As filed with the Securities and Exchange Commission on April 17, 2006.

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 20-F

o     REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(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 001-14662

        Securities registered or to be registered pursuant to Section 12(b) of the Act.

        Securities registered or to be registered pursuant to Section 12(g) of the Act.

        Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.

        Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the Annual Report.

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

Yes o No x

        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.

Yes o No x

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

Yes x No o

        Indicated by check mark whether the registrant is a large accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

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

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

Item 17 o Item 18 x

TABLE OF CONTENTS

INTRODUCTION

        As used in this Annual Report on Form 20-F, references to “we”, “our”, “us”, “Scopus” or the “Company” are references to Scopus Video Networks Ltd., a company organized under the laws of the State of Israel, and its wholly-owned subsidiary, Scopus Video Networks Inc. a Delaware corporation, unless indicated otherwise.

        Our consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles, or U.S. GAAP. Except as otherwise specified, financial information is presented in U.S. Dollars. All references in this Annual Report to “U.S. dollars,” “dollars” or “$” are to United States dollars and all references in this Annual Report to “NIS” or “shekels” are to New Israeli Shekels.

FORWARD LOOKING STATEMENTS

        This Annual report contains forward looking statements. These forward looking statements include, in particular, statements about our plans, strategies and prospects under the headings “Risk Factors,” “Operating and Financial Review and Prospects,” and “Business.” These statements are based on our current expectations and projections about future events and are identified by terminology such as “may,” “will,” “should,” “expect,” “scheduled,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “aim,” “potential,” or “continue” or the negative of those terms or other comparable terminology. These forward looking statements are subject to risks, uncertainties and assumptions about us. Although we believe that our plans, intentions and expectations are reasonable, we may not achieve our plans, intentions or expectations.

        Important factors that could cause actual results to differ materially from the forward looking statements we make in this annual report are set forth in “Item 3. Key Information – 3D. Risk Factors.” All forward looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements in “Risk Factors,” in which we have disclosed the material risks related to our business. These forward looking statements involve risks and uncertainties, and the cautionary statements identify important factors that could cause actual results to differ materially from those predicted in any forward looking statements. We undertake no obligation to update any of the forward looking statements after the date of this annual report to conform those statements to reflect the occurrence of unanticipated events, except as required by applicable law.

        This annual report also includes statistical data that we obtained from industry publications and reports generated by In-Stat and Informa Telecoms & Media. Although we have not independently verified their data, based on our industry experience, we believe that the publications and reports are reliable and their conclusions are reasonable.

        You should read this annual report and the documents that we reference in this annual report and have filed as exhibits to this annual report, of which this annual report is a part, that we have filed with the Securities and Exchange Commission, completely and with the understanding that our actual future results, levels of activity, performance and achievements may be materially different from what we expect. We qualify all of our forward looking statements by these cautionary statements. The forward looking statements contained in this annual report are excluded from the safe harbor protection provided by the Private Securities Litigation Reform Act of 1995 and Section 27A of the Securities Act of 1933, as amended.

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PART I

        Not Applicable.

         Not Applicable.

        The following selected consolidated financial data should be read together with “Operating and Financial Review and Prospects” and our audited consolidated financial statements and related notes included elsewhere in this annual report. The selected consolidated balance sheet data as of December 31, 2004 and 2005 and the selected consolidated statements of operations data for each of the three years in the period ended December 31, 2003, 2004, and 2005 have been derived from our audited consolidated financial statements included elsewhere in this Form 20-F, which have been prepared in accordance with accounting principles generally accepted in the U.S., or U.S. GAAP, and audited by Brightman Almagor & Co., an independent registered public accounting firm, and a member firm of Deloitte Touche Tohmatsu. Their report appears elsewhere in this Form 20-F. The selected consolidated balance sheet data as of December 31, 2001 and 2002, 2003 and the selected consolidated statements of operations data for the years ended December 31, 2001 , 2002 and 2003 have been derived from our audited consolidated financial statements which are not included in this Form 20-F. Historical financial results may not be indicative of our future performance and interim results may not be reflective of the results for the fiscal year.

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Investing in our ordinary shares involves a high degree of risk. You should consider carefully the following risk factors, as well as the other information in this annual report, before deciding to invest in our ordinary shares. Our business, financial condition or results of operations could be affected adversely by any of these risks. The trading price of our ordinary shares could decline due to any of these risks and you might lose all or part of your investment in our ordinary shares.

Risks Related to Our Business and Our Market

If we fail to enhance our existing products, develop new and more technologically advanced products or successfully commercialize these products, the results of our operations would suffer.

        To compete effectively, we must enhance our existing products and introduce new, cost-effective products and features to meet changing customer requirements and evolving industry standards. The markets for our products are characterized by rapidly changing technology and frequent introductions of new products. We, or our competitors, may announce products that have the potential to shorten the life cycle of, or replace, our products. We have made such announcements in the past and may do so in the future. Such announcements could cause customers not to buy our products or to defer decisions to buy our products. We cannot assure you that products or technologies developed by others will not render our products or technologies non-competitive or obsolete.

        We must design our products to support emerging technologies and features, including personalized programming, targeted advertising, new compression standards, high definition television, or HDTV, distributed networking, dense decoding and the greater use of video-over-internet-protocol, or voice-over-IP. Our products must also meet industry standards in the geographical regions in which we operate. Our future products, if and when fully developed and tested, may not perform as we expect or compete successfully with products developed by our competitors. Further, there can be no assurance that the cost of our future development efforts will not materially increase.

        Sales of our products are also dependent on the market acceptance of advanced video services. If adoption of advanced services is not as widespread or as rapid as we expect, or if we are unable to develop new products based on emerging technologies on a timely basis, our results of operations would be materially and adversely affected.

MPEG-4

        Our encoders and decoders do not currently support MPEG-4, a newer compression standard. We are developing an MPEG-4 compatible encoder, which we expect to be available for shipment in the third quarter of 2006. We have not yet begun developing an MPEG-4 compatible decoder. To the extent our targeted customers require MPEG-4 compatibility, we may be unable to successfully market our encoders and decoders until MPEG-4 support can be developed, particularly in the U.S. where there is a growing demand for advanced compression technologies. Developing MPEG-4 support will require significant research and development efforts and license fees. If we are unable to upgrade our products to newer compression technologies in a timely and cost-effective manner, we may not be able to market or sell our products, which would adversely affect our results of operations.

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VC-1

        Although MPEG has evolved as the prevailing standard for compressing digital video in most of our target markets, we cannot assure you that alternative standards will not be adopted. Microsoft has developed a different standard for compressing digital video, called VC-1, which our products do not currently support. Microsoft is currently making efforts to have this standard accepted by the industry. If network operators adopt VC-1, we will need to enhance our products to support this standard, which would be a lengthy and costly process.

HDTV

While our intelligent video gateway processes HDTV content, and we currently resell third-party HDTV encoders and decoders, the encoders and decoders developed by us do not currently support HDTV. We are currently developing HDTV encoders and decoders, which we expect to be available for shipment towards the end of 2007. To the extent our target customers prefer to purchase HDTV encoders and decoders developed by us rather than third-parties, we may be unable to successfully market these products. Until we develop HDTV encoders and decoders, we will rely on the resale of third-party products which have lower gross margins than internally-developed versions. If we are unable to provide HDTV support in our encoding and decoding products, we may not be able to compete effectively, particularly in the U.S., which would adversely affect our results of operations.

Personalized Programming and Targeted Advertising

        The ability to support personalized programming and targeted advertising are essential features of our intelligent video gateway currently under development. While we have successfully demonstrated these features, we do not expect to ship products which incorporate these features until the second quarter of 2006. If we are unable to successfully introduce these features on a timely basis, our prospective customers may be unwilling to purchase our intelligent video gateway and our competitive position and results of operations would be adversely affected.

We only recently introduced our intelligent video gateway, and if we fail in our efforts to sell this product, or if our target customers are unwilling to purchase this product from us, our results of operations would suffer.

        Most of our revenues to date have been derived from sales of encoders and decoders. We began shipping our intelligent video gateway in the fourth quarter of 2003. We have devoted significant research and development and sales and marketing resources toward this product, and we expect sales of this product to represent a growing portion of our revenues in the future. We lack substantial experience selling this product and we cannot be certain that this product will be accepted. In some cases, our current original equipment manufacturer, or OEM, partners resell comparable video processing products provided by our competitors, so it may be difficult for us to build an OEM channel for our intelligent video gateway. The sale of our intelligent video gateway is a critical component of our growth strategy, and if we are unsuccessful in our efforts to expand this portion of our business, our revenues may not grow, we may need to adjust our growth strategy and our results of operations would suffer.

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We intend to increase our sales and marketing efforts in the U.S. and to telecom service providers and major cable operators, which may require us to broaden our OEM partnerships. We may not be successful in these activities, which could adversely affect our results of operations.

        Our ability to increase our sales in the U.S. and to telecom service providers and major cable operators depends on our ability to obtain key customers in these markets, and to devote substantial technical, marketing and sales resources to these markets, which have lengthy equipment qualification and sales cycles. We will need to engage distributors who will be able to market and support our products effectively in the telecom and cable markets. Large cable and telecom operators in the U.S. may be reluctant to purchase products from a small, non-U.S. supplier like us. We therefore intend to expand our OEM partnerships, which exposes us to risks, including reduced gross margins. Large annual purchase agreements or contracts with U.S. telecom service providers and major cable operators are not typical. If we are unable to successfully increase our sales in the U.S., or to telecom service providers or major cable operators, or expand our OEM partnerships, our results of operations would suffer.

We have a history of losses and may never achieve or maintain profitability.

        We have incurred losses in each year since our inception, and as of December 31, 2005, we had an accumulated deficit of $33.1 million. Our losses may increase in the future as we expand our research and development activities and increase our manufacturing and sales and marketing capabilities. The future success of our business will depend on our ability to increase product sales, develop additional products and applications, expand our sales force and distribution network and control costs, which we may be unable to do. We may not generate sufficient revenues from product sales or generate sufficient free cash flow in the future to achieve or maintain profitable operations, resulting in the possibility of future capital requirements.

Our operating results may fluctuate significantly and may fail to meet or exceed the expectations of securities analysts or investors, causing our share price to decline.

Our operating results have fluctuated in the past and are likely to continue to fluctuate in the future on both an annual and quarterly basis as a result of several factors, many of which are outside of our control. Some of the factors that may cause these fluctuations include:

–     the timing, size, delivery, installation and revenue recognition of customer orders;

–     our long and unpredictable sales cycle, which typically lasts approximately 3 to 12 months;

–     the cost and availability of electronic components;

–     our ability to enhance our products and market acceptance of our existing and new products;

–     the potential loss of key OEM partnerships;

–     our customers' need for local franchise and licensing approvals; and

–     regulatory changes in the U.S. and other countries.

We have no supply agreements with our key suppliers, on whom we depend for essential components for our products. If we are unable to obtain these components we may not be able to meet the demand for our products.

        We depend on single sources of supply for certain essential components of our products, including video decoder chips, video encoder chips and network processors. We have no long-term supply agreements with any of these suppliers, and cannot assure you that we will be able to obtain such components on a timely basis or at acceptable prices, if at all. If we are unable to obtain our key components at acceptable prices and on a timely basis, we may not be able to meet the demand for our products, which would adversely affect our production capability, our reputation and results of operations.

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         Discontinued Components

        Our key suppliers routinely develop new components and discontinue the manufacturing of older components. While it is a common practice in our industry to provide at least six months notice before discontinuing production of components, our suppliers are not required to give us advance notice of such changes. When one of our suppliers introduces a new component, or ceases to manufacture older components, we must adapt our current line of products to the new component, which may take longer than the advance notice period, if any, received from the supplier.

         Start-up Company Suppliers

        Some of our third-party suppliers are start-up companies, and are not financially stable. In the event that the supplier of a key component of our products ceases operations or otherwise ceases to do business with us, it would cause delays as we seek an alternate supplier, and we may not have access to the information necessary to enable another supplier to manufacture the component.

         Subcontractors in Israel

        We depend on two subcontractors to assemble our products in Israel. We are restricted by the Office of the Chief Scientist of the Israeli Ministry of Industry, Trade and Labor, or OCS, from manufacturing our products outside of Israel without OCS approval, which would result in an increased royalty rate to the OCS, if granted. Any disruption to our sources of manufacturing, or our inability to manufacture our products at a sufficient rate to keep pace with demand from our customers, would have an adverse effect on our business and customer relationships.

Our products designed for the U.S. market require adaptation before sale outside of the U.S., which may result in additional development costs and delays in sales outside of the U.S.

        The U.S. market imposes specific standards on products such as ours, which are different from those applicable in other parts of the world. As a result, we have directed a substantial portion of our recent research and development efforts toward the development of products for the U.S. market. We need to modify certain of these products before we are able to sell them outside of the U.S., which may result in additional development costs and which may delay our ability to introduce new products outside of the U.S. in a timely manner and have an adverse effect on our results of operations.

Our business is dependent on the capital spending patterns of network operators, and any decrease or delay in capital spending by them would adversely affect our operating results and financial condition.

        Demand for our products will depend on the magnitude and timing of capital spending by network operators as they construct and upgrade their networks. The ordering patterns of our customers is sporadic, and the capital spending patterns of network operators are dependent on a variety of factors, including:

–     competitive pressures, including pricing pressures;

–     consumer demand for new services;

–     emphasis on generating revenues from existing customers instead of new network construction or upgrades;

–     evolving industry standards and network architectures; and

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–     completion of major network upgrades, which may have the effect of reducing capital expenditures by our customers.

        In addition, uncertain and volatile capital markets have depressed the market values of network operators and restricted their access to capital, resulting in delays or the cancellation of certain projects. Financial difficulties among network operators would adversely affect our results of operations.

We may not be able to successfully compete with larger competitors which have greater operations, financial, marketing, human and other resources than us.

        We compete in a highly competitive market. We compete primarily on the basis of the technological merits of our products, cost, support and product availability. Many of our competitors are large companies with significantly greater financial, marketing, human and other resources than us, which may give them competitive advantages over us. Our larger competitors have broader product lines that our target customers may prefer. SBC, one of our targeted telecom customers, recently awarded a large IPTV contract to Scientific-Atlanta which may limit our ability to sell to SBC. Other customers may also award initial contracts to larger suppliers than us. Our revenues and our sale prices may decline significantly if our competitors introduce equivalent or superior products. Scientific-Atlanta recently announced a product similar to our intelligent video gateway. We are currently unable to assess the potential impact this new product may have on our business, or our relationship with Scientific-Atlanta. In addition, many of our competitors manufacture their products in countries where the cost of production is significantly lower than in Israel, where we produce most of our products, thus decreasing their cost and thereby enabling them to offer competitive lower prices for their products.

We rely on third-parties to distribute and market the majority of our products, and our financial performance may be adversely affected if we cannot maintain effective distributor relationships. Some of our distributors may sell products that compete with our products, or may cease selling our products as we increase our direct sales efforts.

        We sell a significant portion of our products through third-party distributors, including resellers, system integrators and agents, and we expect OEM sales to represent a growing portion of our revenues. Our distributors and OEMs may not be successful in marketing and selling our products in the future and may terminate their relationships with us upon short notice with little or no penalty. We may not be able to maintain an effective distributor or OEM network, which could adversely affect our results of operations.

        Some of our distributors have sold in the past, and may sell in the future, products that compete with our products. In addition, we are increasing efforts to sell our products directly to larger cable and telecom operators. Some of these operators are current or target customers of our OEMs, and our OEMs may decide to purchase products from other manufacturers who do not compete directly with them. The loss of one or more of our major distributors or OEM partners, especially in a key market, could have a material adverse effect on our results of operations.

Some of the technology we use is licensed from third-parties and integrated into our products. If our licensors terminate our license agreements, we may be forced to stop selling some of our products, and seek other alternatives, which could harm our business.

        Our products are based on a combination of our core technology and licenses we obtain from third-parties. For example, the software that we use in our products to compress video into an MPEG format is licensed to us by a third-party. While some of our license agreements are perpetual, others are terminable within a short period. If any of our licensors decides to terminate the license agreement we have with such licensor, we may be forced to stop selling some of our products, and seek other alternatives, which could harm our business and results of operations.

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A substantial majority of our sales and substantially all of our other activities occur outside the U.S. We are subject to risks associated with operating in a wide variety of countries, which may negatively affect our operating results.

        Sales to customers outside the U.S. for 2003, 2004 and 2005 represented 92.0%, 88.4%, and 85.6% of our revenues, respectively. We expect that non-U.S. sales will continue to represent a major portion of our revenues for the foreseeable future. Substantially all of our research and development and contract manufacturing occurs in Israel. Our operations, the operations of our contract manufacturers and our sales in non-U.S. markets, are subject to a number of risks, including:

–     longer payment cycles;

–     potentially weak protection of intellectual property rights in certain countries;

–     the burden of complying with a wide variety of foreign laws, treaties and technical standards;

–     import and export license requirements, tariffs, taxes and other trade barriers; and

–     political and economic changes and instability.

