ---------------------------------------------------------------------------------------------------------------------

| | The
UK subsidiary has a tax loss carryforward of approximately $ 2 million which can be
carried forward indefinitely. The US subsidiary has a tax loss carryforward of $ 10
million which can be carried forward for 20 years. The German subsidiary has a tax loss
carry forward of approximately $ 230 thousand, which can be carried forward indefinitely.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | G. | Israel
Tax Reform with effect from January 1, 2003
| | -- | --------------------------------------------------

| | During
the year 2002, tax reform legislation was enacted with effect from January 1, 2003, which
significantly changed the taxation basis of corporate and individual taxpayers from a
territorial basis to a worldwide basis. From such date an Israel resident taxpayer will
be taxed on income produced and derived both in and out of Israel. The main provisions of
the tax reform that may affect the Company are as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | Transfer
pricing of international transactions with related parties.
| | -- | --------------------------------------------------------------------

| | The
Income Tax Ordinance was amended to include provisions concerning transfer pricing
between related parties, where one of the parties is situated abroad. Detailed provisions
are to be included in Income Tax Regulations that have yet to be issued. Although the
Company believes that the transfer pricing policy adopted with foreign affiliates is
economically fair, an adjustment may be required following the issue of the said
Regulations.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Employee
stock incentive plans.
| | -- | -------------------------------

| | The
tax reform codified past practice and determined three alternative tracks for taxing
employee stock option plans. Where a trustee arrangement is in place, the employer can
either claim an expense for tax purposes while the employee will be fully taxed up to the
maximum marginal tax rate of 49% or the employer can waive the tax expense and the
employee will pay a reduced tax rate of 25%. Where there is no trustee arrangement, the
employee is fully taxable and no expense is allowed to the employer. There are detailed
provisions for implementing these tracks. The Company elected the capital gains tax route
of 25%.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 39

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 12 |  | Taxes
on Income (contd)
|------- | - | ------------------------

| | G. | Israel
Tax Reform with effect from January 1, 2003 (contd)
| | -- | -----------------------------------------------------------

| | 3. | Controlled
foreign Company (CFC).
| | -- | ---------------------------------

| | The
amendment to the law introduced Controlled Foreign Company (CFC) provisions, which, in
certain circumstances, will lead to the Israeli company being charged tax on passive
income of foreign affiliates as if it had received a dividend from such companies.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | Capital
gains tax is reduced to 25% from 36%, except with respect to capital           gains from
marketable securities, with transitional provisions for assets           acquired prior
to January 1, 2003.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | The
seven year limit for carrying forward of capital losses has been removed           with
respect to capital losses arising from 1996 and thereafter.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 2006  31%, 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 has no effect on the financial statements of the Company.
| | ---------------------------------------------------------------------

|Note 13 |  | Related
Party Transactions
|------- | - | --------------------------

| | A. | Related parties are comprised of principal shareholders (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 as at December 31, 2005
|                                                                      
|                                                                      

|Note 13 |  | Related
Party Transactions (contd)
|------- | - | -----------------------------------

| | B. | The Company had various agreements with ECI Telecom Ltd. (hereinafter
          ECI), a principle shareholder, as at December 31, 2005. The
          agreements effective throughout 2005 are as follows:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | An
administrative services agreement for various services including, inter alia,
          security and limited human resources-related services, maintenance, catering
and           transportation, and general and administrative services (all mainly through
          third party providers), as well intellectual property services. For the
          performance of each service the Company paid ECI amounts as agreed upon in the
          agreement.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
agreement expired in July 2005 due to Companys relocation to its new facilities.
| | --------------------------------------------------------------------------------------

| | 2. | A
supply agreement with ECI, which replaced an earlier expired supply agreement.
          Under the terms of the new supply agreement, ECI supplies the Company with the
          components (hereinafter: modules) for use in its products. ECI may
          discontinue the production of any modules after giving 12 months prior notice,
          in which case ECI would be obligated to provide the Company with all the
          necessary information to manufacture the modules and integrate them into its
          products, as well as to supply it with spare parts for such 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 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 41

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 13 |  | Related
Party Transactions (contd)
|------- | - | -----------------------------------

| | C. | Balances
due to or from related parties:
| | -- | ----------------------------------------

| |                        | December 31
| | ---------------------- | -----------
|
|
|
|
| | Assets:                |            
| | Trade receivables, net |            
| | Other receivables      |            
| |                        |            
| | Liabilities:           |            
| | Trade payables         |            

| | D. | 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 expenses                  |                       

|Note 14 |  | Supplementary
Financial Statement Information
|------- | - | ---------------------------------------------

| | Balance
sheet:
| | --------------

| | A. | Cash
and cash equivalents
| | -- | -------------------------

| | Including
short-term deposits and marketable securities in the amount of $ 23,847 thousand as at
December 31, 2005 (December 31, 2004  $ 33,654 thousand).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Receivables
| | -- | -----------

| | 1. | Net
of provision for doubtful debts of $ 18,051 thousand as at December 31, 2005
          (December 31, 2004 - $ 20,637 thousand).
| | -- | -----------------------------------------------------------------------------------------------------------------------------------

| | The
activity in the allowance for doubtful accounts for the three years ended December 31,
2005 are 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                     |            
| |                                            |            

