20-F 1 a42226.htm ELRON ELECTRONIC INDUSTRIES LTD.

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 20-F

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2005
Commission File No. 0-11456

ELRON ELECTRONIC INDUSTRIES LTD.
(Exact name of Registrant as specified in its charter and translation of Registrant’s name into English)

ISRAEL
(Jurisdiction of incorporation or organization)

3 Azrieli Center, 42nd Floor, Tel-Aviv, Israel 67023
(Address of principal executive offices)

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

Not Applicable
(Title of Class)

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

Ordinary Shares, nominal value 0.003 New Israeli Shekels per share
(Title of Class)

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

Not Applicable
(Title of Class)

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: 29,483,455

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 of 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

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


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

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

Item 17 o Item 18 x

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

Yes o No x

TABLE OF CONTENTS


		Page

PART I

Item 1.	Identity of Directors, Senior Management and Advisers	3

Item 2.	Offer Statistics and Expected Timetable	3

Item 3.	Key Information	3-21

Item 4.	Information on the Company	21-47

Item 4A.	Unresolved Staff Comments	48

Item 5.	Operating and Financial Review and Prospects	48-73

Item 6.	Directors, Senior Management and Employees	73-86

Item 7.	Major Shareholders and Related Party Transactions	86-90

Item 8.	Financial Information	91-92

Item 9.	The Offer and Listing	92-93

Item 10.	Additional Information	94-113

Item 11.	Quantitative and Qualitative Disclosures about Market Risk	113

Item 12.	Description of Securities Other than Equity Securities	113

PART II		113

Item 13.	Defaults, Dividend Arrearages and Delinquencies	113

Item 14.	Material Modifications to the Rights of Security Holders and Use of Proceeds	113

Item 15.	Controls and Procedures	113

Item 16.	[Reserved]	114

Item 16A.	Audit Committee Financial Expert	114

Item 16B.	Code of Ethics	114

Item 16C.	Principal Accountant’s Fees and Services	114

Item 16D.	Exemptions from the Listing Standards for Audit Committees	115

Item 16E.	Purchases of Equity Securities by the Issuer and Affiliated Purchasers	115

PART III

Item 17.	Financial Statements	115

Item 18.	Financial Statements	115

Item 19.	Exhibits	116

For the purpose of this Annual Report on Form 20-F, the terms “group companies” and “companies in our group” collectively refer to subsidiaries, affiliated and other companies in which we have direct or indirect holdings through our wholly-owned subsidiaries, Elbit Ltd., or Elbit, and DEP Technology Holdings Ltd., or DEP, including DEP’s subsidiary, RDC Rafael Development Corporation Ltd., or RDC. Our ownership interests in our group companies reflected in this Annual Report represent our beneficial ownership interests in the outstanding shares of these companies as of May 31, 2006 unless otherwise expressly indicated. Our beneficial ownership interests in the preferred shares of these companies are represented on an as-converted-basis. We have also indicated our direct holding and our share in the holding of RDC in a group company where applicable. The references in this Annual Report to balance sheet items are as of December 31, 2005, unless otherwise indicated.

Throughout this report we discuss certain information regarding Given Imaging Ltd. and Partner Communications Ltd., companies in our group which have securities registered with the Securities and Exchange Commission in the United States (the “SEC”). Our discussions of these Companies are qualified in their entirety by the reports these companies file with the SEC which are posted on the SEC’s website at www.sec.gov. Please see these reports for additional information on these companies.

Forward-Looking Statements

This Annual Report on Form 20-F includes certain “forward-looking” statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. The use of the words “projects,” “expects,” “may,” “plans” or “intends,” or words of similar import, identifies a statement as “forward-looking.” There can be no assurance, however, that actual results will not differ materially from our expectations or projections. Factors that could cause actual results to differ from our expectations or projections include the risks and uncertainties described in this Annual Report under Item 3 titled “Risk Factors” as well as those discussed elsewhere in this Annual Report and in our other filings with the SEC. Any forward-looking statements contained in this Annual Report speak only as of the date of this Annual Report, and we caution investors and potential investors not to place undue reliance on these statements. We undertake no obligation to update or revise any forward-looking statements. All subsequent written or oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the Risk Factors.

PART I


Item 1.	Identity of Directors, Senior Management and Advisers

Not Applicable.

Item 2.	Offer Statistics and Expected Timetable

Not Applicable.

Item 3.	Key Information


A.	Selected Financial Data

The following selected financial data for the years ended December 31, 2001, 2002, 2003, 2004 and 2005 are derived from our audited consolidated financial statements of which the financial statements as of December 31, 2004 and 2005, and for each of the years ended December 31, 2003, 2004 and 2005 appear later in this Form 20-F. The audited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States, or U.S. GAAP.

CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands of U.S. Dollars, except per share data)


	Year ended December 31

	2001			2002			2003			2004			2005

Income:
Net revenues	$	—		$	5,110		$	9,157		$	11,265		$	12,646
Equity in losses of affiliated companies		(28,787	)		(24,189	)		(8,698	)		(10,492	)		(17,522	)
Gain from disposal of businesses and affiliated companies and changes in holdings in affiliated companies, net		3,179			6,888			25,754			132,396			23,328
Other income (expenses), net		(4,666	)		(747	)		14,637			4,749			58,648
Financial income, net		4,538			1,480			751			1,433			5,483

		(25,736	)		(11,458	)		41,601			139,351			82,583

Costs and Expenses:
Cost of revenues		—			2,903			5,862			6,791			7,907
Research and development costs, net		55			2,265			3,263			2,889			6,163
Marketing and selling expenses, net		—			5,268			6,498			1,311			2,386
General and administrative expenses		5,100			7,568			12,872			12,292			9,249
Restructuring costs		—			396			—			—			—
Amortization of intangible assets		—			269			299			142			392
Impairment of intangible assets		—			—			—			4,192			—


		5,155			(18,670	)		28,794			27,617			26,097
Income (loss) before tax benefit (taxes on income)		(30,891	)		(30,128	)		12,807			111,734			56,486
Tax benefit (taxes on income)		3,786			2,961			(6,796	)		(15,101	)		(10,461	)

Income (loss) after taxes on income		(27,105	)		(27,167	)		6,011			96,633			46,025
Minority interest in losses (income) of subsidiaries		438			2,823			(10,907	)		(4,135	)		5,160

Income (loss) from continuing operations		(26,667	)		(24,344	)		(4,896	)		92,498			51,185
Loss from discontinued operations		(25,692	)		(17,235	)		(2,309	)		(8,365	)		(3,850	)

Net Income (loss)	$	(52,359	)	$	(41,579	)	$	(7,205	)	$	84,133		$	47,335

Income (loss) per share:
Basic -
Income (loss) from continuing operations	$	(1.26	)	$	(0.93	)	$	(0.17	)	$	3.26		$	1.74
Loss from discontinued operations		(1.21	)		(0.65	)		(0.08	)		(0.39	)		(0.13	)

Net income (loss)	$	(2.47	)	$	(1.58	)	$	(0.25	)	$	2.86		$	1.61
Weighted average number of ordinary shares used in computing basic net income (loss) per share (thousands)		21,191			26,272			29,194			29,266			29,437


	Year ended December 31

	2001			2002			2003			2004			2005

Diluted -
Income (loss) from continuing operations	$	(1.27	)	$	(0.93	)	$	(0.17	)	$	3.25		$	1.73
Loss from discontinued operations		(1.21	)		(0.65	)		(0.08	)		(0.39	)		(0.13	)

Net income (loss)	$	(2.48	)	$	(1.58	)	$	(0.25	)	$	2.86		$	1.60
Weighted average number of ordinary shares used in computing diluted net income (loss) per share thousands)		21,191			26,272			29,194			29,385			29,550

Dividend paid per share	$			$	—		$	—		$	—		$	3.0


	As of December 31,

	2001		2002		2003		2004		2005

	(U.S. Dollars in thousands)
Balance Sheet Data
Cash, cash equivalents and short-term and long term investments	$	111,896	$	99,735	$	119,769	$	188,106	$	143,798
Investments in affiliated companies and in other companies and long term receivables		164,967		221,338		285,618		273,053		176711
Total assets		321,512		394,253		450,704		501,156		353,773
Shareholders’ equity		233,915		259,441		296,130		389,080		302,116
Capital stock		217,478		284,583		328,477		337,294		291,445


B.	Capitalization and Indebtedness

Not Applicable.

C.	Reasons for the Offer and Use of Proceeds

Not Applicable.

D.	Risk Factors

Risks Affecting us and the Companies in our Group

Our financial results and financial condition are principally impacted by the results of, and the value of our holdings in, our group companies. For the year ended December 31, 2005, our share in the results of operations of our group companies and gain upon the sale of shares in our group companies accounted for substantially all of our income. In addition, as of December 31, 2005, our holdings in group companies represented approximately 50% of our total assets. If our group companies experience difficulties in the future, or if there are adverse changes in their market price or fair value, our financial results and/or the value of our assets will be adversely affected, and we may need to write-down or write-off the carrying value of our holding or record the share in our group company’s loss. In particular, as of December 31, 2005, the carrying value of our holdings in Given Imaging Ltd., or Given Imaging (Nasdaq:GIVN), represented approximately 19% of our total assets, the carrying value of our holdings in Partner

Communications Ltd., or Partner (Nasdaq: PTNR), represented approximately 7% of our total assets and the carrying value of our holdings in Oncura, Inc., or Oncura, through our subsidiary Galil Medical Ltd., or Galil Medical, represented approximately 6% of our total assets. Any adverse change in the results of operations or financial condition of Given Imaging, Oncura or other of our group companies whose results we consolidate or account for on an equity basis, or any substantial adverse change in the market value of shares in Given Imaging or Partner, may have a substantial negative impact on our results of operations or financial condition.

Our performance significantly depends on the results of operations of our group companies. Our results of operations are directly impacted by the results of operations of our group companies accounted for under the equity or consolidation method. To the extent any of these companies have poor financial results or encounter difficulties in their operations, our financial results will be negatively impacted. Many of these companies have not yet generated significant revenues, have incurred losses and have invested heavily in research, development and marketing of their products. We anticipate that the majority of these companies will continue to record losses in the future.

Our financial results are directly impacted by our ability to conclude profitable “exit” transactions. Our financial results are directly impacted by our ability to conclude profitable “exit” transactions regarding certain of the companies in our group. If worldwide market conditions in the technology industry or other factors do not permit us to conclude these types of transactions, our results will be adversely affected.

We may face difficulties in our ability to dispose of our shares in publicly traded companies in our group. Due to the limitations of U.S. securities laws, material non-public information to which we may become exposed due to our representation on the boards of directors of companies in our group, and contractual and legal limits on the tradability of the shares, we may face difficulties in our ability to dispose of our shares in publicly traded companies in our group at a time and in a manner we deem suitable.

Our market value significantly depends on the market values of publicly-traded companies in our group. Our market value is directly impacted by the market values of Given Imaging and Partner, each of whose shares are traded in the public markets. To the extent that the share prices of either of these companies decline, our market value will be negatively impacted. In particular, we are affected by the price of shares of Given Imaging,. If the share prices of either of these companies decline, our market value could be adversely affected.

The market price of our ordinary shares is subject to fluctuations. The market value of our ordinary shares has fluctuated over time. The following factors, among others, may significantly impact the market price of our ordinary shares:


	•	the market price of our group companies which are publicly traded, in particular, Given Imaging;

	•	our group companies, their competitors or other third parties announcing technological innovations, new products or earnings or losses;

	•	periodic variations in results of operations of our group companies;

	•	factors that generally affect the market for stocks of medical device, telecommunications, semiconductor and advanced materials companies;


	•	political, economic or other developments affecting Israel;

	•	global economic and other external factors; and

	•	quarter-to-quarter fluctuations in our financial results.

Many of our group companies may face difficulties in obtaining future financing on favorable terms or at all. Many of our group companies have extensive research and development and marketing costs and limited revenues, if any. In order to succeed, these companies may require additional capital to fund these costs. If these companies have difficulties in obtaining financing from their current shareholders, which may also include additional investments by us in these companies, or from new financing sources, their continued operations may be at risk. This would adversely affect our financial performance and results of operations.

Bank of Israel regulations limit our and our group companies’ ability to borrow from Israeli banks. Bank of Israel regulations stipulate lending limits of Israeli banks to companies and individuals considered to be in an affiliated group, which limits the amount available to such affiliated group to borrow from such banks. We and our group companies are part of the IDB affiliated group of companies, which is one of the largest groups of affiliated companies in Israel. The IDB group includes many Israeli companies, which require, or which hold ownership interests in companies which require, extensive credit facilities from Israeli banks for the operation of their businesses. These regulations may result in difficulties for us and our group companies to obtain bank financing, if required.

Our results may be affected by volatility in the securities markets. Securities markets in general are volatile, and are particularly volatile with respect to high-technology companies, including companies that have a significant presence in Israel. Although the volatility of these companies’ securities is not necessarily related to their operating performance, these companies may experience difficulties in raising additional financing required to effectively operate and grow their businesses. These difficulties and the volatility of the securities markets in general may also affect our and our group companies’ ability to realize investments.

The downturn experienced by the technology markets in which our group companies operate may re-occur. Our group companies are affected by the demand for the technologies and technology products they develop and produce. The technology sector has previously experienced a prolonged and severe downturn, reflected in a steep decline in technology spending resulting in revenue declines for our more mature companies and difficulties in raising financing for our early stage companies. There is no assurance that a downturn will not re-occur or that the technology sector will continue to grow. If a downturn re-occurs, our and our group companies’ operations will be adversely affected.

We compete with other entities for acquisition and investment opportunities. As part of our overall strategy, we pursue acquisitions of, and investments in, Israeli companies and Israel-related technology companies. The success of a number of Israeli companies, particularly in information and communications technology and medical devices, has prompted potential investors to seek investment opportunities in Israel, which has allowed many Israeli high-technology companies to gain direct access to Israeli and foreign public securities markets. We compete for acquisition and investment opportunities with other established and well-capitalized entities. There can be no assurance that we will be able to locate acquisition or investment opportunities upon favorable terms. Our failure to consummate further acquisitions or

investments in the future may hinder our ability to grow and could harm our business, financial condition and results of operations.

There is no assurance that our subsidiary RDC will be able to continue to develop successful technologies and /or group companies. Our wholly-owned subsidiary DEP holds 50.1% of the outstanding shares and voting rights of RDC, established by DEP together with Rafael Armaments Development Authority Ltd., or Rafael pursuant to an agreement entered into between DEP and Rafael in 1993. RDC has first rights to exploit commercially technologies of Rafael for the development of products for use in non-military markets, which rights are dependent primarily upon RDC’s or Rafael’s identification of existing technologies for commercial uses, or the development by Rafael of new technologies, Rafael’s willingness to transfer the necessary human or other resources to develop and exploit commercially its technology in non-military markets, and RDC reaching agreement with Rafael on the terms of any commercial exploitation. RDC is currently involved in a dispute with Rafael regarding Rafael’s request to limit the scope of RDC’s rights under the agreement to certain fields or applications and to limit the period of the agreement even though the agreement is unlimited in time. Our ability to continue to grow and develop RDC could be harmed, and our business, financial condition and results of operations could be adversely affected, if we are unable to realize the full potential value of RDC’s agreement with Rafael as a result of any of the following:


	•	Rafael and RDC do not reach consensus on Rafael’s requests regarding limiting the scope and period of RDC’s rights under the agreement,

	•	Rafael does not cooperate with RDC in the realization of RDC’s rights under the agreement,

	•	Rafael or RDC do not identify existing technology, or Rafael does not develop new technology, that can be commercially exploited in non-military markets,

	•	Rafael does not transfer the necessary human or other resources to develop and exploit commercially this technology in non-military markets,

	•	RDC does not reach agreement with Rafael on the terms of any commercial exploitation, or

	•	the continued financing of RDC by its shareholders.

Most of our group companies are dependent upon proprietary technology which may be infringed upon or may infringe upon the proprietary technology of others. Most of our group companies greatly depend on their proprietary technology for their success. Like many other technology companies, most of these companies rely on a combination of patent, trade secret, copyright and trademark laws, together with non-disclosure agreements, confidentiality clauses in their agreements, including employment agreements, and technical measures to establish and protect proprietary rights in their products. These companies may not be able to enforce their proprietary rights under the laws of certain jurisdictions. Our group companies may not successfully protect their technology because, among other reasons:


	•	some foreign countries may not protect their proprietary rights as fully as do the laws of the United States;


	•	enforcing their rights may be time consuming and costly, diverting management’s attention and company resources;

	•	measures such as entering into non-disclosure agreements afford only limited protection;

	•	unauthorized parties may attempt to copy aspects of their products and develop similar software or to obtain and use information that they regard as proprietary; and

	•	competitors may independently develop products that are substantially equivalent or superior to their products or circumvent intellectual property rights.

In addition, others may assert infringement claims against our group companies. The cost of responding to infringement claims could be significant, regardless of whether the claims are valid.

Many of our group companies experience intense competition. Many of our group companies experience competition from companies with significantly greater financial, technical, marketing and public relations resources, who have easier market access, better operational infrastructure, longer operating histories, larger installed client bases, greater name recognition, more established relationships and alliances in their industries and offer a broader range of products and services. As a result, these competitors may be able to respond more quickly to new or emerging technologies or changes in clients’ requirements, benefit from greater purchasing economies, offer more aggressive product and services pricing or devote greater resources to the promotion of their products and services. If our group companies are unable to successfully compete, their businesses, financial condition and results of operations could be seriously harmed, which would in turn negatively affect our financial condition and results of operations.

Our group companies may experience delays in product development. Companies in our group involved in technology product development may experience delays in development which may result in loss of, or delay in, market acceptance. Delays and difficulties associated with new product introductions or product enhancements could negatively impact the business, financial condition, prospects and results of operations of these companies and, as a result, our financial results.

Israeli government programs in which certain of our group companies participate may be terminated or reduced in the future. In addition, the terms of such programs restrict the ability of our group companies to manufacture products and/or transfer technologies outside of Israel. Certain of our group companies participate in programs of the Office of the Israeli Chief Scientist, or the OCS and the Israel Investment Center, for which they receive grants and tax related and other benefits. The benefits available under these programs depend on our group companies meeting specified conditions. If our group companies fail to comply with these conditions, they may be required to pay additional taxes and penalties and be denied future benefits. We cannot assure you that these benefits will be available in the future at their current levels or at all.

Under the Israeli Law for the Encouragement of Industrial Research and Development, 1984, and related regulations, the discretionary approval of an OCS committee is required for any transfer of technology developed with OCS funding. There is no assurance that our group

companies will receive the required approvals for any proposed transfer. Such approvals, if granted, may be subject to the following additional restrictions:


	•	our group companies could be required to pay the OCS a portion of the consideration received upon any sale of such technology or group company to an entity that is not Israeli. The scope of the support received, the royalties that were paid, the amount of time that elapsed between the date on which the technology was transferred and the date on which the grants were received, as well as the sale price, will be taken into account in order to calculate the amount of the payment; and

	•	the transfer of manufacturing rights could be conditioned upon an increase in the royalty rate and payment of increased aggregate royalties (up to 300% of the amount of the grant plus interest, depending on the percentage of the manufacturing transferred outside of Israel).

These restrictions may limit the ability of our group companies to conclude transactions with international companies, including “exit” transactions.

We and our group companies may have difficulty retaining key employees. Our success and the success of our group companies depend, in large part, on a limited number of key management, scientific and technical personnel. In addition, future success will depend upon, in part, attracting and retaining highly qualified personnel. There can be no assurance that we or our group companies will be able to either retain present personnel or acquire additional qualified personnel as and when needed. The loss of the services of our key personnel or those of our group companies and the failure to attract highly qualified personnel may have a negative impact on our business.

Many of our group companies depend on international operations. Many of our group companies depend on sales to customers outside Israel. We expect that international sales will continue to account for a significant portion of these companies’ revenues for the foreseeable future. As a result, changes in international, political, economic or geographic events could result in significant shortfalls in orders or revenues. These shortfalls could cause the business, financial condition and results of operations of these companies to be harmed. Some of the risks of doing business internationally include:


	•	unexpected changes in regulatory requirements;

	•	the fluctuation of the New Israeli Shekel/U.S. Dollar representative rate of exchange;

	•	the inability of our group companies, their subsidiaries and subcontractors to obtain export licenses;

	•	imposition of tariffs and other barriers and restrictions;

	•	burdens of complying with a variety of foreign laws;

	•	political and economic instability;


	•	changes in diplomatic and trade relationships; and

	•	acts of terror.

Some of these factors, such as the ability to obtain export licenses and changes in diplomatic relations, may be affected by Israel’s overall political situation. See “Conditions in Israel may affect our operations and the operations of our group companies.” In addition, the economic and political stability of the countries of the major customers and suppliers of our group companies may also impact their business.

Conditions in Israel may affect our operations and the operations of our group companies. We and most of our group companies conduct our principal operations in Israel, and therefore are directly affected by the political, economic, and military conditions affecting Israel and the Middle East. In particular, we could be adversely affected by:


	•	any major hostilities involving Israel;

	•	a full or partial mobilization of the reserve forces of the Israeli army;

	•	the interruption or curtailment of trade between Israel and its present trading partners;

	•	a significant increase in inflation;

	•	a significant downturn in the economic or financial condition of Israel;

	•	a significant downgrading of Israel’s international credit rating;

	•	labor disputes and strike actions; and

	•	political instability

Since September 2000, there has been a significant increase in violence, civil unrest and hostility, including armed clashes, between the State of Israel and the Palestinians, and acts of terror have been committed inside Israel and against Israeli targets in the West Bank and Gaza including armed hostilities between Israel, the Palestinian Authority and other groups in the West Bank and Gaza Strip. Israel has responded with military action and is building a security fence, the route of which has been the subject of a great deal of controversy. Despite Israel’s unilateral withdrawal from part of the territories, there is an impasse in the entire peace process. No predictions can be made as to whether or when a final resolution of the area’s problems will be achieved or the nature thereof and to what extent the situation will impact Israel’s economic development. Any further escalation in these hostilities or any future armed conflict, political instability or violence in the region could have a negative effect on our and our group companies’ business and financial condition, harm our and our group companies’ results of operations and adversely affect our share price or the share prices of our group companies that are publicly traded.

Our and our group companies’ operations could be disrupted as a result of the obligation of key personnel in Israel to perform military service. All non-exempt male adult permanent residents of Israel under a specified age, as a general rule, are obligated to perform military reserve duty and may be called to active duty under emergency circumstances. Our operations and those of our group companies could be disrupted by the absence for a significant period of one or more of our or our group companies’ officers or employees. While we and our group

companies have operated effectively despite these conditions in the past, we cannot assess what impact these conditions may have in the future, particularly if emergency circumstances arise.

The results of operations of our group companies may be harmed by foreign currency exchange rate fluctuations. To the extent that our group companies are based in Israel and have international operations, or operate only in Israel but conduct their business in different currencies, their revenues, expenses, assets and liabilities, are not necessarily in the same currency and therefore they are exposed to foreign exchange rate fluctuations. These fluctuations may negatively affect their results of operations. Some of our group companies may attempt to hedge their foreign currency exposure from time to time; however, we cannot assure you that if they do so they will be successful.

Our group companies may not be able to enforce covenants not to compete. Some of our group companies currently have non-competition agreements with substantial numbers of their employees who are involved in research and development. In many cases, these employees are located primarily in Israel. These agreements prohibit the company’s employees, if they cease working for the company, from directly competing with the company or working for its competitors. Israeli courts have required employers seeking to enforce non-compete 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 any of our group companies cannot demonstrate that harm would be caused to it, the company may be unable to prevent its competitors from benefiting from the expertise of its former employees.

Product liability claims could adversely affect the business results of our group companies operating in the medical device industry. Product liability is an inherent risk for our group companies operating in the medical device industry. A product liability claim, regardless of its merit or eventual outcome, could result in substantial costs to a group company and a substantial diversion of management attention. A product liability claim or any product recalls could also harm a group company’s reputation and result in a decline in revenues. Substantial damages awards have been made in some jurisdictions against medical device companies based upon claims for injuries allegedly caused by the use of their products. There can be no assurance that a future product liability claim or series of claims brought against our group companies would not have an adverse effect on their business or the results of operations, or that product liability insurance would be adequate.

Product regulation may adversely affect the ability of our medical device group companies to bring new products to market or to continue to supply existing products to the market. Our medical device group companies are subject to strict government controls on the development, manufacture, labeling, distribution and marketing of products. They must obtain and maintain regulatory approval for their products from regulatory agencies before products may be sold in a particular jurisdiction. Each regulatory authority may impose its own requirements and delay or refuse to grant approval, even though a product has been approved in another country. Regulatory delays, the inability to successfully complete clinical trials, claims and concerns about safety and efficacy, new discoveries, patents and products of competitors and related patent disputes and claims about adverse side effects are only a few of the factors that could adversely affect the realization of product registration. Noncompliance with applicable regulatory requirements can result in enforcement action which may include recalling products,

ceasing product marketing, paying significant fines and penalties, and similar regulatory actions which could limit product sales, delay or halt product shipment, delay new product clearance or approval, and adversely affect such group companies’ results of operations.

Because the medical device industry is litigious, our medical device group companies are susceptible to intellectual property suits that could cause our group companies to incur substantial costs or pay substantial damages or prohibit them from selling their products. There is a substantial amount of litigation over patent and other intellectual property rights in the medical device industry. Whether a product infringes a patent involves complex legal and factual issues, the determination of which is often uncertain. Infringement and other intellectual property claims, with or without merit, can be expensive and time-consuming to litigate and can divert management’s attention from the company’s core business. See below under “Risks Affecting Our Holdings in Given Imaging.”

If our medical device group companies are unable to obtain reimbursement coverage from third-party healthcare payors for procedures using their products, or if reimbursement is insufficient to cover the costs of purchasing their products, demand for their products may be adversely affected. If physicians, hospitals and other healthcare providers are unable to obtain sufficient coverage and reimbursement from third-party payors for products produced by our medical device group companies, or if reimbursement is insufficient to cover the costs of purchasing our medical device group companies’ products or does not adequately compensate physicians and health care providers as compared to alternative procedures, our medical device group companies may be unable to generate sufficient sales to support their businesses. In addition, our medical device group companies could be adversely affected by changes in reimbursement policies of governmental or private healthcare payors to the extent any such changes affect reimbursement amounts or methods for procedures in which their products are used.

Our telecommunications group companies operate in a highly regulated telecommunications market which limits their flexibility to manage their businesses. The telecommunications market is subject to government regulation regarding licensing, competition, frequency allocation and costs and arrangements pertaining to interconnection and leased lines. The business and operations of our group companies which operate in this market, primarily Partner and NetVision, could be adversely affected by changes in laws, regulations or government policy affecting its business activities. These could include decisions by the regulator increasing the rate of royalties to be paid to the State of Israel, enlarging the types of revenues which the royalties apply to, setting policies and imposing new regulations governing electronic trade and mobile commerce, or further reducing call or Short Message Service, or SMS, termination tariffs, as well as the amendment or revocation of their licenses.

Certain of our telecommunications group companies can only operate their businesses for as long as they have a license from the Ministry of Communications. Partner and NetVision Ltd., or NetVision, conduct their respective operations pursuant to their respective licenses granted to each of them by the Ministry of Communications. These licenses are subject to revocation in accordance with their terms, and the terms of the licenses are subject to change by the Ministry of Communications (including by imposing additional requirements).

The semiconductor industry in which certain of our group companies operate is cyclical in nature and is characterized by ongoing changes. The semiconductor industry has historically been a highly cyclical industry. Companies in the semiconductor industry have expanded aggressively during periods of increased demand. This expansion has frequently resulted in overcapacity and excess inventories during periods of downturn, thereby adversely impacting upon the results of operations of our group companies operating in the semiconductor field.

In addition, the semiconductor industry is characterized by rapid ongoing changes, including: (1) changes in customers’ capacity requirements and capital spending, which depend in part on customers’ inventory levels relative to demand for their products; (2) the importance of driving down cost of ownership of systems; (3) more complex technology requirements; (4) the increasing significance of consumer electronics as a driver for chip demand and the related focus on lower prices; (5) varying levels of business information technology spending; (6) the growing types and varieties of integrated circuits and applications; (7) a rising percentage of business from customers in Asia and emergence of customers and competitors in new geographical regions; (8) customer demands for shorter lead times for the manufacture and installation of semiconductor manufacturing equipment; and (9) higher capital requirements for new semiconductor fabrication plants. If our semiconductor companies do not successfully manage the risks resulting from the ongoing changes occurring in the semiconductor industry, their businesses, financial condition and results of operation could be materially and adversely affected.

Specific Risks Affecting Elron

We may be deemed to be an investment company under the Investment Company Act of 1940. Generally, a company must register under the Investment Company Act of 1940, or the 1940 Act, and comply with significant restrictions on operations and transactions with affiliates if its investment securities exceed 40% of the company’s total assets, or if it holds itself out as being primarily engaged in the business of investing in, owning or holding securities. The 1940 Act provides for various exemptions from the obligation to register thereunder, and in 1980 we received an order from the SEC, declaring that we are not an investment company under the 1940 Act. If certain of our investments were to adversely affect our status under the 1940 Act, we might need to dispose of or acquire other investments to avoid the requirement to register as an investment company on terms that may not be favorable to us. In addition, if we were deemed to be an investment company and therefore required to register as such under the 1940 Act, we would be unable to continue operating as we currently do, as a result of which our market value would be severely harmed.

If we are characterized as a passive foreign investment company for U.S. federal income tax purposes, our U.S. shareholders may suffer adverse tax consequences. Generally, if for any taxable year 75% or more of our gross income is passive income, or at least 50% of our assets are held for the production of, or produce, passive income, we may be characterized as a passive foreign investment company, or PFIC, for U.S. federal income tax purposes.

If we are characterized as a PFIC, our U.S. shareholders may suffer adverse tax consequences, including having gains realized on the sale of our shares taxed at ordinary income rates, rather than the capital gain rate. In addition, both gains upon disposition and amounts

received as distributions could be subject to an additional interest charge by the Internal Revenue Service. If we are determined to be a PFIC for any given year, then dividends paid in that year and in the next year cannot qualify as “qualified dividends” which are eligible for the capital gains rate for certain U.S. Shareholders. A determination that we are a PFIC could also have an adverse effect on the price and marketability of our shares.

Following the sale of our shares in Elbit Systems in 2004, we announced that, as a result of the transaction, we may be characterized as a PFIC for 2004. Following a review of our position and consulting with our advisors on this matter in 2004, and based on certain assumptions and facts known at that time (which we believe have not changed), we believe there is substantial authority for the position that we can rely on the “change of business” exception to PFIC status provided under Section 1298(b)(3) of the U.S. Internal Revenue Code of 1986, as amended. Substantial authority is generally sufficient to support a return reporting position. Pursuant to this exception, in order to avoid PFIC status in 2004, among other requirements, we cannot be a PFIC in 2005 or 2006 (which cannot be determined at this time with respect to 2006) or in any year prior to 2004 (which we believe was not the case).

We believe that in 2005 we were not a PFIC. However, since the determination of whether we are a PFIC is based upon such factual matters as the valuation of our assets and, in certain cases, the assets of companies held by us, there can be no assurance with respect to the position of the Internal Revenue Service or a court of law as to our status as a PFIC. Our analysis related to 2005 is based, among others, upon certain assumptions and methodologies with respect to the values that we have used; our percentage ownership (by value), and the appropriate value of our ownership interest, in companies we held; and the manner in which we have allocated the aggregate value of our assets among our active assets and passive assets.

We cannot assure you that the Internal Revenue Service will not challenge our assumptions and methodologies. If the IRS were to challenge successfully such assumptions or methodologies, we would potentially be classified as a PFIC for 2005 or prior years.

With respect to 2006, the ultimate determination of our PFIC status will depend on the composition of our gross income and assets for the entire year, and the values of those assets, which are difficult to predict at this time and the appropriate value of our ownership interest in our group companies.

In view of the above, it is unclear whether the “change of business” exception would ultimately be satisfied for 2004. We cannot assure shareholders that the Internal Revenue Service will not challenge our reliance on the “change of business” exception or our assumptions used in determining our percentage of passive assets and income. If there are such challenges, we could be classified as a PFIC for 2004, even if we are not a PFIC in 2005 and 2006. Furthermore, there can be no assurance that we will not become a PFIC in the future. See “Item 10. Additional Information – Taxation – U.S. Federal Income Tax Considerations - Tax Consequences if We are a Passive Foreign Investment Company”.

U.S. holders of our shares are urged to consult their tax advisors regarding the application of the passive foreign investment company rules.

One of our shareholders beneficially owns a substantial amount of our ordinary shares and may therefore influence our affairs. As of May 31, 2006, Discount Investment Corporation Ltd., or DIC, beneficially owned an aggregate of approximately 47.6% of our ordinary shares and has the ability, in effect, to elect the members of our board of directors and to significantly influence our business. A majority of the members of our board of directors are officers or directors of DIC or its parent company, IDB Development Corporation Ltd., or IDBD, or its parent company, IDB Holding Corporation Ltd., or IDBH.

It may be difficult to serve process or to enforce a U.S. judgment against us, our directors and our officers. Since all of our directors and officers reside outside the United States, it may be difficult to effect service of process on us, our directors or officers within the United States. Furthermore, because most of our assets are located outside the United States, it may not be possible to enforce any judgment obtained in the United States against us or the aforementioned individuals in the United States. There is doubt as to the enforceability of civil liabilities under the U.S. Securities Act of 1933 and U.S. Securities Exchange Act of 1934 in original actions instituted in Israel.

Risks Affecting Our Holdings in Given Imaging

The following risk factor sections have been condensed for the purposes of this Annual Report. The risks associated with Given Imaging are more fully described in documents filed by Given Imaging with the SEC.

The price of Given Imaging’s shares could fluctuate significantly as a result of a number of factors, including varying quarterly financial performance or its failure to meet its guidance or the expectations of analysts or investors, which may lead to additional volatility in its share price. Given Imaging’s ordinary shares are traded on the Nasdaq National Market and on the Tel Aviv Stock Exchange. In 2005, the closing price of its shares has ranged from $20.39 to $36.04 per share on the Nasdaq National Market and NIS 95.79 to NIS155.3 on the Tel Aviv Stock Exchange. The price of Given Imaging’s shares could fluctuate significantly for, among other things, the following reasons: future announcements concerning Given Imaging or its competitors, the existence of litigation concerning Given Imaging’s intellectual property assets, changes in third-party reimbursement practices, regulatory developments, and new clinical or economic data regarding Given Imaging’s current or future products. In addition, it is Given Imaging’s practice to provide guidance to the market as to its expected revenues and earnings per share based on information available to Given Imaging at the time of the guidance. If Given Imaging’s quarterly operating results do not meet its guidance or the expectations of securities analysts or investors, the price of Given Imaging’s shares would likely decline. Therefore, revenues from system sales may be concentrated at the end of each fiscal quarter making it difficult for Given Imaging to determine the success of each quarter until its end and resulting in lower than expected quarterly revenues if external or other events cause a large number of potential customers to defer their purchasing decisions even for a short period of time. Furthermore, Given Imaging believes that demand for systems and capsules may be materially affected by seasonal factors during the summer months which may result in slower sales during the summer. Share price fluctuations may be exaggerated by low trading volume of Given Imaging’s ordinary shares and changes in trading practices in Given Imaging’s ordinary shares, such as short buying and selling. Securities class action litigation has often been brought against

companies following periods of volatility. Any securities litigation claims brought against Given Imaging could result in substantial expense and divert management’s attention from its business.

Given Imaging may be unable to maintain or increase its profitability. Given Imaging was formed in 1998 and recorded initial sales of its principal product, the Given System, in the third quarter of 2001. Given Imaging incurred losses until the second quarter of 2004 and has maintained profitability until the quarter ended December 31, 2005. Given Imaging has significant operating expenses and must continue increasing its revenues from sales of the Given System and of the PillCam capsules at a higher rate than the increase in its expenses in order to maintain and grow its profits.

If Given Imaging is unable to achieve broader penetration of the Given System among gastroenterologists, it may not be able to maintain its current growth rate. Given Imaging’s principal product is the Given System, consisting of a line of PillCam capsules and the related data recorder and computer workstation. As of December 31, 2005, Given Imaging had sold over 2,860 systems worldwide. Growth in Given Imaging’s installed base has contributed to its revenue growth. If Given Imaging is unable to continue to achieve broad penetration among gastroenterologists, Given Imaging may be unable to maintain its current growth rate.

Given Imaging currently depends on sales of the PillCam SB for a substantial majority of its revenues. A substantial portion of Given Imaging’s annual revenue growth to date has resulted from increased sales of the PillCam SB capsule. Given Imaging expects that a substantial majority of its revenues for the foreseeable future will come from sales of the PillCam SB capsule and other PillCam capsules. Sales of the PillCam SB capsule contributed $22.9 million, or 56.4%, in 2003, $41.6 million, or 64%, in 2004 and $62.5 million, or 72% in 2005 of Given Imaging’s total revenues. Given Imaging believes that the usage rate of the PillCam capsules is an important factor in growing revenues. Increasing the usage rate of customers is also important to attracting new customers to purchase and use the Given System. If Given Imaging is unable to increase the usage rate of the Given System, Given Imaging may not be able to achieve the revenues necessary to maintain its revenue growth.

Given Imaging’s future growth also depends in part on the success of Ethicon Endo-Surgery in marketing its new PillCam ESO video capsule, particularly in the United States. In May 2004, Given Imaging entered into an exclusive sales representation and co-promotion agreement with Ethicon Endo-Surgery, a Johnson & Johnson company. InScope, a division of Ethicon Endo-Surgery established to market products to the gastroenterology market, has exclusive rights to market Given Imaging’s PillCam ESO capsule in the United States. Under the agreement, InScope is responsible for marketing the PillCam ESO capsule and, consequently, Given Imaging’s future growth depends in part on the success of InScope in doing so. Sales of the PillCam ESO capsule in 2005 were lower than expected and may continue to be lower than expected if InScope is not successful in marketing the PillCam ESO capsule. This may negatively impact Given Imaging’s revenue growth.

Given Imaging faces direct competition from manufacturers of capsule endoscopy systems and may lose market share if Given Imaging is unable to compete effectively in the marketplace or utilize its patent portfolio. In October 2005, Olympus Corporation launched a competing capsule endoscopy system and began sales in Europe and Australia. Based on publicly available information, Olympus is also conducting clinical trials in the United States and intends to seek FDA clearance to market its capsule endoscopy system in the United States. In

addition, in April 2006, in response to a request made by Olympus in December 2003 to re-examine Given Imaging’s first U.S. Patent #5,604,531, the USPTO issued an office action confirming the validity of 13 of the original 17 claims of this patent. Given Imaging has the right to appeal the rejection of the four other claims. On May 19, 2006, Olympus Corporation and its subsidiaries filed a complaint in the U.S. District Court for the Eastern District of Pennsylvania against Given Imaging for alleged infringement of U.S. Patent 5,010,412, entitled “High Frequency, Low Power Light Source for Video Camera.” In addition, other companies in Korea and China began selling capsule endoscopy systems in these territories in 2005. If Given Imaging is unable to compete effectively in the marketplace or utilize its patent portfolio against the Olympus capsule endoscopy system and other competing systems, Given Imaging may lose market share or experience delays in completing sales as a result of longer decision making process among potential customers.

Given Imaging may be unable to introduce other products for use in other parts of the gastrointestinal tract. Given Imaging’s objective is to expand the use of the Given System by developing and introducing new capsules for visualizing other parts of the gastrointestinal tract, including the stomach and the colon. There can be no assurance of widespread market acceptance of the Given System as superior to existing technologies for detection of abnormalities in other parts of the gastrointestinal tract or that Given Imaging will succeed in marketing and selling capsules for use in other parts of the gastrointestinal tract. In addition, Given Imaging will be required to obtain FDA clearance in the United States and other regulatory approvals outside of the United States before commercially distributing the Given System for use in other parts of the gastrointestinal tract or introducing new products for use in the gastrointestinal tract. If future clinical trials indicate that the Given System is not as clinically or cost-effective in these parts of the gastrointestinal tract as current methods, or that it causes unexpected complications or other unforeseen negative effects, Given Imaging may not obtain regulatory clearance to market and sell the Given System for use in other parts of the gastrointestinal tract or obtain reimbursement coverage, and its growth would be adversely affected.

Any disruption in the United States market, the primary market for Given Imaging’s products, may result in a material reduction in Given Imaging’s revenues and negatively affect its results of operations.

Since Given Imaging began selling the Given System in 2001, most of its revenues have been generated from sales in the United States. Sales in the United States accounted for, $26.2 million, or 65%, of its revenues in 2003, $46.7 million, or 72%, of its revenues in 2004 and $63.9 million, or 74%, of its revenues in 2005. Any disruption to Given Imaging’s market in the United States resulting from adverse changes in reimbursement policies, regulatory requirements, competitors, macro-economic changes and other events, many of which are outside Given Imaging’s control, may result in a material reduction in its revenues and negatively affect its results of operations.

Given Imaging’s reliance on sole source suppliers could harm its ability to meet demand for the Given System in a timely manner or within budget. Given Imaging depends on sole source suppliers for some of the components necessary for the production of the Given System. Specifically, Micron Technology, Inc., through its Micron Imaging Group and other wholly-owned subsidiaries, is currently the sole supplier of the imaging sensor and the packaging for the sensor, and Zarlink Semiconductors is currently the sole supplier of the transmitter that is

integrated into the PillCam capsules. If the supply of these components is disrupted or terminated, or if these suppliers are unable to supply the quantities of components that Given Imaging requires, it may not be able to find alternative sources for these key components. If Given Imaging is required to change the manufacturer of any of these key components of the Given System, there may be a significant delay in locating and/or verifying a suitable alternative manufacturer. Furthermore, in the event that the manufacturer of a key component of Given Imaging’s product ceases operations or otherwise ceases to do business with Given Imaging, Given Imaging may not have access to the information necessary to enable another supplier to manufacture the component. The occurrence of any of the above events could harm the ability of Given Imaging to meet demand for its products in a timely manner or within budget, which could harm its ability to generate revenues, lead to customer dissatisfaction and damage its reputation.

Risks Affecting Our Holdings in Partner

The following risk factor sections have been condensed for the purposes of this Annual Report. The risks associated with Partner are more fully described in documents filed by Partner with the SEC.

We are restricted in our ability to freely dispose of our holdings in Partner. Almost all of our shares in Partner are subject to transfer restrictions stipulated by Partner’s license which requires that at least 5% of the economic and voting interest of Partner be owned by Israeli citizens and residents (“Minimum Israeli Percentage”). Pursuant to the relationship agreement between the founding shareholders of Partner, each Israeli party to the relationship agreement, including us, has undertaken to maintain such portion of the shares as is necessary to maintain the Minimum Israeli Percentage. These restrictions limit our ability to freely dispose of our shares in Partner.

Partner expects its subscriber growth rate, and consequently its revenue growth rate, to slow because Israel’s mobile telephone services market is highly penetrated, making it more difficult to obtain new subscribers than in the past. Because the Israeli market for mobile telephones is highly penetrated, future demand for Partner’s services will not grow at the same rate as it has in the past, and Partner’s subscriber growth will not develop at the same rate as in the past and will depend significantly on Partner’s ability to retain existing subscribers in its network and to attract subscribers from the other mobile telephone network operators. While Partner’s market share, based on internal estimates, has increased from approximately 13% of Israeli mobile subscribers at December 31, 1999 to approximately 32% at December 31, 2005. Partner’s market share growth has slowed since 2003 and Partner expects this trend to continue.

Competition from existing competitors may require Partner to increase its subscriber acquisition costs and customer retention costs and increase its churn rate. Partner competes primarily with Cellcom (a company controlled by DIC) and Pelephone, two of the other mobile telephone network operators in Israel. Because of the ease of switching between cellular operators, Partner has already faced and may continue to face an increase in its churn rate and may be forced to increase its customer retention costs, including subsidies towards upgrades of subscribers’ handsets, in order to retain subscribers. In 2005, Partner experienced a higher churn rate than in 2004, primarily due to the prepaid sector. Competition, including increased

competition resulting from the introduction of number portability, may further increase the churn rate.

Risks Affecting Our Holdings in Oncura

Oncura may incur future losses and be unable to achieve profitability. Oncura was formed in 2003 and has generated net losses from the commencement of its operations in July 2003 through December 31, 2005. Oncura has significant operating expenses and there is no assurance that Oncura will be able to achieve profitability in the future.

Oncura expects to derive a significant portion of its future revenues from its cryotherapy products, which could fail to achieve broad market acceptance or generate significant revenue growth. Oncura expects that revenues from its cryotherapy products will grow significantly over time. Accordingly, Oncura’s success is in large part dependent on acceptance by physicians and patients of its cryotherapy products. Although cryotherapy has existed for many years, it has not been widely accepted due to a variety of factors including concerns over the safety and efficacy of the technology and the availability of alternative therapies. If Oncura’s cryotherapy products do not achieve broad market acceptance, Oncura may not be able to achieve the revenue growth necessary to achieve and maintain profitability.

Oncura is dependent on its two shareholders, GE Healthcare and Galil Medical and there is no assurance that they will continue to support Oncura. Oncura depends primarily on GE Healthcare and Galil Medical, for manufacturing its products. Although Oncura has long-term supply agreements with each of GE Healthcare and Galil Medical, its business could be seriously harmed if it were unable to maintain these relationships or if GE Healthcare or Galil Medical were unable to continue to manufacture the company’s products. In addition, Oncura’s operations from inception through December 31, 2005 have not generated positive cash flows and its corresponding working capital deficits have been financed by loans from its shareholders. If Oncura is not able to secure suitable third-party financing to fund its working capital deficits, the company will continue to need to rely on its shareholders to provide necessary funding until such time as the company becomes cash flow positive or can obtain necessary financing from a third-party. Each of Oncura’s shareholders provided to Oncura a letter in which they confirmed their intention to continue providing financial support to Oncura through May 31, 2007 or such later date as may be agreed by them. There is no assurance that Oncura’s shareholders, including Galil Medical, of which we beneficially own, as of May 31, 2006, 60% of the shares directly and indirectly, will continue to fund Oncura’s working capital deficit after May 31, 2007 or maintain their respective holdings in Oncura, which may adversely affect Oncura's business and results of operations.

Risk Affecting Our Holdings in NetVision

The market for the supply of Internet access services and value added services in Israel is very competitive. The supply of Internet access services requires a special license from the Israeli Ministry of Communications whose policy is to encourage competition and therefore does

not place any material barriers to entry into the market. Since the beginning of 2004, competition in the market has focused on broadband Internet services. NetVision continues to experience increased competition in gaining broadband communication market share, mainly from companies such as Internet Gold (Nasdaq:IGLD), Bezeq International, Barak I.T.C. (1995) Ltd., or Barak, and 012 Golden Lines Ltd., or Golden Lines. As of December 31, 2005, NetVision estimates that it held approximately 25% of the broadband Internet communication market in Israel. Competition from existing and new competitors may require NetVision to reduce its tariffs and increase its subscriber acquisition and retention costs as a result of which NetVision’s results of operations could be adversely impacted. Due to the intense competition, there has been a slow down in the increase of NetVision’s subscriber base. NetVision is currently engaged in merger discussions with Barak. There is no assurance that the proposed merger will take place.

The market for the supply of international telephone services in Israel is very competitive The market for international telephony services, which NetVision entered in November 2004, is very competitive. The three major competitors are Bezek International, Golden Lines and Barak. Such competition may result in a decrease in prices to a level which will make penetration for NetVision more difficult, decrease NetVision’s profits or even result in losses for NetVision, from these activities. In such event, NetVision’s investment in its international telephone activities will be negatively impacted which in turn will negatively affect NetVision’s results of operations.

NetVision relies on certain third-parties for leased lines. NetVision relies on certain third-party service providers including local and long distance telecommunications companies, such as Bezeq and Med Nautilus, for leased lines. Internet access by NetVision’s customers is dependent on the telecommunications infrastructure owned and maintained by Bezeq and the local cable companies. If NetVision’s subscribers’ access to Israel’s fixed-line telecommunications infrastructure is disrupted, it would significantly impact the services that NetVision provides to its subscribers and could result in a substantial reduction in Internet access volume and revenue. Furthermore an increase in the cost of access to Israel’s fixed-line telecommunications infrastructure could also adversely impact NetVision’s results of operations.

Item 4. Information on the Company

A. History and Development of the Company

We are a high technology operational holding company that operates through our group companies. Our group companies include both publicly traded and privately held companies.

Founded in 1962, we have been a major force in the development of the Israeli high technology industry by building Israeli and Israel-related companies with technologies in the fields of medical devices, advanced defense electronics, telecommunications, semiconductors, software products and services and advanced materials. Historically, most of our group companies were established together with entrepreneurs or started as activities within Elron and were subsequently spun-off. In addition, some of our group companies grew out of our subsidiary, RDC, established by us (through our subsidiary, DEP) together with Rafael, the

largest research and development organization of Israel’s Ministry of Defense, pursuant to an agreement entered into in July 1993 for the purposes of exploiting Rafael’s technology in non-military markets. RDC has first rights to exploit commercially technologies of Rafael in non-military markets, which rights are dependent primarily upon RDC’s identification of new and existing military technology developed by Rafael, for commercial exploitation in non-military markets. Potential projects and opportunities are identified through mutual cooperation and ongoing liaison between RDC and their professional advisors and members of Rafael’s research and development team. Following the identification of a project, RDC commercially exploits the project, initially using its own finance and management resources and thereafter obtains external financing. Given Imaging and Galil Medical are examples of companies that grew out from this cooperation with Rafael. RDC is currently involved in a dispute with Rafael regarding Rafael's request to limit the scope and period of their agreement. See Item 3 “Risks Affecting Us and the Companies in our Group”.

We expect to continue to build and realize value for our shareholders through the sale of a portion or all of our holdings in, or the issuance of shares by any of our group companies to third parties, while simultaneously pursuing the acquisition of, or investment in, new and existing companies at different stages of development including early stage and more mature companies, and building our group companies. We believe that this strategy provides the ability to increase shareholder value as well as capital to support the growth of our group companies.

Our primary activity is our involvement in the management of our group companies, in which we maintain controlling or significant holdings, and, in a limited number of cases, minority holdings. We participate in the management of most of our group companies by means of active membership on their boards of directors and board committees. As a result, we are involved in matters of policy, strategic planning, marketing, selecting and manning senior management positions, approving investments and budgets, financing and the overall ongoing monitoring of our group companies’ performance. In addition to our representation on the boards of directors of our group companies, we provide hands-on assistance to our group companies’ management in support of their growth. We view our hands-on involvement in the operations of our group companies as a key element of our business. Our group companies therefore benefit from the experience of our management team in various areas in which they need support and leadership, including, but not limited to, market analysis, risk management, identifying joint venture opportunities, introductions to potential customers and investors, business plan preparation, budgetary control and strategic planning and research and development guidance.

Both our legal name and our commercial name is Elron Electronic Industries Ltd. We were incorporated in Israel in 1962 under the name of Elron Electronic Industries Ltd. The principal legislation under which we operate is the Israeli Companies Law, 1999. Our shares are publicly traded on Nasdaq National Market under the symbol “ELRN” and on the Tel Aviv Stock Exchange. Elron’s corporate headquarters and registered office is located at 3 Azrieli Center, 42nd Floor, Tel-Aviv 67023, Israel, Tel. 972-3-607-5555, Fax. 972-3-607-5556, e-mail: elron@elron.net. Our web site address is www.elron.com. Information contained on our web site is not part of this Annual Report.

The following are significant transactions and events which we and our group companies have completed or which took place since January 1, 2005:


	•	Sale of Partner shares

		On April 20, 2005 we completed the sale to Partner of 12,765,190 Partner shares for approximately $94 million, as part of the sale together with the other Israeli founding shareholders of Partner of an aggregate of approximately 33.3 million Partner shares to Partner for an aggregate consideration of approximately $245 million. As a result of the sale, we recorded in 2005 a gain of $45.4 million, net of tax.

		In April 2006, we purchased an additional 0.6% of Partner’s outstanding shares from Polar Communications Ltd., one of the other founding shareholders of Partner, for approximately $5.3 million, at a 15% discount to the then market price. Following this transaction, our beneficial holding in Partner is approximately 2.6%. Almost all of our holding is subject to certain transfer restrictions under Partner’s Israeli communications license.

	•	Investment in NuLens Ltd.

		On April 21, 2005, we invested approximately $1.7 million in NuLens Ltd., or NuLens, an Israeli medical device company operating in the field of intra-ocular lenses, mainly for cataract and presbyopia procedures. The investment was the first of two installments. The second installment of approximately $1.1 million was invested in March 2006 simultaneously with the closing of a new investment round of approximately $6.0 million, led by Warburg Pincus, a leading global private equity fund, in which we also invested an additional $1.5 million. Following these investments, we hold 29% of NuLens.

	•	Investment of $16 million in Teledata Networks Ltd.

		On May 8, 2005, we completed an investment of $16 million in Teledata Networks Ltd., or Teledata. The investment was part of an aggregate round of financing of $19 million, in which FBR Infinity II Ventures, a related venture capital fund, or Infinity, invested $3 million, for approximately 4% of Teledata, and with whom we entered into a voting agreement. (See Item 7b-“Related Party Transactions”). Teledata provides innovative access products and solutions for both traditional and next generation networks to telecom operators and service providers. We hold approximately 21% of Teledata.

	•	Sale of Oren Semiconductor

		On June 10, 2005, Zoran Corporation, or Zoran (NASDAQ: ZRAN), acquired Oren Semiconductor, Inc., or Oren, in which we held a 41% interest. Elron received approximately $12.5 million in cash in the acquisition (of which approximately $2 million was escrowed under the terms of the agreement, of which we already received approximately $1 million) and approximately $7.7 million of Zoran shares (based on Zoran’s share price on the completion date of the acquisition). As a result of the transaction we


		recorded a gain in 2005, net of taxes, of approximately $17.2 million. In July 2005, we sold Zoran’s shares for $8.8 million, resulting in a gain net of tax, of $0.7 million.

	•	NetVision Initial Public Offering

		On May 19, 2005, NetVision completed its initial public offering on the Tel Aviv Stock Exchange, or TASE, in Israel for net proceeds of approximately NIS135 million (approximately $31 million). In addition, future proceeds from the exercise of options sold in the offering may amount to approximately NIS28.8 million (approximately $6.6 million). DIC is the other major shareholder of NetVision. We and DIC each converted approximately $3.1 million of loans into equity of NetVision immediately prior to the offering and $2.2 million in loans was repaid to each of us from the proceeds of the offering. As a result of the initial public offering our holding in NetVision decreased from 45.7% to approximately 39% (27.4% on a fully diluted basis taking into account the possible exercise of the convertible securities) resulting in a gain for Elron of approximately $3.0 million.

	•	Investment in BrainsGate Ltd.

		On August 8, 2005, we completed an investment of approximately $6.9 million in BrainsGate Ltd., or BrainsGate, for approximately 22% of the equity of BrainsGate, as part of an aggregate investment of approximately $17.0 million. Infinity, with whom we have a voting agreement, holds approximately 5% of the equity of BrainsGate. See Item 7b - “Related Party Transactions”. BrainsGate is an Israeli company that is developing innovative technologies for neuro–stimulation treatments of brain diseases.

	•	Dividend distribution.

		On September 5, 2005, we declared a cash dividend of $3.00 per share, totaling approximately $88.5 million. The dividend was paid on September 27, 2005, to shareholders of record on September 15, 2005.

	•	Investment in Enure Networks Ltd. (formerly known as Gaia Broadband Services Management Ltd.).

		On October 2, 2005, we completed an investment of approximately $4.0 million in Enure Networks Ltd., or Enure, for approximately 57% of the equity of Enure. Enure is an Israeli software company engaged in developing solutions in the field of broadband services management and home networks.

	•	Establishment of Medingo.

		In November 2005, RDC established Medingo Ltd., or Medingo. Medingo is developing a disposable insulin dispenser for diabetic patients. We beneficially own 100% of the outstanding shares of Medingo through our holding of RDC, which holds directly all the shares of Medingo.


	•	Sale of holdings in Elron Telesoft Ltd. and Elron Telesoft Export Ltd.

		On December 29, 2005, we completed the sale of all of our shares of Elron Telesoft Ltd. and Elron Telesoft Export Ltd. (together, the “ET Group”), to ECtel Ltd. (Nasdaq: ECTX) for $2.5 million, of which $0.4 million shall be paid if certain milestones will be achieved during 2006. The transaction did not materially affect our results of operations

	•	Investment in Safend Ltd.

		On January 2, 2006, we completed an investment of approximately $3.7 million in preferred shares of Safend Ltd., or Safend, for approximately 26% of the equity of Safend. Safend is an Israeli company which develops comprehensive desktop and laptop endpoint security solutions.

	•	$14 million Investment in AMT. On June 8, 2006, A.M.T. Advanced Metal Technologies, or AMT, completed a $14 million financing led by Shamrock Israel Growth Fund, an Israeli private equity fund. We committed to invest an aggregate of $5 million (of which we invested $2.5 million immediately) in the financing round in which other existing shareholders also participated. Following the transaction, we hold approximately 34% of AMT.

The following are the significant investments and divestitures which we and companies in our group completed in 2003 and 2004, in chronological order:

	•	Investment in Notal Vision, Inc.

		In January 2003, we completed an investment of $2.0 million in Notal Vision, Inc., or Notal, an Israeli related medical device company operating in the field of early detection of Age Related Macular Deterioration (AMD). Our investment formed part of an aggregate investment by other investors in Notal of approximately $4.5 million, including an investment by an existing shareholder, Innomed Ventures (Israel) L.P., or Innomed, in which we also hold an interest. We currently hold 23% of the equity of Notal.