        In 2005, most of our revenues were denominated in U.S. dollars, and we expect that a significant portion of our revenues will continue to be denominated in U.S. dollars, with a smaller portion denominated in Euros and other currencies. Our expenses to date have been incurred, in almost equal parts, in U.S. dollars or currencies linked to the U.S. dollar, and in New Israeli Shekels, or NIS. Fluctuations in currency exchange rates could cause fluctuations in our revenues, accounts receivable, accounts payable and other monetary assets and liabilities. We engage in currency hedging from time to time to reduce the risks associated with fluctuations in currency exchange rates. If we do not successfully engage in hedging transactions, our results of operations may suffer. Fluctuations in currency exchange rates also could cause our products to become relatively more expensive to customers in a particular country, leading to a reduction in sales in that country, which could adversely impact our business and results of operations.

If we are unable to protect our intellectual property rights, our competitive position could be harmed.

        Our success and ability to compete depend upon our ability to protect our proprietary technology. We rely on a combination of patent, copyright, trademark and trade secret laws, and on confidentiality and invention assignment agreements in order to protect our intellectual property rights. Our technology is currently covered by two issued patents in the U.S. (U.S. Patent 6,784,811, 6,961,377), and by several additional patent applications pending in the U.S. The process of seeking patent protection can be long and expensive, and there can be no assurance that our existing or future patent applications will result in patents being issued, or that our existing patents, or any patents which may be issued as a result of existing or future applications, will provide meaningful protection or commercial advantage to us. Any issued patents may be challenged, invalidated or legally circumvented by third-parties. We cannot be certain that our patents will be upheld as valid, be enforceable or prevent the development of competitive products. Moreover, we operate, sell and market our products in some countries, including China, with potentially weak protection of intellectual property rights. Consequently, our competitors could develop, manufacture and sell products that directly compete with our products, which could decrease our revenues and gross margins. In addition, competitors could purchase one of our systems and attempt to replicate some or all of the competitive advantages we derive from our development efforts, design around our protected technology or develop their own competitive technologies that fall outside of our intellectual property rights. If our intellectual property is not adequately protected against competitors’ products and methods, our competitive position could be adversely affected, as could our results of operations.

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        We have also developed technical knowledge, which, although not patented, we consider to be significant in enabling us to compete. However, the proprietary nature of such knowledge may be difficult to protect. We generally enter into agreements with our employees and consultants who are involved in our research and development activities or who have access to any of our confidential information prohibiting these individuals from disclosing any confidential information or trade secrets. We cannot assure you that these agreements will provide meaningful protection of our proprietary information in the event of unauthorized use or disclosure of this information, nor in the event of a competing claim to this technology by a previous employer of any of our employees or consultants. Furthermore, in the absence of patent protection, we may be exposed to competitors who independently develop equivalent technology or gain access to our knowledge.

Third-party claims of infringement could require us to redesign our products, seek licenses or engage in future, costly intellectual property litigation, which could impact our future business and financial performance.

        Claims by competitors and other third-parties that our products allegedly infringe upon the patent rights of others could have a material adverse effect on our business. Our industry is characterized by frequent and substantial intellectual property litigation. Intellectual property litigation is complex and expensive, and the outcome of this type of litigation is difficult to predict. Any future litigation, regardless of outcome, could result in substantial expense and significant diversion of the efforts of our management and technical personnel. An adverse determination in any such proceeding could subject us to significant liabilities or require us to seek licenses from third-parties or pay royalties that may be substantial. Furthermore, we cannot assure you that necessary licenses would be available on satisfactory terms, or at all. Accordingly, an adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing or selling certain of our products, any of which could have a material adverse effect on our business and results of operations.

        We may become involved in litigation to protect the trademark rights associated with our name or the names of our products. We do not have a trademark registration or application for our company name. We do not know whether others will assert that our name infringes upon their trademark rights. In addition, names we choose for our products may be claimed to infringe upon names held by others. If we need to change the name of our company or products, we may experience a loss in goodwill associated with our brand name, customer confusion and a loss of revenues.

We have a limited backlog of orders and must maintain sufficient inventory levels to meet anticipated demand. This may result in write-offs of obsolete inventory, which could adversely affect our financial performance.

        The timing and volume of orders for our products are difficult to forecast, as a substantial portion of our sales are booked and shipped in the same quarter pursuant to purchase orders. We generally do not have long-term supply agreements with our customers, and we have a limited backlog of orders for our products and must maintain or have available sufficient inventory levels to satisfy anticipated demand on a timely basis. Maintaining sufficient inventory levels to ensure prompt delivery of our products increases the risk of inventory obsolescence and associated write-offs, which could harm our financial performance. In addition, our limited backlog makes accurately forecasting inventory and other expenditures difficult.

Changes in telecommunications regulations could harm our prospects and future revenues.

        Global efforts to deregulate the telecommunications industry have resulted in increased levels of competition among service providers and a rapidly-evolving industry landscape. In the U.S. for example, the Telecommunications Act of 1996 generally permitted service operators to enter each others’ markets and to provide a variety of voice, video and data services. Changes in telecommunications regulations in the U.S. and other countries could limit the construction or expansion of our customers’ networks and affect the sales of our products. Increased regulation of our customers’ service offerings could limit their capital equipment investments and consequently the purchases of our products. Changes in regulations could have a material adverse effect on our business and results of operations.

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Business combinations and other financial restructurings by network operators or our competitors could adversely affect our business.

        Business combinations and other restructurings in our industry are common, such as the acquisition of AT&T Broadband by Comcast in 2002, the acquisition by The News Corporation in December 2003 of an indirect controlling interest in Hughes Electronics, the parent company of DIRECTV, the recent privatization of Cox Communications, the planned sale of Adelphia Communications out of bankruptcy and the proposed sale of Cablevision’s VOOM satellite assets to Echostar. Further business combinations may occur in our industry, which may reduce the number of network operators and decrease capital spending in our industry, which could reduce demand for our products and adversely affect our results of operations.

        Certain of our customers have accumulated significant levels of debt and have announced reorganizations and financial restructurings, including bankruptcy filings, during recent years. Further business combinations and restructurings may occur again in the future, which may adversely impact our customers’ purchases of new equipment.

        The communications equipment industry is characterized by frequent mergers and acquisitions. An acquisition of one of our competitors, or merger between our competitors, could harm our competitive position or cause our target customers to delay purchases of our products while they assess the impact of the combination. If a larger company with more resources were to acquire a competitor of ours, they may invest additional resources in developing, marketing and supporting competitive products, which would negatively impact our business and results of operations.

We are highly dependent on key members of our executive team, and the failure to attract and retain key personnel could adversely affect our business.

        We are highly dependent on the members of our executive management team and technical staff, including, in particular, David Mahlab, our Chief Executive Officer, who founded Scopus and who has directed our business since inception, and Yaron Simler, our President, who only recently joined our company and is important to our U.S. operations and expansion strategy. Pursuant to a transition plan approved by our board of directors, on January 1, 2007.

        Mr. Gat will step down of his position as the chairman of our board of directors, and will be replaced by Mr. David Mahlab, who will be appointed as the active chairman. Yoel Gat will continue to serve as a consultant and as a director in the board of directors and will be appointed to another position such as a vice chairman of our board of directors. On January 1, 2007, Dr. Simler will replace Mr. David Mahlab as our chief executive officer, and become president and chief executive officer. After the transition, the respective compensation package paid to each of Dr. Simler, Mr. Mahlab and Mr. Gat will remain unchanged. We do not currently carry “key man” insurance with respect to either Mr. Mahlab or Dr. Simler. We depend on our management’s and technical staff’s experience and familiarity with our technology to execute our business strategy. We have entered into employment agreements with both Mr. Mahlab and Dr. Simler pursuant to which they have agreed not to engage in certain activities that directly compete with us upon their termination of employment. However, these prohibitions against Mr. Mahlab and Dr. Simler’s competitive activities are limited to four months and one year, respectively, following their termination of employment. Our employment agreement with Mr. Mahlab requires a one-year notice of termination and that he be entitled to use any of his accrued vacation. Our success will also depend in large part on our ability to continue to attract, retain and motivate highly skilled management and technical personnel. The departure or other loss of any member of our executive management team or technical staff could harm our ability to effectively develop and market our products.

        Competition for certain employees, particularly development engineers, is intense. We may be unable to continue to attract and retain sufficient numbers of highly skilled employees. If we are unable to attract and retain additional qualified and highly skilled employees our business, financial condition and results of operations may be adversely affected.

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We are exposed to additional costs and risks associated with complying with increasing and new regulation of corporate governance and disclosure standards.

        As a public company, we are spending an increased amount of management time and resources to comply with changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and Nasdaq Stock Market rules. Particularly, as a foreign private issuer, we may need to comply with the provisions of Section 404 of the Sarbanes-Oxley Act no later than the filing of our annual report on Form 20-F for the fiscal year ending December 31, 2006. Section 404 requires management’s annual review and evaluation of our internal controls over financial reporting, and attestation of the effectiveness of our internal controls over financial reporting by management and our independent registered public accounting firm in connection with the filing of our annual report on Form 20-F for the fiscal year ending December 31, 2006, and with each subsequently filed annual report on Form 20-F. As part of this process, we will need to document and test our internal control systems and procedures and make improvements in order for us to comply with the requirements of Section 404. This process will require us to hire additional personnel and outside advisory services and will result in significant additional accounting and legal expenses.

We may have difficulty managing our growth, which could limit our ability to increase sales and cash flow.

        We have experienced significant growth in our operations in recent years, with our annual revenues increasing from $20.1 million in 2000 to $44.8 million in 2005. During the next two years, we expect to expand our research and development, sales and marketing and manufacturing activities, including our activities in the U.S. Our growth has placed, and will continue to place, significant demands on our management, as well as our financial and operational resources, as required to:

–     manage a larger organization;

–     implement appropriate operational and financial systems;

–     expand our distribution and manufacturing capacity; and

–     expand our sales and marketing infrastructure and capabilities.

        If we cannot grow and manage our business appropriately, we may not be able to execute our business strategies and our business and financial results would suffer.

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

        We may, in the future, pursue acquisitions of businesses, products and technologies, or establish joint venture arrangements to expand our business. The negotiation of potential acquisitions or joint ventures, as well as the integration of an acquired or jointly developed business, technology, service or products could divert management’s time as well as our resources, and disrupt our operations and cause our business to suffer. We have not acquired a business in the past, and we may be unable to successfully integrate acquired businesses or joint ventures with our operations. Future acquisitions may also require additional capital, which may not be available on favorable terms, if at all, or which may dilute the interests of our shareholders.

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We are subject to regulation by the United States Federal Communications Commission, or FCC, and other foreign governmental and qualification requirements by non-governmental agencies and our customers. If we are unable to obtain and maintain regulatory qualifications or approvals for our products and our future applications and products, our business may be adversely affected.

        Our products are sold worldwide. The regulatory requirements in various countries vary widely, and complying with such regulatory requirements can be an expensive and time-consuming process. In addition, different network operators and national non-governmental standards organizations in the U.S. and worldwide impose varying standards and qualification requirements. While our products have been approved in certain countries, we cannot assure you that we will be able to maintain these regulatory or industry qualifications, clearances or approvals in all the countries in which we operate, or that we will be able to obtain such qualifications, clearances or approvals in new foreign markets or for new products. We may incur significant costs in attempting to maintain or obtain qualifications, clearances or approvals. If we do not comply with the applicable regulatory requirements in each of the jurisdictions in which our products are sold, we may be subject to regulatory enforcement actions which could require us to, among other things, cease selling our products. Furthermore, if our products fail to meet the standards and qualification requirements imposed by network operators or non-governmental standards organizations, we may not be able to successfully market and sell our products. If any of these events were to occur, our business, financial condition and results of operations would suffer.

We may be materially affected by the WEEE and RoHS directives.

        The European Union has adopted the 2002/96/EC Directive on Waste Electrical and Electronic Equipment, or WEEE directive, which regulates the collection, recovery and recycling of waste from electrical and electronic products, and the 2002/95/EC Directive on Restrictions on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment, or RoHS directive, which bans the use of certain hazardous materials including lead, mercury, cadmium, chromium, and halogenated flame-retardants. Our products fall under the scope of both directives as electrical and electronic equipment. Certain of our key components use lead. Under WEEE, we will be responsible for financing operations for the collection, treatment, disposal and recycling of past and future products sold in the European Union. Implementation of these directives is carried out at the national level by each of the European Union Member States. Because the specific national requirements have not yet been finalized in all Member States, we are presently unable to reasonably estimate the amount of any costs that may be necessary in order to comply with WEEE. We cannot assure you that compliance with WEEE and RoHS will not have a material adverse effect on our financial condition or results of operations.

Risks Related to this our Ordinary Shares

Our ordinary shares have only been traded for a short period and our share price may be volatile.

        Our ordinary shares commenced trading in December 2005, there has been no public market for our ordinary shares prior to that. An active public trading market may not develop or, if developed, may not be sustained. The lack of a trading market may result in the loss of research coverage, if any, provided by securities analysts, or the loss of, or failure to secure, coverage by securities analysts which may negatively impact the public trading market for our ordinary shares. The market price of our ordinary shares would be affected by a number of factors, including changes in the estimates of our operating results or changes in recommendations by any securities analysts that elect to follow our ordinary shares, and market conditions in our industry, the industries of our customers and the economy as a whole. If our future quarterly results or guidance for future periods are below the expectations of securities analysts or investors, the price of our ordinary shares would likely decline. Share price fluctuations may be exaggerated if the trading volume of our ordinary shares is low.

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Our major shareholders, officers, directors and affiliated entities own a majority of our ordinary shares and control us.

        Our major shareholders, executive officers, directors and entities affiliated with them, in the aggregate, will beneficially own approximately 59.8% of our outstanding ordinary shares (including shares subject to options granted to such shareholders that are currently exercisable or exercisable within 60 days of March 31, 2006). These shareholders, if acting together, would be able to control all matters requiring approval by our shareholders, including the election of directors and the approval of mergers or other business combination transactions.

Future sales of our ordinary shares could reduce our share price.

        We have 13,103,018 ordinary shares outstanding. We intend to file a registration statement on Form S-8 under the Securities Act to register 6,028,017 ordinary shares issued or issuable under our shares option plans. As of December 31, 2005, options to purchase 3,515,066 ordinary shares were issued and outstanding, of which options to purchase 2,084,435 ordinary shares had vested and had not been exercised. We have granted to a number of our shareholders, who together own a total of approximately 8,462,888 ordinary shares, registration rights with respect to their ordinary shares or ordinary shares underlying other securities. Sales by shareholders of substantial amounts of our ordinary shares, or the perception that these sales may occur in the future, could materially and adversely affect the market price of our ordinary shares. In addition, a substantial number of shares held by our current shareholders or issuable upon exercise of options will be eligible for sale in the public market, and could be sold pursuant to registration under the Securities Act or an exemption from registration. Our executive officers, directors, shareholders and option holders have agreed not to sell an aggregate of approximately 12,110,602 shares owned by them for a period of 180 days following December 14, 2005. As these restrictions on resale end, the market price of our ordinary shares could drop significantly if the holders of these restricted shares sell them or are perceived by the market as intending to sell them.

Our U.S. investors could suffer adverse tax consequences if we are characterized as a Passive Foreign Investment Company.

        If, for any taxable year, our passive income, or our assets that produce passive income, exceed levels provided by U.S. law in relation to our non-passive income or our non-passive assets, respectively, we may be characterized as a passive foreign investment company for U.S. federal income tax purposes.

        Based upon a projection of our income and assets, determined by reference to the expected market value of our shares when issued, and assuming that we are entitled to value our intangible assets with reference to the market value of our shares, and our intended use of the proceeds of this offering, we do not believe that we will be a passive foreign investment company for our current taxable year. However, because passive foreign investment company status is based on our income and assets for the entire taxable year, it is not possible to determine whether we will have become a passive foreign investment company for the current taxable year until after the close of the year. Moreover, we must annually determine our passive foreign investment company status based on tests which are factual in nature, and we are therefore unable to determine whether we will become a passive foreign investment company in the future. While we intend to manage our business to avoid passive foreign investment company status, to the extent consistent with our other business goals, we cannot predict whether our business plans will allow us to avoid passive foreign investment company status or whether our business plans will change in a manner that affects our passive foreign investment company status determination. In addition, because the market price of our ordinary shares is likely to fluctuate after this offering, and our market price may affect the determination of whether we will be considered a passive foreign investment company, we cannot assure you that we will not be considered a passive foreign investment company for any taxable year. Characterization as a passive foreign investment company could result in adverse U.S. tax consequences to our shareholders.

        U.S. shareholders should consult with their own U.S. tax advisors with respect to the U.S. tax consequences of investing in our ordinary shares. For a discussion of how we might be characterized as a passive foreign investment company and related tax consequences, see “Item 10E. U.S. Federal Income Tax Consequences – Passive Foreign Investment Company Considerations.”

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Risks Related to Our Operations in Israel

Security, political and economic instability in Israel may impede our ability to operate and harm our financial results.