F - 42

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 14 |  | Supplementary
Financial Statement Information (contd)
|------- | - | ------------------------------------------------------

| | B. | Receivables (contd)
| | -- | --------------------

| | 2. | Substantially
most of the Companys sales are to large telecommunications           service
providers. In certain cases the Company obtains collaterals from its           customers,
such as letters of credit and promissory notes.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | The
Company entered into accounts receivables factoring agreements with number           of
financial institutions (banks). Under the terms of the agreement,
          the Company has the option to factor receivables, with the bank on a
          non-recourse basis, provided that the bank approves the receivable in advance.
          The company continues to be obligated in the event of the commercial disputes,
          (such as product defects) which are not covered under the credit insurance
          policy, unrelated to the credit worthiness of the customer.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 2005 trade receivables in amount of $ 423 thousand were sold (December 31,
2004  $ 2,779 thousand).
| | -------------------------------------------------------------------------------------------------------------------

| | C. | Other
Payables and Accrued Liabilities
| | -- | --------------------------------------

| | Consists
of the following:
| | --------------------------

| |                                           | December 31
| | ----------------------------------------- | -----------
|
|
|
|
| | Employees and social benefits             |            
| | Government authorities                    |            
| | Chief Scientist                           |            
| | Commissions payable                       |            
| | Verint Purchase agreement (see Note 18)   |            
| | Product warranty liability (see Note 10G) |            
| | Other payables                            |            
| |                                           |            
| |                                           |            
| |                                           |            
| |                                           |            

F - 43

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 14 |  | Supplementary
Financial Statement Information (contd)
|------- | - | ------------------------------------------------------

| | D. | Disclosures
about segments and related information
| | -- | --------------------------------------------------

| | 1. | The
Company has only one segment, which is divided on geographical basis for
          presentation purpose.
| | -- | ------------------------------------------------------------------------------------------------------------

| | 2. | Information
on sales by geographic distribution:
| | -- | ------------------------------------------------

| |                           | Year ended December 31
| | ------------------------- | ----------------------
|
|
|
|
| | Israel                    |                       
| | Asia Pacific              |                       
| | North America             |                       
| | Europe                    |                       
| | Central and Latin America |                       
| | Rest of the World         |                       
| |                           |                       
| |                           |                       
| |                           |                       
| |                           |                       

| | Revenues
are attributed to geographic distribution based on the location of the customer.
| | -----------------------------------------------------------------------------------------

| | 3. | Sales
to single customers exceeding 10% of sales :
| | -- | --------------------------------------------------

| |            | Year ended December 31
| | ---------- | ----------------------
|
|
|
|
| | Customer A |                       
| | Customer B |                       
| | Customer C |                       
| |            |                       
| |            |                       
| |            |                       
| |            |                       

F - 44

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 14 |  | Supplementary
Financial Statement Information (contd)
|------- | - | ------------------------------------------------------

| | D. | Disclosures
about segments and related information (contd)
| | -- | -----------------------------------------------------------

| | 4. | Long-lived
assets on a geographical basis :
| | -- | -------------------------------------------

| |                   | Israel | United States | Europe | Total 
| | ----------------- | ------ | ------------- | ------ | ------
|
|
|
|
| | December 31, 2005 |        |               |        | 14,583
| | December 31, 2004 |        |               |        | 11,195
| | December 31, 2003 |        |               |        | 16,235

| | E. | Cost
of revenues:
| | -- | -----------------

| |                                             | Year ended December 31
| | ------------------------------------------- | ----------------------
|
|
|
|
| | Materials and components                    |                       
| | Salaries, wages and employee benefits       |                       
| | Depreciation                                |                       
| | Royalties to Chief Scientist (see Note 10B) |                       
| | Other manufacturing and service costs       |                       
| |                                             |                       
| |                                             |                       
| | Decrease in inventories                     |                       
| | Inventory write off                         |                       
| |                                             |                       
| |                                             |                       
| |                                             |                       

| | F. | Research
and development costs, net:
| | -- | ------------------------------------

| |                             | Year ended December 31
| | --------------------------- | ----------------------
|
|
|
|
| | Expenses incurred           |                       
| | 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    |                       
| | Other expenses                 |                       
| |                                |                       
| |                                |                       
| |                                |                       
| |                                |                       