	•	Galil Medical and Amersham Health Plc (now GE Healthcare) merge urology therapy units

		On July 1, 2003, the merger between the urology business of our subsidiary, Galil Medical, and the brachytherapy business of Amersham plc, now a subsidiary of GE Healthcare, was completed and a new company, Oncura, was incorporated. Oncura provides minimally invasive treatment options for prostate cancer using brachytherapy (radio-active seeds) and cryotherapy (hyper-cooling) technologies. Amersham Health Plc (now GE Healthcare) and Galil Medical each contributed the related operations


		and assets necessary for Oncura to conduct the brachytherapy business and the cryotherapy business, respectively, in the urology field. In exchange for such assets, GE Healthcare received 78% and Galil Medical received 22% of the outstanding shares of Oncura. In addition, at the closing, Galil Medical purchased 3% of Oncura from GE Healthcare for $4.5 million in cash, which was paid in full as of April 26, 2004, resulting in Galil Medical’s aggregate ownership interest of 25% of Oncura. Galil Medical has an option to purchase an additional 3% of Oncura from GE Healthcare for $5.4 million, exercisable until 45 days following the closing of an initial public offering of Oncura. As a result of the transaction, a gain in the amount of $21.2 million was recorded by Galil Medical in 2003. Our share in this gain (net of minority interest and income taxes) amounted to $4.4 million.

	•	Sale of Shares of Given Imaging by RDC

		In 2003, RDC sold, in a series of transactions, 753,600 shares of Given Imaging for approximately $7.8 million, resulting in a gain of approximately $4.4 million ($0.1 million net of tax and minority interest).

	•	Purchase of Shares of Given Imaging from RDC

		In May 2003, a Share Purchase Agreement was signed between RDC, Elron and Rafael, according to which RDC sold two million shares of Given Imaging, representing 7.9% of Given Imaging’s then outstanding shares, to Elron and Rafael (one million or 3.95% each) for total consideration of $12.2 million. RDC used $5.0 million of the proceeds to repay shareholders’ loans to Rafael and Elron. This transaction did not have any effect on our consolidated results of operations.

	•	Sale of approximately 6.3 million Shares of Partner

		In the second and third quarters of 2003, we sold, in a series of transactions, an aggregate of approximately 6.3 million shares of Partner, representing approximately 3% of Partner’s then outstanding shares, to Israeli institutional investors for approximately $29.3 million, as a result of which we recorded in 2003 an aggregate gain, net of tax, of approximately $7.1 million.

	•	Sale of Elron SW, Inc.

		On September 2, 2003, our subsidiary, Elron SW Inc., or ESW, sold substantially all of its assets and business to Zix Corporation, or Zix (Nasdaq: ZIXI), a global provider of e-messaging protection and transaction services, in consideration for 1,709,402 shares of Zix’s common stock, then with a market value of approximately $6.0 million and a 5.75% convertible note (“the Note”) of $1.0 million. ESW granted a beneficial interest in approximately 85,000 common shares it received to certain of its former employees in recognition of services rendered to ESW. In addition, Zix assumed certain liabilities of ESW in the net amount of approximately $1.0 million. The transaction resulted in a gain of approximately $4.1 million. Simultaneously with the closing of the sale, we purchased the 1,709,402 shares of Zix common stock and the Note from ESW for approximately $6.2 million, based on the principal amount of the Note and the closing sale price of Zix shares on the Nasdaq National Market on the day prior to the closing.


		As of December 31, 2004, we had sold all our shares of Zix (including 262,454 shares resulting from the conversion of the Note) for approximately $17 million, and recognized an aggregate gain of approximately $10.2 million ($6.8 million net of tax). In December 2004, ESW was voluntarily dissolved.

	•	Purchase of shares of 3DV Systems Ltd.

		On February 1, 2004, we and our subsidiary, RDC purchased approximately 47% of the outstanding share capital of 3DV Systems Ltd., or 3DV, in which we and RDC previously together held 48%, from the majority of the other shareholders of 3DV in consideration for an option, which has since expired, to receive up to 40% of the share capital of a new company to be established. We and RDC together currently hold 89% of 3DV.

	•	Sale of KIT eLearning Ltd.

		In March 2004, KIT eLearning Ltd., or KIT, a provider of online academic programs, in which we held a 45% ownership interest, was sold to Online Higher Education, a subsidiary of Laureate Education, Inc., or Laureate (Nasdaq: LAUR) (formerly known as Sylvan Learning Systems, Inc.), a global leader in higher education, for an immediate cash payment of $9.4 million and a future payment of up to an additional $10.0 million based on earnings of KIT in 2006 and 2007 (of which our share will be up to $5.7 million). The other selling shareholders of KIT were DIC, our largest shareholder, and Kidum IT Ltd., a privately held Israeli company. From the $9.4 million immediate proceeds of the sale, we received approximately $5.7 million and we recorded a gain of approximately $5.3 million.

	•	Given Imaging secondary offering

		On June 23, 2004, Given Imaging completed a secondary public offering of 2,880,750 ordinary shares at $32.00 per share, of which 1,500,000 shares were sold by Given Imaging and 1,380,750 shares were sold by selling shareholders, including 300,000 shares sold by our subsidiary, RDC. Given Imaging received net proceeds from the offering of approximately $44.3 million. We also hold a direct interest in Given Imaging, but did not participate in the offering.

		As a result of the sale of Given Imaging’s shares by RDC and the decrease in our direct and indirect interest (through our holdings in RDC) in Given Imaging to approximately 15%, we recorded a gain in 2004, net of tax and minority interest, of approximately $6.7 million.

	•	Sale of all of our holdings in Elbit Systems Ltd.

		On July 28, 2004, we sold all of our holdings in Elbit Systems Ltd., or Elbit Systems, (Nasdaq: ESLT), constituting approximately 19.6% of the then outstanding share capital of Elbit Systems, to the Federmann group, following the exercise of its right of


		first refusal, for approximately $196.6 million. As a result, we recorded in 2004 a gain, net of tax, of approximately $91.5 million.

	•	Purchase of additional shares of Given Imaging

		In August and November 2004, we purchased approximately 1.4 million additional shares of Given Imaging in various transactions for an aggregate amount of approximately $44 million. As a result of these purchases, our direct and indirect ownership interest in Given Imaging (through our holdings in RDC) increased from approximately 15% to approximately 20% and our beneficial ownership increased to approximately 25%.

	•	Tender offer by DIC to purchase 7.5% of our shares

		On August 22, 2004, DIC completed a tender offer to purchase 2,203,425 of our ordinary shares for $15 per share, net to the seller in cash, less any required withholding taxes and without interest. Following consummation of the tender offer, DIC owned approximately 46% of our outstanding shares. DIC has purchased additional shares from time to time and as of May 31, 2006, holds approximately 47.6% of our outstanding shares.

	•	Investment of $3 million in Starling Advanced Communications Ltd.

		On October 21, 2004, we completed an investment of $3 million in preferred shares of Starling Ltd., or Starling, of which $1.5 million was invested immediately and $1.5 million was invested in April 2005. Following the investments our direct interest in Starling is approximately 33% and our beneficial ownership (directly and through RDC) is approximately 66%.

	•	Investment of $6.7 million in Jordan Valley Semiconductor Ltd.

		On October 21, 2004, we invested approximately $6.7 million in Jordan Valley Semiconductor Ltd., or Jordan Valley, for preferred shares constituting 28% of the equity of Jordan Valley, as part of an aggregate amount of approximately $9 million raised by Jordan Valley. Our holding was subject to adjustment based upon Jordan Valley’s performance for the period July 1, 2004 until June 30, 2005 with an option to make an additional investment on the same terms as the original investment to enable us to hold 25% of Jordan Valley’s equity, on a fully diluted basis, after the adjustment. In October 2005, we exercised this option and invested an additional amount of approximately $1.4 million, following which we hold approximately 28% of the equity of Jordan Valley. The balance of the aggregate investment in Jordan Valley was invested indirectly by Clal Industries and Investments Ltd., or Clal. Jordan Valley is an Israeli private company engaged in developing solutions for advanced in-line thin film metrology for the semiconductor industry. Jordan Valley is 40% owned (indirectly) by Clal, a subsidiary of IDBD, which then owned approximately 67% of DIC. Clal, IDBD and DIC are publicly traded on the Tel Aviv Stock Exchange. Our investment in Jordan Valley was approved in accordance with Israeli law by the shareholders of Elron and Clal on October 21, 2004.


	•	Investment in Impliant

		On December 28, 2004, we invested approximately $7.3 million for preferred shares of Impliant constituting approximately 23% of the equity of Impliant, as part of a financing round of approximately $18 million from new and existing investors of Impliant. In October 2005, we invested an additional $1 million as part of an extension of the initial financing round. Following this additional investment, we hold 21.5% of the equity of Impliant. Impliant is a privately held medical device company engaged in the development of a novel posterior motion preservation system for spine surgery.

B. Business Overview

Our group companies are engaged in four main fields of advanced technology, namely: (i) medical devices; (ii) information and communications technology; (iii) semiconductors and (iv) advanced materials. The business overview is presented, for the purposes of convenience only, according to the four main fields listed above, none of which is considered a separate reportable segment.

1. Medical Devices

Our activities in the field of medical devices consist mainly of our holdings in the following companies:


	•	Given Imaging, in which we beneficially own approximately 36% of the outstanding shares representing all shares owned by us, RDC and DIC (which we may be deemed to beneficially own as a result of the voting agreement between DIC and us), or approximately 19% representing our direct holding and our share in the holding of RDC;

	•	Galil Medical, in which we beneficially own approximately 60% of the outstanding shares representing all shares owned by us and RDC, or approximately 40%, representing our direct holding and our share in the holding of RDC;

	•	Oncura, in which we beneficially own approximately 25% of the outstanding shares representing shares owned by Galil Medical, or approximately 10%, representing our share in the holding of Galil Medical;

	•	Notal, in which we hold approximately 23% of the outstanding shares;

	•	Impliant, in which we hold approximately 21.5% of the outstanding shares;

	•	NuLens, in which we hold approximately 29% of the outstanding shares;

	•	BrainsGate, in which we hold approximately 22% of the outstanding shares; and

	•	Medingo, in which we beneficially own 100% of the outstanding shares representing all shares held by RDC which holds directly all the shares of Medingo.

Given Imaging

Given Imaging is an Israeli company that develops, manufactures and markets innovative diagnostic products for disorders of the gastrointestinal tract. It pioneered capsule endoscopy, a proprietary approach to visual examination of the gastrointestinal tract through the use of a miniaturized video camera contained in a disposable capsule.

Given Imaging was incorporated in Israel by our subsidiary, RDC, in January 1998. Its initial public offering and listing on the Nasdaq National Market occurred in October 2001. In March 2004, Given Imaging also listed its shares on the TASE. In June 2004, Given Imaging completed its secondary public offering raising $44.3 million.

Given Imaging’s principal product, which incorporates its core technology, is the Given System, a proprietary wireless imaging system which uses disposable video capsules, referred to as the PillCam capsules. The PillCam video capsules are easily ingested by the patient and move naturally through the gastrointestinal tract without discomfort while wirelessly transmitting high quality color images and data to a portable recorder, enabling gastroenterologists to view high quality video, images and data on their workstations. Given Imaging believes that capsule endoscopy provides a patient-friendly solution that addresses a significant market opportunity and overcomes many of the shortcomings of traditional diagnostic tools for gastrointestinal disorders.

As of December 31, 2005, Given Imaging had an installed base of approximately 2,860 Given Systems and had sold approximately 307,000 PillCam SB capsules in over 50 countries worldwide.

In November 2004, Given Imaging received FDA marketing clearance for its second PillCam capsule, the PillCam ESO capsule, for visualizing the esophagus. Given Imaging markets the PillCam ESO video capsule through a strategic marketing and sales alliance formed in May 2004 with InScope, a division of Ethicon Endo-Surgery, a Johnson & Johnson company. Under the terms of the agreement, InScope committed to pay Given Imaging $50 million subject to achievement of certain milestones. Out of this amount, to date, Given Imaging has received $25 million.

Given Imaging has also developed the AGILE Patency Capsule and system, which is a dissolvable capsule that enables physicians to determine whether there are obstructions or strictures in the gastrointestinal tract. Given Imaging launched the AGILE Patency Capsule and system in Europe in November 2003 and in May 2006 received FDA clearance to market this system in the United States.

Given Imaging’s research and development efforts are focused primarily on developing improvements to its existing products and developing new capsules to be used in the detection of abnormalities in other areas of the gastrointestinal tract. For example, in the second half of 2005, Given Imaging began performing initial clinical trials with the PillCam Colon capsule, which is still under development. If initial results are favorable, Given Imaging intends to commence broader studies during 2006 which will then be used to support a submission of the PillCam Colon capsule for FDA clearance.

In April 2006, Given Imaging appointed Nachum (Homi) Shamir as its new President and Chief Executive Officer, to replace Mr. Gavriel Meron, co-founder of Given Imaging. At the same time Mr. Meron was appointed Executive Vice Chairman of Given Imaging’s Board of Directors. Mr. Meron subsequently resigned in June 2006 following a transition period to pursue other interests.

Given Imaging recorded revenues of $86.7 million in 2005, $65.0 million in 2004 and $40.5 million in 2003.

Third-party payors in the United States began issuing coverage policies for capsule endoscopy in early 2002. Initially, all reimbursement policies issued coverage for capsule endoscopy of the small bowel only for the diagnosis of obscure gastrointestinal bleeding. Subsequently, reimbursement coverage has been expanded to include other indications and as of December 31, 2005, most Medicare carriers and private payors, with a total insured population in the United States of approximately 209 million individuals, also cover capsule endoscopy of the small bowel for suspected Crohn’s disease, suspected small bowel tumors and other small bowel pathologies. Almost all of the reimbursement policies currently in effect require that a previous procedure, such as endoscopy or radiology, be performed prior to using the Given System and some may require prior authorization. In 2005, several third-party payors have issued new or updated policies that do not require endoscopy or other procedure prior to performing small bowel capsule endoscopy. As of December 31, 2005, approximately 11.5 million individuals in the United States had coverage under these new or updated policies.

As of December 31, 2005, no third party payor had established published coverage policy for capsule endoscopy of the esophagus using the PillCam ESO capsule. Meanwhile, numerous payers are reimbursing this procedure on a case by case basis. Given Imaging does not expect broad coverage for this procedure prior to assignment of a CPT code, which Given Imaging does not expect to occur until late 2006, effective January 2007.

Given Imaging currently markets and sells the Given System through a combination of direct sales through its subsidiaries, and through independent distributors in over 50 jurisdictions. Currently, Given Imaging markets the Given System directly in Australia, France, Germany, the United States and Israel through approximately 80 sales and marketing personnel employed by Given Imaging and its subsidiaries in those jurisdictions. In the United States, which accounted for 72% of Given Imaging’s revenues in 2004, and 74% of its revenues in 2005, Given Imaging markets its products through its wholly-owned subsidiary, Given Imaging, Inc. As of December 31, 2005, Given Imaging had a direct sales force in the United States of approximately 45 personnel. In the first quarter of 2006, Given Imaging substantially increased its direct sales force in the United States.

Sales to Given Imaging’s local distributors worldwide accounted for approximately 15% of its revenues in 2005. Under the terms of Given Imaging’s distribution agreements, Given Imaging generally grants to one distributor in each particular country or region the right to market the Given System for an initial period of approximately three years. During this period, the distributor is required to meet minimum sales targets set out in each distribution agreement.

Given Imaging may, in its sole discretion, upon prior written notice, terminate a distribution agreement with a distributor in the event that a distributor fails to meet its minimum sales targets.

The Given System consists of Pillcam capsules, a portable data recorder and sensor array, and a dedicated computer workstation. Given Imaging manufactures the PillCam capsules at its facilities in Yoqneam, Israel using three semi-automated production lines. Two of these production lines are used to manufacture the PillCam SB capsule and one to manufacture the PillCam ESO capsule. Given Imaging has constructed a fourth semi-automated production line, which it plans to use for manufacturing the PillCam ESO capsule.Each semi-automatic production line in Yoqneam, Israel facility has a capacity to manufacture approximately 270,000 PillCam capsules per year. Given Imaging has also installed at Pemstar’s facilities in Ireland, a semi-automated production line of the PillCam SB capsule for backup purposes, which has a capacity to manufacture an additional 270,000 PillCam capsules per year. Current production capacity is sufficient to support sales in the foreseeable future.

The portable data recorders are manufactured externally and assembled and tested at Given Imaging’s facilities. The sensor arrays are manufactured and assembled externally and are tested at Given Imaging’s facilities. The computer workstation is an off-the-shelf computer workstation pre-loaded with Given Imaging’s RAPID software. Given Imaging’s research and development activities are conducted internally by its research and development staff, primarily at its facilities in Yoqneam, Israel.

Given Imaging’s first issued patents in the United States and Israel are on an in vivo video camera system. Given Imaging acquired the rights to these issued U.S. and Israeli patents in January 1998 under a technology purchase and license agreement with Rafael. These issued patents in the United States and Israel expire in January 2014 and January 2015, respectively. As of December 31, 2005, Given Imaging held 36 additional issued patents in Australia, France, South Korea, Israel and the United States covering different elements of its technology and expiring between July 2014 and August 2022. As of December 31, 2005, Given Imaging had 421 patent applications worldwide based on 120 priority applications relating to various elements and functions of its product and enhancements.In April 2006, in response to a request made by Olympus in December 2003 to re-examine Given Imaging’s first U.S. Patent #5,604,531, the USPTO issued an office action confirming the validity of 13 of the original 17 claims of this patent. Given Imaging has the right to appeal the rejection of the four other claims. On May 19, 2006, Olympus and its subsidiaries filed a complaint in the U.S. District Court for the Eastern District of Pennsylvania against Given Imaging for alleged infringement of U.S. Patent 5,010,412, entitled “High Frequency, Low Power Light Source for Video Camera.” In response to this law suit, Given Imaging announced that it believes the complaint filed by Olympus has no merit and that it intends to take all necessary steps to protect its interests.

For additional information on Given Imaging’s business, including additional products, manufacturing and suppliers and regulatory approvals, see Given Imaging’s filings with the SEC.

Galil Medical

Galil Medical, an Israeli company established by RDC in 1997, is a provider of minimally invasive temperature based therapies for the treatment of benign and malignant diseases. Since 1999, Galil was focused on developing products to address specific urologic diseases including prostate and kidney cancer. In July 2003, Galil Medical completed the merger of its urology related cryotherapy business with Amersham Health’s brachytherapy business, which created Oncura. Galil Medical holds 25% of Oncura. Galil Medical has entered into supply and R&D services agreements with Oncura, pursuant to which Galil Medical provides Oncura with certain exclusive supply, manufacturing and R&D services in the urology field, upon a cost plus basis.

In addition to its urology activities for Oncura, Galil Medical is now focusing on developing minimally invasive cryotherapy solutions for woman’s health conditions such as uterine fibroids and breast fibroadenoma. In 2005, Galil Medical received FDA approval for breast fibroadenoma and the CE Mark for uterine fibroids.

Galil Medical’s intellectual property consists of intellectual property, which was received from Rafael, and intellectual property developed by Galil Medical’s research and development team. Galil Medical has 15 patents and 23 pending applications.

As of December 31, 2005, Galil Medical had 320 SeedNet™ machines installed worldwide. Galil Medical recorded revenues of $8.3 million in 2005, $7.6 million in 2004 and $7.6 million in 2003. Revenues for the first half 2003 represented sales to the end user customer, while the majority of the revenues for the second half of 2003 and for the years 2004 and 2005 represented sales and services to Oncura.

Galil Medical’s research and development and manufacturing facilities are based in Yoqneam, Israel.

As of May 31, 2006, Galil Medical had approximately 52 employees.

Oncura

Oncura, a Delaware corporation, markets and sells therapeutic device systems and related consumables used primarily in the performance of minimally-invasive, urologic cancer treatment. Oncura’s products include implantable radioactive seeds and cryotherapy devices and related disposable kits used in the treatment of prostate and other urologic cancers.

Oncura’s formation was the result of a merger, completed July 1, 2003, between the urology business of Galil Medical, and the brachytherapy business of Amersham plc, now a subsidiary of General Electric Company (“GE Healthcare”), as a result of which Galil Medical and GE Healthcare acquired 78% and 22% of the issued and outstanding shares of Oncura, respectively. Galil Medical purchased an additional 3% of Oncura from GE Healthcare for $4.5 million, resulting in Galil Medical owning an aggregate interest of 25% in Oncura. In addition, Galil Medical has an option to purchase an additional 3% of Oncura from GE Healthcare for $5.4 million, exercisable until 45 days following the closing of an initial public offering of Oncura.

Oncura is headquartered in Plymouth Meeting, Pennsylvania. In addition, Oncura has an international management office located in Amersham, United Kingdom.

Oncura does not manufacture any of the products it sells. A majority of Oncura’s products are manufactured by its two shareholders, GE Healthcare and Galil Medical, and sold to Oncura under long-term supply agreements. Oncura also purchases certain products, principally a type of radioactive seed not manufactured by GE Healthcare, from a third-party supplier.

Oncura markets and distributes its products directly and indirectly to numerous international markets, including, the United States, Canada, Europe, Russia, Israel, Greece, Korea, Philippines, Hong Kong, Australia, New Zealand, and portions of South America. In the United States, Oncura sells principally through its direct sales force. Outside of the United States, Oncura sells through its direct sales force along with a network of affiliated and independent distributors and agents. In certain markets outside the United States Oncura’s products are distributed under long-term distribution agreements with affiliates of GE Healthcare.

Oncura has also entered into services and research and development agreements with its shareholders and affiliates for the provision of certain administrative and research and development services.

Oncura terminated most of its existing service and distributor arrangements with its shareholders in 2004 and 2005. Oncura expects to terminate two additional distributor arrangements with GE Healthcare in 2006. Subsequent to 2006 and for the foreseeable future Oncura expects to continue its remaining distribution agreements with GE Healthcare in Scandinavia, Austria, Portugal and New Zealand.

Oncura’s intellectual property consists primarily of product brand names and product patented technology that it either owns or is licensed to Oncura by GE Healthcare and Galil Medical under exclusive licensing agreements.

As of May 31, 2006, Oncura had approximately 99 employees.

Oncura’s activities in the marketing and distribution of cancer therapy products are subject to extensive laws, regulations, regulatory approvals and guidelines. Within the United States, the Company’s products must comply with the U.S. Federal Food Drug and Cosmetic Act, which is enforced by the FDA. Oncura must also comply with the regulations of the Competent Authorities of the European Union for any products sold in the member nations of the European Union. Oncura is also subject to various other regulations, regulatory approvals and guidelines in other markets in which it distributes its products. Oncura’s radioactive seeds are manufactured by GE Healthcare and third-party vendors and physical handling and delivery of all radioactive seeds to customers, including those manufactured by third parties, is the exclusive responsibility of these affiliated and other non-affiliated vendors.

Oncura’s revenues were approximately $72.1 million in 2005 and $68.8 million in 2004, and approximately $31.4 million for the period from commencement of operations in July 1, 2003 through December 31, 2003.

Notal

Notal is a medical device company founded in 2000, operating mainly in the field of early detection of Age Related Macular Degeneration (AMD). AMD is a common eye disease that gradually destroys central visual function, manifested in two forms: dry AMD, a mild form of the disease, and wet AMD, a progression of dry AMD, which often leads to rapid, severe visual deterioration and blindness. To address the growing need for early detection of wet AMD and for the continuous monitoring of patients with dry AMD, Notal Vision has developed the patented Preferential Hyperacuity Perimetry (PHP), designed to detect and monitor the progression of the disease in a non-invasive manner. Notal launched, together with Carl Zeiss Meditec, or Zeiss, the Preview PHP device, intended for professional use by ophthalmologists and optometrists in their clinics. The current diagnostic device enables early detection of wet AMD among the at-risk population, those already diagnosed with the dry form of the disease. Future versions may also target for screening purposes the full population at risk (e.g., anyone over the age of 55) who may be unaware that they may have dry AMD, as well as patients already treated for wet AMD for post-treatment follow-up. Post treatment follow-up is intended to identify the recurrence of the disease and confirm the stage of the disease. Sales of the Preview PHP device to end-users started in the third quarter of 2004.

Based on the PHP technology, Notal is also developing the “Home Device,” a monitoring device intended for home use. The monitoring device will enable patients with dry AMD to monitor themselves at home on a more frequent basis, ensuring timely intervention by a physician should the disease progress to the wet form. In May 2005, Notal appointed TLC Vision Corporation, or TLC, as it exclusive distributor for the sale and distribution of the “Home Device” in North America. TLC also signed an investment agreement with Notal, pursuant to which TLC committed to invest $4.25 million in Notal (of which $2.8 million has already been invested) subject to achievement of milestones, primarily for the purpose of funding the development of the Home Device.

Notal commenced sales in 2003 and recorded revenues of $0.1 million in 2005, $1.0 million in 2004 and $0.9 million in 2003.

The decrease in Notal’s revenues in 2005 resulted primarily from Zeiss’ non-compliance with Notal’s exclusive distribution agreement with Zeiss. Notal and Zeiss are in the process of negotiating their disputes through arbitration or mediation.

Notal’s headquarters are located in Tel Aviv, Israel and as of May 31, 2006, had 25 employees. Notal has one patent and three pending patent applications.

Innomed, 14% held by us, is also a 29% shareholder of Notal (see below, “Other Holdings in Medical Devices”).

Impliant

Impliant is a developer of posterior motion preservation spine implants. The company’s TOPS™ System—Total Posterior Spine™ System, is a mobile spine implant that addresses the major degenerative spine diseases of the posterior spinal column. The TOPS™ System

reestablishes a full range of motion, including axial rotation, lateral bending, flexion and extension. Impliant began clinical trials on the device in January 2005.

In March 2006, Impliant received a CE Mark to sell its products in Europe.

Impliant’s headquarters are located in Milford, Connecticut, with research and development activities taking place in Ramat Poleg, Israel. As of May 31, 2006, Impliant had 26 employees.

Impliant has 10 pending patent applications.

Innomed, 14% held by us, is also a 11% shareholder of Impliant (see below, “Other Holdings in Medical Devices”).

Impliant is currently in the development stage and has not commenced sales.

NuLens

NuLens, established in September 2002, operates in the field of intra-ocular lenses or IOLs mainly for treatment of cataracts and presbyopia. NuLens is focused on exploiting the novel technologies in its patents and developing a real accommodative IOL (“RA-IOL”) with the capacity of providing over 10 Diopters in real accommodative power to the cataract and presbyopia markets. NuLens is currently in the process of pre-clinical trials. In May 2006, NuLens received approval from the Ministry of Health in Spain to commence clinical trials and is expected to commence a clinical pilot study in the second half of 2006.

NuLens has two patents and nine pending patent applications.

NuLens’ offices are located in Herzliya, Israel and Alicante, Spain. As of May 31, 2006, NuLens had 10 employees.

NuLens is currently in the development stage and accordingly has not commenced sales.

BrainsGate

Established in 2000, BrainsGate is a medical device company developing innovative therapies for patients suffering from Central Nervous System (CNS) diseases. BrainsGate’s platform technology involves electrical stimulation of the spheno-palatine ganglion (SPG) to increase cerebral blood flow and to increase the permeability of the blood-brain barrier (BBB).

BrainsGate is exploring several applications for its technology, and is currently focusing on two directions, drug delivery into the CNS, and treatment of acute ischemic stroke.

BrainsGate has developed the NeuroPath™ System, based on a miniature electrode implanted at the roof of the mouth using a minimally invasive surgery.

BrainsGate has eight pending patent applications and 24 patents.

BrainsGate initiated clinical feasibility trials in Europe, treating patients with Grade-IV Astrocytoma (GBM). Clinical trials for the ischemic stroke application are planned to commence in the second half of 2006.

BrainsGate is headquartered in Ra’anana, Israel. As of May 31, 2006, BrainsGate had 21 employees.

BrainsGate is currently in the development stage and accordingly has not commenced sales.

Medingo

Medingo, wholly-owned by RDC, was established in November 2005. Medingo develops solutions specifically to the needs of insulin-dependent diabetic patients. Medingo’s device is a miniature dispensing patch, which is convenient, easy to use, discreet and more cost-effective than standard insulin pumps.

Medingo has five pending patent applications.

Medingo’s offices are located in Yokneam, Israel. As of May 31, 2006, Medingo had 15 employees.

Medingo is currently in the development stage and accordingly has not commenced sales.

Other Holdings in Medical Devices

Our other holding in the medical devices field is in Innomed, which is a seed stage fund that initiates and invests in Israeli and Israeli related companies in the field of medical devices and life sciences. We hold, through our subsidiary DEP, approximately 14% of the partnership interest in Innomed. Innomed is a member of the Jerusalem Global Ventures Group of venture capital funds.


2.	Information, Communications & Technology, or ICT.

	Our activities in the field of ICT consist of our holdings in the following main companies:

	•	Partner, in which we hold approximately 2.6% of the outstanding shares;

	•	NetVision, in which we hold approximately 39% of the outstanding shares;

	•	Teledata, in which we hold approximately 21% of the outstanding shares and Infinity, a related venture capital fund, holds approximately 4% of the outstanding shares;

	•	Wavion, in which we hold approximately 38% of the outstanding shares;

	•	Starling, in which we beneficially own approximately 72% of the outstanding shares representing all shares owned by us and RDC, or approximately 50%, representing our direct holding and our share in the holding of RDC;

	•	Enure, in which we hold approximately 57% of the outstanding shares;


	•	Safend, in which we hold approximately 26% of the outstanding shares;

	•	Pulsicom Israel Technologies Ltd., or Pulsicom, in which we hold approximately 18% of the outstanding shares; and

	•	CellAct Ltd., or CellAct, in which we hold approximately 45% of the outstanding shares.

Partner

Partner is a publicly traded, Israel-based company. Its shares are traded on the Tel Aviv Stock Exchange under the symbol “PTNR”. American Depositary Shares, or ADSs, each representing one of the Company’s ordinary shares, are quoted on the Nasdaq National Market under the symbol “PTNR” and are traded on the London Stock Exchange under the symbol “PCCD”. Partner was the first Global System for Mobile Communications, or GSM, mobile telephone network operator in Israel and is one of four cellular service providers in Israel.

On April 20, 2005, we completed the sale to Partner of most of our Partner shares for approximately $94 million, as part of the sale together with the other Israeli founding shareholders of Partner of an aggregate of approximately 33.3 million Partner shares to Partner for an aggregate consideration of approximately $245 million, following which we held approximately 2% of Partner’s outstanding shares. On March 21, 2006, we purchased an additional 0.6% of Partner’s outstanding shares from one of the other Israeli founding shareholders of Partner for approximately $5.3 million.

Our remaining shares, constituting approximately 2.6% of Partner’s outstanding shares, are no longer pledged to the banks providing financing to Partner. However, almost all Partner shares held by us are subject to certain transfer restrictions under Partner’s Israeli communications license. Under Partner’s Israeli communications license, the Israeli founding shareholders are required to maintain such amount of shares to ensure that at least 5% of Partner’s shares are held by Israeli citizens and residents. In addition, the Israeli founding shareholders are required to appoint, generally, 10% of Partner’s board of directors. On April 20, 2005, the Israeli founding shareholders, including us, entered into a Restated Relationship Agreement among themselves and Partner’s controlling shareholders, Hutchison BV and Advent Investments Pte Ltd., and a shareholders agreement among themselves to regulate the above issues as between them. For a description of the material terms of these agreements, See Item 10C - “Material Contracts”.

Partner’s principal business is the provision of mobile telephone services in Israel. Partner currently operates in the 900 MHz and 1800 MHz bands. Its GSM network covers approximately 97% of the Israeli population. Its services include standard and enhanced GSM services, as well as value added services and products such as voice mail, voice messaging, color picture messaging, icon, ringtone and game downloads, information services, High Speed Circuit Switched Data or HSCSD, General Packet Radio Services, or GPRS, which enables the packet transfer of data in an “always on” mode at a speed of up to 20-30 Kbps, personal numbering and data and fax transmission services. Partner also offers its subscribers the ability to roam using their mobile phones outside Israel.

Partner’s 3G network, which as of the end of 2005 covered approximately 92%, of the Israeli population, offers a wide range of new services, such as video calls, a new portal of

content services including a broad selection of video-based services under the “obox live” brand, and the transmission of data at speeds of up to 384 Kbps.

Partner distributes its services primarily through direct sales through Partner-owned sales centers and business sales representatives and indirect sales through traditional networks of specialist dealers and non-traditional networks of retail chains and stores, which account for a majority of Partner’s sales. Partner also offers 24-hour, seven days a week customer service, as well as handset repair and replacement services, to subscribers who acquire these services.

Partner is subject to extensive regulation related to the spectrum and its ability to operate mobile telephone service in Israel. The Israeli Ministry of Communications controls the granting of licenses to operate mobile telephone service in Israel. It has granted licenses to several companies to operate such mobile networks, and may grant additional licenses in the future. Additionally, Partner must erect antennae that carry its network transmissions in order to maintain the coverage of the Israeli population required in its license. The erection and operation of these antennae must comply with local, regional and national regulations.

Partner is also dependent on a number of licenses and agreements to operate its mobile telephone network, and Partner maintains contracts with a number of dealers through which its products are sold and has contracts with Nortel, Nokia and Ericsson to provide it with equipment to run its network. Such equipment is available only through a limited number of suppliers. Partner also leases most of its transmission capacity from Bezeq. Partner maintains agreements with mobile telephone network operators in foreign countries through which it provides its customers with international service.

As of December 31, 2005, Partner had approximately 2.529 million subscribers, representing approximately 32% of the total Israeli cellular market. Partner’s revenues were approximately NIS5.12 billion ($1.11 billion) in 2005, NIS 5.14 billion ($1.12 billion) in 2004 and NIS 4.47 billion ($0.97 billion in 2003) The dollar amounts are based on the shekel-dollar representative rate of exchange on December 31, 2005 of NIS4.603 equal to $1.00.

In the third quarter of 2005, Partner’s Board of Directors and shareholders approved the distribution of its first cash dividend, in the amount of NIS 0.57 per share, totaling approximately NIS 86.4 million to its shareholders of record as of September 26, 2005. In the first quarter of 2006, Partner’s Board of Directors and shareholders approved the distribution of an additional cash dividend in the amount of NIS 0.65 per share (totaling approximately NIS 100 million) to its shareholders of record as of April 10, 2006. In the second quarter of 2006, Partner’s Board of Directors approved the distribution of an additional cash dividend in the amount of NIS 0.45 per share (totaling approximately NIS70 million) to its shareholders of record as of June 6, 2006.

NetVision

NetVision provides Internet services and solutions in Israel and international telephony services through Voice over IP technology (VoIP). On May 19, 2005, NetVision completed its initial public offering on the TASE of shares and convertible securities in consideration for aggregate immediate net proceeds of approximately NIS135 million (approximately $31 million). In addition, future proceeds from the exercise of options sold in the offering may amount up to approximately NIS28.8 million (approximately $6.6 million). NetVision’s total revenues were $74.3 million in 2005, $66 million in 2004 and $61.3 million in 2003 based on the

shekel-dollar representative rate of exchange as of December 31, 2005 of NIS 4.603 equal to $1.00.

NetVision’s activities in the Internet area focus on providing Internet connectivity and related services and products, content and electronic commerce services and the establishment and supply of Internet-based applications. NetVision provides international telephone services through 017 prefix, which are provided using Voice Over Internet Protocol (“VOIP”) technology, a technology that enables voice transmission over the Internet infrastructure.

NetVision estimates that as of December 31, 2005, its share of the Internet connectivity market in Israel was approximately 25%, with 425,000 customers receiving Internet connectivity services from NetVision (of which approximately 272,000 were broadband).

NetVision also provides various content and electronic commerce services. NetVision maintains “Nana”, a portal which provides a variety of content and e-commerce services, such as search engines and mail boxes, chat rooms, forums and blogs, Web site indexing for both local and international sites, shopping and advertising.

NetVision is involved in e-commerce activity and currently operates through “Nanashops” website (previously called “Netaction”), which enable e-commerce through various sale methods - auction, public sale and group purchases.

NetVision is dependent on the communication services provided by Bezeq which has a monopoly for domestic telecommunications in Israel. NetVision is also dependent on maintaining its operating license granted by the Israeli Ministry of Communications

On May 1, 2006, NetVision announced that it will be entering into merger discussions with Barak, a subsidiary of Clal Industries and Investments Ltd., or Clal. Elron, Clal and DIC, the other major shareholder of NetVision, are all part of the IDB group of companies. Barak engages mainly in the provision of international telecommunication services. The transaction, if it takes place, will be subject to the signing of a definitive agreement as well as corporate and regulatory approvals. There is no assurance that the transaction will take place.

NetVision’s headquarters are located in Haifa, Israel. As of May 31, 2006, NetVision had 1,195 employees.

Teledata

Teledata provides innovative access products and solutions for both traditional and Next Generation Networks, or NGN, to telecom operators and service providers which allow operators to provide a large variety of wireline services, including Voice, Data and Video (Triple Play) for business and residential customers. Teledata’s solutions provide a smooth migration path from existing legacy networks into NGN based on IP and soft switches. Teledata has two families of products: BroadAccess™ which is a carrier-class Integrated Multiservice Access Platform (IMAP) providing integration into both ATM and IP networks and HighPGate™, an access gateway for voice, data and protocol conversion into NGN.

Teledata sells its products directly and through distributors in Europe, Asia, Africa and South America. Teledata’s revenues were $55.9 million in 2005, $38.9 million in 2004, and $20.8 million in 2003. Teledata’s revenues depend to a large extent on being awarded large projects with new customers mainly in third world countries. There is no assurance that Teledata will be able to maintain its revenues at the same level as in the past.

Teledata was established in 1981 and maintains its headquarters in Herzliya, Israel. Teledata also operates through subsidiaries in the Netherlands, Australia and Brazil. As of May 31, 2006, Teledata had 161 employees worldwide.

Teledata has 14 patents and 26 pending patent applications, primarily in the United States.

Wavion

Wavion develops and delivers access points for outdoor metro applications. Wavion commenced development of its products in the second quarter of 2000. Wavion’s proprietary signal processing algorithms for digital beam forming utilize multipath to provide significant performance gains in system capacity, operating range, data rate and interference mitigation. The modular technology can be customized to meet the requirements of most equipment vendors and integrates easily into any wireless communication system.

In May 2006, Wavion launched its product and expects to commence product sales in the second half of 2006.

Wavion is a Delaware corporation with research and development facilities in Yoqneam, Israel.

Wavion has two pending patent applications and as of May 31, 2006, Wavion had 64 employees.

Starling

Founded at the end of 2003, Starling is a provider of innovative connectivity solutions for the broadband access market for mobile platforms, currently focusing on aircraft. Its antenna and SATCOM (satellite communications) systems are based on proven technology developed at Rafael and Elbit Systems Ltd. Starling provides a unique connectivity solution that makes possible the delivery of advanced Internet services and applications for VOIP, security, entertainment and operations on all three major categories of aircraft, namely, business jets, narrow-body and wide-body. The Starling MIJET product line incorporates a two-way Ku-band low profile antenna with a proprietary SATCOM resource allocation system that effectively utilizes satellite transponder capacity. The solution enables the delivery of high-speed Internet services on a broadband connection.

Starling does not expect to receive purchase orders prior to the end of 2006.

Starling has its headquarters in Yoqneam, Israel.

Starling has two pending patent applications. As of May 31, 2006, Starling had 26 employees.

Enure

Enure, established in 2003, develops software that automates the operation of broadband services in the home. Enure’s software is intended to ensure that the home network and applications work reliably, problems are automatically fixed and installations, upgrades, and policies management by service providers, are all executed automatically.

Enure’s main target market is broadband service providers, a rapidly growing arena with major technology investments. For service providers, such as telecommunication companies and Multi Service Organizations, or MSO’s, typically cable companies, Enure’s software drives operating expense reduction and establishes the solid basis for future advanced services, such as VoIP, IPTV and Triple and Quadruple Play.

Enure’s software uses patent-pending core technology. Enure’s home-residing software is sold under the brand ServiceShield™, and its optional service-provider-residing server under the brands ServiceShield Concentrator™ and TIC™.

As of December 31, 2005, Enure had not yet generated revenues.

Enure operates from Herzelia, Israel and as of May 31, 2006, Enure had 25 employees. Enure has two pending patent applications.

Safend

Safend, established in 2003, develops comprehensive endpoint security solutions that enable organizations to adopt new communication technologies without sacrificing security. Safend products focus on securing enterprise desktops and laptops by providing visibility and control over wired and wireless commuinication ports.

Safend’s end-point security solutions provide the enterprise with granular visibility and control over the myriad of devices users connect to their desktops and laptops.

In 2005 Safend recorded revenues in the amount of $0.4 million.

Safend is headquartered in Tel Aviv, Israel with a subsidiary in Philadelphia, Pennsylvania. As of May 31, 2006, Safend had 44 employees worldwide.

Safend has filed two Patent Cooperation Treaty or PCT applications and three additional provisional patent applications.

Pulsicom

Pulsicom Israel Technologies Ltd. develops high accuracy, real time locating and tracking systems for confined spaces. Pulsicom’s technology employs short-pulse technologies, including very-and ultra-wideband and sophisticated position-determination algorithms.

Pulsicom is an early stage development company, which has not yet completed its commercial product development. In order to generate revenues, Pulsicom provides development services to different customers. Pulsicom has limited resources and its continued operations depend on its ability to raise additional capital. There is no assurance that Pulsicom will be successful in its efforts to raise additional capital. As of May 31, 2006, Pulsicom had 6 employees.

Cellact

Cellact Ltd. is a developer of cellular messaging platforms and applications, based on proprietary technology. Cellact’s main product, Large Account gateway, was first commercially released in July 2001. The Large Account gateway is a product aimed at mobile operator, virtual mobile operators and mobile service providers. The Large Account gateway provides the operator with the ability to easily connect and manage content providers and enterprises to its SMS and MMS systems. Cellact’s customers come from a variety of industries, including telecom, finance and call centers


3.	Semiconductors

Our activities in the field of semiconductors consist of our holdings in the following companies:


	•	ChipX, in which we hold approximately 29% of the outstanding shares.

	•	Jordan Valley, in which we hold approximately 28% of the outstanding shares;

	•	Sela – Semiconductor Engineering Laboratories Ltd., or SELA, in which we beneficially own approximately 66% of the outstanding shares representing all the shares owned by us and RDC, or approximately 39%, representing our direct holding and our share in the holding of RDC; and

	•	3DV, in which we beneficially own approximately 89% of the outstanding shares representing all shares owned by us and RDC, or approximately 62%, representing our direct holding and our share in the holding of RDC.

ChipX

ChipX is a manufacturer of late stage programmable structured ASICs (Application Specific Integrated Circuits). ChipX’s innovative, patented technology consolidates wafer manufacture tooling, reduces time-to-market and minimizes the cost of initial production. In 2004, ChipX discontinued the low volume OneMask business to focus on specific higher volume vertical markets with its future products, which were introduced during the second half of 2005. Initial customer purchases of these products are expected to commence in late 2006. ChipX also discontinued the back end production processes relating to low volume production, in effect becoming a totally fabless operation.

ChipX’s Structured ASIC solution specifically addresses applications with medium to high production volumes. Along with standard cell ASIC vendors, ChipX primarily addresses the hard-wired ASIC market serving a wide variety of end markets, including automotive, computer, consumer, industrial and communications markets.

ChipX depends upon third-party manufacturers to manufacture its products. ChipX uses a wide range of parts and raw materials in the production of its semi-conductors, including silicon wafers, and electronic and mechanical components.

ChipX generally does not have guaranteed supply arrangements with its suppliers and does not maintain an extensive inventory of parts and materials for manufacturing.

ChipX’s patented structured ASIC technology is protected by several core patents on its basic architecture, special logic cell and metal configurable memory. In addition, ChipX has internally developed routing software and metal programmable input/output cells to take advantage of its proprietary technology. ChipX has 19 U.S. patents and 2 pending applications.

ChipX’s total revenues were $14.7 million in 2005, $16.2 million in 2004 and $13.7 million in 2003.

ChipX’s headquarters are located in Santa Clara, California with research and development operations taking place in Haifa, Israel. As of May 31, 2006, ChipX had 73 employees.

Jordan Valley

Jordan Valley offers inline metrology solutions with ultra thin film measurement capability and wide range of application coverage based on X-ray technology. The company’s JVX® platform exploits various X-ray-based schemes to provide a broad range of measurement capabilities including thickness, density, roughness, and composition of metals and dielectric films. The platform features small spot size, non-destructive, enabling product wafer metrologies.

Jordan Valley operates two business divisions: analytic division and semiconductor division. Jordan Valley focuses in the semiconductor industry, selling, directly in the United States and via distributors in Japan, Europe, Taiwan, Korea and China.

Jordan Valley’s revenues were $10.4 million in 2005, $8.2 million in 2004 and $3.2 million in 2003.

Jordan Valley’s headquarters, manufacturing, and R&D facilities are located in Migdal Haemek, Israel. Marketing offices are located in the United States. As of May 31, 2006, Jordan Valley had 90 employees.

In the field of X-Ray metrology, Jordan Valley holds 19 U.S. patents with 15 applications pending, as well as five patents with 24 applications pending in foreign jurisdictions.

SELA

SELA develops and manufactures yield enhancing and automation equipment for the semiconductor and optical component industries. SELA is dedicated to the development and marketing of solutions for failure analysis and process monitoring in the semiconductor industry. SELA’s automated sample preparation systems are used primarily by semiconductor manufacturers to prepare samples for scanning electron microscopy and transmission electron microscopy. SELA has six patents and two pending patent applications. SELA’s revenues were $4.2 million in 2005, $5.1 million in 2004 and $4.3 million in 2003. SELA’s headquarters are located in Yoqneam, Israel and it maintains a marketing office in Sunnyvale, California. As of May 31, 2006, SELA had 36 employees.

3DV

3DV designs and develops three dimensional image sensors chip sets that generate both color and depth information, for each object captured by a camera, in real time. 3DV’s business is currently focused on applications in the video gaming field and ceased engaging in applications in the medical field.

3DV has not yet generated significant revenues and its ability to continue to operate is dependent upon financial support from its shareholders and its ability to raise financing from external investors. 3DV is headquartered in Yoqneam, Israel and as of May 31, 2006, 3DV had 19 employees.


4.	Advanced Materials

Our activities in the field of amorphous metals consist of our holding in AMT, in which we hold approximately 34% of the outstanding shares on an as converted basis as of June 8, 2006.

AMT operates through its group companies in developing, marketing and licensing technologies for amorphous and nano-crystalline advance materials, as a solution for a wide range of commercial applications. AMT’s thin ribbons, microwires and nano powder amorphous materials exhibit magnetic, electrical, mechanical and chemical properties that enable the enhancement of existing products and applications, as well as the introduction of new products and solutions for various industrial and high-tech applications and markets. AMT operates in four fields: heating, sensoring (authentication and anti-shop lifting), micro wires and electronic elements. AMT’s current main focus is in the field of heating through A.H.T. Advanced Heating Technology Ltd., or AHT, and in the sensoring field (authentication and anti-shop lifting) through A.C.S. Advanced Coding Systems Ltd, or ACS. The continued operations of AMT’s group companies are largely dependent upon their ability to generate sufficient revenues. There is no assurance that AMT’s group companies will be able to successfully market their respective products in the worldwide market.

AHT, in which AMT holds approximately 93% of the outstanding shares, is engaged in the development and production of heating applications based on thin ribbon, amorphous materials. AHT holds a global patent on using amorphous ribbons for heating products. AHT has developed a variety of heating products for domestic, outdoor, agricultural and pipe heating markets. AHT’s electrical heating element enables the heating of very large surface areas at lower temperatures and higher efficiency and therefore at a lower cost and presents competitive advantages over other electrical and non-electrical heating alternatives. AHT currently focuses on two principal markets: under floor indoor heating and outdoor heating.

AHT has agreements with distributors in various countries, including most recently, a distribution agreement with Mohawk Carpet Distribution, L.P signed in 2005 for distribution of its products in the United States.

AHT’s revenues were $2.6 million in 2005, $1.2 million in 2004, and $0.8 million in 2003.

AHT has five patents.

AHT is headquatered in Netanya, Israel and as of May 31, 2006, AHT had 21 employees.

ACS

ACS, in which AMT holds directly and indirectly approximately 89% of the outstanding shares, develops, markets and sells products using microwires amorphous material for brand protection against counterfeiting and theft and electronic article surveillance tags for anti-shoplifting. ACS competes in the electronic article surveillance tags, data and authentication tags markets. ACS’s revenues were $1.0 million in 2005, $0.8 million in 2004 and $0.6 million in 2003.

ACS has 3 patents and 5 patents pending.

ACS is headquatered in Even Yehuda, Israel and as of May 31, 2006, ACS had 12 employees.

Other Holdings

Elbit Vision Systems Ltd., or EVS, [OTCBB: EVSNF.OB], in which we beneficially hold approximately 9.3% of the outstanding shares (not including 1,512,939 warrants to purchase ordinary shares of EVS), designs, develops, manufactures, markets and supports automatic visual inspection and quality monitoring systems for a broad range of industries. EVS’ automatic in-line inspection and quality monitoring systems are designed to increase the accuracy, consistency and speed of detection of defects in the manufacturing process in order to reduce labor costs, improve product quality and increase manufacturing efficiency. EVS’ Microelectronic Division primarily provides optical inspection and correction systems for the manufacture of liquid crystal displays, flat panel displays. EVS’s, Industrial Division provides automatic optical inspection (AOI) and non-destructive ultrasound inspection systems for “heavy” manufacturing industries (automotive, aeronautics, steel and others) and industrial materials (textiles, non-wovens, plastic, paper and others).

EVS maintains a global sales force and service coverage with over 850 inspection systems installed in 25 countries and has more than 100 customers.

EVS’s revenues were $20.8 million in 2005, $11.0 million in 2004 and $6.3 million in 2003.

EVS is headquartered in Yoqneam, Israel, with offices in the United States and Korea, and as of May 31, 2006, had 118 employees.


C.	Organizational Structure

As of May 31, 2006, DIC, an Israeli company, holds approximately 47.6% of our total outstanding shares. For additional information about DIC, see “Major Shareholders” in Item 7 below. For our holdings in our group companies, see above.


D.	Property, plants and equipment

Our corporate headquarters and executive offices are located in Tel-Aviv, Israel. These offices, which measure approximately 980 square meters, are leased at an annual rent of approximately $0.3 million.

We believe that the above facilities are adequate for our operations as currently conducted. In the event that additional facilities are required, we believe that we could obtain such additional facilities at commercially reasonable prices.

In addition, we have contractual rights to long-term leases in property located in Karmiel, in northern Israel, totaling approximately 15,760 square meters, consisting of building facilities. These premises are currently leased to Elbit Systems Ltd., or Elbit Systems.

Item 4A. Unresolved Staff Comments

Not applicable.

Item 5. Operating and Financial Review and Prospects

OVERVIEW

We are a high technology operational holding company that operates through subsidiaries and affiliated companies, referred to as our group companies. Founded in 1962, we have been a major force in the development of the Israeli high technology industry by building Israeli and Israel-related companies with technologies in the fields of medical devices, advanced defense electronics, communications, semiconductors, software products and services and advanced materials. Some of our group companies grew out of our subsidiary, RDC. Our group companies include both publicly traded and privately held companies.

Our primary activity is our involvement in the management of our group companies in which we maintain controlling or significant holdings, and, in a limited number of cases, non-significant holdings. We participate in the management of most of our group companies by means of active membership on their boards of directors and board committees. As a result, we are involved in matters of policy, strategic planning, marketing, selecting and manning senior management positions, approving investments and budgets, financing and the overall ongoing monitoring of our group companies’ performance. In addition to our representation on the boards of directors of our group companies, we provide hands-on assistance to the group companies’ management in support of their growth. We view our hands-on involvement in the operations of our group companies as a key element of our business. Our group companies therefore benefit from the experience of our management team in various areas in which they need support and leadership, including, but not limited to, strategic planning, research and development guidance, identifying joint venture opportunities, introductions to potential customers and investors, risk management, market analysis, business plan preparation, budgetary control, and legal support.

Technology industries are characterized by the high degree of risk inherent in their products, their continuous technological innovation and their penetration into world markets, which requires investment of considerable resources and continuous development efforts. The future success of our group companies is dependent upon their technological quality, the prices and nature of their products in comparison to their competitors and their ability to introduce new products to the markets at the right time, while offering cost effective solutions suitable to their customers’ needs as well as their ability to raise financing and the condition of the capital markets.

We expect to continue to build and realize value for our shareholders through the sale to third parties of a portion or all of our holdings in, or the issuance of shares by, our group companies, while simultaneously pursuing the acquisition of, or investment in, new and existing companies at different stages of development including early stage and more mature companies. We believe that this strategy provides the ability to increase shareholder value as well as to create capital to support the growth of our group companies and to invest in new opportunities.

The nature of our business, therefore, will result in some volatility in our results of operations, depending on the transactions that occur within a particular period.

Our net income (or loss) in any given period is due, for the most part, to the results of operations of those of our group companies which are accounted by us under the consolidation or equity method of accounting and dispositions and changes in our holdings of group companies. As most of our group companies are technology companies which have not yet generated significant revenues and which invest considerable resources in research and development and in marketing activities, we have experienced, and expect to continue to experience, losses in respect of these companies. However, as a result of recent accounting pronouncements described below under “CRITICAL ACCOUNTING POLICIES”, some of our group companies and new companies in which we may invest may be accounted for at cost, thereby not affecting our results of operation.

Our capital resources in any given period are primarily affected by the extent of our investment in existing and new companies and the realization of certain holdings as well as the impact of any dividends or distributions to our shareholders. The results of operations of our group companies, and consequently, our results of operations and capital resources, are affected by general economic conditions as well as by factors specifically related to the technology markets, which also affect the ability of our group companies to raise financing and our ability to dispose of holdings and realize gains from our holdings.

TREND INFORMATION

Technology industries are affected by economic trends and the condition of the capital markets. Since the second half of 2003, there has been a recovery in the technology sectors and capital markets from the downturn which commenced in 2001. This trend was reflected in the improvement in the results of operations of most of our group companies as well as the raising of funds from new strategic and other investors in private placements completed by some of our group companies. In addition, we recorded significant gains from realizing certain of our holdings, mainly in 2004 as a result of the sale of our holdings in Elbit Systems Ltd. and in the second quarter of 2005 from the sale of most of our shares in Partner and the sale of all of our shares in Oren (see ITEM 4 “Information on the Company”). Should the improvement in the technology sectors and capital markets continue, we anticipate that it will have a positive effect on our group companies and their ability to raise additional capital. In addition, during 2004 and 2005 we invested approximately $48.3 million in new companies (see Item 4 “Information on the Company” for more information regarding new investments in 2005) and an additional $64.8 million in existing group companies (mainly in Given Imaging) including an amount of $12.4 million in consolidated subsidiaries.

CRITICAL ACCOUNTING POLICIES

We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States (“US GAAP”). Our significant accounting policies are more fully described in Note 2 to our Consolidated Financial Statements included elsewhere in this report. Certain accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are

reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenues and expenses during the periods presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. The significant accounting policies that we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:


	•	Principles of accounting for holdings in group companies;

	•	Business combinations and purchase price allocation;

	•	Impairment of goodwill and other intangible assets;

	•	Other-than-temporary decline in value of investments in group companies; and

	•	Accounting for income taxes.

Principles of Accounting for Holdings in Group Companies

The various holdings that we have in our group companies are accounted for under several methods, based among others, on our level of ownership and the type and form of our holdings in our group companies, as described below.

Consolidation. Companies over which we have control are accounted for under the consolidation method of accounting. Control is usually assumed when we own directly or through our subsidiaries, more than 50% of the outstanding voting securities of a company. However, whether or not we control a group company also depends on an evaluation of several factors, including, among others, our representation on the board of directors and any minority participating rights and other factors which require management to make judgment and involve the use of significant estimates and assumptions.

Under the consolidation method, a controlled company’s assets and liabilities are included within our consolidated balance sheet and its income and expense items are included within our consolidated statements of operations. The share of other shareholders in the net assets and in the net income or losses of a consolidated company is reflected in minority interest in our consolidated balance sheet and in our consolidated statements of operations, respectively. The minority interest amount adjusts our consolidated net income (loss) to reflect only our share in the earnings or losses of any consolidated company.

Notwithstanding the above, in January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, “Consolidation of Variable Interest Entities – An Interpretation of Accounting Research Bulletin No. 51” (“FIN 46”), relating to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. In December 2003, the FASB issued FASB Interpretation No. 46 (revised December 2003) (FIN 46R), which replaced FIN 46. FIN 46R defines the provisions under which a Variable Interest Entity (“VIE”) should be consolidated. In general, a VIE is a corporation, partnership, limited-liability corporation, trust, or any other legal structure used to conduct activities or hold assets that either (1) has an insufficient amount of equity to carry out

its principal activities without additional subordinated financial support, (2) has a group of equity owners that is unable to make significant decisions about its activities, or (3) has a group of equity owners that does not have the obligation to absorb losses or the right to receive returns generated by its operations. FIN 46R provides several exceptions to its scope, such as that an entity that is deemed to be a business need not be evaluated to determine if it is a VIE unless one of the conditions specified in FIN 46R exists. FIN 46R requires a VIE to be consolidated by the party with an ownership, contractual or other pecuniary interest in the VIE (a variable interest holder) that will absorb a majority of the risk of loss from the VIE’s activities, is entitled to receive a majority of the VIE’s residual returns (if no other variable interests absorb a majority of the VIE’s losses), or both. A variable interest holder that consolidates the VIE is called the primary beneficiary.