        Our principal executive offices, research and development facilities and contract manufacturer are located in Israel. Accordingly, security, political and economic conditions in Israel may directly affect our business. Over the past several decades, a number of armed conflicts have occurred between Israel and its Arab neighbors. Any hostilities involving Israel, or the interruption or curtailment of trade between Israel and its present trading partners, could adversely affect our operations. Since October 2000, terrorist violence in Israel has increased significantly and negotiations between Israel and Palestinian authorities have occurred only intermittently. In addition, despite the progress towards peace between Israel, its Arab neighbors and the Palestinians, some countries, principally those in the Middle East as well as Malaysia and Indonesia, and some companies and organizations in those countries, continue to participate in a boycott of Israeli firms. Increased hostilities, future armed conflicts, political developments in other states in the region, or continued or increased terrorism could disrupt our operations and adversely affect the willingness of customers outside Israel to buy our products, which could increase our costs and adversely affect the expansion of our business and our results of operations.

Our results of operations could be negatively affected by the obligations of our personnel to perform military service in Israel.

        All male and a portion of female adult Israeli citizens under the age of approximately 48, unless exempt, are obligated to perform military service duty annually for a period of up to approximately 36 days. Additionally, they can be called to active duty at any time under emergency circumstances. Should the hostilities in the region escalate, some of our executive officers, directors and employees could be called to active military duty, possibly resulting in interruptions in our sales and development efforts and other adverse impacts on our business and operations which we can not currently assess.

You may have difficulties enforcing a U.S. judgment against us, our executive officers or our directors, asserting U.S. securities laws claims in Israel or serving process on our executive officers and directors and the Israeli experts named in this annual report.

The majority of our executive officers and directors, and the Israeli experts named in this prospectus are located in Israel, and a majority of our assets, and the assets of these persons, are located in Israel. Therefore, a judgment obtained against us or any of them in the U.S., including one based on the civil liability provisions of the U.S. federal securities laws, may not be collectible in the U.S. and may not be enforced by an Israeli court. Further, if a foreign judgment is enforced by an Israeli court, it generally will be payable in Israeli currency. It also may be difficult for you to assert U.S. securities law claims in original actions instituted in Israel.

The government grants we have received for research and development expenditures limit our ability to manufacture products and transfer technologies outside of Israel and require us to satisfy specified conditions. If we fail to satisfy these conditions, we may be required to refund grants previously received together with interest and penalties, and may be subject to criminal charges.

        Our research and development efforts have been financed, in part, through grants from the OCS. We, therefore, must comply with the requirements of the Israeli Law for the Encouragement of Industrial Research and Development, 1984 and related regulations, or the Research Law. In recent years, the government of Israel has accelerated the rate of repayment of OCS grants and may further accelerate them in the future. In addition, if we fail to comply with any of the requirements imposed by the OCS, such as change of control notices and annual reporting requirements, we may be required to refund any grants previously received together with interest and penalties, and a person transferring OCS backed technology may be subject to criminal charges and up to three years in prison.

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        While, under OCS rules, we may sell final electronic products which are based on technology developed with OCS funding worldwide without violating OCS transfer restrictions, the technology itself may not be transferred and any transfer of technology generally requires the approval of an OCS committee. A transfer for the purpose of OCS rules, means an actual sale of the technology, any exclusive license to develop, market, and manufacture products resulting from the technology or any other transaction which in essence constitutes a transfer of the technology. There is no assurance that we will receive the required approvals should we wish to transfer this technology in the future. These restrictions may impair our ability to sell our technology assets or to outsource manufacturing outside of Israel, and the restrictions continue to apply even after we have repaid 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 tax benefits available to us under Israeli law require us to meet several conditions, including making specified investments in property and equipment, and financing a percentage of investments with share capital, and may be terminated or reduced in the future, which would increase our taxes.

        We have not yet generated any taxable income and have therefore not taken advantage of tax exemptions and reductions resulting from the “Approved Enterprise” status of our facilities in Israel. To be eligible for these tax benefits, we must meet conditions, including making specified investments in property and equipment, and financing a percentage of investments with share capital. If we fail to meet these conditions in the future, the tax benefits would be canceled and we could be required to refund any tax benefits we might already have received. These tax benefits may not be continued in the future at their current levels, or at any level. In recent years, the Israeli government has reduced the benefits available and has indicated that it may further reduce or eliminate some of these benefits in the future. The termination or reduction of these benefits may increase our income tax expense in the future. Additionally, if we increase our activities outside of Israel, for example, through acquisitions, our increased activities generally will not be eligible for inclusion in Israeli tax benefit programs. See “Israeli Taxation – Law for the Encouragement of Capital Investments, 1959” for more information about these programs.

Provisions of our articles of association, other corporate documents and Israeli law may delay, prevent or make difficult an acquisition of us, which could prevent a change of control and negatively impact our share price.

        Israeli corporate law regulates mergers, requires tender offers for acquisitions of shares above specified thresholds, requires special approvals for transactions involving directors, officers or significant shareholders and regulates other matters that may be relevant to these types of transactions. Moreover, as noted above, the transfer of our technology (including by acquisition) is subject to certain restrictions and approvals of the OCS, which provided grants for the development of our technology. Furthermore, Israeli tax considerations may make potential transactions unappealing to us or to some of our shareholders. These provisions of Israeli law may delay, prevent or make difficult an acquisition of our company, which could prevent a change of control and therefore depress the price of our shares.

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Under current U.S. and Israeli law, we may not be able to enforce covenants not to compete and therefore may be unable to prevent our competitors from benefiting from the expertise of some of our former employees.

        We have entered into non-competition agreements with the majority of our professional employees. These agreements prohibit our employees, if they cease working for us, from competing directly with us or working for our competitors for a limited period of time. Under current U.S. and Israeli law, we may be unable to enforce these agreements, in whole or in part, and it may be difficult for us to restrict our competitors from gaining the expertise our former employees gained while working for us. For example, Israeli courts have recently required employers seeking to enforce non-competition undertakings of a former employee to demonstrate that the competitive activities of the former employee will harm one of a limited number of material interests of the employer which have been recognized by the courts, such as the secrecy of a company’s confidential commercial information or its intellectual property. If we cannot demonstrate that material harm would be caused to us, we may be unable to prevent our competitors from benefiting from the expertise of our former employees.

        We were incorporated in the State of Israel in December 1993 as Telcatel Teletec Advanced Telecommunications Ltd., a wholly-owned subsidiary of Tadiran Ltd. We changed our name in 1994 to Scopus Imaging Ltd., and in 1995, Tadiran spun-off its activity in the field of digital video networking to us, and we were renamed Scopus D.V.C. Ltd. In 1996, we changed our name to Tadiran Scopus Ltd., in 2001 to Scopus Network Technologies Ltd. and in 2005 to Scopus Video Networks Ltd. We have a wholly-owned subsidiary, Scopus Video Networks Inc. a Delaware corporation located at 3 Independence Way, 1st floor Princeton NJ, 08540, which also serves as our agent for service of process in the U.S. We maintain regional sales offices in China, Germany, India, Japan and Russia.

        Our principal executive offices are located at 10 Ha’amal St., Park Afek, Rosh Ha’ayin 48092, Israel. Our telephone number is (972-3) 900-7777. Our website address is www.scopus.net. The information on our website does not constitute part of this annual report.

        We have registered our trademark “CODICO” in France, Germany, Israel, Japan, the U.K. and the U.S.

        Principal Capital Expenditures

        We had capital expenditures of $1.2 million in 2005, $0.8 million in 2004 and $0.4 million in 2003. We have financed our capital expenditures with cash generated from operations and financing activities.

        Our capital expenditures in 2005 consisted primarily of purchases of a laboratory equipments for R&D and test equipment for production. Our capital expenditures in 2004 and 2003 consisted primarily of purchases of laboratory equipments for R&D.

Overview

        We develop, market and support digital video networking products, including intelligent video gateways, encoders, decoders and network management products. Our customers include satellite, cable and telecom service providers and terrestrial broadcasters, collectively referred to as network operators. Our products are typically installed in a network operator equipment facility or broadcast center to support digital television, high-definition television, or HDTV, live event coverage and the distribution of video content between network operator facilities. We focus exclusively on digital video networking, which we believe allows us to offer products with compelling features and performance at competitive prices. We provide a comprehensive digital video networking product offering, which we believe is a key competitive differentiator for us. We market our products through a combination of third-party distribution, direct sales and partnerships with original equipment manufacturers, or OEMs. Our products are used by over 500 network operators in 50 countries.

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Industry Background

Growth of the Worldwide Digital Video Market

        Digital video offers benefits over analog video in picture quality, bandwidth efficiency, interactivity, flexibility and integration with other content delivered over IP-based networks. Recognizing these benefits, network operators began transitioning to digital technology during the 1990s. Direct-to-home satellite operators, such as DirecTV, Echostar and Sky, launched national networks to deliver hundreds of channels of high-quality digital video programming. Largely in response to the threat posed by satellite operators, cable operators invested significant resources to upgrade their networks to support digital video and two-way, broadband services. More recently, many telecom service providers have either committed to, or initiated, projects to offer digital video services over an IP-based network, referred to as IPTV.

        The worldwide transition from analog to digital video is still at an early stage. According to Informa Telecoms & Media, a market research firm, the rate of digital television adoption in North America is expected to increase from 53% of television households in 2005, to 91% in 2010. On a worldwide basis, the rate of digital television adoption is expected to increase from 13% of television households at the end of 2005, to 32% by the end of 2010. We believe the worldwide transition to digital video is driven by the inherent performance and efficiency advantages of this technology, as well as the following key factors:

        Intense competition among network operators. Global deregulation of the telecommunications industry has resulted in increased competition among service providers and a rapidly-evolving industry landscape. Network operators are striving to deploy bundled voice, video and data services as a means to increase service revenue, improve subscriber retention and offer differentiated entertainment and pricing plans. While traditional voice and data services leave little room for differentiation and the prices of these services are decreasing steadily, video represents an important source of spending by consumers. Network operators are therefore striving to offer a broad selection of high-quality, digital video programming in order to distinguish themselves and build customer loyalty.

        Increasing consumer demand for digital content. In recent years, demand by consumers for digital content has grown, driven in large part by the growth of the Internet and the availability of affordable broadband access services. The clear shift towards digital entertainment formats is evidenced by the rapid consumer adoption of CDs, DVDs, MP3 players, digital video recorders and digital satellite radio. Digital formats provide consumers with a broader variety of high-quality content that can be accessed at home, at the office or while traveling, and viewed on a wide variety of devices. Network operators are seeking to capitalize on these consumer demand trends by rapidly expanding the amount of digital video programming offered.

        Benefits of personalized programming. To attract and retain subscribers, network operators are utilizing digital video technologies to deploy personalized content that is tailored for specific interests or communities. For example, video-on-demand and digital video recorders provide consumers with the ability to start a wide array of programs at the time of their choosing with full pause, rewind and fast-forward capabilities. According to Informa Telecoms & Media, the revenues generated by on-demand services are expected to increase from $5.2 billion at the end of 2005, to $11.6 billion at the end of 2010. Digital program insertion allows network operators to seamlessly blend local advertisements into live programming. Digital advertising insertion enhances advertising effectiveness and network operator revenues by delivering targeted advertising to specific regions, cities or even neighborhoods.

        Expanding channel lineups. Increased competition among service providers, coupled with greater consumer demand for a broad range of programming, has led to significant increases in the number of television channels offered. Direct-to-home satellite operators are expanding their already broad channel lineups with the introduction of local television channels in selected markets, as well as dedicated HDTV channels. The introduction of local channels has been a key contributor to the growth in satellite subscribers and demonstrates the appeal of localized content. In response, cable operators have greatly expanded their programming menus, including the introduction of on-demand, HDTV and other premium channels. Selected cable operators have also begun simultaneously offering analog channels over new digital networks through a process known as digital simulcast, further increasing channel counts. Digital video networks, which offer the advantages of sophisticated compression technologies, allow network operators to offer more channels over a fixed amount of network capacity.

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        Growth in HDTV programming. Network operators have begun offering HDTV programming, which offers greater resolution than standard definition digital video. HDTV is typically delivered in a wide-screen format and may be accompanied by digital surround-sound. The superior quality of the HDTV viewing experience has led to a rapid expansion of HDTV programming offered by network operators and increased sales of HD-compatible television sets. According to Informa Telecoms & Media, the number of worldwide households subscribing to HDTV services is expected to increase from 9.8 million at the end of 2005, to 80.0 million by the end of 2010, representing a 52% compounded annual growth rate.

Transition to Video-over-IP

        While video has traditionally been delivered over discrete networks, network operators are beginning to migrate their video services onto IP-based networks. Video-over-IP, including IPTV, offers the following key advantages:

–     Elimination of discrete networks. Because IP technology has the flexibility to support multiple services over a single network, network operators can reduce the number of discrete networks built and maintained, offering long-term cost-savings (after factoring initial transition costs).

–     Bandwidth efficiency. An IP network allows for the transmission of only the channel or service currently selected by the consumer rather than simultaneously transmitting all available channels, saving network capacity.

–     Open platform. IP is a standards-based technology, which facilitates interoperability between network elements from different equipment providers.

–     New applications. The non-proprietary nature of IP networks allows the more rapid development and introduction of new services.

–     Cost-savings. IP-based networks are more cost-effective to deploy because they make use of widely-available, standards-based technologies.

Challenges for Network Operators

        Network operators face a unique set of challenges as they look to deploy digital video services and migrate to video-over-IP. As operators offer new services and seek to deliver personalized content, networks are becoming increasingly complex and capacity constrained. The initial capital costs and ongoing operating expenses associated with the deployment of new services are considerable. Rapidly evolving technologies and standards are leading to market confusion and increased deployment risk. The commercial-skipping features of many digital video recorders are threatening valuable sources of advertising revenues and are necessitating new methods of delivering targeted advertising. Therefore, while digital video represents a significant opportunity for network operators, the challenges involved in deploying successful and profitable digital video services are equally significant. Specific challenges for various market segments include:

        Cable. Cable operators have aggressively introduced a range of new services in recent years, including digital television, HDTV, high-speed data, telephony, video-on-demand and digital video recorders, which has resulted in network capacity constraints. Because of the expense associated with upgrading network capacity, cable operators are looking to optimize existing bandwidth by converting analog customers to digital through a process known as digital simulcast. Certain major cable operators have begun exploring video-over-IP as an alternative to traditional network designs.

        Telecom. Many telecom service providers are seeking to enter the video market with the introduction of IPTV services. Because they lack a preexisting video network, most telecom service providers must deploy new video equipment facilities, which creates a significant opportunity for digital video equipment suppliers. Certain telecom service providers have decided to utilize copper telephone lines to deliver video to end-users. This approach poses bandwidth constraints and requires the use of video compression products.

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        Satellite. To create a more compelling alternative to digital cable, satellite operators are continuing to expand their programming lineups with the addition of local channels and HDTV programming. These efforts have resulted in a sharp increase in the number of channels offered and network bandwidth consumed. Because a satellite has a fixed amount of transmission capacity, and the process of launching new satellites is extremely costly and time-consuming, satellite operators employ advanced digital video compression technologies to maximize satellite bandwidth utilization.

        Broadcast. In the terrestrial broadcasting market, operators in many countries are now required by regulation to convert from analog to digital transmission in order to free broadcast spectrum. The conversion to digital transmission often provides the opportunity to deliver new services, such as HDTV and data transmission. Like cable and satellite operators, these broadcasters must convert analog signals to digital prior to transmission and must also effectively manage the available bandwidth to maximize their revenue.

The Scopus Solution

        We develop, market and support digital video networking products, including intelligent video gateways, encoders, decoders and video management products. Our products are designed to allow our customers to increase service revenues, improve customer retention and minimize capital and operating expenses. Intelligent Video Networking, or IVN, is system architecture upon which our products are designed and defines a common set of principles for digital video networking.

        Our solution offers the following key benefits:

        Comprehensive product offering. We provide a comprehensive digital video networking offering, including intelligent video gateways, encoders, decoders and network management products. Our intelligent video gateway performs content aggregation and processing, while our encoders and decoders perform content compression, encryption, decoding and reception. We believe our ability to deliver all of these capabilities is a key competitive differentiator for us. Our video management system enhances our overall product offering and provides additional value to our customers.

        All-digital, IP-based processing. Our products process traffic completely within the digital domain, eliminating unnecessary analog-to-digital and digital-to-analog conversions, resulting in substantial performance and efficiency advantages. Because our products are compatible with both traditional broadcast networks and newer broadband, IP-based networks, we allow network operators to gradually evolve their networks to video-over-IP. We believe our all-digital, IP-based approach allows our customers to deliver new services, improve network efficiency, deliver a superior picture quality and reduce long-term costs by combining separate networks.

        Distributed architecture. Our products are designed to operate in a manner that supports a distributed architecture, whereby video is processed both at central facilities in a service provider network, and at smaller, local facilities positioned nearer to the subscriber. Distributing a portion of the processing power to the edge of the network delivers increased scalability and resiliency by eliminating bottlenecks and single points of failure which can plague centralized systems. Our distributed architecture is also intended to minimize network congestion and facilitate personalized programming and advertising.