F - 45

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 14 |  | Supplementary
Financial Statement Information (contd)
|------- | - | ------------------------------------------------------

| | H. | General
and administrative expenses:
| | -- | ------------------------------------

| |                                           | Year ended December 31
| | ----------------------------------------- | ----------------------
|
|
|
|
| | Salaries and employee benefits            |                       
| | Doubtful debts                            |                       
| | Other administrative and general expenses |                       
| |                                           |                       
| |                                           |                       
| |                                           |                       
| |                                           |                       

| | I. | Financial
income and expenses:
| | -- | ------------------------------

| |                                           | Year ended December 31
| | ----------------------------------------- | ----------------------
|
|
|
|
| | Financial expenses:                       |                       
| | Interest and bank charges                 |                       
| | 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                              |                       

F - 46

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 15 |  | Balances
in Currencies Other Than the U.S Dollar:
|------- | - | -------------------------------------------------

| | A. | Comprised
of:
| | -- | -------------

| |                             | December 31, 2005 | December 31, 2004
| | --------------------------- | ----------------- | -----------------
|
|
|
|
| | 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 gains for the years ended December 31, 2005, 2004 and
          2003 are $ 123 thousand, $ 22 thousand and $ 116 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

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|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, long-term marketable securities, accounts payable and
accruals, and other long-term liabilities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
view of their nature, the fair value of the financial instruments included in working
capital of the company is usually identical or close to their carrying value.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Cash
and cash equivalents, current receivables, accounts payable and accruals and other
long-term liabilities  The carrying amounts approximate the fair value due to the
short maturity of those instruments.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of long-term marketable securities also approximate the carrying value since
it bear interest at rates closed to the prevailing market rates.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 contracts 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
2005 | December 31
2004 | December 31
2003
| | ------------------------- | ---------------- | ---------------- | ----------------
|
|
|
|
| | Restructuring costs 2005  |                  |                  |                 
| | Restructuring income 2004 |                  |                  |                 
| |                           |                  |                  |                 
| |                           |                  |                 
| |                           |                  |                  |                 
| |                           |                  |                  |                 

| | The
following table summarizes the components of restructuring costs:
| | ---------------------------------------------------------------------

| |                                     | Year ended December 31, 2005
| | ----------------------------------- | ----------------------------
|
|
|
|
| | At the beginning of the year        |                             
| | Restructuring expenses              |                             
| | Reversal related to prior year plan |                             
| | Paid                                |                             
| |                                     |                             
| | At the end of the year              |                             
| |                                     |                             

F - 48

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 18 |  | 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.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 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 Companys
employees who were hired by Verint Systems including retention bonuses, severance and
compensation liabilities with respect to the termination of certain of Companys
officers, and an accrual for certain research and development and customization expenses.
The Company has retained its existing government surveillance projects and warranty
obligations and subcontracted the performance thereof to Verint Systems upon agreed terms.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
at December 31, 2005 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 (loss) of discontinued operations, |                       
| | nil of tax                                |                       
| |                                           |                       

| | * | Gain
from sale of government surveillance business.
| | - | ---------------------------------------------------

F - 49

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 19 |  | Recently
Enacted Accounting Standards
|------- | - | -------------------------------------

| | SFAS
123R  Share-Based Payments
| | --------------------------------

| | In
December 2004, FASB issued SFAS No. 123 (revised 2004), Share-Based Payments (SFAS
123R). SFAS 123R 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 and EITF Issue No. 96-18, Accounting
for Equity InstrumentsThat Are Issued to Other Than Employees for Acquiring, or
in Conjunction with Selling, Goods or Services.SFAS 123R is effective for
public entities that do not file as small business issuers as of the beginning of the
first annual reporting period that begins after June 15, 2005. Accordingly, the Company
is required to adopt SFAS 123R effective January 1, 2006. The Company will implement SFAS
123R using the modified prospective method starting January 1, 2006. Under this method,
the Company will begin recognizing compensation cost for all new awards and for awards
modified, repurchased or canceled after January 1, 2006. Furthermore, the Company will be
required to recognize compensation cost for unvested options as of January 1, 2006 based
on the grant date fair value of these awards, as previously calculated and reported for
pro forma disclosure purposes. The Company expects stock-based compensation expense under
SFAS 123R, related to stock-based awards issued through fiscal 2005, to be approximately
$ 490 thousand, $ 475 thousand, $ 240 thousand and $ 65 thousand in fiscal 2006, 2007,
2008, and 2009, respectively. In addition, the Company expects to grant additional
stock-based awards in future years which will result in additional stock-based
compensation expense.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | SFAS
151  Inventory Costs, an amendment of Accounting Research Bulletin (ARB)
No. 43
| | ---------------------------------------------------------------------------------------

| | In
November 2004, the FASB issued SFAS No. 151, Inventory Costs  an amendment
of Accounting Research Bulletin No. 43,Chapter 4 (SFAS 151).
The amendments made by SFAS 151 clarify that abnormal amounts of idle facility expense,
freight, handling costs and wasted materials (spoilage) should be recognized as
current-period charges and require the allocation of fixed production overheads to
inventory based on the normal capacity of the production facilities. The guidance is
effective for inventory costs incurred during fiscal years beginning after June 15, 2005.
Management has not yet determined the impact, if any, the adoption of this standard will
have on its financial position and results of operations.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 50

