Document:

6-K

Exhibit 10.1  

TOP IMAGE SYSTEMS LTD. AND
ITS SUBSIDIARIES 

INTERIM CONSOLIDATED
FINANCIAL STATEMENTS 

AS OF JUNE 30, 2005 

IN U.S. DOLLARS 

UNAUDITED 

INDEX 

	 	Page 

	Consolidated Balance Sheets 	2 -3 
	Consolidated Statements of Operations 	4 
	Statements of Changes in Shareholders' Equity 	5 
	Consolidated Statements of Cash Flows 	6 - 7 
	Notes to Consolidated Financial Statements 	8 - 17 

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	CONSOLIDATED BALANCE SHEETS
	

	In U.S. dollars 

		June 30,

2005
	December 31,

2004

		Unaudited
	
	 		
			
			
	    ASSETS	 	 	 		 	 		 
	  	 	 
	CURRENT ASSETS:	 	 
	  Cash and cash equivalents	 	 	$	   8,125,720	 	$	  10,136,141	 
	  Marketable securities	 	 	 	1,503,235	 	 	278,635	 
	  Trade receivables, net	 	 	 	6,493,101	 	 	5,541,006	 
	  Other current assets	 	 	 	709,666	 	 	566,258	 
		
		
	
	  	 	 
	Total current assets 	 	 	 	16,831,722	 	 	16,522,040	 
		
		
	
	  	 	 
	LONG-TERM DEPOSITS	 	 	 	144,406	 	 	147,065	 
		
		
	
	  	 	 
	PROPERTY AND EQUIPMENT:	 	 
	  Cost	 	 	 	2,292,785	 	 	2,194,509	 
	  Less - accumulated depreciation	 	 	 	(1,688,308	)	 	(1,576,285	)
		
		
	
	  	 	 
	 	 	 	 	604,477	 	 	618,224	 
		
		
	
	  	 	 
	INTANGIBLE ASSETS:	 	 
	  Goodwill, net	 	 	 	430,324	 	 	453,584	 
	  Other intangible assets, net	 	 	 	1,259,372	 	 	1,418,750	 
		
		
	
	  	 	 
	 	 	 	 	1,689,696	 	 	1,872,334	 
		
		
	
		 	 
	Total assets 	 	 	$	  19,270,301	 	$	  19,159,663	 
		
		
	

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

- 2 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	CONSOLIDATED BALANCE SHEETS
	

	In U.S. dollars 

		June 30,

2005
	December 31,

2004

		Unaudited
	
	 		
			
			
	    LIABILITIES AND SHAREHOLDERS' EQUITY	 	 	 		 	 		 
	  	 	 
	CURRENT LIABILITIES:	 	 
	  Short-term bank loans	 	 	$	   2,396,151	 	$	   1,707,151	 
	  Trade payables	 	 	 	645,590	 	 	404,522	 
	  Other accounts payable and accruals	 	 	 	2,154,273	 	 	2,177,951	 
		
		
	
	  	 	 
	Total current liabilities	 	 	 	5,196,014	 	 	4,289,624	 
		
		
	
	  	 	 
	LONG-TERM LIABILITIES:	 	 
	  Accrued severance pay, net	 	 	 	176,307	 	 	186,514	 
		
		
	
	  	 	 
	COMMITMENTS, CONTINGENCIES AND CHARGES	 	 
	  	 	 
	SHAREHOLDERS' EQUITY:	 	 
	  Share capital:	 	 
	    Ordinary shares of NIS 0.04 par value -	 	 
	      Authorized: 125,000,000 shares at June 30, 2005 and December 31, 2004;	 	 
	      Issued and outstanding: 8,757,366 and 8,753,991 shares at June 30, 2005	 	 
	      and December 31, 2004, respectively	 	 	 	96,797	 	 	96,766	 
	  Additional paid-in capital	 	 	 	29,507,554	 	 	29,578,981	 
	  Accumulated deficit	 	 	 	(15,706,371	)	 	(14,992,222	)
		
		
	
	  	 	 
	Total shareholders' equity	 	 	 	13,897,980	 	 	14,683,525	 
		
		
	
	  	 	 
	Total liabilities and shareholders' equity	 	 	$	  19,270,301	 	$	  19,159,663	 
		
		
	

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

- 3 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	CONSOLIDATED STATEMENTS OF OPERATIONS
	

	In U.S. dollars 

		Six months ended
June 30,
	Three months ended
June 30,
	Year ended
December 31,

		2005
	2004
	2005
	2004
	2004

		Unaudited
	
	 					
						
	Revenues:	 	 	 		 	 		 	 		 	 		 	 		 
	  Product sales	 	 	$	   4,471,096	 	$	   3,085,624	 	$	   2,382,344	 	$	   1,276,251	 	$	   6,964,418	 
	  Service revenues	 	 	 	3,529,275	 	 	1,717,808	 	 	1,660,742	 	 	1,162,695	 	 	4,214,030	 
		
		
		
		
		
	
	  	 	 
	Total revenues	 	 	 	8,000,371	 	 	4,803,432	 	 	4,043,086	 	 	2,438,946	 	 	11,178,448	 
		
		
		
		
		
	
	  	 	 
	Cost of revenues:	 	 
	  Product costs	 	 	 	1,446,838	 	 	753,836	 	 	742,359	 	 	383,370	 	 	1,970,670	 
	  Service costs	 	 	 	1,755,312	 	 	534,708	 	 	795,472	 	 	284,383	 	 	1,501,429	 
		
		
		
		
		
	
	  	 	 
	Total cost of revenues	 	 	 	3,202,150	 	 	1,288,544	 	 	1,537,831	 	 	667,753	 	 	3,472,099	 
		
		
		
		
		
	
	  	 	 
	Gross profit	 	 	 	4,798,221	 	 	3,514,888	 	 	2,505,255	 	 	1,771,193	 	 	7,706,349	 
		
		
		
		
		
	
	  	 	 
	Operating expenses:	 	 
	  Research and development	 	 	 	729,433	 	 	401,983	 	 	360,710	 	 	205,161	 	 	929,432	 
	  Selling and marketing	 	 	 	2,754,918	 	 	2,060,338	 	 	1,185,579	 	 	996,834	 	 	4,546,695	 
	  General and administrative	 	 	 	1,887,623	 	 	998,717	 	 	840,809	 	 	522,047	 	 	2,588,014	 
		
		
		
		
		
	
	  	 	 
	Total operating expenses	 	 	 	5,371,974	 	 	3,461,038	 	 	2,387,098	 	 	1,724,042	 	 	8,064,141	 
		
		
		
		
		
	
	  	 	 
	Operating profit (loss)	 	 	 	(573,753	)	 	53,850	 	 	118,157	 	 	47,151	 	 	(357,792	)
	  	 	 
	Financial income (expenses), net	 	 	 	(140,396	)	 	(17,037	)	 	(61,447	)	 	(25,344	)	 	179,400	 
		
		
		
		
		
	
	  	 	 
	Net income (loss)	 	 	$	    (714,149	)	$	      36,813	 	$	      56,710	 	$	      21,807	 	$	    (178,392	)
		
		
		
		
		
	
	  	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 	 
	Net earnings (loss) per share	 	 	$	       (0.08	)	$	        0.01	 	$	        0.01	 	$	        0.00	 	$	       (0.03	)
		
		
		
		
		
	
	  	 	 
	Weighted average number of shares used in	 	 
	  the computation of net earnings (loss) per	 	 
	  share	 	 	 	8,944,544	 	 	6,345,116	 	 	8,944,544	 	 	6,369,640	 	 	7,092,434	 
		
		
		
		
		
	

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

- 4 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
	

	In U.S. dollars 

		Share capital
	Additional
paid-in
capital
	Accumulated

deficit
	Total

		Number of
shares
	Amount

	 					
						
						
	Balance at January 1, 2004	 	 	 	6,120,765	 	$	      73,274	 	$	  22,380,262	 	$	 (14,813,830	)	$	   7,639,706	 
	  	 	 
	Issuance of shares, net	 	 	 	2,524,351	 	 	22,519	 	 	6,959,647	 	 	-	 	 	6,982,166	 
	Exercise of stock options	 	 	 	108,875	 	 	973	 	 	239,072	 	 	-	 	 	240,045	 
	Net loss	 	 	 	-	 	 	-	 	 	-	 	 	(178,392	)	 	(178,392	)
		
		
		
		
		
	
	  	 	 
	Balance at December 31, 2004	 	 	 	8,753,991	 	 	96,766	 	 	29,578,981	 	 	(14,992,222	)	 	14,683,525	 
	  	 	 
	Issuance expenses	 	 	 	-	 	 	-	 	 	(77,000	)	 	-	 	 	(77,000	)
	Exercise of stock options	 	 	 	3,375	 	 	31	 	 	5,573	 	 	-	 	 	5,604	 
	Net loss	 	 	 	-	 	 	-	 	 	-	 	 	(714,149	)	 	(714,149	)
		
		
		
		
		
	
	  	 	 
	Balance at June 30, 2005 (unaudited)	 	 	 	8,757,366	 	$	      96,797	 	$	  29,507,554	 	$	 (15,706,371	)	$	  13,897,980	 
		
		
		
		
		
	

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

- 5 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	CONSOLIDATED STATEMENTS OF CASH FLOWS
	

	In U.S. dollars 

		Six months ended
June 30,
	Year ended
December 31,

		2005
	2004
	2004

		Unaudited
	
	 			
				
	Cash flows from operating activities: 	 	 	 		 	 		 	 		 
	  	 	 
	  Net income (loss)	 	 	$	    (714,149	)	$	      36,813	 	$	    (178,392	)
	  Adjustments to reconcile net income (loss) to net cash used in	 	 
	    operating activities:	 	 
	    Depreciation and amortization	 	 	 	287,276	 	 	86,157	 	 	282,167	 
	    Accrued severance pay, net	 	 	 	(10,207	)	 	13,891	 	 	(4,402	)
	    Exchange rate changes on marketable securities	 	 	 	3,386	 	 	-	 	 	(4,557	)
	    Loss (gain) from marketable securities, net	 	 	 	(6,986	)	 	2,160	 	 	2,379	 
	    Increase in trade receivables	 	 	 	(952,095	)	 	(563,918	)	 	(934,752	)
	    Increase in other current assets	 	 	 	(143,408	)	 	(98,390	)	 	(152,542	)
	    Increase (decrease) in trade payables	 	 	 	241,068	 	 	(70,756	)	 	98,569	 
	    Increase (decrease) in other accounts payable and accruals	 	 	 	225,235	 	 	(376,742	)	 	(181,510	)
		