        Density and scalability. We have designed our products to provide superior levels of density and scalability. Density refers to the ability to process a large amount of content from a compact product, while scalability is a measure of the ease at which a product or a network can increase its processing capacity. Our products generally utilize a compact, modular design that allows our customers to purchase our products at low initial costs and to preserve space and power. For example, our intelligent video gateway supports up to several hundred video channels in a unit measuring the approximate size of a pizza box. Our recently introduced UE-9000 encoder and IRD-2900 support four and two channels of video, respectively,  in a single product. Network operators can add our products incrementally to the network to accommodate increased capacity requirements, versus a larger-scale and more costly upgrade.

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        Superior picture quality. Video subscribers require a high quality picture without service interruptions and are likely to switch service providers if their expectations are not met. Our products are designed to deliver a consistently superior picture quality through the application of our video processing, networking and management expertise. Ensuring a consistent quality-of-service allows network operators to increase customer satisfaction and retention, minimize technical support costs and deliver a more competitive service offering.

        Application flexibility. Our flexible products address multiple digital video applications and operate in satellite, cable, telecom and terrestrial broadcasting environments. For example, our products currently support digital television, HDTV, live event coverage and content distribution and are currently being enhanced to support personalized programming and targeted advertising. The flexibility of our products allows our customers deliver multiple applications from a single product and more easily expand the types of services offered to their subscribers.

Products

        We develop, market and support digital video networking products that enable network operators to offer advanced video services to their subscribers. Our products are typically installed in a network operator equipment or broadcast center. The principle elements of our product line include:

Intelligent video gateways. Our IVG-7000 intelligent video gateway is a high-capacity video processing platform. Video processing refers to a collection of steps involved in digital video delivery, including:

–     aggregating multiple digital video channels;

–     adjusting the transmission rate of the various channels;

–     selecting and dropping specific channels to create desired program combinations;

–     encrypting the signal; and

–     directing the content over the network using the most desirable path.

        Our intelligent video gateway performs these functions completely within the digital domain, avoiding the inefficiency of analog-to-digital and digital-to-analog conversions and the costs of additional equipment. High-capacity video processing provides network operators with greater control over their video services, including the ability to offer personalized programming and targeted advertising. Our flexible intelligent video gateway can support a variety of services and is upgradeable to support future applications. Our platform currently supports digital television, HDTV, IPTV and content distribution, among other applications. We are developing an enhanced version of the product to support personalized programming and targeted advertising, which we expect to be available for shipment in the second half of 2006. The compact, modular design of our intelligent video gateway allows our customers to purchase the system with a minimal upfront investment, and gradually increase network capacity by adding additional products. We offer versions of the product tailored for cable, satellite and telecom networks. We began shipping our intelligent video gateway in the fourth quarter of 2003.

        Encoders. Encoders convert analog video content into a digital format and compress and encrypt the traffic for transmission across a network. Our encoders are designed to allow network operators to securely deploy bandwidth-intensive video content, preserve network capacity and deliver a superior picture quality. We offer two families of encoders. Our E Series is a field-proven and cost-effective family of encoders supporting a single MPEG-2 video channel. We began shipping the E Series, our third generation of encoders, in 2000. We recently introduced the UE-9000, our fourth generation encoder. The UE-9000 is a dense encoder supporting up to four video channels and eight audio channels in a compact, pizza-box form-factor. We began shipping a version supporting MPEG-2 compression technology in the first quarter of 2006 and expect to begin shipping an MPEG-4 compatible version in the third quarter of 2006.

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        Decoders. Decoders receive digital video signals and covert the content back to its original analog format. With over 50,000 units shipped to date, we believe our 2600/2800 Series is among the most widely deployed decoders outside of the U.S. We began shipping the 2600/2800 Series in 2000. We recently introduced the IRD-2900 Series, a high-density decoder which replaces the 2600/2800 Series. We began shipping versions of the IRD-2900 featuring single and dual decoders in the third quarter of 2005. We also recently introduced the UID-2900, a product designed to decode IP-based content, allowing cable operators to transition their analog networks to digital through a process known as digital simulcast, among other applications. We began shipping a version of the UID-2902 featuring dual decoders in the second quarter of 2005 and we have a version featuring 12 decoders available for shipment since the first quarter of 2006. Our decoders currently support MPEG-2.

        Management Products. We offer a range of products designed to enable our customers to more easily deploy and manage their video services. Our NMS-4000 network management system is designed to provide network operators with greater control over their video networks, thereby protecting the quality and availability of their critical services. Our CAS-5000 conditional access system enables small- and medium-sized network operators to control access to, and bill for, video services. Our products also interoperate with a variety of third-party, open conditional access systems. We began shipping our NMS-4000 and CAS-5000 products in 2001.

        Ancillary Products. We provide a range of ancillary products to assist our customers in the build-out and operation of their digital video networks. For example, our statistical multiplexers and remultiplexers combine and separate multiple digital video streams to simplify transmission and conserve network bandwidth. We also resell third-party modulators used to transport video streams over various networks and third-party HDTV encoders and decoders supporting MPEG-2.

Technology

        We have a key set of technology skills that we apply to the development of our products. Key areas of expertise include:

        Video encoding. Video encoding technology converts analog video signals into a digital format and compresses the content for more efficient transmission across a network. Video signals carry a large amount of redundant information that is largely imperceptible to the human eye. Using sophisticated algorithms, we strip redundant information from the video signal, resulting in significant bandwidth savings with minimal signal quality degradation. Our video encoding expertise encompasses both the prevailing MPEG-2 and emerging MPEG-4 standards.

        Audio encoding. Audio encoding technology converts analog audio signals into a digital format and compresses the content for more efficient transmission across a network. Our audio encoding expertise encompasses the MPEG-2 MUSICAM standard, as well as the Advanced Audio Compression, or AAC, encoding standard currently under development. We also posses expertise in Dolby Digital encoding techniques and have been certified by Dolby Laboratories as a qualified manufacturer.

        Video pre-processing. Our video pre-processing techniques condition video content prior to encoding in order improve picture quality and conserve bandwidth. Application of our pre-processing capabilities results in smoother, sharper pictures than would otherwise be possible without pre-processing.

        Splicing. Our splicing expertise allows network operators to add video content directly into an existing program. Splicing allows network operators to add local content to national new feeds, deliver targeted advertising and overlay logos and other messages onto a video stream. Unlike traditional analog techniques, we perform splicing completely within the digital domain. We also employ sophisticated techniques to splice content with different data transmission rates.

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        Bit rate reduction. We utilize bit rate reduction to further compress already encoded content, resulting in additional bandwidth savings of up to 30%. Bit rate reduction can be applied to either a single program or multiple programs using our statistical re-multiplexing algorithm, either in constant bit rate mode for cable and IPTV applications, or in variable bit rate mode for satellite applications.

        Video-over-IP. Delivering high-quality video-over-IP requires dedicated mechanisms to overcome common deficiencies of IP networks, including jitter, latency and packet loss. We have developed sophisticated techniques to address these limitations to optimize video quality.

        Video and audio decoding. Decoding technology converts digital signals into an analog format, usually for re-transmission over analog cable or terrestrial networks. Decoding also involves the processing of related analog content embedded within a video or audio stream, such as closed caption and parental control information. Our decoding capabilities encompass MPEG-2 and MPEG-4 video and audio and Dolby Digital audio standards, among others.

        Statistical multiplexing. Our TriplePass statistical multiplexing technology performs simultaneous pre-processing, compression complexity estimation and statistical multiplexing to optimize channel bandwidth utilization. Using our TriplePass algorithm, we believe network operators can achieve bandwidth savings of up to 30%.

        Network management. Our network management technologies allows network operators to identify service failures in certain locations within a distributed network and can automatically redirect traffic to minimize customer service interruptions.

Sales and Marketing

        We market our products through a combination of third-party distribution, direct sales and partnerships with original equipment manufacturers, or OEMs. Our direct and OEM channels generally target large accounts, while we rely on our network of approximately 100 third-party distributors to target small- and mid-size customers.

        We have made selective use of OEM partnerships to increase access to certain customers and geographies. Our conditional access neutral decoders 2600/2800 and UID-2912 decoders are currently resold by Scientific-Atlanta as models D9840/42 and UID-2912, respectively, and our decoders are currently resold by Harmonic. In addition, our decoders and intelligent video gateways are resold under the Grass Valley brand through an OEM agreement with Thomson. While sales through OEM partners have constituted a small portion of our revenues to date, we view this channel as a key growth opportunity and intend to expand our existing relationships and form new relationships. In particular, the OEM channel is a key element of our strategy to access larger cable and telecom service providers, particularly in the U.S.

        We organize our worldwide sales efforts into the following territories:

        Europe, the Middle East and Africa. Our sales efforts in this region are directed through regional sales offices in Germany and Russia and through our headquarters in Israel.

        Asia and the Pacific Rim. Our sales efforts in Asia and the Pacific Rim are centered in China, India, Japan, Korea and Taiwan. We maintain regional sales offices in China, India and Japan, although the majority of our sales in this region are made through local distributors.

        North and South America. Our sales efforts in the Americas are directed from our Princeton, New Jersey office, which also serves as our U.S. headquarters. We also maintain a regional sales presence in Mexico and Brazil.

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        During 2005, these three regions accounted for 51%, 28% and 21% of our revenues, respectively. Sales outside of the U.S. accounted for 84.9% of our revenues in 2005. While the majority of our sales efforts to date have been focused on Europe and Asia, we view the U.S. as a key growth opportunity and expect to expand our sales and marketing efforts in this region.

        See “Item 5. Operating and Financial Review and Prospects – Revenues” below for information regarding the breakdown of our revenues by geographical region.

        We focus our marketing efforts on product positioning, increasing brand awareness, communicating product advantages and generating qualified leads for our sales organization. We rely on a variety of marketing communications channels, including our website, trade shows, industry research, the press and special events to gain wider market exposure. Our marketing organization also works closely with industry experts in various business development activities.

Customers

        Our products have been deployed by over 500 network operators in 50 countries, including satellite and cable operators, telecom service providers and terrestrial broadcasters. Our top ten customers accounted for 52.5%, 39.5% and 37.3% of our revenues for 2003, 2004 and 2005, respectively. Luzhou Broadcasting Bureau and Smart Network Solutions, a reseller servicing the Guangdong Microwave project, accounted for 7% and 6% of our revenues, respectively, for 2005. We generally do not have long-term, binding written agreements with our customers, and instead, ship products based upon either short-term projects or purchase orders received.

Service and Support

        We believe our technical support and professional services capabilities are an important element of our overall offering. Our global customer care network offers local support representatives in each of our key territories of operation. Prior to a sale, we offer our customers a range of professional services including assistance in product selection, network design consultation, system integration and project management. Post-sale, we offer our customers a choice of two support programs designed to maximize network up-time and minimize operating expenses. Our basic customer care program includes help-desk access during normal business hours, product repair services, software upgrades and product training. Our extended customer care program adds 24x7 help-desk access, expedited product replacement, dedicated support engineer assistance, diagnostics and remote troubleshooting, and configuration and software revision management.

Research and Development

        We devote a significant amount of our resources toward research and development to introduce and enhance products to support our growth strategies. Our research and development efforts have benefited from grants from the Israeli Ministry of Industry, Trade and Labor Office of the Chief Scientist, or OCS, including our participation in international programs meant to foster joint technology and business development opportunities between companies in Israel and those of other nations.

        Research and development expenses, net of participation by the OCS, as a percentage of revenues in 2003, 2004, and 2005 were 20.9%, 26.2% and 22.6%, respectively. Our current research and development efforts are focused heavily on video compression systems incorporating MPEG-2 and newer compression standards such as MPEG-4. We also devote considerable development resources to video-over-IP, splicing, dense decoding and network management. Over 80% of our research and development staff are accredited engineers and the remainder are professional technicians.

        Our success in designing, developing and manufacturing new or enhanced products will depend on a variety of factors, including the identification of products addressing market demand, timely design and development and effective manufacturing and assembly processes. Because of the complexity of our research and development efforts, we cannot ensure that we will successfully develop new products, or that our newly developed products will achieve market acceptance. Our failure to successfully develop and introduce new products could harm our business and operating results.

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Manufacturing and Sources of Supply

        We currently rely on two contract manufacturers located in Israel to substantially manufacture our products and to perform partial assembly and product testing. We believe that outsourcing our manufacturing enables us to conserve working capital, better adjust manufacturing volumes to meet changes in demand and quickly deliver products. We are restricted by the OCS from manufacturing our products outside of Israel without OCS approval. We currently perform final product and system test at our Israel facility, although we plan to outsource these functions for large orders in the future. For additional details regarding the OCS program and associated restrictions on our business, refer to “Item 5. Operating and Financial Review and Prospects –Government Grants.”

        Most electronic components are imported from the United States, Europe and the Far East. Our production capacity is sufficient for our level of sales and permits us, in most cases, to ship products typically within 1-2 months of receipt of customer orders if requested by the customer.

        Most of the components required for our products are available from a number of sources throughout the world at competitive prices. Notwithstanding the foregoing, we depend on single sources of supply for certain essential components of our products, including video decoder chips, video encoder chips and network processors. We have no long-term supply agreements with any of these suppliers, and cannot assure you that we will be able to obtain such components on a timely basis or at acceptable prices, if at all. If we are unable to obtain our key components at acceptable prices and on a timely basis, we may not be able to meet the demand for our products, which would adversely affect our production capability, our reputation and results of operations.

        Our key suppliers routinely develop new components and discontinue the manufacturing of older components. While it is a common practice in our industry to provide at least six months notice before discontinuing production of components, our suppliers are not required to give us advance notice of such changes. When one of our suppliers introduces a new component, or ceases to manufacture older components, we must adapt our current line of products to the new component, which may take longer than the advance notice period, if any, received from the supplier.

        Some of our third-party suppliers are start-up companies, and are not financially stable. In the event that the supplier of a key component of our products ceases operations or otherwise ceases to do business with us, it would cause delays as we seek an alternate supplier, and we may not have access to the information necessary to enable another supplier to manufacture the component.

Seasonality

        We have not identified a clear seasonal pattern to our business.

Competition

        We compete in the market for digital video networking products, which we define to include video processing platforms, such as our intelligent video gateway, encoders, decoders and video management products. Our market is highly competitive, and we expect competition to increase as additional network operators, including telecom service providers, begin deploying video services, and the deployment of digital television, HDTV, personalized content and video-over-IP progresses. Our plans to increase our sales efforts in the U.S. and toward larger cable and telecom operators will likely expose us to additional competitive pressures.

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        Our primary competitors in the intelligent video gateway market are Terayon Communications Systems and BigBand Networks. Scientific-Atlanta announced in the part a product to address this market and expected to begin commercial shipments in the fourth quarter of 2005 Our primary competitors in the market for encoders and decoders are Tandberg Television and Harmonic. From time-to-time, we compete with larger companies such as Scientific-Atlanta, Thomson and Motorola.

        We also face competition from the adoption of industry standards that our products do not support. For example, Microsoft is actively marketing a compression standard, referred to as VC-1, which our products do not currently support. To the extent our targeted customers adopt VC-1, or other standards that our products do not support, we would be limited in our ability to sell our products to those customers until we could enhance our products to support those standards, which may be a costly and time-consuming process.

        Our competitors are generally larger in size and have greater resources, well-established brands and customer relationships than we do. Our competitors may develop products that shorten the life cycle of our products or technologies or render them non-competitive or obsolete. In certain cases, we may choose to partner with a competitor or potential competitor, which may expose us to conflicts and other potential competitive risks.

        We compete principally on the basis of product features, performance, quality, completeness of the overall offering, initial price, total cost of ownership and customer service. We believe we compete favorably in these areas.

Intellectual Property

        Our success and ability to compete depend upon our ability to protect our proprietary technology. We rely on a combination of patent, copyright, trademark and trade secret laws, and on confidentiality and invention assignment agreements in order to protect our intellectual property rights. Our technology is currently covered by two issued patent in the U.S. (U.S. Patent 6,784,811, 6,961,377) and we have several additional patent applications pending in the U.S. We also have developed technical knowledge, which, although not patented, we consider to be significant in enabling us to compete. We have registered our trademark “CODICO” in France, Germany, Israel, Japan, the U.K. and the U.S. We also license technology from, and pay royalties to, Dolby Laboratories and MPEG under license agreements.

        The steps we have taken to protect our intellectual property rights may not be adequate. Third-parties may infringe upon or misappropriate our proprietary rights. In order to protect our intellectual property rights, we may need to take legal action against those who may infringe upon our rights. There is no guarantee that we will be successful in protecting our intellectual property in the future. Competitors may also independently develop technologies that are substantially equivalent or superior to the technologies we employ in our products. If we fail to protect our proprietary rights adequately, our competitors could offer similar products, potentially significantly harming our competitive position and decreasing our revenues.

Employees

        As of March 31, 2006, we had 260 full-time employees, consisting of 105 in research and development, 70 in sales, marketing, service and support, 62 in operations and 23 in general and administrative functions within the organization. We consider our relationships with our employees to be good.