As an operational holding company, we have made investments in and granted loans to companies that are engaged in various fields of high technology. Some of these companies are in their early stages of development and will require substantial external investments until they can finance their activities, they are currently engaged in, without additional support from other parties and may be considered VIEs. These companies are currently primarily funded with financing from venture capital funds, other holding companies and private investors.

Our assessment of whether a group company is within the scope of FIN 46R, whether a group company is a VIE and the determination of the primary beneficiary is judgmental in nature and involves the use of significant estimates and assumptions regarding the fair value of certain entities and their variable interests. The estimates and assumptions include, among others, forecasted cash flows, their respective probabilities and the economic value of certain preference rights.

As of December 31, 2005, Wavion, in which we hold approximately 37.8% is considered to be a VIE, but Elron is not its primary beneficiary. As of December 31, 2005, our maximum exposure to loss as a result of our involvement in Wavion does not exceed the carrying value of our investment in Wavion in the amount of approximately $0.8 million.

Equity Method. Group companies which we do not control, but over whom we exercise significant influence over the operating and financial policies and in which we hold common stock or in-substance common stock as defined in EITF 02-14 “Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than Common Stock” (“EITF 02-14”) (which is further described below), are accounted for under the equity method of accounting. Significant influence is usually assumed when we hold 20% or more of a group company’s voting securities, however, whether or not we exercise significant influence with respect to a group company also depends on an evaluation of several additional factors, including, among others, our representation on the board of directors, agreements with other shareholders, our participation in policy making processes, the existence of material intercompany transactions and technological dependency, the extent of ownership by an investor in relation to the concentration of other shareholdings, and other factors which may require management to make certain judgmental decisions regarding significant influence.

EITF 02-14, which became effective at the beginning of the fourth quarter of 2004, defines in-substance common stock as an investment with similar risk and reward characteristics to common stock. In certain holdings we invested, among others, in preferred shares which include rights, among others, such as cumulative and participating dividends, dividend preferences and

liquidation preferences. Based on EITF 02-14, new companies in which we invested in the fourth quarter of 2004 and in 2005, namely Jordan Valley, Impliant, Teledata, NuLens and BrainsGate, are being accounted for at cost notwithstanding our significant influence in such companies, as the investment in these companies is not considered to be in-substance-common stock. Any assessment of whether we hold in substance common stock in a group company is judgmental in nature and involves the use of significant estimates and assumptions such as assessing the fair value of the subordinated equity of the group company.

We also account for our interests in private equity funds under the equity method of accounting, based on our holding percentage.

Under the equity method of accounting, a group company’s assets and liabilities are not included within our consolidated balance sheet and their results of operations are not reflected within our consolidated statements of operations. However, our share in the net income or losses of the group company is reflected as an equity income (loss) in our consolidated statements of operations. The share of income or losses is generally based upon our ownership level of the outstanding share capital of the group company. In circumstances where the equity method is being applied, our ownership in an investee is in the form of a preferred security or other senior security which is considered to be in-substance common stock and the investment in common stock is zero, we recognize equity method losses based on our ownership level in the particular investee security or loan held by us to which the equity method losses are being applied.

Other Methods. Our holdings in companies that we do not account for under either the consolidation or the equity method of accounting are accounted for under three different methods:


	•	Non-marketable securities are presented at cost. Under this method, our share in the income or losses of these entities is not included in our consolidated statements of operations.

	•	Marketable securities which are classified as available-for-sale are presented at fair market value and the effect of any unrealized change in market value is reflected in other comprehensive income (loss). When realized, gain or loss is included in our results of operations.

See below for a discussion of “Other-Than-Temporary Decline in Value of Investments in Group Companies”.

Business Combinations and Purchase Price Allocation

Business combinations are accounted for using the purchase method of accounting, under which the total purchase price is allocated to proportional interest in the acquired company’s assets and liabilities based on their estimated fair values, and the remainder, if any, is attributed to goodwill.

The aggregate purchase price of any investment accounted for under either the consolidation or the equity method of accounting is being allocated to identifiable net assets, intangible assets other than goodwill, in-process research and development (“IPR&D”) activities, and to goodwill. The amount allocated to IPR&D is being charged immediately to our results of operations in accordance with FASB Interpretation No. 4, “Applicability of FASB Statement No.

2 to Business Combinations Accounted for by the Purchase Method” (“FIN 4”). The amounts allocated to finite-lived intangible assets other than goodwill are amortized on a straight-line basis over their weighted average expected useful life. In 2005 and 2004, IPR&D charges amounted to $1.1 million and $2.3 million (which are part of our share in the net income or loss of affiliated companies). IPR&D in 2004 resulted mainly from the purchase of Given Imaging shares for approximately $43.9 million.

Estimating the fair value of certain assets acquired and liabilities assumed is judgmental in nature and often involves the use of significant estimates and assumptions, mainly with respect to intangible assets. While there are a number of different methods for estimating the value of intangibles acquired, the primary method we use is the discounted cash flow approach. Some of the more significant estimates and assumptions inherent in the discounted cash flow approach include projected future cash flows, including their timing, a discount rate reflecting the risk inherent in the future cash flows and a terminal growth rate. Another area which requires judgment which can impact our results of operations is estimating the expected useful lives of the intangible assets. To the extent intangible assets are ascribed with longer useful lives, there may be less amortization expenses recorded in any given period. As we and our group companies operate in industries which are rapidly evolving and extremely competitive, the value of the intangible assets, including goodwill, their respective useful lives and the investments in companies is exposed to future adverse changes which can result in a charge to our results of operations (See also “Other-Than-Temporary Decline in Investments in Group Companies” under this section).

Impairment of Goodwill and Other Intangible Assets

We conduct a goodwill impairment review at least annually and on an interim basis whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that we consider important which could trigger an impairment review include significant underperformance relative to historical or expected future operating results and significant negative industry or economic trends. We test for impairment at a level referred to as a reporting unit. Determining fair value involves the use of significant estimates and assumptions. These estimates and assumptions could have an impact on whether or not an impairment charge is recognized. To determine fair value, we may use a number of valuation methods including quoted market prices, discounted cash flows and revenue multipliers. As mentioned above, these approaches use estimates and assumptions including projected future cash flows, discount rate and terminal growth rate. Using different assumptions could result in different results. In 2005 and 2004, a goodwill impairment charge in the amount of $1.3 million and $2.0 million, respectively, was recorded with respect to the operation of the ET group in light of its results of operation (following the sale of this business, these charges are presented as part of the loss from discontinued operations in the statements of operations). At December 31, 2005, consolidated goodwill amounted to approximately $2.7 million.

Other intangible assets with definite useful lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted cash flows expected to be generated by the asset. If an asset is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. In the evaluation

of fair value, we use significant estimates and assumptions such as projected future cash flows which are subject to high degree of judgment. In 2004 we recorded impairment charges of other intangible assets of $2.9 million with respect to the ET group in light of its results of operation (following the sale of this business, this charge is presented as part of the loss from discontinued operations in the statements of operations). In addition in 2004 we recorded impairment charges of other intangible assets of $4.2 million with respect to MediaGate due to our revised estimate about future proceeds from the sale of its technology. Intangible assets with an indefinite useful life are tested for impairment at least annually by comparing the fair value of the intangible asset to its carrying value. If the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. In the valuation of fair value we use judgment as to which is the most appropriate method to use for measuring fair value and as to what assumptions to use in implementing the methodology chosen. As we operate in industries which are rapidly evolving and extremely competitive, changes in the assumptions and estimates may affect the carrying value of the intangible assets, and could result in an additional impairment charge to our results of operations. At December 31, 2005, consolidated intangible assets, other than goodwill, amounted to approximately $2.8 million.

Other-Than-Temporary Decline in Value of Investments in Group Companies

At the end of each reported period we evaluate whether an other-than-temporary decline in the value of an investment in a group company has been sustained. This evaluation is judgmental in nature. If it has been determined that an investment has sustained an other-than-temporary decline in its fair value relative to its carrying value, the investment is written down to its fair value by a charge to our results of operations.

An evaluation of fair value is dependent upon specific facts and circumstances. Factors that are considered by us in this determination include financial information (including, among others, budgets, business plans and financial statements) and the value at which independent third parties have invested or have committed to invest and independent appraisals, if available. Factors indicative of an other-than-temporary decline include recurring operating losses, credit defaults, specific conditions affecting the investment, such as in the industry or in geographic area, and subsequent rounds of financing at an amount below the cost basis of the investment. This list is not all inclusive and we weigh all quantitative and qualitative factors in determining if an other-than-temporary decline in value of an investment has occurred. As we operate in industries which are rapidly evolving and extremely competitive, it is possible that our estimates could change in the near term and there can be no assurance that an additional write-down or write-off of the carrying value will not be required in the future. In 2005 and 2004 we recorded write-downs in the amounts of $6.0 million and $1.5 million, respectively, with respect to certain group companies (in 2005 mainly with respect to Oncura and Avantry Ltd., and in 2004 mainly with respect to Textology Inc., 3DV and Ingeneo Ltd.).

Accounting for Income Taxes

At the end of each reported period, we are required to estimate our income taxes. This process requires us to estimate our actual current tax liabilities and make an assessment of temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our net deferred tax

assets will be realized through future taxable income and, to the extent we believe that realization is not likely, we must establish a valuation allowance. Management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. Our judgment as to the likelihood to realize our net deferred tax assets is largely based upon interpretations of certain tax laws and estimates and assumptions mainly with respect to our ability to realize investments in our group companies. Our ability to realize investments is mainly dependent upon factors such as the condition of the securities markets and other general economic conditions. As the securities markets for our group companies are highly volatile, changes in our assumptions and estimates may require us to increase the valuation allowance and therefore we may be required to include an expense within the tax provision in our statement of operations.

As of December 31, 2005, deferred tax assets with respect to the corporate carryforward losses that are more likely than not to be realized in future years amounted to approximately $6.5 million ($10.6 million as of December 31, 2004). In 2005, we reduced our previous valuation allowance by $19.6 million, which included $13.3 million as a result of Elbit’s receipt of final tax assessment (of which $3.9 million was recorded as a reduction of goodwill since the deferred tax assets related to carryforward losses of Elbit incurred in periods prior to our acquisition of Elbit) and $5.0 million as a result of the sale of the ET group. In 2004, we reduced our previous valuation allowance by $28.7 million in respect of losses incurred in prior periods mainly due to the sale of our shares in Elbit Systems and due to final tax assessments for previous years.

Deferred tax liabilities as of December 31, 2005 amounted to $9.5 million, mainly with respect to our investment in Partner which is accounted for as available-for-sale securities and with respect to our investment in Given Imaging which is accounted under the equity method.

As of December 31, 2005 Elron had carryforward losses of approximately $69.0 million.


A.	Operating Results

Basis of Presentation

Consolidation. Our consolidated financial statements include the accounts of Elron and all of our direct or indirect (through Elbit, DEP and RDC) controlled subsidiaries. The following are our main subsidiaries:


2005	2004	2003

Elron TeleSoft¹	Elron TeleSoft	Elron Telesoft
RDC	RDC	RDC
Galil Medical	Galil Medical	Galil Medical
SELA	SELA⁶	MediaGate
MediaGate	MediaGate	ESW
3DV	3DV⁴
Starling	Starling
Medingo²	ESW⁵
Enure³


	¹ Sold on December 29, 2005.
	² Established by RDC in the fourth quarter of 2005.
	³ Consolidated since the beginning of the fourth quarter of 2005.
	⁴ Consolidated following the purchase of a controlling interest during the first quarter of 2004
	⁵ Liquidated as of December 31, 2004 following the sale of all of its assets and business in 2003.
	⁶ Consolidated since the end of the second quarter of 2004.

Equity Method. Our main group companies held by us or through Elbit, DEP, Galil Medical and/or RDC accounted for under the equity method of accounting include:


2005	2004	2003

Given Imaging	Elbit Systems²	Elbit Systems
Oren Semiconductor¹	Given Imaging	Given Imaging
NetVision	Oren Semiconductor	Oren Semiconductor
ChipX	NetVision	NetVision
Wavion	ChipX	ChipX
Notal Vision	Wavion	Wavion
AMT	Notal Vision	Notal Vision
Oncura	AMT	AMT
Pulsicom	Oncura	Oncura³
CellAct	Pulsicom	Pulsicom
	CellAct	CellAct
	SELA³	KIT⁴
		3DV
		Avantry (formerly: Witcom)⁵

¹ Sold on June 10, 2005.

² Sold on July 28, 2004.

³ Through the end of the second quarter of 2004.

⁴ Sold on March 31, 2004

⁵ Through December 31, 2003, following a merger with another Israeli company.

Cost. Our main group companies held by us accounted for under the cost method of accounting include:


2005	2004	2003

Jordan Valley	Jordan Valley	-
Impliant	Impliant
Teledata	Avantry
BrainsGate
NuLens

Available for Sale. Investments in Partner and EVS were accounted for by us as “securities available for sale” as of December 31, 2005, 2004 and 2003. Our investment in Zix was accounted for by us as “securities available for sale” as of December 31, 2004 and 2003.

Results of Operations

The following tables set forth our results of operations in the reported periods:


	Year ended December 31,

	2005		2004		2003

	(millions of $, except per share data)
Net income (loss)		47.3		84.1		(7.2	)
Net income (loss) per share		1.61		2.87		(0.25	)

The net income we reported in 2005 was mainly due to the following gains from changes in holding and dispositions of affiliated and other group companies:


(i)	a gain, net of tax, of approximately $45.4 million resulting from the sale of Partner’s shares. The tax expense relating to the aforementioned gain was decreased by approximately $9.4 million resulting from a decrease in our previous valuation allowance in respect of losses incurred in prior periods, following our receipt of a final tax assessment;

(ii)	a gain, net of tax, of approximately $17.2 million resulting from the sale of Oren shares;

(iii)	a gain of approximately $3.0 million from the decrease in our interest in NetVision following its initial public offering; and

(iv)	a tax benefit of $5 million, resulting from a decrease in our previous valuation allowance in respect of losses incurred on our investment in the ET group.

The above gains were offset by losses, net, which we recorded with respect to our group companies in the amount of $23.0 million in 2005.

The net income we reported in 2004 included the following gains from changes in holding and dispositions of group companies:


(i)	a gain, net of tax, of approximately $91.5 million resulting from the sale of our holdings in Elbit Systems. The tax expense relating to the aforementioned gain was decreased by approximately $21.6 million resulting from a decrease in our previous valuation allowance in respect of losses incurred in prior periods following our receipt of a final tax assessment;

(ii)	a gain, net of tax and minority interest, of approximately $6.7 million resulting from the sale of Given Imaging shares by RDC and the decrease in our direct and indirect interest in Given Imaging following the completion of Given Imaging’s secondary public offering;

(iii)	a gain of approximately $5.3 million resulting from the sale of our shares in KIT eLearning; and

(iv)	a gain, net after tax, of approximately $3.6 million resulting from the sale of Zix shares (which were received as consideration for the sale of the ESW business in 2003) for aggregate consideration of $8.1 million.

The above gains were offset by losses, net, which we recorded with respect to our group companies in the amount of $23.3 million in 2004.

The net loss we reported in 2003 included the following gains from changes in holding and dispositions of group companies:


(i)	a gain, net after tax, of approximately $7.1 million, resulting from the sale of Partner shares in 2003;


(ii)	our share in the gain resulting from the merger in 2003 of the urology therapy units of Galil Medical and Amersham (later acquired by GE Healthcare) in the amount of approximately $4.4 million; and

(iii)	a gain of approximately $4.1 million resulting from the sale of substantially all of ESW assets and business to Zix and a gain, net of tax, of approximately $3.2 million resulting from the subsequent sale of Zix shares.

The above gains were offset by losses, net, which we recorded with respect to our group companies in the amount of $24.2 million in 2003.

Subsequent to the sale of the ET group in 2005 and ESW in 2003 we operate in one segment. The following table summarizes our operating results in the reported periods:


	Year ended December 31,

	2005			2004			2003

	(millions of $)
Net revenues		12.6			11.3			9.1
Net loss from equity investments		(17.5	)		(10.5	)		(8.7	)
Gains from disposal of business and affiliated companies and changes in holdings in affiliated companies		23.3			132.4			25.8
Other income, net		58.6			4.7			14.6
Finance income, net		5.5			1.4			0.8

Total income		82.5			139.3			41.6


Cost of revenues		7.9			6.8			5.9
Operating expenses*		17.8			16.5			22.6
Amortization of intangible assets		0.4			0.1			0.3
Impairment of long-lived assets		—			4.2			—

Total costs and expenses		26.1			27.6			28.8

Gain from continuing operations before income taxes		56.5			111.7			12.8
Taxes on income		(10.5	)		(15.1	)		(6.8	)
Minority interest		5.2			(4.1	)		(10.9	)

Net income (loss) from continuing operations		51.2			92.5			(4.9	)
Discontinued operations of the ET group (**)		(3.9	)		(7.9	)		(2.1	)
Discontinued operations of ESW and others		—			(0.5	)		(0.2	)

Net income (loss)		47.3			84.1			(7.2	)

* Excluding amortization of intangible assets and impairment of long lived assets which are presented as a separate line item.

** As described under ITEM 4, “Information on the Company”, in December 2005, we sold all our holdings in the ET group and accordingly the current period results of operations and the gain on the sale have been classified as discontinued operations, and prior periods results have been reclassified accordingly. The following table sets forth the composition of the discontinued operating results of the ET group for the reported periods:


	Year ended December 31,

	2005			2004			2003

	(millions of $)
Loss from operations		(4.1	)		(7.9	)		(2.1	)
Gain on disposal		0.2			—			—

Loss from discontinued operations		(3.9	)		(7.9	)		(2.1	)

The loss from operations in 2004 was primarily due to an impairment charge of long lived assets and goodwill in the aggregate amount of $4.9 million. In 2005, a goodwill impairment in the amount of $1.3 million was recorded.

Year Ended December 31, 2005 compared to Year Ended December 31, 2004.

Income

Net revenues. Net revenues consisted of sales of products and services by our subsidiaries, mainly Galil Medical and SELA. The following table sets forth these revenues:


	Year ended December 31,

	2005		2004

	(millions of $)
Galil Medical		8.3		7.6
SELA¹		4.2		3.3
Other		0.1		0.4

		12.6		11.3

¹ SELA’s results have been consolidated since July 1, 2004

In 2005, Galil Medical recorded revenues of $8.3 million, compared to $7.6 million in 2004. Galil Medical’s revenues derived mainly from the supply of cryo products and R&D services to Oncura, in which it has a 25% ownership interest.

SELA recorded revenues of $4.2 million in 2005, compared to $5.1 million in 2004 (of which $3.3 million were in the second half of 2004 and was consolidated in our financial statements of 2004).

Share in net losses of affiliated companies. Our share in net losses of affiliated companies resulted from our holdings in certain investments that are accounted for under the equity method (see above under “Basis of Presentation”). Our share in net losses of affiliated companies amounted to $17.5 million in 2005, compared to $10.5 million in 2004. The increase in our share in net losses of our affiliated companies is primarily due to the sale of our holding in Elbit Systems in the third quarter of 2004, which positively contributed $4.7 million in the first half of 2004, and due to impairment charges of $5.1 million, with respect to our investment in Oncura (through Galil Medical) in 2005.

Highlights of the Results of Operations of Our Major Affiliates:


	*Given Imaging (Nasdaq: GIVN) (a 19.4% holding directly and indirectly through RDC as of December 31, 2005).* Given Imaging, a medical device company that develops, manufactures and markets innovative diagnostic systems for visualizing the gastrointestinal tract, using a disposable miniature swallowable video capsules, recorded revenues of $86.8 million in 2005, an increase of approximately 35% over the revenues recorded in 2004 of $65.0 million. The increase in revenues resulted primarily from the increase in sales of Given PillCam video capsule for the small bowel. Given Imaging’s net income in 2005 was $6.3 million, compared to $2.9 million in 2004. Given Imaging’s net income in 2005 included a special provision recorded in the second quarterof $1.8 million, before tax effect, for uncollectable sales tax related to its U.S. subsidiary.

	*Oncura (a 25% holding by Galil Medical as of December 31, 2005).* Oncura, which markets and sells therapeutic device systems and related consumables used primarily in the performance of minimally-invasive, urologic cancer treatment, recorded revenues in 2005 of approximately $72.1 million compared to $68.8 million in 2004 and its net loss amounted to $6.2 million compared to $2.2 million in 2004. The increase in the net loss resulted primarily due to the increase in operating expenses, mainly selling and marketing expenses. In light of Oncura’s results of operations, we recorded an impairment charge of $5.1 million in 2005 ($2.1 million after minority interest). Each of Galil Medical and GE Healthcare have confirmed their intention to continue providing financial support to Oncura through May 31, 2007 or such later date as may be agreed by them.

	*NetVision (a 39% holding as of December 31, 2005) (TASE: NTSN).* NetVision provides internet services and solutions in Israel and commencing in the fourth quarter of 2004, international telephone services through voice over IP (VOIP). NetVision’s revenues increased in 2005 by 12.6% to $74.3 million (of which $3.3 million were derived from international telephony services) from $66.0 million in 2004 and its customer base at December 31, 2005 reached approximately 425,000 (of which approximately 272,000 were broadband) compared to 390,000 at the end of 2004 (of which approximately 225,000 were broadband). NetVision’s operating income in 2005 increased by 43.3% to $9.5 million, compared to $6.6 million in 2004 and its net income amounted to $5.4 million compared to $3.9 million in 2004. NetVision’s operating currency is the New Israeli Shekel (NIS) and accordingly, all figures above are translations for convenience purposes of NetVision’s NIS figures into US dollars at the representative rate of exchange prevailing at December 31, 2005 according to which $1.00 equaled NIS 4.603.

	*Wavion (a 38% holding as of December 31, 2005).* Wavion is a developer of broadband wireless access systems for Wi-Fi networks. Wavion’s net loss amounted to $6.3 million in 2005, approximately the same as in 2004, which consists primarily of expenses relating to the development of its product.

	*ChipX (a 27% holding as of December 31, 2005).* ChipX is a manufacturer of late stage programmable application-specific integrated circuits, or structured ASICs. ChipX’s revenues in 2005 amounted to $14.7 million, compared to $16.2 million in 2004, and its net loss amounted to $6.3 million, compared to $5.6 million in 2004. Revenues decreased as ChipX shifted from its previous product to the new structured ASIC products.

AMT (a 42% holding as of December 31, 2005). The AMT group develops technologies and products based on amorphous metals. AMT’s consolidated revenues in 2005 amounted to $3.6 million, compared to $2.6 million in 2004, and its consolidated net loss amounted to $3.9 million, compared to $3.0 million in 2004. AMT’s main subsidiary, AHT, which uses amorphous metals for heating products, recorded revenues of $2.6 million in 2005, compared to $1.2 million in 2004, and recorded a net loss of $1.9 million in 2005, the same as in 2004.

We expect that most of our group companies as well as new companies in which we will invest will continue to recognize losses in future periods, as they invest significant resources in research and development and sales and marketing activities and have not yet generated significant revenues. Our results of operations will therefore be affected by the extent of our share in their net losses (to the extent they are reported under the equity or consolidation method of accounting).

Results of operations of significant group companies which are accounted for other than under the equity method of accounting and whose results do not affect our results of operations.


	*Partner (Nasdaq: PTNR) (a 2% holding as of December 31, 2005).* Partner is a Global System for Mobile Communications, or GSM, mobile telephone network operator in Israel. Our investment in Partner is accounted for as available-for-sale securities. The market value of our investment in Partner as of December 31, 2005 amounted to $26.0 million. Almost all of the remaining Partner shares held by us as of December 31, 2005, amounting to approximately 3.1 million shares, are subject to certain transfer restrictions under Partner’s Israeli communications license but are no longer pledged to Partner’s lending banks.

	In 2005, Partner recorded revenues of $1,113 million compared to $1,117 million in 2004 and its net income amounted to $77 million, compared to $102.4 million in 2004. Partner’s subscriber base as of December 31, 2005 was 2,529,000 compared to 2,340,000 at the end of 2004. Partner’s operating currency is the NIS and accordingly, all figures above are translations for convenience purposes of Partner’s NIS figures into U.S. dollars at the representative rate of exchange prevailing at December 31, 2005 according to which $1.00 equaled NIS 4.603.

	*Teledata (a 21% holding as of December 31, 2005).* Teledata provides innovative access products and solutions for both traditional and next generation networks to telecom operators and service providers. Teledata’s revenues in 2005 amounted to $55.9 million compared to $38.9 million in 2004 and its net income amounted to $1.8 million in 2005 compared to a net loss of $2.5 million in 2004. The increase in revenues resulted mainly from an increase in revenues from existing customers.

	*Jordan Valley (a 28% holding as of December 31, 2005).* Jordan Valley is engaged in developing solutions for advanced in-line thin film metrology for the semiconductor industry. Jordan Valley’s revenues in 2005 increased to $10.4 million from $8.3 million in 2004, primarily due to the launch of new products. Jordan Valley’s net loss in 2005 was $0.1 million, compared to $0.7 million in 2004.

Gains from Disposal of Business and Affiliated Companies and Changes in Holdings in Affiliated Companies. Gains from disposal of businesses and affiliated companies and changes in our holdings in affiliated companies in 2005 amounted to $23.3 million, compared to $132.4 million in 2004. The gain in 2005 resulted primarily from the following: (i) a gain of approximately $19.7 million (which after income taxes amounted to $17.2 million) resulting from the sale of Oren’s shares in consideration for $20.3 million; (ii) a gain of approximately $3.0 million from the decrease in our interest in NetVision following its initial public offering; and (iii) a gain of $1.2 million (which after minority interest and income taxes amounted to $0.5 million) resulting from the exercise of a call option granted to a former senior executive of RDC to purchase 70,200 shares of Given Imaging for the aggregate exercise price of approximately $12,000.

The gain recorded in 2004 resulted primarily from the following: (i) a $104.6 million gain (which after income taxes amounted to $91.5 million) resulting from the sale of our holding in Elbit Systems; (ii) a $15.2 million gain (which after minority interest and income taxes amounted to $6.7 million) resulting from the sale of shares of Given Imaging by RDC and the decrease in our direct and indirect interest in Given Imaging following Given Imaging’s secondary public offering; and (iii) a gain of $5.8 million (which after minority interest and income taxes amounted to $1.4 million) resulting from the purchase by RDC of treasury shares amounting to approximately 3% of its outstanding shares from one of its shareholders (a former senior executive of RDC) in consideration for distribution of 200,000 shares of Given Imaging; and (iv) a $5.3 million gain from the sale of our share of KIT eLearning, for an immediate cash payment of $9.4 million (from which we received $5.7 million). Based on future earnings of KIT in 2006 and 2007, there may be an additional payment of up to $10 million, of which our share will be up to $5.7 million. If we receive this additional payment, we will record an additional gain.

Other Income, net. Other income, net, amounted to $58.6 million in 2005 compared to $4.7 million in 2004. The gain in 2005 was primarily due to the following (i) a $56.4 million gain (which after income taxes amounted to $45.4 million) from the sale of shares of Partner for approximately $94.0 million; (ii) a gain of $1.1 million ($0.7 million net of tax) from the sale of Zoran’s shares received as part of the consideration for Oren’s shares; and (iii) a gain from a dividend received from Partner in the amount of $0.4 million. The gain in 2004 resulted mainly from a $5.4 million gain, before tax, from the sale of shares of Zix received in consideration for ESW’s assets and business sold to Zix in 2003.

Expenses

Cost of revenues. Cost of revenues consisted primarily of expenses related to salaries and hardware associated with delivering products and services of our subsidiaries, mainly Galil Medical and SELA (whose results have been consolidated since July 1, 2004). Cost of revenues in 2005 amounted to $7.2 million, compared to $6.3 million in 2004.

Operating expenses. Operating expenses are comprised of research and development expenses, sales and marketing and general and administrative expenses of our and RDC’s corporate operations and of our subsidiaries, mainly Galil Medical, SELA, Starling and 3DV. The following table sets forth operating expenses (excluding amortization of intangible assets which is presented as a separate line item and amounted to $0.4 million in 2005 and $0.1 million in

2004, which also constitute part of operating expenses under US GAAP but for presentation purposes are included as a separate line item):


	Year ended December 31,

	2005		2004

	(millions of $)
Corporate		6.9		7.3
Galil Medical		2.8		2.3
SELA¹		3.1		1.6
Starling		2.4		1.6
3DV		1.9		1.2
Other (mainly RDC)		0.7		2.5

		17.8		16.5

¹SELA’s results have been consolidated since July 1, 2004

Operating expenses of Galil Medical in 2005 amounted to $2.8 million, as compared to $2.3 million in 2004, and its operating results amounted to an operating loss of $0.5 million compared to operating income of $0.1 million in 2004. The change in Galil Medical’s operating results was due to the commencement of the development of its cryotherapy technology for application in the women’s health field at the end of 2004. In November 2005, Galil Medical’s cryo products received FDA clearance for the treatment of breast fibroadenoma (non cancerous breast lumps).

SELA’s operating expenses amounted to $3.1 million in 2005, compared to $2.9 million in 2004 (of which $1.6 million was incurred in the second half of 2004 and was consolidated in our financial statements of 2004) and its operating loss amounted to $0.7 million compared to an operating income of $0.4 million in 2004 (of which $0.5 million was incurred in the second half of 2004 and was consolidated in our financial statements of 2004), resulting from the decrease in revenues recognized in 2005.

The decrease in operating expenses of the other companies resulted mainly from income recorded by RDC in 2005 with respect to the decrease in the fair value of call options held by RDC’s employees to purchase shares of affiliated companies.

Finance income, net. Finance income, net, amounted in 2005 to $5.5 million, compared to $1.4 million in 2004. The increase is mainly due to higher cash resources during the period as a result of the sale of our holding in Elbit Systems in 2004 for approximately $197 million and from the sale of Partner shares in the second quarter of 2005 for approximately $94.0 million. Income from interest in future periods is expected to decrease due to a decrease in cash resources mainly as a result of a cash dividend payment to our shareholders on September 27, 2005.

Income Taxes. Income taxes, net, amounted to $10.5 million in 2005 which included mainly $11.0 million of income taxes with respect to the gain from the sale of Partner shares (which includes an offset of $9.4 million due to the reduction in our previous valuation allowance with respect to losses incurred in prior periods following our receipt of a final tax assessment) and $2.4 million from the sale of Oren shares and approximately $3.0 million in respect of financing income. These were partially offset mainly by a tax benefit of $5.0 million, resulting from a

decrease in our previous valuation allowance due to the sale of the ET group and an approximately $1.2 million adjustment of a prior year tax provision in Elbit. Income taxes, net, in 2004 were $15.1 million resulting mainly from the sale of our holding in Elbit Systems, the secondary public offering of Given Imaging, the purchase of treasury stock in RDC in consideration for distribution of Given Imaging’s shares and the sale of Zix shares. Income taxes were partially offset by a tax benefit in the amount of $2.9 million due to the change in the Israeli tax rate enacted in 2004 and a $1.5 million tax benefit related to the impairment of future royalties to be received by MediaGate.

Year Ended December 31, 2004 compared to Year Ended December 31, 2003.

Income

Net revenues. Net revenues consisted of sales of products and services by our subsidiaries, mainly Galil Medical and SELA (which results have been consolidated since July 1, 2004). The following table sets forth revenues:


	Year ended December 31,

	2004		2003

	(millions of $)
Galil Medical		7.6		7.6
SELA		3.3		—
MediaGate		—		1.5
Other		0.4		0.1

		11.3		9.2


	*Galil Medical’s* revenues in 2004 and in 2003 (from July 1, 2003) were derived mainly from the supply of cryo products and R&D services to Oncura, in which it has a 25% ownership interest.

	*SELA* recorded revenues of $5.1 million in 2004 (of which $3.3 million were in the second half of 2004) compared to $4.3 million in 2003.

Share in net losses of affiliated companies. The share in net losses of affiliated companies amounted to $10.5 million in 2004, as compared to $8.7 million in 2003. As a result of the completion of the sale of our holding in Elbit Systems during the third quarter of 2004, our share in net income of Elbit Systems was included through the end of the second quarter of 2004 based on Elbit Systems’ unaudited financial report as of June 30, 2004 and amounted to $4.7 million. Our share in the net income of Elbit Systems in 2003 amounted to $9.1 million. Elbit Systems revenues in 2004 through the end of the second quarter amounted to $445.3 million as compared to $420.9 million in the first half of 2003 and its net income amounted to $24.0 million as compared to $21.5 million in the same period of 2003.

Highlights of the Results of Operations of Our Major Affiliates:

Given Imaging (a 20% holding directly and indirectly through RDC as of December 31, 2004). Given Imaging’s revenues in 2004 were $65.0 million, an increase of 60.4% over 2003 revenues of $40.5 million. As of December 31, 2004, cumulative unit sales of Given Imaging capsule for the small intestine had reached 171,800 and its installed base reached more than 1,300 workstations in the United States and approximately 2,300 worldwide. Given Imaging’s gross profit increased to 72.7% of revenues in 2004 compared to 66.6% in 2003 and it reported net income of $2.9 million in 2004, compared to a net loss of $9.6 million in 2003.

During the second quarter of 2004, Given Imaging completed a secondary offering to the public in which it raised net proceeds of $44.3 million. In addition, Given Imaging entered into an exclusive sales representation and co-promotion agreement with Ethicon Endo-Surgery, Inc., a Johnson & Johnson company, according to which Ethicon has exclusive rights to market Given Imaging’s Pillcam™ ESO video capsule for visualization of the esophagus. Following FDA clearance to market the PillCam™ ESO in late November and through December 31, 2004, more than 3,400 PillCam ESO capsules were sold.

Oncura (a 25% holding through Galil as of December 31, 2004). Oncura’s revenues in 2004 amounted to $68.8 million and its net loss amounted to $2.2 million. Oncura’s revenues in the period since commencing operation on July 1, 2003 and through December 31, 2003 amounted to $31.4 million and its net loss amounted to $0.9 million.

NetVision (a 46% holding as of December 31, 2004). In 2004 NetVision continued to experience increased competition in gaining broadband Internet services market share, resulting from the transition of customers to broadband Internet services. Nonetheless, NetVision revenues increased in 2004 by 7.6% to $70.5 million from $65.5 million in 2003 and its customer base at December 31, 2004 reached approximately 390,000 (of which approximately 225,000 were connected through broadband) compared to 341,000 at December 31, 2003 (of which approximately 146,000 were connected through broadband). NetVision’s operating income increased by 47.2% to $7.3 million in 2004 compared to $5.0 million in 2003 and its net income increased to $4.3 million in 2004 compared to $1.0 million in 2003. NetVision’s operating currency is the New Israeli Shekel (NIS) and accordingly, all figures above are translations for convenience purposes of NetVision’s NIS figures into US dollars at the representative rate of exchange prevailing December 31, 2004 according to which $1.00 equaled NIS 4.308.

During 2004, we and DIC each granted NetVision a $5.3 million loan, in order to enable NetVision to repay its line of credit to one of its lending banks and to set up its international telephony services. As a result of the extension of the original repayment period of the loans and in accordance with EITF 02-18, we recorded a portion of the loan, in the amount of $2.0 million, as a loss, representing the funding of NetVision’s previous years’ losses.

Wavion (a 38% holding as of December 31, 2004). Following a financing round in which Wavion raised $12.5 million in the second half of 2003, Wavion directed resources away from its subcontracting activities to R&D activities, resulting in a decrease in revenues from

subcontracting services in 2004 to $0.1 million compared to $1.8 million in 2003 and an increase in its net loss which amounted to $6.3 million in 2004 compared to $1.7 million in 2003.

ChipX (a 27% holding as of December 31, 2004). ChipX’s revenues in 2004 increased by 18% to $16.2 million from $13.7 million in 2003, primarily due to the launch of new products and the recovery in the semiconductor industry, and its net loss in 2004 decreased to $5.6 million from $7.8 million in 2003. In March 2004, ChipX raised $12.0 million in a private placement, the proceeds of which were being used to finance its sales and marketing efforts and development investments in its structured ASIC technology.

AMT (a 40% holding as of December 31, 2004). During 2004 AMT completed a private placement of $6.0 million, in which we invested an additional $3.0 million. AMT’s consolidated revenues in 2004 amounted to $2.6 million, compared to $1.3 million in 2003 and its net loss in 2004 amounted to $3.0 million, compared to $3.5 million in 2003.

Results of operations of significant group companies which are accounted for other than under the equity method of accounting.

Partner (an 8.6% holding as of December 31, 2004). At December 31, 2004, the market value of our investment in Partner amounted to approximately $136.2 million. The following are highlights of the results of operations of Partner for 2004 (all figures below are convenience translations of Partner’s nominal New Israeli Shekel (NIS) figures into US dollars at the rate of the exchange prevailing at December 31, 2004 according to which $1.00 equaled NIS 4.308). Partner’s revenues in 2004 increased to $1,193.3 million, up 15.1% from $1,037.1 million in 2003. Partner’s subscriber base at the end of 2004 was 2,340,000 as compared to 2,103,000 at the end of 2003. Partner’s net income in 2004 was $109.5 million, as compared to $269.9 million in 2003. The decrease in Partner’s net income in 2004 resulted primarily from the utilization of its accumulated tax loss carry forward and the creation of deferred tax asset in 2003 in the amount of $146.9 million.

Jordan Valley (a 28% holding as of December 31, 2004). Jordan Valley’s revenues in 2004 increased to $8.3 million from $3.2 million in 2003, primarily due to the launch of new products for the semiconductor industry, and its net loss in 2004 decreased to $0.7 million from $2.5 million in 2003.

Impliant (a 23% holding as of December 31, 2004). Impliant’s net loss in 2004 amounted to $3.3 million, compared to $2.3 million in 2003, mainly as a result of increase in research and development expenses.

Gains from Disposals of Businesses and Affiliated companies and Changes in Holdings in Affiliated Companies. Our gains from disposals of businesses and affiliated companies and changes in holdings in affiliated companies amounted to $132.4 million in 2004 compared to $25.8 million in 2003.

The gain in 2004 consisted primarily from the following: (i) a $104.6 million gain (which after income taxes amounted to $91.5 million) resulting from the sale of our holding in Elbit Systems (we used Elbit Systems’ unaudited financial report as of June 30, 2004 in order to record

the carrying value of our investment in Elbit Systems as of the date of sale and to determine the gain resulting from the sale); (ii) a $15.2 million gain (which after minority interest and income taxes amounted to $6.7 million) resulting from the sale of shares of Given Imaging by RDC and the decrease in our direct and indirect interest in Given Imaging following Given Imaging’s secondary public offering; (iii) a $5.3 million gain from the sale of our share of KIT to a subsidiary of Laureate for a cash payment of $9.4 million (from which we received $5.7 million) (based on future earnings of KIT in 2006 and 2007, there may be an additional payment of up to $10 million, of which our share will be up to $5.7 million;. If we receive this additional payment, we will record an additional gain); (iv) a gain of $5.8 million (which after minority interest and income taxes amounted to $1.4 million) resulting from the sale of shares of Given Imaging in connection with the purchase by RDC of treasury shares amounting to approximately 3% of its outstanding shares from one of its shareholders (a former senior executive of RDC); and (v) a gain of $0.6 million resulting from the exercise of a call option granted to the chairman of our board of directors to purchase 21,751 shares of Given Imaging from us for the aggregate exercise price of approximately $49,000.

The gain in 2003 was mainly due to the gain from the merger of the urology therapy business of Galil Medical and GE Healthcare in the amount of approximately $21.2 million (which after minority interest and income taxes amounted to $4.4 million) and the $4.5 million gain from the sale of 753,600 shares of Given Imaging held by RDC for approximately $7.8 million and changes in our holding in Given Imaging as a result of exercise of options.

Other Income (expenses), net. Other income, net, amounted to $4.7 million in 2004 compared to $14.6 million in 2003. The gain in 2004 included mainly a $5.4 million gain, before tax, from the sale of shares of Zix received in consideration for ESW’s assets and business sold to Zix in 2003, a $0.5 million loss representing the funding of 3DV’s previous years’ losses and $0.8 million write down of investment, mainly with respect to Textology.

The gain in 2003 resulted primarily from the following: (i) the sale of Partner shares for approximately $29.3 million which resulted in a $11.1 million gain before tax; (ii) the sale of shares of Zix for approximately $9.0 million which resulted in a $4.8 million gain before tax; and (iii) a $2.0 million gain, before tax, from the sale of all of our shares of 24/7 Real Media shares (Nasdaq: TFSM) for approximately $5.2 million. These gains were partially offset by $3.7 million of write-downs mainly with respect to Cellenium and Textology.

Finance income, net. Finance income, net, amounted to $1.4 million in 2004 compared to $0.8 million in 2003. The increase in finance income was primarily due to the increase in cash balances following the completion of the sale of our holding in Elbit Systems for $196.6 million.

Expenses

Cost of revenues. Cost of revenues amounted to $6.3 million, compared to $5.6 million in 2003, which consisted primarily of expenses related to salaries, materials, subcontractors and hardware associated with delivering products and services of our subsidiaries, mainly Galil Medical, MediaGate, 3DV (the results of which have been consolidated since January 1, 2004) and SELA (the results of which have been consolidated since July 1, 2004).

Operating expenses. Operating expenses are comprised of research and development expenses, sales and marketing and general and administrative expenses of our subsidiaries, mainly Galil Medical, MediaGate, 3DV (the results of which have been consolidated since January 1, 2004) and SELA (the results of which have been consolidated since July 1, 2004), and of our and RDC’s corporate operations. The following table sets forth operating expenses. The operating expenses presented below for 2004 exclude impairment and amortization of intangible assets in the amount of $0.1 million ($0.3 million in 2003), which also constitute part of operating expenses under US GAAP but for presentation purposes is included as a separate line item:


	Year ended December 31,

	2004		2003

	(millions of $)
Corporate		7.3		7.1
Galil Medical		2.3		10.4
SELA		1.6		—
MediaGate		—		3.1
Starling		1.6		—
3DV		1.2		—
Other (mainly RDC)		2.5		2.0

		16.5		22.6

Operating expenses of Galil Medical in 2004 decreased to $2.3 million from $10.4 million in 2003, resulting in operating loss of $0.1 million, compared to $7.6 million in 2003. The decrease in Galil Medical’s operating expenses and operating loss was mainly due to the merger of the urology therapy units of Galil Medical and GE Healthcare which resulted in a significant decrease in Galil Medical’s marketing and selling expenses. Galil Medical started at the end of 2004 to develop its cryotherapy technology for application in the women’s health field.

The decrease in MediaGate’s operating expenses resulted from the sale of its assets and business to Telrad in January 2004, following which MediaGate ceased its operations.

SELA’s operating expenses amounted to $2.9 million in 2004 (of which $1.6 million were incurred in the second half of 2004 and the amount was consolidated in our financial statements of 2004), compared to $2.4 million in 2003 and its net income amounted to $0.2 million, compared to $0.1 million.

Impairment. An impairment charge of $4.2 million ($2.7 million net of tax) was recorded with respect to future royalties to be received by MediaGate in connection with the sale of MediaGate’s business in January 2004 to Telrad. The write-off was due to our revised estimate about the realizability of future royalties. However, MediaGate’s bank loan in the amount of approximately $2.6 million, which was secured by a first ranking pledge over these future royalties and which was not guaranteed by us, was not written-off even though it could only be repaid from royalties to be received. This is in accordance with SFAS 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - A Replacement of FASB Statement 125”, which allows derecognition of a liability only if it has been extinguished, either through payment or when the debtor is legally released from being the

primary obligor under the liability. In the first quarter 2006, we recorded a gain of approximately $2.7 million resulting from the extinguishment of the loan as a result of an agreement signed with the bank.

Income Taxes. Income taxes, net, in 2004 were $15.1 million, which included mainly $13.1 million of income taxes with respect to the gain resulted from the sale of our holdings in Elbit Systems (which includes an offset of $21.6 million due to the reduction in our valuation allowance with respect to previous years’ losses), $6.7 million resulting from the secondary public offering of Given Imaging and the purchase of treasury stock in RDC in consideration for distribution of Given Imaging’s shares and $1.8 million resulting from the sale of Zix shares. These amounts were offset primarily by a tax benefit in the amount of $2.9 million due to the change in the Israeli tax rate enacted in 2004, which gradually reduces the corporate tax rate in Israel from 36% in 2003 to 30% in 2007, a $2.4 million tax benefit with respect to corporate expenses, net and $1.5 million tax benefit related to the impairment of future royalties to be received by MediaGate from Telrad.

Income taxes, net, in 2003 were $6.8 million, which included mainly $7.0 million of income taxes with respect to the sale of shares of Partner, Given Imaging and 24/7 Real Media as well as with respect to the merger of the urology therapy units of Galil Medical and GE Healthcare and a tax benefit of $1.7 million mainly with respect to corporate expenses, net.


B.	Liquidity and Capital Resources

Consolidated cash, debentures and deposits at December 31, 2005, were approximately $143.8 million compared with $188.1 million at December 31, 2004. At December 31, 2005, corporate cash, debentures and deposits were $133.8 million compared with $175.7 million at December 31, 2004.

The main sources of corporate cash and other liquid instruments in 2005 were $94.0 million of proceeds from the sale of Partner shares, $10.5 million cash proceeds from the sale of shares in Oren, $8.8 million from the sale of Zoran shares received as part of the consideration for Oren’s shares, $2.2 million repayment of loan by NetVision and $2.1 million proceeds from the sale of the ET group.

The main uses of corporate cash and other liquid instruments in 2005 were an $88.5 million dividend, income tax payments of approximately $27.1 million (mainly with respect to the sale of Elbit Systems shares in 2004 and Partner shares in 2005) and $40.5 million of investments (including loans) in new and existing group companies as detailed below (in millions of $):


*Consolidated companies ()**

Starling		1.5
Galil Medical		0.8
3DV		0.7
Enure		4.0
Other		2.1

		9.1


	Affiliated companies and other investments

	Wavion			1.4
	Teledata			16.0
	Brainsgate			6.9
	Nulens			1.7
	AMT			1.4
	Jordan Valley			1.4
	Impliant			1.0
	Other			1.6

				31.4


	Total corporate investments			40.5

* These investments do not affect the cash included in the consolidated financial statements.

In addition, during 2005 RDC invested $6.1 million, which included $0.6 million in a new company established at the end of 2005 (Medingo) which is developing a miniature disposable insulin dispenser for insulin dependent diabetic patients.

Consolidated working capital at December 31, 2005 amounted to $136.2 million compared to $162.2 million at December 31, 2004. The decrease is mainly due to the decrease in corporate cash and other liquid instruments.

Consolidated loans at December 31, 2005, were approximately $7.3 million, compared to $7.5 million at December 31, 2004. In the first quarter of 2006 MediaGate’s bank loan in the amount of approximately $2.8 million was settled in consideration for $0.1 million. As a result, we recorded in the first quarter of 2006 a gain of approximately $2.7 million.

Subsequent to December 31, 2005 and through May 31, 2006, we invested an additional aggregate amount of approximately $17.1 million in new and existing group companies as detailed below:


Consolidated companies
*()**

RDC				2.0


Total				2.0


Affiliated companies and other investments

Wavion			1.4
NuLens			2.6
Partner			5.3
Safend			3.5
ChipX			2.3

Total			15.1


Total corporate investments			17.1


*	These investments do not affect the cash included in the consolidated financial statements.

On June 8, 2006 we invested additional $2.5 million in AMT.

Our investment policy for managing our funds is in general to invest in bank deposits and U.S. government securities with high liquidity.

We believe that our existing capital will be sufficient to fund our and our subsidiaries’ operations and our investment plan in existing and new companies for at least the next twelve months.

Shareholders’ equity at December 31, 2005, was approximately $302.1 million, representing approximately 85% of total assets, compared with $389.1 million, representing approximately 78% of total assets at December 31, 2004. The decrease in shareholders’ equity is mainly due to our dividend distribution in 2005.

Market Risk

Market risks relating to our operations result primarily from changes in interest rates, exchange rates and equity prices. In order to limit our exposure, we may enter, from time to time, into various derivative transactions. Our objective is to reduce exposure and fluctuations in earnings and cash flows associated with changes in interest rates, foreign currency rates and equity prices. We do not use financial instruments for trading purposes. It is our policy and practice to use derivative financial instruments only to limit exposure. As part of this policy, in 2005 we hedged the dollar value of the expected proceeds from the sale of our shares in Partner by the purchase of call options and by selling put options, at a dollar/NIS exchange rate ranging from $4.36 to $4.44 for a period of 81 days. This transaction had no material effect on our results of operations.

Interest Rate Risks

We are exposed to market risks resulting from changes in interest rates, relating primarily to our debentures and deposits. We do not use derivative financial instruments to limit exposure to interest rate risk. As of December 31, 2005, we held U.S. government debentures with a market value of approximately $62.6 million. The market value of the debentures depends on changes and expectations of changes in the interest rates in the United States and general market conditions in the United States. At December 31, 2005, all of our debentures and short-term deposits were fixed rate based with an average annual rate of 3.7% and a weighted average maturity of approximately 1.7 years. In 2005, as a result of increase in interest rates, we recorded

an other than temporary decline in value, net of tax, of approximately $0.6 million on debentures held by us.

Exchange Rate Risk

Since most of our group companies are Israeli-related, our main exposure, if any, results from changes in the exchange rate between the New Israeli Shekel and the U.S. dollar. Our functional currency, as well as that of our principal subsidiaries and affiliated companies, is the U.S. dollar. Our policy is to reduce exposure to exchange rate fluctuations by having most of our and our subsidiaries’ assets and liabilities, as well as most of the revenues and expenditures in U.S. dollars, or U.S. dollar linked. Therefore, we believe that the potential loss that would result from an increase or decrease in the exchange rate is immaterial to our business and net assets. See above regarding the hedging of the dollar value of the proceeds from the sale of our shares in Partner.

Equity Price Risk

We are exposed to fluctuations in the equity price of our holdings in publicly traded companies. At December 31, 2005 we directly and indirectly held shares of publicly traded companies, primarily Given Imaging, Partner, NetVision and EVS. Stock prices in the industries of these companies, and of these companies themselves, have historically experienced significant volatility. Changes in the market value of our publicly traded holdings, including holdings through our affiliates, which are accounted under the equity method of accounting or as available-for-sale securities will not affect our results of operations but may have a significant effect on our market value. We view the risks of reduction in market price of these companies as part of our business risks and we examine, from time to time, the possibility of having a partial hedge against equity price risks. Based on closing market prices at December 31, 2005, the market value of our holdings in public securities was approximately $197.0 million. At December 31, 2005, no instruments were used to hedge the risk of equity price fluctuations.

Changes in the market value of our available-for-sale securities (Partner and EVS) are reported in other comprehensive income, which is included as a component of shareholders’ equity, and not as part of our results of operations. The market value of our available-for-sale securities as of December 31, 2005 amounted to $27.85 million.


C.	Research and Development

Since we, through our group companies, engage in fields of high-technology, our group companies invest significant resources in research and development (“R&D”) activities.

The combined R&D costs of all group companies amounted to approximately$43.5 million in 2005, $58.9 million in 2004 and $85.1 million in 2003 (including R&D expenses of Elbit Systems which was sold in the second half of 2004 in the amount of $0, $27.1 million and $54.9 million, in 2005, 2004 and 2003, respectively). The decrease in R&D costs in 2005 as compared to 2004 was primarily due to the sale of Elbit Systems. This decrease was offset by the R&D expenses of our new affiliates and subsidiaries in which we invested at the end of 2004 and during 2005, including Jordan Valley, Impliant, Teledata, BrainsGate, NuLens, Enure and Medingo as well by the increase in the R&D expenses of our group companies, mainly RDC, Given Imaging, Galil Medical, Oncura, 3DV, Starling and SELA. The decrease in R&D costs in 2004 as compared to 2003 was primarily due to the sale or discontinued operations of some of

our group companies during 2003 and 2004 (mainly Elbit Systems in July 2004, ESW and MediaGate), which was partially offset by an increase in R&D expenses in some of our group companies (mainly Wavion, Starling and ChipX).

Our consolidated research and development costs amounted to $6.2 million, $2.9 million and $3.3 million in 2005, 2004 and 2003, respectively. The increase in the consolidated R&D costs resulted mainly from the increase in R&D expenses of our subsidiaries RDC, Galil Medical, Starling and 3DV as well as from our new consolidated companies, Medingo and Enure (both consolidated since the fourth quarter of 2005) and SELA (consolidated since the second half of 2004).

D.	Trend Information

“Trend Information” pertaining to our group companies and us is incorporated by reference to Item 4, “Information on the Company” of this Report and this Item 5 under “Results of Operations”.


E.	Off Balance Sheet Arrangements

There is no principal amount of off balance sheet transactions.


F.	Tabular Disclosure of Financial Obligations

At December 31, 2005, we and our subsidiaries had no material contractual obligations which are expected to affect our consolidated cash flow in future periods, except for lease obligations and payments of bank credits, bank loans and loans from others, including short term loans taken by our subsidiaries, in each case due in future periods as set forth in the table below (in million of $):


Type of Obligation*	2006	2007	2008	2009	2010	Total

Loans from banks	3.8	—	—	—	—	3.8
Loans from other	2.1	1.4	—	—	—	3.5
Operating leases	0.8	0.7	0.4	0.2	—	2.1

* Does not include accrued severance pay and retirement obligation of $2.6 million at December 31, 2005.

Item 6. Directors, Senior Management and Employees


A.	Directors and Senior Management

As of May 31, 2006, our executive officers and directors are as follows:


	Name	Age		Position

Ami Erel ⁽⁵⁾		59	Chairman of the Board of Directors
Avraham Asheri ⁽¹⁾⁽⁴⁾		68	Director
Prof. Gabi Barbash		56	Director
Prof. Yair Be’ery		49	Director
Nochi Dankner^{(5) (6)}		51	Director
Avraham Fischer⁽⁵⁾		49	Director
Yaacov Goldman ^{(1)(2)(3) (4)}		50	External Director
Ari Bronshtein⁽⁵⁾		36	Director
Shay Livnat^{(5) (6)}		47	Director
Dori Manor^{(5) (6)}		39	Director
Professor Daniel Sipper⁽¹⁾⁽²⁾		73	External Director
Doron Birger		55	President and CEO
Moshe Fourier		58	Vice President, Chief Technology Officer
Rinat Remler		34	Vice President, Chief Financial Officer
Yair Cohen		51	Vice President
Assaf Topaz ⁽⁷⁾		35	Vice President


1.	Member of our audit committee.

2.	External director under the Israeli Companies Law.

3.	Designated Financial Expert under Sarbanes-Oxley Act of 2002.

4.	Designated Financial Expert under Israeli Companies Law.

5.	Director or Officer of IDBH, IDBD and/or DIC.

6.	See Item 7A – “Major Shareholders”.

7.	Assaf Topaz is the husband of Michal Topaz, daughter of Ruth and Isaac Manor. See Item 7A – “Major Shareholders.”

Ami Erel has served as the Chairman of our Board of Directors of Elron since November 1999 and served as our Chief Executive Officer from November 1999 to December 2001. Mr. Erel has served as President and Chief Executive Officer of DIC since June 1, 2001. Mr. Erel is also Chairman of the board of directors of Cellcom Israel Ltd., NetVision and Scailex Corporation (formerly Scitex Corporation) and serves as a director of Property and Building Corporation Ltd. and Super-Sol Ltd. Mr. Erel also serves as the Chairman or a member of the boards of various other subsidiaries and affiliates of DIC and Elron. From 1997 to 1999, Mr. Erel served as President and Chief Executive Officer of Bezeq-The Israel Telecommunications Corp. Ltd. (“Bezeq”). From 1997 to 1998, he was Chairman of the board of directors of PelePhone Communications Ltd. As of January 2005, Mr. Erel serves as Chairman of the Executive Committee of the Manufacturers Association of Israel. From January 2000 to January 2004, Mr. Erel served as Chairman of the Board of Israel Association of Electronics & Information Industries. Mr. Erel holds a B.Sc. in electrical engineering from the Technion, Israel Institute of Technology.

Avraham Asheri joined Elron as a director in December 1999. He serves as the Chairman of our Audit Committee. He is an economic and financial advisor. Mr. Asheri is a member of the boards of directors of Discount Mortgage Bank Ltd., Africa Israel Investments Ltd., Elbit Systems Ltd. and Scailex Corporation Ltd. (formerly Scitex Corporation Ltd.) Mr. Asheri was the President and Chief Executive Officer of Israel Discount Bank from November 1991 until July 1998. Prior to joining Israel Discount Bank in 1983 as Senior Executive Vice President and a member of its management committee, Mr. Asheri held the position of Director General of the Ministry of Industry and Trade. During his 23 years at the Ministry of Industry and Trade and at the Ministry of Finance, Mr. Asheri held several key offices in Israel and abroad, including Managing Director of the Investment Center in Israel, and Trade Commissioner of Israel to the United States. Mr. Asheri holds a bachelors degree in economics and political science from the Hebrew University in Jerusalem.

Prof. Gabi Barbash joined Elron as a director in May 2003. Since 1999, Prof. Barbash has been Director General of the Tel-Aviv Sourasky Medical Center and between 2000 and 2003 he served as Chairman of the Board of Directors of Teuza Venture Capital Fund. Between 1998 and 2000, Prof. Barbash was the Chairman of the Israeli National Transplant Center. Between 1996 and 1999, Prof. Barbash was the Director General of the Israeli Ministry of Health. Between 1995 and 1998, Prof. Barbash was a member of the Scientific Committee of the Interdisciplinary Center for Technological Analysis and Forecasting at Tel-Aviv University. Between 1993 and 1996, Prof. Barbash was the Director General of the Sourasky Medical Center. Between 1986 and 1993, Prof. Barbash was the Deputy Director of the Sheba Medical Center and from 1990 to 1993, he was Director of the Rehabilitation Hospital of the Sheba Medical Center. Prof. Barbash holds an M.D. degree from the Hebrew University, Jerusalem, Hadassah Medical School and a masters degree in public health from Harvard University.