		
		
	
	  	 	 
	Net cash used in operating activities	 	 	 	(1,069,880	)	 	(970,785	)	 	(1,073,040	)
		
		
		
	
	  	 	 
	Cash flows from investing activities:	 	 
	  	 	 	 	 	 	 	 	 	 	 	 
	  Acquisition of business activity (a)	 	 	 	(72,517	)	 	-	 	 	(1,762,763	)
	  Purchase of property and equipment	 	 	 	(90,891	)	 	(120,915	)	 	(415,997	)
	  Proceeds from sale of marketable securities	 	 	 	279,000	 	 	-	 	 	138,062	 
	  Purchase of marketable securities	 	 	 	(1,500,000	)	 	-	 	 	(138,004	)
	  Decrease (increase) in long-term deposits	 	 	 	2,659	 	 	8,348	 	 	(61,070	)
		
		
		
	
	  	 	 
	Net cash used in investing activities	 	 	 	(1,381,749	)	 	(112,567	)	 	(2,239,772	)
		
		
		
	
	  	 	 
	Cash flows from financing activities:	 	 
	  	 	 	 	 	 	 	 	 	 	 	 
	  Proceeds from issuance of shares, net	 	 	 	-	 	 	-	 	 	7,239,341	 
	  Payment of accrued issuance expenses	 	 	 	(253,396	)	 	-	 	 	-	 
	  Proceeds from exercise of stock options	 	 	 	5,604	 	 	159,070	 	 	240,045	 
	  Increase in short-term bank credit, net	 	 	 	689,000	 	 	3,899	 	 	115,131	 
		
		
		
	
	  	 	 
	Net cash provided by financing activities	 	 	 	441,208	 	 	162,969	 	 	7,594,517	 
		
		
		
	
	  	 	 
	Increase (decrease) in cash and cash equivalents	 	 	 	(2,010,421	)	 	(920,383	)	 	4,281,705	 
	Cash and cash equivalents at beginning of the period	 	 	 	10,136,141	 	 	5,854,436	 	 	5,854,436	 
		
		
		
	
	  	 	 
	Cash and cash equivalents at end of the period	 	 	$	   8,125,720	 	$	   4,934,053	 	$	  10,136,141	 
		
		
		
	
	  	 	 
	Non-cash activity	 	 
	  Accrued issuance expenses	 	 	$	      77,000	 	$	  -	 	$	     257,175	 
		
		
		
	
	  	 	 
	  Accrued expenses on account of acquisition	 	 	$	  -	 	$	  -	 	$	     202,451	 
		
		
		
	

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

- 6 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	CONSOLIDATED STATEMENTS OF CASH FLOWS
	

	In U.S. dollars 

		Year ended
December 31,
2004

	 	
		
		
		
	(a)   Acquisition of business activity:	 	 	 		 
	  	 	 	 	 	 
	      Fair value of assets acquired at the acquisition date:	 	 
	  	 	 	 	 	 
	        Identifiable intangible assets	 	 	$	  1,500,000	 
	        Goodwill	 	 	 	465,214	 
		
	
	  	 	 	 	 	 
	 	 	 	 	1,965,214	 
	  	 	 	 	 	 
	      Accrued expenses on account of acquisition	 	 	 	(202,451	)
		
	
	 	 	 	$	  1,762,763	 
		
	

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

- 7 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	

	In U.S. dollars 

	NOTE 1:  	– 	
GENERAL  

	 	a. 	Top
Image Systems Ltd. (“TIS” or the “Company”) is engaged           in
the development and marketing of a variety of information recognition systems
          and technologies and automated document capture solutions for the efficient
flow           of information within and between organizations. The Company’s
software           minimizes the need for manual data entry by automatically capturing,
reading,           understanding, identifying, processing, classifying and routing the
information           contained in documents, increasing data capture accuracy and the
rate of           information processing. The Company’s shares are traded on the
National           Association of Securities Dealers’ Automatic Quotation System
SmallCap           Market in the United States under the symbol “TISA”. 

	 	b. 	In
connection with the private placement held in September 2004, the Company           filed
a resale registration statement covering the shares purchased in the           private
placement. The registration statement became effective on March 1, 2005.
          However, the Company did not obtain effectiveness of the registration statement
          within the timeframe set forth in the agreements with the investors, which has
          subjected the Company to liquidated damages in the amount of $163,475, recorded
          under General and Administrative expenses in the results of operations for the
          six months ended June 30, 2005. 

	NOTE 2:  	– 	
UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS  

	 	
The
accompanying unaudited interim consolidated financial statements have been prepared in
accordance with generally accepted accounting principles (“GAAP”) in Israel for
interim financial information. Accordingly, they do not include all the information and
footnotes required by Israeli GAAP for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered
necessary for a fair presentation have been included. See Note 5 for the effect of
material differences between Israeli GAAP and U.S. GAAP. Operating results for the six
months ended June 30, 2005 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2005. 

	NOTE 3:  	– 	
SIGNIFICANT ACCOUNTING POLICIES  

	 	a. 	The
significant accounting policies applied in the annual financial statements
               of the Company as of December 31, 2004 are applied consistently in these
               financial statements. 

	 	b.	        Effect
of a new Accounting Standards: 

	 	
In
July  2005,  the  Israel  Accounting  Standards  Board  issued  Accounting  Standard  No.
 22,                      "Financial Instruments: Disclosure and Presentation". 

- 8 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	

	In U.S. dollars 

	NOTE 3:  	– 	
SIGNIFICANT ACCOUNTING POLICIES (Cont.)  

	 	
This
Standard prescribes principles regarding the presentation of financial instruments and
details the proper disclosure required in their respect in the financial statements. The
presentation principles apply to the classification of financial instruments or their
component parts, on initial recognition as a financial liability, financial asset or
equity instrument; the classification of related interest, dividends, losses and gains;
and the circumstances in which a financial asset and a financial liability should be
offset. This Standard shall apply to financial statements for periods commencing on or
after January 1, 2006. 

	 	
According
to the new standard, compound financial instruments, that include both a liability and an
equity component, should be bifurcated between the equity and liability component and
each component should be classified separately in accordance with the Standard’s
guidance. That is in contrast to current accounting principles, according to which the
aforementioned financial instrument is classified as a financial liability or a mezannine
item (depending on the probability of conversion). Transaction costs (net of any related
income tax benefit) of an equity transaction are accounted for as a deduction from
equity, while transaction costs of a financial liability are deducted from the liability
and are taken into account, when calculating the effective interest rate. 

	 	
The
new Standard also broadens the definition of a financial liability, thus causing certain
financial instruments, which are considered under current accounting guidance to be
equity instruments, to be considered as financial liabilities. In addition, the new
Standard supersedes Standards No. 48 and 53 of the Institute of Certified Public
Accountants in Israel, according to which an investor should record a provision for a
probable loss to result from decrease in its interest in the investee, following the
conversion of the investee’s convertible instruments (“loss provision”). 

	 	
The
Standard shall be applied prospectively. Comparative data presented in financial
statements for periods beginning on the Standard’s effective date will not be
restated. Financial instruments that were issued prior to the Standard’s effective
date will be classified and presented in accordance with the provisions of the Standard
beginning on the Standard’s effective date. Compound financial instruments, which
were issued in prior periods and were not yet converted or redeemed as of the Standard’s
effective date, will be bifurcated to their components and presented accordingly,
beginning on the Standard’s effective date. A loss provision included in the
financial statements of an investor at the Standard’s effective date should be
reversed at such date as a cumulative effect in the current period. 

	 	
In
the Company’s opinion, the effect of the new Standard on its financial position,
results of operations and cash flows is not expected to be material. 

	 	
In
September 2005, the Israel Accounting Standards Board promulgated Accounting Standard No.
24, “Share Based Payment” (“the Standard”). The Standard shall apply
to financial statements for the periods commencing on or after January 1, 2006
(effective date). 

- 9 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	

	In U.S. dollars 

	NOTE 3:  	– 	
SIGNIFICANT ACCOUNTING POLICIES (Cont.)  

	 	
This
Standard requires the Company to recognize share based payment transactions in its
financial statements in respect to, for example, the purchase of merchandise or services.
Such transactions include transactions with employees or other parties that must be
settled through the Company’s capital instruments or by cash, as well as
transactions that allow the Company or the supplier of the service or merchandise to
elect between settling in cash or settling with capital instruments. Corresponding with
the recognition of merchandise or services received, it is necessary to recognize in the
financial statements the increase in shareholders’ equity when the share based
payment transaction will be settled through capital instruments, and with a liability
– where this transaction will be settled by cash. This contrasts with the situation
until now pursuant to which certain types of transactions, as aforesaid, were not
expressed in the financial statements. 

	 	
The
Standard prescribes the measurement principles with regard to the merchandise or the
services that were provided in exchange for the granted capital instrument In particular,
measurement principles were prescribed with respect to transactions with employees and
others who are providing similar services, transactions with parties who are not
employees and transactions that are measured according to the fair value of the granted
capital instruments. In addition, requirements were prescribed for cases where changes
occur in the conditions for granting the capital instrument. 

	 	
In
respect to transactions settled with capital instruments, the Standard applies to grants
made prior to March 15, 2005, but which had not yet matured as of January 1,
2006 (the effective date). The Standard shall also apply to changes (not just to grants)
that occurred in the conditions of transactions settled with capital instruments that
were carried out subsequent to March 15, 2005, even if the grants in whose respect
the changes occurred, do not come under the force of the Standard. In the 2006 financial
statements, the 2005 financial statements shall be restated in order that they may
reflect to the charging of the related expense to the grants, as stated above. 

	 	
In
the Company’s opinion, the effect of the new Standard on its financial position,
results of operations and cash flows is not expected to be material. 

	NOTE 4:  	– 	
TAXES ON INCOME  

	 	
On
July 25, 2005, the Knesset (Israeli Parliament) passed the Law for the Amendment of the
Income Tax Ordinance (No. 147), 2005, which prescribes, among other things, a gradual
decrease in the corporate income tax rate in Israel to the following rates: in 2006 –31%,
in 2007 – 29%, in 2008 – 27%, in 2009 – 26% and in 2010 and thereafter
– 25%. The amendment is not expected to have a material effect on the Company’s
financial position and results of operations. 