Legal Proceedings

        We are currently a party to a legal dispute with one of our suppliers with respect to services allegedly provided by the supplier. In November 2004, the supplier filed a lawsuit against us and our CEO seeking approximately $147,000 plus additional amounts contingent upon our financial results in 2004 through 2006, to be paid in cash and a grant of options to purchase our ordinary shares (which the supplier has recently alleged equal $700,000 for 2003 and 2004, 20% of which the supplier claims is to be paid by a grant of an option to purchase our ordinary shares). We believe that the supplier’s calculations are incorrect and that the suit is without merit and intend to defend ourselves vigorously. In December 2004, we submitted a statement of defense and a cross action in the amount of $130,000.

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        The Israeli Stamp Duty on Documents Law, 1961 (Stamp Duty Law), provides that most documents signed in Israel or related to Israeli assets are subject to a stamp duty, generally at a rate of between 0.4% and 1.0% of the value of the subject matter of such document. Until June 1, 2003, the stamp duty has generally been paid only if and when a document is filed with a governmental authority or with the courts. As a result of an amendment to the Stamp Duty Law that came into effect on June 1, 2003, the Israeli tax authorities have approached many companies in Israel and requested the disclosure of all agreements signed by such companies after June 1, 2003 with the aim of collecting stamp duty on such agreements. In September 2004, we received a letter from the Israeli tax authorities demanding that we present all the documents that have been signed by us from June 1, 2003 and onward. On December 2005, the Stamp Duty Law was amended, so that documents signed on January 1, 2006 and onward are no longer subject to stamp duty. We believe that our consolidated financial statements as of December 31, 2004 and September 2005 included an adequate provision for this matter.

        From time to time, we may be subject to other various claims and legal actions arising in the ordinary course of business. We also intend to pursue legal remedies when necessary to defend our business and intellectual property.

Government Regulation

        We are subject to regulation by the United States Federal Communications Commission, or FCC, and other foreign governmental and qualification requirements by non-governmental agencies and our customers. Our products are sold worldwide. The regulatory requirements in various countries vary widely, and complying with such regulatory requirements can be an expensive and time-consuming process. In addition, different network operators and national non-governmental standards organizations in the U.S. and worldwide impose varying standards and qualification requirements. While our products have been approved in certain countries, we cannot assure you that we will be able to maintain these regulatory or industry qualifications, clearances or approvals in all the countries in which we operate, or that we will be able to obtain such qualifications, clearances or approvals in new foreign markets or for new products. We may incur significant costs in attempting to maintain or obtain qualifications, clearances or approvals. If we do not comply with the applicable regulatory requirements in each of the jurisdictions in which our products are sold, we may be subject to regulatory enforcement actions which could require us to, among other things, cease selling our products. Furthermore, if our products fail to meet the standards and qualification requirements imposed by network operators or non-governmental standards organizations, we may not be able to successfully market and sell our products. If any of these events were to occur, our business, financial condition and results of operations would suffer.

        The European Union has adopted the 2002/96/EC Directive on Waste Electrical and Electronic Equipment, or WEEE directive, which regulates the collection, recovery and recycling of waste from electrical and electronic products, and the 2002/95/EC Directive on Restrictions on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment, or RoHS directive, which bans the use of certain hazardous materials including lead, mercury, cadmium, chromium, and halogenated flame-retardants. Our products fall under the scope of both directives as electrical and electronic equipment. Certain of our key components use lead. Under WEEE, we will be responsible for financing operations for the collection, treatment, disposal and recycling of past and future products sold in the European Union. Implementation of these directives is carried out at the national level by each of the European Union Member States. Because the specific national requirements have not yet been finalized in all Member States, we are presently unable to reasonably estimate the amount of any costs that may be necessary in order to comply with WEEE. We cannot assure you that compliance with WEEE and RoHS will not have a material adverse effect on our financial condition or results of operations.

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        Our research and development efforts have been financed, in part, through grants from the OCS. We, therefore, must comply with the requirements of the Israeli Law for the Encouragement of Industrial Research and Development, 1984 and related regulations, or the Research Law. In recent years, the government of Israel has accelerated the rate of repayment of OCS grants and may further accelerate them in the future. In addition, if we fail to comply with any of the requirements imposed by the OCS, such as change of control notices and annual reporting requirements, we may be required to refund any grants previously received together with interest and penalties, and a person transferring OCS backed technology may be subject to criminal charges and up to three years in prison.

        While, under OCS rules, we may sell final electronic products which are based on technology developed with OCS funding worldwide without violating OCS transfer restrictions, the technology itself may not be transferred and any transfer of technology generally requires the approval of an OCS committee. A transfer for the purpose of OCS rules, means an actual sale of the technology, any exclusive license to develop, market, and manufacture products resulting from the technology or any other transaction which in essence constitutes a transfer of the technology. There is no assurance that we will receive the required approvals should we wish to transfer this technology in the future. These restrictions may impair our ability to sell our technology assets or to outsource manufacturing outside of Israel, and the restrictions continue to apply even after we have repaid 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.

Conditions in Israel

        We are incorporated under the laws of the State of Israel and our principal executive offices and substantially all of our research and development facilities are located in Israel. Accordingly, we are affected directly by political, economic and military conditions in Israel. Our operations would be substantially impaired if major hostilities involving Israel occur or if trade between Israel and its present trading partners is curtailed.

        Political Conditions

        Since the establishment of the State of Israel in 1948, a state of hostility has existed, varying in degree and intensity, between Israel and the Arab countries. In 1979, however, a peace treaty between Israel and Egypt was signed and in October 1994, Israel and Jordan signed a peace treaty. These treaties provide, among other things, for the commencement of full diplomatic relations between the two countries, including the exchange of ambassadors and consuls. In addition, the treaty with Jordan expresses the mutual desire of the parties for economic cooperation and calls for both parties to lift economic barriers and discrimination against the other and to act jointly towards the removal of any economic boycotts by third-parties. To date, there are no peace treaties between Israel and Syria or Lebanon.

        Since 1993, a series of agreements were signed by Israel and Palestinian authorities, outlining several interim Palestinian self-government arrangements. The implementation of these agreements with the Palestinian authorities has been subject to difficulties and delays and a resolution of all of the differences between the parties remains uncertain. Since October 2000, terrorist violence in Israel has increased significantly and negotiations between Israel and Palestinian authorities have occurred only intermittently.

        We cannot predict whether any other agreements will be entered into between Israel and its neighboring countries, whether a final resolution of the area’s problems will be achieved, the nature of any resolution of this kind, or whether the current civil unrest will continue and to what extent this unrest will have an adverse impact on Israel’s economic development, on our operations in the future and on our share price.

        Despite the progress towards peace between Israel, its Arab neighbors and the Palestinians, some countries, principally those in the Middle East as well as Malaysia and Indonesia, and some companies and organizations in those countries, continue to participate in a boycott of Israeli firms. We do not believe that the boycott has had a material adverse effect on our business, but restrictive laws, policies or practices directed towards Israel or Israeli businesses may have an adverse impact on the expansion of our business.

        Military Service

        Generally, all male and a portion of female adult citizens and permanent residents of Israel under the age of approximately 48, unless exempt, are obligated to perform military service duty annually for a period of up to approximately 36 days. Additionally, all of these residents may be called to active duty at any time under emergency circumstances. Currently, a majority of our officers and employees located in Israel are obligated to perform annual reserve duty. While we have operated effectively under these requirements since we began operations, we cannot assess the full impact of the requirements on our workforce or business if conditions should change, and we cannot predict the effect any expansion or reduction of these obligations might have on us.

        Trade Agreements

        Israel is a member of the United Nations, the International Monetary Fund, the International Bank for Reconstruction and Development and the International Finance Corporation. Israel is also a signatory to the General Agreement on Tariffs and Trade, which provides for reciprocal lowering of trade barriers among its members. Israel has also been granted preferences under the Generalized System of Preferences from Japan. These preferences allow Israel to export the products covered by these programs either duty-free or at reduced tariffs.

        Israel and the U.S. entered into a Free Trade Agreement (FTA) in 1985. Under the FTA, most products receive immediate duty-free status. The FTA eliminated all tariff and some non-tariff barriers on most trade between the two countries in 1995. Israel became associated with the European Economic Community, now known as the European Union, under a 1975 Free Trade Agreement, which confers some advantages with respect to Israeli exports to most European countries and obligates Israel to lower its tariffs with respect to imports from those countries over a number of years. Israel is a member of the European Union’s Sixth Research and Development Program, giving Israelis access to research and development tenders in the European Union countries. Since 1993, a free trade agreement has been in effect between Israel and the European Free Trade Association, or EFTA, whose members include Switzerland, Norway, Iceland and Liechtenstein. The agreement grants the exporting countries of EFTA trading with Israel conditions similar to those Israel enjoys with the U.S.

        In recent years, Israel has established commercial and trade relations with a number of other nations, including Russia, China, India and other nations in Asia and Eastern Europe, with which Israel previously had not had these relations.

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        Scopus Video Networks Ltd. is organized under the laws of the State of Israel and has a wholly-owned subsidiary, Scopus Video Networks Inc. a Delaware corporation.

        We lease approximately 46,500 square feet of office space in Rosh Ha’ayin, Israel under a lease that expires in May 2008 with an option to extend until May 2011. Our Israeli office serves as our worldwide headquarters, houses our primary research and development efforts and also functions as a regional sales office for Europe, the Middle East and Africa.

        Our U.S. headquarters and primary sales office for the Americas is located in Princeton, New Jersey in a 7,350 square foot facility with a lease that expires in November 2010, with an option for additional 5 year period.

        We maintain regional sales offices in China, Germany, India, Japan and Russia. We believe that our facilities are adequate for our currently anticipated needs, and we expect that additional facilities will be available on reasonable terms in other geographic locations to the extent we add new offices.

        The majority of our fixed assets, both in Israel, consist of machinery, R&D lab equipment and other advanced equipment used for the production, assembly and quality control of our products.

        Not Applicable

        The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Consolidated Financial Data” and our consolidated financial statements and the related notes to those statements included elsewhere in this annual report. In addition to historical consolidated financial information, the following discussion and analysis contains forward looking statements that involve risks, uncertainties and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward looking statements as a result of many factors, including those discussed under “Risk Factors,” “Forward looking Statements” and elsewhere in this annual report. The forward looking statements contained in this annual report are excluded from the safe harbor protection provided by the Private Securities Litigation Reform Act of 1995 and Section 27A of the Securities Act of 1933, as amended.

Overview

        We develop, market and support digital video networking products including intelligent video gateways, encoders, decoders and network management products. Our customers include satellite, cable and telecom service providers and terrestrial broadcasters, collectively referred to as network operators. Our products are typically installed in a network operator equipment facility or broadcast center to support digital television, high-definition television, or HDTV, live event coverage and the distribution of video content between network operator facilities. We market our products through a combination of third-party distribution, direct sales and partnerships with original equipment manufacturers, or OEMs.

        We introduced the first generation of our encoders and decoders in 1995. The majority of our revenues to date have been derived from sales of encoders and decoders. In 2001, we began the development of our intelligent video gateway, an advanced video processing product. We have since directed a large portion of our research and development efforts towards developing and marketing this product. We began shipping our intelligent video gateway in the fourth quarter of 2003. Our operating expenses increased in 2004 as we continued development and marketing activities related to this product. During 2005, sales of our intelligent video gateway represented approximately 9.2% of our revenues. We expect the percentage contribution to our revenues from our intelligent video gateway to increase in future periods as we increase our sales and marketing efforts related to this product line.

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        On December 16, 2005, we completed an initial public offering of 4,500,000 of our ordinary shares at a price to the public of $7 per share.

        We expect our sales and marketing expenses to increase as we attempt to increase our sales to large cable operators and telecom service providers, including those in the U.S. We lack experience selling to these customers and in this market and cannot be certain that our products will be accepted. We also expect our entrance into this market will expose us to new competitors. In some cases, our current OEM partners resell video processing products provided by our competitors, so it may be difficult for us to build an OEM channel for our intelligent video gateway. Sales of our intelligent video gateway are a critical component of our growth strategy, and if we are unsuccessful in our efforts to expand this portion of our business, our revenues may not grow, we may need to adjust our growth strategy and our financial condition could suffer.

        We devote a significant amount of our resources toward research and development to introduce and enhance products in support of our growth strategies. Research and development expenses, net of participation by the Office of the Chief Scientist in the Israeli Ministry of Industry, Trade and Labor, or OCS, as a percentage of revenues in 2003, 2004, and 2005 were 20.9%, 26.2% and 22.6%, respectively.

        Our current research and development efforts are focused heavily on personalized programming, targeted advertising, HDTV and video compression incorporating MPEG-2 and newer compression standards such as MPEG-4. We also devote considerable development resources to video-over-IP, dense decoding and network management. Our success in designing, developing and manufacturing new or enhanced products will depend on a variety of factors, including the identification of products addressing market demand, timely design and development and effective manufacturing and assembly processes. Because of the complexity of our research and development efforts, we cannot ensure that we will successfully develop new products, or that our newly developed products will achieve market acceptance. Our failure to successfully develop and introduce new products could harm our business, operating results, and profits.

        We organize our worldwide sales efforts into three territories, including: Europe, the Middle East and Africa; Asia and the Pacific Rim; and North and South America. During 2005, these three regions accounted for 51.4%, 27.7% and 20.9% of our revenues, respectively. We market our products through a combination of third-party distribution, direct sales and partnerships with OEMs. Our Conditional Access neutral decoders 2600/2800 and UID2902 decoders are currently resold by Scientific-Atlanta as models D9840/42 and UID2902, respectively, and our decoders are currently resold by Harmonic. In addition, our decoders and intelligent video gateways are resold under the Grass Valley brand through an OEM agreement with Thomson. While sales through OEMs have constituted a small percentage of our revenues to date, we view this channel as a key growth opportunity. We have expanded our marketing resources to keep pace with increasing demand in our target non-U.S. markets which have historically accounted for the majority of our business. However, we view the U.S. as a large opportunity for us. Since the second half of 2004, our research and development efforts have included designing products containing features that are directed to the U.S. market. Consistent with this approach, we have expanded our U.S. sales and marketing staff. Increasing our sales in the U.S. and to major cable and telecom operators will require substantial technical, marketing and sales resources dedicated to these markets, which are characterized by lengthy sales cycles. We will need to engage distributors who will be able to market and support our products effectively in the U.S. cable and telecom markets. Large network operators in the U.S. may be reluctant to purchase products from a small, non-U.S. supplier like us. We therefore intend to expand our OEM partnerships, which exposes us to the risk of reduced gross margins. If we are unable to successfully increase our sales in the U.S. or to large cable and telecom operators, or expand our OEM partnerships, our revenues and results of operations could be adversely affected.

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        We use the U.S. dollar as our functional currency. Our consolidated financial statements included elsewhere in this annual report are presented in U.S. dollars and prepared in accordance with generally accepted accounting principles in the U.S., or U.S. GAAP. In 2005, most of our revenues were denominated in U.S. dollars and we expect that a significant portion of our revenues will continue to be denominated in U.S. dollars, with a smaller portion denominated in Euros and other currencies. Our expenses to date have been incurred, in almost equal parts, in U.S. dollars or currencies linked to the U.S. dollar, and in New Israeli Shekels, or NIS. Our transactions denominated in currencies other than the U.S. dollar are converted into U.S. dollars and recorded based on the exchange rate at the time of the transaction.

         Revenues

        We generate revenues principally through product sales and, to lesser extent, by providing associated services, including product maintenance, installation and customer training. Almost all of our revenues are derived from sales to cable, satellite and telecom service providers and terrestrial broadcasters. Demand for our products will depend on the magnitude and timing of capital spending by these customers to construct and upgrade their networks.

        We sell a significant portion of our products through third-party distributors. Our sales to individual customers vary significantly from year to year depending largely upon the timing of their decisions to deploy or upgrade their video networks, the timing of deregulation by governments in different countries and the success rate of our sales efforts. For example, in 2005 we experienced revenues from 2 new customers in China which represented 14% of our revenues in 2005, while in 2004 our revenues increased primarily due to a large project with Caribbean Broadcasting, which represented 11.2% of our revenues in 2004.

        We have historically focused our marketing efforts in regions outside the U.S. Sales to non-US customers in 2003, 2004 and 2005 represented 92.0%, 88.4% and 85.6% of our revenues, respectively. In order to increase sales in the U.S., we plan to develop products and features that are targeted toward this region and enhance our sales and marketing efforts in the U.S. In addition, we believe that sales in Asia will account for an increasing percentage of our revenues as we expand our sales and marketing activities in this region. According to In-Stat, a market research firm, the Asian market for digital headend and distribution equipment is expected to grow from $116 million in 2004 to $699 million in 2009, representing a 43% compound annual growth rate.

        In 2005, we opened an additional office in Japan and added three new Japanese customers.