Prof. Yair Be’ery joined Elron as a director in January 2004. Since 1985, Prof. Be’ery has been with the Department of Electrical Engineering at Tel Aviv University and served as its Chairman from 1999 until 2003. From 1998 until 2005, Prof. Be’ery worked with Benny Steinmetz’s Group and co-founded STI Ventures, a high technology venture investment company. From 1989 until 1996, Prof. Be’ery served as Vice President of Advanced Technology of the DSP Group Inc. Prof. Be’ery serves as a member of the board of directors of Teledata, one of our group companies. Prof. Be’ery is also a member of the advisory boards of ChipX, also one of our group companies, and Mplicity Ltd. Prof. Be’ery served previously on the boards of directors and advisory boards of numerous Israel-related technology companies. Prof. Be’ery holds B.Sc., M.Sc. and Ph.D. degrees (Electrical Engineering) from Tel Aviv University, Israel.

Ari Bronshtein joined Elron as a director in March 2006. In January 2006, Mr. Bronshtein joined DIC as Vice-President. From 2004 to 2005, Mr. Bronshtein served as Vice President and head of the Economics and Business Development division of Bezeq. From 2000 to 2003, Mr. Bronshtein served as Director of Finance and Investments at Bezeq. From 1999 to 2000, Mr. Bronshtein served as Manager of business analysis at Comverse Technologies, Inc. From 1996 to 1999, Mr. Bronshtein served in various positions at Tadiran Ltd., his last position being Director of the Finance and Investments division. Mr. Bronshtein serves as a director of American Israeli Paper Mills Ltd., and as an external director and chairman of the investment committee of Koor - Tadiran Gemel. Mr. Bronshtein has previously served as a director of Bezeq International Ltd., Xpert Systems Ltd. and Simcha Urieli & Sons Engineering & Construction Company Ltd. In

addition, Mr. Bronshtein has served as an external director and member of the investment committee of Dash Mutual Fund Management Ltd. Mr. Bronshtein has also served as chairman of the investment committee of Stage One and as a member of the investment committee of Eurofund, both venture capital funds. Mr. Bronshtein holds a Bachelors Degree in Finance and Management and Masters Degree in Finance and Accounting, both from Tel Aviv University.

Nochi Dankner joined Elron as a director in June 2005. Mr. Dankner is the Chief Executive Officer and Chairman of the board of directors of IDBH and serves as Chairman of the board of directors of IDBD, DIC and Clal Industries and Investments Ltd. Mr. Dankner is the founder of the Ganden Group and serves as a director of companies in the Ganden Group which holds investments in companies operating primarily in the fields of real estate and tourism, including as Chairman of Ganden Holdings Ltd. and Ganden Investments (2000) Ltd. and as Co-Chairman of Ganden Tourism and Aviation Ltd. and Israir Ltd. In addition, Mr. Dankner serves as a director of Cellcom Israel Ltd., Clal Insurance Company Ltd., Nesher-Israeli Cement Enterprises Ltd., Property and Building Corporation Ltd., Azorim Investments, Development and Construction Company Ltd., Super-Sol Ltd. and other public and private companies in the IDB group. Mr. Dankner is Chairman of the IDB Fund “For the Community” and is a member of “Matan - Your Way to Give”, a non-profit organization. Mr. Dankner also serves as a member of the Management Committee of the Association of Friends of the Tel Aviv Sourasky Medical Center, and as a member of the Board of Trustees of the Tel Aviv University. Mr. Dankner holds an LL.B. degree from the Tel Aviv University and a Bachelor of Arts degree in Political Science from Tel Aviv University.

Avraham Fischer joined Elron as a director in August 2003. He is the Executive Vice President of IDBH, the deputy Chairman of IDBD, Co-Chief Executive Officer of Clal Industries and Investments Ltd. and Chairman of Clal Biotechnology Industries Ltd. In addition, he is a partner of Fischer, Behar, Chen & Co., a leading Israeli law firm. Mr. Fischer is the co-founder and co-Chairman of Ganden Tourism and Aviation Ltd., a company holding investments in Israeli companies, operating primarily in the field of tourism, and is the co-founder and Vice-Chairman of Ganden Holdings Ltd., which is the principal shareholder of IDB Holding Ltd. He serves as a director of Clal Industries & Investments Ltd., IDBH, DIC, Scailex Corporation (formerly Scitex Corporation Ltd.), ECI Telecom Ltd., American Israeli Paper Mills Ltd., Vyyo Inc. and several other companies. Mr. Fischer is a co-chairman of “Matan – Your Way to Give”, a non-profit organization. Mr. Fischer holds an LL.B. degree from the Tel Aviv University and is a member of the Israeli bar association.

Yaacov Goldman joined Elron as an external director in March 2003 and was reappointed as an external director for a second three year term in March 2006. He serves as a member of our Audit Committee and is our designated financial expert on the audit committee. Mr. Goldman also serves as a director of Bank Leumi Le’Israel B.M., Mer Telemanagement Solutions Ltd., Golden House Ltd. and Renewable Resources Ltd. Mr. Goldman serves as the Professional Secretary of the Peer Review Institute of the Certified Public Accountants Institute in Israel. Commencing in 1981 Mr. Goldman worked for Kesselman & Kesselman (member firm of PriceWaterhouseCoopers) for 19 years, and from 1991 until 2000, as a partner and then senior partner of such firm. From September 2000 until November 2001, Mr. Goldman served as managing director of Argoquest Holdings, LLC. From March 2002 until October 2002, Mr. Goldman acted as a consultant to a private equity initiative with Poalim Capital Markets &

Investments Ltd. Mr. Goldman is a certified public accountant in Israel, having received his Bachelor of Economics and Accounting from the Tel Aviv University.

Shay Livnat joined Elron as a director in June 2005 and is the founder, President & Chief Executive Officer of Zoe Holdings Ltd. He is also the founder and co-chairman of UPS Israel and UTI (Isuzu) Israel. Since 2004, Mr. Livnat has been a director of IDBD, Clal Industries and Investments Ltd., Clal, Scaelix Corporation and Scitex Vision Ltd. Since 1992, Mr Livnat has been a director of Taavura Holdings Ltd. Between 1988 and 1998, Mr. Livnat was the Managing Director of Tashtit Ltd (DAF, Liebherr) and Vice-President of the Taavura Group. Mr. Livnat holds a Bachelor of Science in Electrical Engineering, Fairleigh Dickinson University, New Jersey, USA.

Dori Manor joined Elron as a director in August 2003. He has served as Chief Executive Officer of David Lubinski Ltd., a group of automotive companies, since 2000, and was the Vice President from 1997 until 2000 and Assistant Director from 1994 until 1996. During 1994 and 1995, he served as a director of Morasco Ltd. During 1992 and 1993, he was engaged as an Industrial Engineering consultant for Factory Design Ltd. Mr. Manor serves as a director of IDBH, IDBD, DIC and Clal Industries and Investments Ltd. Mr. Manor received an MBA degree from the European Institute of Business Administration (INSEAD) in Fontainebleau, France, in 1996 and a Bachelor of Science degree in Industrial Engineering from Tel Aviv University in 1993.

Professor Daniel Sipper joined Elron as an external director in February 2001. Professor Sipper serves on our Audit Committee. Professor Sipper serves in the faculty of the Department of Industrial Engineering at Tel-Aviv University. He received his bachelor of science from the Technion, Israel Institute of Technology, a masters of science degree from Columbia University and a Ph.D. in Industrial Engineering from the Georgia Institute of Technology.

Doron Birger joined Elron in 1994 as Vice President of Finance. Mr. Birger has served as President and Chief Executive Officer of Elron since August 2002, President since September 2001, Chief Financial Officer from 1994 to May 2002 and Corporate Secretary from 1994 to September 2001. Mr. Birger is Chairman of Given Imaging and ChipX Corporation as well as a director of RDC, NetVision, Teledata and various others of our group companies. From 1991 to 1994, Mr. Birger was Vice President-Finance at North Hills Electronics Ltd., an advanced electronics company. From 1990 to 1991, Mr. Birger served as Chief Financial Officer of Middle-East Pipes Ltd., a manufacturer in the metal industry. From 1988 to 1990, Mr. Birger served as Chief Financial Officer of Maquette Ltd., a manufacturer and exporter of fashion items. From 1981 to 1988, Mr. Birger was Chief Financial Officer and director at Bateman Engineering Ltd. and I.D.C. Industrial Development Company Ltd. From 1979 to 1981, Mr. Birger was the Chief Financial Officer of Fibronics Ltd. Mr. Birger is a member of “Young Entrepeneurs”, a non-profit organization, and a director of the National Science & Technology Museum in Haifa. Mr. Birger holds a B.A. and an M.A. in economics from the Hebrew University, Jerusalem.

Moshe Fourier joined Elron as Vice-President and Chief Technical Officer on June 1, 2000. Mr. Fourier serves as a director of Wavion, Starling and other Elron group companies. From 1999 to 2000, he served as the Chief Operations Officer for Terayon Communications’

broadband voice division, one of the leading companies that provides cable modems and telecommunications solutions over the cable television infrastructure. From December 1993 until 1999, he joined the founder of Telegate and jointly initiated this start-up providing telecommunications equipment for delivering voice, data and video over cable television infrastructure, and served as Deputy Chief Executive Officer and Vice President of Research and Development and Technology. In June 1992, he joined RADA Electronic Industries as Vice President of Engineering. In August 1975, Mr. Fourier joined Astronautics Corporation of America - the Israeli division, as the first engineer and was promoted in 1978 to Vice President of Engineering. Mr. Fourier holds a bachelor of science degree in electrical engineering (BSEE) and an associated electrical engineering degree from the Technion, Israel Institute of Technology.

Rinat Remler joined Elron in April 2000 as Director of Finance and in November 2005 was appointed as Vice President & Chief Financial Officer. From 1997 to 2000, Ms. Remler worked for Luboshitz Kasierer, a leading Israeli auditing firm, now part of Ernst & Young International. Ms. Remler serves on the boards of directors of NetVision, RDC and other Elron group companies. Ms. Remler was a lecturer in accounting and economics at the University of Haifa from to 1997 to 1998 and at the Technion, Israel Institute of Technology, from 1995 to 1997. Ms. Remler holds a BA degree in Economics from the Haifa University (summa cum laude) and a M.A. degree in Business Administration from the Technion, Israel Institute of Technology. Ms. Remler has been a licensed CPA in Israel since 1997.

Yair Cohen joined Elron in July 2005 as Vice President. Prior to joining Elron, Mr. Cohen served since 2000 as Brigadier General of the special Unit 8200, the central military intelligence unit of the Israeli Defense Force, engaged in the development of state of the art technology. Mr. Cohen serves on the Boards of Directors of RDC, Galil Medical and other Elron group companies. Mr. Cohen holds a BA degree in History and Arabic (summa cum laude) from Bar-Ilan University, Israel, and a M.A. degree in Management of National Resources (summa cum laude) from Industrial College (NDU), Washington D.C.

Assaf Topaz joined Elron in April 2004 as Director of Business Development and in April 2005, was appointed as Vice President. Mr. Topaz serves as director of Enure Networks and Jordan Valley Semiconductor. Prior to joining Elron, from 1998 to 2002, Mr. Topaz was co-founder and Chief Operations Officer of Gilian Technologies, Inc, a technology company engaged in the web security market. From 1996 to 1998, Mr. Topaz was a business development executive for Euro Tel Aviv, an advertising agency. From 1995 to 1996, Mr. Topaz was an account executive at McCann Erickson-Kesher Advertising Ltd. Mr. Topaz holds a B.A., Economics and Geography from the Hebrew University of Jerusalem, Israel and a Masters Degree in Business from Stanford University.


B.	Compensation

During the year ended December 31, 2005, we paid aggregate remuneration to our directors and officers as a group who served in the capacity of director or executive officer during such year of approximately $2,192,000. This amount does not include amounts expended by us for automobiles made available to our officers in the aggregate amount of $38,000.

The following table sets forth the approximate aggregate compensation paid by us during the fiscal year ended on December 31, 2005 to all of our directors and officers.


	Cash and Cash-Equivalent Forms of Compensation (in thousands of U.S. $)

2005⁽¹⁾	Salaries, Fees, Directors’ Fees, Commissions and Bonuses	Securities⁽²⁾ or Property, Insurance Benefits or Reimbursements and Personal Benefits

All Directors	245	—
All Officers	1,734	213


(1)	Does not include an increase in provision for vacation in the amount of approximately $30,000.
(2)	See “Share Ownership” under this Item 6 and “Compensation of the Chairman under Item 7- Related Party Transactions.

C.	Board Practices

None of our directors have service contracts with us or any of our group companies providing for benefits upon termination of employment. Two of our directors have consulting agreements with us pursuant to which they provide services to us. See Item “7” – Related Party Transactions”. Compensation of our officers is recommended by our senior management and approved by the board of directors or a committee of the board of directors. Compensation of all other employees is determined by our senior management.

Board of Directors

Our Articles of Association provide for a board of directors of not less than five members and no more than fifteen members, including external directors. Each director, other than external directors, is elected to serve until the end of the first annual meeting following their appointment. However, if no directors are elected at such annual meeting, the then present directors shall continue in office. The board of directors may appoint additional directors, provided that the total number of directors does not exceed the maximum number of fifteen as mentioned above. A director appointed as such shall serve until the end of the next annual meeting held following his or her appointment and he or she shall be eligible for re-appointment. Notwithstanding any of the above, any director, other than external directors, may be removed from office by an ordinary resolution of a general shareholders meeting or by two thirds of the directors. A director need not hold any of our shares to qualify as one of our directors. Our Articles provide that our board of directors may delegate its powers to its committees, subject to limitations determined by the Israeli Companies Law.

Substitute Directors

Our Articles of Association provide that any director may, by written notice to us, appoint another person to serve as a substitute director and may cancel such appointment. The identity of a substitute director requires the approval of the board of directors. Under the Israeli Companies Law, there shall not be appointed as a substitute director, any person who is not himself qualified to be appointed as a director or a person who is already serving as a director or a person who is already serving as a substitute director for another director. Nevertheless, a director may be appointed as a substitute director for a committee of the board of directors if he or she is not already serving as a member of the committee. Under the Israeli Companies Law, there shall not be appointed a substitute director for an external director.

The term of appointment of a substitute director may be for one meeting of the board of directors or for a specified period or until notice is given of the cancellation of the appointment. To our knowledge, no director currently intends to appoint any other person as a substitute director, except if the director is unable to attend a meeting of the board of directors.

External Directors

The Israeli Companies Law requires Israeli companies with shares that have been offered to the public in or outside of Israel (public companies) to appoint two external directors. No person may be appointed as an external director if the person or the person’s spouse, siblings, parents, grandparents, descendants, spouses descendants and the spouses of any of the foregoing (referred to as a relative), partner, employer or any entity under the person’s control, has or had, within the two years preceding the date of the person’s appointment to serve as external director, any affiliation with the company or any entity controlling, controlled by or under common control with the company. The term “affiliation” includes:


	•	an employment relationship;

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

	•	control; and

	•	service as an office holder, as defined below in Item 10, excluding service as a director who was appointed to serve as an external director in a company which is going to initially offer its shares to the public.

	•	No person may serve as an external director if the person’s position or other business activities create, or may create, a conflict of interest with the person’s responsibilities as an external director or may otherwise interfere with the person’s ability to serve as an external director. If, at the time external directors are to be appointed, all current members of the board of directors are of the same gender, then at least one external director must be of the other gender.

Pursuant to a 2005 amendment to the Companies Law, a public company is required to appoint as an external director a person, who has “professional capability” or a person, who has “financial and accounting expertise”, provided that at least one of the external directors shall have “financial and accounting expertise”. In addition, pursuant to the same amendment to the Companies Law, the board of directors of a public company is required to determine the minimum number of directors with “financial and accounting expertise” serving on the board of

directors. The qualifications for “professional capability” and “financial and accounting expertise” are determined by regulations. In March 2006, we determined the minimum number of directors with “financial and accounting expertise” serving on our board of directors to be two. Mr. Goldman and Mr. Asheri are designated as our two directors with financial and accounting expertise.

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


	•	the majority of shares voted at the meeting, including at least one-third of the shares held by non-controlling shareholders, or their representatives, which voted at the meeting, vote in favor of election of the director without taking abstentions into account. According to the Israeli Companies Law, a controlling shareholder is defined as a person who has the ability to direct the activities of a company, other than if this power derives solely from its position on the board of directors or any other position with the company. A person is presumed to be a controlling shareholder if he holds half or more of the following: (1) voting rights in the general meeting, or (2) rights to appoint directors or the Chief Executive Officer; or

	•	the total number of shares held by non-controlling shareholders voted against the election of the director does not exceed one percent of the aggregate voting rights in the company.

The initial term of an external director is three years and may be extended for an additional three years. Both of our external directors are currently serving their respective additional terms, which end in 2007 and 2009, respectively. External directors may be removed only in a general meeting, by the same percentage of shareholders as is required for their election, or by a court, and in both cases only if the external directors cease to meet the statutory qualifications for their appointment or if they violate their duty of loyalty to the company. Each committee of a company’s board of directors must include at least one external director and all of the external directors must be members of the audit committee.

An external director is entitled to compensation in accordance with the regulations adopted under the Israeli Companies Law and is otherwise prohibited from receiving any other compensation, directly or indirectly, in connection with service provided as an external director.

Audit Committee

The Israeli Companies Law requires public companies to appoint an audit committee. The responsibilities of the audit committee include identifying irregularities in the management of the company’s business and approving related party transactions as required by law. An audit committee must consist of at least three directors, including, as mentioned, all of the external directors of the company. The Chairman of the board of directors, any director employed by or otherwise providing services to the company, and a controlling shareholder or any relative of a controlling shareholder, may not be a member of the audit committee.

Our two external directors serve on the audit committee of the board of directors. All members of our audit committee meet the definition of independent directors under the Sarbanes Oxley Act of 2002 and the Nasdaq Marketplace Rules. None of them is an affiliated person of us

or has received any consulting, advisory or other compensatory fee from us, other than in their capacity as directors. Yaacov Goldman is our designated financial expert under the Sarbanes-Oxley Act of 2002.

Internal Auditor

Under the Israeli Companies Law, the board of directors of public companies must appoint an internal auditor, nominated by the proposal of the audit committee. The role of the internal auditor is to examine, among other matters, whether the company’s actions comply with the law and orderly business procedure. Under the Israeli Companies Law, the internal auditor may be an employee of the company but not an office holder (as defined below in Item 10), an interested party, a relative of an office holder or an interested party, and he may not be the company’s independent accountant or its representative. According the Israeli Companies Law, an interested party is defined as a shareholder who holds 5% or more of the outstanding share capital or the voting power, a director, a general manager or a shareholder who has the right to appoint at least one director or the general manager. Doron Cohen of Fahn Kane, a member of Grant Thornton International, is our internal auditor.

Nasdaq Listing Standards

Our ordinary shares are currently listed on the Nasdaq National Market and are subject to the rules and regulations established by Nasdaq as being applicable to listed companies. Rule 4350 imposes various corporate governance requirements on listed securities. Section (a)(1) of Rule 4350 provides that foreign private issuers are required to comply with certain specific requirements of Rule 4350, but, as to the balance of Rule 4350, foreign private issuers may comply with the laws of their home jurisdiction in lieu of the requirements of such sections of Rule 4350.

We have chosen to follow the rules of our home jurisdiction, the Israeli Companies Law, in lieu of the requirements of Section 4350(c) relating to:


	•	independence of the board of directors;

	•	executive sessions of independent directors;

	•	the requirement that compensation of executive officers is to be determined by an independent committee of the board or by the independent members of the board of directors;

	•	the requirement that director nominees must be selected by an independent committee of the board or by the independent members of the board of directors.

The above requirements of Rule 4350 are not required under the Israeli Companies Law.


D.	Employees

All of our employees are located in Israel. The following table sets forth, for the last three financial years, the number of our employees.


Period ended December 31,	2005	2004	2003

Management and Administration	22	22	22

Certain provisions of Israeli employment laws and of Extension Orders based upon provisions of the collective bargaining agreements between the Histadrut (General Federation of Labor in Israel) and the Coordination Bureau of Economic Organizations (including the Industrialists’ Associations) are applicable to employees in Israel by order of the Israeli Ministry of Labor. These provisions concern principally the length of the work day, minimum daily wages for professional workers, insurance for work-related accidents, procedures for dismissing employees, determination of severance pay, and other conditions of employment. We generally provide employees with benefits and working conditions beyond the minimum requirements.

Israeli law generally requires severance pay, which may be funded by Managers’ Insurance described below, upon the retirement or death of an employee or termination of employment without cause (as defined in the law). The payments thereto amount to approximately 8.33% of wages. Furthermore, Israeli employees and employers are required to pay predetermined sums to the National Insurance Institute, which is similar to the United States Social Security Administration. Such amounts also include payments for national health insurance. The payments to the National Insurance Institute are equal to approximately 16.3% of the wages, of which the employee contributes approximately 66% and the employer contributes approximately 34%.

A general practice followed by us and some of our group companies although not legally required, is the contribution of additional funds on behalf of most of the employees to a fund known as Managers’ Insurance. This fund provides a combination of savings plan, insurance and severance pay benefits to the employee, giving the employee a lump sum payment upon retirement and securing the severance pay, if legally entitled, upon termination of employment. The employer decides which employees are entitled to participate in the plan, and each employee who agrees to participate contributes an amount equal to 5% of his or her salary and the employer contributes between 13.3% and 15.8% of the employee’s salary.

Share Ownership

The number of our ordinary shares beneficially owned by each of our directors, and by our directors and officers as a group, as of May 31, 2006, is as follows:


Director	Ordinary Shares

Ami Erel, Chairman⁽¹⁾	10,376	⁽²⁾
Avraham Asheri	0
Prof. Gabi Barbash	0
Ari Bronshtein⁽¹⁾	0
Prof. Yair Be’ery	0
Nochi Dankner⁽¹⁾	0
Avraham Fischer⁽¹⁾	0
Yaacov Goldman	0
Shay Livnat⁽¹⁾	0
Dori Manor⁽¹⁾	0
Prof. Daniel Sipper	0
All officers and directors as a group	171,866	⁽³⁾


(1)	Director or officer of DIC, IDBD or IDBH. Ownership excludes shares beneficially owned by these companies.

(2)	Consists solely of options to purchase our ordinary shares, based on our share price as of May 31, 2006. See below Series 9 and Series 11 under “Stock Option Plans”.

(3)	Includes options to purchase 170,626 of our ordinary shares currently exercisable or exercisable within 60 days of May 31, 2006.

Stock Option Plans

As of May 31, 2006, 451,551 options to purchase our ordinary shares granted to our officers and employees were outstanding. Details concerning these options are as follows:

Series 9 Options

The Chairman of our board of directors was granted options to purchase 58,154 of our ordinary shares (the “Series 9 Options”). The Series 9 Options were granted ratably over a period of three years commencing on February 2000 and are exercisable for a period of three years, commencing two years after the date of grant. Series 9 Options to purchase 38,768 of our ordinary shares, granted in February 2000 and 2001, have since expired.

The per share exercise price of the Series 9 Options granted in February 2002 is $10.01. Upon exercise of the Series 9 Options, the option holder is granted a number of shares reflecting the benefit component of the options exercised, as calculated at the exercise date.

Series 10 Options

There are outstanding options to purchase an aggregate of 25,000 of our ordinary shares which are held by two of our officers (the “Series 10 Options”). The Series 10 Options are exercisable at a price of $29.38 per share. The optionholders are entitled to exercise 25% of the amount granted, each year, starting in October 2001. The Series 10 Options will expire in October 2007.

Series 11 Options

The Chairman of our board of directors was granted options to purchase 58,000 of our ordinary shares (the “Series 11 Options”). The Series 11 Options were granted ratably over a period of three years commencing in June 2001 and are exercisable for a period of three years, commencing two years after the date of grant. The first amount of 19,333 Series 11 Options was granted in June 2001 and expired in June 2006. The second amount of 19,333 Series 11 Options was granted in June 2002 and were exercised in December 2004 into 8,623 shares based upon a per share exercise price of $8.337. The third amount of 19,334 Series 11 Options was granted in June 2003. The per share exercise price of the Series 11 Options granted in June 2003 is $5.437.

Upon exercise of the Series 11 Options, the option holder is granted a number of shares reflecting the benefit component of the options exercised, as calculated at the exercise date.

Series 12 Options

There are outstanding options to purchase an aggregate of 24,000 of our ordinary shares held by one of our officers (the “Series 12 Options”). The Series 12 Options are exercisable at a price per share of $18.87 per share. The officer is entitled to exercise 25% of the amount granted each year, starting in February 2002. The Series 12 Options will expire in June 2008.

2003 Option Plan

During May 2003, our Board of Directors adopted the 2003 Option Plan which was subsequently ratified by our shareholders on November 30, 2003. Under this plan, options to purchase an aggregate of up to 500,000 ordinary shares may be granted. The 2003 Option Plan provides that the exercise price per share shall be reduced by an amount equal to the amount of any dividend per share distributed. The optionees are entitled to exercise 25% of the amount granted, each year, commencing on the date of grant and expiring five years later. In granting the options, the Board of Directors selected the capital gains tax track pursuant to the new tax reform legislation which came into effect on January 1, 2003. For more details see Item 10 – “Taxation” – “Employee Stock Options.”

The following options were granted by during the period May 2003 to March 2006 and remain outstanding:


Date of Grant	Aggregate No. of Options		Aggregate No. of Options Granted to Officers (or former Officers)			Exercise Price

May 2003		199,500		175,000		$	5.00	(i)
December 2004		20,000		20,000		$	9.41	(i)
July 2005		40,000		40,000		$	7.84	(i)
November 2005		80,000		55,000	(ii)	$	9.12
March 2006		5,000		—		$	9.05


	(i)	Exercise price reduced as a result of $3.00 dividend per share distributed in September 2005.

	(ii)	30,000 options were issued under Section 3(i) of the Israeli Income Tax Ordinance due to the classification of the optionee as a “controlling person” under the Income Tax Ordinance. These options are still subject to shareholder approval. (For more details – see Item 10 – “Taxation” – Employee Stock Options.”)

Options of certain officers to acquire shares in our private group companies

During 2001, the Board of Directors approved the grant of options to certain of our officers to acquire between 1% and 2% of our investments in certain private companies. The options are exercisable at the weighted average price of our investments. The options vest ratably over a three year period and are exercisable for an additional three years. These options are in addition

to those granted to our Chairman, Mr. Ami Erel. See Item 7 – “Major Shareholders and Related Party Transactions - Compensation of Chairman.”

Item 7. Major Shareholders and Related Party Transactions


A.	Major Shareholders

The following table sets forth, as of May 31, 2006, unless otherwise specified, the number of ordinary shares beneficially owned by all shareholders known to us to beneficially own more than 5% of our ordinary shares. The voting rights of our major shareholders do not differ from the voting rights of other holders of our ordinary shares. As of May 12, 2006, there were a total of 526 holders of record of our ordinary shares, of which 416 were registered with addresses in the United States. We believe that the number of beneficial owners is substantially greater than the number of record holders, because a large portion of our common stock is held of record in broker “street names.” United States holders of record held approximately 11% of our then outstanding ordinary shares.


Name and Address	Number of Ordinary Shares	Percent of Ordinary Shares

Discount Investment Corporation Ltd. (1) Tel Aviv, Israel	14,048,613	47.6	%

Clal Insurance Group (2) Tel Aviv, Israel	109,972	0.4	%
All Officers and Directors as a group (3)	171,866	0.6	%

(1) IDBH is the parent of IDBD, which, in turn, is the parent of DIC and Clal Insurance Enterprise Holdings Ltd. (“Clal”). IDBH, IDBD, DIC and Clal are public companies traded on the Tel Aviv Stock Exchange.

As of May 31, 2006, approximately 51.7% of the outstanding share capital of IDBH was owned by a group comprised of: (i) Ganden Investments I.D.B. Ltd. (“Ganden Investments”), a private Israeli company controlled by Nochi Dankner and his sister, Shelly Bergman, which held 31.02% of the equity of and voting power in IDBH; (ii) Manor Investments-IDB Ltd. (“Manor Investments”), a private Israeli company controlled by Ruth Manor, which held 10.37% of the equity of and voting power in IDBH; and (iii) Avraham Livnat Investments (2002) Ltd. (“Livnat Investments”), a private Israeli company controlled by Avraham Livnat, which held 10.34% of the equity of and voting power in IDBH. Ganden Investments, Manor Investments and Livnat Investments, owning in the aggregate approximately 51.7% of the equity of and voting power in IDBH, entered into a Shareholders Agreement relating, among other things, to their joint control of IDBH, the term of which is until May 19, 2023 (“IDB Shareholders Agreement”). Ganden Investments, Manor Investments and Livnat Investments pledged their shares of IDBH to a financial institution as collateral for the repayment of loans borrowed to purchase such shares.

In addition, as of May 31, 2006, (i) Ganden Holdings Ltd. (“Ganden Holdings”), another private Israeli company controlled by Nochi Dankner and his sister, Shelly Bergman, which is the parent company of Ganden Investments, held directly approximately 11.38% of the equity and voting power of IDBH, (ii) Ganden Investments additionally held directly approximately 6.71% of the equity in IDBH, (iii) Shelly Bergman held, though a wholly owned company, approximately 7.23% of the equity of and voting power in IDBH, (iv) another private Israeli company controlled by Ruth Manor, which is the parent company of Manor Investments, held approximately 0.03% of the equity and voting power in IDBH and (v) another private Israeli company controlled by Avraham Livnat, which is the parent company of Livnat Investments, held approximately 0.04% of the equity and voting power in IDBH. Substantially all of the additional shares of IDBH set forth in (i) and (ii) above held directly by Ganden Holdings and Shelly Bergman’s wholly owned company, were acquired with borrowed funds and are pledged to each respective shareholder’s lending institution. None of the shares set forth in (i) –(v) above are subject to the IDB Shareholders Agreement.

Ganden Investments, Manor Investments and Livnat Investments have pledged their shares of IDBH in favor of certain financial institutions as collateral for the repayment of certain loans borrowed by them in order to finance part of the consideration paid for the shares of IDBH purchased by them. The lenders may realize these pledges in certain events described in the agreements with such financial institutions.

Nochi Dankner is Chairman of IDBH, IDBD and DIC and a director of Clal and Elron. Zehava Dankner (the mother of Nochi Dankner) is a director of IDBH, IDBD and DIC and Clal. Zvi Livnat (a son of Avraham Livnat) is a director of IDBH, IDBD and DIC. Shay Livnat (a son of Avraham Livnat) is a director of IDBD and Elron. Isaac Manor (the husband of Ruth Manor) is a director of IDBH, IDBD, DIC and Clal and Dori Manor (the son of Isaac and Ruth Manor) is a director of IDBH, IDBD, DIC and Elron.

DIC’s address is 3 Azrieli Center, 44th floor, Tel Aviv 67023, Israel.

(2) The Clal Insurance Group is comprised of Clal and its subsidiary companies, which are deemed to be major shareholders of the Company. Clal is majority owned by IDBD, the parent company of DIC, which in turn is a controlling shareholder of the Company. As of May 31 2006, the other major shareholder of Clal was Bank Hapoalim, which held approximately 17.53% of Clal’s shares (including holdings of mutual and provident funds that are controlled by Bank Hapoalim B.M.). None of the remaining shareholders of Clal held more than 5% of its shares.

The Clal Insurance Group’s address is 48 Menachem Begin Rd., Clal Development Bldg., Tel Aviv, Israel.

(3) This amount includes 170,626 shares underlying options that are currently exercisable or that will become exercisable within 60 days of May 31, 2006. This amount does not include any shares that may be deemed to be beneficially owned by directors by virtue of their affiliation with DIC.


B.	Related Party Transactions

Directors’ Compensation

In 2006, we agreed to grant compensation to each of our external directors and to one of our other directors not employed by DIC or IDBH equal to the maximum compensation permitted under the Companies Law and Regulations for a dual listed company, namely NIS112,008 (approximately $25,000) per director and up to NIS3,360 (approximately $750) per director for participation in each meeting of the board of directors or any committee thereof, in each case, adjusted to the Israeli Consumer Price Index from time to time. With respect to the remaining directors, in 2006, and with respect to all the directors, in each of the fiscal years 2004 and 2005 respectively, we agreed to grant compensation, according to the amount then permitted according to the Israeli Companies Regulations (Rules Regarding Compensation and Expenses for an External Director), 2000 (the “External Director Regulations”), for companies of the same classification in relation to its shareholder’s equity, which were as of May 31, 2006, in addition to reimbursement of expenses, approximately NIS 47,320 (approximately $10,500) per director for one year and in addition approximately NIS 1,820 (approximately $400) per director for participation in each meeting of the board of directors or any committee thereof.

Consulting Agreements with Directors

On March 12, 2006, following the approval of the Audit Committee and the Board of Directors, our shareholders approved a consulting agreement with Prof. Yair Beery with effect from January 1, 2005 until December 31, 2006 pursuant to which Prof. Beery provides services to us and our group companies in consideration for $5,000 per month.

In May 2006, the Audit Committee and the Board of Directors approved a consulting agreement with Prof. Gabi Barbash with effect from January 1, 2006 until December 31, 2006 pursuant to which Prof. Barbash provides services to us and our group companies in consideration for $5,000 per month. The agreement with Prof. Barbash is subject to shareholders approval. The matter will be presented to shareholders at our annual meeting to be held later this year.

Compensation of the Chairman

Mr. Ami Erel has options to acquire up to 1.5% of any shares or other securities acquired by us in Wavion, Inc. and up to 0.75% of any shares or other securities acquired by us and through DEP in Galil Medical Ltd. (each an “Invested Company”) (together, the “Option”). The Option shall be exercisable at the weighted average price of investments made by us with respect to any such Invested Company until the date of exercise of the Option. The Option shall be exercisable for a period of three years commencing on the later of January 1, 2000 or the date of the latest investment by us in the relevant Invested Company, provided that at the time of the Option exercise Mr. Erel is a director or an employee of ours and that we have not sold or otherwise transferred to a third party our securities in the relevant Invested Company.

Mr. Erel shall be entitled to participate in a sale by us of shares which were, or are, subject to Mr. Erel’s Option hereunder, by selling the same proportion of his shares along with us. We may require Mr. Erel to sell such shares together with a sale of shares by us. Sales by Mr. Erel of

shares acquired upon exercise of the foregoing Options, which are not publicly traded, will require our approval. To date, none of the foregoing options have been exercised.

Investments in and loans to Galil Medical Ltd.

From January 1, 2005 through May 31, 2006, we, our subsidiary RDC, and DIC invested in and provided loans to Galil Medical.

These transactions were approved by our Audit Committee and our Board of Directors due to DIC’s participation in the transactions.

Grant of Letters of Exemption and Indemnification

In 2001, following the approval of our audit committee, board of directors and shareholders, and in accordance with the provisions of the Companies Law, we granted letters of indemnification to our directors and officers. The aggregate indemnification shall not exceed 25% of our shareholders equity according to our consolidated financial statements for the year ended December 31, 2000, for all persons and cases to be indemnified. In addition, we undertook to exempt our directors and officers, to the extent permitted by law, from any liability towards us for any damage caused or that may be caused to us by them, if caused or that may be caused following a breach of their duty of care towards us. We continue to grant letters of indemnification and exemption to our directors and officers in accordance with the above terms.

Directors and Officers Insurance Policy

In April 2005, following the resolution and recommendation of our Audit Committee and Board of Directors, our shareholders approved and ratified the purchase of a directors’ and officers’ liability insurance policy (the “Policy”) for our directors and officers from Clal Insurance Company Ltd., a related party and separately approved the application of the Policy to Dori Manor, one of our directors, and any future director or officer of the Company who may currently be considered a “Controlling Shareholder” under the Companies Law, 1999. The principal terms of the Policy are as follows:


	(1)	The Policy was for a period beginning on January 1, 2005 and ending on June 30, 2006.

	(2)	The coverage under the Policy was limited to $30 million per claim and in the aggregate during the Policy period.

	(3)	The annual premium to be paid with respect to the Policy was approximately $475,000.

In addition, our shareholders approved: (i) any renewal and/or extension of the Policy for all our directors and officers; and (ii) the purchase of any other directors’ and officers’ liability insurance policy for our directors and officers upon the expiration of the Policy; provided that any such renewal, extension or purchase referred to in clauses (i) and (ii) above is for the benefit of our previous and/or current and/or future directors and officers and on terms substantially similar to those of the Policy; and that the premium will not increase by more than 25% in any year, as compared to the previous year.

We expect to renew the Policy by June 30, 2006.

Voting Agreement with DIC regarding Given Imaging

On September 29, 2003, we and DIC entered into a voting agreement pursuant to which, among other things, DIC agreed to vote all of its ordinary shares in favor of nominees to the board of directors of Given Imaging proposed by us. The voting agreement is for a term of one year and renews automatically each year thereafter unless terminated by notice of either party to the other party no later than August 30 in each year. By virtue of this agreement, we may be deemed to beneficially own the shares held by DIC in Given Imaging, which together with the shares of Given Imaging which we hold directly as well as those held by RDC, represents approximately 36% of the outstanding shares of Given Imaging. This agreement was approved by our Audit Committee and our Board of Directors.

Voting Agreement with Infinity regarding Teledata

On May 8, 2005, as part of our investment in Teledata, we and Infinity, a related venture capital fund, entered into a voting agreement pursuant to which we agreed to vote in concert with each other at meetings of shareholders of Teledata. Clal, a subsidiary of IDBD, is the largest limited partner of Infinity. DIC, our largest shareholder, is also a subsidiary of IDBD. This agreement was approved by our Audit Committee and our Board of Directors as part of our investment in Teledata.

Voting Agreement with Infinity regarding Brainsgate

On July, 2005, as part of our investment in BrainsGate, we and Infinity entered into a voting agreement pursuant to which we agreed to vote in concert with each other at meetings of shareholders of BrainsGate. This agreement was approved by our Audit Committee and our Board of Directors as part of our investment in BrainsGate.

Shareholders Agreement with DIC regarding NetVision

On May 10, 2005, immediately prior to the NetVision initial public offering, we and DIC entered into a shareholders agreement pursuant to which we and DIC agreed to vote all of our shares in favor of our respective nominees to the board of directors of NetVision. In addition, under the agreement, we and DIC have rights of first refusal and co-sale rights on the sale of our respective shares subject to and in accordance with the mechanisms set forth in the agreement. The agreement shall terminate upon the earlier of our mutual consent or either us or DIC holding less than 10% of NetVision. This agreement was approved by our Audit Committee and our Board of Directors.


C.	Interests of Experts and Counsel

Not Applicable.

Item 8. Financial Information


A.	Consolidated Statements and Other Financial Information

Our consolidated financial statements and other financial information are incorporated herein by reference to Item 18 below.

Legal Proceedings

Gesser Claim

On September 8, 1999, we received a copy of a statement of claim, along with a court order requiring a motion to approve this claim as a class action, submitted by David Gesser, a shareholder of Elscint Ltd., or Elscint, The motion requests that this claim be approved as class action instead of the previous claim submitted by Yonatan Aderet. This claim names as defendants Elscint, Elbit, our company, and Emmanuel Gill, Uzia Galil, Dov Tadmor, Micha Angel and Yigal Baruchi, former directors of Elscint, and Yonatan Aderet, the former President and director of Elscint. The motion was submitted by the applicant on behalf of all existing shareholders of Elscint who held Elscint’s shares on February 18, 1999. The plaintiff seeks damages of approximately $158.0 million.

The claim alleges that the defendants, by their decisions regarding the sale of Elscint’s assets, caused damage to Elscint and its minority shareholders. The plaintiff seeks a court order requiring Elscint, or the other defendants, to purchase from each of the members of the represented class all shares held by them at a price of $27.46 per share. The lawsuit has been suspended pursuant to an arrangement reached by the parties pending the outcome of the appeal in the Investors claim described below. The arrangement provides that if the appeal as described in the “Investors Claim” immediately below is accepted, then the proceedings to recognize the lawsuit as a class action will proceed. Otherwise, the application to recognize the claim as a class action suit will be dismissed.

Investors Claim

On November 2, 1999, we received a statement of claim and an application to claim as a class action against Europe Israel (M.M.S.) Ltd. (EIL), Elbit Medical Imaging, Elscint, Control Centers Ltd. (the controlling shareholder of EIL), Marina Herzliya Limited Partnership 1988 (which is controlled by Control Centers) and against us and 25 past and present officers of the above companies, including our officers.

The claim was submitted by a number of investors and others, who hold shares in Elscint, while the application to approve the claim as a class action was submitted on behalf of shareholders who held shares in Elscint on September 6, 1999 and continued to hold such shares on the date of application, excluding the respondents.

The allegations, which the claimants raised against us and our officers, relate to the period prior to the sale of our holdings in Elbit Medical Imaging to EIL. These allegations include, among others, that (i) we and our officers gave preference to the interests of our company and the personal interests of our officers over the interests of Elscint and its minority shareholders; (ii) we and our officers did not act in order to enable the minority shareholders of Elscint to participate in the proceeds of the sale of Elscint’s assets; and (iii) general allegations against the

transactions whereby we sold our holdings in Elbit Medical Imaging to EIL. Further allegations were raised against the other respondents.

The plaintiffs seek a court order pursuant to which Elbit Medical Imaging would be compelled to execute the alleged buy-out of shares at $14 per share. Alternatively, the claimants have requested additional remedies set forth in the statement of claim, including a remedy requested also from us and our officers regarding compensation for the damages that they allege were suffered by them and/or by Elscint. Certain of the remedies have been requested also as derivative claims on behalf of Elscint. The maximum liability in this claim is not specified by the plaintiffs.

On August 16, 2000, the Haifa District Court dismissed the application to recognize the claim as a class action. Some of the claimants requested and were granted permission to appeal to the Supreme Court of Israel. The appeal to the Supreme Court is still pending. In addition, the claimants submitted an amended claim in February 2001, which was not recognized as a class action suit. The allegations are similar to those in the previous claim. It has not yet been determined when the defendants are required to file their statements of defense to the claim. The claimants and the defendants are currently involved in various proceedings, primarily involving a disagreement concerning the court fees.

We deny all the allegations set forth in the above claims and are defending and intend to continue defending against such claims.

Other than the above matters, we are not a party to any material litigation.

Dividend Policy

Currently we do not have any fixed dividend policy. The declaration of dividends is determined by the board of directors taking into consideration our financial status, profitability, realization of assets and our investment requirements. In September 2005, we distributed a dividend of $3.00 per share, or approximately $88.5 million in the aggregate.


B.	Significant Changes

Except as otherwise disclosed in this Annual Report, no significant change has occurred since December 31, 2005.

Item 9. The Offer and Listing


A.	Offer and Listing Details

Markets and Share Price History

Our ordinary shares are traded on the Nasdaq National Market, where our shares are listed and traded under the symbol “ELRN”. Our shares are also traded on the Tel Aviv Stock Exchange (TASE) in Israel. The following table sets forth, for the periods indicated, the high and low reported sales prices of our Ordinary Shares on the Nasdaq National Market and, in New Israeli Shekels (NIS), on the Tel Aviv Stock Exchange, which reflect the distribution of a dividend of $3.00 per share in 2005:


	NASDAQ	NASDAQ
Period	High (US dollars)	Low (US dollars)	TASE High (NIS)	TASE Low (NIS)

2001	20.44	8.37	86.26	41.12
2002	11.77	4.37	54.24	23.40
2003	9.06	3.91	42.53	20.09
First Quarter 2004	11.23	9.2	53.59	43.55
Second Quarter 2004	11.64	9.86	55.70	48.86
Third Quarter 2004	11.85	10.57	56.82	51.46
Fourth Quarter 2004	12.09	9.875	56.30	46.94
First Quarter 2005	13.09	11.51	60.05	54.11
Second Quarter 2005	12.82	9.92	58.68	47.93
Third Quarter 2005	11.55	9.61	55.04	46.52
Fourth Quarter 2005	11.74	9.8	54.01	46.41
December 2005	11.74	10.63	54.01	48.72
January 2006	11.64	10.79	54.19	48.77
February 2006	11.47	10.55	52.37	49.42
March 2006	11.09	10.4	52.01	49.33
April 2006	11.25	10.76	50.81	49.30
May 2006	12.2	10.39	54.04	46.38

B. Plan of Distribution

Not Applicable.

C. Markets

As noted above, our Ordinary Shares are traded on the Nasdaq National Market under the symbol “ELRN”. Our shares are also traded on the Tel Aviv Stock Exchange in Israel.

D. Selling Shareholders

Not Applicable.

E. Dilution

Not Applicable.

F. Expenses of the Issue

Not Applicable.

Item 10. Additional Information

A Share Capital

Not Applicable

B. Memorandum and Articles of Association

Articles of Association; Israel Companies Law

Our shareholders approved the adoption of our Articles of Association in March 2001. The objective of Elron as stated in our Articles and in our Memorandum of Association is to engage in any lawful activity.

We have currently outstanding only one class of securities, our ordinary shares, par value NIS 0.003 per share. No preferred shares are currently authorized.

Holders of ordinary shares have one vote per share, and are entitled to participate equally in the payment of dividends and share distributions and, in the event of our liquidation, in the distribution of assets after satisfaction of liabilities to creditors. According to our Articles, any modification of the Articles requires the approval of a special majority at a general meeting. A special majority is defined in our Articles as at least a majority of 67% of the shareholders who voted at the general meeting, without taking abstaining votes into account.

The Israeli Companies Law and our Articles require that we hold our annual general meeting of shareholders each year no later than 15 months from the last annual meeting, at a time and place determined by the board of directors, upon at least 21 days prior notice to our shareholders. Under the Israeli law and regulations and our Articles of Association, notice of the meeting is required to be published in two widely distributed daily newspapers published in Hebrew and to be sent to shareholders whose names appear in the shareholders register if their registered shares are not in Israel. Commencing April 2, 2006, The Companies Law requires us to issue a voting instrument in order to enable shareholders to vote through a voting instrument, if certain matters are on the agenda of the meeting. No business may be commenced until a quorum of two or more shareholders holding at least one third of the voting rights are present in person or by proxy. The Israeli Companies Law provides that the record date for the participation of shareholders of a company whose shares are traded or registered outside of Israel such as us may be no more than 40 but no less than 4 days prior to the meeting, provided that notice for said meeting is given prior to the record date. Resolutions regarding the following matters must be passed at a general meeting of shareholders:


	•	amendments to our Articles and Memorandum of Association;

	•	appointment or termination of our auditors;

	•	appointment and dismissal of directors;

	•	approval of interested party actions and transactions requiring general meeting approval as provided in sections 255 and 268 to 275 of the Israeli Companies Law;

	•	increase or reduction of our authorized share capital and alterations of our share capital;


	•	a merger as provided in section 320 of the Israeli Companies Law;

	•	the exercise of the board of directors’ powers by a general meeting, if the board of directors is unable to exercise its powers and the exercise of any of its powers is vital for our proper management, as provided in section 52(a) of the Israeli Companies Law; and

	•	any matter that is required to be adopted by resolution of a general meeting pursuant to the Israeli Companies Law or in accordance with our Articles.

An extraordinary meeting of our shareholders shall be convened by the decision of the board, or at the request of any two directors or one quarter of the officiating directors, or by request of one or more shareholders holding at least 5% of the voting rights in our company. Shareholders requesting an extraordinary meeting must submit their proposed resolution with their request. Within 21 days of receipt of the request, the board must convene an extraordinary meeting and send out notices setting forth the date, time and place of the meeting. Such notice must be given at least 21 days, but not more than 35 days, prior to the extraordinary meeting.

The Israeli Companies Law codifies the fiduciary duties and duty of care that office holders owe to a company. An office holder, is defined in the Israeli Companies Law, as a (i) director, (ii) general manager, (iii) chief business manager, (iv) deputy general manager, (v) vice general manager, (vi) executive vice president, (vii) vice president, (viii) another manager directly subordinate to the general manager or (ix) any other person assuming the responsibilities of any of the forgoing positions without regard to such person’s title. Each person listed in the table under “Directors and Senior Management” in Item 6 above is an office holder.

The Israeli Companies Law requires that an office holder of a company promptly disclose, and no later than the first board meeting in which such transaction is discussed, any personal interest that he or she may have and all related material information known to him or her, in connection with any existing or proposed transaction by the company. In addition, if the transaction is an extraordinary transaction, the office holder must also disclose any personal interest held by the office holder’s relative. An extraordinary transaction is defined as a transaction not in the ordinary course of business, not on market terms, or that is likely to have a material impact on the company’s profitability, assets or liabilities.

In the case of a transaction in which an officer has a personal interest that is not an extraordinary transaction, after the office holder complies with the above disclosure requirement, board approval is required unless the Articles of Association of the company provide otherwise. Our Articles of Association provide that a transaction with one of our office holders or a transaction, in which an office holder has a personal interest which, in each case, is not regarded as an extraordinary transaction, requires the approval of the board or the audit committee or by such other organ empowered by the board for such purpose. If the transaction in which an officer has a personal interest is an extraordinary transaction, then, it must also be approved by the audit committee and by the board of directors.

Agreements regarding directors’ terms of employment require the approval of audit committee, the board of directors and the shareholders. In all matters in which a director has a personal interest, including matters of his/her terms of employment, he/she shall not be permitted to vote on the matter or be present in the meeting in which the matter is considered. However,

should a majority of the audit committee or of the board of directors have a personal interest in the matter then:


	a)	all of the directors shall be permitted to vote on the matter and attend the meeting in which the matter is considered; and

	b)	the matter requires approval of the shareholders at a general meeting.

According to the Israeli Companies Law, the disclosure requirements discussed above also apply to a controlling shareholder of a public company. The term “controlling shareholder” for these purposes also includes shareholders that hold 25% or more of the voting rights if no other shareholder owns more than 50% of the voting rights in the company. In general, extraordinary transactions with a controlling shareholder or in which a controlling shareholder or his relative has a personal interest, and agreements relating to employment and compensation terms of a controlling shareholder require the approval of the audit committee, the board of directors and the shareholders of the company.

Such shareholder approval must either include at least one-third of the shares held by disinterested shareholders who participate in the vote (without taking abstaining votes into account), or, alternatively, the total shareholdings of the disinterested shareholders who vote against the transaction must not represent more than one percent of the voting rights in the company. Under specified circumstances, such shareholder approval is not required.

Under the Israeli Companies Law, if a private placement: (1) will entail 20% or more of the voting rights of a company prior to the placement, and all or part of the private placement consideration is not in cash or in public traded securities or is not upon market terms and if as a result of the private placement the holdings of substantial shareholder shall increase or result in a person becoming a substantial shareholder, or (2) result in a person becoming a controlling shareholder, then the allotment must be approved by the board of directors and by the shareholders of the company. A “substantial shareholder” is defined as a shareholder that holds 5% or more of the company’s outstanding share capital, assuming the exercise of all of the securities convertible into shares held by that person. In order for the private placement to be on “market terms” the board of directors has to determine, on the basis of a detailed examination, that the private placement is on market terms, unless proved otherwise. Any placement of securities that does not fall within the above description may be issued at the discretion of the board of directors.

Under the Israeli Companies Law, a shareholder has a duty to act in good faith towards the company and other shareholders when exercising his rights and refrain from abusing his power in the company, including, among other things, voting in the general meeting of shareholders on the following matters:


	•	any amendment to the Articles of Association;

	•	an increase of the company’s authorized share capital;

	•	a merger; or

	•	approval of interested party acts and transactions that require general meeting approval as provided in sections 255 and 268 to 275 of the Israeli Companies Law.

In addition, any controlling shareholder, any shareholder who knows that it possesses power to determine the outcome of a shareholder vote and any shareholder who has the power to appoint or prevent the appointment office holder in the company is under a duty to act with fairness towards the company. The Israeli Companies Law does not describe the substance of this duty. The Israeli Companies Law requires that specified types of transactions, actions and arrangements be approved as provided for in a company’s articles of association and in some circumstances by the audit committee, by the board of directors and by the general meeting of the shareholders. The vote required by the audit committee and the board of directors for approval of these matters, in each case, is a majority of the directors participating in a duly convened meeting.


C.	Material Contracts

	1.	*Deed of Transfer for Sale of Shares of Elbit Systems*

	On July 28, 2004, we signed a deed of transfer to sell all of our holdings in Elbit Systems, constituting approximately 19.6% of the outstanding share capital of Elbit Systems, to the Federmann group, for approximately $196.6 million.

	2.	*Sale of shares of Partner*

		Buyback

On April 20, 2005 we completed the sale to Partner of 12,765,190 Partner shares for approximately $94 million, as part of the sale together with the other Israeli founding shareholders of Partner of an aggregate of approximately 33.3 million Partner shares to Partner for an aggregate consideration of approximately $245 million, pursuant to the terms of an irrevocable offer letter February 7, 2005. Under the terms of the offer letter, we, Polar Communications Ltd. (“Polar”) and Eurocom Communications Ltd. (“Eurocom”), offered to sell to Partner, severally and not jointly, all of our respective Ordinary Shares, for aggregate consideration of between NIS 984.6 million ($225.2 million) and NIS 1.02 billion ($233.6 million) (the “Buyback”). Matav Investments Ltd. (“Matav”), the remaining Israeli founding shareholder, had the option to participate in the Buyback which it exercised. The sale price formula of the Buyback reflected a 10% discount from the 20-trading day volume weighted average market price of the Partner ordinary shares on the Tel Aviv Stock Exchange prior to the meeting of Partner shareholders in which the Buyback is approved, up to a maximum price of NIS 32.22 per share ($7.37 based on the applicable exchange rate of NIS 4.372 per $1.00) but not below NIS 31.04 per share ($7.10 based on such exchange rate). The sale was completed at the maximum price per share.

Restatement of Relationship Agreement

On April 20, 2005, in connection with the completion of the Buyback, we, the other Israeli founding shareholders, Eurocom, Polar and Matav (the “Israeli Shareholders”) together with Advent Investments Pte Ltd. and Hutchison Telecommunications International (Netherlands) B.V., entered into the Restated Relationship Agreement, which replaced the Relationship Agreement dated October 10, 1999 among the parties.

The Restated Relationship Agreement requires the Israeli Shareholders, severally but not jointly, based on their respective holdings in Partner as of April 20, 2005, to hold a sufficient number of Partner ordinary shares to comply with the minimum aggregate holdings by Israeli entities required under Partner’s license and articles of association (the “Required Israeli Percentage”). The Required Israeli Percentage is currently 5% of the outstanding share capital of Partner. The number of Partner ordinary shares required to be held by the Israeli Shareholders to maintain the Required Israeli Percentage is calculated based on the number of Partner ordinary shares outstanding from time to time up to a maximum of 160,922,344 ordinary shares outstanding, as adjusted to reflect stock splits, stock dividends and similar changes that apply to all the ordinary shares.

The Restated Relationship Agreement also requires the Israeli Shareholders to transfer such ordinary shares that are subject to the holding requirement of Required Israeli Percentage (the “Restricted Shares”) only in accordance with the transfer limitations provided by Partner’s license and articles of association.

In addition, pursuant to the Restated Relationship Agreement, the Israeli Shareholders undertook to appoint and retain the number of Israeli directors of Partner that are required pursuant to applicable law (including its license and articles of association) to be appointed and retained by Israeli Shareholders (the “Israeli Director(s)”). Partner’s license currently requires that at least 10% of its directors be Israeli Directors, but one Israeli director is sufficient so long as there are fewer than 15 directors. Based on the current size of Partner’s board of directors, which is comprised of 13 directors, one Israeli Director is currently required.

On March 21, 2006, pursuant to our purchase of Polar’s shares in Partner, we joined the Restated Relationship Agreement in place of Polar.

Shareholders Agreement

On April 20, 2005, we together with the other Israeli Shareholders also entered into a shareholders agreement. The shareholders agreement sets forth the mechanism for appointing the Israeli Director(s). Specifically, the Israeli Director(s) will be appointed on a rotation basis. Subsequently, this agreement was amended to provide that we will not participate in the rotation. On March 21, 2006, pursuant to our purchase of Polar’s shares in Partner, we joined the shareholders agreement in place of Polar.


D.	Exchange Controls

The Israeli Currency Control Law, 1978 imposes certain limitations concerning foreign currency transactions and transactions between Israeli and non-Israeli residents, which limitations may be regulated or waived by the Controller of Foreign Exchange at the Bank of Israel, through “general” and “special” permits. In May 1998, a new “general permit” was issued pursuant to which substantially all transactions in foreign currency are permitted. Any dividends or other distributions paid in respect of ordinary shares and any amounts payable upon our dissolution, liquidation or winding up, as well as the proceeds of any sale in Israel of our securities to an Israeli resident are freely repatriable into non-Israeli currencies at the rate of exchange prevailing at the time of conversion, provided that Israeli income tax has been paid on (or withheld from) such payments.


E.	Taxation

General

The following is a summary of the material provisions of the current tax law applicable to companies in Israel, with special reference to its effect on us and our group companies. The following also contains a discussion of material Israeli tax consequences to our shareholders and government programs from which we and some of our group companies benefit. To the extent that the discussion is based on tax legislation that has not been subject to judicial or administrative interpretation, we cannot assure you that the views expressed in the discussion will be accepted by the tax authorities in question.