- 10 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	

	In U.S. dollars 

	NOTE 5:  	– 	
EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN ISRAEL
AND IN THEUNITED STATES  

	 	a.	   Details
of differences: 

	 	
The
Company prepares its financial statements in conformity with Israeli GAAP. As applicable
to these financial statements, Israeli GAAP and U.S. GAAP differ in certain significant
respects. The Major differences that have an affect on these financial statements are
described below: 

	 	1.	       Accounting
for stock-based compensation:  

	 	
According
to U.S. and Israeli GAAP, the Company has elected to follow Accounting Principles Board
Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”)
and FASB Interpretation No. 44, “Accounting for Certain Transactions Involving Stock
Compensation” (“FIN No. 44”) in accounting for its employee stock option
plans. Under APB No. 25, when the exercise price of the Company’s stock option is
less than the market price of the underlying shares on the date of grant, compensation
expense is recognized. 

	 	
Statement
of Financial Accounting Standard No. 123, “Accounting for Stock-Based Compensation” (“SFAS
No. 123”), as amended by Financial Accounting Standards Board (FASB) issued SFAS No.
148, “Accounting for Stock Based Compensation – Transition and Disclosure – an
Amendment of SFAS No. 123", requires companies that apply APB No. 25 in accounting
for employee stock options to provide pro forma information regarding net income (loss)
and net earnings (loss) per share determined as if the Company had accounted for its
employee stock options under the fair value method of SFAS 123. 

	 	
For
purposes of pro forma disclosure, the fair value for these options was estimated at the
date of grant using a Black-Scholes Option pricing model, with the following
weighted-average assumptions for each of the six months ended June 30, 2005 and 2004:
expected volatility of 36% and 70%, respectively; a risk-free interest rate of 3.25% and
2.25% respectively; dividend yield of 0% for all period; and a weighted-average expected
life of 4 and 5 years, respectively. 

	 	
For
purposes of pro forma disclosure, the estimated fair value of the options is amortized to
expenses over the options’ vesting period, which is between three to four years. 

- 11 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	

	In U.S. dollars 

	NOTE 5:-  	– 	EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN ISRAEL AND IN
THE UNITED STATES (Cont.)  

	 	
Pro
forma information under SFAS No. 123, is as follows:  

		Six months ended
June 30,
	Year ended
December 31,

		2005
	2004
	2004

	 			
				
				
	Net income (loss):	 	 	 		 	 		 	 		 
	U.S. GAAP as reported in Note 5b(2)	 	 	$	 (692,247	)	$	   30,886	 	$	 (167,927	)
	  	 	 
	Add - Stock-based employee 	 	 
	    compensation - intrinsic value	 	 	 	-	 	 	-	 	 	-	 
	  	 	 
	Deduct - Stock-based compensation expense	 	 
	   determined under fair value method for	 	 
	   all awards	 	 	 	95,832	 	 	89,005	 	 	178,010	 
		
		
		
	
	  	 	 
	Pro forma net loss	 	 	$	 (788,079	)	$	  (58,119	)	$	 (345,937	)
		
		
		
	
	  	 	 
	Pro forma basic and diluted net 	 	 
	   loss per share	 	 	$	    (0.09	)	$	    (0.01	)	$	    (0.05	)
		
		
		
	
	  	 	 
	Basic and diluted loss per share as	 	 
	   reported under U.S. GAAP in Note 5b(3)	 	 	$	    (0.08	)	$	     0.01	 	$	    (0.02	)
		
		
		
	

	 	2.	     Marketable
securities:  

	 	
According
to Israeli GAAP, marketable securities designated for sale in the short-term are carried
at market value, in accordance with Israeli Statement of Opinion No. 44. Unrealized gains
from securities classified as a “current investment” in accordance with Israeli
GAAP are reflected in earnings even if transactions are not carried out on the basis,
which would meet the definition of the trading security under U.S. GAAP. 

	 	
For
U.S. GAAP purposes, the Company has determined, as of the purchase date and as of the
balance sheet date, that its marketable securities should be classified as
available-for-sale and stated at fair value, with unrealized gains and losses, reported
in the accumulated other comprehensive income (loss), in accordance with Statement of
Financial Accounting Standard No. 115, “Accounting for Certain Investments in Debt
and Equity Securities” (“SFAS No. 115”). 

- 12 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	

	In U.S. dollars 

	NOTE 5:  	– 	
EFFECT OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN ISRAEL
AND IN THE UNITED STATES (Cont.)  

	 	3.	         Comprehensive
income:  

	 	
Under
U.S. GAAP, in accordance with SFAS 130, “Reporting Comprehensive Income”, the
Company should include and display specific 

	 	
income
components as comprehensive income as part of shareholders’ equity. Under Israeli
GAAP, there are no such disclosure requirements. 

	 	
Comprehensive
income consists of net loss and net unrealized gain (losses) on securities and is
presented as a separate component in the statement of changes in shareholders’equity. 

	 	
See
5b(4) below for the presentation of the statements of changes in shareholders’ equity
under U.S. GAAP. 

- 13 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	

	In U.S. dollars 

	NOTE 5:  	– 	EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN ISRAEL AND IN
THE UNITED STATES (Cont.)  

	 	4.	     Accrued
severance pay:  

	 	
Under
U.S. GAAP, the Company applies EITF 88-1, “Determination of Vested Benefit
Obligation for a Defined Benefit Pension Plan” under which deferred vested benefits
should record the obligation as if it was payable at each balance sheet date. Accrued
severance pay is included in the balance sheet under total liabilities. Amounts funded
through provident funds and insurance policies are included as an asset on the Company’s
balance sheet. Income from earnings on amounts funded is added to the severance pay fund. 

	 	
According
to Israeli GAAP, accrued severance pay is included in the balance sheets net of severance
pay fund. 

	 	5.	       Earnings
(loss) per share:  

	 	
According
to Israeli GAAP, in accordance with Statement No. 55 of the Institute of Certified Public
Accountants in Israel, the dilutive effect of options, warrants and other convertible
securities is included in the computation of basic earnings per share only if their being
exercised is considered to be probable, based on the ordinary relationship between the
market price of the shares issuable upon the exercise of the options, warrants and other
convertible securities, and the discounted present value of the future proceeds derived
from the exercise of such options, warrants and convertible securities. 

	 	
According
to U.S. GAAP, basic net earnings per share are computed based on the weighted average
number of Ordinary shares outstanding during each year. Diluted net earnings (loss) per
share is computed based on the weighted average number of Ordinary shares outstanding
during each year, plus dilutive potential Ordinary shares considered outstanding during
the year, in accordance with FASB Statement No. 128, “Earnings per Share”. 

	 	
See
5b(3). below for the reconciliation of earnings (loss) per share computation.  

	 	6.	          Goodwill
amortization:  

	 	
Under
Israeli GAAP, goodwill is amortized over the estimated period of benefit, but usually no
longer than 10 years. Goodwill is reviewed for impairment when circumstances indicate the
possibility that impairment exists. 

	 	
Under
U.S. GAAP, under Statement of Financial Accounting Standard No. 142, “Goodwill and
Other Intangible Assets” goodwill acquired in a business combination for which the
date is on or after July 1, 2001, shall not be amortized. 

- 14 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	

	In U.S. dollars 

	NOTE 5:  	– 	EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN ISRAEL AND IN
THE UNITED STATES (Cont.)  

	 	
SFAS
No. 142 requires goodwill to be tested for impairment on adoption and at least annually
thereafter or between annual tests in certain circumstances, and written down when
impaired, rather than being amortized as previous accounting standards required. Goodwill
is tested for impairment by comparing the fair value of each reporting unit with its
carrying value. Fair value is determined using discounted cash flows, market multiples
and market capitalization. Significant estimates used in the methodologies include
estimates of future cash flows, future short-term and long-term growth rates, weighted
average cost of capital and estimates of market multiples for each of the reportable
units. 

	 	
For
the six months ended June 30, 2005 and for the year ended December 31, 2004, the impact
of the accounting difference on the financial statements amounted to $ 23,260 and $
11,630, respectively, which was recorded as goodwill amortization under Israeli GAAP and
would not be recorded as expenses under U.S. GAAP. 

	 	7.	         Recently
Issued Accounting Standards:  

	 	
In
May 2005, the FASB issued SFAS No. 154 “Accounting Changes and Errors Corrections” (“FAS
154”). FAS 154 replaces APB No. 20 “accounting changes” and SFAS No. 3
“Reporting Accounting changes in Interim Financial Statements”. FAS 154 applies
to all voluntary changes in accounting principle, and changes the accounting for and
reporting of a change in accounting principle. FAS 154 requires, unless impracticable,
retrospective application as the required method for reporting a change in accounting
principle in the absence of explicit transition requirements specific to the newly
adopted accounting principle. This statement also provides guidance for determining
whether retrospective application of a change in accounting principle is impracticable
and for reporting a change when retrospective application is impracticable. APB No. 20
previously required that most voluntary changes in accounting principle be recognized by
including in net income of the period of the change the cumulative effect of changing to
the new accounting principle. FAS 154 is effective for accounting changes and corrections
of errors made in fiscal years beginning after December 15, 2005. The Company does not
believe that FAS 154 will have a material effect on its financial statements. 

- 15 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	

	In U.S. dollars 

	NOTE 5:  	– 	EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN ISRAEL AND IN
THE UNITED STATES (Cont.)  

	 	b.	      Effect
of differences: 

	 	
The
effect of the material differences between Israeli and U.S. GAAP of the aforementioned
items on the financial statements is as follows: 

	 	1.	        On
balance sheet items:  

		June 30, 2005
	December 31, 2004

		As per

Israeli GAAP
	Adjustment
	As per

U.S.

GAAP
	As per

Israeli

GAAP
	Adjustment
	As per

U.S.