        The following table provides information regarding the breakdown of our revenues by geographical region. The information is provided for 2003, 2004 and 2005:

        Cost of revenues. Our cost of revenues consists primarily of component and material costs, salary and other personnel-related expenses for our operating staff, as well as related overhead costs, amounts paid to subcontractors and warranty costs related to our products. We also include royalties due to the OCS that are described in more detail later in this section in “-Government Grants.” We also pay royalties to Dolby Laboratories, European Telecommunications Standards Institute, or ETSI, and MPEG under license agreements.

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        The following table provides information regarding the breakdown of our royalty expenses for 2003, 2004 and 2005:

        Since our royalty obligations to the OCS are paid as a percentage of our revenues, we expect OCS royalty payments to continue to have a similar relative impact on our operating results in the future, unless we obtain additional grants or re-pay current OCS grants in full.

        Research and development expenses. Our research and development expenses are related to the design, development, engineering and testing of our products. These costs consist of salaries and other personnel-related expenses of employees primarily engaged in research and development activities, materials used in research and amounts paid to subcontractors and consultants, as well as related overhead expenses. We expense our research and development expenses as they are incurred, net of amounts received or receivable from the Government of Israel through the OCS participation in certain research and development projects, referred to as OCS grants. Since the second half of 2004, as part of our initiative to increase our revenues in the U.S., we shifted resources towards developing product features targeted toward the U.S. market.

        Sales and marketing expenses. Our sales expenses consist primarily of salaries and commissions paid to internal sales personnel, travel and related costs and commissions paid to independent sales representatives. Our current and expected marketing expenses consist primarily of costs related to trade shows, demonstration products, marketing materials and the development of our website, as well as the use of subcontractors and related overhead expenses. Since 2004, we have invested resources toward industry trade shows and publications. In addition, we increased our sales and marketing efforts worldwide, opened additional offices and reorganized our professional services and sales department. We expect our sales and marketing expenses to increase in future periods as we hire additional sales and marketing personnel, primarily in the U.S.

        General and administrative expenses. Our general and administrative expenses consist primarily of salaries and other related costs for our executive, accounting and administrative personnel, insurance, legal and accounting expenses as well as related overhead expenses and other miscellaneous general corporate expenses. We recently entered into employment agreements with Mr. Mahlab, Dr. Simler, and Mr. Eisenberg, which include salaries, bonuses and stock option grants, and which increased the Company’s administrative expenses for 2005, by approximately 8.5%. Our employment agreement with Mr. Mahlab requires a one-year notice of termination and that he be entitled to use any of his accrued vacation. We expect general and administrative expenses to increase for the foreseeable future as our operations continue to expand. We also expect additional general and administrative expenses associated with us becoming a public company, including increased professional services fees, liability insurance for our directors and officers and costs associated with regulatory compliance and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, and new rules implemented by the Securities and Exchange Commission regulations and the Nasdaq Stock Market. We cannot estimate with certainty the annual expenses related to the foregoing, but based on industry standards, we expect approximately $600,000 of annual expenses associated with becoming a public company, including approximately $200,000 for compliance with the requirements of the Sarbanes-Oxley Act of 2002, which we expect to pay from our working capital.

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        Stock-based compensation. As of December 31, 2005, we have incurred amortization of stock-based compensation of $158,000 all arising from June 2005 grants. Following the implementation of SFAS no. 123R commencing after January 2006, we expect this expense to be approximately $ 400,000 per quarter for the next 8 quarters. The amortization of stock-based compensation is allocated based on the division in which the recipient of each option grant is employed. Stock-based compensation results from the granting of share options to employees with exercise prices per share determined to be below the deemed fair market value per ordinary share on the date granted. The stock-based compensation when incurred will be amortized over the vesting period of the individual options.

        Taxes. As of 2006, Israeli companies are generally subject to a corporate income tax rate of 31%. The income tax rate for Israeli companies is scheduled to be gradually reduced to 25% by 2010. In 1996, we were granted “Approved Enterprise” status under the tax-exempt benefit track provided by the Israeli Law for the Encouragement of Capital Investments of 1959 for the production of digital-video compression and distribution systems. In 2000, after our first investment program ended, we received an approval certificate for an expansion of our “Approved Enterprise” status. The second-program’s investments were concluded in December 2003, and we submitted a final performance report for the first expansion program, which was approved in September 2005. In 2004, we received an approval certificate for a third expansion program of our “Approved Enterprise” status. This expansion program will end on July 18, 2006 with an option to be extended for another year. The tax-exempt benefit track provides for a tax exemption on undistributed earnings derived from assets included in the “Approved Enterprise” investment program for the first two years (except for our first program which provides an exemption of four years) of a seven to ten year benefit period and tax rates between 10% and 25% for the remaining five to eight years (except for our first program which provides a remaining period of between two to six years) of the benefit period depending on the level of foreign investment. See “Israeli Taxation–Law for the Encouragement of Capital Investment, 1959.” The period during which we are entitled to receive these benefits is limited to seven or ten years, depending on the extent of non-Israeli ownership of our shares, from the first year that taxable revenues are generated, or within 12 years from the first year defined as the “operational year” pursuant to Israeli tax law or 14 years from the respective year our program received “Approved Enterprise” status. The availability of the Israeli tax benefits is subject to certain requirements, including making specified investments in property and equipment, and financing a percentage of investments with share capital. If we do not meet these requirements in the future, the tax benefits may be canceled and we could be required to refund any tax benefits that we received, plus interest and penalties thereon.

        As of December 31, 2005, we had approximately $22 million of net operating loss carry-forwards for Israeli tax purposes which we will have to utilize before we can make use of the tax benefits arising from our “Approved Enterprise” status. These net operating loss carry-forwards have no expiration date.

Critical Accounting Policies and Estimates

        Our discussion and analysis of our financial condition and results of our operations is based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, revenue, expenses and disclosure of contingent assets or liabilities. On a periodic basis we evaluate our estimates, including those related to revenue recognition, warranty costs, allowance for doubtful accounts, fair value of share based compensation and inventory valuation. We base our estimates on historical circumstances. These estimates are subject to an inherent degree of uncertainty, and actual results could differ from those estimates. Our significant accounting policies are more fully described in Note 2 in the “Index to Consolidated Financial Statements.”

        The following are our critical accounting policies and the significant judgments and estimates affecting the application of those policies on our consolidated financial statements.

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        Revenue recognition criteria.

    –     We recognize revenue from sales of products in accordance with SAB 101 as amended by SAB 104 upon delivery, provided that persuasive evidence of an arrangement exists, the fee is fixed or determinable, and collectibility is reasonably assured. In instances where final acceptance of the product is specified by the customer, revenue is deferred until all material acceptance criteria have been met. In instances in which we enter into transactions that represent multiple-deliverable arrangements, with elements including products, maintenance, installation and training, we implement the guidance in EITF No. 21 in which multiple-deliverable arrangements are assessed to determine whether they can be separated into more than one unit of accounting. A multiple-deliverable arrangement is separated into more than one unit of accounting if all of the following criteria are met:

    –       The delivered item has value to the customer on a stand-alone basis.

    –       There is objective and reliable evidence of the fair value of the undelivered item.

    –       If the arrangement includes a general right of return relative to the delivered items, delivery or performance of the undelivered item is considered probable and substantially in our control.

        If these criteria are not met, then revenue is deferred until such criteria are met or until the last undelivered element is delivered unless the undelivered element is considered inconsequential or perfunctory. If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the arrangement consideration is allocated to the separate units of accounting based on each unit’s relative fair value However, in cases in which there is an objective and reliable evidence for the fair value of the undelivered items in the arrangements but no such evidence for the delivered items, we use the residual method to allocate the arrangement consideration.

        Our business includes the license of network management system software. Since this software component is considered incidental to the arrangement as a whole, we do not apply the accounting guidance prescribed in SOP 97-2 “Software Revenue Recognition.”

    –       Service revenues from product maintenance agreements are recognized ratably over the service period. Service revenues from installation and training are recognized when the service is performed.

    –       Revenue from long-term contracts is recognized under the percentage-of-completion method on the basis of using actual working hours incurred relative to total expected working hours under the contract. Revisions in estimates of costs and profits are reflected in the accounting period in which the facts that require the revision become known. At the time a loss on a contract is known, the entire amount of the estimated loss is accrued. Amounts received from customers in excess of revenues earned under the percentage-of-completion method are recorded as advance payments from customers. Related contract costs include all direct material and labor costs and the related indirect costs, and are included in costs of sales in the consolidated statements of operations.

    –       Revenues from operating lease agreements are recognized ratably over the lease period.

        Stock-based compensation.

        We follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”, or APB 25, and authoritative interpretations thereof. Accordingly, we account for share options granted to employees and directors based on the intrinsic value, as estimated by our board of directors and management, of the options on the measurement date. Deferred compensation is amortized to compensation expense over the vesting period of the options on a straight-line method generally three or four years.

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        We account for stock-based compensation for non-employees using the fair value method in accordance with Financial Accounting Standards Board, or FASB, Statement No. 123, “Accounting for Stock-Based Compensation” (SFAS 123) and EITF 96-18: “Accounting for Equity Instruments That are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.”

        At each option grant date during 2005, our board of directors and management determined the deemed fair value of our ordinary shares. During 2005, there has been no public market for our ordinary shares, therefore, those determinations are necessarily subjective. The board of directors has considered a number of factors, including:

    –       Our sale of series A preferred shares and series B preferred shares to third parties;

    –       The liquidation preference and other rights of the series A preferred shares and series B preferred shares; and

    –       Our operating and financial performance.

        We have reviewed the methodologies used in making these determinations in light of the AICPA’s Practice Aid Valuation of Privately-Held-Company Equity Securities Issued as Compensation, which we refer to as the practice aid. Management and the board of directors took into consideration the market and income approaches to valuation as set forth in the practice aid. We believe that the valuation methodologies that we have used are consistent with the practice aid.

        Our management engaged an unrelated third party valuation specialist to conduct contemporaneous valuations of the fair value of our ordinary shares as of October 27, 2005 and July 10, 2005, and a retrospective valuation of the fair value of our ordinary shares as of December 31, 2004 in order to support our estimate of the fair value for financial reporting purposes of our ordinary shares for the twelve months preceding our initial public offering process, based on the subjective factors mentioned above, the various approaches to valuation set forth in the practice aid, the third-party valuation study and an assessment of market considerations, including the likelihood of an initial public offering, the uncertainties inherent in an initial public offering and discussions with the underwriters in this offering.

        Based on this analysis, our board of directors has concluded that the exercise price of the options granted up to March 31, 2005 is equal to the fair value assessment of our ordinary shares, the exercise price of the options granted during the quarter ended June 30, 2005, is below the fair value assessment of our ordinary shares and the exercise price of the options granted during the period beginning July 1, 2005 through December 31, 2005 is equal to the fair value. As disclosed in Note 11 to our consolidated financial statements, we recorded a deferred stock-based compensation in the amount of $1.2 million with regard to the grants made during the quarter ended June 30, 2005.

        The following table shows the Company’s stock option activity during 2005, including the weighted exercise price per share, the weighted fair market value of our ordinary shares for financial reporting purposes, and the differences between the two.

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Allowance for doubtful accounts. The allowance for doubtful accounts is computed based on historical experience with regard to specific accounts, which, in our opinion, are doubtful for collection, and in part based on a certain percentage of trade accounts receivable, based on historical experience and management estimation.

Provision for warranty. The provision for warranty is computed on the basis of past experience as well as our estimates.

Inventories. Inventories are stated at the lower of cost or market value. We record costs for raw materials and finished products from third-parties on the basis of the moving average cost per unit. We determine the cost of work in progress, and finished products on the basis of standard cost, which approximates actual production cost. We assess the value of our inventory on a quarterly basis and determine whether we need to record an inventory write-down. We also assess our inventories for obsolescence based upon assumptions about future demand and market conditions. The cost of finished products used for demonstration purposes is amortized over the period on which the products are under demonstration (generally, six months).

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Results of Operations

        The following table sets forth our financial results, as a percentage of revenues, for 2003, 2004 and 2005:

Comparison of the Years Ended December 31, 2005 and 2004

        Revenues. Revenues increased by 27.8%, from $35.1 million for the year ended 2004 to $44.8 million for 2005. The following factors contributed to this increase:

–     Increased revenues in Europe, the Middle East and Africa, which increased from $16.5 million to $23.0 million, and revenues in the U.S., which increased from $4.1 million to $6.4 million, due to our increased marketing and sales efforts;

–     An increase of $3.0 million in revenues in Asia and the Pacific Rim, which mainly resulted from $6.0 million from two customers in China;

–     Increased productivity of our sales force, which resulted from our sales and marketing efforts to target specific customers and markets;

–     Increased sales of our intelligent video gateway product by 177%, which sales represented approximately 9.2% of our revenues;

–     Increased demand for our E-1720 encoder; and

–     Increased sales to Telco C&D.

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        Gross profit. Gross profit increased by 17.0%, from $19.0 million for 2004 to $22.2 million for 2005. Gross profit as a percentage of revenues decreased from 54.1% for 2004 to 49.6% for 2005. This decrease was due primarily to the timing of the recognition of revenues for lower margin, ancillary, third-party products such as modulators, matrixes, hubs and routers, related to a specific contract with Luzhou Broadcasting Bureau, which represented 7.0% of our revenues in 2005.

        Research and development expenses. Research and development expenses increased by 6.5%, from $11.3 million for 2004 to $12.0 million for 2005. These amounts exclude OCS grants of $2.1 million and $1.9 million for 2004 and 2005, respectively. The increase in our research and development expenses primarily reflects our increased investment in the development of our intelligent video gateway.

        Sales and marketing expenses. Sales and marketing expenses increased by 22.7%, from $10.8 million for 2004 to $13.2 million for 2005. The increase was due to the expansion of our sales and marketing efforts, including the hiring of additional personnel and paying more commissions on increased revenues. In 2005, we added eight additional employees in sales and marketing worldwide.

        General and administrative expenses. General and administrative expenses increased by 42.0%, from $2.1 million for 2004 to $3.0 million for 2005. This increase was primarily the result of an increase in account receivable that we were not able to collect, and that had been recorded as doubtful accounts, the hiring of Dr. Yaron Simler as our President and director, and options granted during the quarter ended June 30, 2005 below the fair value assessment of our ordinary shares. We recorded amortization of deferred stock-based compensation in the amount of $158,000.

        Financing income. Financing income increased from income of $187,000 for 2004 to income of $346,000 for 2005. The increase in the financing income was primarily the result of the decrease of the value of the NIS against the U.S. dollar.

        Income tax expense. Income tax expense increased from $30,000 for 2004 to $55,000 for 2005. The income tax expense for 2005 resulted from taxable income from the operations of our U.S. subsidiary.

Comparison of the Years Ended December 31, 2004 and 2003

        Revenues. Revenues increased by 12.9%, from $31.1 million for 2003 to $35.1 million for 2004. This increase resulted primarily from:

–     Two large new projects in the Caribbean and Asia totaling $5.2 million; and

–     Increased productivity of our sales force, following the reorganization of our sales force in the second quarter of 2004.

        Gross profit. Gross profit increased by 30.2%, from $14.6 million for 2003 to $19.0 million for 2004. Gross profit as a percentage of revenues increased from 46.9% for 2003 to 54.1% for 2004. The increase is due primarily to sales of higher gross margin products such as encoders and multiplexers, a reduction in our component costs and increased labor productivity, as a result of new quality control testing stations and an improvement in our test procedures.

        Research and development expenses. Research and development expenses increased by 19.4%, from $9.4 million in 2003 to $11.3 million in 2004. These amounts exclude OCS grants of $2.9 million and $2.1 million in 2003 and 2004, respectively. The increase in research and development expenses was due primarily to the development of features for products that are aimed at the U.S. market, particularly our intelligent video gateway.

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        Sales and marketing expenses. Sales and marketing expenses increased by 11.8%, from $9.6 million in 2003 to $10.8 million in 2004. The increase was due primarily to the expansion of our offices in Europe and an increase in our marketing activities worldwide, including our participation in industry trade shows and conferences.

        General and administrative expenses. General and administrative expenses remained approximately the same at $2.1 million in both 2003 and 2004.

        Financing income. Financing income increased from $99,000 in 2003 to $187,000 in 2004. The increase in financing income was primarily due to increased interest income earned on higher cash balances.

        Income tax expense. Income tax expense decreased from $56,000 in 2003 to $30,000 in 2004. The income tax expense for those periods were the result of taxable income from the operations of our U.S. subsidiary.

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Quarterly Results of Operations

        The following tables set forth our unaudited quarterly statements of operations and our financial results as a percentage of revenues for each of the ten quarters ended December 31, 2005. You should read these tables in conjunction with our financial statements and accompanying notes included in this annual report. We have prepared this unaudited information on the same basis as our audited financial statements. These tables include all adjustments, consisting only of normal recurring adjustments, that we consider necessary for a fair presentation of our operating results for the quarters presented. Operating results for any quarter are not necessarily indicative of results for any subsequent periods.

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        Our quarterly results are influenced mainly by the intermittent timing of our product sales and the gross margin of the products sold in any given quarter. Our quarterly results have, in the past, been subject to seasonality, with the fourth quarter revenue typically being the strongest due to customer spending patterns and the first quarter earnings being the weakest due to the timing of our receipt of grants from the OCS.