The discussion is not intended, and should not be construed, as legal or professional tax advice and is not exhaustive of all possible tax considerations.

Israeli Tax Reform

In July 2002, the Israeli Parliament approved a law enacting extensive changes to Israel’s tax law (the “Tax Reform Legislation”) generally effective January 1, 2003. Among the key provisions of the Tax Reform Legislation are (i) changes which may result in the imposition of taxes on dividends received by an Israeli company from its foreign subsidiaries; and (ii) the introduction of the “controlled foreign corporation” concept according to which an Israeli company may become subject to Israeli taxes on certain income of a non-Israeli subsidiary if the subsidiary’s primary source of income is passive income (such as interest, dividends, royalties, rental income or capital gains). An Israeli company that is subject to Israeli taxes on the income of its non-Israeli subsidiaries will receive a credit for income taxes paid/withheld or will be paid/withheld by the subsidiary in its country of residence, according to the terms and conditions determined in the Israeli Tax Ordinance.

On July 25, 2005, the Israeli Knesset (Parliament) approved a significant amendment which came into effect on January 1, 2006. This amendment includes, among others, changes in the capital markets tax rate.

General Corporate Tax Structure

Israeli companies are generally subject to company tax at the rate of 34% (31% in 2006, 29% in 2007 and 27% in 2008, 26% in 2009 and 25% in 2010 and thereafter) of taxable income. However, the effective tax rate payable by a company that derives income from an Approved Enterprise (as further discussed below) may be considerably less, or the same in 2010.

Law for the Encouragement of Capital Investments, 1959

From time to time, certain operations of our group companies have been granted Approved Enterprise status under the Law for the Encouragement of Capital Investments, 1959, as amended, or the Investment Law.

The Investment Law provides that a capital investment in eligible facilities may, upon application to the Investment Center of the Ministry of Industry and Trade of the State of Israel, or the Investment Center, be designated as an Approved Enterprise. Each certificate of approval

for an Approved Enterprise relates to a specific investment program delineated both by its financial scope, including its capital sources, and by its physical characteristics, e.g., the equipment to be purchased and utilized pursuant to the program. The tax benefits derived from any such certificate of approval relate only to taxable income attributable to the specific Approved Enterprise.

Taxable income of a company derived from an Approved Enterprise is subject to company tax at the rate of up to 25% (rather than 34%, in 2005, as stated above) for a period of time termed the benefit period. The benefit period is a period of seven years commencing with the year in which the Approved Enterprise first generated taxable income. The benefits may be shorter as it is limited to 12 years from the commencement of production of the Approved Enterprise or 14 years from the date of approval, whichever is earlier. Under certain circumstances (as further detailed below), the benefit period may extend to a maximum of ten years from the commencement of the benefit period. A company which operates under more than one approval or that has capital investments which are only partly approved (such a company being designated as a Mixed Enterprise), may have an effective company tax rate that is the result of a weighted combination of the various applicable rates.

A company owning an Approved Enterprise may elect to forego certain government grants extended to Approved Enterprises in return for what is termed an alternative package of tax benefits (referred to as the Alternative Package). Under the Alternative Package, a company’s undistributed income derived from an Approved Enterprise will be exempt from company tax for a period of between two and ten years, depending on the geographic location of the Approved Enterprise within Israel. Such company will be eligible for the tax benefits under the Investment Law for the remainder of the benefit period.

Should the percentage of share capital of the companies having Approved Enterprises held by foreign shareholders exceed 25%, future Approved Enterprises of such companies would qualify for reduced tax rates for an additional three years, after the seven years mentioned above.

The company tax rate applicable to income earned from Approved Enterprise programs (currently, for programs on which an application for an approved enterprise status was submitted before December 31, 2004) in the benefit period by a company meeting these qualifications is as follows:


% of Foreign Ownership	Tax Rate

Over 25% but less than 49%		25%
49% or more but less than 74%		20%
74% or more but less than 90%		15%
90% or more		10%

Entitlement to these benefits is subject to the final ratification of the Investment Center, and is conditioned upon fulfillment of all terms of the approved program. However, there can be no assurance that our group companies which enjoy Approved Enterprise benefits will obtain approval for additional Approved Enterprises, or that the provisions of the Investment Law will not change with respect to future approvals, or that the above-mentioned shareholding portion will be reached for each subsequent year.

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A company that pays a dividend out of income derived from the Approved Enterprise(s) during the tax exemption period will be subject to deferred company tax in respect of the amount distributed (including the recipient’s tax thereon) at the rate which would have been applicable had such company not elected the Alternative Package. This rate is generally 10% to 25%, depending on the extent to which non-Israeli shareholders hold such company’s shares.

The dividend recipient is taxed at the reduced rate applicable to dividends from Approved Enterprises (generally 15% as compared to 25% (or compared to 20% from January 1, 2006 if the dividend recipient is not a substantial shareholder - shareholders owning, directly or indirectly, 10% or more of our outstanding voting capital) for individuals or an exemption for companies), if the dividend is distributed during the tax benefit period or within 12 years after this period. However, the limitation does not apply if the company qualifies as a foreign investors’ company. This tax must be withheld by such company at source, regardless of whether the dividend is converted into foreign currency.

Subject to certain provisions concerning income subject to Mixed Enterprises, all dividends are considered to be attributable to the entire enterprise and the effective tax rate on the dividend is the result of a weighted combination of the various applicable tax rates. However, such company is not obliged to distribute exempt retained profits under the Alternative Package, and such company may generally decide from which year’s profits to declare dividends.

Each application to the Investment Center is reviewed separately, and a decision as to whether or not to approve such application is based, among other things, on the then prevailing criteria set forth in the Investment Law, on the specific objectives of the applicant company set forth in such application and on certain financial criteria of the applicant company. Accordingly, there can be no assurance that any such application by any of our group companies will be approved. In addition, the benefits available to an Approved Enterprise are conditional upon the fulfillment of certain conditions stipulated in the Investment Law and its regulations and the criteria set forth in the certificate of approval, as described above. In the event that these conditions are violated, in whole or in part, a company with an Approved Enterprise would be required to refund the amount of tax benefits, with the addition of the Israeli consumer price index linkage differences and interest

Reform (Amendment) of the Encouragement of Capital Investment Law

On March 29, 2005, the Israeli Knesset (Parliament) passed an amendment to the Investment Law, that revamps the Israeli tax incentives for future industrial and hotel investments (“2005 amendment”). A tax “holiday” package can now be elected for up to 15 years for a “Privileged Enterprise” as defined in the 2005 amendment, if certain conditions are met, without needing to obtain approval. The extent of the tax benefits available depends mainly upon the level of foreign investment and the geographical location of the “Privileged Enterprise”.

The 2005 amendment became effective on April 1, 2005. Taxpayers may, under certain conditions, claim Privileged Enterprise status for new and expanded enterprises with respect to 2004 or subsequent years, unless the Investment Center granted such taxpayer Approved Enterprise status prior to December 31, 2004.

Subject to certain conditions, various alternative tax-only benefit packages can now be elected with respect to investments in a “Privileged Enterprise”. Companies in industry or tourism in Israel may elect between:

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	• Tax “holiday” package - for a “Privileged Enterprise”: a tax exemption applies to undistributed profits for 2 to 15 years depending on geographical location of the “Privileged Enterprise” and the level of foreign ownership. Company tax rates of between 10% and 25% apply to distributed exempt profits or profits derived subsequent to the exempt period. The total period of tax benefits is 7 to 15 years, or

	• Grant / Reduced tax package - for an “Approved Enterprise”: Fixed asset grants up to 24% for enterprises in a development area and reduced company tax rates between 0% and 25% for 7 to 15 years.

Dividend withholding tax also applies at a rate of 4% or 15% depending on the package selected.

Taxation under Inflationary Conditions

The Income Tax Law (Inflationary Adjustments), 1985 (referred to as the Inflationary Adjustments Law) is intended to neutralize the erosion of capital investments in business and to prevent tax benefits resulting from deduction of inflationary expenses. This law applies a supplementary set of inflationary adjustments to the normal taxable profits computed under regular historical cost principles. We and our group companies operating in Israel are taxed under this law.

Under the Inflationary Adjustments Law, results for tax purposes are measured in real terms, in accordance with the changes in the consumer price index. In addition, subject to certain limitations, depreciation of fixed assets and losses carried forward are adjusted for inflation on the basis of changes in the consumer price index.

The salient features of the Inflationary Adjustments Law can be described generally as follows:

A special tax adjustment for the preservation of equity whereby certain corporate assets are classified broadly into Fixed (inflation resistant) Assets and Non-Fixed (soft) Assets. Where a company’s equity, as defined in such law, exceeds the depreciated cost of Fixed Assets, a deduction from taxable income that takes into account the effect of the applicable annual rate of inflation on such excess is allowed (up to a ceiling of 70% of taxable income in any single tax year, with the unused portion permitted to be carried forward on a linked basis to the following year and will be considered a business loss). If the depreciated cost of Fixed Assets exceeds a company’s equity, then such excess multiplied by the applicable annual rate of inflation is added to taxable income.

Subject to certain limitations, depreciation deductions on Fixed Assets and losses carried forward are adjusted for inflation based on the increase in the consumer price index (from the beginning of the 1982 fiscal year, and as of the 1985 fiscal year, with respect to equipment).

Law for the Encouragement of Industry (Taxes), 1969

Certain of our group companies currently qualify as Industrial Companies within the definition of the Law for the Encouragement of Industry (Taxes), 1969 (referred to as the Industry Encouragement Law). According to the Industry Encouragement Law, an Industrial Company is a company resident in Israel, at least 90% of the income of which in any tax year (exclusive of income from defense loans, capital gains, interest and dividends) is derived from an

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Industrial Enterprise owned by it. An Industrial Enterprise is defined as an enterprise whose major activity in a given tax year is industrial production activity.

The following preferred corporate tax benefits are available to Industrial Companies: (a) deduction of purchases of know-how and patents over an eight-year period for tax purposes; (b) under certain interpretations, deduction of expenses incurred in connection with a public issuance of securities over a three-year period; and (c) an election under certain conditions to file a consolidated tax return with additional related Israeli Industrial Companies and/or with a company that controls an Industrial Company and a specified percentage of its assets are invested in industrial companies; and (d) accelerated depreciation rates on equipment and buildings.

Eligibility for the benefits under the Industry Encouragement Law is not subject to receipt of prior approval from any governmental authority. No assurance can be given that any of our group companies will qualify and/or continue to qualify as an Industrial Company or that the benefits described above will be available in the future.

Capital Gains Tax

Israeli law imposes a capital gains tax on the sale of capital assets. The law distinguishes between the Real Gain and the Inflationary Surplus. The Real Gain is the excess of the total capital gain over the Inflationary Surplus, computed on the basis of the increase of the consumer price index between the date of purchase and date of sale. The Inflationary Surplus accumulated until December 31, 1993 is taxed at a rate of 10% for residents of Israel (reduced to no tax for non-residents if calculated according to the exchange rate of the foreign currency lawfully invested in shares of an Israeli resident company, instead of the consumer price index). Inflationary Surplus accumulated from and after December 31, 1993 is exempt from any capital gains tax, while the Real Gain is added to ordinary income, which effective until December 31 2002 is taxed at the marginal rate of up to 49% for individuals and 34% for corporations (in 2005). Effective January 1, 2003, the capital gains tax rate imposed upon sale of capital assets acquired after that date has been reduced to 25%; capital gains accrued from assets acquired before that date are subject to a blended tax rate based on the relative periods of time before and after that date that the asset was held.

Under current law, effective January 1, 2003 so long as our ordinary shares are listed on a stock exchange the sale of these shares is subject to 15% tax (20% tax from January 1,2006) in case the shares were purchased after December 31, 2002, and in case the shares were purchased before that date the sale will be subject to a blended tax in which the portion of the gain accrued until December 31, 2002 will be exempt from Israeli capital gains tax and the portion of the real gain accrued from January 1, 2003 until the date of sale will be subject to 15% tax (20% tax from January 1, 2006). Companies upon which the provisions of the Income Tax Law (Inflationary Adjustments), 1985 were not imposed before January 1, 2006 are subject to a 25% tax rate on real capital gains derived on or after January 1, 2003 from the sale of the shares. Notwithstanding the above, companies upon which the provisions of the Income Tax law (Inflationary Adjustments), 1985 were imposed before January 1, 2006 are subject to regular corporate tax rate on real capital gains derived on the sale of the shares prior to January 1, 2006.

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The taxable real gain will be based on the difference between the adjusted average value of the shares during the last three trading days before January 1, 2003 (or the adjusted original cost if it is higher than the adjusted average value) and the value of the shares at the date of sale. In the event the above mentioned calculation creates a loss, such loss can only be offset against a capital gain from other traded securities according to the provisions of the Israeli law. The amount of the loss is limited to the difference between the adjusted average value and the value of the shares at the date of sale.

Employee Stock Options

Effective from January 1, 2003, the Tax Reform Legislation enables a company to grant options through one of three tax tracks:

(a) the income tax track through a trustee pursuant to which the optionee pays income tax rate (according to the marginal tax rate of the optionee- up to 49% tax) plus payments to the National Insurance Institute and health tax on the profit gained upon the earlier to occur of the transfer of the options or the underlying shares from the trustee to the optionee or the sale of the options or the underlying shares by the trustee, and the company may recognize expenses pertaining to the options for tax purposes. The options (or upon their exercise, the underlying shares), must be held by a trustee for a period of 12 months commencing from the end of the year in which the options were granted (as of January 1, 2006, a period of 12 months commencing from the date of which the options were granted; or

(b) the capital gains tax track through a trustee pursuant to which the optionee pays capital gains tax at a rate of 25% on the capital profit portion and marginal tax rate ( including payments to the National Insurance Institute and health tax) on the income portion (in general, the income portion is the profit derived from the difference between the average market value of the share 30 days before the allotment date and the exercise price of the option) upon, the earlier to occur of the transfer of the options or the underlying shares from the trustee to the optionee or the sale of the options or the underlying shares by the trustee. (On the capital profit the optionee is not required to make payments to the National Insurance Institute and health tax). In this track, on the capital profit, the Company may not recognize expenses pertaining to the options for tax purposes but may do so on the income portion. The options (or upon their exercise, the underlying shares), must be held by a trustee for a period of 24 months commencing from the end of the year in which the options were granted (as of January 1, 2006, a period of 24 months commencing from the date of which the options were granted); or

(c) the income tax track without a trustee pursuant to which the optionee pays income tax rate (according to the marginal tax rate of the optionee- up to 49% tax) plus payments to the National Insurance Institute and health tax on the profit at the allotment date, and pays capital gains tax at a rate of 25% on the capital profit upon the sale of the underlying shares, and the company may not recognize expenses pertaining to the capital gain for tax purposes but may recognize expenses pertaining to the profit at the allotment date.

In accordance with the provisions of the Tax Reform Legislation, if a company has selected the capital gains track, the company must continue granting options under the selected capital gains track until the end of the year following the year in which the first grant of options under that trustee track will be made. Notwithstanding the above, the company may at any time also grant options under the provisions of the income tax track without a trustee.

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The above rules apply only to employees, including officer holders but excluding controlling shareholders.

Controlling shareholders will be taxable under section 3i to the tax ordinance, according to which, the optionee pays income tax rate (according to the marginal tax rate of the optionee- up to 49%) on the profit upon the sale of the underlying shares.

U.S.-Israel Tax Treaty

Pursuant to the Convention Between the Government of the United States of America and the Government of Israel with Respect to Taxes on Income (referred to as the U.S.-Israel Tax Treaty), the sale, exchange or disposition of ordinary shares by a person who qualifies as a resident of the United States within the meaning of the U.S.-Israel Tax Treaty and who is entitled to claim the benefits afforded to such resident by the U.S.-Israel Tax Treaty (called a Treaty U.S. Resident) will not be subject to Israeli capital gains tax unless (a) such Treaty U.S. Resident is an individual and was present in Israel for more than 183 days during the relevant taxable year or (b) such Treaty U.S. Resident holds, directly or indirectly, shares representing 10% or more of the voting power of a company during any part of the 12-month period preceding such sale, exchange or disposition. A sale, exchange or disposition of shares by a Treaty U.S. Resident who is an individual and was present in Israel for more than 183 days during the relevant taxable year or who holds, directly or indirectly, shares representing 10% or more of the voting power of a company at any time during such preceding 12-month period would be subject to such Israeli tax, to the extent applicable, unless the aforementioned exemption from capital gain tax for shares listed on the Tel-Aviv Stock Exchange applies; however, in case under the U.S.-Israel Tax Treaty and the Israeli tax law a Treaty U.S. Resident will be subject to capital gain tax in Israel, such Treaty U.S. Resident would be permitted to claim a credit for such taxes against the U.S. income tax imposed with respect to such sale, exchange or disposition, subject to the limitations in U.S. laws applicable to foreign tax credits.

Taxation of Non-Residents

Non-residents of Israel are subject to income tax on income accrued or derived from sources in Israel. Such sources of income include passive income such as dividends, royalties and interest, as well as non-passive income from services rendered in Israel and capital gain as mentioned above. On distributions of dividends other than bonus shares (stock dividends), income tax at the rate of 20% is withheld at source, unless a different rate is provided in a treaty between Israel and the shareholder’s country of residence. For example, the tax rate would be 12.5% if the non-resident is a company which holds 10% or more of our voting power (during the part of our tax year which precedes the date of payment of the dividend and during the entire prior tax year) which pursuant to the U.S.-Israel Tax Treaty. Under the U.S.-Israel Tax Treaty, the maximum tax on dividends paid to a holder of ordinary shares who is a resident of the United States will be 25%. However, under the Investment Law, dividends generated by an Approved Enterprise in any case are taxed at the rate of 15%. In addition, if our ordinary shares are traded on the Tel Aviv Stock Exchange (or listed on a stock exchange recognized by the Israeli Ministry of Finance), gains on the sale of ordinary shares held by non-Israeli tax resident investors will generally be exempt from Israeli capital gains tax.

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U.S. Federal Income Tax Considerations

Subject to the limitations described herein, this discussion summarizes the material U.S. federal income tax consequences of the purchase, ownership and disposition of our ordinary shares to a U.S. holder. A U.S. holder is a holder of our ordinary shares who is:


	•	an individual citizen or resident of the U.S. for U.S. federal income tax purposes;

	•	a corporation or partnership (or another entity taxable as a corporation or partnership for U.S. federal income tax purposes) created or organized under the laws of the United States or any political subdivision thereof;

	•	an estate, the income of which may be included in gross income for U.S. federal income tax purposes regardless of its source; or

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

Unless otherwise specifically indicated, this discussion does not consider the U.S. tax consequences to a person that is not a U.S. holder and considers only U.S. holders that will own the ordinary shares as capital assets.

This discussion is based on current provisions of the Internal Revenue Code of 1986, as amended (the “Code”), current and proposed Treasury regulations promulgated under the Code and administrative and judicial interpretations of the Code, all as currently in effect and all of which are subject to change, possibly with a retroactive effect. This discussion does not address all aspects of U.S. federal income taxation that may be relevant to any particular U.S. holder based on the U.S. holder’s particular circumstances. In particular, this discussion does not address the U.S. federal income tax consequences to U.S. holders who are broker-dealers or who own, directly, indirectly or constructively, 10% or more of our outstanding voting shares, U.S. holders holding the ordinary shares as part of a hedging, straddle or conversion transaction, U.S. holders whose functional currency is not the U.S. dollar, insurance companies, tax-exempt organizations, financial institutions and persons subject to the alternative minimum tax, who may be subject to special rules not discussed below. Additionally, the tax treatment of persons who are, or hold the ordinary shares through, a partnership or other pass-through entity is not considered, nor is the possible application of U.S. federal estate or gift taxes or any aspect of state, local or non-U.S. tax laws.

You are advised to consult your tax advisor with respect to the specific U.S. federal, state, local and foreign income tax consequences to you of purchasing, holding or disposing of our ordinary shares.

Taxation of Distributions on Ordinary Shares

Subject to the discussion below under “Tax Consequences If we are a Passive Foreign Investment Company,” a distribution paid by us with respect to the ordinary shares to a U.S. holder will be treated as dividend income to the extent that the distribution does not exceed our current and accumulated earnings and profits, as determined for U.S. federal income tax purposes. The amount of a distribution with respect to the ordinary shares will equal the amount

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

The amount of any distribution which exceeds the amount treated as a dividend will be treated first as a non-taxable return of capital, reducing the U.S. holder’s tax basis in its ordinary shares to the extent thereof, and then as capital gain from the deemed disposition of the ordinary shares. Corporate holders will not be allowed a deduction for dividends received in respect of the ordinary shares.

Dividends paid by us in NIS will be included in the income of U.S. holders at the dollar amount of the dividend (including any Israeli taxes withheld therefrom), based upon the spot rate of exchange in effect on the date the distribution is included in income. U.S. holders will have a tax basis in the NIS for U.S. federal income tax purposes equal to that dollar value. Any subsequent gain or loss in respect of the NIS arising from exchange rate fluctuations will generally be taxable as U.S. source ordinary income or loss.

Subject to the limitations set forth in the Code and the Treasury regulations thereunder, U.S. holders may elect to claim as a foreign tax credit against their U.S. federal income tax liability the Israeli income tax withheld from dividends received in respect of the ordinary shares. The limitations on claiming a foreign tax credit include, among others, computation rules under which foreign tax credits allowable with respect to specific classes of income cannot exceed the U.S. federal income taxes otherwise payable with respect to each such class of income. In this regard, dividends paid by us will be foreign source “passive income” for U.S. foreign tax credit purposes or, in the case of a financial services entity, “financial services income” (and, for tax years beginning after December 31, 2006, as “general category income”). U.S. holders that do not elect to claim a foreign tax credit may instead claim a deduction for the Israeli income tax withheld if they itemize deductions. The rules relating to foreign tax credits are complex, and you should consult your tax advisor to determine whether and to what extent

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you would be entitled to this credit. A U.S. holder will be denied a foreign tax credit for Israeli income tax withheld from a dividend received on the ordinary shares (i) if the U.S. holder has not held the ordinary shares for at least 16 days of the 31-day period beginning on the date which is 15 days before the ex-dividend date with respect to such dividend or (ii) to the extent the U.S. holder is under an obligation to make related payments with respect to positions in substantially similar or related property. Any days during which a U.S. holder has substantially diminished its risk of loss on the ordinary shares are not counted toward meeting the required 16 day holding period. Distributions of current or accumulated earnings and profits will be foreign source passive income for U.S. foreign tax credit purposes.

Taxation of the Disposition of Ordinary Shares

Subject to the discussion below under “Tax Consequences if We are a Passive Foreign Investment Company,” upon the sale, exchange or other disposition of our ordinary shares, a U.S. holder will recognize capital gain or loss in an amount equal to the difference between the amount realized on the disposition and the U.S. holder’s tax basis in the ordinary shares. The gain or loss recognized on the disposition of the ordinary shares will be long-term capital gain or loss if the U.S. holder held the ordinary shares for more than one year at the time of the disposition and is eligible for a maximum 15% rate of taxation for individuals. Capital gain from the sale, exchange or other disposition of ordinary shares held for one year or less is short-term capital gain and taxed as ordinary income at a maximum rate of 35%. Gain or loss recognized by a U.S. holder on a sale, exchange or other disposition of ordinary shares will be treated as U.S. source income or loss for U.S. foreign tax credit purposes.

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

Tax Consequences if We are a Passive Foreign Investment Company

We will be a passive foreign investment company, or PFIC, if either (1) 75% or more of our gross income in a taxable year is passive income; or (2) the average percentage (by value) in a taxable year of our assets that produce, or are held for the protection of, passive income, is at least 50%. If we own (directly or indirectly) at least 25% by value of the stock of another corporation, we will be treated for purposes of the foregoing tests as owning our proportionate share of the other corporation’s assets and as directly earning our proportionate share of the other corporation’s income. If we are a PFIC, a U.S. holder must determine under which of three alternative taxing regimes it wishes to be taxed:

The “QEF” regime applies (to the exclusion of the “excess distribution” regime, described below) if the U.S. holder elects to treat us as a “qualified electing fund” (“QEF”) for the first

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taxable year in which the U.S. holder owns our ordinary shares during which we are a PFIC, and if we comply with certain reporting requirements. If the QEF regime applies, then each year that we are a PFIC such U.S. holder will include in its gross income a proportionate share of our ordinary earnings (which is taxed as ordinary income) and net capital gain (which is taxed as long-term capital gain), subject to a separate election to defer payment of taxes, which deferral is subject to an interest charge. These amounts would be included in income by an electing U.S. holder for its taxable year in which our taxable year ends, whether or not such amounts are actually distributed to the U.S. holder. A U.S. holder’s basis in our ordinary shares for which a QEF election has been made would be increased to reflect the amount of any taxed but undistributed income. Generally, a QEF election allows an electing U.S. holder to treat any gain realized on the disposition of his ordinary shares as capital gain.

Once made, the QEF election applies to all subsequent taxable years of the U.S. holder in which it holds our ordinary shares and for which we are a PFIC and can be revoked only with the consent of the Internal Revenue Service. A shareholder makes a QEF election by attaching a completed Internal Revenue Service Form 8621, including the PFIC annual information statement, to a timely filed United States federal income tax return. Even if a QEF election is not made, a U.S. person who is a shareholder in a PFIC must file a completed Internal Revenue Service Form 8621 every year.

If a QEF election is made by the U.S. holder after the first taxable year in which the U.S. holder holds our ordinary shares during which we are a PFIC, then both the QEF regime and the excess distribution regime, defined below, will apply simultaneously unless the U.S. holder makes a special election.

A second regime, the “mark-to-market” regime, may be elected so long as our ordinary shares are publicly traded. Pursuant to this regime, an electing U.S. holder’s ordinary shares are marked-to-market each year in which we are a PFIC, and the U.S. holder recognizes as ordinary income or loss an amount equal to the difference as of the close of the taxable year between the fair market value of our ordinary shares and the U.S. holder’s adjusted tax basis in our ordinary shares. Losses are allowed only to the extent of net mark-to-market gain previously included by the U.S. holder under the election for prior taxable years. An electing U.S. holder’s adjusted basis in our ordinary shares is increased by income recognized under the mark-to-market election and decreased by the deductions allowed under the election.

Under the mark-to-market election, as long as we are a PFIC, gain on the sale of our ordinary shares is treated as ordinary income, and loss on the sale of our ordinary shares, to the extent the amount of loss does not exceed the net mark-to-market gain previously included, is treated as ordinary loss. The mark-to-market election applies to the tax year for which the election is made and all later tax years in which we are a PFIC, unless the ordinary shares cease to be marketable or the Internal Revenue Service consents to the revocation of the election.

If the mark-to-market election is made after the first taxable year in which a U.S. holder holds our ordinary shares and we are a PFIC, then special rules would apply.

A U.S. holder making neither the QEF election nor the mark-to-market election is subject to the “excess distribution” regime. Under this regime, “excess distributions” are subject to special tax rules. An excess distribution is either (1) a distribution with respect to shares that is greater than 125% of the average distributions received by the U.S. holder from us over the shorter of either the preceding three years or such U.S. holder’s holding period for our shares, or

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(2) 100% of the gain from the disposition of our shares (including gain deemed recognized if the ordinary shares are used as security for a loan).

Excess distributions must be allocated ratably to each day that a U.S. holder has held our ordinary shares. A U.S. holder must include amounts allocated to the current taxable year, as well as amounts allocated to taxable years prior to the first year in which we were a PFIC, in its gross income as ordinary income for that year. All amounts allocated to prior years of the U.S. holder during which we were a PFIC would be taxed at the highest tax rate applicable to ordinary income for each such prior year. The U.S. holder also would be liable for interest on the deferred tax liability for each such prior year calculated as if such liability had been due with respect to each such prior year. A U.S. holder that is an individual is not allowed a deduction for interest on the deferred tax liability. The portions of gains and distributions that are not characterized as “excess distributions” are subject to tax in the current year under the normal tax rules of the Code.

A U.S. person who inherits shares in a foreign corporation that was a PFIC in the hands of the decedent (who was not a nonresident alien and did not make either of the elections described above), is denied the otherwise available step-up in the tax basis of such shares to fair market value at the date of death. The U.S. person steps into the shoes of the decedent and will be subject to the rules described above.

If we are determined to be a PFIC for any given year, then dividends in that year and in the next year cannot qualify as “qualified dividends” which are eligible for the capital gains rate.

Following the sale of our shares in Elbit Systems in 2004, we announced that, as a result of the transaction, we may be characterized as a PFIC for U.S. federal income tax purposes for 2004. Following a review of our position and consulting with our advisors on this matter in 2004, and based on certain assumptions and facts known at that time (which we believe have not changed), we believe there is substantial authority for the position that we can rely on the “change of business” exception to PFIC status provided under Section 1298(b)(3) of the U.S. Internal Revenue Code of 1986, as amended. Substantial authority is generally sufficient to support a return reporting position. Pursuant to this exception, in order to avoid PFIC status in 2004, among other requirements, we cannot be a PFIC in 2005 or 2006 (which cannot be determined at this time with respect to 2006) or in any year prior to 2004 (which we believe was not the case).

110

With respect to subsequent years, the tests for determining passive foreign investment company status are applied annually and it is difficult to make accurate predictions of future income and assets, which are relevant to this determination. As described above, the tests are impacted, by, among other factors, changes in value of our group companies which are difficult to predict at this time and the appropriate value of our ownership interest in our group companies. Accordingly, there can be no assurance that we will not become a PFIC for the current fiscal year ending December 31, 2006 or in a future year. We will notify U.S. holders in the event we conclude that we will be treated as a PFIC for any taxable year to enable U.S. holders to consider whether or not to elect to treat us as a QEF for U.S. federal income tax purposes or to “mark to market” the ordinary shares or to become subject to the “excess distribution” regime.

U.S. holders are urged to consult their tax advisors regarding the application of the PFIC rules, including eligibility for and the manner and advisability of making, the QEF election or the mark-to-market election.

Information Reporting and Backup Withholding

A U.S. holder generally is subject to information reporting and may be subject to backup withholding at a rate of up to 28% with respect to dividend payments and receipt of the proceeds from the disposition of the ordinary shares. Backup withholding will not apply with respect to payments made to exempt recipients, including corporations and tax-exempt organizations, or if a U.S. holder provides a correct taxpayer identification number (or certifies that he has applied for a taxpayer identification number), certifies that such holder is not subject to backup withholding or otherwise establishes an exemption. Backup withholding is not an additional tax and may be claimed as a credit against the U.S. federal income tax liability of a U.S. holder, or alternatively, the U.S. holder may be eligible for a refund of any excess amounts withheld under the backup withholding rules, in either case, provided that the required information is furnished to the Internal Revenue Service.

Non-U.S. holders of Ordinary Shares

Except as provided below, a non-U.S. holder of ordinary shares (except certain former U.S. citizens and long-term residents of the United States) will not be subject to U.S. federal income or withholding tax on the receipt of dividends on, and the proceeds from the disposition of, an ordinary share, unless that item is effectively connected with the conduct by the non-U.S. holder

111

of a trade or business in the United States and, in the case of a resident of a country which has an income tax treaty with the United States, that item is attributable to a permanent establishment in the United States or, in the case of an individual, a fixed place of business in the United States. In addition, gain recognized by an individual non-U.S. holder will be subject to tax in the United States if the non-U.S. holder is present in the United States for 183 days or more in the taxable year of the sale and other conditions are met.

Non-U.S. holders will not be subject to information reporting or backup withholding with respect to the payment of dividends on ordinary shares unless the payment is made through a paying agent, or an office of a paying agent, in the United States. Non-U.S. holders will be subject to information reporting and backup withholding at a rate of up to 28% with respect to the payment within the United States of dividends on the ordinary shares unless the holder provides its taxpayer identification number, certifies to its foreign status, or otherwise establishes an exemption.

Non-U.S. holders will be subject to information reporting and backup withholding at a rate of up to 28% on the receipt of the proceeds from the disposition of the ordinary shares to, or through, the United States office of a broker, whether domestic or foreign, unless the holder provides a taxpayer identification number, certifies to its foreign status or otherwise establishes an exemption. Non-U.S. holders will not be subject to information reporting or backup withholding with respect to the receipt of proceeds from the disposition of the ordinary shares by a foreign office of a broker; provided, however, that if the broker is a U.S. person or a “U.S. related person,” information reporting (but not backup withholding) will apply unless the broker has documentary evidence in its records of the non-U.S. holder’s foreign status or the non-U.S. holder certifies to its foreign status under penalties of perjury or otherwise establishes an exemption. For this purpose, a “U.S. related person” is a broker or other intermediary that maintains one or more enumerated U.S. relationships. Backup withholding is not an additional tax and may be claimed as a credit against the U.S. federal income tax liability of a non-U.S. holder, or alternatively, the non-U.S. holder may be eligible for a refund of any excess amounts withheld under the backup withholding rules, in either case, provided that the required information is furnished to the Internal Revenue Service.


F.	Dividends and Paying Agents

Not Applicable.


G.	Statement by Experts

Not Applicable.


H.	Documents on Display

We are required to file reports and other information with the Securities and Exchange Commission, or SEC, under the Securities Exchange Act of 1934 and the regulations thereunder applicable to foreign private issuers. Reports and other information filed by us with the SEC may be inspected and copied at the SEC’s public reference facilities described below. Although as a foreign private issuer we are not required to file periodic information as frequently or as promptly as United States companies, we generally do publicly announce our quarterly and year-end results promptly and file periodic information with the SEC under cover of Form 6-K. As a

112

foreign private issuer, we are also exempt from the rules under the Exchange Act prescribing the furnishing and content of proxy statements and our officers, directors and principal shareholders are exempt from the reporting and other provisions in Section 16 of the Exchange Act.

You may review a copy of our filings with the SEC, including any exhibits and schedules, at the SEC’s public reference facilities in Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the regional offices of the SEC. You may also obtain copies of such materials from the Public Reference Section of the SEC, Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. You may call the SEC at 1-800-SEC-0330 for further information on the public reference rooms. You may read and copy any reports, statements or other information that we file with the Securities and Exchange Commission at the facilities listed above. In addition, certain of our filings are available to the public at the SEC’s website at http://www.sec.gov. We also generally make available on our own web site (www.elron.com) all our quarterly and year-end financial statements as well as other information. Our website is not part of this Annual Report.

Any statement in this Annual Report about any of our contracts or other documents is not necessarily complete. If the contract or document is filed as an exhibit to this Annual Report, the contract or document is deemed to modify the description contained in this Annual Report. We urge you to review the exhibits themselves for a complete description of the contract or document.


I.	Subsidiary Information

Not Applicable.

Item 11. Quantitative and Qualitative Disclosures About Market Risk

For disclosures regarding our market risk exposures, see Item 5, Operating and Financial Review and Prospects above.

Item 12. Descriptions of Securities Other than Equity Securities

Not Applicable.

PART II

Item 13. Defaults, Dividend Arrearages and Delinquencies

Not Applicable.

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

Not Applicable.

Item 15. Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e)of the Securities Exchange Act of 1934, as amended), have concluded that, as of December 31, 2005, our disclosure controls and procedures were effective to ensure that information required to be

113

disclosed by us in reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure and is recorded, processed, and reported within the periods specified by the SEC’s rules and forms. There were no changes in our internal controls over financial reporting identified with the evaluation thereof that occurred during the period covered by this annual report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Item 16. [Reserved]

Item 16A. Audit Committee Financial Expert

The board of directors has determined that Mr. Yaacov Goldman is the audit committee financial expert serving on its audit committee. Mr. Goldman is “independent” as defined in Rule 4200 of the NASDAQ Marketplace Rules.

Item 16B. Code of Ethics

We have adopted a code of ethics applicable to our employees, officers and directors A copy of the code of ethics was filed as an Exhibit 11.1 to our Annual Report on Form 20F filed with the Securities Exchange Commission on June 29, 2004, and is also available on our website, www.elron.com.

Item 16C. Principal Accountant Fees and Services

The following table sets forth the total remuneration that was paid by us and our subsidiaries to our principal accountants Kost Forer Gabbay & Kasierer (a member of Ernst & Young Global) in each of our previous two fiscal years:


	2004		2005

	(in thousands)

Audit fees (1)		250		269
Tax fees (2)		109		144
All other fees (3)		100		20

Total		459		433

No audit – related fees were paid in 2004 or 2005.


	(1) Audit Fees consist of fees billed for the annual audit services engagement and other audit services, which are those services that only the external auditor can reasonably provide, and include statutory audits; consents; and assistance with and review of documents filed with the SEC.

	(2) Tax Fees include fees billed for tax compliance services, including the preparation of original and amended tax returns and claims for tax refund; tax consultations, such as assistance and representation in connection with tax audits and appeals, and requests for rulings or technical advice from taxing authority; and tax planning services.

114


	(3) Services relating to Elron’s status under the PFIC rules.


	Our audit committee’s policy is to pre-approve each audit and non-audit service to be performed by our independent auditors for us and our subsidiaries.

Item 16D. Exemptions from the Listing Standards for Audit Committees

Not Applicable

Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers

During 2005 and 2006 to date, DIC purchased an additional aggregate of 604,955 of our ordinary shares on the TASE as set forth in the table below, thereby increasing its shareholding to approximately 47.6%. Except for these purchases, neither we nor any affiliated purchaser purchased any of our equity securities during the period covered by this Annual Report.


Period	(a) Total number of shares (or units purchased)	(b) Average price paid per share (or units)	(c) Total number of shares (or units) purchased as part of publicly announced plans or programs	(d) Maximum number (or approximate dollar value) of shares (or units) that may yet be purchased under the plans or programs

June 19 to June 30, 2005	565,111	NIS58.40	—	—

March 29, 2006	39,844	NIS49.76	—	—

PART III

Item 17. Financial Statements

Not Applicable.

Item 18. Financial Statements

115

Our financial statements follow the certifications following the signature page of this Annual Report.


Item 19. Exhibits

1.1	Articles of Association (English translation) approved by the registrant’s shareholders on March 19, 2000, incorporated by reference to Exhibit 1.1 to the registrant’s Form 20-F for the year ended December 31, 2000, filed with the Commission on June 8, 2001.
1.2	Memorandum of Association of Elron Electronic Industries Ltd., incorporated by reference to Exhibit 1.2 to the registrant’s Form 20-F for the year ended December 31, 2000, filed with the Commission on June 8, 2001.
4.1	Agreement dated as of April 1993 among Discount Investment Corporation Ltd., PEC Israel Economic Corporation, Rafael Armament Development Authority Ltd., Galram Technology Industries Limited, incorporated by reference to Exhibit 10.4 to Amendment No. 5 to the registrant’s Registration Statement on Form F-4, filed with the Commission on March 14, 2002.
4.2	License from the Israeli Ministry of Communications issued to Partner Communications Company Ltd. on April 8, 1998, incorporated by reference to Exhibit 4.5 to the Annual Report on Form 20-F/A of Elbit Ltd., filed with the Commission on March 15, 2002 as may be amended from time to time and incorporated in subsequent filings by Partner with the Commission.
4.3	Addendum to Agreement dated June 16, 2003 among DEP Technology Holdings Ltd., Rafael Armament Development Authority Ltd., Galram Technologies Industries Ltd. and RDC Rafael Development Corporation Ltd. incorporated by reference to Exhibit 4.17 of the registrant’s Form 20-F, filed with the Commission on June 30, 2003.
4.4	Restatement of Relationship Agreement dated April 20, 2005 by and among Hutchison Telecommunications International (Netherlands) B.V., Advent Investments Pte Ltd., Elbit Ltd., Eurocom Communications Ltd. Polar Comunications Ltd., Matav Investments Ltd., Matav Cable Systems Media Ltd. and Tapuz Cellular Systems Ltd. incorporated by reference to Exhibit 1 to amendment no. 3 to registrant’s filing on Form 13 D filed with the Commission on May 16, 2005.
4.5	Shareholders Agreement dated April 20, 2005 by and among Elbit Ltd., Eurocom Communications Ltd. Polar Comunications Ltd., Matav Investments Ltd. and Matav Cable Systems Media Ltd. incorporated by reference to Exhibit 2 to amendment no.3 to registrant’s filing on Form 13 D filed with the Commission on May 16, 2005.
8.1	List of subsidiaries
11.1	Code of Ethics incorporated by reference to Exhibit 11.1 to the registrant’s Annual Report on Form 20-F filed with the Commission on June 30, 2004.
12.1	Certification of Chief Executive Officer of the Registrant pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
12.2	Certification of Chief Financial Officer of the Registrant pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
13.1	Certification of Chief Executive Officer of the Registrant pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*
13.2	Certification of Chief Financial Officer of the Registrant pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

116


15.1	Consent of Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global, for Elron Electronic Industries Ltd.
15.2	Consent of Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global, for Elbit Systems Ltd.
15.3	Consents of Brightman Almagor & Co., a member of Deloitte Touche Tohmatsu, for A.M.T. Advanced Metal Technologies Ltd.
15.4	Consent of Somekh Chaikin, a member firm of KPMG International, for Given Imaging Ltd.
15.5	Consent of PricewaterhouseCoopers LLP for ChipX Incorporated.
15.6	Consent of Kost Forer Gabbay & Kasierer, a member of Ernst & Young Global, for ChipX (Israel) Ltd.
15.7	Consent of Kesselman & Kesselman CPA(Isr.) a member of PricewaterhouseCoopers International Limited for Notal Vision, Inc.
15.8	Consents of PriceWaterhouseCoopers LLP for Oncura, Inc.
15.9	Consent of Kesselman & Kesselman CPA(Isr.) a member of PricewaterhouseCoopers International Limited for Pulsicom Israel Technologies Ltd.
15.10	Consent of Kesselman & Kesselman CPA(Isr.) a member of PricewaterhouseCoopers International Limited for Ingenio Technologies Ltd.


*	This document is being furnished in accordance with SEC Release No. 33-8212 and 34-47551.

117

SIGNATURES

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


Dated: June 27, 2006	ELRON ELECTRONIC INDUSTRIES LTD.

		By:	/s/ Doron Birger

		Name:	Doron Birger

		Title:	President & Chief Executive Officer

		By:	/s/ Rinat Remler

		Name:	Rinat Remler

		Title:	Vice President & Chief Financial Officer

118

ELRON ELECTRONIC INDUSTRIES LTD.
AND ITS SUBSIDIARIES

CONSOLIDATED

FINANCIAL STATEMENTS

As of December 31, 2005

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

AS OF DECEMBER 31, 2005

INDEX


	Page


Report of Independent Registered Public Accounting Firm	2

Consolidated Balance Sheets	3-4

Consolidated Statements of Operations	5

Statements of Shareholders’ Equity	6

Consolidated Statements of Cash Flows	7-8

Notes to the Consolidated Financial Statements	9-52

Annex to the Consolidated Financial Statements	53

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of
ELRON ELECTRONIC INDUSTRIES LTD

We have audited the accompanying consolidated balance sheets of Elron Electronic Industries Ltd. (the “Company”) and its subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of certain affiliates, the investment in which, at equity, amounted to $ 46.2 million and $ 56.7 million as of December 31, 2005 and 2004, respectively, and the Company’s equity in their income (losses) amounted to $ (9.1) million, $ 1.2 million and $ (9.7) million for the years ended December 31, 2005, 2004 and 2003, respectively. Those financial statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included for those companies, is based solely on the reports of other auditors.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits and the reports of other auditors provide a reasonable basis for our opinion.

In our opinion, based on our audits and the reports of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and its subsidiaries as of December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

As discussed in Note 2(s) to the consolidated financial statements, effective January 1, 2003, the Company adopted the full provisions of SFAS 123, “Accounting for Stock – Based Compensation” with respect to all employee awards granted, modified or settled after January 1, 2003. As discussed in Note 2(i) to the consolidated financial statements, effective October 1, 2004, the Company adopted the provisions of EITF 02-14 “Whether an Investor Should Apply the Equity Method of Accounting to Investments Other than Common Stock”.


Tel-Aviv, Israel	KOST FORER GABBAY & KASIERER
March 14, 2006	A Member of Ernst & Young Global

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

U.S. dollars in thousands, except share and per share data


		December 31,

	Note	2005		2004 ***

ASSETS
CURRENT ASSETS
Cash and cash equivalents	4	$	26,520	$	42,097
Short-term investments	5		54,661		101,024
Available for sale marketable securities	6		62,617		44,985
Trade receivables(net of allowance of doubtful accounts of $426 and $463 at December 31, 2005 and 2004 respectively)*			6,440		3,698
Other receivables and prepaid expenses *			2,846		1,505
Inventories			2,117		1,961
Total assets attributed to discontinued operations**	22		—		7,652


Total current assets			155,201		202,922


INVESTMENTS AND LONG-TERM RECEIVABLES
Investments in affiliated companies	7		102,780		117,124
Investments in other companies and long-term receivables *	8		73,931		155,929
Deferred taxes	14		6,521		5,493
Severance pay deposits			1,971		2,136


Total investments and long-term receivables			185,203		280,682


PROPERTY AND EQUIPMENT, NET	9		7,809		8,057


INTANGIBLE ASSETS	10
Goodwill			2,742		6,657
Other intangible assets			2,818		2,838


Total intangible assets			5,560		9,495


Total assets		$	353,773	$	501,156


*	Includes short-term receivables from related parties in the aggregate amount of $5,043 and $2,292 as of December 31, 2005 and 2004, respectively, and long-term receivables from related parties in the aggregate amount of $434 and $405 as of December 31, 2005 and 2004, respectively.
**	Includes short-term receivables from related parties in the aggregate amount of $663 as of December 31, 2004.
***	Reclassified – see Note 3(d) and Note 22.

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

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

U.S. dollars in thousands, except share and per share data


		December 31,

	Note	2005		2004***

LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES
Short-term loans from banks and others	11	$	3,808	$	389
Current maturities of long-term loans from banks and others	13		2,065		2,974
Trade payables			2,146		2,024
Other payables and accrued expenses	12		11,025		29,681
Total liabilities attributed to discontinued operations	22		—		5,602


Total current liabilities			19,044		40,670


LONG-TERM LIABILITIES
Long-term loans from banks and others	13		1,477		4,072
Accrued severance pay and retirement obligations			2,635		3,006
Deferred taxes	14		9,494		41,233


Total long-term liabilities			13,606		48,311


CONTINGENT LIABILITIES, PLEDGES AND COMMITMENTS	15

MINORITY INTEREST			19,007		23,095


SHAREHOLDERS’ EQUITY:	16
Ordinary shares of NIS 0.003 par value; Authorized: 35,000,000 shares as of December 31, 2005 and 2004; Issued and outstanding: 29,483,455 and 29,414,424 shares as of December 31, 2005 and 2004, respectively;			9,572		9,572
Additional paid-in capital			271,132		270,005
Accumulated other comprehensive income	24		10,741		57,717
Retained earnings			10,671		51,786


Total shareholders’ equity			302,116		389,080


Total liabilities and shareholders’ equity		$	353,773	$	501,156


***	Reclassified – see Note 3(d) and Note 22.

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

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

U.S. dollars in thousands, except share and per share data


		Years ended December 31

	Note	2005			2004***			2003***

INCOME
Net revenues*		$	12,646		$	11,265		$	9,157
Equity in losses of affiliated companies	18		(17,522	)		(10,492	)		(8,698	)
Gain from disposal of businesses and affiliated companies and changes in holdings in affiliated companies, net	19		23,328			132,396			25,754
Other income , net	20		58,648			4,749			14,637
Financial income , net	21		5,483			1,433			751


			82,583			139,351			41,601

COSTS AND EXPENSES

Cost of revenues			7,907			6,791			5,862
Research and development costs, net			6,163			2,889			3,263
Marketing and selling expenses, net			2,386			1,311			6,498
General and administrative expenses			9,249			12,292			12,872
Amortization of intangible assets			392			142			299
Impairment of intangible assets	10		—			4,192			—


			26,097			27,617			28,794


Income before taxes on income			56,486			111,734			12,807
Taxes on income	14		(10,461	)		(15,101	)		(6,796	)

Income after taxes on income			46,025			96,633			6,011
Minority interest in losses (income) of subsidiaries			5,160			(4,135	)		(10,907	)

Income (loss) from continuing operations			51,185			92,498			(4,896	)
Loss from discontinued operations**	22		(3,850	)		(8,365	)		(2,309	)


Net income (loss)		$	47,335		$	84,133		$	(7,205	)


Income (loss) per share	17
Basic:
Income (loss) from continuing operations		$	1.74		$	3.26		$	(0.17	)
Loss from discontinued operations		$	(0.13	)	$	(0.39	)	$	(0.08	)


Net income (loss)		$	1.61		$	2.87		$	(0.25	)


Diluted :
Income (loss) from continuing operations		$	1.73		$	3.25		$	(0.17	)
Loss from discontinued operations		$	(0.13	)	$	(0.39	)	$	(0.08	)


Net income (loss)		$	1.60		$	2.86		$	(0.25	)


Weighted average number of Ordinary shares used in computing basic net income (loss) per share (thousands)			29,437			29,266			29,194

Weighted average number of Ordinary shares used in computing diluted net income (loss) per share (thousands)			29,550			29,385			29,194


*	Includes revenues from related parties in the amount of $8,046, $7,182 and $3,535, for the years ended December 31, 2005, 2004 and 2003, respectively.
**	Includes revenues from related parties in the amount of $174, $1,298 and $620, for years ended December 31, 2005, 2004 and 2003, respectively.
***	Reclassified – see Note 3(d) and Note 22.

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

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

STATEMENT OF SHAREHOLDERS’ EQUITY

U.S. dollars in thousands, except share and per share data


	Number of shares		Share capital		Additional paid-in capital			Accumulated other comprehensive income			Retained earnings (Accumulated deficit)			Total shareholders’ equity			Total comprehensive income

Balance as of January 1,2003		29,180,970	$	9,572	$	267,482		$	7,529		$	(25,142	)	$	259,441

Exercise of options		25,875		—		177			—			—			177			—
Changes in additional paid-in capital in affiliated companies		—		—		(932	)		—			—			(932	)		—
Stock based compensation		—		—		386			—			—			386			—
Other comprehensive income (loss), net of tax:
Unrealized gains on available for sale securities		—		—		—			55,960			—			55,960		$	55,960
Reclassification adjustment for gain realized included in net loss		—		—		—			(11,113	)		—			(11,113	)		(11,113	)
Foreign currency translation adjustment		—		—		—			(304	)		—			(304	)		(304	)
Minimum pension liability in an affiliated company		—		—		—			(172	)		—			(172	)		(172	)
Unrealized loss on derivative instrument in affiliated company		—		—		—			(108	)		—			(108	)		(108	)
Net loss		—		—		—			—			(7,205	)		(7,205	)		(7,205	)


Balance as of December 31, 2003		29,206,845		9,572		267,113			51,792			(32,347	)		296,130
Total comprehensive income																	$	37,058


Exercise of options		207,579		—		2,097			—			—			2,097
Stock based compensation		—		—		545			—			—			545
Tax benefit in respect of options exercised		—		—		250			—			—			250
Other comprehensive income (loss), net of tax:
Unrealized gains on available for sale securities		—		—		—			8,489			—			8,489			8,489
Reclassification adjustment for gain realized included in net income		—		—		—			(3,582	)		—			(3,582	)		(3,582	)
Foreign currency translation adjustments		—		—		—			202			—			202			202
Unrealized gain on derivative instruments in affiliated company		—		—		—			84			—			84			84
Reclassification adjustments for loss on derivative instruments, minimum pension liability and foreign currency translation adjustments, included in net income due to sale of affiliated companies		—		—		—			732			—			732			732
Net income		—		—		—			—			84,133			84,133			84,133


Balance as of December 31, 2004		29,414,424		9,572		270,005			57,717			51,786			389,080
Total comprehensive income																	$	90,058


Exercise of options		69,031		—		697			—			—			697
Stock based compensation		—		—		405			—			—			405
Tax benefit in respect of options exercised		—		—		25			—			—			25
Dividend paid		—		—					—			(88,450	)		(88,450	)
Other comprehensive income (loss), net of tax:
Unrealized loss on available for sale securities		—		—		—			(10,450	)		—			(10,450	)		(10,450	)
Reclassification adjustment for gain realized and other than temporary impairment included in net income		—		—		—			(36,335	)		—			(36,335	)		(36,335	)
Foreign currency translation adjustments		—		—		—			(191	)		—			(191	)		(191	)
Net income		—		—		—			—			47,335			47,335			47,335


Balance as of December 31, 2005		29,483,455	$	9,572	$	271,132		$	10,741		$	10,671		$	302,116

Total comprehensive income																	$	359

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

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

U.S. dollars in thousands, except share and per share data


	Year ended December 31,

	2005			2004			2003

CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)	$	47,335		$	84,133		$	(7,205	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Equity in losses of affiliated companies		17,522			10,492			8,698
Dividend from affiliated companies		—			1,719			2,971
Minority interest in income (losses) of subsidiaries		(5,160	)		4,135			10,907
Gain from disposal of businesses and affiliated companies and changes in holdings in affiliated companies, net		(23,328	)		(132,396	)		(25,754	)
Gain from sale of investments in available for sale securities		(56,515	)		(5,360	)		(17,924	)
Gain from disposal of businesses included in discontinued operations		(213	)		—			(4,137	)
Depreciation and amortization		1,513			1,868			3,573
Impairment of intangible assets and property and equipment		1,329			7,097			—
Impairment of goodwill		—			1,980			—
Decline in value of other investments		636			803			3,716
Equity in losses (gains) of partnerships		(174	)		7			547
Stock based compensation and changes in liability in respect of call options		(811	)		3,033			2,564
Deferred taxes, net		(7,288	)		(2,409	)		6,229
Changes in operating assets and liabilities
Decrease (increase) in trade receivables		(947	)		(139	)		3,491
Decrease (increase) in other receivables and prepaid expenses		(38	)		88			1,888
Decrease (increase) in trading securities, net		4			5			(4	)
Decrease (increase) in inventories and contracts-in-progress		(519	)		333			589
Decrease in trade payables		(834	)		(1,184	)		(2,009	)
Increase (decrease) in other payables and accrued expenses (mainly provision for income taxes)		(12,139	)		16,935			(5,275	)
Other		(753	)		(552	)		652

Net cash used in operating activities		(40,380	)		(9,412	)		(16,483	)

CASH FLOWS FROM INVESTING ACTIVITIES
Investment in affiliated companies		(3,823	)		(57,916	)		(14,884	)
Proceeds from sale of affiliated companies shares		10,522			211,360			13,878
Cash and cash equivalents resulting from newly consolidated subsidiaries(Schedule A)		—			247			—
Change in cash and cash equivalents resulting from disposal of businesses (Schedule B)		1,800			—			(4,648	)
Investment in other companies		(27,651	)		(15,264	)		(299	)
Proceeds from sale of investments in other companies		237			—			—
Proceeds from repayment of loan from an affiliate		2,253			—			—
Collection of long term receivables		—			—			772
Proceeds from sale of available for sale securities		119,888			8,062			46,143
Investments in debentures and deposits		(59,185	)		(105,378	)		(8,925	)
Investment in available for sale securities		(35,405	)		(43,000	)		(1,952	)
Proceeds from maturities of held to maturity debentures and deposits		105,802			33,345			8,975
Purchase of property and equipment		(995	)		(728	)		(547	)
Proceeds from sale of property and equipment		197			—			329
Purchase of treasury stock from the minority by a subsidiary		(823	)		—			—

Net cash provided by investing activities		112,817			30,728			38,842

CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from options exercised		697			2,097			177
Proceeds from exercise of options in a subsidiary		8			—			—
Receipt of long-term loans from banks		—			519			4,032
Repayment of long-term loans		(777	)		(50,677	)		(6,200	)
Decrease in short-term bank loan, net		(1,079	)		(15,842	)		(4,076	)
Repayment of loans from minority shareholders of a subsidiary		—			—			(4,246	)
Receipt of short-term loans, convertible loans and long-term loans from minority shareholders of a subsidiary		1,003			1,539			3,959
Issuance expenses in a subsidiary		(75	)		(180	)		—
Issuance of shares to the minority of a subsidiary		145			—			—
Dividend paid		(88,450	)
Dividend to minority shareholders of a subsidiary		—			(67	)		—

Net cash used in financing activities		(88,528	)		(62,611	)		(6,354	)

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(16,091	)		(41,295	)		16,005
CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE YEAR		42,611			83,906			67,901

		26,520			42,611			83,906
LESS CASH AND CASH EQUIVALEMENTS ATTRIBUTED TO DISCONTINUED OPERATIONS		—			(514	)		(2,567	)

CASH AND CASH EQUIVALENTS AT THE END OF THE YEAR		26,520		$	42,097		$	81,339

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

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Cont.)