GAAP

	 						
							
							
	Assets:	 	 	 		 	 		 	 		 	 		 	 		 	 		 
	Amounts funded with	 	 
	 respect of severance pay	 	 	$	           -	 	$	     731,115	 	$	     731,115	 	$	      -	 	$	     571,213	 	$	     571,213	 
	Goodwill	 	 	 	430,324	 	 	34,890	 	 	465,214	 	 	453,584	 	 	11,630	 	 	465,214	 
		
		
		
		
		
		
	
	  	 	 
	Total assets	 	 	$	  19,270,301	 	$	     766,005	 	$	  20,036,306	 	$	  19,159,663	 	$	     582,843	 	$	  19,742,506	 
		
		
		
		
		
		
	
	Liabilities:	 	 
	Accrued severance pay	 	 	$	    (176,307	)	$	    (731,115	)	$	    (907,422	)	$	    (186,514	)	$	    (571,213	)	$	    (757,727	)
	Shareholders' equity	 	 	 	(13,897,980	)	 	(34,890	)	 	(13,932,870	)	 	(14,683,525	)	 	(11,630	)	 	(14,695,155	)
		
		
		
		
		
		
	
	  	 	 
	Total liabilities and	 	 
	  shareholders' equity	 	 	$	 (19,270,301	)	$	    (766,005	)	$	 (20,036,306	)	$	 (19,159,663	)	$	    (582,843	)	$	 (19,742,506	)
		
		
		
		
		
		
	

	 	2.	       On
statement of operations items:  

	 	
Loss
from securities defined as available-for-sale should be reconciled as follows:  

		Six months ended
June 30,
	Year ended
December 31,

		2005
	2004
	2004

	 			
				
				
	Net income (loss) - Israeli GAAP	 	 	$	 (714,149	)	$	   36,813	 	$	 (178,392	)
	Net adjustment to comprehensive income	 	 
	  in respect of unrealized gains on	 	 
	  marketable securities	 	 	 	(1,358	)	 	(5,927	)	 	(1,165	)
	Goodwill amortization expenses	 	 	 	23,260	 	 	-	 	 	11,630	 
		
		
		
	
	  	 	 
	Net income (loss) - U.S. GAAP	 	 	$	 (692,247	)	$	   30,886	 	 	(167,927	)
		
		
		
	

- 16 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	

	In U.S. dollars 

	NOTE 5:  	– 	EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN ISRAEL AND IN
THE UNITED STATES (Cont.)  

	 	3.	          On
earnings (loss) per Ordinary share:  

	 	
The
following table sets forth the computation of basic and diluted net earnings (loss) per
share in accordance with U.S. GAAP: 

		Six months ended
June 30,
	Year ended
December 31,

		2005
	2004
	2004

	 			
				
				
	Numerator for basic and diluted earnings	 	 	 		 	 		 	 		 
	  (loss) per share - income (loss)	 	 
	  available to shareholders	 	 	$	    (692,247	)	$	     30,886	 	$	   (167,927	)
		
		
		
	
	  	 	 
	Weighted average shares outstanding:	 	 
	  	 	 	 	 	 	 	 	 	 	 	 
	Denominator for basic net earnings (loss)	 	 
	  per share	 	 	 	8,755,169	 	 	6,155,741	 	 	6,905,559	 
	Effect of dilutive securities	 	 	*)	-	 	 	143,281	 	*)	-	 
		
		
		
	
	  	 	 
	Denominator for diluted net earnings	 	 
	  (loss) per share	 	 	 	8,755,169	 	 	6,299,022	 	 	6,905,559	 
		
		
		
	
	  	 	 
	Basic and diluted net earnings (loss) per	 	 
	  share	 	 	$	       (0.08	)	$	       0.01	 	$	      (0.02	)
		
		
		
	

	*) 	      Anti
dilutive. 

- 17 -

	TOP IMAGE SYSTEMS LTD. AND ITS SUBSIDIARIES 
	 
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	

	In U.S. dollars 

	NOTE 5:  	– 	EFFECT
OF MATERIAL DIFFERENCES BETWEEN GENERALLY ACCEPTED ACCOUNTING PRINCIPLES IN ISRAEL AND IN
THE UNITED STATES (Cont.)  

	 	4.	         Statement
of changes in shareholders’ equity and comprehensive income           (loss):  

		Amount
	Additional
paid-in
capital
	Accumulated
other
comprehensive
income
(loss)
	Accumulated
deficit
	Comprehensive
income (loss)
	Total

	 						
							
							
							
	Balance at January 1, 2004  	 	 	$	      73,274	 	$	  22,380,262	 	$	       (2,523	)	$	 (14,811,307	)	 	  	 	$	   7,639,706	 
	Net unrealized gains on	 	 
	  available-for-sale securities	 	 	 	-	 	 	-	 	 	1,165	 	 	-	 	$	        1,165	 	 	1,165	 
	Net loss	 	 	 	-	 	 	-	 	 	-	 	 	(167,927	)	 	(167,927	)	 	(167,927	)
										
			
	Comprehensive loss	 	 	 	  	 	 	  	 	 	  	 	 	  	 	$	     (166,762	)	 	  	 
										
			
	Issuance of shares and	 	 
	  warrants, net	 	 	 	22,519	 	 	6,959,647	 	 	-	 	 	-	 	 	  	 	 	6,982,166	 
	Exercise of stock	 	 
	  options	 	 	 	973	 	 	239,072	 	 	-	 	 	-	 	 	  	 	 	240,045	 
		
		
		
		
				
	
	 						
	Balance at December 31, 2004  	 	 	 	96,766	 	 	29,578,981	 	 	(1,358	)	 	(14,979,234	)	 	  	 	 	14,695,155	 
							
	Net unrealized gains on	 	 
	  available-for-sale	 	 
	  securities	 	 	 	-	 	 	-	 	 	1,358	 	 	-	 	$	        1,358	 	 	1,358	 
	Net loss	 	 	 	-	 	 	-	 	 	-	 	 	(692,247	)	 	(692,247	)	 	(692,247	)
										
			
	Comprehensive loss	 	 	 	  	 	 	  	 	 	  	 	 	  	 	$	     (690,889	)	 	  	 
										
			
	Issuance expenses	 	 	 	-	 	 	(77,000	)	 	-	 	 	-	 	 	  	 	 	(77,000	)
	Exercise of stock	 	 
	  options	 	 	 	31	 	 	5,573	 	 	-	 	 	-	 	 	  	 	 	5,604	 
		
		
		
		
				
	
	Balance at June 30,	 	 
	  2005 (unaudited)	 	 	$	      96,797	 	$	  29,507,554	 	$	           -	 	$	 (15,671,481	)	 	  	 	$	  13,932,870	 
		
		
		
		
				
	

- 18 -

SELECTED FINANCIAL DATA 

        The
following selected consolidated financial data as of, and for the years ended, December
31, 2000, 2001, 2002, 2003 and 2004 have been derived from, and should be read in
conjunction with, the Company’s audited consolidated financial statements, related
notes and other financial information included in the Company’s annual reports on
Form 20-F previously filed with the Securities and Exchange Commission. The selected
consolidated financial data as of, and for the six months ended, June 30, 2005 have been
derived from, and should be read in conjunction with, the Company’s unaudited
consolidated financial statements, related notes and other financial information included
elsewhere in this report. The selected consolidated financial data should also be read in
conjunction with and are qualified by reference to “Operating and Financial Review
and Prospects” included in the applicable annual reports and elsewhere in this
report. Our consolidated financial statements have been prepared in accordance with
generally accepted accounting principles in Israel, or Israeli GAAP. Israeli GAAP vary in
certain significant respects from generally accepted accounting principles in the United
States, or U.S. GAAP. Application of U.S. GAAP would have affected the selected
consolidated financial data set forth below to the extent summarized in the notes to the
consolidated financial statements from which they were derived. 

		Year Ended December 31
	Six-month

period

ended

June 30,

		2000
	2001
	2002
	2003
	2004
	2005

		In US$ except for weighted average number of shares data
	 						
							
	Statement of Operations Data 	 	 	 		 	 		 	 		 	 		 	 		 	 		 
	under Israeli GAAP: 	 	 
	   Revenues	 	 	$	  10,626,342	 	$	  11,959,249	 	$	   7,799,093	 	$	   8,319,002	 	$	  11,178,448	 	$	   8,000,371	 
	     Cost of revenues	 	 	 	3,923,932	 	 	3,072,333	 	 	3,005,463	 	 	2,339,790	 	 	3,472,099	 	 	3,202,150	 
	    Gross profit	 	 	 	6,702,410	 	 	8,886,916	 	 	4,793,630	 	 	5,979,212	 	 	7,706,349	 	 	4,798,221	 
	     Research and development, net	 	 	 	2,121,901	 	 	2,198,628	 	 	1,340,408	 	 	863,209	 	 	929,432	 	 	729,433	 
	     Selling, administrative and general	 	 	 	11,386,054	 	 	9,800,622	 	 	7,464,572	 	 	5,818,426	 	 	7,134,709	 	 	4,642,541	 
	     Financial expense (income), net	 	 	 	(439,972	)	 	(287,197	)	 	(187,318	)	 	(98,376	)	 	179,400	 	 	(140,396	)
	     Other (income) expense	 	 	 	460	 	 	(33,708	)	 	3,756	 	 	-	 	 	-	 	 	-	 
	     Minority share in loss of a subsidiary	 	 	 	2,410	 	 	-	 	 	-	 	 	-	 	 	-	 	 	-	 
	   Net income (loss)	 	 	 	(6,363,623	)	 	(2,791,429	)	 	(3,827,788	)	 	(604,047	)	 	(178,392	)	 	(714,149	)
		
		
		
		
		
		
	
	Israeli GAAP net basic and dilutive	 	 
	   income (loss) per share	 	 	$	      (1.088	)	$	      (0.440	)	$	      (0.628	)	$	      (0.096	)	$	       (0.03	)	$	       (0.08	)
		
		
		
		
		
		
	
	Israeli GAAP weighted average number	 	 
	   of shares outstanding	 	 	 	5,848,890	 	 	6,341,390	 	 	6,098,890	 	 	6,252,996	 	 	7,092,434	 	 	8,944,544	 
		
		
		
		
		
		
	

		As of December 31
	As of

June 30,

		2000
	2001
	2002
	2003
	2004
	2005

		In US$
	 						
							
	Summary of Balance Sheet Data 	 	 	 		 	 		 	 		 	 		 	 		 	 		 
	under Israeli GAAP: 	 	 
	   Cash and cash equivalents	 	 	$	 12,107,098	 	$	  9,419,165	 	$	  7,400,889	 	$	  5,854,436	 	$	 10,136,141	 	$	  8,125,720	 
	   Working capital	 	 	 	14,075,684	 	 	11,292,455	 	 	7,739,509	 	 	7,353,113	 	 	12,232,416	 	 	11,635,708	 
	   Total Assets	 	 	 	18,069,247	 	 	15,548,725	 	 	12,001,066	 	 	11,628,430	 	 	19,159,663	 	 	19,720,301	 
	   Long Term debt	 	 	 	-	 	 	-	 	 	-	 	 	-	 	 	-	 	 	-	 
	   Total liabilities	 	 	 	3,389,362	 	 	3,528,128	 	 	3,798,801	 	 	3,998,724	 	 	4,476,138	 	 	5,372,321	 
	   Shareholders' equity	 	 	 	14,679,885	 	 	12,020,597	 	 	8,202,265	 	 	7,639,706	 	 	14,683,525	 	 	13,897,980	 