---

---



|ECtel Ltd. and subsidiaries                                           
|----------------------------------------------------------------------
|                                                                      
|Notes to the Consolidated Financial Statements as at December 31, 2005
|                                                                      
|                                                                      

|Note 19 |  | Recently
Enacted Accounting Standards (contd)
|------- | - | ----------------------------------------------

| | SFAS
153 - Exchanges of Nonmonetary Assets, an amendment of Accounting Principles Bulletin
(APB) Opinion No. 29, "Accounting for Nonmonetary Transaction
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets
 an amendment of Accounting PrinciplesBulletin (APB) Opinion No. 29,
Accounting for Nonmonetary Transactions (SFAS 153).The guidance in
APB Opinion No. 29 is based on the principle that exchanges of nonmonetary assets should
be measured based on the fair value of the assets exchanged. The guidance in Opinion No.
29, however, included certain exception to that principle. SFAS 153 amends Opinion No. 29
to eliminate the exception for nonmonetary assets exchanges of similar productive assets
and replaces it with a general exception for exchanges of nonmonetary assets that do not
have commercial substance. A nonmonetary exchange has commercial substance if the future
cash flows of the entity are expected to change significantly as a result of the
exchange. SFAS 153 in effective for fiscal periods beginning after June 15, 2005 and
shall be applied prospectively. The adoption of this statement is not expected to result
in a material impact on the Companys financial position and results of operations.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | SFAS
154  Accounting Changes and Errors Corrections
| | ----------------------------------------------------

| | In
May 2005, the FASB issued SFAS No. 154, Accounting Changes and Errors Corrections(SFAS
154). SFAS 154 replaces APB Opinion No. 20, Accounting Changes, and
FASB Statement No. 3, Reporting Accounting Changes in Interim FinancialStatements,
although it carries forward some of their provisions. SFAS 154 requires retrospective
application to prior periods financial statements of changes in accounting
principle, unless it is impracticable to determine either the period-specific effects or
the cumulative effect of the change. A change in depreciation, amortization, or depletion
method for long-lived, nonfinancial assets will be accounted for as a change in
accounting estimate effected by a change in accounting principle. SFAS 154 is effective
for changes in accounting principle made in fiscal years beginning after December 15,
2005. The Company does not expect the adoption of SFAS 154 to have material impact on its
financial position or result of operations.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | SFAS
155  Accounting for Certain Hybrid Financial Instruments
| | --------------------------------------------------------------

| | In
February 2006, the FASB issued SFAS No. 155 Accounting for Certain Hybrid Financial
Instruments. SFAS No. 155 amends SFAS No. 133 and SFAS No. 140 and allows financial
instruments that have embedded derivatives that otherwise would require bifurcation from
the host to be accounted for as a whole, if the holder irrevocably elects to account for
the whole instrument on a fair value basis.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Subsequent
changes in the fair value of the instrument would be recognized in earnings. The standard
also:
| | ----------------------------------------------------------------------------------------------------------

| |  | Clarifies
which interest-only strips and principal-only strips are not subject to the requirements
of statement 133;
| | - | --------------------------------------------------------------------------------------------------------------------

| |  | Established
a requirement to evaluate interests in securitized financial assets to determine whether
interests are freestanding derivatives or are hybrid financial instruments that contain
an embedded derivative requiring bifurcation;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Clarified
that concentrations of credit risk in the form of subordination are not embedded
derivatives, and
| | - | -----------------------------------------------------------------------------------------------------------

| |  | Amends
Statement 140 to eliminate the prohibition on a qualifying special-purpose entity from
holding a derivative financial instrument that pertains a beneficial interest (that is
itself a derivative financial instrument).
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | SFAS
No. 155 is effective for all financial instruments acquired or issued after the beginning
of an entitys first fiscal year that begins after September 15, 2006. The Company
is currently evaluating the impact adoption of SFAS No. 155 is expected to have on its
financial position and results of operations.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Note 20 |  | Subsequent
Events
|------- | - | -----------------

| | On
January 16, 2006, the Company changed the acquired companies names from Elron
Telesoft Ltd. and Elron Telesoft Export (98) Ltd. to ECtel Telesoft Ltd. and ECtel
Telesoft Export (98) Ltd., respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 51

---

---