U.S. dollars in thousands, except share and per share data


	Year ended December 31,

	2005		2004		2003

Supplemental cash flow information:
Cash paid during the year for:
Income taxes	$	30,591	$	172	$	96


Interest	$	203	$	1,044	$	1,466


Proceeds from sale of an affiliate not yet received	$	1,958	$	—	$	—


Proceeds from sale of an affiliate received in Zoran shares	$	7,700	$	—	$	—

SCHEDULE A:


	Year ended December 31,

	2005			2004			2003

Change in cash and cash equivalents resulting from newly consolidated subsidiaries
Assets and liabilities at date of sale:
Working capital deficiency, net (except cash and cash equivalents)	$	75		$	1,071		$	—
Deposits		—			(31	)		—
Property and equipment		(14	)		(618	)		—
Intangible assets		(237	)		(1,350	)		—
Accrued severance pay, net		27			—			—
Long-term liabilities		—			431			—
Investment at equity prior to acquisition		—			678			—
Minority interests		—			66			—
Liability incurred		149			—			—


Cash and cash equivalents acquired	$	—		$	247		$	—

SCHEDULE B:


	2005			2004		2003

Change in cash and cash equivalents resulting from disposal of businesses
Assets and liabilities at date of sale:
Working capital deficiency, net (except cash and cash equivalents)	$	(671	)	$	—	$	(708	)
Property and equipment		40			—		1,274
Intangible assets		2,389			—		6,532
Deferred tax liability		—			—		(907	)
Accrued severance pay, net		(171	)		—		—
Gain resulting from sale of businesses		213			—		22,833
Securities received:
Marketable securities		—			—		(5,400	)
Other investments		—			—		(1,000	)
Investment in affiliated Company		—			—		(30,272	)
Liability incurred		—			—		3,000


Net increase (decrease) in cash and cash equivalents	$	1,800		$	—	$	(4,648	)

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

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 1:-	GENERAL

	a.	Elron Electronic Industries Ltd. (“Elron” or “the Company”), an Israeli corporation, is high technology operational holding company. Elron’s global business is conducted through subsidiaries and affiliates, primarily in the fields of medical devices, information and communication technology, semiconductors and advanced materials.

	b.	On August 22, 2004 Discount Investment Corporation Ltd. (“DIC”) completed a tender offer to purchase 7.5% of the Company’s shares. In addition, in May 2005, DIC purchased additional 1.8% of the Company’s shares. Following the consummation of the tender offer and the additional purchase of shares, DIC’s interest in the Company increased from approximately 38.5% to approximately 46% in 2004 and to 47.5% in 2005 of the Company’s outstanding shares.

NOTE 2:-	SIGNIFICANT ACCOUNTING POLICIES

	The financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”).

	The significant accounting policies followed in the preparation of the financial statements, applied on a consistent basis, are:

	a.	Use of estimates

		The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of income and expenses during the reported period. Actual results could differ from those estimates.

	b.	Financial statements in U.S. dollars

		The financial statements have been prepared in U.S. dollars, since the currency of the primary economic environment in which the operations of the Company, its principal subsidiaries and affiliates are conducted is the U.S. dollar. Most of the Company’s assets and liabilities are in U.S. dollars and sales of its subsidiaries are mainly in U.S. dollars. Therefore, the functional and reporting currency of the Company and its subsidiaries is the U.S. dollar.

		Transactions and balances originally denominated in U.S. dollars are presented at their original amounts. Transactions and balances in other currencies have been remeasured into U.S. dollars in accordance with the principles set forth in Statement of Financial Accounting Standards (“SFAS”) No. 52, “Foreign Currency Translation” (“SFAS 52”).

		Accordingly, amounts in currencies other than U.S dollars have been translated as follows:

		Monetary balances - at the exchange rate in effect on the balance sheet date.

		Revenues and costs – at the exchange rates in effect as of the date of recognition of the transactions.

		All exchange gains and losses from the remeasurement mentioned above are reflected in the statement of operations in financial income, net.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 2:-	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	b.	Financial statements in U.S. dollars (Cont.)

		The financial statements of an affiliate accounted for under the equity method, whose functional currency is not the U.S. dollar, have been translated into dollars in accordance with SFAS 52. All balance sheet accounts have been translated using the exchange rate in effect at the balance sheet date. Statement of income amounts have been translated using average exchange rates prevailing during the year. The resulting aggregate translation adjustments are reported as a component of accumulated other comprehensive income in shareholders’ equity.

	c.	Principles of consolidation

		The consolidated financial statements include the accounts of the Company and its subsidiaries, in which the Company has a controlling voting interest and of VIEs for which the Company is the primary beneficiary according to the provisions of FIN 46, as described below. Inter-company balances and transactions have been eliminated upon consolidation.

		In December 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46(R), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN 46”). FIN 46 provides a new framework for identifying variable interest entities (“VIE”) and determining when a company should include the assets, liabilities, noncontrolling interests and results of activities of a VIE in its consolidated financial statements.

		In general, a VIE is a corporation, partnership, limited-liability corporation, trust, or any other legal structure used to conduct activities or hold assets that either (1) has an insufficient amount of equity to carry out its principal activities without additional subordinated financial support, (2) has a group of equity owners that is unable to make significant decisions about its activities, or (3) has a group of equity owners that does not have the obligation to absorb losses or the right to receive returns generated by its operations.

		FIN 46 requires a VIE to be consolidated by the party with an ownership, contractual or other financial interest in the VIE (a variable interest holder) that will absorb a majority of the risk of loss from the VIE’s activities, is entitled to receive a majority of the VIE’s residual returns (if no other variable interests absorb a majority of the VIE’s losses), or both.

		A variable interest holder that consolidates the VIE is called the primary beneficiary. Upon consolidation, the primary beneficiary generally must initially record all of the VIE’s assets, liabilities and noncontrolling interests at fair value and subsequently account for the VIE as if it were consolidated based on a majority voting interest. FIN 46 also requires disclosures about VIEs that the variable interest holder is not required to consolidate but in which it has a significant variable interest.

		FIN 46 was effective immediately for VIEs created after January 31, 2003. For VIEs created before January 31, 2003, the provisions of FIN 46, as revised, were adopted as of March 31, 2004. The adoption of FIN 46 did not have a material effect on the company’s financial statements.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 2:-	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	c.	Principles of consolidation (Cont.)

		As of the balance sheet date the significant subsidiaries whose balances and results are consolidated are:


	December 31,

	2005		2004

	Consolidated % of outstanding share capital



Elbit Ltd. (“Elbit”)		100.0		100.0
DEP Technology Holdings Ltd. (“DEP”)		100.0		100.0
RDC Rafael Development Corporation Ltd. (“RDC”)		50.1		49.6
Elron Telesoft Ltd. and Elron Telesoft Export Ltd. (together the “ET group”)		—		100.0
Galil Medical Ltd. (“Galil”)		59.1		59.1
Mediagate Ltd. (“Mediagate”)		100.0		100.0
SELA Semiconductors Engineering Laboratories Ltd. (“SELA”)		66.2		54.4
Starling Advanced Communications Ltd. (“Starling”)		66.5		66.5
3DV Systems Ltd. (“3DV”)		88.7		94.8
Enure Networks Ltd. (“Enure”) (formerly Gaia broadband services management Ltd.)		57.2		—


	d.	Business combinations

		Business combinations have been accounted for using the purchase method of accounting. Under the purchase method of accounting the results of operations of the acquired business are included from the effective date of acquisition. The costs to acquire companies, including transactions costs, have been allocated to the underlying net assets of each acquired company in proportion to their respective fair values. Any excess of the purchase price over estimated fair values of the identifiable net assets acquired has been recorded as goodwill.

	e.	Cash and cash equivalents

		Cash and cash equivalents are short-term highly liquid investments that are readily convertible to cash with original maturities of three months or less at the date acquired.

	f.	Bank deposits

		Bank deposits with original maturities of more than three months but less than one year are presented as part of short-term investments. Deposits are presented at their cost including accrued interest. Interest on deposits is recorded as financial income.

	g.	Marketable securities

		Management determines the classification of marketable investments in debt securities with fixed maturities and marketable equity securities at the time of purchase and reevaluates such designations at each balance sheet date.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 2:-	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	g.	Marketable securities (Cont.)

		Certain marketable securities covered by SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities”, (“SFAS 115”) are classified as available-for-sale. Accordingly, these securities are measured at fair value, with unrealized gains and losses reported net-of-tax in accumulated other comprehensive income, a separate component of shareholders’ equity. Realized gains and losses on sales of investments, and a decline in value which is considered as other than temporary, are included in the consolidated statement of operations. The Company considers a decline in value to be other than temporary with regard to available-for-sale marketable debentures when the fair value is lower than cost for a continuing period which exceeds six months and when the Company does not intend to hold the debentures until maturity. When computing realized gain or loss, cost is determined on an average basis. Interest and amortization of premium and discount on debt securities are recorded as financial income.

		Debt securities, which the Company has the positive intent and ability to hold to maturity, are classified as held-to-maturity investments. Held-to-maturity investments are measured at amortized cost plus accrued interest. Interest and amortization of premium and discount on such debt securities are recorded as financial income.

	h.	Inventories and contracts in progress

		Inventories are stated at the lower of cost or market value. Inventory write-offs are provided for slow-moving items and technological obsolescence.

		Cost is determined as follows:

		Raw materials - using the “first in, first out” method.

		Contracts-in-progress (included in assets attributed to discontinued operations) - represent amounts related to contracts as determined by the percentage of completion method of accounting.

		Finished Products – on the basis of direct manufacturing costs with the additional of allocable indirect manufacturing costs, with cost measured on an average basis.

	i.	Investments in companies

		Investments in common stock or in-substance-common stock of entities in which the Company has significant influence but less than a controlling voting interest are accounted for using the equity method (“affiliated companies”) (see below for provisions of EITF 02-14). Significant influence is presumed to exist when the Company holds between 20%-50% of the investee’s voting stock. However, whether or not the Company has significant influence depends on evaluation of certain factors including among others, the Company’s representation on the investee’s board of directors, agreements with other shareholders, additional voting rights, participation in policy making processes, existence of material intercompany transactions and technological dependency and the extent of ownership by the Company in relation to the concentration of other shareholders.

		The Company discontinues applying the equity method when its investment (including advances and loans) is reduced to zero and it has not guaranteed obligations of the affiliate or is not otherwise committed to provide further financial support to the affiliate.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 2:-	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	i.	Investments in companies (Cont.)

		In July 2004, the EITF reached a consensus on Issue No. 02-14, “Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than Common Stock” (“EITF 02-14”).EITF 02-14 states that the Company must apply the equity method of accounting to investments in common stock and in in-substance-common stock if it has the ability to exercise significant influence over the operating and financial policies of the investee.

		EITF 02-14 defines in-substance-common stock as an investment with similar risk and reward characteristics to common stock. The provisions of EITF 02-14 are effective since the beginning of the fourth quarter of 2004. For investments that are not common stock or in-substance-common stock, but were accounted for under the equity method prior to the effective date of EITF 02-14, the equity method of accounting should be discontinued at the effective date. Previously recognized equity method earnings and losses were not reversed. Upon adoption of EITF 02-14, the Company evaluated all of its investments at the adoption date and concluded that no change should be made to its then implemented accounting treatment as a result of the adoption of EITF 02-14.

		The Company applies EITF 02-18 “Accounting for Subsequent Investments in an Investee after suspension of Equity Method Loss Recognition” (“EITF 02-18”) in cases where the Company suspended equity method loss recognition in a certain investee, and it subsequently invests in the aforementioned investee (not resulting in the ownership interest increasing from one of significant influence to one of control), if the additional investment, in whole or in part, represents, in substance, the funding of prior losses, the Company recognizes previously suspended losses up to the amount of the additional investment determined to represent the funding of prior losses. Whether the investment represents the funding of prior losses, however, depends on the facts and circumstances.

		In circumstances where the Company’s ownership in an affiliate is in the form of a preferred security or other senior security, the Company recognizes losses based on the ownership level of the particular affiliate’s security or loan held by the Company to which the equity method losses are being applied.

		The excess of the purchase price over the proportional fair value of net tangible assets acquired is attributed to goodwill, technology and other identifiable intangible assets. Technology and other identifiable intangible assets are amortized over a weighted averaged period of approximately 14 years, commencing from the acquisition date.

		Gains arising from issuance of shares by affiliated companies to third parties are recorded as income in the consolidated statements of operations, unless the issuing company is a development stage company for which the gain (loss) from issuance is accounted for as an equity transaction pursuant to Staff Accounting Bulletin (“SAB”) No. 51 “Accounting for Sales of Stock by a Subsidiary”.

		When an investment in common stock or in-substance common stock, that was previously accounted for on other than the equity method, becomes qualified for use of the equity method by an increase in level of ownership, the equity method of accounting is adopted retroactively and financial statements of prior periods are adjusted accordingly.

		Investments in partnerships in which the Company has a greater than five percent interest, are accounted for under the equity method.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 2:-	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	i.	Investments in companies (Cont.)

		Investments in non-marketable securities of companies, in which the Company does not have the ability to exercise significant influence over their operating and financial policies, and investments in non-marketable companies that are not common stock or in-substance-common stock, are presented at cost.

		Management evaluates investments in affiliates and other companies for evidence of other than temporary declines in value. When relevant factors indicate a decline in value that is other than temporary, the Company records a provision for the decline in value. A judgmental aspect of accounting for investments involves determining whether an other-than-temporary decline in value of the investment has been sustained. Such evaluation is dependent on the specific facts and circumstances. Accordingly, management evaluates financial information (e.g. budgets, business plans, financial statements, etc.) in determining whether an other-than-temporary decline in value exists. Factors indicative of an other-than-temporary decline include recurring operating losses, failure of research and development efforts, extremely negative deviation from the business plan, credit defaults, specific conditions affecting the investment such as in the industry or in geographic area and subsequent rounds of financings at an amount below the cost basis of the investment. This list is not all inclusive and management weighs all quantitative and qualitative factors in determining if an other-than-temporary decline in value of an investment has occurred.

	j.	Property and equipment

		Property and equipment are stated at cost, net of accumulated depreciation and investment grants. Depreciation is calculated by the straight-line method over the estimated useful lives of the assets at the following annual rates:


			%

	Land and Buildings		0 - 4
	Computers, Machinery and Furniture		6 - 33
	Motor vehicles		15
	Leasehold improvements		over the term of the lease


	k.	Impairment and disposal of long-lived assets

		The Company and its subsidiaries long-lived assets (including identifiable intangible assets subject to amortization) are reviewed for impairment in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”), whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted cash flows expected to be generated by the asset. If an asset is considered to be impaired, the impairment is measured by the difference between the carrying amount of the asset and its fair value. Assets to be disposed of are reported at the lower of their carrying amount or fair value less costs to sell.

		See Note 3c regarding impairment of intangible assets.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 2:-	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	l.	Intangible assets

		Intangible assets include mainly technology, goodwill and other identifiable intangible assets acquired in connection with the purchase of subsidiaries and businesses. Technology and other identifiable intangible definite lived assets are amortized over their estimated useful lives.

		The Company evaluates the amortization periods of all identifiable intangible assets to determine whether events or circumstances warrant revised estimates of useful lives.

		Under SFAS No. 142 “Goodwill and other Intangible Assets” (“SFAS 142”) goodwill and intangible assets with indefinite lives are no longer amortized but instead are tested for impairment at least annually (or more frequently if impairment indicators arise).

		SFAS 142 prescribes a two phase process for impairment testing of goodwill. The first phase screens for impairment; while the second phase (if necessary) measures impairment.
		In the first phase of impairment testing, goodwill attributable to each of the reporting units is tested for impairment by comparing the fair value of each reporting unit with its carrying value. If the carrying value of the reporting unit exceeds its fair value the second phase is then performed. The second phase of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit.

		Fair value of the company’s reporting unit is determined using market capitalization.

		In 2004 and in the second quarter of 2005 when performing the first phase of the goodwill impairment test, the fair value of the systems and projects segment (reporting unit) of the ET group, which is included in discontinued operations, was found to be lower than its carrying value. Therefore the second phase of the goodwill impairment test was then performed and as a result goodwill was written down by $1,980 in 2004 and $1,300 in 2005. The fair value of the reporting unit was determined using the discounted cash flow method. Significant estimates used in the discounted cash flow methodology include estimates of future cash flows, future short-term and long-term growth rates and discount rates. The Company performs its annual impairment tests during the fourth fiscal quarter of each year.

		The impairment test for other intangible assets not subject to amortization consists of a comparison of the fair value of the intangible asset with its carrying value. If the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.

	m.	Revenue recognition

		The Company’s subsidiaries sell software license, support systems products and disposable medical products.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 2:-	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	m.	Revenue recognition (Cont.)

		The ET group generated revenues from sale of software, license and support systems, which are included in discontinued operations. Software sales are accounted for in accordance with Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as amended. Other product sales and revenues are accounted for in accordance with SAB No. 104, “Revenue Recognition in Financial Statements” (“SAB 104”).

		Revenues from license fees or product sales are recognized when delivery of the product has occurred, the fee is fixed or determinable, collectibility is probable and persuasive evidence of an arrangement exists.

		When the products are warranted, a provision is recorded for probable costs, in connection with the warranties, based on the Company’s subsidiaries’ experience and estimates.

		Revenues from software licenses that require significant customization, integration and installation (included in discontinued operations) are recognized based on SOP 81-1, “Accounting for Performance of Construction Type and Certain Production - Type Contracts”, according to which revenues are recognized on a percentage of completion basis. Percentage of completion is measured by the efforts expended method based on the ratio of hours performed to date to estimated total hours at completion. Anticipated losses on contracts are charged to earnings when identified. Estimated gross profit or loss from contracts may change due to changes in estimates resulting from differences between actual performance and original forecasts. Such changes in estimated gross profit are recorded in results of operations when they are reasonably determinable by management, on a cumulative catch-up basis. Revenues derived from software licensing arrangements based on new technology, in which the Company’s subsidiary does not have sufficient prior experience and estimates are not reasonably determinable, are recognized using the completed-contract method.

		Deferred revenues include unearned amounts received under maintenance and support contracts and amounts received from customers but not recognized as revenues.

		Revenues from service agreement on a cost plus basis are recognized as the services are performed, based on the costs incurred.

	n.	Research and development costs

		Research and development costs, net of grants received, are charged to the statement of operations as incurred. SFAS No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed” requires capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on the subsidiaries’ product development process, technological feasibility is established upon completion of a working model. Costs, incurred by the Company’s subsidiaries between completion of the working models and the point at which the products are ready for general release, have been insignificant. Therefore, research and development costs are charged to the statement of operations, as incurred.

	o.	Advertising costs

		Advertising costs are charged to the consolidated statement of operations as incurred.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 2:-	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	p.	Royalty-bearing grants

		Royalty-bearing grants from the Government of Israel and other governmental institutions for funding approved research and development projects are recognized at the time the Company is entitled to such grants, on the basis of the costs incurred. Such grants are included as a deduction of research and development costs, since at the time received it is not probable that they will be repaid.

		Research and development grants received by certain of the Company’s subsidiaries in 2005 amounted to $1,528 (2004 - $1,535, 2003 - $382).

		Research and development grants received by the ET group, which are presented in the discontinued operations in 2005 amounted to $0 (2004 - $181, 2003 - $105).

	q.	Income taxes

		The Company and its subsidiaries account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”. This Statement prescribes the use of the liability method whereby deferred tax assets and liability account balances are determined based on differences between financial reporting and tax bases of assets and liabilities, using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company and its subsidiaries provide a valuation allowance, if necessary, to reduce deferred tax assets to the amount that is more likely than not to be realized.

	r.	Income (loss) per share

		Basic net income (loss) per share is computed based on the weighted average number of ordinary shares outstanding during each year. Diluted net income (loss) per share is computed based on the weighted average number of ordinary shares and ordinary share equivalents outstanding during the year; ordinary share equivalents are excluded from the computation if their effect is anti-dilutive.

		In 2003, all shares relating to the outstanding stock options were excluded from the calculation of the diluted net loss per ordinary share because all such stock options were anti-dilutive. The total ordinary share equivalents relating to the outstanding options, excluded from the calculations of diluted net loss per share, were 1,799 for the year ended December 31, 2003.

	s.	Stock based compensation

		For stock options granted prior to 2003, the Company has elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and the FASB Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation” in accounting for its employee stock option plans. According to APB 25, compensation expense is measured under the intrinsic value method, whereby compensation expense is equal to the excess, if any, of the quoted market price of the stock over the exercise price at the grant date of the award or if applicable at a subsequent measurement date. Compensation cost is recorded over the vesting period on a straight line basis.

		Effective January 1, 2003 the Company adopted the fair value recognition provisions of FASB Statement No.123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Under the prospective method of adoption selected by the company under the provisions of FASB Statement No.148, “Accounting for Stock-Based Compensation - Transition and Disclosure” (“SFAS 148”), the fair value recognition provisions were applied to all employee awards granted, modified, or settled after January 1, 2003. Compensation cost is recorded over the vesting period on a straight line basis.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 2:-	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	s.	Stock based compensation (Cont.)

		The expense related to stock-based employee compensation included in the determination of net income (loss) for 2005, 2004 and 2003 is less than that which would have been recognized if the fair value method had been applied to all awards granted after the original effective date of SFAS 123. If the Company, its subsidiaries and its affiliated companies had elected to adopt the fair value recognition provisions of SFAS 123 as of its original effective date, pro forma net income (loss) and pro forma basic and diluted net income (loss) per share would be as follows:


	Year ended December 31,

	2005		2004		2003


Net income (loss), as reported	$	47,335	$	84,133	$	(7,205	)
Add: Stock-based employee compensation expense included in reported net income (loss)		347		202		1,030

Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards		2,739		2,981		3,094


Pro forma net income (loss)	$	44,943	$	81,354	$	(9,269	)


Income (loss) per share:
Basic - as reported	$	1.61	$	2.87	$	(0.25	)
Basic - pro forma		1.53		2.78		(0.32	)

Diluted - as reported		1.60		2.86		(0.25	)
Diluted - pro forma		1.52		2.77		(0.32	)


		The fair value of stock options for the company was estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions for 2005, 2004 and 2003:


	2005			2004			2003


Risk-free Interest Rate		4.75	%		2.5	%		1	%

Expected Dividend Yield *)		0	%		0	%		0	%

Expected Volatility		38	%		42	%		53	%

Expected Lives		2.8			2.8			2.7


	*)	According to the Company’s option plan, the exercise price is to be reduced in the event of a distribution of a dividend in the amount of the dividend distributed per share. Accordingly, the Company, when calculating fair value of the options based on the Black-Scholes option-pricing model, assumes a 0% dividend yield. Consequently, when such a reduction in exercise occurs, there is no accounting consequence.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 2:-	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	s.	Stock based compensation (Cont.)

		The Company’s additional disclosures required by SFAS 123 and SFAS 148 are provided in Note 16.

		Call options granted to employees to purchase shares in subsidiaries, affiliates and other companies are recorded at fair value using the Black-Scholes option-pricing model. The fair value of the option is recorded as a liability and changes in the liability are recorded as compensation expenses in general and administrative expenses.

	t.	Comprehensive income

		Comprehensive income consists of net income (loss) and other gains and losses affecting shareholders equity that under generally accepted accounting principles are excluded from the net income (loss). For the Company, such items consist of unrealized gains and losses on available for sale securities and foreign currency translation adjustments (See Note 24).

	u.	Severance pay

		The Company’s and its subsidiaries’ liability for severance pay, with respect to their Israeli employees, is calculated pursuant to Israeli severance pay law and employee agreements based on the most recent salary of the employees. The Company’s liability for all of its Israeli employees is fully provided for by monthly deposits with insurance policies and by an accrual. The value of these policies is recorded as an asset in the Company’s balance sheet.

		The deposited funds include profits accumulated up to the balance sheet date. The deposited funds may be withdrawn only upon the fulfillment of the obligations pursuant to Israeli severance pay law or labor agreements. The value of the deposited funds is based on the cash surrender value of these policies, and includes immaterial profits.

		Severance pay expenses for the years ended December 31, 2005, 2004 and 2003 amounted to $354, $816 and $611, respectively.

		Severance pay expenses for the years ended December 31, 2005, 2004 and 2003 presented in the discontinued operations amounted to $28, $62 and $120, respectively.

	v.	Discontinued operations

		Under SFAS 144, when a component of an entity, as defined in SFAS 144, has been disposed of or is classified as held for sale, the results of its operations, including the gain or loss on its disposal should be classified as discontinued operations and the assets and liabilities of such component should be classified as assets and liabilities attributed to discontinued operations, that is provided that the operations, assets and liabilities and cash flows of the component have been eliminated from the Company’s consolidated operations and the Company will no longer have any significant continuing involvement in the operations of the component.

	w.	Fair value of financial instruments

		SFAS No. 107, “Disclosure about Fair Value of Financial Instruments”, requires disclosure of an estimate of the fair value of certain financial instruments. The Company’s financial instruments consist of cash and cash equivalents, marketable securities, short-term deposits and debentures, trade receivables, other receivables, trade payables, other payables and short-term and long-term bank loans. The estimated fair value of these financial instruments approximates their carrying value as of December 31, 2005 and 2004, unless otherwise

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 2:-	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	w.	Fair value of financial instruments (Cont.)

		stated. The estimated fair values have been determined through information obtained from market sources and management estimates.

		It was not practical to estimate the fair value of the Company’s investments in shares and loans of non-public affiliates and other companies because of the lack of a quoted market price or without incurring excessive costs. The carrying amounts of these companies were $75,143 and $64,146 at December 31, 2005 and 2004, respectively, and they represent the original cost, net of any impairment charges, and in the case of affiliates also the Company’s equity in the losses of the affiliates and its share in the changes of the affiliates equity, since the dates of acquisition.

	x.	Concentrations of credit risk

		Financial instruments that potentially subject the Company and its subsidiaries to concentrations of credit risk consist principally of cash and cash equivalents, short-term bank deposits, marketable debentures and trade receivables.

		Cash and cash equivalents and bank deposits are invested mainly in U.S. dollars with major banks in the United States and Israel. Marketable debentures are mainly debentures of U.S. government agencies with high credit quality and with limited amount of credit exposure to any corporation. Accordingly, the Company’s management believes that minimal credit risk exists with respect to these investments.

		Trade receivables are derived from sales to major customers located primarily in the U.S and in Asia. The Company’s subsidiaries perform ongoing credit evaluations of their customers and obtain letters of credit and bank guarantees for certain receivables. An allowance for doubtful accounts is determined with respect to those amounts that were determined to be doubtful of collection and a general allowance is provided to cover additional potential exposures.

		As of the balance sheet date there is no significant off-balance-sheet concentration of credit risk such as foreign exchange contracts, option contracts or other foreign hedging arrangements.

	y.	Recently issued accounting pronouncements

		i. In May 2005, the FASB issued SFAS No. 154 “Accounting Changes and Errors Corrections” (“FAS 154”). FAS 154 replaces APB No. 20 “accounting changes” (“APB 20”) and SFAS No. 3 “Reporting Accounting changes in Interim Financial Statements”. FAS 154 applies to all voluntary changes in accounting principle, and changes the accounting for and reporting of a change in accounting principle. FAS 154 requires, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. This statement also provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. APB 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. FAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. There is no effect on the Company’s financial position and results of operations.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 2:-	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	y.	Recently issued accounting pronouncements (Cont.)

		ii. In November 2005, the FASB issued FSP (“FASB staff positions”) FAS 115-1. The FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. The FSP also includes accounting considerations subsequent to the recognition of other than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in this FSP amends FASB Statements No. 115, “Accounting for Certain Investments in Debt and Equity”. The FSP replaces the impairment evaluation guidance of EITF Issue No. 03-1, “The Meaning of other-than-Temporary Impairment and its Application to Certain Investments”, with references to the existing other-than-temporary impairment guidance. The FSP clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell an impaired security has not been made. The guidance in this FSP is to be applied to reporting periods beginning after December 15, 2005. The Company does not expect that the adoption of FSP FAS 115-1 will have a material effect on its financial position or results of operations.

		iii. On December 16, 2004 the FASB issued FASB Statement No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”), which is a revision of SFAS 123. SFAS 123(R), supersedes APB 25, and amends FASB Statement No. 95, “Statements of Cash Flows”. Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS 123. However, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. SFAS 123(R) was to have been effective as of the beginning of the first interim or annual reporting period that commences after June 15, 2005 (July 1, 2005 for the Company); however, on April 14, 2005, the United States Securities and Exchange Commission (“SEC”) delayed effectiveness of FAS 123(R) for companies with fiscal years ending December 31, 2005 (such as the Company) to January 1, 2006.

		SFAS 123(R) permits public companies to adopt its requirements using one of two methods:


		1.	A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date of SFAS 123(R) that remain unvested on the effective date.

		2.	A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS 123 for purpose of pro forma disclosures all prior periods presented.


		The company plans to adopt SFAS 123(R) using the modified-prospective method.

		The Company adopted the fair-value-based method of accounting for share-based payments effective January 1, 2003 using the prospective method” described in SFAS 148.

		Because SFAS 123(R) must be applied not only to new awards but also to previously granted awards that are not fully vested on the effective date, and because the Company adopted SFAS 123 using the prospective transition method (which applied only to award granted, modified or settled after the adoption date), compensation cost for some previously granted awards that were not recognized under SFAS 123 will be recognized under SFAS 123(R). However, had the Company adopted SFAS 123(R) in prior periods, the impact of that

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 2:-	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	y.	Recently issued accounting pronouncements (Cont.)

		standard would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net income and earnings per share in Note 2(s) to the consolidated financial statements.

		In March 2005, the SEC released SEC Staff Accounting Bulletin No. 107, “Share-Based Payment” (“SAB 107”). SAB 107 provides the SEC staff’s position regarding the application of FAS 123(R) and contains interpretive guidance related to the interaction between SFAS 123(R) and certain SEC rules and regulations, and also provides the SEC staff’s views regarding the valuation of share-based payment arrangements for public companies. SAB 107 highlights the importance of disclosures made relating to the accounting for share-based payment transactions. The Company is currently reviewing the effect of SAB 107, however it does not believe that SAB 107 will have a material effect on its financial position, results of operations or cash flows.

	z.	Reclassifications

		Certain prior year amounts were reclassified to conform with current year financial statement presentation.


NOTE 3:-	BUSINESS COMBINATIONS AND SALE OF BUSINESSES

	a.	Galil

		Galil Medical Ltd. (“Galil”) develops, manufactures and markets systems and disposable kits for the performance of minimal invasive cryo-therapy by means of freezing tissues.

		1.	On July 1, 2003, Galil announced the completion of the merger of Galil’s urology business and the Brachytherapy business of Amersham plc (“Amersham”) (Amersham was subsequently acquired by General Electric Company (NYSE:GE) (“GE”)). According to an agreement signed on April 22, 2003, a new company, Oncura Inc. (“Oncura”), was incorporated. Oncura provides minimally invasive treatment options for prostate cancer using brachytherapy and cryotherapy technologies. At the closing, Amersham and Galil each contributed the assets necessary for Oncura to conduct the Cryotherapy business and the Brachytherapy business, respectively, in the urology field and in exchange, Amersham received 78% and Galil received 22% of the outstanding shares of Oncura. In addition, at the closing, Galil purchased 3% of Oncura from Amersham in consideration for $4,500 resulting in Galil’s owning an aggregate interest of 25% in Oncura.

			Galil and Amersham each entered, separately, into supply and R&D service agreements pursuant to which Galil and Amersham provide Oncura with certain exclusive supply, manufacturing and R&D services, on a cost plus basis, according to terms and conditions stipulated in the relevant agreements.

			Galil accounted for the transfer of its business in exchange for an interest in Oncura as a non-monetary exchange which was recorded at fair value. The fair value of the transaction was approximately $150,000. As Galil retains an indirect interest in the tangible and intangible assets transferred to Oncura, the portion of the gain relating to the interest retained has been deferred. This deferred gain is realized according to the rate of amortization of the assets transferred by Galil to Oncura.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 3:-	BUSINESS COMBINATIONS AND SALE OF BUSINESSES (Cont.)

	a.	Galil (Cont.)

			Accordingly, the investment in Oncura, which is accounted for under the equity method, was recorded in the amount of approximately $30,000.

			As a result, a gain on the transaction of approximately $21,200 was recorded in 2003 in the statement of operations under “Gain from disposal of businesses and affiliated companies and changes in holdings in affiliated companies, net”. The gain is net of realization of goodwill, related to the “Other Holdings and Corporate Operations” segment, in the amount of approximately $500. Elron’s share in the gain (net of minority interest and income taxes) amounted to approximately $4,400.

			The investment in Oncura as of the date of the transaction included amounts allocated to goodwill of approximately $14,200, to other intangibles of $23,800 and to deferred tax liabilities of $9,100.

			In 2005, due to an impairment of a certain intangible relating to a contract, the Company wrote down an amount of $1,700 ($800 net of minority interest), which is the unamortized portion of the investment amount allocated to the aforementioned intangible asset at the date of the investment in Oncura. In addition, in light of Oncura’s results, the Company recorded in 2005 an impairment loss on the investment in Oncura in the amount of $3,400 ($1,400 net of minority interest), due to an other than temporary decline in value of such investment. The impairment losses were presented in the statement of operations in the line item “equity in losses of affiliated companies”.

			In 2003, Galil signed a loan agreement with Oncura, according to which Galil has committed to extend loans to Oncura up to an aggregate principal amount of $2,000. As of December 31, 2005, Galil advanced $875 to Oncura in respect of this agreement. The loan bears an interest rate of Libor+0.75% per annum and is to be repaid in March 2007.

			Each of Galil and GE provided to Oncura a letter in which they confirmed their intention to continue providing financial support to Oncura through March 1, 2007 or such later date, as may be agreed by Oncura’s shareholders.

	b.	ESW

		On September 2, 2003, Elron’s majority owned subsidiary, Elron Software Inc. (“ESI”), sold substantially all of its assets and business to Zix Corporation (“Zix”), a publicly traded company on NASDAQ (NASDAQ: ZIXI). In consideration for the assets and business sold, Zix issued to ESI 1,709,402 unregistered shares of its Common stock, with a market value of approximately $6,000 and a convertible note bearing an interest rate of 5.75% (“the Note”) in the amount of $1,000. The Note was converted into 262,454 shares of Zix Common stock, in the fourth quarter of 2003. As part of the transaction, Zix assumed certain liabilities of ESI in the net amount of approximately $1,000. Following the transaction, ESI changed its name to ELRON SW, INC. (“ESW”).

		In determining the gain on the sale of ESI’s business, Elron valued the Zix Common stock at $5,400 (a discount from market value of approximately 10% due to certain restrictions on their sale). Accordingly, Elron recorded a gain on the sale of approximately $4,100, of which $2,500 represents an elimination of a liability to minority shareholders previously recorded by Elron with respect to options granted to ESW’s employees due to the expiration of the unexercised options.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 3:-	BUSINESS COMBINATIONS AND SALE OF BUSINESSES (Cont.)

	b.	ESW (Cont.)

		The business sold by ESW represents a component of an entity as defined in SFAS 144 and since the criteria for reporting discontinued operations under SFAS 144 is met, the results of operations of the business and the gain on the sale have been classified as discontinued operations in the statement of operations.

		The Zix Common stock had been accounted for as available for sale securities in accordance with SFAS 115. Of the 1,971,856 shares received, 1,117,155 shares (including 262,454 shares which resulted from the conversion of the convertible note) were sold in 2003 in consideration for approximately $9,000, resulting in a realized gain of approximately $4,800 ($3,200 net of tax) and 854,701 shares were sold in 2004 in consideration for approximately $8,100 resulting in a realized gain of approximately $5,400 ($3,600 net of tax).

		ESW was voluntarily dissolved in December 2004.

	c.	Mediagate

		In December 2003, Mediagate signed an agreement, for the sale of its technology and related intellectual property assets. The closing of the transaction occurred on January 28, 2004 with no effect on the consolidated results of operations. According to the agreement, the consideration for the technology is in the form of royalties, up to a maximum of $5,000 to be paid on future sales through December 31, 2009, of products that are based on Mediagate’s technology.

		As a result of the Company’s revised estimate about the realizability of future royalties to be received, the Company recorded in 2004 an impairment loss of approximately $4,200 ($2,700 net of tax) in respect of the intangible asset relating to Mediagate’s technology. This impairment loss is included as a separate line item in the statement of operations.

	d.	Elron Telesoft

		On December 29, 2005, Elron sold all of its shares of Elron Telesoft to ECtel Ltd. (NASDAQ: ECRX) for $2,500, of which $2,100 paid in cash immediately and up to an additional $400 shall be paid if certain milestones will be achieved during 2006. The above transaction resulted in an immaterial gain (due to previous impairment charges which were recorded on Elron Telesoft assets).

		According to SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, when a component of an entity, as defined in SFAS 144, has been disposed of or is classified as held for sale, the results of its operations, including the gain or loss on its disposal should be classified as discontinued operations when the operations and cash flows of the component have been eliminated from the Company’s consolidated operations and the Company will no longer have any significant continuing involvement in the operations of the component. The business sold by Elron Telesoft met the criteria for reporting discontinued operations and therefore the 2005 results of operations of the business and the gain on the sale have been classified as discontinued operations in the statement of operations and prior periods results have been reclassified accordingly. In addition, the comparative data of the assets and liabilities have been reclassified as assets and liabilities attributed to discontinued operations in the balance sheets.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 3:-	BUSINESS COMBINATIONS AND SALE OF BUSINESSES (Cont.)

	e.	Enure

		On October 2, 2005, Elron completed an investment of approximately $4,000 in Enure, in consideration for 213,690 Series A preferred shares. Enure is an Israeli software company engaged in developing unique solutions in the field of broadband services management and home networks. Following Elron’s investment, Elron holds approximately 44% of Enure, on a fully diluted and on an as converted basis (approximately 57% on an outstanding basis).Since the Company has control over Enure, Enure’s financial statements have been consolidated in the Company’s consolidated financial statements. The majority of the purchase price was allocated to cash and other monetary current assets and liabilities.

NOTE 4:-	CASH AND CASH EQUIVALENTS

	Includes mainly bank deposits in U.S. dollars, bearing an annual weighted average interest rate of 4.1% per annum (December 31, 2004 – 2.22%).

NOTE 5: -	SHORT-TERM INVESTMENTS


	Annual Weighted Average Interest rate as of December 31, 2005		December 31,

	%		2005		2004


Certificate of deposits				—		223
Bank deposits		3.77%		54,661		100,801


			$	54,661	$	101,024


NOTE 6: -	AVAILBLE FOR SALE MARKETABLE SECURITIES


Available-for-sale securities: (1) U.S. government agencies and corporate debentures			3.68%	$	62,617		$	44,985


					62,617			44,985

	(1)	Includes unrealized losses		$	—	*)	$	253


	* )	In 2005 –the unrealized losses in the amount of $909 were reclassified as finance income, net due to other than temporary decline in value

	Maturities

As of December 31, 2005:

Available-for-sale securities:
Due in one year or less	$	19,882
Due after one year to three years		35,755
Due after three years to five years		6,980
		62,617

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 7:-	INVESTMENTS IN AFFILIATED COMPANIES

	a.	Affiliated companies are as follows:


				December 31,

				2005		2004

	Note			Consolidated % of outstanding share capital


Elbit Systems (“ESL”)		7d(1	)		—		—
Given Imaging		7d(2	)		24.2		24.7
ChipX		7d(3	)		26.5		26.5
K.I.T eLearning		7d(4	)		—		—
Wavion		7d(5	)		37.8		37.5
Oren Semiconductors		7d(6	)		—		40.9
NetVision		7d(7	)		39.1		45.7
AMT		7d(8	)		41.8		40.3
Oncura		3a			25.0		25.0
Pulsicom		—			18.2		18.2
Notal Vision		—			25.6		25.5
CellAct		—			45.0		45.0


	b.	Composition of investments: (1)(2)


		December 31

		2005	2004


Given Imaging		68,956		71,748
Oncura		22,072		29,259
Netvision		5,549		3,542
Others		6,203		12,575


	$	102,780	$	117,124


⁽¹⁾Includes loans and convertible loans (bearing a weighted average interest rate of 6.42% per annum (December 31, 2004 – 5.03%))	$	1,417	$	7,122

⁽²⁾Difference between the carrying amounts of investments and the Company’s share in the net equity of affiliates, attributed to technology, goodwill and other intangible assets	$	69,913	$	81,726


	c.	Fair market value of public traded companies:


		December 31

		2005		2004

	Stock Exchange	U.S. dollars in millions

Given Imaging	Tel-Aviv and NASDAQ	$	176	$	245
Netvision	Tel-Aviv	$	27.7		—

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 7:-	INVESTMENTS IN AFFILIATED COMPANIES (Cont.)

	d.	Additional information

		1.	ESL

			On July 8, 2004, Elron announced the signing of a definitive agreement for the sale of all of its holdings in Elbit Systems Ltd. (“ESL”) (NASDAQ: ESLT) constituting approximately 19.6% of the outstanding share capital of ESL to Tadiran Communications Ltd., in consideration for approximately $197,000. The closing of the transaction was subject to the right of first refusal of Federmann Enterprises Ltd. (“Federmann Enterprises”), the other major shareholder of ESL. On July 28, 2004, Federmann Enterprises exercised its right of first refusal, following which the shares were sold to Federmann Enterprises for approximately $197,000. As a result, Elron recorded, in 2004, a gain of approximately $104,600 which net of tax amounted to approximately $91,500. The gain net of tax includes a reduction of approximately $21,600 in the tax expense as a result of the reversal of a valuation allowance previously recorded in respect of deferred tax assets relating to loss carryforwards.

		2.	Given

		a.	Given Imaging Ltd. (“Given”), a medical device company that develops, manufactures and markets innovative diagnostic systems for visualizing the gastrointestinal tract, using a disposable miniature swallowable video capsules.

			In 2003, RDC, then a 48% held subsidiary sold 753,600 shares of Given for a total consideration of approximately $7,800, resulting in a gain of approximately $4,400 ($70 net of tax and minority interest) as a result, Elron’s directly and indirectly ownership interest in Given decreased to approximately 17%.

		b.	In May 2003, a Share Purchase Agreement was signed between RDC, Elron and Rafael Armament Development Authority (“Rafael”) (the other shareholder of RDC), according to which, RDC sold 2,000,000 unregistered shares of Given to Elron and Rafael (one million each) for a total consideration of $12,184. RDC used $5,000 of the proceeds to repay shareholders’ loans to Rafael and Elron. This transaction did not have any effect on the Company’s consolidated results of operations and the Company’s direct and indirect interest in Given.

		c.	In April 2004, RDC purchased from one of its shareholders (a former senior executive of RDC) treasury shares amounting to approximately 3% of its outstanding share capital. In consideration for the treasury shares, RDC distributed to the shareholder 200,000 shares of Given. The number of the distributed Given shares was calculated based on the relative fair values of the shares of RDC and of Given on the date the agreement to purchase the treasury shares was signed (May 2003). The transaction was completed in April 2004, after receipt of various approvals required under the agreement.

			RDC recorded the purchase of the treasury shares based on the fair value of Given’s shares on the date of distribution. Accordingly, RDC recorded a gain on the distribution of Given shares of approximately $5,800. RDC’s purchase of the treasury shares resulted in Elron increasing its interest in RDC by approximately 1.5% to approximately 49.6%. This acquisition of the additional interest in RDC was accounted for by the purchase method.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 7:-	INVESTMENTS IN AFFILIATED COMPANIES (Cont.)

	d.	Additional information (Cont.)

		2.	Given (Cont.)

			Accordingly, Elron recorded the additional interest in RDC at fair value of approximately $1,900 and recorded its share of the gain in the distribution of Given shares in the amount of $1,400, net of tax and minority interest.

			The excess of the purchase price over the Company’s share in the equity acquired amounted to approximately $1,900 and was allocated mostly to RDC’s remaining investment in Given.

		d.	In June 2004, Given completed its secondary public offering of 2,880,750 ordinary shares at $32.00 per share, comprising 1,500,000 shares issued by Given and 1,380,750 shares (including 375,750 shares as a result of the exercise of the underwriters’ over allotment option) sold by existing shareholders. In the aforementioned offering, RDC sold 300,000 ordinary shares in consideration for approximately $9,000. Given received net proceeds of approximately $44,300. As a result of the sale of Given’s shares by RDC and the issuance of shares by Given, Elron’s directly and indirectly ownership interest in Given decreased from approximately 16% to approximately 15%, and Elron recorded a gain of $15,200 ($6,700 net of tax and minority interest).

		e.	During the second half of 2004, Elron purchased 1,373,513 ordinary shares of Given in consideration for approximately $43,900. As a result, Elron’s direct and indirect ownership interest in Given increased from approximately 15% to approximately 20%. The excess of the purchase price over the Company’s share in the equity acquired amounted to approximately $39,500 and was allocated as follows: approximately $30,400, net of deferred tax liability in the amount of $1,900, to intangible assets other than goodwill, such as customer relationships and technology, approximately $1,700 to in-process research and development activities (“IPR&D”), and approximately $7,400 to goodwill.

			Products which did not receive marketing clearance by regulatory authorities as of the acquisition date are considered to be incomplete and accordingly the amount allocated to such products is considered to be IPR&D. The amount allocated to IPR&D was charged immediately to the Company’s results of operations in accordance with FASB Interpretation No. 4, “Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method” (“FIN 4”). The amounts allocated to intangible assets other than goodwill are amortized on a straight-line basis over their weighted average expected useful life of 12 years. The amortization of the identifiable intangible assets as well as the write-off of the IPR&D are included as part of the line item “Equity in losses of affiliated companies” in the statements of operations.

		f.	During 2004, the Company’s Chairman of the Board exercised options previously granted to him and purchased 21,751 shares of Given from the company, in consideration for approximately $49 and the elimination of the related liability previously recorded in Elron’s books. As a result, Elron recorded a gain of approximately $600.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 7:-	INVESTMENTS IN AFFILIATED COMPANIES (Cont.)

	d.	Additional information (Cont.)

			During 2005 a former senior employee of RDC exercised options previously granted to him, and purchased from RDC 70,200 shares of Given in consideration for approximately $12 and the elimination of the related liability previously recorded in RDC’S books. As a result, RDC recorded a gain of approximately $1,200 ($500 net of tax and minority interest).

		3.	ChipX

			ChipX is a manufacturer of late stage programmable structured ASICs (application-specific integrated circuits). In March 2004, ChipX Incorporated (“ChipX”) completed a private placement in which it issued 7,594,928 redeemable preferred shares in consideration for $12,000. Elron purchased 1,632,564 redeemable preferred shares in consideration for approximately $2,600. As a result, Elron’s voting interest in ChipX decreased from approximately 33% to approximately 26%. The aforementioned transaction had no effect on Elron’s results of operations.

		4.	KIT

			In July 2003 Elron invested $2,000 in K.I.T.eLearning B.V (“KIT”), in consideration for 1,243,396 Series B-2 preferred shares, as part of an aggregate investment of $4,000, the balance of which was invested by DIC. KIT was previously held by Elron at a rate of approximately 29%.

			In addition to this investment, Elron’s loan to KIT in the amount of $1,500 (which was granted during 2001 and 2002) was converted into 324,388 series B-1 preferred shares of KIT. Following the investment and the loan conversion, Elron held approximately 45% of KIT’s outstanding shares.

			In March 2004, Elron together with the other shareholders of KIT, DIC and Kidum IT Ltd. (together “the sellers”) completed the sale of KIT, to Online Higher Education B.V, a subsidiary of Laureate Education, Inc. (NASDAQ: LAUR), a global leader in higher education, in consideration for $9,400, of which Elron received approximately $5,700. The gain resulting from the sale amounted to approximately $5,300. In addition, the sellers are entitled to a future payment of up to $10,000 based on future earnings of KIT in the years 2006 and 2007, from which Elron’s share will be up to approximately $5,700.

		5.	Wavion

			In 2003, Elron invested $3,000 in Wavion Inc. (“Wavion”) in consideration for 3,575,686 Series B preferred shares, out of an aggregate amount of $12,500 raised by Wavion in a private placement from Elron and new investors. In addition to this investment, Elron converted previously granted loans into 1,787,843 Series A1 preferred shares. In 2005, Elron invested $1,424 in consideration for 1,696,728 Series B preferred shares, out of an aggregate amount of $3,600. Wavion is a developer of broadband wireless access systems for Wi-Fi networks. As of December 31, 2005, Elron’s holds approximately 38% of Wavion on a fully diluted and on an as converted basis.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 7:-	INVESTMENTS IN AFFILIATED COMPANIES (Cont.)

	d.	Additional information (Cont.)

		5.	Wavion (Cont.)

			Wavion is considered to be a variable interest entity, however, the Company is not the primary beneficiary of Wavion, and accordingly has not consolidated Wavion. As of December 31, 2005, the Company’s maximum exposure to loss as a result of its involvement in Wavion does not exceed the carrying value of its investment in Wavion in the amount of approximately $761.

		6.	Oren

		a.	In July 2003, Elron purchased 6,581,671 preferred E2 shares of Oren Semiconductors Inc. (“Oren”) in consideration for $3,000, as part of an aggregate investment of $8,000 of existing shareholders and of Zoran Corporation (NASDAQ: ZRAN) (“Zoran”).

			In addition to this investment, Elron and other existing shareholders converted all the loans previously granted to Oren, in the amount of approximately $8,400, of which Elron’s part was approximately $4,400. Elron’s loans were converted to 3,824,563 preferred E1 shares of Oren. Following the investment and the loan conversion, Elron’s interest in Oren increased from approximately 17% to approximately 41% and accordingly Elron began applying retroactively the equity method of accounting to its investment in Oren.

		b.	On June 10, 2005, Zoran completed the acquisition of Oren. Prior to the transaction, Zoran held approximately 17% of Oren.

			The consideration paid by Zoran to the other shareholders in Oren was determined based on a value of Oren of $53,500. Zoran paid approximately $44,600 in the form of cash and Zoran common stock for the remaining 83% of Oren. Upon completion of the transaction, Elron received cash of approximately $12,500 and Zoran common stock with a value of approximately $7,700 (based on the market price of Zoran shares on the date of completion). An amount of approximately $1,900 out of the cash received is deposited in an escrow account, half until June 2006 and half until June 2007, for the assurance of Oren’s representations in accordance with the agreement. As a result of the sale, Elron recorded a gain, in 2005, of approximately $19,700 (approximately $17,200 net of taxes).

			In July 2005, Elron sold all shares of Zoran received by it in the aforementioned sale for approximately $8,800 and recorded a gain of approximately $1,100 (approximately $700 net of tax).

		7.	NetVision

		a.	NetVision provides Internet services and solutions in Israel and international telephony services through Voice over IP technology. During 2004, Elron and DIC each granted NetVision Ltd. (“NetVision”) a loan of $2,000 in order to enable NetVision to repay a portion of its line of credit to a lending bank. DIC is the other major shareholder of Netvision. In accordance with EITF 02-18, Elron recognized all previously suspended equity method losses in NetVision in the amount of the loan granted.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 7:-	INVESTMENTS IN AFFILIATED COMPANIES (Cont.)

	d.	Additional information (Cont.)

		7.	NetVision (Cont.)

			During the second half of 2004, Elron and DIC each granted NetVision additional loans of approximately $3,300. The loans from Elron bore an interest rate of Libor +2% per annum.

		b.	On May 19, 2005, Netvision completed its initial public offering on the Tel Aviv Stock Exchange in Israel of shares and convertible securities in consideration for the immediate net proceeds of approximately NIS 135 million (approximately $31,000). Out of the proceeds received, an amount of approximately NIS 38 million (approximately $8,600) was allocated to the shares and an amount of approximately NIS 97 million (approximately $22,400) was allocated to the convertible securities based on the relative fair value of such securities. In addition, future proceeds from the exercise of options sold in the offering may amount to a maximum of approximately NIS 28.8 million (approximately $6,600). Elron and DIC each converted approximately $3,100 of loans into equity of Netvision immediately prior to the offering and $2,200 in loans was repaid to each Elron and DIC from the proceeds of the offering. As a result of the initial public offering, Elron’s interest in Netvision decreased from 45.7% to approximately 39% resulting in a gain of approximately $3,000. If all convertible securities in Netvision are converted to shares, Elron’s interest in Netvision will decrease to 27.4%.

		8.	AMT

			The AMT group develops technologies and products based on amorphous metals. In June 2004, Elron completed an investment of $3,000 in convertible notes of AMT then held 28% by Elron, together with an international strategic partner which also invested $3,000 in AMT’s convertible notes. In addition, existing AMT shareholders, including Elron, converted shareholder loans into convertible notes in the aggregate amount of approximately $2,700, of which Elron converted approximately $1,600. In addition, Elron and the other investors in AMT were issued warrants to purchase convertible notes of AMT for a total amount of up to approximately $33,250, which may be exercised over various periods up to a maximum of 48 months from the closing date of the transaction. As a result of the transaction, Elron increased its ownership interest to approximately 35% on a fully diluted basis (excluding warrants) and on an “as converted” basis. The excess of the purchase price over the Company’s share in the equity acquired amounted to approximately $4,200 and was allocated as follows: approximately $2,900, net of deferred tax liability in the amount of approximately $300, to intangible assets other than goodwill with a weighted average useful life of 10 years, approximately $1,100 to IPR&D and approximately $140 to tangible assets.

			In 2005, Elron invested additional $900 in convertible notes and $500 in loans bearing an interest rate of 8% per annum.

		9.	Oncura

			Regarding the investments in Oncura, see Note 3(a)(1).

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 7:-	INVESTMENTS IN AFFILIATED COMPANIES (Cont.)

	e.	Summarized information

		Summarized combined financial information is as follows:


	Given		Oncura			Others

December 31, 2005:

Balance sheet information:
Current assets	$	108,976	$	23,998		$	57,548
Non-current assets		40,134		37,496			53,876
Total assets		149,110		61,494			111,423
Current liabilities		22,759		30,724			53,498
Non-current liabilities		24,246		3,574			53,127
Minority interest		61		—			143
Redeemable preferred stock		—		—			36,108
Shareholders’ equity (deficiency)		102,044		27,196			(31,453	)

Year Ended December 31, 2005:

Statement of operations information:
Revenues	$	86,776	$	72,063		$	95,707
Gross profit		64,706		31,183			25,859
Net income from continuing operations and net income		6,343		—			5,405
Net loss from continuing operations and net loss		—		(6,209	)		(18,680	)


	Given		Others

December 31, 2004:

Balance sheet information:
Current assets	$	110,433	$	66,990
Non-current assets		13,791		96,426
Total assets		124,224		163,419
Current liabilities		17,446		82,060
Non-current liabilities		10,984		49,278
Minority interest		1,177		493
Redeemable preferred stock		—		34,272
Shareholders’ equity (deficiency)		94,617		(2,684	)

Year Ended December 31, 2004:

Statement of operations information:
Revenues	$	65,020	$	158,965
Gross profit		47,286		53,494
Net income from continuing operations and net income		2,888		4,446
Net loss from continuing operations and net loss		—		(23,586	)


		Following is the summary of information from ESL’s unaudited financial report as of June 30, 2004, which the Company used in order to record in 2004 its share in the equity and results of ESL until the date of sale of the investment in ESL (on July 28, 2004) and in order to determine the gain resulting from the aforementioned sale (see Note 7d1).

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 7:-	INVESTMENTS IN AFFILIATED COMPANIES (Cont.)

	e.	Summarized information


	ESL

June 30, 2004: (unaudited)

Balance sheet information:
Current assets	$	559,848
Non-current assets		452,190
Total assets		1,012,038
Current liabilities		358,671
Non-current liabilities		171,419
Minority interest		3,972
Shareholders’ equity		477,976

Six months ended June 30, 2004 (unaudited):

Statement of operations information:
Revenues	$	445,317
Gross profit		115,438
Net income from continuing operations and net income		24,039


	f.	Goodwill and intangible assets allocated to investments

		The annual estimated amortization expense relating to intangible assets allocated to investments accounted for under the equity method, which will be included in the line item “Equity in losses of affiliated companies” in the statement of operations, for each of the five years in the period ending December 31, 2010 is approximately $4,600.

		The weighted average amortization period of the intangible assets is approximately 14 years.

		At the balance sheet date, the Company has goodwill in the amount of $20,650 allocated to investments accounted for under the equity method.

	g.	Impairment

		As a result of an other-than-temporary decline in value of certain investments, the Company recorded impairment losses with respect to affiliated companies of $5,300 (including $1,700 relating to a certain intangible asset in an investee), $700 and $500, in 2005, 2004 and 2003, respectively. Such impairment losses are included as part of the Company’s equity in losses of affiliated companies.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 8:-	INVESTMENTS IN OTHER COMPANIES AND LONG-TERM RECEIVABLES


	December 31

	2005		2004


Marketable securities presented as available- for- sale securities: (1)
Partner (2)	$	25,998	$	136,208
Other		1,065		950


		27,063		137,158


Partnerships		3,698		3,176


Other investments and long-term receivables (3)(4)		43,170		15,595


	$	73,931	$	155,929


(1) Includes unrealized gains	$	17,540	$	90,484


		(2)	Partner Communications Company Ltd. (“Partner”)

			As of December 31, 2005 and 2004, Elbit holds 3,091,361 and 15,856,551 shares of Partner, respectively. In 2003, Elbit sold 6,278,226 shares of Partner in consideration for approximately $29,300. As a result, Elron recorded a realized gain of approximately $11,000 ($7,100 net of tax). On April 20, 2005 Elbit completed the sale of 12,765,190 Partner shares to Partner for approximately $94,000, as part of the sale together with the other Israeli founding shareholders of Partner, of approximately 33.3 million Partner shares to Partner. As a result of the sale, Elron recorded in the statement of operations, a gain of approximately $56,400 (approximately $45,400 net of tax).

			The gain net of tax includes a reduction of approximately $9,400 in the tax expense as a result of the reversal of a valuation allowance previously recorded in respect of deferred tax assets relating to loss carryforwards. See Note 14 (e).

			Subsequent to the aforementioned sale and as of December 31, 2005, Elbit holds approximately 2% of the outstanding shares of Partner. This interest in Partner is no longer pledged to the banks providing financing to Partner.

			On March 8, 2006, Elron announced the signing of a definitive agreement to acquire approximately 823,000 shares of Partner from one of the other Israeli founding shareholders of Partner for approximately $5,300, reflecting approximately 15% discount from the market price, subject to adjustments in accordance with the terms of the agreement. Upon completion of the acquisition, we will hold approximately 2.6% of Partner. The completion of the acquisition is subject to the satisfaction of certain closing conditions including regulatory approval. There is no assurance that the acquisition will be completed.

			Almost all of these shares are subject to transfer restrictions under Partner’s license.