- 1 -

		Year Ended December 31
	Six-month

period

ended

June 30,

		2000
	2001
	2002
	2003
	2004
	2005

		In US$ except for weighted average number of shares data
	 						
							
	Statement of Operations Data 	 	 	 		 	 		 	 		 	 		 	 		 	 		 
	under U.S. GAAP: 	 	 
	   Revenues	 	 	$	  10,626,342	 	$	  11,959,249	 	$	   7,799,093	 	$	   8,319,002	 	$	  11,178,448	 	$	   8,000,371	 
	     Cost of revenues	 	 	 	3,923,932	 	 	3,072,333	 	 	3,005,463	 	 	2,339,790	 	 	3,472,099	 	 	3,202,150	 
	    Gross profit	 	 	 	6,702,410	 	 	8,886,916	 	 	4,793,630	 	 	5,979,212	 	 	7,706,349	 	 	4,798,221	 
	     Research and development, net	 	 	 	2,121,901	 	 	2,198,628	 	 	1,340,408	 	 	863,209	 	 	929,432	 	 	729,433	 
	     Selling, administrative and	 	 
	     general	 	 	 	11,386,054	 	 	9,800,622	 	 	7,464,572	 	 	5,818,426	 	 	7,123,079	 	 	4,619,281	 
	     Financial expense (income), net	 	 	 	(439,209	)	 	(286,712	)	 	(189,561	)	 	(108,835	)	 	178,235	 	 	(141,754	)
	     Other (income) expense	 	 	 	460	 	 	(33,708	)	 	3,756	 	 	-	 	 	-	 	 	-	 
	     Minority share in loss of a	 	 
	     subsidiary	 	 	 	2,410	 	 	-	 	 	-	 	 	-	 	 	-	 	 	-	 
	   Net income (loss)	 	 	 	(6,364,386	)	 	(2,791,914	)	 	(3,825,545	)	 	(593,588	)	 	(167,927	)	 	(692,247	)
		
		
		
		
		
		
	
	U.S. GAAP net basic and dilutive	 	 
	   income (loss) per share	 	 	$	      (1.095	)	$	      (0.458	)	$	      (0.627	)	$	      (0.097	)	$	       (0.02	)	$	       (0.08	)
		
		
		
		
		
		
	
	U.S. GAAP weighted average number of	 	 
	   shares outstanding for basic	 	 
	   net earnings (loss) per share	 	 	 	5,810,376	 	 	6,098,890	 	 	6,098,890	 	 	6,102,496	 	 	6,905,559	 	 	8,755,169	 
		
		
		
		
		
		
	
	U.S. GAAP weighted average number of	 	 
	   shares outstanding for dilutive	 	 
	   net earnings (loss) per share	 	 	 	5,810,376	 	 	6,098,890	 	 	6,098,890	 	 	6,102,496	 	 	6,905,559	 	 	8,755,169	 
		
		
		
		
		
		
	

		As of December 31
	As of

June 30,

		2000
	2001
	2002
	2003
	2004
	2005

		In US$
	 						
							
	Summary of Balance Sheet Data 	 	 	 		 	 		 	 		 	 		 	 		 	 		 
	under U.S. GAAP: 	 	 
	   Cash and cash equivalents	 	 	$	 12,107,098	 	$	  9,419,165	 	$	  7,400,889	 	$	  5,854,436	 	$	 10,136,141	 	$	  8,125,720	 
	   Working capital	 	 	 	14,075,684	 	 	11,292,455	 	 	7,739,509	 	 	7,353,113	 	 	12,232,416	 	 	11,635,708	 
	   Total Assets	 	 	 	18,069,247	 	 	16,161,294	 	 	12,488,439	 	 	12,130,676	 	 	19,742,506	 	 	20,036,306	 
	   Long Term debt	 	 	 	-	 	 	-	 	 	-	 	 	-	 	 	-	 	 	-	 
	   Total liabilities	 	 	 	3,389,362	 	 	4,140,697	 	 	4,286,174	 	 	4,490,970	 	 	5,047,351	 	 	6,103,436	 
	   Shareholders' equity	 	 	 	14,679,885	 	 	12,020,597	 	 	8,202,265	 	 	7,639,706	 	 	14,695,155	 	 	13,932,870	 

- 2 -

OPERATING AND
FINANCIAL REVIEW AND PROSPECTS 

	A.  	Operating
Results  

        The
following discussion of our consolidated financial condition and consolidated results of
operations should be read together with our consolidated financial statements and notes to
our consolidated financial statements contained in this report and in our annual reports
previously filed with the Securities and Exchange Commission on Form 20-F, as well as the
discussion of our financial condition and results of operations under the heading
“Operating and Financial Review and Prospects” contained in this report and in
such annual reports. This discussion contains certain forward-looking statements that
involve risks, uncertainties and assumptions. As a result of many factors, including those
set forth under “Risk factors” in our annual report on Form 20-F for the year
ended December 31, 2004, our actual results may differ materially from those anticipated
in these forward-looking statements. 

        The
following table sets forth certain items from our results of operations as a percentage of
total revenues for the periods indicated: 

		Year Ended December 31
	Six-month

period

ended June

30,

		2000
	2001
	2002
	2003
	2004
	2005

		In US$ except for weighted average number of shares data
							
							
	Statement of Operations Data 	 	 	 		 	 		 	 		 	 		 	 		 	 		 
	as a percentage of total revenues 	 	 
	for the periods indicated: 	 	 
	    Revenues	 	 	 	100.0	%	 	100.0	%	 	100.0	%	 	100.0	%	 	100.0	%	 	100.0	%
	       Cost of revenues	 	 	 	36.93	%	 	25.69	%	 	38.54	%	 	28.13	%	 	31.06	%	 	40.03	%
	    Gross profit	 	 	 	63.07	%	 	74.31	%	 	61.46	%	 	71.87	%	 	68.94	%	 	59.97	%
	      	 	 
	       Research and development, net	 	 	 	19.97	%	 	18.38	%	 	17.19	%	 	10.38	%	 	8.31	%	 	9.12	%
	       Selling, administrative and general	 	 	 	107.15	%	 	81.95	%	 	95.71	%	 	69.94	%	 	63.83	%	 	58.03	%
							
	   Total operating expenses	 	 	 	127.12	%	 	100.33	%	 	112.90	%	 	80.32	%	 	72.14	%	 	67.15	%
	   Operating income (loss) before finance	 	 	 	(64.04	)%	 	(26.02	)%	 	(51.43	)%	 	(8.44	)%	 	(3.20	)%	 	(7.17	)%
							
	       Financial expense (income), net	 	 	 	4.14	%	 	2.40	%	 	2.40	%	 	1.18	%	 	(1.60	)%	 	1.75	%
							
	       Other (income) expense	 	 	 	(0.00	)%	 	0.28	%	 	(0.05	)%	 	0.00	%	 	0.00	%	 	0.00	%
	         Net income (loss) before	 	 
	         minority share in loss of a	 	 
	         subsidiary	 	 	 	(59.91	)%	 	(23.34	)%	 	(49.08	)%	 	(7.26	)%	 	(4.81	)%	 	(5.42	)%
	    Minority share in loss of a subsidiary	 	 	 	0.02	%	 	-	 	 	-	 	 	-	 	 	-	 	 	-	 
	  Net income (loss)	 	 	 	(59.89	)%	 	(23.34	)%	 	(49.08	)%	 	(7.26	)%	 	(1.60	)%	 	(8.93	)%

        As
a result of our strategy of pursuing strategic alliances with value added resellers,
distributors and system integrators, most of our revenues are derived from such alliances.
During the years ended December 31, 2002, 2003, 2004 and the six-month period ended June
30, 2005, revenues deriving from value added resellers, distributors and system
integrators accounted for approximately 72%, 51%, 28%, and 40% respectively, of our
revenues. In 2004, the percentage of revenues derived from distributors decreased mainly
because of our direct sales to Swiss Post – Finance and a move towards a direct sale
approach, a trend that continued in the period of six months ended June 30, 2005. 

        Historically,
we have recognized a substantial portion of our revenues from product sales. During the
years ended December 31, 2002, 2003 and 2004 and the six-month period ended June 30, 2005,
product revenues accounted for approximately 82%, 75%, 62% and 56% respectively, of
revenues, while service revenues accounted for approximately 18%, 25%, 38% and 44%
respectively, of revenues. 

- 3 -

        Quarterly
Results; Seasonality 

        Our
sales cycle of our eFLOWTM ranges from 9 to 12 months. These
sales cycles vary by customer and could extend for longer periods depending on the time
required by the customer to evaluate the utility of the applicable product to its
operations. Our operating results could vary between periods as a result of this
fluctuation in the length of our sales cycles, the purchasing patterns of potential
customers, the timing of introduction of new products and product enhancements introduced
by us and our competitors, technological factors, variations in sales by distribution
channels, competitive pricing and generally non-recurring product sales. Consequently, our
product revenues may vary significantly by quarter. During 2002, 30% of our revenues in
the first quarter were from Schneider Logistics, a customer in the United States, while it
only accounted for 10% of our annual revenues. During 2003, 32% of our revenues in the
third quarter were from Swiss Post – Finance, a customer in Switzerland, which
accounted for 17% of our 2003 annual revenues. During 2004, 14% and 13% of our revenues in
the second and third quarter were from Swiss Post – Finance, which accounted for 7%
of our revenues in the 2004. During the period of six months ended June 30, 2005, no
customer exceeded 10% or more, of our revenues in that period. 

        Geographical
Considerations 

        The
following tables summarize (i) total revenues, (ii) product revenues and (iii) service
revenues by geographic region for each of the last three fiscal years and the six-month
period ended June 30, 2005. 