Government Grants

        Our research and development efforts have been financed, in part, through OCS grants. As of December 31, 2005 we have been awarded grants totaling $14.6 million from the OCS since our inception, of which we have received $14.1 million. We are required to repay these grants to the OCS through payments of royalties amounting to 3.5% of revenues until the entire amount is repaid, plus interest. As of December 31, 2005 total royalties paid were $6.2 million. We record these costs in our cost of revenues. In addition, if we fail to comply with any of the requirements imposed by the OCS, such as change of control notices and annual reporting requirements, we may be required to refund any grants previously received together with interest and penalties, and a person transferring OCS backed technology may be subject to criminal charges and up to three years in prison.

        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 of technology and manufacturing rights 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 of technology developed with OCS funding, including pursuant to a merger or similar transaction, and the transfer of rights related to the manufacture of more than 10% of a product developed with OCS funding is subject to approval by an OCS committee and to the following conditions:

–     Transfer of Technology. If thecommittee 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 portion 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 plus interest), adjusted for royalty payments to the OCS and the amount of time that has passed since receipt 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 on the technology.

–     Transfer of Manufacturing Rights. The committeeis 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, and an accelerated rate of annual return, or (2) a transfer of manufacturing rights into Israel of another product of similar or more advanced technology, as determined by the OCS.

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–     Merger or Acquisition. If thecommittee 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 plus interest, adjusted for royalty payments to the OCS and the amount of time that has passed since receipt of the grant.

        In the event that the committee believes that the consideration to be paid in a transaction requiring payment to the OCS pursuant to the provisions of the law described above does not reflect the true value of the technology or the company being acquired, it may determine an alternate value to be used as the basis for calculating the requisite payments. The OCS requires that it be notified of any transfer of 25% or more of our shares.

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Recently Issued Accounting Pronouncements

SFAS No. 151 – Inventory Costs, an Amendment of ARB No. 43, Chapter 4

        In November 2004 the FASB issued SFAS No. 151, “Inventory Costs, an Amendment of ARB No. 43, Chapter 4". SFAS No. 151 amends the guidance in ARB 43, Chapter 4, “Inventory Pricing”, which provides guidance on the allocation of certain costs to inventory. SFAS 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) should be recognized as current-period charges. In addition, SFAS 151 requires that allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this statement are effective for inventory costs incurred during fiscal years beginning after June 2005. The provisions of this statement shall be applied prospectively. We assess the impact of the adoption of this Standard, and currently we estimate that its adoption is not expected to have a material effect on our financial position and results of operations.

SFAS No. 123 (revised 2004) “Share Based Payments”

        In December 2004, the FASB issued SFAS No. 123 (revised 2004) “Share Based Payments” (“SFAS 123(R)”). This Statement is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation”, which supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and its authoritative interpretations.

        SFAS 123(R) establishes accounting standards for the transactions in which an entity exchanges its equity instruments for goods or services; focuses primarily on accounting for transactions in which an entity obtains employee and directors services in share-based payment transactions; and does not change the accounting guidance for share-based payment transactions with parties other than employees.

        SFAS 123(R) eliminates the alternative to use APB 25‘s intrinsic value method of accounting that was provided in SFAS 123 as originally issued and requires the measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. The fair-value-based method in this Statement is similar to the fair-value-based method in SFAS 123 in most respects. The costs associated with the awards will be recognized over the period during which an employee is required to provide service in exchange for the award – the requisite service period (usually the vesting period).

        The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those instruments (unless observable market prices for the same or similar instruments are available). If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification.

        The provisions of SFAS 123(R) apply to all awards to be granted by companies after December 31, 2005 and to awards modified, repurchased, or cancelled after that date. When initially applying the provisions of SFAS 123(R), in the first quarter of 2006, companies will be required to elect between using either the “modified prospective method” or the “modified retrospective method”.

        Under the modified prospective method, companies are required to recognize compensation cost for all awards granted after the adoption of SFAS 123(R) and for the unvested portion of previously granted awards that are outstanding on that date. Under the modified retrospective method, companies are required to restate its previously issued financial statements to recognize the amounts previously calculated and reported on a pro forma basis, as if the original provisions of SFAS 123 had been adopted. Under both methods, it is permitted to use either a straight line or an accelerated method to amortize the cost as an expense for awards with graded vesting.

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        The effect of the adoption of this standard on our financial position and results of operations depends on the extent of new allotments of share-based awards and modifications of the share-based awards in future periods.

        We assess the impact of the adoption of this standard under the existing stock-based compensation plans. However, had we adopted SFAS 123R in prior periods, the impact of that standard would have approximated the impact of SFAS 123.

SFAS No. 153 “Exchange of Non-Monetary Assets”

        In December 2004, the FASB issued SFAS No. 153, “Exchanges of Non-monetary Assets an amendment of APB No. 29". This Statement amends Opinion 29 to eliminate the exception for non-monetary exchanges of similar productive assets and replaces it with a general exception for exchanges of non-monetary assets that do not have commercial substance. The Statement specifies that a non-monetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. This Statement is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The impact of the adoption of SFAS 153 did not have a material effect on the Company’s financial position and results of operation.

SFAS No. 154 “Accounting Changes and Error Corrections”

        This Statement, published in May 2005, replaces APB Opinion No. 20, Accounting Changes, and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements,” and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle, and to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions.

        Opinion 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. This Statement requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine the specific effects or the cumulative effect of the change. The Statement also provides guidance for cases in which it is impracticable to determine the period-specific effects of an accounting change on one or more individual prior periods presented, and/or for cases in which it is impracticable to determine the cumulative effect of applying a change in accounting principle to all prior periods.

        This Statement defines retrospective application as the application of a different accounting principle to prior accounting periods as if that principle had always been used or as the adjustment of previously issued financial statements to reflect a change in the reporting entity. This Statement also redefines restatement as the revisiting of previously issued financial statements to reflect the correction of an error.

        This Statement also requires that a change in depreciation, amortization, or depletion method for long-lived, non-financial assets, be accounted for as a change in accounting estimates effected by a change in accounting principle. This Statement carries forward without change the guidance contained in Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. This Statement also carries forward the guidance in Opinion 20 requiring justification of a change in accounting principle on the basis of preferability.

        The provisions of this Statement are effective for accounting changes and corrections of errors made during fiscal years beginning after December 15, 2005. The adoption of this Standard is not expected to have a material effect our financial position or results of operations.

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        Since beginning operations in 1995 through December 31, 2005, we have financed our operations with:

–     $47.5 million in cash generated through private sales of our ordinary shares, preferred shares and convertible notes. All of our outstanding convertible notes and preferred shares have been converted into ordinary shares; and

–     On December 16, 2005, we completed an initial public offering of 4,500,000 of our ordinary shares at a price to the public of $7.00 per share. The initial public offering generated $29.295 million, net of underwriter’s commission (before deduction of other offering costs).

–     OCS grants of $14.1 million. These grants are described in more detail in “ – Government Grants.”

        As of December 31, 2005, we had $33.6 million in cash and cash equivalents and $41.7 million of working capital.

        Our capital requirements are dependent on our ability to generate positive operating cash flow, which is primarily impacted by the market acceptance and pricing of our products and our level of expenses associated with research and development and sales and marketing activities. We intend to increase our capital expenditures in the future consistent with our anticipated growth. We anticipate that our cash resources will be used primarily to fund our operating activities, as well as for capital expenditures.

        We believe that our cash reserves and cash from operations, will be sufficient to meet our anticipated cash needs for working capital, capital expenditures, and research and development activity of new technologies for at least the next 24 months. However, if, in the future, cash generated from operations is insufficient to satisfy our liquidity requirements, or if our estimates of revenues, expenses, capital or liquidity requirements change or are inaccurate, we may need to raise additional funds. We may also need to raise additional funds to finance expansion plans, develop or acquire new products or technologies, enhance our existing products or respond to competitive pressures. We cannot be certain that we will be able to obtain additional financing on commercially reasonable terms or at all, which could limit our ability to grow and execute our business plan

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Comparison of the Years Ended December 31, 2005 and 2004

        Operating activities. Net cash used in operating activities increased from $4.6 million for 2004 to $ 6.2 million for 2005. The increase of $1.7 million resulted primarily from an increase of $1.7 million in our trade account receivable due to an increase in revenues of $9.7 million and an increase of $1.8 million in inventory due to our decision to increase inventories in response to increased customer demand and orders. The increase was offset by an increase of $ 0.6 million in our trade account payable and an increase of $2.1 million in our payable and other current liabilities.

        Investment activities. Net cash used in investing activities for the year 2004 was $885,000, compared to $1,158,000 for year 2005. Our investing activities in each of those periods consisted primarily of the purchase of fixed assets, such as laboratory equipment for R&D, testing equipment for production and to add additional quality control testing stations to improve our labor productivity.

        Financing activities. Net cash provided by financing activities increased from $7.4 million for the year 2004 to $28.4 million for the year 2005. Net cash provided by financing activities for 2005 resulted primarily from our initial public offering, which generate proceeds of $29.5 million net of underwriter’s commission.

Comparison of the Years Ended December 31, 2004 and 2003

        Operating activities. Net cash used in operating activities increased from $3.2 million for 2003 to $4.6 million for 2004. The increase in net cash used in operating activities in 2004 compared to 2003 resulted primarily from an increase of $1.9 million in our trade accounts receivable due to an increase of $4.0 million in revenues, a decrease of $1.0 million in our payables and other current liabilities and an increase of $1.3 million in our inventory, primarily due to the purchase of end-of-life components required by us to meet our anticipated revenues. The increase was offset by a decrease of $642,000 in our net loss, a decrease of $1.2 million in our receivables and other current assets, particularly OCS grants received and other current assets, and an increase in trade accounts payable.

        Investment activities. Net cash used in investing activities increased from $409,000 for 2003 to $885,000 for 2004. The increase was primarily due to our increased research and development activity, which required purchase of additional laboratory equipment and computers.

        Financing activities. Net cash provided by financing activities decreased from $7.5 million for 2003 to $7.4 million for 2004. Net cash provided by financing activities in 2003 resulted from the first installment of the proceeds received in connection with the sale and issuance of series B preferred shares in the amount of $7.8 million. Net cash provided by financing activities in 2004 resulted primarily from the second installment of the proceeds received in connection with the sale and issuance of series B preferred shares in the amount of $7.8 million.

        We place considerable emphasis on research and development projects designed to upgrade our existing product lines and to develop new applications of our technologies. As of December 31, 2005, 108 employees were engaged primarily in research and development.

        The following table shows the total research and development expenditures of the Company and participation in such expenditures by the Government of Israel for the periods indicated:

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        The competition among Satellite, Telco, Cable and Terrestrial network operators is being intensify and therefore we are facing global momentum in potential new revenue generators for those operators such as High Definition TV, IPTV as well as localization and personalization services.

        High definition TV utilizing H.264 coding started to roll out in the Satellite Direct To Home market. The HD H.264 coding enables satellite operators to offer more HD channels over the same infrastructure in order to be in more competitive position versus the Cable and Telco operators.

        As a counter offering Cable TV operators are in a process to offer more localized and on demand services such as target advertising that eventually will turn into personalization.

        Similar trend affect IPTV services where personalization is an inherent characteristics of the service offering.

        These market trends may affect our products and solution offering.

        We are not a party to any material off-balance sheet arrangements. In addition, we have no unconsolidated special purpose financing or partnership entities that are likely to create material contingent obligations.

        The following table of our material commitments and contingent liabilities as of December 31, 2005, excluding royalty payments commitments, such as the amount due to the OCS, summarizes the aggregate effect that these obligations are expected to have on our cash flows in the periods indicated:

        As of December 31, 2005, the total amount of OCS grants received, net of royalties paid or accrued, was $8,383,000.

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        The following table sets forth information regarding our executive officers and directors as of March 31, 2006:

        Yoel Gat has served as the Chairman of our board of directors since August 2003. From 1995 to 2003, Mr. Gat served as the Chief Executive Officer and Chairman of the Board of Directors of Gilat Satellite Networks Ltd. and from 1987 to 1995, Mr. Gat served as the Chief Executive Officer of Gilat Satellite Networks Ltd. Mr. Gat is the Chairman of the Board of Directors of Raysat, Inc. Mr. Gat is a two-time winner of the Israel Defense Award (1979 and 1988), Israel’s most prestigious research and development award. Mr. Gat holds a B.Sc. in Electrical Engineering from the Technion – Israel Institute of Technology, and M.Sc. in Business Management and Information Systems from Tel Aviv University.

        David Mahlab is our co-founder and has served as our Chief Executive Officer and Director since 1995. He previously served as our President until August 2005. From 1992 to 1995, Mr. Mahlab severed as the manager of Tadiran Communication’s RPV Data Links business unit in Israel. From 1988 to 1992, Mr. Mahlab served as the project manager of Tadiran Communication’s Airborne Search and Rescue System. Mr. Mahlab holds a B.Sc. (Summa Cum Laude) and M.Sc. (Summa Cum Laude) in Electrical Engineering from the Technion – Israel Institute of Technology and holds an MBA and LLB from Tel Aviv University.

        Yaron Simler has served as our President and Director since August 2005. From 2000 to 2005, Dr. Simler served as President of the Convergent Systems Division (CSD) of Harmonic, Inc. Previously, from 2000 to 2001, Dr. Simler served  as Vice President of Marketing for CSD. Dr. Simler received a B.Sc. in Electrical Engineering from Tel Aviv University and a Ph.D. in Electrical Engineering from the University of California, Berkeley.

        Moshe Eisenberg has served as our Chief Financial Officer since October 2005. Before joining us, he served as Chief Financial Officer of Unipier Mobile Ltd. From 2000 to 2005, he served as Vice President, Finance and Chief Financial Officer of Spacenet Inc., a wholly owned U.S. subsidiary of Gilat Satellite Networks Ltd. From 1999 to 2000, he served as the Controller of Spacenet Inc. From 1995 to 1999, Mr. Eisenberg served as Director of Finance of Gilat Satellite Network Ltd. Mr. Eisenberg holds an MBA in Finance from Tel Aviv University and a B.Sc. in Agricultural Economics from the Hebrew University of Jerusalem.

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        Ovadia Cohen is our co-founder and has served as our Vice President, Marketing since 1995. From 1984 to 1995, Mr. Cohen held different positions at Tadiran Communication, where he worked as a systems engineer in communications systems and signal processing, and served as marketing manager of the Data Links Department. Mr. Cohen holds a B.Sc. in Electrical Engineering from the Technion – Israel Institute of Technology and is a graduate of Business Administration from the Hebrew University, Israel.

        Shlomo Arbiv has served as our Vice President, Finance since 1998. Between 1996 and 1998, Mr. Arbiv served as a Treasurer at Tadiran Ltd. Between 1995 and 1997, Mr. Arbiv worked as a VP Finance and Control of Tadiran Operations. Between 1990 and 1995, Mr. Arbiv worked as a Manager of Finance and Derivatives for Tadiran Ltd. He managed derivative hedge positions and was a team member for several Initial Public Offerings in the U.S. (Tadiran Ltd) and Israel (Tekem Ltd & Contahal Ltd). Mr. Arbiv holds an MBA in Finance and Accounting, a Masters in Information Systems and a B.A. in Economics & Political Science from Tel Aviv University.

        Eitan Koter has served as our Vice President, Sales since 2004. From 2001 to 2003, Mr. Koter served as a Sales Manager for Asia and the Pacific Rim and, from 2003 to 2004, as our Director of Sales for Europe, the Middle East and Africa. From 1999 to 2001, Mr. Koter served as Sales Manager of the Next Generation Telephony and DCME division of Veraz Networks, formerly ECI Telecom. From 1995 to 1999, Mr. Koter served as the Marketing and Sales Director at CoreQuest, a start-up ASIC company specializing in transmission and reception components for the cable TV industry. Mr. Koter holds a B.A. in Business Administration from New England College, New Hampshire and a degree in Engineering from the Management College, Israel.

        Itzik Ben Bassat has served as our Vice President, Research and Development since 2002, and as our Chief Technology Officer from 2006. Mr. Ben Bassat oversees the design and development of our products. From 1992 to 2002, Mr. Ben Bassat served as Senior Director of the Satellite IP Product Line at Gilat Satellite Networks Ltd. Mr. Ben Bassat holds a B.Sc. in Electrical Engineering (cum laude) from the Technion – Israel Institute of Technology.

        Ronit Kalujny has been our Vice President, Operations since December 2002. From 1999 to 2002, she served as a Director of Purchasing at Gilat Satellite Networks Ltd. From 1990 to 1998, Ms. Kalujny was responsible for purchasing and management information systems at Alliance Tire. From 1982 to 1987, Ms. Kalujny served as the head of the Economic Department at Carmel Carpets. Ms. Kalujny, an adjunct lecturer at the Technion – Israel Institute of Technology on the subject of Operations Research, holds a B.Sc. in Industrial Engineering, Chemistry and Education from Ben-Gurion University.