		(3)	During 2005, 2004 and 2003, Elron recorded impairment losses of approximately $600, $800 and $3,700, respectively, in respect of certain investments and receivables.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 8:-	INVESTMENTS IN OTHER COMPANIES AND LONG-TERM RECEIVABLES (Cont.)


		(4)	Other investments include mainly the following companies:


	December 31,

	Note	2005	2004

		% of outstanding share capital on an as converted basis

Jordan Valley	8(4)(a)	27.8	27.8
Impliant	8(4)(b)	21.5	20.1
Nulens	8(4)(c)	21.6	—
Teledata	8(4)(d)	21.1	—
Brainsgate	8(4)(e)	22.3	—
Safend	8(4)(f)	—	—


	(a)	Jordan Valley

		On October 21, 2004, Elron purchased 32,901 Preferred A shares of Jordan Valley Semiconductor Ltd. (“Jordan Valley”), in consideration for approximately $6,700, as part of an aggregate investment of approximately $9,000 raised by Jordan Valley. The balance of the aggregate investment in Jordan Valley was invested by Clal Industries and Investments Ltd. (“Clal”) by way of conversion of previously granted loans. Jordan Valley is an Israeli private company engaged in developing solutions for advanced in-line thin film metrology for the semiconductor industry. Following the investment Elron holds 25% of Jordan Valley on a fully diluted basis and on an as converted basis. According to the agreement, Elron’s holding percentage was subject to adjustment based on Jordan Valley’s future performance and therefore Elron invested in October 2005 an additional $1,400. Jordan Valley is also 40% owned (indirectly) by Clal, an entity under common control with DIC. Elron’s investment in Jordan Valley was approved by the shareholders of Elron and Clal on October 21, 2004. Since the investment in preferred A shares is not considered to be an investment that is in-substance-common stock, the investment in Jordan Valley is accounted for under the cost method.

	(b)	Impliant

		On December 28, 2004, Elron invested approximately $7,300 in consideration for 19,962,500 Preferred C shares of Impliant Inc. (“Impliant”) as part of a financing round of approximately $18,000 from new and existing investors of Impliant. In 2005 Elron invested an additional $1,000 in consideration for 2,682,907 Preferred C shares as part of a financing round of approximately $5,400. Impliant is a privately held medical device company, engaged in the development of a novel posterior motion preservation system for spine surgery. Following the aforementioned investments, Elron holds approximately 20% of Impliant, on a fully diluted basis and on an as converted basis. Since the investment in preferred C shares is not considered to be an investment that is in-substance-common stock, the investment in Impliant is accounted for under the cost method.

	(c)	NuLens

		On April 21, 2005, Elron completed an investment of approximately $2,900 in NuLens Ltd. (“NuLens”), in consideration for 763,584 Series A preferred shares, as part of an aggregate investment of approximately $3,400. NuLens is an Israeli medical device company operating in the field of intra-ocular lenses mainly for cataract and presbyopia procedures. Elron’s investment was in two installments, the first of approximately $1,700 was invested immediately for approximately 17% of NuLens on a fully diluted and on an

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 8:-	INVESTMENTS IN OTHER COMPANIES AND LONG-TERM RECEIVABLES (Cont.)


	(c)	NuLens (Cont.)

		as converted basis and an additional amount of approximately $1,200 was invested on March 9, 2006, simultaneously with an additional investment of $1,500, for 241,158 Series B preferred shares as part of a new round of investment in the aggregate amount of approximately $6,000. The new round was led by Warburg Pincus, a leading global private equity fund. Following the above investments, Elron holds 25% of NuLens, on a fully diluted and on an as converted basis. Since the investments in preferred A and B shares are not considered to be an investment that is in-substance-common stock, the investment in NuLens is accounted for under the cost method

	(d)	Teledata

		On May 8, 2005, Elron completed an investment of $16,000 in Teledata Networks Ltd. (“Teledata”), in consideration for 4,923,194 series A preferred shares. The investment is part of an aggregate round of financing of $19,000, in which FBR Infinity II Ventures, an indirectly related venture capital fund (“Infinity”), invested the remaining $3,000. Teledata provides innovative access products and solutions for both traditional and next generation networks to telecom operators and service providers. Following the investment, Elron holds approximately 21% of Teledata, on a fully diluted and on an as converted basis. Since the investment in preferred A shares is not considered to be an investment that is in-substance-common stock, the investment in Teledata is accounted for under the cost method.

	(e)	BrainsGate

		On August 8, 2005, Elron completed an investment of approximately $6,900 in BrainsGate Ltd. (“BrainsGate”), in consideration for 1,733,141 Series B-1 preferred shares, as part of an aggregate investment of approximately $17,000. BrainsGate is an Israeli company that is developing implantable medical devices to treat various central nervous system diseases (CNS) related pathologies. Following Elron’s investment, Elron holds approximately 20% of BrainsGate, on a fully diluted and on an as converted basis. Since the investment is in preferred B-1 shares, which are not considered to be an investment that is in-substance- common stock, the investment in BrainsGate is accounted for under the cost method.

	(f)	Safend

		On January 2, 2006 Elron completed an investment of approximately $3,700 in Safend Ltd. (“Safend”) of which $200 were granted as a bridge loan in December 2005, in consideration for 1,942,261 Series B preferred shares, as part of an aggregate investment of approximately $7,400. Following Elron’s investment, Elron holds approximately 22% of Safend on a fully diluted and on an as converted basis. Safend is an Israeli company which develops comprehensive desktops and laptops endpoint security solutions.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 9:-	PROPERTY AND EQUIPMENT, NET


	December 31

	2005		2004


Land and Building	$	9,944	$	10,060
Leasehold improvements		2,508		2,389
Computers, furniture and machinery		4,176		3,691
Motor vehicles		561		521

		17,189		16,661
Less - accumulated depreciation		9,380		8,604


Property and equipment, net	$	7,809	$	8,057


	Depreciation expenses amounted to approximately $1,016, $1,013 and $1,336 for the years ended
	December 31, 2005, 2004 and 2003, respectively.

	Depreciation expenses included in the discontinued operations, amounted approximately $10, $124 and $254 for the years ended December 31, 2005, 2004 and 2003, respectively.


NOTE 10:-	GOODWILL AND OTHER INTANGIBLE ASSETS


			December 31
	Period of
	amortization		2005		2004

		years

Cost:
Technology and other intangible assets (1)		14	$	425	$	383

Accumulated amortization:
Technology and other intangible assets (1)				236		174


				189		209


Intangible assets with indefinite useful life				2,629		2,629

Goodwill				2,742		6,657


Amortized cost			$	5,560	$	9,495


	1.	The annual estimated amortization expense relating to Elron’s amortizable intangible assets existing as of December 31, 2005, for each of the five years in the period ending December 31, 2010 is approximately $40.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 10:-	GOODWILL AND OTHER INTANGIBLE ASSETS (Cont.)


	2.	The changes in the carrying amount of goodwill for the years ended December 31, 2005, 2004 and 2003 are as follows:


	Other Holdings and Corporate operations

Balance as of January 1, 2003		$ 14,862
Goodwill write-off relating to sale of business		(781	)
Adjustment of goodwill due to reversal of valuation allowance in respect to deferred tax assets (4)		(7,653	)

Balance as of December 31, 2003		$ 6,428

Newly consolidated companies		229

Balance as of December 31, 2004		$ 6,657
Adjustment of goodwill due to reversal of valuation allowance in respect to deferred tax assets (4)		(3,915	)


Balance as of December 31, 2005		$ 2,742


	3.	Amortization expenses amounted to approximately $61, $142 and $299 for the years ended December 31, 2005, 2004 and 2003, respectively.

	4.	In 2003, Elbit recorded a tax benefit in the amount of approximately $7,700, and reduced its valuation allowance in respect of deferred tax assets. Since the tax benefit was in respect of losses carryforward of Elbit at the date of Elbit’s merger with Elron (May 2002) (“the merger”), Elron recorded the tax benefit as a reduction from goodwill that had resulted from the merger.

		With respect to 2005 – see Note 14 (e).

	5.	Regarding the write down of an intangible asset relating to Mediagate, see Note 3c.


NOTE 11:-	SHORT-TERM LOANS FROM BANKS AND OTHERS


	Weighted Average Interest rate December 31, 2005			December 31

	%			2005		2004


Short-term loans from banks denominated in NIS		—		$	—	$	9
Short-term loans from banks denominated in U.S. dollars		6.62	%		3,808		380


				$	3,808	$	389

As of December 31, 2005, the balance also includes a bank loan to Mediagate in the amount of approximately $2,600 bearing an annual interest rate of the Wholesale Interest Rate plus 1% (the Wholesale Interest Rate as of December 31, 2005 and 2004 was approximately 5.3% and 3.3%, respectively). In 2004 the loan was represented as long term loan. In February 2006, the loan (including accrued interest) was extinguished for a consideration of $100. As a result Elron will record in the first quarter of 2006 a gain of approximately $2,700.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 12:-	OTHER PAYABLES AND ACCRUED EXPENSES


	December 31

	2005		2004


Payroll and related expenses ⁽¹⁾	$	2,502	$	2,559
Provision for income taxes		4,252		19,044
Accrued expenses		850		348
Deferred revenues		—		89
Employees call options ⁽²⁾		836		3,835
Provision for rent		—		1,007
Provision for Professional expenses		455		314
Chief Scientist		443		525
Others		1,687		1,960

	$	11,025	$	29,681


(1) Includes provision for vacation pay	$	958	$	818


	(2)	EMPLOYEE CALL OPTIONS

	a.	The Company’s Chairman of the Board has options to acquire up to 1.5% of any shares or other securities acquired by the Company in Wavion and up to 0.75% of any shares or other securities acquired directly and indirectly by the Company in Galil. These options shall be exercisable at the weighted average price of investments made by the Company with respect to any of those two companies until the date of exercise of the options. The options shall be exercisable for a period of three years commencing on the later of January 1, 2000 or the date of the latest investment by the Company in the relevant entity.

	b.	During 2001, the Board of directors approved the grant of options to certain officers of the Company to acquire between 1% to 2% of Elron’s investments in certain private companies. The options are exercisable at the weighted average price of the investments made by Elron. The options vest ratably over a three year period and are exercisable for an additional three years.

	c.	In 1999, RDC granted two former senior employees with call options to purchase up to 5% of the investments held by RDC at that date at an exercise price as determined in the call option agreement. During 2005, a former senior employee of RDC exercised a call option with respect to 70,200 shares of Given at an exercise price of $0.17 per share (See Note 7d(2)).

	d.	In 2004, RDC granted to a key employee call options to purchase up to 0.75% of RDC’s investment in Starling at an exercise price as determined in the call option agreement. Approximately 67% of the options vest ratably over a period of 4 years and the balance are fully vested.


	All aforementioned options were recorded at fair value. The fair value of each option granted (as described in paragraphs a - d above) is estimated using the Black and Scholes option pricing model with the following weighted average assumptions for the years ended December 31, 2005, 2004 and 2003, respectively: (1) expected life of the option of 1.8, 4 and 3.89, respectively; (2) dividend yield of 0% for all periods; (3) expected volatility of the options of 50%, 50% and 0% to 65%, respectively; and (4) risk-free interest rate of 4.6%, 2.5% and 1%, respectively.

	In respect of the aforementioned call options, compensation expense (income) amounted to $(1,041), $1,414 and $957 for the years ended December 31, 2005, 2004 and 2003, respectively. These compensation expenses are included in General and administrative expenses.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 13:-	LONG-TERM LOANS FROM BANKS AND OTHERS


	a.	COMPOSITION


	December 31

	2005			2004


Long-term loans from banks (1)	$	23		$	3,420
Long-term loans from others (2)		3,519			3,626

		3,542			7,046

Less-current maturities (2)		(2,065	)		(2,974	)


	$	1,477		$	4,072


	(1)	In 2004, with respect to Mediagate’s loan see Note 11.

	(2)	As of December 31, 2005 and 2004 an amount of $2,058 and $2,199, respectively, represents loans from Rafael to RDC which are denominated in New Israeli Shekel (“NIS”) and do not bear interest or linkage. These amounts are included in current maturities of long term loans.

		As of December 31, 2005, the amount also includes a loan of approximately $1,379 from the minority shareholders of Galil. The loan bears interest at a rate of Libor plus 3%.

b.	The maturities of long-term loans for years subsequent to the balance sheet date are as follows:


First year (current maturities)	$	2,065
Second year		1,469
Third year		8


	$	3,542


NOTE 14:-	INCOME TAXES


	a.	Measurement of taxable income under the Income Tax (Inflationary Adjustments) Law, 1985:

		In accordance with the above law, results for tax purposes are measured and reflected in real terms in accordance with the change in the Israeli CPI. As explained in Note 2b, the consolidated financial statements are presented in U.S. dollars. The differences between the change in the Israeli CPI and in the NIS/U.S. dollar exchange rate causes a difference between taxable income or loss and the income or loss before taxes reflected in the consolidated financial statements. In accordance with paragraph 9(f) of SFAS 109, the Company has not provided deferred income taxes on this difference between amounts in the reporting currency and the tax bases of assets and liabilities.

	b.	Tax benefits under Israel’s Law for the Encouragement of Industry (Taxation), 1969:

		Certain of the Company’s subsidiaries in Israel are “industrial companies”, as defined by the Law for the Encouragement of Industry (Taxation), 1969, and as such, are entitled to certain tax benefits, mainly accelerated depreciation and the right to claim public issuance expenses and amortization of costs relating to intangible assets and patents as deductible expenses for tax purposes.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 14:-	INCOME TAXES (Cont.)


	c.	Tax benefits under the Law for the Encouragement of Capital Investments, 1959:

		Some of the Company’s subsidiaries have been granted an “Approved Enterprise” status for their production facilities in Israel under the Law for the Encouragement of Capital Investments, 1959. The main benefit to which these subsidiaries are entitled, conditional upon the fulfilling of certain conditions stipulated by the above law, is a ten-year exemption from tax on income derived from their production facilities in Israel. The ten-year period is limited to the earlier of twelve years from the commencement of production, or fourteen years from the approval date.

	d.	In 2004, the Israeli parliament approved on amendment to the Income Tax Ordinance (No. 140 and Temporary Provision) which reduces the corporate tax rate from 36% to 35% in 2004 and progressively to a rate of 30% in 2007. As a result, Elron recorded in 2004 a tax benefit in the amount of approximately $2,900.

		On July 25, 2005, the Israeli parliament approved the Law for the Amendment of the Tax Ordinance (No. 147), 2005 which progressively reduces the corporate tax rate in Israel to the following tax rates: in 2006 - 31%, in 2007 – 29%, in 2008 - 27%, in 2009 - 26% and in 2010 and thereafter - 25% (the “Amendment”). The amendment had no material effect on the Company’s financial position and results of operations in 2005.

	e.	Taxes on income (tax benefit) are comprised as follows:


	Year ended December 31,

	2005			2004			2003


Current taxes*	$	19,031		$	16,363		$	385
Adjustments of deferred tax assets and liabilities for enacted changes in tax rates		116			(2,917	)		—
Deferred income taxes		(7,404	)		508			6,229
Taxes in respect of prior years		(1,282	)		1,147			182


	$	10,461		$	15,101		$	6,796


Domestic	$	10,461		$	15,101		$	6,796


Foreign	$	—		$	—		$	—


	*	In 2005, Elbit received final tax assessments for the years 2002 to 2004, according to which certain prior year losses are to be offset from certain gains. Consequently, Elbit reversed a valuation allowance previously recorded in respect of deferred tax assets relating to loss carryforwards. This reversal resulted in a tax benefit of $14,500. Since a portion of the valuation allowance reversed was in respect of loss carryforwards of Elbit existing at the date of the merger, Elron recorded a tax benefit in the amount of $3,900 relating to such portion as a reduction of the remaining goodwill.

f.	Deferred income taxes:

	Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax liabilities and assets are as follows:

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 14:-	INCOME TAXES (Cont.)


	f.	Deferred income taxes:


	Deferred Tax Asset						Deferred Tax Liability

	Non current			Current			Current		Non current			Total

As of December 31, 2005
Deferred tax assets:
Provision for doubtful accounts, vacation and others	$	—		$	201		$	—	$	—		$	201
Accrued severance pay, net		156			—			—		—			156
Trading marketable securities		—			22			—		—			22
Investments in subsidiaries, affiliates and other companies, net		31,946			—			—		(1,848	)		30,098
Property and equipment and intangible assets		28			—			—		(744	)		(716	)
Tax loss carryforwards		36,505			—			—		955			37,460
Other					356			—		—			356

	$	68,635		$	579		$	—	$	(1,637	)	$	67,577

Deferred tax liabilities:
Available-for-sale marketable securities		—			—			—		(7,857	)		(7,857	)

								—
Valuation allowance ⁽¹⁾		(62,114	)		(579	)		—		—			(62,693	)

	$	6,521		$	—		$	—	$	(9,494	)	$	(2,973	)


		Deferred Tax Asset					Deferred Tax Liability

	Non current			Current			Current		Non current			Total


As of December 31, 2004
Deferred tax assets:
Provision for doubtful accounts, vacation and others	$	—		$	341		$	—	$	—		$	341
Accrued severance pay, net		363			—			—		—			363
Trading marketable securities		—			20			—		—			20
Investments in subsidiaries, affiliates and other companies, net		39,801			—			—		(1,659	)		38,142
Property and equipment and intangible assets		184			—			—		(811	)		(627	)
Tax loss carryforwards		72,545			—			—		6,473			79,018
Other		—			1,151			—		—			1,151


	$	112,893		$	1,512		$	—	$	4,003		$	118,408

Deferred tax liabilities:
Available-for-sale marketable securities		—			—			—		(45,236	)		(45,236	)

		112,893			1,512			—		(41,233	)		73,172

Valuation allowance		(107,400	)		(1,512	)		—		—			(108,912	)


	$	5,493		$	—		$	—	$	(41,233	)	$	(35,740	)


	(1)	As of December 31, 2005, the valuation allowance for deferred tax assets, for which their reversal will be allocated to reduce other non-current intangible assets, aggregated approximately $1,800.

g.	A reconciliation between the theoretical tax expense, assuming all income is taxed at the statutory tax rate applicable to income of the Company and the actual tax expense as reported in the statement of income, is as follows:

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 14:-	INCOME TAXES (Cont.)


	Year ended December 31,

	2005			2004			2003


Income (loss) before taxes as reported in the consolidated statements of operations	$	56,486		$	111,734		$	12,807


Statutory tax rate		34	%		35	%		36	%

Theoretical tax expense (income)	$	19,205		$	39,107		$	4,611
Equity in losses of affiliated companies		6,076			3,672			3,131
Non-deductible expenses, tax exempt and reduced tax rate		(639	)		856			1,514
Differences arising from the basis of measurement for tax purposes		1,233			(1,024	)		2,783
Deferred taxes on losses for which valuation allowance was provided		5,370			2,940			1,977
Reversal of valuation allowance		(19,618	)		(28,680	)		(7,402	)
Taxes in respect of previous years		(1,282	)		1,147			182
Effect of change in tax rate		116			(2,917	)		—

Actual tax expenses	$	10,461		$	15,101		$	6,796

Effective tax rate		18.5	%		13.5	%		53.1	%


	h.	As of December 31, 2005 the Company had tax loss carryforwards of approximately $69,000, its Israeli subsidiaries had tax loss carryforwards of approximately $51,000. Carryforward tax losses in Israel may be carryforward indefinitely and may be set against future taxable income.

	i.	Income before taxes on income is comprised as follows:


	Year ended December 31,

	2005		2004		2003


Domestic	$	56,486	$	111,576	$	20,671
Foreign		—		158		(7,864	)


	$	56,486	$	111,734	$	12,807


NOTE 15:-	CONTINGENT LIABILITIES, PLEDGES AND COMMITMENTS


	a.	The Company and its subsidiaries have operating lease agreements in respect of their premises for periods ending through 2011. Rent expenses amounted to approximately $593, $534 and $456 for the years ended December 31, 2005, 2004 and 2003, respectively. The future minimum rental payments under these agreements in the years following the balance sheet date are as follows:


First year	$	797
Second year		686
Third year		387
Fourth year		201
Fifth year and thereafter		258


	$	2,329

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 15:-	CONTINGENT LIABILITIES, PLEDGES AND COMMITMENTS (Cont.)


	b.	Certain of the Company’s subsidiaries are required to pay royalties to the Office of the Chief Scientist of the Israeli Ministry of Industry and Trade and other institutions at the rate of 3%-5% of revenues derived from research and development projects in which the Government of Israel or the other institutions participated in financing up to an amount equal to 100% of the amount received by each company and in certain cases plus interest of Libor. As of December 31, 2005, the aggregate contingent obligation royalty amounted to approximately $3,868.

	c.	Legal proceedings:

	1.	During September 1999, the Company received copies of two claims and a request to approve such claims as a class action on behalf of public shareholders of Elscint (formerly an affiliated company) against the Company and others. The allegation raised by the claimants related to the decision regarding the sale of Elscint’s substantial assets. The claim has been stayed pursuant to an arrangement reached by the parties pending the outcome of the appeal in the claim described in paragraph 2 below. The arrangement provides that if the appeal as described in paragraph 2 below is accepted, then the proceedings to recognize the lawsuit as a class action will proceed. Otherwise, the application to recognize the claim as a class action suit will be dismissed.

	2.	On November 2, 1999, the Company received a copy of a claim, and a request to approve such a claim, as a class action on behalf of some institutional investors and others and those who held shares in Elscint on September 6, 1999. The allegations raised against the Company and certain of its officers including former officers, among others, relate to the period prior to the sale of the Company’s holdings in Elbit Medical Imaging (“EMI”) (the parent company of Elscint and formerly an affiliated company). The claimants seek a court order pursuant to which EMI would be compelled to execute the alleged buy-out of Elscint’s share at $14 per share or other remedies. On August 16, 2000, the Haifa District court dismissed the application to recognize the claim as a class action. Some of the claimants applied for and have been granted permission to appeal to the Supreme Court in Israel, which appeal is currently pending.

		In addition, in February 2001, the claimants submitted a revised claim similar to the previous one but not as a class action. It has not been determined when the defendants are required to file their statements of defense to the claim. The claimants and the defendants are currently involved in various proceedings, mostly regarding the disagreement concerning the court fees.

		The Company denies all the allegations set forth in the above claims, and based on legal advice received, management is of the opinion that the Company has good defense arguments which, if accepted, will cause dismissal of the above allegations.


NOTE 16:-	SHAREHOLDERS’ EQUITY


	a.	Share capital

		An ordinary share confers upon its holder voting rights, the right to receive dividends and the right to share in excess assets upon liquidation of the Company.

	b.	Dividend

		On September 5, 2005, Elron has declared a cash dividend of $3.00 per share, totaling approximately $88,500. The dividend was paid on September 27, 2005.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 16:-	SHAREHOLDERS’ EQUITY (Cont.)


c.	Options to employees

	1.	Options to Elron’s Employees

		The Company has various stock option plans under which the Company may grant options to purchase the Company’s shares to officers, directors and employees of the Company. Such options have been granted mainly with exercise prices below market price at the date of the grant. Generally, the options vest over a four-year period from the date of grant in four equal annual portions. The options expire after 5 to 7 years from the date of grant.

		In May 2003, the Board of directors of the Company approved an option plan (the “2003 Option Plan”) providing for the grant of 500,000 options to purchase 500,000 ordinary shares of the Company to eligible employees, directors and officers of the Company or of any subsidiaries of the Company. According to the option plan the exercise price is to be reduced in the event of a distribution of a dividend in the amount the dividend distributed.

		As of December 31, 2005, 388,000 options were granted under the 2003 Option Plan at an average exercise price of $6.37 per share. The exercise price was adjusted to reflect the abovementioned dividend. The options vest over a period of four years in four equal annual portions and expire after 5 years from date of grant.


	2005						2004					2003

	Number of options			Weighted average exercise price			Number of options			Weighted average exercise price		Number of options			Weighted average exercise price


Outstanding-beginning of the year		574,702		$	12.44			791,777		$	12.01		557,880		$	13.92
Granted		120,000			9.69			20,000			12.41		291,333			8.03
Exercised		(69,031	)		10.11			(218,290	)		10.35		(25,875	)		6.84
Forfeited		(85,236	)		13.95			(18,785	)		13.39		(31,561	)		13.10


Outstanding - end of the year		540,435		$	9.53	(*)		574,702		$	12.44		791,777		$	12.01


Options exercisable at the end of the year		281,435		$	11.88	(*)		259,369		$	16.56		313,320		$	15.66


	(*) After an adjustment as a result of the dividend distributed of $3 per share (see Note 16(b)).

			The weighted average fair values and weighted average exercise prices of options granted during the years ended December 31, 2005, 2004 and 2003 were as follows:


	For options with an exercise price on the grant date that:

	Exceeds market price						Less than market price

	Year ended December 31,						Year ended December 31,

	2005		2004		2003		2005		2004		2003


Weighted average exercise prices	$	—	$	—	$	8.44	$	9.69	$	12.41	$	8.00
Weighted average fair values on grant date	$	—	$	—	$	1.3	$	4.18	$	5.51	$	2.95

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 16:-	SHAREHOLDERS’ EQUITY (Cont.)

	c.	Options to employees (Cont.)

		2.	The following table summarizes information regarding outstanding and exercisable options as of December 31, 2005:


Options outstanding				Options exercisable

Exercise price	Number outstanding at December 31, 2005		Weighted- average remaining contractual life (years)	Weighted- average exercise price		Number outstanding at December 31, 2005		Weighted- average exercise price

$5-7.838		307,333	2.67	$	5.4		143,333	$	5.06
$9.12-10.01		119,384	4.09	$	9.31		24,384	$	9.89
$15.76-18.87		80,718	1.42	$	17.45		80,718	$	17.45
$29.38		33,000	1.83	$	29.38		33,000	$	29.38


		540,435					281,435



		3.	In December 1999, the Company’s shareholders approved a plan whereby the Chairman of the Board and the then Chief Executive Officer of the Company were granted options to purchase up to 58,154 ordinary shares of the Company (the “1999 grant”). The options were granted ratably over a period of 3 years commencing February 2000 and are exercisable for a period of three years, commencing two years after the date of the grant. On February 2005, the first portion expired. The exercise prices of the options granted in February 2001 and 2002 were $15.76 and $10.01, respectively, as adjusted for the abovementioned dividend distributed in 2005.

			In March 2001, the Company’s shareholders approved a plan whereby the Chairman of the Board and the then Chief Executive Officer of the Company were granted options to purchase up to 58,000 ordinary shares of the Company (the “2001 grant”). The options were granted ratably over a period of 3 years commencing June 2001 and are exercisable for a period of three years, from the date of the grant. The exercise prices of the options granted in June 2001 and 2003 were $16.05 and $5.437, respectively as adjusted for the abovementioned dividend distributed in 2005.

			In December 2004, 19,333 options at an exercise price per share of $8.34 from the 2001 grant were exercised into 8,623 shares.

			As of grant date, the weighted average fair value of the remaining 1999 grant and the remaining 2001 grant was $ 7.62 and $ 2.64 per share, respectively. The fair value was calculated using the Black & Scholes option-pricing model (see Note 2s for the assumptions used in the calculation).

			Upon exercise of the options, the option holder will be granted a number of shares reflecting the intrinsic value of the options exercised, as calculated at the exercise date, in consideration for their par value only. These plans are considered to be variable plans as defined in APB 25 (except for the third portion of the 2001 grant which is accounted for under SFAS 123, See Note 2s). For options accounted under APB 25, compensation expense is estimated based on the quoted market price of the Company’s stock at the end of each reporting period and is amortized over the remaining vesting period of the options.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 16:-	SHAREHOLDERS’ EQUITY (Cont.)

	c.	Options to employees (Cont.)

		4.	Compensation expense recorded during 2005 amounted to $ 405 (2004- $ 545, 2003- $ 386).

		5.	The balance of deferred compensation as of December 31, 2005 amounted to $856.

NOTE 17:-	INCOME (LOSS) PER SHARE

	Income (loss) per share is computed as follows:


	Year Ended December 31
	income			2005 Number of shares ( in thousands)		Per share amount		Income			2004 Number of shares (in thousands)		Per share amount		Loss			2003 Number of shares (in thousands)		Per share amount


Basic	$	47,335				$	1.61	$	84,133			29,266	$	2.87	$	(7,205	)		29,194	$	(0.25	)


Effect of options of investees		(20	)		—				(95	)		—				(200	)		—
Effect of dilutive stock options					113				—			119				—			—


Diluted		47,315			29,550	$	1.60		84,038			29,385	$	2.86		(7,405	)		29,194	$	(0.25	)


	In 2003 all stock options issued by Elron were not included in the computation of diluted loss per share because their effect was anti-dilutive.

NOTE 18:-	EQUITY IN LOSSES OF AFFILIATED COMPANIES


	Year ended December 31,

	2005			2004			2003

Affiliated companies:
ESL(1)		—			4,706			9,110
Given		(2,036	)		(2,573	)		(3,184	)
Others(2)		(15,486	)		(12,625	)		(14,624	)


	$	(17,522	)	$	(10,492	)	$	(8,698	)


	The equity in losses includes amortization of intangible assets allocated to the investments in affiliated companies.

	(1)	Through the sale date, see Note 7d(1).
	(2)	Including equity in net losses of consolidated entities through the dates of commencement of consolidation.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 19:-	GAIN FROM DISPOSAL OF BUSINESSES AND AFFILIATED COMPANIES AND CHANGES IN HOLDINGS IN AFFILIATED COMPANIES, NET


	Year ended December 31,

	2005		2004		2003

Netvision (See Note 7d(7))		2,989		—		—
Oren (See Note 7d(6))		19,673		—		—
ESL (See Note 7d(1))	$	—	$	105,171	$	(35	)
Given (See Note 7d(2))		666		21,667		4,548
KIT (See Note 7d(4))		—		5,302		—
Galil Medical’s urology business (See Note 3a)		—		—		21,241
Others		—		256		—


	$	23,328	$	132,396	$	25,754


NOTE 20:-	OTHER INCOME, NET


	Year ended December 31,

	2005			2004			2003

Gain (loss) from sale and increase (decrease) in market value of: (see a and b below)
Partner shares (see Note 8(2))	$	56,423		$	—		$	11,071
24/7 shares		—			—			2,019
Zix shares (see Note 3(b))		—			5,360			4,815
Zoran shares (see Note 7(d)(6))		1,053			—			—
Kana shares ⁽¹⁾		(4	)		(5	)		4
Other companies, net		137			—			19
Other than temporary decline in investments		(568	)		(803	)		(3,716	)
Equity in losses of partnerships		174			(7	)		(547	)
Other income, net		1,433			204			972


	$	58,648		$	4,749		$	14,637


	⁽¹⁾	Realized gains and losses on trading securities.

		Realized gains from sale of available-for-sale securities amounted to approximately $57,500, $5,400 and $17,900 in the years ended December 31, 2005, 2004 and 2003, respectively. The proceeds from such sales amounted to approximately $103,000, $8,000 and $46,100 for the years ended December 31, 2005, 2004 and 2003, respectively.

		Regarding an other than temporary decline in value of other investments see Note 8(3).

NOTE 21:-	FINANCING INCOME, NET


	Year ended December 31,

	2005		2004		2003

Income:
Interest on cash equivalents, bank deposits, debentures and loans	$	6,473	$	2,577	$	1,403
Foreign currency gains		1,532		862		615


		8,005		3,439		2,018

Expenses:
Interest on short-term credit, long-term loans and others		1,333		586		767
Foreign currency losses		88		1,420		500


		1,421		2,006		1,267


Loss from sale of debentures		192		—		—
Other than temporary decline in value of Availble for sale Debentures		909		—		—


	$	5,483	$	1,433	$	751

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 22:-	DISCONTINUED OPERATIONS

	During 2003 and 2005, the Company disposed of certain subsidiaries and businesses, which met the definition of a component under SFAS 144. Accordingly, the results of operations of these subsidiaries and businesses and the gain resulting from the disposals have been classified as discontinued operations in the statement of operations and prior periods results have been reclassified accordingly. In addition comparative data of the assets and liabilities attributed to the discontinued operations have been reclassified in the balance sheet.

	a.	The following is the composition of discontinued operations:


	Year ended December 31,

	2005			2004			2003


Loss from operations of discontinued components
ET group (See Note 3d): *
Impairment of goodwill		(1,329	)		(1,980	)		—
Impairment of intangible assets and property and equipment		—			(2,904	)		—
Operating losses		(2,734	)		(3,027	)		(2,074	)

	$	(4,063	)	$	(7,911	)	$	(2,074	)

ESW (see Note 3b) *		—			(454	)	$	(4,825	)
Vflash *		—			—			453

		(4,063	)		(8,365	)		(6,446	)

Gain on disposal
ESW (see Note 3b)		—			—			4,137
ET group(See Note 3d)		213			—			—

		213			—			4,137


	$	(3,850	)	$	(8,365	)	$	(2,309	)

* Pre tax loss of ET group	$	(4,063	)	$	(7911	)	$	(2,074	)

* Pre-tax loss of ESW	$	—		$	(454	)	$	(4,829	)

* Pre-tax income of Vflash	$	—		$	—		$	453


	Revenues relating to discontinued operations for the years ended December 31, 2005, 2004 and 2003 were as follows:


	Year ended December 31,

	2005		2004		2003


ET group	$	2,954	$	5,065	$	7,390

ESW	$	—		—	$	4,740


	$	2,954	$	5,065	$	12,130


	b.	The breakdown of assets and liabilities attributed to discontinued operations of the ET group as of December 31, 2004 was as follows:

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 22:-	DISCONTINUED OPERATIONS (Cont.)


	December 31, 2004


Assets:
Cash and cash equivalents	$	514
Trade receivables, net		2,414
Other receivables and prepaid expenses		441
Contract-in-progress		23
Severance fund		501
Property and equipment, net		9
Goodwill		3,610
Other intangible assets		140


	$	7,652


	December 31, 2004

Liabilities:
Short-term loans from banks	$	1,690
Trade payables		1,435
Other payables and accrued expenses		1,653
Accrued severance pay		802
Other		22


	$	5,602


		ESW’s assets and liabilities were not material as of December 31, 2004.

NOTE 23:-	RELATED PARTY TRANSACTIONS

	a.	Balances with related parties:


	December 31

	2005		2004

Trade receivables:
Affiliated companies	$	4,984	$	2,271


Other receivables:
Affiliated companies		9		21
Other companies		50		—

		59		21
Long-term receivables:
Other companies		434		405

	$	5,477	$	2,697


	b.	Income and expenses from affiliated and other companies:


	Year ended December 31,

	2005		2004		2003

Income:
Revenues	$	8,046	$	7,182	$	3,535
Interest and commission for guarantees		235		142		110
Participation in Directors’ remuneration		68		38		35
Participation in expenses		25		89		76
Costs and Expenses:
Participation in expenses		19		40		191
Directors’ remuneration		91		30		33

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 23:-	RELATED PARTY TRANSACTIONS (Cont.)

	c.	Option to the Chairman of the Board - see Note 16c(3).

	d.	The Company holds certain investments together with DIC as of December 31, 2005, the significant are as follows:


	% holding by
	DIC		Elron and RDC

Galil		21.9		59.1
Netvision		39.1		39.1
Given		12.4		24.1


NOTE 24:-	ACCUMULATED OTHER COMPREHENSIVE INCOME


	Unrealized gains on securities			Foreign currency translation adjustments			Minimum pension liability in an affiliated company			Unrealized loss on derivatives in an affiliated company			Total


Balance as of January 1, 2004 (net of tax effect of $29,430)	$	53,306		$	(637	)	$	(769	)	$	(108	)	$	51,792

Unrealized gains on available for sale securities (net of tax effect of $4,049)		8,489			—			—			—			8,489
Reclassification adjustment for realized gain included in net loss (net of tax effect of $1,179)		(3,582	)		—			—			—			(3,582	)
Unrealized loss on derivative instruments in an affiliated company		—			—			—			84			84
Foreign currency translation adjustment		—			202			—			—			202
Reclassification adjustments for loss on derivative instruments, minimum pension liability and foreign currency translation adjustments, included in net income due to sale of affiliated companies		—			(61	)		769			24			732

Balance as of December 31, 2004 (net of tax effect of $32,300)		58,213			(496	)		—			—			57,717

Unrealized gains on available for sale securities (net of tax effect of $5,359)		(10,450	)		—			—			—			(10,450	)
Reclassification adjustment for realized gain and other than temporary impairment included in net income (net of tax effect of $20,601)		(36,335	)		—			—			—			(36,335	)
Unrealized loss on derivative instruments in an affiliated company		—			—			—
Foreign currency translation adjustments		—			(191	)		—			—			(191	)

Balance as of December 31, 2005 (net of tax effect of $6,340)	$	11,428		$	(687	)	$	—		$	—		$	10,741

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands, except share and per share data


NOTE 25:-	BUSINESS SEGMENT

	a.	Subsequent to the sale of ET group (see Note 3d) the Company operates in one segment, namely the “Other Holdings and Corporate Operations” in which the Company is directly engaged. This segment includes corporate headquarters and reflects the investments in companies that operate in the fields of medical devices, information and communication technology, semiconductors and advanced materials.

		The ET group, which comprised the system and projects segment was sold on December 29, 2005 and therefore has been reclassified as discontinued operations. The operations of the System and Projects segment included development and supply of software solutions for the management of large and complex communication and internet networks.

		Prior to September 2, 2003, the Company operated indirectly through ESW in a third business segment – Internet Products – which has been sold and therefore classified as discontinued operations (see Note 3b).

	b.	Revenues according to location of customers are as follows:


	2005		2004		2003


Israel	$	271	$	49	$	857
USA		9,781		8,688		6,474
Europe		802		511		565
Asia		1,792		2,017		1,261


	$	12,646	$	11,265	$	9,157


	c.	Revenues from major customers were as follows:


	2005		2004		2003

In the Other Holdings and Corporate Operations segment:
Oncura (See Note 23)		64%		64%		39%


	d.	The majority of the long-lived assets are located in Israel.

ELRON ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARIES

ANNEX TO THE CONSOLIDATED FINANCIAL STATEMENTS

U.S. dollars in thousands

ANNEX TO THE FINANCIAL STATEMENTS
U.S dollars in thousands

Details relating to major investments as of December 31, 2005:


			Carrying value of the investment as of			Market value of the publicly traded investments as of
	% of ownership interest ⁽¹⁾		December 31, 2005⁽²⁾			December 31, 2005		March 13, 2006


Consolidated Companies:
Galil Medical Ltd. ⁽³⁾	40	%		1,999			—		—
3DV Systems Ltd. ⁽³⁾	62	%		(302	)		—		—
Starling ⁽³⁾	50	%		941			—		—
SELA ⁽³⁾	39	%		1,150			—		—
Enure (formerly: Gaia)	57	%		3,492			—		—
Medingo ⁽³⁾	50	%		47			—		—

Affiliated Companies (equity):
Given Imaging Ltd. (NASDAQ: GIVN) ⁽³⁾	19	%		64,203			141,376		121,605
NetVision Ltd. (TASE: NTSN)	39	%		5,549			27,692		31,481
ChipX	26	%		2,287			—		—
CellAct Ltd.	45	%		451			—		—
Oncura ⁽⁴⁾	10	%		8,827			—		—
AMT	42	%		2,780					—
Wavion, Inc.	38	%		761			—		—
Pulsicom Israel Technologies Ltd.	18	%		17			—		—
Notal Vision, Inc.	26	%		—			—		—

Available for sale:
Partner (NASDAQ: PTNR)	2	%		25,998			25,998		23,494
EVS (NASDAQ: EVSNF.OB)	10	%		1,499			2,030		2,393

Partnership:
Gemini Israel Fund L.P.	5	%		33			—		—
InnoMed Ventures L.P.	14	%		3,665			—		—

Cost:
Avantry (formerly:Witcom Ltd.) ⁽³⁾	7	%		2			—		—
Jordan Valley	28	%		8,137			—		—
Impliant Inc.	22	%		8,340			—		—
Teledata Ltd.	21	%		16,000			—		—
Nulens Ltd.	22	%		1,722			—		—
Brainsgate	22	%		6,947			—		—


⁽¹⁾	On the basis of the outstanding share capital.
⁽²⁾	Includes loans and convertible notes.
⁽³⁾	Represents the carrying value and the ownership interest of the investment in Elron’s books and Elron’s share in the carrying value and ownership interest of the investment in RDC’s books.
⁽⁴⁾	Represents Elron’s share in the carrying value and the ownership interest of the investment in Galil’s books.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TO THE SHAREHOLDERS OF

A.M.T. ADVANCED METAL TECHNOLOGIES LTD.

We have audited the accompanying consolidated balance sheets of A.M.T. Advanced Metal Technologies Ltd. ("the Company") as of December 31, 2005 and 2004 and the related consolidated statements of operations, changes in shareholders’ deficiency and cash flows for the years then ended. These financial statements are the responsibility of the Company’s Board of Directors and management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by the board of directors and management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2005 and 2004 and the results of its operations and its cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.

/s/ Brightman Almagor & Co.

Certified Public Accountants

A member of Deloitte Touche Tohmatsu

Tel-Aviv, March 7, 2006

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE SHAREHOLDERS OF
A.M.T. ADVANCED METAL TECHNOLOGIES LTD.

We have audited the accompanying consolidated balance sheets of A.M.T. Advanced Metal Technologies Ltd. (“the Company”) as of December 31, 2004 and 2003 and the related consolidated statements of operations, changes in shareholders’ deficiency and cash flows for the years then ended. These financial statements are the responsibility of the Company’s Board of Directors and management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by the board of directors and management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2004 and 2003 and the results of its operations and its cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.

/s/ Brightman Almagor & Co.
Certified Public Accountants
A member of Deloitte Touche Tohmatsu

Tel-Aviv, February 17, 2005

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders
Given Imaging Ltd.

We have audited the accompanying consolidated balance sheets of Given Imaging Ltd. and its subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of operations, changes in shareholders’ equity and cash flows for each of the years in the three year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s Board of Directors and of its management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2005 and 2004, and the consolidated results of its operations and cash flows for each of the years in the three year period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

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

Tel - Aviv, Israel
February 7, 2006

Report of Independent Registered Public Accounting Firm

To The Board of Directors and Stockholders of

ChipX, Incorporated (formerly Chip Express Corporation)

In our opinion, based on our audits and the report of other auditors, the accompanying consolidated balance sheets and the related consolidated statements of operations, of mandatorily redeemable convertible preferred stock and stockholders’ deficit and of cash flows present fairly, in all material respects, the financial position of ChipX, Incorporated (formerly Chip Express Corporation) and its subsidiaries at December 31, 2004 and December 31, 2003, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of ChipX, (Israel) Limited (“CXL”), a wholly-owned subsidiary, which statements reflect total assets of $905,000 and $1,225,000 as of December 31, 2004 and December 31, 2003, respectively, and total revenues of $2,603,000 and $2,768,000 for the years then ended. Those statements were audited by other auditors whose report thereon has been furnished to us, and our opinion expressed herein, insofar as it relates to the amounts included for CXL, is based solely on the report of the other auditors. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits and the report of other auditors provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

February 28, 2005

San Jose, CA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCONTING FIRM

To the Shareholders of
Chip X (Israel) Limited.

We have audited the accompanying balance sheets of ChipX (Israel) Limited. (former name: Chip Express (Israel) Ltd) (the “Company”) as of December 31, 2004 and 2003, and the related statements of operations, changes in shareholders’ equity and cash flows for the two years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

In our opinion the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2004 and 2003, and the results of its operations and its cash flows for the two years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.


Haifa, Israel	/s/ KOST FORER GABBAY & KASIERER
January 30, 2005	A Member of Ernst & Young Global

Report of Independent Registered Public Accounting Firm

To the board of Directors
Oncura, Inc.:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, shareholders’ equity and cash flows present fairly, in all material respects, the financial position of Oncura, Inc. and its subsidiaries at December 31, 2005 and December 31, 2004, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As disclosed in Notes 10, 11 and 15, the Company has extensive transactions with its shareholders.

/s/ PricewaterhouseCoopers LLP
March 6, 2006
Philadelphia, PA

Report of Independent Registered Public Accounting Firm

To the board of Directors
Oncura, Inc.:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, shareholders’ equity and cash flows present fairly, in all material respects, the financial position of Oncura, Inc. and its subsidiaries at December 31, 2004 and December 31, 2003, and the results of their operations and their cash flows for the year ended December 31, 2004 and the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As disclosed in Notes 10, 11 and 15, the Company has extensive transactions with its shareholders.

/s/ PricewaterhouseCoopers LLP
February 18, 2005
Philadelphia, PA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the shareholders of
NOTAL VISION INC.

We have audited the consolidated balance sheets of Notal Vision Inc. (hereafter - the Company) and its subsidiary, as of December 31, 2005 and 2004 and the related consolidated statements of operations, changes in shareholders’ equity (capital deficiency) and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s board of directors and management. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and its subsidiary as of December 31, 2005 and 2004 and the consolidated results of operations, changes in shareholders’ equity (capital deficiency) and cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1a(1) to the financial statements, the Company has incurred operating losses and cumulative negative cash flow from operations since its inception and has capital deficiency of $329,272 through December 31, 2005. These facts raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ Kesselman & Kesselman

Certified Public Accountants (Isr.)

A member of PricewaterhouseCoopers International Limited

Tel-Aviv

March 7, 2006

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of:
PULSICOM ISRAEL TECHNOLOGIES LTD.

We have audited the balance sheets of Pulsicom Israel Technologies Ltd., An Israeli corporation in the development stage (the “Company”) as of December 31, 2003 and 2002 and the related statements of operations, changes in shareholders’ equity (capital deficiency) and cash flows for each of the three years in the period ended December 31, 2003 and for the period from September 20, 2000 (date of incorporation and commencement of operations) to December 31, 2003. These financial statements are the responsibility of the Company’s board of directors and management. Our responsibility is to express an opinion on these financial statements based on our audits.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2003 and 2002and the results of their operations, the changes in shareholders’ equity (capital deficiency) and its cash flows for each of the periods referred to above, in conformity with accounting principles generally accepted in the United States.

Without qualifying our opinion we draw the attention to the Company’s capital deficiency and ability to continue operating as a going concern. The abovementioned financial statements have been prepared assuming that the Company will continue operating as a going concern. Results of the Company’s activity, as described in note 1a in the financial statements, raise substantial doubt regarding its ability to continue operating as a going concern. The Company’s ability to continue, as a going concern is dependent on the ability to raise additional funding from its shareholders or from other investors until the stage in which the Company become profitable from its operations. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ Kesselman & Kesselman

Certified Public Accountants (Isr.)

A member of PricewaterhouseCoopers International Limited

Tel-Aviv, Israel

February 25, 2004

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the shareholders of
INGENEO TECHNOLOGIES LTD.

We have audited the financial statements of Ingeneo Technologies Ltd. (an Israeli corporation in the development stage; hereafter - the Company) and the consolidated financial statements of the Company and its subsidiary: balance sheets as of December 31, 2003 and 2002 and the related statements of operations, changes in capital deficiency and cash flows for each of the two years ended on those dates, and cumulatively, for the period from November 4, 1999 (date of inception) to December 31, 2003. These financial statements are the responsibility of the Company’s board of directors and management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States), and auditing standards generally accepted in Israel, including those prescribed by the Israeli Auditors (Mode of Performance) Regulations, 1973. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the board of directors and management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position - of the Company and consolidated - as of December 31, 2003 and 2002 and the results of operations, changes in capital deficiency and cash flows - of the Company and consolidated - for each of the two years ended on those dates, and cumulatively, for the period from inception to December 31, 2003, in conformity with accounting principles generally accepted in Israel.

Accounting principles generally accepted in Israel vary in certain significant respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented in note 12 to the consolidated financial statements.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in note 1a to the financial statements, the Company has suffered recurring losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ Kesselman & Kesselman

Certified Public Accountants (Isr.)

A member of PricewaterhouseCoopers International Limited

Tel-Aviv, Israel

February 23, 2004

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS
as of December 31, 2004
(In U.S. dollars)

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS
as of December 31, 2004
In U.S. dollars

C O N T E N T S


	Page



REPORT OF INDEPENDENT REGISTRED PUBLIC ACCOUNTING FIRM	2 – 3

CONSOLIDATED FINANCIAL STATEMENTS:

Consolidated Balance Sheets	4 – 5

Consolidated Statements of Income	6

Statements of Changes in Shareholders’ Equity	7 – 8

Consolidated Statements of Cash Flows	9 – 10

Notes to the Consolidated Financial Statements	11 – 56

# # # # # # #

(ERNST & YOUNG LOGO)

To the Shareholders of
Elbit Systems Ltd.

Haifa, Israel

REPORT OF INDEPENDENT REGISTRATED PUBLIC ACCOUNTING FIRM

We have audited the accompanying consolidated balance sheets of Elbit Systems Ltd. (the “Company”) and its subsidiaries as of December 31, 2004 and 2003 and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the two years in the period ended December 31, 2004. Our audits also include the financial statement schedule listed in the Index at Item 19a. These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above, present fairly, in all material respects, the consolidated financial position of the Company and its subsidiaries as of December 31, 2004 and 2003 and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2004 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note 2(X) to the consolidated financial statements, on January 1, 2004 the Company adopted SFAS No. 123 “Accounting for Stock-Based Compensation.”


	Kost Forer Gabbay & Kasierer
	A member of Ernst & Young Global

Haifa, Israel
March 14, 2005

(ERNST & YOUNG LOGO)

REPORT OF INDEPENDENT AUDITORS

To the Shareholders of Elbit Systems Ltd.

We have audited the accompanying consolidated statements of operations, changes in shareholders’ equity and cash flows of Elbit Systems Ltd. And its subsidiaries for the year ended December 31, 2002. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

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

In our opinion, the consolidated financial statements referred to above, present fairly, in all material respects, the consolidated results of the Company and its subsidiaries operations and their cash flows for the year ended December 31, 2002 in conformity with United States generally accepted accounting principles.


	LUBOSHITZ KASIERER
	AN AFFILIATE MEMBER OF ERNST & YOUNG INTERNATIONAL

Haifa, Israel
March 24, 2003

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

U. S. dollars (In thousands)


		December 31,

	Note	2004		2003


CURRENT ASSETS:
Cash and cash equivalents		$	34,109	$	76,156
Short-term bank deposits			738		690
Trade receivables, (net of allowance for doubtful accounts in the amount of $3,064 and $3,861 as of December 31, 2004 and 2003, respectively)	(3)		214,816		203,281
Other receivables and prepaid expenses	(4)		52,335		48,363
Inventories, net of advances	(5)		249,041		249,225

Total current assets			551,039		577,715


INVESTMENTS AND LONG-TERM RECEIVABLES:
Investments in affiliated companies and a partnership	(6A)		33,124		26,478
Available for sale securities	(1G)		18,017		—
Investments in other companies	(6B)		11,745		11,745
Long-term bank deposits and trade receivables	(7)		2,102		2,347
Severance pay fund	(2P)		82,998		76,218

			147,986		116,788


PROPERTY, PLANT AND EQUIPMENT, NET	(8)		244,288		229,221


INTANGIBLE ASSETS:	(9)
Goodwill			32,847		32,576
Other intangible assets, net			63,140		67,436

			95,987		100,012


		$	1,039,300	$	1,023,736

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

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

U. S. dollars (In thousands, except share and per share data)


		December 31,

	Note	2004			2003

CURRENT LIABILITIES:
Short-term bank credit and loans	(10)	$	8,592		$	8,509
Current maturities of long-term loans	(13)		1,656			6,532
Trade payables			118,391			106,252
Other payables and accrued expenses	(11)		169,702			157,820
Customers advances and amounts in excess of costs incurred on contracts in progress	(12)		80,109			99,618

Total current liabilities			378,450			378,731


LONG-TERM LIABILITIES:
Long-term loans	(13)		86,234			62,324
Advances from customers	(12)		10,320			7,592
Deferred income taxes	(15)		24,516			24,916
Accrued termination liability	(14,2P)		100,740			93,979

			221,810			188,811


COMMITMENTS AND CONTINGENT LIABILITIES	(16)

MINORITY INTERESTS			4,340			4,115


SHAREHOLDERS’ EQUITY:	(17)
Share capital
Ordinary shares of New Israeli Shekels (NIS) 1 par value; Authorized – 80,000,000 shares as of December 31, 2004 and 2003; Issued – 40,969,947 and 39,746,125 shares as of December 31, 2004 and 2003, respectively; Outstanding – 40,561,126 and 39,337,304 shares as of December 31, 2004 and 2003, respectively			11,548			11,273
Additional paid-in capital			274,432			259,033
Accumulated other comprehensive loss			(3,346	)		(3,992	)
Retained earnings			156,387			190,086
Treasury shares - 408,821 shares as of December 31, 2004 and 2003			(4,321	)		(4,321	)

			434,700			452,079

		$	1,039,300		$	1,023,736

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

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

U. S. dollars (In thousands, except share and per share data)


		Year ended December 31,

	Note	2004			2003			2002

Revenues	(18)	$	939,925		$	897,980		$	827,456
Cost of revenues			689,626			672,711			605,313

Gross profit			250,299			225,269			222,143


Research and development costs, net	(19)		66,846			54,919			57,010
Marketing and selling expenses			69,912			69,943			65,691
General and administrative expenses			47,832			46,077			41,651


			184,590			170,939			164,352


Operating income			65,709			54,330			57,791

Financial expenses, net	(20)		(5,852	)		(4,870	)		(3,035	)
Other income (expenses), net			770			53			(462	)

Income before taxes on income			60,627			49,513			54,294
Taxes on income	(15)		15,219			11,334			9,348

			45,408			38,179			44,946
Equity in net earnings of affiliated companies and partnership			7,765			7,209			675
Minority interests in losses (earnings) of subsidiaries			(180	)		557			(508	)

Net income		$	52,993		$	45,945		$	45,113


Earnings per share	(17G)
Basic net earnings per share		$	1.33		$	1.18		$	1.17


Diluted net earnings per share		$	1.29		$	1.14		$	1.13

Number of share used in computation of basic net earnings per share			39,952			39,061			38,489


Number of share used in computation of diluted net earnings per share			41,041			40,230			39,863

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

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

U. S. dollars (In thousands, except share and per share data)


	Number of outstanding shares		Share capital		Additional paid-in capital			Accumulated other comprehensive income (loss)			Retained earnings			Treasury shares			Total shareholders’ equity			Total other comprehensive income

Balance as of January 1, 2002		38,330,272	$	11,054	$	244,625		$	—		$	126,627		$	(4,321	)	$	377,985
Exercise of options		473,235		100		4,040			—			—			—			4,140
Tax benefit in respect of options exercised		—		—		648			—			—			—			648
Stock based compensation		—		—		(926	)		—			—			—			(926	)
Dividends paid		—		—		—			—			(12,717	)		—			(12,717	)
Other comprehensive income (loss):
Minimum pension liability		—		—		—			(2,882	)		—			—			(2,882	)	$	(2,882	)
Net income		—		—		—			—			45,113			—			45,113			45,113

Total comprehensive income																				$	42,231

Balance as of December 31, 2002		38,803,507	$	11,154	$	248,387		$	(2,882	)	$	159,023		$	(4,321	)	$	411,361

Exercise of options		533,797		119		5,147			—			—			—			5,266
Tax benefit in respect of options exercised		—		—		758			—			—			—			758
Stock based compensation		—		—		4,741			—			—			—			4,741
Dividends paid		—		—		—			—			(14,882	)		—			(14,882	)
Other comprehensive income (loss):
Unrealized loss on derivative instruments		—		—		—			(578	)		—			—			(578	)	$	(578	)
Foreign currency translation differences		—		—		—			340			—			—			340			340
Minimum pension liability		—		—		—			(872	)		—			—			(872	)		(872	)
Net income		—		—		—			—			45,945			—			45,945			45,945

Total comprehensive income																				$	44,835

Balance as of December 31, 2003		39,337,304	$	11,273	$	259,033		$	(3,992	)	$	190,086		$	(4,321	)	$	452,079

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

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (CONT.)