Total Revenues by Region 

		Year Ended December 31,	Six-month period

ended
		2002	2003	2004	June 30, 2005
					(unaudited)
		$
	%
	$
	%
	$
	%
	$
	%

									
	Europe	 	 	 	3,491,333	 	 	45	 	 	5,728,496	 	 	69		 	7,966,580		 	71	 	 	4,610,183	 	 	58	 
	North America	 	 	 	1,127,091	 	 	14	 	 	391,999	 	 	5		 	1,253,881		 	11	 	 	801,484	 	 	10	 
	Far East (excluding Japan)	 	 	 	816,117	 	 	11	 	 	1,455,126	 	 	17	 	 	923,985	 	 	8	 	 	557,936	 	 	7	 
	Africa	 	 	 	503,454	 	 	6	 	 	144,164	 	 	2	 	 	179,900	 	 	2	 	 	20,500	 	 	0	 
	Japan	 	 	 	1,577,651	 	 	20	 	 	51,399	 	 	1	 	 	669,880	 	 	6	 	 	1,597,114	 	 	20	 
	Israel	 	 	 	46,074	 	 	1	 	 	30,658	 	 	0	 	 	184,222	 	 	2	 	 	118,153	 	 	1	 
	South America	 	 	 	93,544	 	 	1	 	 	516,000	 	 	6	 	 	-	 	 	-	 	 	295,000	 	 	4	 
	Middle East (excluding Israel)	 	 	 	93,829	 	 	1	 	 	1,160	 	 	0	 	 	-	 	 	-	 	 	-	 	 	-	 
	Other	 	 	 	50,000	 	 	1	 	 	-	 	 	-	 	 	-	 	 	-	 	 	-	 	 	-	 
	Total	 	 	 	7,799,093	 	 	100	%	 	8,319,002	 	 	100		 	11,178,448		 	100	 	 	8,000,371	 	 	100	 

Product Revenues by Region 

		Year Ended December 31,	Six-month period

ended
		2002	2003	2004	June 30, 2005
					(unaudited)
		$
	%
	$
	%
	$
	%
	$
	%

									
									
	Europe	 	 	 	2,656,670	 	 	41.4	 	 	4,279,397	 	 	69	 	 	141,699	 	 	2	 	 	2,853,879	 	 	64	 
	Far East (excluding Japan)	 	 	 	690,769	 	 	10.8	 	 	1,315,888	 	 	21.1	 	 	598,431	 	 	9	 	 	365,649	 	 	8	 
	South America	 	 	 	70,000	 	 	1.1	 	 	506,000	 	 	8.1	 	 	5,356,075	 	 	77	 	 	280,000	 	 	6	 
	Africa	 	 	 	432,478	 	 	6.7	 	 	55,845	 	 	0.9	 	 	607,303	 	 	9	 	 	0	 	 	0	 
	North America	 	 	 	934,335	 	 	14.5	 	 	43,125	 	 	0.7	 	 	0	 	 	-	 	 	402,150	 	 	10	 
	Israel	 	 	 	13,166	 	 	0.2	 	 	10,271	 	 	0.2	 	 	166,000	 	 	2	 	 	59,900	 	 	1	 
	Middle East (excluding Israel)	 	 	 	90,393	 	 	1.4	 	 	-	 	 	0		 	0		 	-		 			 	0	
	Japan	 	 	 	1,485,537	 	 	23.1	 	 	-	 	 	0	 	 	94,910	 	 	1	 	 	509,497	 	 	11	 
	Other	 	 	 	50,000	 	 	0.8	 	 	-	 	 	0		 	0		 	-		 		 	 		 
	Total	 	 	 	6,423,348	 	 	100	 	 	6,210,526	 	 	100	 	 	141,699	 	 	100	 	 	4,471,075	 	 	100	 

- 4 -

Service Revenues by Region 

		Year Ended December 31,	Six -month period

ended
		2002	2003	2004	June 30, 2005
					(unaudited)
		$
	%
	$
	%
	$
	%
	$
	%

									
									
	Europe	 	 	 	834,663	 	 	60.7	 	 	1,449,099	 	 	68.7	 	 	42,523	 	 	1	 	 	1,756,304	 	 	50	 
	North America	 	 	 	192,756	 	 	14	 	 	348,874	 	 	16.5	 	 	325,554	 	 	8	 	 	399,334	 	 	11	 
	Far East (excluding Japan)	 	 	 	125,348	 	 	9.1	 	 	139,238	 	 	6.6	 	 	2,610,505	 	 	62	 	 	192,288	 	 	5	 
	Africa	 	 	 	70,976	 	 	5.2	 	 	88,379	 	 	4.2	 	 	646,578	 	 	15	 	 	20,500	 	 	1	 
	Japan	 	 	 	92,114	 	 	6.7	 	 	51,399	 	 	2.4	 	 	0	 	 	-	 	 	1,087,618	 	 	31	 
	Israel	 	 	 	32,908	 	 	2.4	 	 	20,387	 	 	1	 	 	13,900	 	 	-	 	 	58,253	 	 	2	 
	South America	 	 	 	23,544	 	 	1.7	 	 	10,000	 	 	0.5	 	 	0	 	 	-	 	 	15,000	 	 	0	 
	Middle East (excluding Israel)	 	 	 	3,436	 	 	0.2	 	 	1,160	 	 	0.1	 	 	574,970	 	 	14	 	 	0	 	 	0	 
	Total	 	 	 	1,375,745	 	 	100	 	 	2,108,476	 	 	100	 	 	4,214,030	 	 	 	 	 	3,529,296	 	 	100	 

        Six-month
Period Ended June 30, 2005 Compared to Six-month Period Ended June 30, 2004 

             Revenues.
          Total revenues for the six-month period ended June 30, 2005 amounted to
          $8,000,371 compared to $4,803,432 for the six-month period ended June 30, 2004.
          Product sales increased by $1,385,472, or 45%, from $3,085,624 in 2004 to
          $4,471,096 in 2005, mainly because of an increase in demand for our products in
          Germany. Service revenues increased by $1,811,467, or 105%, from $1,717,808 in
          the six-month period ended June 30, 2004 to $3,529,275 in the six-month period
          ended June 30, 2005. This significant increase is attributable mainly to
          services performed in Japan and due to our continued focus on providing
          comprehensive support to our customers document management environment. 

        Cost
of Revenues. Cost of revenues increased $1,913,606 or 148 % from $1,288,544 in the
six-month period ended June 30, 2004 to $3,202,150 in the six-month period ended June 30,
2005. The increase is a result of growth in demand for our services, which led us to
allocate and invest more resources to support such increase, mainly in Japan. 

        Research
and Development. During 2005, we continued to focus efforts in the enhancement of our
software recognition and core abilities. Research and development expenses in the
six-month period ended June 30, 2005 amounted to $729,433 compared to $401,983 for the
six-month period ended June 30, 2004. The increase is attributable mainly to an increase
of our Research and Development personnel and as a result of the acquisition of the
business in Japan. 

        Selling,
General and Administrative Expenses. Selling, general and administrative expenses in
the six-month period ended June 30, 2005 amounted to $4,642,541compared to $3,059,055 for
six-month period ended June 30, 2004. This increase of $1,583,486 or 52% is mainly
attributable to the expansion of our sales force in Europe and the costs of our new
operations in Japan. In the first quarter, we also held the TIS International Conference
in Barcelona, which amounted to approximately $211,000. 

        In
connection with the private placement held in September 2004, we filed a resale
registration statement covering the shares purchased in the private placement. The
registration statement became effective on March 1, 2005. However, we did not obtain
effectiveness of the registration statement within the timeframe set forth in our
agreements with the investors, which has subjected us to liquidated damages in the amount
of $163,475 which were calculated based on 1% of the amount invested and an additional 1%
for every month in which we did not cure the issue that led to the obligation. The amount
was recorded under general and administrative costs in our results of operations. In the
period of six months ended June 30, 2005, we paid $81,600 of these liquidated damages. 

- 5 -

        Financing
Income (Loss). Financing loss for the six-month period ended June 30, 2005 amounted to
$140,396 compared to financing income of $17,037 for six-month period ended June 30, 2003.
The increase in financing expenses was primarily due to significant strengthening of the
US$ against the Euro, Japanese Yen and the GBP compared to the rates of December 31, 2004,
which caused erosion in these non-dollar monetary accounts. 

        Net
Income (Loss). As a result of the foregoing, net loss for the six-month period ended
June 30, 2005 was $(714,149) compared to a net income of $36,813 in the six-month period
ended June 30, 2004. 

	B.  	Liquidity
and Capital Resources  

        As
of June 30, 2005, our cash, cash equivalents, bank deposits were $8,125,720, compared to
$10,136,141 as of December 31, 2004. The decrease is a mainly a result of investment in
bond securities in the amount of $1,500,000 at the second quarter. We believe that our
cash, cash equivalents, bank deposits and short-term marketable securities will be
sufficient to fund our working capital needs and planned capital expenditures for the next
twelve months. 

        Net
cash used in operating activities for the period of six months ended June 30, 2005 was
$1,069,880, as compared to $970,785 in the corresponding period in 2004. This increase was
attributable primarily to the increase in our sales. Our trade receivables increased to
$6,493,101 at June 30, 2005 from $5,170,172 at June 30, 2004. This increase reflects our
increased sales in 2005. As sales increase, we incur cash costs of sales in the current
period, but do not receive of the cash flows from such sales until later periods. While
the effect of increasing sales on our cash flows will continue if we succeed in further
sales growth, we believe that the cash flows from operations and other resources will be
sufficient to support such growth. We expect trade receivables to continue to increase as
our sales grow and to represent a significant portion of our working capital for the
foreseeable future.  Other payables and accrued expenses increased by 
$225,235 from December 31, 2004, mainly as result of payments connected with our
annual conference event on February in approximately $211,000. 

        Total
net cash used in investing activities in the period of six months ended June 30, 2005
amounted to $1,381,749 compared to $112,567 in the corresponding period. The increase is
mainly a result of investment in AAA bonds securities in the amount of $1,500,000 at
the end of the second quarter. For the period of six months ended June 30, 2005, the
aggregate amount of our capital expenditures was $90,891. These expenditures were
principally for the purchases of computer hardware and software and facilities
improvements. 

        Total
net cash provided from finance activities in the period of six months ended June 30, 2005
amounted to $441,208 compared to $162,969 in the corresponding period. The increase is
mainly a result of increase in our approved short-term line of credit with First
International Bank of Israel during the first quarter of 2005 from $1,500,000 to
$2,300,000. As of June 30, 2005 the short-term bank loans amounted to $2,396,151 after
extension of additional credit from the bank. 

- 6 -STRICTLY PRIVATE & CONFIDENTIAL

 

 

12 September 2005

 

Daniel Abrams

8a Gordon Avenue

Stanmore

Middlesex

HA7 3QD

 

 

 

 

Dear Daniel,

On behalf of Cambridge Display Technology Ltd. ('CDT'), I am pleased to offer you the position of Chief Financial Officer.  CDT will provide a salary of GBP185,000 per annum paid monthly. In addition, you will be eligible to participate in CDT's bonus scheme, which is payable up to a maximum of 35% of your annual salary and is awarded against achievement of agreed performance targets.  Your estimated date of hire is 26 September 2005.