        Boaz Felsenstein has served as our Vice President, Human Resources since 2001. From 1997 to 2001, Mr. Felsenstein served as Vice President of Human Resources at Orckit Communications Ltd. From 1985 to 1996, Mr. Felsenstein served as Vice President of Human Resources at Tadiran Communication. Mr. Felsenstein holds a B.A. in Social Work and a M.A. in Labor Studies from Tel Aviv University.

        Jackie Goren (Rozenblum) has served as our Director since January 2003. Ms. Goren has served as Vice President, Corporate Development of Koor Industries Ltd. since January 2005, and as Managing Director of Koor Corporate Venture Capital (Koor CVC), Koor Industries’ venture capital arm, since June 2003. Prior to managing Koor CVC, from 2000, Ms. Goren was a Partner with and Legal Counsel of Koor CVC. From 1998 to 2000, Ms. Goren was in charge of the legal aspects of Koor Industries’ mergers, acquisitions and divestitures. Ms. Goren serves on the board of directors of Telrad Networks Ltd., Symbionix U.S.A Corp. and NSC Natural Speech Communication Ltd. Ms. Goren holds an Executive MBA from Kellogg-Recanati School in Tel Aviv University, an LLB from Tel Aviv University and a B.A. in Medical Science from the Hebrew University, Israel.

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        Michael Anghel has served as our Director since December 2005. Mr. Anghel served as President of the investment banking arm of the Israel Discount Bank from 2004 to June 2005. Dr. Anghel serves as director on the board of Orbotech Ltd., Powerdsine Ltd., and Syneron Medical Ltd. Previously Dr. Anghel served on the board of several public companies, including DIC Investment Corporation Ltd., Elbit Systems Ltd., Elron Electronic Industries Ltd., Elscint Ltd., Gilat Satellite Networks Ltd., American Israeli Paper Mills Ltd., as well as other financial institutions and operating companies, including Cellcom Israel Ltd., a major Israeli cellular operator, and Tevel–Israel International Communications Ltd, a major Israeli TV cable operator, both of which he was involved in founding. In 2000, Dr. Anghel founded CAP Ventures Ltd., an operating venture capital company focusing on communications and information technology. Formerly, Dr. Anghel was a member of the faculty of the Graduate School of Business at the Tel-Aviv University and founded their Executive Program. Dr. Anghel holds a Ph.D. and an M.B.A. from Columbia University and a B.A. in Economics and Political Science from Hebrew University.

        Louis Silver has served as our Director since December 2005. Mr. Silver is a Principal of RP Capital Group (RPC) and has served as an advisor to RPC since April 2005. He has also provided services as a private banking consultant since January 2005. From August 2002 until April 2005, Mr. Silver acted as a legal and business development advisor to companies and individuals. From September 1996 until June 2002, Mr. Silver served as an advisor and counsel to Discount Bank & Trust Company. Since November 1999, Mr. Silver has served as a member of the board of directors of DSP Group, Inc. and since April 2002 he has served as a member of the board of directors of CEVA, Inc. Mr. Silver holds an A.B. from Harvard College, a LLB from Tel Aviv University School of Law and a LLM from New York University School of Law.

        Izhak Tamir has served as our Director since December 2005. Mr. Tamir has been President and a Director of Orckit Communications Ltd. since its founding in 1990 and a Director of Gilat Satellite Networks since 2005. Mr. Tamir also serves as Chairman and CEO of Tikro. From 1987 until 1989, Mr. Tamir was employed by Comstream Inc., in San Diego, California. From 1985 until 1987, he was vice president of A.T. Communication Channels Ltd., a subsidiary of Bezeq. From 1978 to 1985, he was a senior engineer in the Israeli Government. Mr. Tamir holds an engineering degree from the Technion (Cum Laude) and an M.B.A. from Tel Aviv University.

        Except as we otherwise describe below, we have not paid any cash compensation to members of our board of directors who are not officers for their services as directors. Directors are reimbursed for expenses incurred in order to attend board or committee meetings.

        The aggregate direct compensation we paid to our directors and executive officers as a group for 2005 (11 persons) was $1.6 million. This amount includes $214,000 that was set aside or accrued to provide for pension, retirement or similar benefits. This amount does not include expenses we incurred for other payments, including dues for professional and business associations, business travel and other expenses, and other benefits commonly reimbursed or paid by companies in Israel.

        We recently entered into employment agreements with Mr. Mahlab, Dr. Simler, and Mr. Eisenberg, which include salaries, bonuses and stock option grants. Our employment agreement with Mr. Mahlab requires a one-year notice of termination and that he is entitled to use any of his accrued vacation.

        During 2005 two of our non-employee directors were entitled to receive aggregate fees of $36,000 per quarter, plus reimbursement of related expenses. Directors who are also our employees do not receive any additional compensation for serving on the board of directors or attending board meetings.

        As of March 31, 2006, there were outstanding options to purchase 2,187,029 ordinary shares granted to our directors and officers (10 persons).

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Board of Directors and Executive Officers

        The Sarbanes-Oxley Act of 2002, as well as related new rules subsequently implemented by the Securities and Exchange Commission and the Nasdaq National Market, requires issuers to comply with various corporate governance practices.  Our Board of Directors consists of seven directors, four of whom are independent, and our audit committee consists of three directors, all of whom are be independent. In addition, Israeli law requires that we have at least two external directors, as described in greater detail below.

        Other than the external directors, who are subject to special election requirements under Israeli law, our directors will be elected in three staggered classes by the vote of a majority of the shareholders present, in person or by proxy, at a shareholders’ meeting. The directors of only one class will be elected at each annual meeting, so that the regular term of only one class of directors expires annually. At our annual general meeting to be held in 2007, the term of the first class, consisting of Izhak Tamir, will expire, and the director elected at that meeting will be elected for a three-year term. At our annual general meeting to be held in 2008, the term of the second class, consisting of Yaron Simler and Yoel Gat, will expire and the directors elected at that meeting will be elected for three-year terms. At our annual general meeting to be held in 2009, the term of the third class, consisting of Jackie Goren and David Mahlab, will expire and the directors elected at that meeting will be elected for three-year terms. After these initial terms, directors (other than the external directors) shall serve in office until the end of the third annual shareholders’ meeting following the one in which they were elected. Any director elected following the removal or resignation of one of the directors, shall serve until the third annual meeting of the shareholders following the meeting in which he was elected.

        The number of directors that we have under the articles of association is seven. Any increase in directors above this number requires an amendment of our articles of association and an approval by a supermajority vote of seventy-five percent (75%) or more of the votes cast by those shareholders present and voting, not taking into consideration abstentions. A general meeting may remove a director, during the term only by a supermajority vote of seventy five percent (75%) or more of the votes cast by those shareholders present and voting, not taking into consideration abstentions (except for external directors, who may be removed pursuant to the Companies Law).

        Each of our executive officers serves at the discretion of our board of directors and holds office until his or her successor is elected or his or her resignation or removal.

        Pursuant to a transition plan approved by our board of directors, on January 1, 2007, Mr. Gat will step down of his position as the chairman of our board of directors, and will be replaced by Mr. David Mahlab, who will be appointed as the active chairman. Yoel Gat will continue to serve as a consultant and as a director in the board of directors and will be appointed to another position such as a vice chairman of our board of directors. On January 1, 2007 Dr. Simler will replace Mr. David Mahlab as our chief executive officer, and become president and chief executive officer. After the transition, the respective compensation package paid to each of Dr. Simler, Mr. Mahlab and Mr. Gat will remain unchanged.

External Directors

        We are subject to the Israeli Companies Law. Under the Companies Law, an Israeli company whose shares have been offered to the public or whose shares are listed for trading on a stock exchange in or outside of Israel, is required to appoint at least two external directors to serve on its board of directors. At least one of the external directors is required to have “financial and accounting expertise” and the other external director or directors are required to have “professional expertise.”

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        A person may not serve as an external director if at the date of the person’s appointment or within the prior two years the person, or his or her relatives, partners, employers or entities under the person’s control, have or had any affiliation with us or any entity controlling, controlled by or under common control with us. Under the Companies Law, “affiliation” includes:

–     an employment relationship;

–     a business or professional relationship maintained on a regular basis;

–     control; and

–     service as an office holder, excluding service as a director in a private company prior to the first offering of its shares to the public if such director was appointed as a director of the private company in order to serve as an external director following the initial public offering.

        An “office holder” is defined as any director, managing director, general manager, chief executive officer, executive vice president, vice president, other manager directly subordinate to the general manager or any other person assuming the responsibilities of any of these positions regardless of that person’s title. Each person listed in the table under “Item 6A. – Directors and Senior Management” is an office holder.

        A person may not serve as an external director if that person’s position or other business activities create, or may create a conflict of interest with the person’s service as a director or may otherwise interfere with the person’s ability to serve as a director. If at the time any external director is appointed, all members of the board are the same gender, then the external director to be appointed must be of the other gender. A director of a company shall not be appointed as an external director of another company if at such time, a director of the other company is acting as an external director of the first company. Until the lapse of two years from the termination of office, a company may not engage an external director to serve as an office holder and cannot employ or receive services from that person, either director or indirectly, including through a corporation controlled by that person. Louis Silver and Michael Anghel appointment as external directors shall be ratified at our next annual meeting.

        External directors are elected by a majority vote at a shareholders’ meeting, as long as either:

–     the majority of shares voted for the election includes at least one-third of the shares of non-controlling shareholders voted at the meeting; or

–     the total number of shares of non-controlling shareholders voted against the election of the external director does not exceed one percent of the aggregate voting rights of our company.

        The Companies Law provides for an initial three-year term for an external director, which may be extended for one additional three-year term. External directors may be removed only by the same special majority required for their election or by a court, and then only if the external directors cease to meet the statutory qualifications for their appointment or if they violate their duty of loyalty to our company. In the event of a vacancy created by an external director, our board of directors is required under the Companies Law to call a shareholders meeting to appoint a new external director.

        External directors may be compensated only in accordance with regulations adopted under the Companies Law. Compensation of an external director must be determined prior to the person’s consent to serve as an external director. Compensation of all directors requires the approval of our audit committee, board of directors and shareholders, in that order.

Committees of the Board of Directors

        Our board of directors has established an audit committee and a compensation committee.

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Audit Committee. Under the Companies Law, the board of directors of any public company must establish an audit committee. The audit committee must consist of at least three directors and must include all of the external directors. The audit committee may not include the chairman of the board, any director employed by us or providing services to us on a regular basis, a controlling shareholder or any of the controlling shareholder’s respective relatives. In addition, under the listing requirements of the Nasdaq National Market, we also are required to maintain an audit committee consisting of at least three directors, all of whom must be independent under the Nasdaq National Market listing requirements.

        Pursuant to the Israeli Companies Law at least one external director is required to have “accounting and financial expertise” and the other is required to have “professional expertise” or “accounting and financial expertise”. A director has “professional expertise” if he or she satisfies one of the following:

        A director with “accounting and financial expertise” is a person that due to his or her education, experience and skills has high skills and understanding of business-accounting issues and financial reports which allow him to deeply understand the financial reports of the company and hold a discussion relating to the presentation of financial information. The company’s board of directors will take into consideration in determining whether a director has “accounting and financial expertise”, among other things, his or her education, experience and knowledge in any of the following:

        The above qualifications do not apply to external directors appointed prior to January 19, 2006. However, an external director may not be appointed to an additional term unless: (i) such director has “accounting and financial expertise”; or (ii) he or she has “professional expertise”, and on the date of appointment for another term there is another external director who has “accounting and financial expertise” and the number of “accounting and financial experts” on the board of directors is at least equal to the minimum number determined appropriate by the board of directors.

        Izhak Tamir, Michael Anghel, and Louis Silver serve as members of our audit committee.

        The audit committee’s duties include providing assistance to the board of directors in fulfilling its legal and fiduciary obligations in matters involving our accounting, auditing, financial reporting, internal control and legal compliance functions by approving the services performed by our independent accountants and reviewing their reports regarding our accounting practices and systems of internal accounting controls. The audit committee also oversees the audit efforts of our independent accountants and takes those actions as it deems necessary to satisfy itself that the accountants are independent of management. Under the Companies Law, the audit committee also is required to monitor deficiencies in the administration of our company, including by consulting with the internal auditor, and to review and approve related party transactions.

        Compensation Committee. Our compensation committee will consist of Izhak Tamir, Michael Anghel, and Jackie Goren (Rozenblum). The compensation committee’s duties include making recommendations to the board of directors regarding the issuance of employee share options under our share option and benefit plans and determines salaries and bonuses for our executive officers and incentive compensation for our other employees. Prior to sale of the shares offered hereby we intend to add one external director to our compensation committee, as required by Israeli law, and to reconstitute our compensation committee in order to satisfy the Nasdaq National Market Listing requirements.

        No Nomination Committee. We currently do not have a nomination committee in place, and the actions ordinarily taken by such committee are resolved by the majority of our independent directors, in accordance with the Nasdaq National Market Listing requirements.

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Internal Auditor

        Under the Companies Law, the board of directors also must appoint an internal auditor nominated following the recommendation of the audit committee. The prime role of the internal auditor is to examine whether a company’s actions comply with the law and proper business procedure. The internal auditor may be an employee of ours but may not be an interested party or office holder, or a relative of any interested party or office holder, and may not be a member of our independent accounting firm or its representative. The Companies Law defines an “interested party” as a holder of 5% or more of the shares or voting rights of a company, any person or entity that has the right to nominate or appoint at least one director or the general manager of the company or any person who serves as a director or as the general manager of a company. Our internal auditor is Doron Cohen, CPA (Isr.), CIA (USA).

6D. Employees

        The following table sets forth the number of full-time employees employed by us on December 31 of the years 2005, 2004, and 2003

        As of December 31, 2005, of our full-time employees, 64 were employed in production, 106 in research and development, 71 in marketing and sales, and 23 in administration. We believe that we have good relations with our employees and we have never experienced a labor dispute, strike or work stoppage.

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        Israeli law, as well as orders of the Israeli Ministry of Labor and Welfare, contain provisions regarding conditions of employment, including, among other things, the length of the work day, minimum wages, insurance for work-related accidents, the determination of severance pay, and adjustments of wages in accordance with inflation. We generally provide our employees with benefits and working conditions above the required minimum.

        Israeli law generally requires severance pay, which may be funded by Manager’s Insurance (“Bituach Menahalim”, which is described below) upon the retirement or death of an employee or termination without cause (as defined in the law). Our payments to Manager’s Insurance for severance pay amount to approximately 8.33% of the wages paid during the employment period. Furthermore, Israeli employees and employers are required to pay predetermined sums to the National Insurance Institute, , as well as for national health insurance. The payments to the National Insurance Institute are equal to approximately 15.1% of wages (up to a specified amount), of which the employer contributes approximately 66% and the employee contributes 34%.

        A general practice followed by us until June 2000 with respect to our employees in Israel, although not legally required, is the contribution of funds on behalf of most of its employees to Manager’s Insurance. This fund provides a combination of savings plans, insurance, and severance pay benefits to the employee, providing the employee with a lump sum payment upon retirement and securing severance pay for the employee, if legally entitled, upon the termination of employment. Each employee who participates in such plan contributes an amount of up to 5% of such employee’s salary, and we contribute the equivalent of 13.3% to 15.8%, which includes the 8.33% for the severance pay mentioned above. In June 2000 we entered into a collective agreement with the local labor union and a certain social insurance corporation (Mivtachim), effective as of April 2000, pursuant to which all of our new production workers will be covered by policies similar to the Manager’s Insurance issued by Mivtachim. Our contribution to such policies is similar to our contributions to Manager’s Insurance. Employees that wish to replace their Manager’s Insurance with the Mivtachim insurance may do so, subject to the approval of Mivtachim. As an additional benefit to most employees, we also contribute 5% to 7.5% of the employee’s wages to “professional advancement” funds for managers, engineers and others, and such employees contribute an additional 2.5% of their wages to such fund.

        Effective July 1984, a Collective Agreement regarding the benefits which apply to employees in the Industries of Metal, Electricity, Electronics and Software was entered into by the Israeli Industrial Association, the Histadrut (the general labor union), and the representatives in the Histadrut of the employees of such industries, which agreement applies to us and most of our employees. We substantially comply with the requirements of such Collective Agreement.

        The wages of our employees are linked to a certain percentage of the increase in the Israeli standard of living as determined by periodic agreements between the Histadrut and the Israeli government.

        All our officers, employees except one are party to individual employment agreements. We have entered into a non-disclosure and non-competition agreement with each of our executive officers and key employees.

        We are subject to the labor laws and regulations in the other jurisdictions in the world where we have employees, specifically in the United States.

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        The following table sets forth, as of March 31, 2006, the number of Ordinary Shares beneficially owned by (i) each of the directors and officers and (ii) our directors and officers as a group.  The information in this table is based on 13,103,018 Ordinary Shares outstanding as of March 31, 2006. The number of Ordinary Shares beneficially owned by a person includes Ordinary Shares subject to options held by that person that were currently exercisable at, or exercisable within 60 days of, March 31, 2006. The Ordinary Shares issuable under these options are treated as if they were outstanding for purposes of computing the percentage ownership in the table below.