You will be eligible to join the Stock Option scheme established at CDT, subject to the rules of the scheme.  You will be awarded 180,000 stock options as soon as possible after your start date with CDT, at a grant price at the fair market value on your date of hire.

You will be eligible to participate in the benefits program (including private health insurance, pension plan and life assurance) established at CDT. 

By accepting this offer you confirm that: 

	you are not subject to restrictions or other obligations relating to the nature or scope of your employment with another employer; and 

	by your performance of your duties as contemplated by this letter you will not knowingly violate the terms or conditions of any prior employment agreements you may have executed; and  

	you are currently in good health and will pass any medical examinations necessary for the establishment of your benefits package.

 

This offer is comprised of this letter and the attached statement of the main terms and conditions of employment.  No prior promises, representations or understandings relative to any terms or conditions of your employment are to be considered as part of this agreement unless expressed in writing in this offer package. This offer is subject to you being legally able to live and work in the United Kingdom.

If you accept the offer of employment, I should be grateful if you would return to me one copy of the offer letter and a copy of the statement of the main terms and conditions of employment signed by yourself.  A copy is also enclosed for your records.

If you have any queries regarding the offer we have made to you please do not hesitate to contact me to discuss these queries. 

This offer is valid until 18 September 2005.

Yours sincerely,

/s/ Emma Jones

Emma Jones

VP, Human Resources and Facilities

 

 

I agree to the above Signed:/s/ Daniel Abrams

 Daniel Abrams

Dated:14.9.05

 

 

 

 

Statement Of Main Terms And Conditions Of Employment

This Agreement is made on the 12 September 2005.

Between:

	Cambridge Display Technology Limited (company number 2672530) whose registered office is at Building 2020, Cambourne Business Park, Cambridgeshire, CB3 6DW ('CDT' and/or 'the Company'); and

	Daniel Abrams of 8a Gordon Avenue, Stanmore, Middlesex, HA7 3QD ('You' and/or 'Your').

It is agreed that the following is a statement of the main terms and conditions applying to your employment with CDT, including all particulars required to be given to you in writing under the Employment Rights Act 1996.  This statement together with your offer letter, and the stipulated provisions of the relevant employment policies, constitutes your contract of employment

Date Of Commencement Of Employment 

Your continuous employment with CDT dates from 26 September 2005.

Your employment with any previous employer does not count as part of your continuous period of employment.

Main Place Of Work    

Your main place of work will be the CDT office Cambourne, or such other location within the United Kingdom as CDT reasonably requires.

You may on occasion be required to work at other locations in the United Kingdom, including, but not limited to, Cambridge or Godmanchester. 

The nature of your appointment may require you to travel inside and outside the UK on company business, as required for the performance of your duties.  There is no current requirement for you to work outside the United Kingdom for any consecutive period in excess of one month.

Job Title and Duties

You are employed as a Chief Financial Officer, reporting to the Chief Executive Officer.

Your job title is not regarded as exclusive or exhaustive.  There will be other duties and requirements associated with your position that are within your capabilities and which you may be required by the Board of Directors (the 'Board') to undertake.

At all times during your employment you shall:

	unless prevented by ill health and except during annual leave/holidays taken in accordance with this Agreement, devote the whole of the your working time and attention to your duties;

	perform the duties of a Chief Financial Officer faithfully and diligently; 

	obey all lawful and reasonable directions of the Board, observe such restrictions or limitations as may from time to time be imposed by the Board upon you and implement and abide by any relevant Company policy which may be promulgated or operated in practice from time to time;

	use best endeavours to promote the interests of the Company and shall not do or willingly permit to be done anything which is harmful to those interests; and 

	keep the Board fully informed (in writing if so requested) of your conduct of the business or affairs of the Company and provide such explanations as the Board may require.

	Remuneration

Your annual salary is GBP185,000.  Any changes to your annual salary will be notified to you in writing. You will be paid monthly in arrears on the 28th day of each month by direct credit transfer to your UK bank account.  Where the 28th day falls on a weekend or a bank holiday, you will be paid on the preceding working day.  

You will be provided with an itemised pay statement.

	Other Benefits

You will be eligible to participate in the CDT benefits program that will include:

	Private Health Insurance

	Life Assurance

	Pension Plan

	Bonus Scheme 

	Hours Of Work

Your normal starting time is 9.00 a.m. and your normal finishing time is 5.30 p.m. Monday to Friday with an unpaid lunch break of one hour each day.  You are required to work at such other times as CDT may reasonably require and as may be necessary for the proper performance of your duties.  As a salaried employee overtime is not payable.

	Holidays And Holiday Pay

Your annual paid holiday entitlement is 27 working days in any complete calendar year of employment, which accrues on a pro-rata basis for each completed month of employment.  The holiday year at CDT runs from 1 January to 31 December.

Should you be absent for more than 4 weeks for any reasons, CDT reserves the right to suspend accrual of any holiday in excess of the minimum 4 weeks conferred by the Working Time Regulations (where applicable, this clause will not apply to the Ordinary Maternity Leave period).

Further details of the holiday policy can be obtained from your Line Manager.

Bank and Public Holidays

In addition to annual holidays, you are entitled to paid holiday on all English statutory public holidays and any additional holidays as awarded by CDT.

	Sick Pay Scheme

	Any absence due to sickness or injury must be notified to your designated Line Manager as soon as possible together with an estimate of the period of absence envisaged.  Any change in the estimated period of absence must be notified as soon as possible.

	In the event of you being absent for more than 7 days (inclusive of weekends), medical evidence must be produced in the form of a statement of reasons for absence completed by a qualified medical practitioner and sent to your Line Manager.

	Any payments made in addition to Statutory Sick Pay are entirely at the discretion of CDT and will not create a precedent either for CDT or for the individual. 

	Pension Scheme

CDT provides access to a Group Stakeholder Pension Plan for all employees.  CDT will contribute 5% of your pensionable salary to this plan provided that you also contribute a minimum of 5% of your pensionable salary.  You can choose to pay less than 5% of your pensionable salary into the plan if you wish, however you will not then receive a contribution from CDT.  You can also elect to contribute more than 5% of your salary to this plan (subject to legislative maximums) however CDT will not match any payments above 5%.

Details of this scheme will be provided to you when you join.  If you choose not to join this scheme, CDT will pay you a cash allowance equivalent to 5% of your pensionable salary (subject to statutory deductions).

	Maternity / Paternity Provisions

CDT's Maternity or Paternity policy and procedure can be obtained from your Line Manager, where applicable.

	Parental leave 

CDT's Parental Leave policy and procedure can be obtained from your Line Manager.

	Emergency domestic leave

CDT's Emergency Domestic Leave policy can be obtained from your Line Manager.

	Grievances

 

If you have any grievance in relation to your employment you should outline your grievance in writing to the Chief Executive Officer.  The further steps that will follow this application are set out in the Company's grievance procedure, a copy of which is available from your Line Manager.

	Disciplinary Procedures

You are subject to the Company's disciplinary and dismissal procedure, a copy of which is available from HR.  Application of the procedure is discretionary and is not a contractual entitlement.  If you are dissatisfied with any disciplinary decision relating to you or any decision to dismiss you should outline this in writing to the Chief Executive Officer.

In order to investigate a complaint against you of misconduct CDT may suspend you on full pay for so long as may be necessary to carry out a proper investigation and hold any disciplinary hearing.

 

 

 

	Termination Of Employment

12.1The length of notice you are required to give and entitled to receive to terminate your employment shall be 12 months'.  Notice given by either party shall not be effective until given in writing. CDT may at its option pay you a lump sum in lieu of your notice period.

12.2CDT has the right to dismiss you without notice or pay in lieu of notice in the case of gross misconduct, your bringing CDT into disrepute, your conviction for a criminal offence for which you receive a sentence of imprisonment, your bankruptcy and any prohibition by law from you being a director.

12.3CDT shall have the right during the period of notice or any part thereof, to place you on leave, paying you during this period your normal salary and benefits.

12.4Your employment with CDT will automatically terminate when you reach the normal retirement age for CDT's employees, which is currently 60 years of age.  You will be notified of any change in CDT's retirement age.

12.5On the termination of your employment or (if earlier) at any time after notice is given by CDT or you to terminate your employment, you shall, at CDT's request resign from all and any offices which you may hold as director and from all other appointments or offices which you hold as nominee or representative of CDT.  If you should fail to resign you hereby irrevocably authorise CDT to appoint a person in your name to sign any documents or do any things necessary to effect such resignation.

12.6Subject to clauses 12.7, 12.8 and 12.9 below, in the event of the termination of this Agreement within one year of a Change of Control (as defined in clause 12.10 below) of CDT or any other significant change in the operational structure of CDT, either by the Company otherwise than in accordance with clause 12.2 above or by you in circumstances when you are entitled to terminate by reason of CDT's fundamental and repudiatory breach of contract, then forthwith thereafter CDT shall by way of liquidated damages:-

	pay to you a sum equal to the then current rate of annual basic salary;

	pay to you a sum equal to the cost to CDT of providing the benefit of private medical and dental insurance of the kind then provided for one year from the date of termination;

	pay to you a sum equal to 5% of your annual pensionable basic salary in lieu of your entitlement to a cash allowance in respect of your pension.

12.7In the event of termination of this Agreement pursuant to clause 12.6 above, you shall not be entitled to any payments under any existing or future bonus arrangements and any payment made to you pursuant to clause 12.6 shall be deemed to include a payment in respect of any statutory and contractual notice you would otherwise be entitled to.

12.8Subject to any rights accrued at the date of termination of your employment under the provisions of any pension scheme of CDT, any provision of liquidated damages by CDT shall be made in full and final settlement of all and any claims arising out of your employment, or its termination, or your ceasing to hold the office of director of CDT or any group company.

12.9Clause 12.6 shall not apply where, in connection with a scheme of reconstruction or amalgamation or a reorganisation of CDT and one or more of its subsidiaries or associated companies, you refuse an offer of employment on terms identical or identical in all but immaterial respects to those hereunder.

12.10For the purposes of clause 12.6 a person has control of CDT if he holds, directly or indirectly, shares which together with shares held by any person acting in concert with him carry 50% or more of the voting rights in CDT and 'Change of Control' shall be construed accordingly and shall be deemed to be effective when it is unconditional in all respects.  For the avoidance of doubt, a Change of Control shall not include an internal re-organisation, reconstruction or amalgamation within the CDT Group. 

	Garden Leave

CDT reserves the right to require you to remain at home on garden leave during any notice period and remain available to attend the workplace if required.  During any notice you may not be engaged in any capacity with another company without written permission.

	Outside Interests

	You agree not to be, without the prior approval of the Board, directly or indirectly employed, engaged, concerned or interested in any other business which 

	is wholly or partly in competition with the business of CDT  or that of any 'Group Company' (which shall include CDT and any holding company, subsidiary or subsidiary of a holding company of CDT, the terms 'holding company' and 'subsidiary' having the meanings given to them in section 736 Companies Act 1985); or

	we consider requires or might reasonably require you to disclose or make use of Confidential Information in order to properly discharge your duties to or further your interest in that business; or

	we consider impairs or might reasonably be thought to impair your ability to act in the best interests of our business or that of any Group Company;

PROVIDED THAT you may be interested in any such business, for investment purposes only, as the holder (directly or through nominees) of any units of any authorised unit trust and/or up to 5% of the issued shares, debentures or other securities of any class of any company which is listed on a Recognised Investment Exchange as defined in Section 207 Financial Service Act. 

	You must not without the prior approval of the Board (which will not be refused unreasonably) accept any employment, engagement or office (whether paid or unpaid) with or in any person, firm, company or other organisation outside of any Group Company.

	You must not at any time (whether during or outside normal working hours) take any preparatory steps to become engaged or interested in any capacity whatsoever in any business or venture which is in or is intended to enter into competition with our business or that of any Group Company.

 

 

	Confidentiality and Protection of Business

You will in the course of your employment learn trade secrets and confidential or commercially sensitive information (including but not limited to methods, processes, device structures, techniques, shop practices, equipment, research data, opportunities for business marketing and sales information, strategies and pricing, personnel data, customer lists, potential customers, financial data, plans and all other know-how and trade secrets) which is in our possession or that of any Group Company or in respect of which CDT owes a duty of confidentiality to a third party, and which has not been published or disclosed to the general public ('Confidential Information'). You will also deal with our customers, corporate and academic collaborators and those of any Group Company and you agree that you will not: -

	during your employment (save as required for the proper performance of your duties or as duly authorised by us in writing) and at any time after its termination, directly or indirectly use or disclose any Confidential Information. 

	during your employment and for six months after its termination, directly or indirectly and whether on your own behalf or on behalf of any other person, firm, company or other body, solicit or entice away or seek to entice away any person who is or was at the date of termination of your employment or during the period of six months preceding the date of termination, employed or engaged by our business or any Group Company in a managerial, research and development, or sales and marketing post and was a person with whom you have dealt during the course of your employment or who by reason of their employment or engagement is likely to have knowledge of any trade secrets or Confidential Information; 

	for six months after the termination of your employment carry on your own account or as a partner or be engaged as an employee, officer, consultant or adviser in any other business which is in competition with our business or that of any Group Company with which you have been concerned or engaged to any material extent, for whom you provided services or from whom you had access to Confidential Information during the six months preceding the date of termination (particularly, but without limitation, through commercialising electroluminescent polymers and dendrimer technology) and which we consider requires or might reasonably be thought to require you to disclose or make use of any Confidential Information in order properly to discharge your duties to or to further your interest in that business or venture;

	for a period of six months following the termination of your employment whether on your own account or with, through, for or on behalf of any other person, firm, company or organisation, directly or indirectly canvas or solicit or procure to be canvassed or solicited in competition with us or any Group Company for whom you provided services or from whom you had access to Confidential Information the custom of any person, firm, company or organisation whom or which was at any time during the six months prior to the termination of your employment a Customer of ours or any Group Company and with whom or which you dealt or of whom or of which you have knowledge by virtue of your employment with us during that period.

	during the period of six months following the termination of your employment whether on your own account or with, through, for or on behalf of any other person, firm, company or organisation, directly or indirectly deal with or attempt to deal with in competition with us or any Group Company for whom you provided services or from whom you had access to Confidential Information any person, firm, company or organisation whom or which was at any time during the six months prior to the termination of your employment a Customer of ours or of any  Group Company and with whom or which you dealt or of whom or of which you have knowledge by virtue of your employment with us during that period.

	Intellectual property

	If at any time during your employment you conceive, originate, improve, develop, discover or invent (either alone or in conjunction with any person or persons) any products, services, designs, processes, systems or inventions (including but not limited to any and all computer programs, photographs, plans, records, drawings, models, any know-how technique, process, improvement, invention or discovery), which could relate directly or indirectly to our business or that of any Group Company you will immediately disclose to us full details of the same in writing and you shall not disclose the same (or any proposals we communicate to you) to any third party without our prior written consent.  You agree that we shall own all documents, drawings, models, samples, prototypes and the like prepared by you and which relate to such rights.  

	It is our common intention that all intellectual property and proprietary rights of whatever nature (including (without limitation) inventions, patents, know-how, technical information, copyright, registered design right or unregistered designs or similar rights as well as the right to apply for registered protection for any such rights) arising in the course of or as a result of work done by you during your employment shall belong to us as absolute owner.  To the extent that these do not automatically vest in us, you will hold them on trust for us and will take all such steps as we shall direct (whether during your employment hereunder or thereafter) at our expense to sign such documents as are necessary to vest them in us in accordance with the above intention

	You hereby assign (in so far as title does not automatically vest in us as a consequence of your employment) to us by way of future assignment all copyright, designs and other proprietary rights, if any, which may be so assigned for the full term thereof throughout the world in respect of all works (within the meaning of Section 1(1) of the Copyright, Designs and Patents Act 1988 or such other legislation as shall hereafter be enacted containing any like definition or provisions) authored, drawn, written, originated, conceived or otherwise made by you either alone or jointly with any other person or persons during the period of your employment hereunder or pertaining to such subject matter as form part of your duties hereunder.  You waive all moral rights conferred on you by Chapter IV, Part I, Copyright Designs and Patents Act 1988 and any other moral rights provided for under the laws now or in future in force in any part of the world arising from any such works.

	You shall if and whenever required so to do by us at our expense apply or join with us in applying for letters patent, utility model, registered design or other protection in any part of the world for any such intellectual property and shall, at our expense, execute or do, or procure to be executed or done, all instruments and things necessary for vesting such intellectual property and all such rights, titles and interest to and in the same in us or in such other person as we may direct or require and we shall (and shall procure that any such other person shall) hold the same and all such right, title and interest to and in the same upon trust for ourselves and (to the extent that it is entitled thereto by Section 39 of the Patents Act 1977 or such other legislation as shall hereafter be enacted containing like provisions) you according to our and your respective interests.

	For the purposes of this clause you hereby irrevocably appoint us, as your attorney in your name and on your behalf to execute any documents and/or do any and all things which are necessary or desirable for us to give effect to the provisions of this clause and we are hereby empowered to appoint and remove in our sole discretion any person as agent and substitute for and on behalf of us in respect of all or any of the matters aforesaid provided always that we shall notify you of each such action in writing.

	Data Protection

You understand and agree that CDT is permitted to hold personal information about you as part of its personnel and other business records and may use such information in the course of CDT's business.  You agree that CDT may disclose such information to third parties, in the event that such disclosure is, in CDT's view, required for the proper conduct of CDT's business.  This clause applies to information held, used or disclosed in any medium.

	Public Relations

You agree that you will not either during your employment or at any time after termination of your employment make any statement or give any interview to the news media or submit a letter, learned paper or article for publication about your work for us, about us or about any Group Company or any third party involved with our business, or otherwise without the prior written approval of the Chief Executive or in his absence his deputy. You must promptly inform a director of any requests for statements, interviews, learned papers or articles you receive.

You agree that after the termination of your employment you will not be held out or represented by you or any other person, firm, company or other body, as being in any way connected with or interested in our business or that of any Group Company.

	Health & Safety

You have a duty to take care for your own health and safety and that of other members of staff. You agree to observe our Safety Rules for the time being and to comply with our Health & Safety policies for the time being including those concerning eating, drinking, applying cosmetics and smoking cigarettes or tobacco on our premises.

	Company Property

All books, documents, lists, files, data, accounts and records whether or not made by you and whether stored in human readable or machine readable form which may come into your possession during your employment respecting our business or affairs or those of any Group Company or any third party involved with our business (including notes, minutes, memoranda, correspondence and copies of documents made by you in the course of your employment) will belong to us and these and all our other property and documents in your possession, custody, power or control must be returned to us immediately on the termination of your employment.

	Obligations Upon Termination Of Employment

On the termination of your employment hereunder you will:

	forthwith tender your resignation from any office you held with us or any Group Company offices you then hold (without payment or agreement of compensation therefore) and you hereby irrevocably authorise the Company Secretary for the time being on your behalf to sign any documents and do any things necessary or requisite to give effect thereto;

	deliver up to us all correspondence drawings documents and other papers and all other property belonging to us or any Group Company or any third party involved with our business which may be in your possession or control (including such as may have been made or prepared by or have come into your possession or in the course of employment which relate in any way to our business or affairs or those of the Group Company or any third party involved with our business or any suppliers agents distributors or customers) and you must not without our written consent retain any copies thereof;

	if so requested send to the Company Secretary a signed statement confirming that you have complied with a sub-clause 21.1 and 21.2 thereof;

	not at any time represent that you are still connected with us or any Group Company; and 

	forthwith discharge all your outstanding obligations to us, whether monetary (e.g. reimbursement of advances) or otherwise, incurred during, by virtue of or in connection with your employment, and agree that without prejudice CDT may withhold payment of any money or delivery of other things due to you by virtue of your employment, whether before or after termination, until you have fully discharged all such obligations to us.

 

	Collective Agreement

There are no collective agreements, which affect the terms and conditions of your employment.

	Third Party Rights 

	Unless expressly provided in clause 23.2 below, no term of this Statement is enforceable pursuant to the Contracts (Rights of Third Parties) Act 1999 by any person who is not a party to it.

	Subject to the Contract (Rights of Third Parties) Act 1999 and to the provisions of this Statement, clauses 14, 15, 16, 18, 20 and 21 may be enforced by any officer, employee or agent of the Company in his or her own right any Group Company in its own right and by any officer, employee or agent of any Group Company in his or her own right.

 

This Agreement has been executed as a deed on the date of signing as indicated below.

Executed as a Deed by )

Daniel Abrams)     /s/ Daniel Abrams

On date)

in the presence of: /s/ Emma Jones)

Name of witness:  Emma Jones

Address: 2 College Farm Court, Barton, Cambridge, CB3 7AL

Executed as a Deed)

by )     

CDT)

acting by:)

Director                       /s/ David Fyfe

Director/Secretary      /s/ S. Chandler

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