U. S. dollars (In thousands, except share and per share data)


	Number of outstanding shares		Share capital		Additional paid-in capital			Accumulated other comprehensive loss			Retained earnings			Treasury shares			Total shareholders’ equity			Total other comprehensive income

Balance as of January 1, 2004		39,337,304	$	11,273	$	259,033		$	(3,992	)	$	190,086		$	(4,321	)	$	452,079
Cumulative effect of first time adoption of the fair value based method for stock based compensation expense		—		—		(152	)		—			—			—			(152	)
Exercise of options		1,223,822		275		10,985			—			—			—			11,260
Tax benefit in respect of options exercised		—		—		1,179			—			—			—			1,179
Stock based compensation		—		—		3,387			—			—			—			3,387
Dividends paid		—		—		—			—			(86,692	)		—			(86,692	)
Other comprehensive income (loss):
Unrealized loss on derivative instruments		—		—		—			(299	)		—			—			(299	)		(299	)
Foreign currency translation differences		—		—		—			450			—			—			450			450
Unrealized gains on available for sale securities, net									1,396									1,396			1,396
Minimum pension liability		—		—		—			(901	)		—			—			(901	)		(901	)
Net income		—		—		—			—			52,993			—			52,993			52,993

Total comprehensive income																				$	53,639

Balance as of December 31, 2004		40,561,126	$	11,548	$	274,432		$	(3,346	)	$	156,387		$	(4,321	)	$	434,700

Accumulated other comprehensive loss (net of taxes)


	December 31,

	2004			2003

Accumulated gains on derivative instruments	$	(877	)	$	(578	)
Accumulated foreign currency translation differences		790			340
Accumulated gains on available for sale securities		1,396			—
Accumulated minimum pension liability		(4,655	)		(3,754	)

Accumulated other comprehensive loss	$	(3,346	)	$	(3,992	)

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

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

U. S. dollars (In thousands)


	Year ended December 31,

	2004			2003			2002

CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	52,993		$	45,945		$	45,113
Adjustments required to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		42,261			37,890			32,937
Stock based compensation		3,387			4,741			(926	)
Deferred income taxes, net		153			35			(5,620	)
Accrued severance pay, net		(2,304	)		(1,240	)		6,260
Gain (loss) on sale of property, plant and equipment		143			(915	)		743
Tax benefit in respect of options exercised		1,179			758			648
Minority interests in earnings (losses) of subsidiaries		180			(557	)		508
Equity in net losses (earnings) of affiliated companies and partnership, net of dividend received (*)		385			(4,995	)		(675	)
Changes in operating assets and liabilities:
Decrease (increase) in short and long-term trade receivables, other receivables and prepaid expenses		(16,871	)		45,297			58,554
Decrease (increase) in inventories		2,932			(38,651	)		(55,106	)
Increase (decrease) in trade payables, other payables and accrued expenses		20,522			32,147			(19,321	)
Increase (decrease) in advances received from customers		(18,535	)		(27,855	)		42,999
Settlement of royalties with the Office of the Chief Scientist		(3,714	)		(1,581	)		9,197
Other adjustments		(1,228	)		337			683

Net cash provided by operating activities		81,483			91,356			115,994


CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property, plant and equipment		(53,008	)		(61,287	)		(46,003	)
Investment grants received for property, plant and equipment		—			—			119
Acquisition of subsidiaries and businesses (Schedule A)		(2,315	)		(2,458	)		(5,280	)
Investments in affiliated companies and subsidiaries		(2,522	)		(1,049	)		(1,681	)
Proceeds from sale of property, plant and equipment		2,560			5,815			956
Grant of long-term loan		—			—			(714	)
Collection of long-term loan		—			2,400			—
Collection of short-term loan		—			—			1,371
Investment in long-term bank deposits		(1,203	)		(1,750	)		(1,228	)
Proceeds from sale of long-term bank deposits		1,507			3,568			1,689
Short-term bank deposits, net		(48	)		960			(204	)
Investment in available for sale securities		(15,869	)		—			—

Net cash used in investing activities		(70,898	)		(53,801	)		(50,975	)


CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from exercise of options		11,260			5,266			4,140
Repayment of long-term bank loans		(35,826	)		(27,066	)		(3,249	)
Receipt of long-term bank loans		58,410			10,000			2,233
Dividends paid		(86,692	)		(14,882	)		(12,717	)
Change in short-term bank credit and loans, net		216			(10,997	)		(19,729	)

Net cash used in financing activities		(52,632	)		(37,679	)		(29,322	)

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(42,047	)		(124	)		35,697
CASH AND CASH EQUIVALENTS AT THE BEGINNING OF THE YEAR		76,156			76,280			40,583

CASH AND CASH EQUIVALENTS AT THE END OF THE YEAR	$	34,109		$	76,156		$	76,280

(*) Dividend received	$	8,150		$	2,214		$	—

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

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONT.)

U. S. dollars (In thousands)


	Year ended December 31,

	2004			2003			2002


SUPPLEMENTAL CASH FLOW INFORMATION:

Cash paid during the year for:
Income taxes	$	13,305		$	14,666		$	21,730

Interest	$	3,122		$	4,034		$	2,947


SCHEDULE A:
Subsidiaries and businesses acquired (*)

Estimated net fair value of assets acquired and liabilities assumed at the date of acquisition was as follows:

Working capital (surplus) deficiency (excluding cash and cash equivalents)	$	(707	)	$	657		$	—
Property, plant and equipment		(10	)		(249	)		(275	)
Goodwill and other intangible assets		(1,598	)		(1,334	)		(5,078	)
Deferred income taxes		—			(1,765	)		—
Long-term liabilities		—			198			—
Minority interest		—			35			—

		(2,315	)		(2,458	)		(5,353	)
Less short-term debt incurred on acquisition		—			—			73


	$	(2,315	)	$	(2,458	)	$	(5,280	)


(*)	Defense Systems Division of Elron Telesoft in 2002 (see Note 1(C)).
	In 2003 a European subsidiary (see Note 1(D)) and AD&D (see Note 1(E)).
	In 2004 the assets of Computer Instruments Corporation Inc. (see Note 1(F))

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

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

U. S. dollars (In thousands)


Note 1 -	GENERAL

	A.	Elbit Systems Ltd. (the “Company”) is an Israeli corporation, 49% owned by the Federmann Group. On July 28, 2004, Elron Electronic Industries Ltd. completed the sale of all of its holdings in the Company, constituting approximately 19% of the Company’s outstanding share capital, to Federmann Enterprises Ltd. The Company’s shares are traded on the Tel Aviv Stock Exchange and on the Nasdaq National Market in the United States. The Company and its subsidiaries (the “Group”) are engaged mainly in the field of defense electronics. The Company’s principal wholly-owned subsidiaries are EFW Inc. (“EFW”) and Elop Electro-Optics Industries, Ltd. (“El-Op”).

	B.	A majority of the Group’s revenues are derived from direct or indirect sales to governments or to government agencies. As a result, a substantial portion of the Group’s sales is subject to the special risks associated with sales to governments or to government agencies. These risks include, among others, the dependency on the resources allocated by governments to defense programs, changes in governmental priorities and changes in governmental approvals regarding export licenses required for the Group products and for its suppliers. As for major customers refer to Note 18(C).

	C.	In January 2002, the Company acquired from Elron Telesoft Inc. and its subsidiaries (“Elron Telesoft”) the assets and the business of the Defense Systems Division of Elron Telesoft (“the Government Division”) in consideration for $5,700 in cash. The excess of the purchase price over the fair value of net tangible assets acquired in the amount of approximately $5,100 was allocated to technology and other intangible assets to be amortized over a weighted average period of 3 years.

		The Government Division is engaged mainly in the development of communication systems, information technology and image intelligence processing for defense and military applications.

		The results of the Government Division have been included in the consolidated financial statements from the first quarter of 2002.

		Pro forma information in accordance with SFAS No. 141 has not been provided, since the revenues and net income of the Government Division were not material in relation to total consolidated revenues and net income for the year 2002.

	D.	In June 2003, the Company (through El-Op) acquired all of the outstanding ordinary shares of a European subsidiary, a company registered in Belgium, in consideration for $1,846 in cash. The acquisition was accounted for by the purchase method of accounting.

		This subsidiary develops, manufactures and supports electro-optical products, mainly for the defense and space markets.

		The results of this subsidiary’s operations have been included in the consolidated financial statements from the date of acquisition.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 1 -	GENERAL (Cont.)

		Pro forma information in accordance with SFAS No. 141 has not been provided, since the revenues and net income of this subsidiary. were not material in relation to total consolidated revenues and net income for the years 2002 and 2003.

	E.	In July 2003, the Company acquired approximately 54% of the outstanding shares of Aero Design Development Ltd. (“AD&D”) an Israeli company in consideration for $1,406 in cash. The acquisition was accounted for by the purchase method of accounting.

		AD&D develops, manufactures and builds airborne models and other engineered products.

		The excess of the purchase price over the fair value of net tangible assets acquired in the amount of approximately $1,334 was allocated to technology ($1,000) to be amortized by the straight-line method over a period of 10 years and to technology goodwill ($334).

		The results of AD&D.’s operations have been included in the consolidated financial statements from the date of acquisition.

		Pro forma information in accordance with SFAS No. 141 has not been provided, since the revenues and net income of AD&D were not material in relation to total consolidated revenues and net income for the years 2002 and 2003.

	F.	In August 2004, the Company (through a subsidiary of EFW) acquired a business from Computer Instruments Corporation Inc. (“CIC”) of Westbury, New York in consideration for approximately $2,315 in cash. The acquired assets relate to the design and manufacture of aviation pressure transducers, air data probes and air data computers.

		The following table summarizes the fair value of the assets acquired and liabilities assumed at the date of acquisition as estimated by the Company, with the support of an external appraisal:


Current Assets	$	994
Property and equipment		10
Technology		1,327
Goodwill		271

Total assets acquired		2,602
Current liabilities assumed		(287	)

Net assets acquired	$	2,315


		The technology acquired will be amortized by the straight-line method over a period of 5-7 years. The results of CIC’s operations have been included in the consolidated financial statements from the date of acquisition.

		Pro forma information in accordance with SFAS No. 141 has not been provided, since the revenues and net income of CIC were not material in relation to total consolidated revenues and net income for the years 2003 and 2004.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 1 -	GENERAL (Cont.)

	G.	On December 27, 2004, the Company reached an agreement with Koor Industries (“Koor”) to purchase all of Koor’s holdings in Tadiran Communications Ltd. (“Tadiran”), which represents approximately a 32% interest in Tadiran. This purchase will be made in parallel to Koor’s purchase of approximately 9.8% of the Company’s shares from Federmann Enterprises Ltd. (“Federmann”) based on agreements reached between Federmann and Koor. The transaction will be executed in two stages as described below.

		In the first stage, the Company will purchase from Koor approximately 13.8% of Tadiran’s shares, and Koor will purchase from Federmann approximately 5.3% of the Company’s shares. As of March 1, 2005, the Company held approximately 6% of Tadiran’s shares acquired through purchases on the market, and therefore, following completion of the first stage the Company will own approximately 20% of Tadiran’s shares. On completion of the first stage, Koor will support the Company’s appointment of the greater of 3 members or 20% of Tadiran’s board of directors, and Federmann will support Koor’s appointment of a member to the Company’s board of directors.

		In the second stage, the Company will purchase the balance of Koor’s holdings in Tadiran. Koor will purchase an additional approximately 4.5% of the Company’s shares from Federmann, and Federmann will support Koor’s appointment of an additional member to the Company’s board of directors, including the board’s Vice Chairman. The second stage is subject to Koor completing the sale to Tadiran of Koor’s 70% holdings in Elisra Electronic Systems Ltd. (“Elisra”) on agreed upon terms. Subject to those terms the Company agreed to support the purchase of the Elisra shares by Tadiran at Tadiran’s general shareholders meeting. In the event that the sale of the Elisra shares to Tadiran is not made by April 2006, then Koor and the Company will have equal representation on Tadiran’s board of directors, and an agreement regarding joint control of Tadiran will enter into effect between the Company and Koor.

		The Company will purchase from Koor the 32% of the Tadiran shares at a price of $37 per share, resulting in a total purchase price of approximately $146,000. Koor will purchase from Federmann the 9.8% of the shares in the Company at a price of $24.70 per share, resulting in a total purchase price of approximately $99,000.

		Under the Koor-Federmann shareholders agreement, which will became effective upon the completion of the first stage of the Koor-Federmann transaction, Koor will obtain certain tag along rights in the event of Federmann’s sale of shares in the Company, and Koor will be subject to certain restrictions on the transfer of its shares in the Company. Also, Koor has agreed to vote at general shareholders meetings of the Company in accordance with Federmann’s instructions, with certain exceptions, and Koor will receive certain additional non-transferable rights.

		On January 5, 2005, the Company’s Audit Committee and board of directors approved the agreements with Koor relating to the Company’s purchase of Koor’s shares in Tadiran.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 1 -	GENERAL (Cont.)

		On February 28, 2005, the Company’s shareholders at an extraordinary general shareholders meeting approved the agreements with Koor relating to the Company’s purchase of Koor’s shares in Tadiran. As of March 1, 2005, the parties were in the process of obtaining the remaining approvals required for the transaction.

Note 2 -	SIGNIFICANT ACCOUNTING POLICIES

	The consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). As applicable to the consolidated financial statements of the Group, such principles are substantially identical to accounting principles generally accepted in Israel, except as described in Note 22.

	A.	USE OF ESTIMATES

		The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported and disclosure of contingent assets and liabilities in the financial statements and accompanying notes. Actual results could differ from those estimates.

	B.	FINANCIAL STATEMENTS IN U.S. DOLLARS

		The Company’s revenues are generated mainly in U.S. dollars. In addition, most of the Company’s costs are incurred in U.S. dollars. The Company’s management believes that the U.S. dollar is the primary currency of the economic environment in which the Company operates. Thus, the functional and reporting currency of the Company is the U.S. dollar.

		Transactions and balances originally denominated in U.S. dollars are presented at their original amounts. Transaction and balances in other currencies have been remeasured into U.S. dollars in accordance with principles set forth in SFAS No. 52 “Foreign Currency Translation”. All exchange gains and losses from the remeasurement mentioned above are reflected in the statement of income in financial income or expenses.

		For those foreign subsidiaries whose functional currency has been determined to be other than the U.S. dollar, assets and liabilities are translated at year-end exchange rates and statement of income items are translated at average exchange rates prevailing during the year. Such translation adjustments are recorded as a separate component of accumulated other comprehensive income in shareholders’ equity.

	C.	PRINCIPLES OF CONSOLIDATION

		The consolidated financial statements include the accounts of the Company and its wholly and majority-owned subsidiaries.

		The consolidated subsidiaries include El-Op, EFW and other Israeli and non-Israeli subsidiaries.

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	C.	PRINCIPLES OF CONSOLIDATION (CONT.)

		Intercompany transactions and balances including profit from intercompany sales not yet realized outside the Group have been eliminated upon consolidation.

	D.	CASH EQUIVALENTS

		Cash equivalents, are short-term highly liquid investments that are readily convertible to cash with maturities of three months or less at the date of acquisition.

	E.	SHORT-TERM BANK DEPOSITS

		Short-term bank deposits are deposits with maturities of more than three months but less than one year. The short–term bank deposits are presented at their cost.

	F.	MARKETABLE SECURITIES

		Investments in a marketable securities are designed as available for sale according to Statement of Financial Accounting Standard No. 115 “Accounting for Certain Investments in Debt and Equity Securities”, (“SFAS No. 115”). Accordingly, these securities are stated at fair value, with unrealized gains and losses, net of taxes, reported in accumulated other comprehensive income (loss), a separate component of the shareholders equity.

	G.	INVENTORIES

		Inventories are stated at the lower of cost or net realizable value. Inventory write-offs are provided for slow-moving items or technological obsolescence for which recoverability is not probable.

		Cost is determined as follows:
		•	Raw materials using the average cost method.
		•	Costs incurred on long-term contracts in progress include direct labor costs, material costs, subcontractors, other direct costs and overheads. These costs represent recoverable costs incurred for production, allocable operating overhead cost and, where appropriate, research and development costs (refer to Note 2(T)).
		•	Labor overhead is generally included in our hourly rate and is allocated to each project according to the amount of hours invested. Material overhead is allocated to each project based on the value of direct material that is charged to the project.

		Advances from customers are allocated to the applicable contract inventories and are reflected as an offset against the related inventory balances.

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	H.	INVESTMENT IN AFFILIATED COMPANIES, PARTNERSHIP AND OTHER COMPANIES

		Investments in non-marketable shares of companies in which the Group holds less than 20% and the Group does not have the ability to exercise significant influence over operating and financial policies of the companies are recorded at cost.

		Investments in companies and partnership over which the Group can exercise significant influence (generally, entities in which the Group holds between 20% and 50% of voting rights) are presented using the equity method of accounting. Profits on intercompany sales, not realized outside the Group, were eliminated. The Group discontinues applying the equity method when its investment (including advances and loans) is reduced to zero and it has not guaranteed obligations of the affiliate or otherwise committed to provide further financial support to the affiliate.

		The Group applies Emerging Issues Task Force (“EITF 99-10”) “Percentage Used to Determine the Amount of Equity Method Losses”, according to which the Group recognizes equity method losses based on the ownership level of the particular investee security or loan held by the Group to which the equity method losses are being applied.

		A change in the Company’s proportionate share of a subsidiary’s or investee’s equity, resulting from issuance of shares by the subsidiary or investee to third parties, is recorded as a gain or loss in the consolidated income statements. If the realization is not assured, such as when the issuing company is a development stage company, the gain from issuance is accounted for as an equity transaction pursuant to SAB 51 “Accounting Sales of Stock by a Subsidiary”.

		Management evaluates investments in affiliates and other companies for evidence of other than temporary declines in value. When relevant factors indicate a decline in value that is other than temporary, the Company records a provision for the decline in value. A judgmental aspect of accounting for investments involves determining whether an other-than-temporary decline in value of the investment has been sustained. Such evaluation is dependent on the specific facts and circumstances. Accordingly, management evaluates financial information (e.g. budgets, business plans, financial statements, etc.) in determining whether an other-than-temporary decline in value exists. Factors indicative of an other-than-temporary decline include recurring operating losses, credit defaults and subsequent rounds of financings at an amount below the cost basis of the investment. This list is not all inclusive and management weighs all quantitative and qualitative factors in determining if an other-than-temporary decline in value of an investment has occurred.

	I.	LONG-TERM TRADE RECEIVABLES

		Long-term trade receivables from extended payment agreements are recorded at their estimated present values (determined based on the original rates of interest).

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	J.	LONG-TERM BANK DEPOSITS

		Long-term bank deposits are deposits with maturities of more than one year. These deposits are presented at cost including accumulated interest.

	K.	PROPERTY, PLANT AND EQUIPMENT

		Property, plant and equipment are stated at cost, net of accumulated depreciation and investment grants. For equipment produced for the Group’s own use, cost includes materials, labor and overhead, but not in excess of the fair value of the equipment.

		Depreciation is calculated by the straight-line method over the estimated useful life of the assets at the following annual rates:


	%

Buildings		2-4	(mainly 4%)
Instruments, machinery and equipment		10-33
Office furniture and other		6-33
Motor vehicles		15-20	(mainly 15%)


		Land rights and leasehold improvements - over the term of the lease.

	L.	INVESTMENT GRANTS

		As a governmental incentive for industrial companies in Israel, the “Investment Center”, which is a branch of the Israel Ministry of Industry and Trade, permits industrial companies to submit a request to qualify as an “Approved Enterprise”. An Approved Enterprise is entitled to certain benefits in respect of capital investments. The benefits may be in the form of reduced tax rates and of capital grants received as a percentage of the investments of the Approved Enterprise. The amount of a capital grant is determined as a percentage of the Approved Enterprise investment in property, plant and equipment. As a condition to the granting of these benefits, the Approved Enterprise is obligated to perform the applicable industrial plan as detailed in the request to the Investment Center (see Note 15(A)(3) and 16(J)). These capital grants are non-royalty bearing and are not conditioned on the results of operations. As the capital grants are a direct participation in the cost of the acquisition, of property, plant and equipment they are offset against property, plant and equipment and amortized over the period of the related investments.

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U. S. dollars (In thousands)


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	M.	IMPAIRMENT OF LONG-LIVED ASSETS

		The Group’s long-lived assets and identifiable intangible assets are reviewed for impairment in accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted cash flows expected to be generated by the asset. If an asset is determined to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. As of December 31, 2004, no impairment losses have been identified.

	N.	INTANGIBLE ASSETS

		Intangible assets are stated at cost net of accumulated amortization. Intangible assets are being amortized over their useful life using the straight-line method.

	O.	GOODWILL

		Goodwill represents the excess of the cost of acquired businesses over the net fair values of the assets acquired and liabilities assumed. Goodwill that arose from acquisitions prior to July 1, 2001, was amortized until December 31, 2001 on a straight-line basis over 10 - 20 years. Under SFAS No. 142, effective as of January 1, 2002, goodwill is no longer amortized, but is instead tested for impairment at least annually (or more frequently if impairments indicators arise).

		SFAS 142 prescribes a two phase process for impairment testing of goodwill. The first phase screens for impairment, while the second phase (if necessary) measures impairment.

		In the first phase of impairment testing, goodwill attributable to each of the reporting units is tested for impairment by comparing the fair value of each reporting unit with its carrying value. If the carrying value of the reporting unit exceeds its fair value, the second phase is then performed. The second phase of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.

		Fair value of a reporting unit is determined using discounted cash flows. Significant estimates used in the methodology include estimates of future cash flows, future short-term and long-term growth rates and weighted average cost of capital for each of the reporting units.

		As of December 31, 2004, no impairment losses have been identified.

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	P.	SEVERANCE PAY

		Under Israeli law and employment agreements, the Group’s companies in Israel are required to make severance payments and, in certain situations, pay pensions to terminated employees. The calculation is based on the employee’s latest salary and the period of his/her employment. The companies’ obligation for severance pay and pension is provided by monthly deposits with insurance companies, pension funds and by an accrual.

		The value of severance pay funds is presented in the balance sheet and includes profits accumulated to balance sheet date. The amounts deposited may be withdrawn only after fulfillment of the obligations pursuant to Israeli severance pay law or labor agreements. The values of the deposited funds are based on the cash surrendered value of these funds and include immaterial profits.

		Severance pay expenses for the years ended December 31, 2004, 2003 and 2002, amounted to approximately $15,574, $11,491and $10,138, respectively.

	Q.	REVENUE RECOGNITION

		The Group generates revenues from long-term contracts involving the design, development, manufacture and integration of defense systems and products and providing support and services for such systems and products.

		Revenues from long-term contracts are recognized based on Statement of Position 81-1 “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” (“SOP 81-1”) according to which revenues are recognized on the percentage of completion basis.

		Sales under long-term fixed-price contracts which provide for a substantial level of development efforts in relation to total contract efforts are recorded using the cost-to-cost method of accounting as the basis to measure progress toward completing the contract and recognizing revenues. According to this method, sales and profits are recorded based on the ratio of costs incurred to estimated total costs at completion. In certain circumstances, when measuring progress toward completion, the Company considers other factors, such as achievement of performance milestones.

		Sales and anticipated profit under long-term fixed-price production type contracts are recorded on a percentage of completion basis, using the units-of-delivery as the basis to measure progress toward completing the contract and recognizing revenues.

		Sales and anticipated profit under long-term fixed-price contracts that involve both development and production are recorded on a percentage of completion basis, using the cost-to-cost method and units-of-delivery method as applicable. In certain circumstances, when measuring progress toward completion under the development portion of the contract, the Company considers other factors, such as achievement of performance milestones.

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	Q.	REVENUE RECOGNITION (CONT.)

		Estimated contract profit is included in earnings in proportion to recorded sales.

		The percentage-of-completion method of accounting requires management to estimate the cost and gross profit margin for each individual contract. Estimated gross profit or loss from long-term contracts may change due to changes in estimates resulting from differences between actual performance and original estimated forecasts. Such changes in estimated gross profit are recorded in results of operations when they are reasonably determinable by management, on a cumulative catch-up basis. Anticipated losses on contracts are charged to earnings when determined to be probable.

		Sales under cost-reimbursement-type contracts are recorded as costs are incurred. Applicable estimated profits are included in earnings in the proportion that incurred costs bear to total estimated costs.

		Amounts representing contract change orders, claims or other items are included in sales only when they can be reliably estimated and realization is probable. Penalties and awards applicable to performance on contracts are considered in estimating sales and profit rates and are recorded when there is sufficient information to assess anticipated contract performance.

		The Group believes that the use of the percentage of completion method is appropriate as the Group has the ability to make reasonably dependable estimates of the extent of progress towards completion, contract revenues and contract costs. In addition, contracts executed include provisions that clearly specify the enforceable rights regarding services to be provided and received by the parties to the contracts, the consideration to be exchanged and the manner and terms of settlement. In all cases the Group expects to perform its contractual obligations and its customers are expected to satisfy their obligations under the contract.

		In cases where the contract involves the delivery of products and performance of services, the Group follows the guidelines specified in EITF 00-21, “Revenue Arrangements with Multiple Deliverables” in order to allocate the contract fees between the products accounted for under SOP 81-1 and the services accounted for under SAB 104. The services are recognized throughout the service period.

		In certain circumstances, sales under short-term fixed-price production type contracts are accounted for in accordance with SAB No. 104, “Revenue Recognition in Financial Statements” (“SAB 104”), and recognized when the following criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the seller’s price to the buyer is fixed or determinable, no further obligation exists and collectability is reasonably assured.

		As for research and development costs accounted for as contract costs refer to Note 2(T).

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	R.	PRE-CONTRACT COSTS

		Pre-contract costs are deferred and included in inventory, only when such costs can be directly associated with a specific anticipated contract and if their recoverability from the specific contract is probable according to the guidelines of SOP 81-1.

	S.	WARRANTY

		The Group estimates the costs that may be incurred under its basic warranty and records a liability in the amount of such costs at the time revenue is recognized as part of contract costs. The specific terms and conditions of those warranties vary depending upon the product sold, the country in which the Group does business, etc. In addition, the Company estimates the costs to be incurred in connection with basic design and system operating difficulties arising subsequent to delivery and acceptance by the customers and records a liability for such costs as part of contract costs. Factors that affect the Group’s warranty liability include the number of delivered products, the warranty period, engineering estimates and anticipated rates of warranty claims. The Group periodically assesses the adequacy of its recorded warranty liability and adjusts the amount as necessary.

		Changes in the Group’s provision for warranty during the year are as follows:


	2004			2003

Balance, at January 1	$	36,653		$	37,800
Warranties issued during the year		17,907			13,301
Warranties forfeited or exercised during the year		(20,527	)		(14,448	)


Balance, at December 31	$	34,033		$	36,653



	T.	RESEARCH AND DEVELOPMENT COSTS

		Research and development costs, net of participations, are charged to operations as incurred. Group sponsored research and development costs primarily include independent research and development and bid and proposal efforts.

		Under certain arrangements in which a customer participates in product development costs, the Group’s portion of such unreimbursed costs is expensed as incurred. Customer-sponsored research and development costs incurred pursuant to contracts are accounted for as part of the contract costs.

		Certain Group companies in Israel receive grants (mainly royalty-bearing) from the Government of Israel and from other sources for the purpose of funding approved research and development projects. These grants are recognized as a deduction from research and development costs at the time the applicable company is entitled to such grants on the basis of the research and development costs incurred.

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	U.	INCOME TAXES

		The Group accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”. This Statement prescribes the use of the liability method whereby deferred tax assets and liability account balances are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Group provides a valuation allowance, if necessary, to reduce deferred tax assets to their estimated realizable value.

	V.	CONCENTRATION OF CREDIT RISKS

		Financial instruments that potentially subject the Group to concentrations of credit risk consist principally of cash and cash equivalents, short and long-term deposits and trade receivables.

		The majority of the Group’s cash and cash equivalents and deposits are invested in dollar instruments with major banks in Israel and in the U.S. Management believes that the financial institutions that hold the Group investments are financially sound, and accordingly, minimal credit risk exists with respect to these investments.

		The Group’s trade receivables are derived primarily from sales to large and stable customers and governments located mainly in Israel, the United States and Europe. The Group performs ongoing credit evaluations of its customers and to date, has not experienced any unexpected material losses except for a one time loss in 2002 of approximately $4,600 due to the insolvency of one of the Group’s customers. An allowance for doubtful accounts is determined with respect to those amounts that the Group has determined to be doubtful of collection.

	W.	DERIVATIVE FINANCIAL INSTRUMENTS

		Financial Accounting Standards Board Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), requires companies to recognize all of its derivative instruments as either assets or liabilities in the statement of financial position at fair value. The accounting for changes in the fair value (i.e. gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, a company must designate the hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge or a hedge of a net investment in a foreign operation.

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	W.	DERIVATIVE FINANCIAL INSTRUMENTS (CONT.)

		For derivative instruments that are designated and qualify as a fair value hedge (i.e., hedging the exposure to changes in the fair value of an asset or a liability or an identified portion thereof that is attributable to a particular risk), the gain and loss on the derivative instrument as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in the same line item associated with the hedged item in current earnings during the period of the change in fair values. For derivative instruments that are designated and qualify as a cash flow hedge (i.e. hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same line item associated with the forecasted transaction in the same period or periods during which the hedged transaction affects earnings.

		The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of future cash flows of the hedged item, if any, is recognized as a financial expense in current earnings during the period of change.

		For derivative instruments not designated as hedging instruments, the gain or loss is recognized as a financial expense in current earnings during the period of change.

		As part of its hedging strategy, the Group enters into forward exchange contracts in order to protect the Group from the risk that the eventual dollar cash flows from the sale of products to international customers will be adversely affected by changes in the exchange rates.

		As part of its cash flow hedging strategy the Group enters into forward exchange contracts to hedge forecasted salary expenses denominated in a currency other than the U.S. dollar.

		As of December 31, 2004, the Group had forward contracts with a notional amount of approximately $30,900 to purchase and sell foreign currencies ($20,800 in Euro, $5,400 in Great Britain Pounds (“GBP”) and $4,800 in other currencies). The Group also had options to hedge future cash flow denominated in GBP in the amount of $154,000. The forward contracts and the options mature in 2005.

		The fair value of the foreign exchange contracts and the options as of December 31, 2004 is minimal.

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	X.	STOCK-BASED COMPENSATION

		Up until January 1, 2004, the Company elected to follow Accounting Principles Board Opinion No. 25 (“APB 25”) “Accounting for Stock Issued to Employees” and FASB Interpretation No. 44 (“FIN 44”) “Accounting for Certain Transactions Involving Stock Compensation” in accounting for its employee stock option plans. Under APB 25, the Company accounted for stock option grants using the intrinsic value method whereby compensation expense is equal to the excess, if any, of the quoted market price of the stock over the exercise price at the grant date of the award or if applicable at a subsequent measurement date. The Company recognized the expense over the vesting period of the award on a straight-line basis. Phantom options were accounted for as variable awards and accordingly, compensation expenses were measured at the end of each reporting period and amortized on an accelerated basis over the remaining vesting period. (See Note 17).

		Effective January 1, 2004, the Company adopted the fair value recognition provisions of SFAS No. 123. Under the modified prospective method of adoption selected by the Company under the provisions of SFAS No. 148, the recognition provisions are applied to all employee awards granted, modified, or settled after January 1, 2004, and to previously granted awards that were not fully vested on the date of adoption. Compensation cost is recorded over the vesting period on a straight-line basis.

		The cumulative effect on the deferred taxes relating to stock based compensation resulting from the adoption of SFAS No. 123 amounted to a reduction of $152 and was recorded as a one time adjustment to additional paid-in capital.

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U. S. dollars (In thousands, except share and per share data)


Note 2 -	SIGNIFICANT ACCOUNTING POLICIES (CONT.)

	X.	STOCK-BASED COMPENSATION (CONT.)

		If the Company had elected to adopt the fair value recognition provisions of SFAS No. 123 as of its original effective date, pro forma net income and pro forma basic diluted net income per share for the years ended December 31, 2002 and 2003 would be as follows:


	Year ended December 31,
	2004			2003			2002


Net income as reported	$	52,993		$	45,945		$	45,113
Add - Stock based compensation expense (income), net of related tax effects as reported (intrinsic method in 2003 and 2002)		2,710			3,793			(741	)
Deduct - Stock based compensation expense under fair value based method of SFAS 123 net of related of tax effects		(2,710	)		(2,956	)		(2,956	)

Pro forma net income	$	52,993		$	46,782		$	41,416


Net earnings per share:
Basic net earnings per share as reported	$	1.33		$	1.18		$	1.17


Diluted net earnings per share as reported	$	1.29		$	1.14		$	1.13


Pro forma basic net earnings per share	$	1.33		$	1.20		$	1.08


Pro forma diluted net earnings per share	$	1.29		$	1.16		$	1.04


		The fair value for these options was estimated using a Black-Scholes option pricing model with the following weighted average assumptions:


	2004		2003		2002

Divided yield	2.20	%	2.19	%	1.99	%
Expected volatility	26.7	%	19.03	%	21.9	%
Risk-free interest rate	4	%	1.20	%	1.34	%
Expected life	4 years		6 years		6 years

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Note 2 -	SIGNIFICANT ACCOUNTING POLICIES (CONT.)

	Y.	FAIR VALUE OF FINANCIAL INSTRUMENTS


		The carrying amount reported in the balance sheet for cash and cash equivalents, short-term bank deposits, trade receivables, short-term bank credit and loans and trade payables approximate their fair values due to the short-term maturities of such instruments.

		The carrying amount of the available for sale marketable securities is recorded according to its fair market value, as determined by quoted market prices on stock exchange.

		Long-term loans are estimated by discounting the future cash flows using current interest rates for loans of similar terms and maturities. The carrying amount of the long-term loans approximates their fair value.

		The fair value of foreign currency contracts (used for hedging purposes) is estimated by obtaining current quotes from investment bankers.

		It was not practicable to estimate the fair value of the Group’s investments in shares of non-public companies that are accounted for under the cost and equity method because of the lack of a quoted market price and the inability to obtain valuation of each company without incurring excessive costs. The carrying amounts of these companies as of December 31, 2003 and 2004 were $38,223 and $44,869, respectively, and represent the original cost of acquisition, and in the case of affiliates also the Company’s equity in the earnings/losses of the affiliates and its share in the changes of the affiliates’ equity since the dates of acquisition.

	Z.	BASIC AND DILUTED NET EARNINGS PER SHARE

		Basic net earnings per share are computed based on the weighted average number of ordinary shares outstanding during each year. Diluted net earnings per share is computed based on the weighted average number of ordinary shares outstanding during each year, plus dilutive potential ordinary shares considered outstanding during the year. Outstanding stock options are excluded from the calculation of the diluted net earnings per ordinary share when such securities are anti-dilutive. In all the years presented no stock options were excluded.

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Note 2 -	SIGNIFICANT ACCOUNTING POLICIES (CONT.)

	AA.	IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS


		(1).	In February 2004, the FASB issued EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-1”). This EITF was issued to determine the meaning of other-than-temporary impairment and its application to investments in debt and equity securities within the scope of SFAS 115. EITF 03-1 also applies to investments in equity securities that are both outside SFAS 115’s scope and are not accounted for by the equity method, which are defined as “cost method investments”. The impairment measurement and recognition guidance prescribed in EITF 03-1 is delayed until the final issuance of FSP EITF 03-01-a. The disclosure requirements for investments accounted for under SFAS 115 are effective for annual reporting periods ending after June 15, 2003 and for costs method investments for annual reporting periods ending after June 15, 2004. The Company does not expect that the adoption of the provisions of EITF 03-1 will have a material effect on its financial position or results of operations.

		(2).	In November 2004, the FASB issued Statement of Financial Accounting Standard No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4.” (“SFAS 151”). SFAS 151 amends Accounting Research Bulletin (“ARB”) No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight handling costs and wasted materials (spoilage) should be recognized as current-period charges. In addition, SFAS 151 requires that allocation of fixed production overheads to the costs of conversion be based on normal capacity of the production facilities. SFAS 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does not expect that the adoption of SFAS 151 will have a material effect on its financial position or results of operations.

		(3).	On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004) (“123(R)”), “Share-Based Payment”, which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation”. Statement 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and amends FASB Statement No. 95, “Statement of Cash Flows”. Generally, the approach in Statement 123(R) is similar to the approach described in Statement 123. However, Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. Statement 123(R) must be adopted no later than July 1, 2005. Early adoption will be permitted in periods in which financial statements have not yet been issued. The Company expects to adopt Statement 123(R) on July 1, 2005. Since, as noted in Note 2(AA) below, the Company adopted, effective January 1, 2004, the fair-value-based method of accounting for share-based payments, the adoption of Statement 123(R) is not expected to have a material impact on the Company’s results of operation or its financial position.

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U. S. dollars (In thousands)


Note 2 -	SIGNIFICANT ACCOUNTING POLICIES (CONT.)

	AA.	IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS (CONT.)


		Statement 123(R) permits public companies to adopt its requirements using one of two methods:

		•	A “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of Statement 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of Statement 123(R) for all awards granted to employees prior to the effective date of Statement 123(R) that remains unvested on the effective date.

		•	A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under Statement 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption.

	The Company plans to adopt Statement No. 123(R) using the modified prospective method.

	The Company adopted the fair-value-based method of accounting for share-based payments effective January 1, 2004 using the “modified prospective method” described in FASB Statement No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”. Currently, the Company uses the Black-Scholes-Merton formula to estimate the value of stock options granted to employees and expects to continue to use this acceptable option valuation model upon the required adoption of Statement 123(R) on July 1, 2005. The Company does not anticipate that adoption of Statement 123(R) will have a material impact on its results of operations or its financial position. However, Statement 123(R) also requires that the benefits of tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after the effective date. While the Company cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows recognized in prior periods for such excess tax deductions was $1,179, $758, and $648 in 2004, 2003 and 2002, respectively.

AB.	RECLASSIFICATIONS

	Certain financial statement data for prior years has been reclassified to conform to current year financial statement presentation.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 3 -	TRADE RECEIVABLES, NET

	Trade receivables


	December 31,

	2004			2003

Open accounts (*)	$	181,995		$	170,287
Unbilled receivables		35,885			36,855
Less - allowance for doubtful accounts		(3,064	)		(3,861	)

	$	214,816		$	203,281

(*) Includes affiliated companies)	$	10,823		$	6,668


Note 4 -	OTHER RECEIVABLES AND PREPAID EXPENSES


	December 31,

	2004		2003

Deferred income taxes	$	20,603	$	21,908
Prepaid expenses		17,914		14,310
Government institutions		5,719		5,826
Employees		1,204		513
Others		6,895		5,806

	$	52,335	$	48,363


Note 5 -	INVENTORIES, NET OF ADVANCES


	December 31,

	2004		2003

Cost incurred on long-term contracts in progress	$	254,009	$	254,910
Raw materials		71,813		78,504
Advances to suppliers and subcontractors		21,164		20,137

		346,986		353,551
Less -
Cost incurred on contracts in progress deducted from customer advances		14,533		14,581

		332,453		338,970
Less -
Advances received from customers (*)		75,776		77,482
Provision for losses		7,636		12,263

	$	249,041	$	249,225


	The Company has transferred legal title of inventories to certain customers as collateral for advances received.

	(*) Advances are allocated to the relevant inventories on a per-project basis. In cases (projects) where the advances are in excess of the inventories, the net amount is presented as a liability. In cases where the inventories are in excess of advances received, the net amount is presented as an asset.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 6 -	INVESTMENTS IN AFFILIATED COMPANIES, PARTNERSHIP AND OTHER COMPANIES

	A.	Investments in companies accounted for under the equity method:


	December 31,

	2004		2003

SCD (1)	$	19,186	$	17,347
VSI (2)		6,966		6,149
RedC (5)		3,100		—
Opgal (3)		2,873		2,390
Others (4)		999		592

	$	33,124	$	26,478


		(1)	Semi Conductor Devices (“SCD”) is an Israeli partnership, held 50% by the Company and 50% by Rafael Armaments Development Authority Ltd. (“Rafael”). SCD is engaged in the development and production of various thermal detectors and laser diodes. SCD is jointly controlled and therefore is not consolidated in the Company’s financial statements.

		(2)	Vision Systems International LLC (“VSI”) based in San Jose, is a California limited liability company that is held 50% by EFW and 50% by a subsidiary of Rockwell Collins Inc. VSI operates in the area of helmet mounted display systems for fixed wing military and paramilitary aircraft. VSI is jointly controlled and therefore is not consolidated in the Company’s financial statements.

		(3)	Opgal Optronics Industries Ltd. (“Opgal”) is an Israeli company owned 50.1% by the Company and 49.9% by a subsidiary of Rafael. Opgal focuses mainly on commercial applications of thermal imaging and electro-optic technologies. The Company jointly controls Opgal with Rafael, and therefore Opgal is not consolidated in the Company’s financial statements.

		(4)	Mediguide Inc. (“Mediguide”) and its Israeli subsidiary, Mediguide Ltd., were established in 2000 as a spin-off from the Company. The share capital of Mediguide consists of Common shares and Preferred A, B, C and D shares. The Common shares and the Preferred shares, both have voting rights. The Company holds all of the Common shares of Mediguide which constitute approximately 55% (43% on a fully diluted basis) of the voting rights of Mediguide. During 2001 - 2004, Mediguide issued Preferred shares to other investors in consideration for approximately $34,355. The Preferred shares issued entitle the other investors to preference rights senior to all other classes of shares previously issued by Mediguide in a liquidation or a deemed liquidation event. Therefore, the Company did not record any gain as a result of the above transaction. In addition, the Preferred shares entitle their holders to certain participating rights. Accordingly, based on the guidance in EITF 96-16, the Company does not consolidate Mediguide. The carrying value of the investment in Mediguide is zero.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 6 -	INVESTMENTS IN AFFILIATED COMPANIES, PARTNERSHIP AND OTHER COMPANIES (CONT.)


	A.	Investments in companies accounted for under the equity method (cont.)


		(5)	RedC Optical Networks Inc. (“RedC”), a company registered in Delaware, is engaged in the multi-focal optic communications sector and as of December 31, 2003 was held 36.5% by El-Op. RedC designs develops and manufactures optical amplifiers for dense wave-length multiplexing optical networks for telecommunications. In the year ended December 31, 2002, the Company recorded a provision for loss on its investment in RedC of $2,500. This provision has been presented in the Consolidated Statements of Income under “Equity in net earnings of affiliated companies and partnership”.

			In November 2004, El-Op acquired all of the outstanding voting Preferred A shares of RedC from MRV Communications Inc. for a consideration of $2,000, in accordance with El-Op’s right of first refusal based on the Preferred A shares investment agreement. Prior to the acquisition, El-Op held 57% of the Ordinary shares of RedC which reflected 36.5% of its voting rights. Following the acquisition, El-Op held 57% of the Ordinary shares and 100% of the Preferred A shares, which reflected 72.5% of RedC’s voting rights.

			In December 2004, El-Op signed a Transfer Agreement for selling all of it’s holdings in RedC, including the Ordinary shares and Preferred A shares, in consideration for $3,100, which was paid in cash on the closing date in January 2005. The closing was subject to certain conditions, which were all met by January 21, 2005.

			El-Op allocated the purchase price to the fair value of the assets acquired and liabilities assumed.

			Such allocation resulted in negative goodwill amounting to approximately to $1,100. Since RedC had no assets which could be reduced by the negative goodwill, according to the provisions of FAS 141, this goodwill was recorded as other income in the financial statements.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 6 -	INVESTMENTS IN AFFILIATED COMPANIES, PARTNERSHIP AND OTHER COMPANIES (CONT.)

	A.	Investments in companies accounted for under the equity method (cont.)

		(6)	The summarized aggregate financial information of companies accounted for under the equity method is as follows:

			Balance Sheet Information:


	December 31,

	2004		2003


Current assets	$	124,352	$	105,457
Non-current assets		21,646		15,799

Total assets		145,998		121,256


Current liabilities		68,655		59,076
Non-current liabilities		3,868		4,584
Shareholders’ equity		73,475		57,596

	$	145,998	$	121,256


			Income Statement Information:


	Year ended December 31,

	2004		2003		2002


Revenues	$	213,680	$	183,426	$	138,493
Gross profit		55, 285		45,616		36,278
Net income		15,195		13,976		6,904


		(7)	See Note 16(F) for guarantees.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 6 -	INVESTMENTS IN AFFILIATED COMPANIES, PARTNERSHIP AND OTHER COMPANIES (CONT.)

	B.	Investments in companies accounted for under the cost method


	December 31,

	2004		2003

Sultam (1)	$	3,500	$	3,500
ISI (2)		7,230		7,230
AAI (3)		1,000		1,000
Others		15		15

	$	11,745	$	11,745


		(1)	Sultam Systems Ltd. (“Sultam”), held 10%, is an Israeli company engaged in the development and manufacturing of military systems in the artillery sector.

		(2)	ImageSat International N.V. (“ISI”), held 14% (10% on a fully diluted basis), is engaged in the operation of satellite photography formations and commercial delivery of satellite photography for civil purposes.

		(3)	AeroAstro Inc. (“AAI”) - In January 2003, the Company purchased 8.33% (on a fully diluted basis) of the common stock of AAI, a Delaware corporation in consideration for $1,000. AAI is engaged in innovative micro and nanospacecraft applications. AAI manufactures low-cost satellite systems and components, used in its own spacecraft and for spacecraft development in and outside the U.S.

Note 7 -	LONG–TERM BANK DEPOSITS AND TRADE RECEIVABLES


	December 31,

	2004		2003


Deposits with banks for loans granted to employees (*)	$	1,603	$	1,901
Long-term trade receivables		452		393
Other deposits with banks		47		53

	$	2,102	$	2,347


	(*)	The deposits are linked to the Israeli CPI, bear annual interest of 4% and are presented net of current maturities of $534 (2003 - $633).

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 8 -	PROPERTY, PLANT AND EQUIPMENT, NET


	December 31,

	2004			2003

Cost (1):
Land, buildings and leasehold improvements (2)	$	151,285		$	140,812
Instruments, machinery and equipment (3)		222,153			196,229
Office furniture and other		26,828			25,254
Motor vehicles		37,308			29,776

		437,574			392,071
Accumulated depreciation		(193,286	)		(162,850	)

Depreciated cost	$	244,288		$	229,221


	Depreciation expenses for the years ended December 31, 2004, 2003 and 2002 amounted to $35,001, $30,775 and $26,525, respectively.

	(1)	Net of investment grants received (mainly for instruments, machinery and equipment) in the amounts of approximately $29,800 as of both December 31, 2004 and 2003.

	(2)	Includes, rights in approximately 9,225 square meters of land in Tirat Hacarmel, Israel. The land is leased from the Israel Land Administration until the years 2014 to 2024 with a renewal option for additional periods of up to 49 years. The Company’s rights in the land have not yet been registered in its name.

		Includes, rights in approximately 10,633 square meters of land in Rehovot, Israel. The land is leased from the Israel Land Administration until the year of 2043 with a renewal option for additional periods of up to 49 years. The Company’s rights in the land have not yet been registered in its name.

	(3)	Includes equipment produced by the Group for its own use in the aggregate amount of $69,146 and $59,318 as of December 31, 2004 and 2003, respectively.

	(4)	As for pledges of assets – see Note 16(I).

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)

Note 9 -	INTANGIBLE ASSETS, NET

	A.


	Weighted average number of years of amortization		December 31,

			2004		2003

Original cost:
Technology (1)		15	$	85,413	$	82,449
Trade marks (2)		17		8,000		8,000
Goodwill (3)				37,884		37,613

				131,297		128,062

Accumulated amortization:
Technology				28,365		21,555
Trade marks				1,908		1,458
Goodwill				5,037		5,037

				35,310		28,050


Amortized cost			$	95,987	$	100,012


(1)	The technology acquired consists of four major items as follows:

	In 2000, the Company completed a merger with El-Op. A portion of the purchase price was allocated to technology ($45,000), based on an independent appraisal. The technology acquired in the merger with El-Op comprises various technologies relating to:

	a.	Diode pumped and other advanced solid-state lasers incorporating add-on eye-safety options.

	b.	Detectors for thermal imaging devices, including 2-D arrays for second and third generation forward looking infrared sensors.

	c.	Line of sight command, control and stabilization systems employing computerized digital controllers.

	d.	Sophisticated image and signal processing, utilizing the modern equipment and software.

	e.	High precision mechanical and optical component design and manufacturing for the visible, ultraviolet and infrared spectra, including special and exotic materials, diffractive and planar optics, space borne lightweight optics and multi-layer coatings.

	f.	Aviation instruments such as precision altimeters and air speedometer.

	In 2000, EFW acquired from Honeywell Inc., Honeywell’s business relating to head-up displays and tracking systems for pilot helmets. An amount of $9,300 was allocated to the acquired technology based on its estimated fair value as prepared by the Company.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 9 -	INTANGIBLE ASSETS, NET (CONT.)


		In 2001 and 2002, the Company acquired a Brazilian company which serves as a center for the production and logistic support of defense electronics programs in Brazil. An amount of $5,500 was allocated to technology related to the maintenance and support of avionic equipment.

		In 2002, the Company acquired the business of the Defense Systems Division of Elron Telesoft as detailed in Note 1(C) above in consideration for $5,700. An amount of $5,100 was allocated to the technology related to the government information technology control systems software developed by Elron Telesoft.

	(2)	Includes trade marks acquired in the merger with El-Op in 2000.

	(3)	Includes mainly goodwill resulting from the merger with El-Op ($34,200) in 2000 and goodwill acquired from Honeywell Inc. ($1,800) in 2000. Until January 1, 2002, goodwill was amortized at an annual rate of 5% - 10%. The change in goodwill results from an acquisition of the business of CIC (See Note 1(F) above).

B.	Amortization expenses amounted to $7,260, $7,222 and $6,412 for the years ended December 31, 2004, 2003 and 2002, respectively.

C.	The annual amortization expense relating to intangible assets existing as of December 31, 2004 is estimated to be approximately as follows:

2005	$	6,900
2006		5,600
2007		5,400
2008		5,200
2009		4,900
Thereafter		35,140

Total	$	63,140


Note 10 -	SHORT-TERM BANK CREDIT AND LOANS


	December 31,

	2004			2003			2004		2003
	Interest Rate


Short-term bank loans:
In U.S. dollars		4.2-4.6	%		3.3-4.75	%	$	3,967	$	533
In Euro		—			3.5	%		—		1,927

								3,967		2,460

Short-term bank credit:
In NIS unlinked		5.7-8.1	%		7.2	%		2,120		4,684
In U.S. dollars		4.4	%		2.6	%		2,505		1,365

								4,625		6,049

							$	8,592	$	8,509

Weighted Average Interest Rate		4.7	%		5.4	%

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 11 -	OTHER PAYABLES AND ACCRUED EXPENSES


	December 31,

	2004		2003

Payroll and related expenses	$	42,491	$	33,382
Provision for vacation pay		26,936		25,280
Provision for income taxes, net of advances paid, and VAT		13,774		9,094
Provisions for royalties		17,845		16,149
Provision for warranty		34,033		36,653
Cost provision for unbilled services rendered to the Company and others(*)		34,623		37,262

	$	169,702	$	157,820


	(*) The other cost provision, primarily includes provisions for (1) estimated future costs in respect of potential contractual penalties and the probable loss from claims (legal or unasserted) in the ordinary course of business (e.g. damages caused by the items sold and claims as to the specific products ordered).

	Note 12 - CUSTOMERS ADVANCES AND AMOUNTS IN EXCESS OF COSTS INCURRED ON CONTRACTS IN PROGRESS


	December 31,

	2004		2003

Advances received	$	180,738	$	199,273
Less -
Advances presented under long-term liabilities		10,320		7,592
Advances deducted from inventories		75,776		77,482

		94,642		114,199
Less -
Costs incurred on contracts in progress		14,533		14,581

	$	80,109	$	99,618


	As for guarantees and liens see Note 16(F).

Note13 -	LONG-TERM LOANS


					December 31,
		Interest %	Years of maturity
	Currency	Interest %	Years of maturity		2004		2003

Banks	U.S. dollars	Libor + 0.75%-1.25%		mainly 2-3	$	83,469	$	57,574
Banks	NIS-unlinked	Israeli Prime		—		—		3,599
Office of Chief Scientist	NIS-linked to the Israeli-CPI	4.4%		3		4,131		7,683
Other						290		—

						87,890		68,856
Less-current maturities						1,656		6,532

					$	86,234	$	62,324

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 13 -	LONG-TERM LOANS (CONT.)

	The Libor rate as of December 31, 2004 was 2.56%.
	The maturities of these loans after December 31, 2004 are as follows:


2005 – current maturities	$	1,656
2006		40,527
2007		42,550
2008		165
2009		170
2010 and thereafter		2,822

	$	87,890


	See Note 16(G) for covenants.

Note 14 -	BENEFIT PLANS

	EFW, the Company’s subsidiary in the U.S., has adopted for its employees in the U.S. benefits plans as follows:

	Defined Benefit Retirement Plan

	EFW has two defined benefit pension plans (the “Plans”) substantially covering its employees in the U.S. Monthly benefits are based on years of benefit service and annual compensation. Annual contributions to the Plans are determined using the unit credit actuarial cost method and are equal to or exceed the minimum required by law. Pension fund assets of the Plans are invested primarily in stock, bonds and cash by a financial institution, as the investment manager of the Plans’ assets.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 14 -	BENEFIT PLANS (Cont.)

	The following table reconciles the benefit obligations, Plans assets, funded status and net asset (liability) information of the Plans:


	December 31,

	2004			2003

Benefit obligation at beginning of year	$	34,965		$	28,439
Service cost		3,000			2,480
Interest cost		2,191			1,921
Actuarial losses		2,307			2,825
Unrecognized transition obligation		1,056			—
Benefits repaid		(822	)		(700	)

Benefit obligation at end of year		42,697			34,965


Plans assets at beginning of year		21,196			15,558
Actual return on Plan assets		1,756			2,689
Contributions by employer		2,971			3,649
Benefits repaid		(822	)		(700	)

Plans assets at end of year		25,101			21,196

Funded status of Plans (underfunded)		(17,595	)		(13,769	)
Unrecognized prior service cost		(180	)		(195	)
Unrecognized transition obligation		1,056			—
Unrecognized net actuarial loss		11,447			9,395

Net amount recognized	$	(5,272	)	$	(4,569	)

Net asset (liability) consists of:
Accrued benefit liability	$	(13,899	)	$	(11,011	)
Intangible asset		895			51
Accumulated other comprehensive income		7,732			6,391

Net amount recognized	$	(5,272	)	$	(4,569	)

Weighted average assumptions:
Discount rate as of December 31,		6.00	%		6.25	%
Expected long-term rate of return on Plan’s assets		8.50	%		9.00	%
Rate of compensation increase		3.00	%		3.00	%


	Year ended December 31,

	2004			2003			2002

Components of net periodic pension cost:
Service cost	$	3,000		$	2,480		$	2,067
Interest cost		2,191			1,921			1,678
Expected return on Plans’ assets		(1,951	)		(1,573	)		(1,597	)
Amortization of prior service cost		(15	)		(15	)		28
Recognized net actuarial loss		451			339			—

Net periodic pension cost	$	3,676		$	3,152		$	2,176

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 14 -	BENEFIT PLANS (Cont.)

	Defined Contribution Plan

	The 401(k) savings plan (“401(k) plan”) is a defined contribution retirement plan that covers all eligible employees, as defined in section 401(k) of the U.S. Internal Revenue Code. EFW’s employees may elect to contribute a percentage of their annual gross compensation to the 401(k) plan. EFW may make discretionary matching contributions as determined by the subsidiary. Total expense under the 401(k) plan amounted to $1,744 for the year ended December 31, 2004 (2003 - $1,629, 2002 - $1,369).

Note 15 -	TAXES ON INCOME

	A.	APPLICABLE TAX LAWS

		(1)	Measurement of taxable income under Israel’s Income Tax (Inflationary Adjustments) Law, 1985:

			Results for tax purposes for the Company and certain of its Israeli subsidiaries are measured and reflected in accordance with the change in the Israeli Consumer Price Index (“CPI”). As explained above in Note 2(B), the consolidated financial statements are presented in U.S. dollars. The differences between the change in the Israeli CPI and in the NIS/U.S. dollar exchange rate cause a difference between taxable income and the income before taxes reflected in the consolidated financial statements.

			In accordance with paragraph 9(f) of SFAS No. 109, the Company has not provided deferred income taxes on the above differences resulting from changes in exchange rates and indexing for tax purposes.

		(2)	Tax benefits under Israel’s Law for the Encouragement of Industry (Taxes), 1969:

			The Company and certain subsidiaries in Israel (mainly El-Op and Cyclone Aviation Products Ltd.) are “Industrial Companies”, as defined by the Law for the Encouragement of Industry (Taxes), 1969, and as such, these companies are entitled to certain tax benefits, mainly amortization of costs relating to know-how and patents over eight years, accelerated depreciation and the right to deduct public issuance expenses for tax purposes.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 15 -	TAXES ON INCOME (CONT.)

		(3)	Tax benefits under Israel’s Law for the Encouragement of Capital Investments, 1969:

			Several expansion programs of the Company and certain of its Israeli subsidiaries (“the companies”) have been granted “Approved Enterprise” status under Israel’s Law for the Encouragement of Capital Investments, 1959. For some expansion programs, the companies have elected the grants track and for others they have elected the alternative tax benefits track, waiving grants in return for tax exemptions.

			Accordingly, certain income of the companies, derived from the “Approved Enterprise” expansion programs is tax exempt for two-year to ten-year period and subject to reduced tax rates of 25% for a five-year to eight-year period commencing in the year in which the companies had taxable income (limited to twelve years from commencement of production or fourteen years from the date of approval, whichever is earlier). As of December 31, 2004, the tax benefits for these exiting expansion programs will expire within the period of 2005 to 2012.

			The entitlement to the above benefits is subject to the companies fulfilling the conditions specified in the above referred law, regulations published hereunder and the letters of approval for the specific investments in “Approved Enterprises”. In the event of failure to comply with these conditions, the benefits may be canceled and the companies may be required to refund the amount of the benefits, in whole or in part, including interest. (For liens – see Note 16(J)). As of December 31, 2004, Management believes that the companies are meeting all conditions of the approvals.

			As of December 31, 2004, retained earnings included approximately $116,500 in tax-exempt profits earned by the companies’ “Approved Enterprises”. If the retained tax-exempt income is distributed, it would be taxed at the corporate tax rate applicable to such profits as if the Company had not elected the alternative tax benefits track (currently - 25%) and an income tax liability would be incurred of approximately $29,100 as of December 31, 2004.

			The companies’ boards of directors have decided that their policy is not to declare dividends out of such tax-exempt income. Accordingly, no deferred income taxes have been provided on income attributable to the companies’ “Approved Enterprises”.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 15 -	TAXES ON INCOME

		(3)	Tax benefits under Israel’s Law for the Encouragement of Capital Investments, 1969 (Cont.):

			In Israel, income from sources other than the “Approved Enterprise” during the benefit period will be subject to tax at the regular corporate tax rate of 35%.

			Since the companies are operating under more than one approval, and since part of their taxable income is not entitled to tax benefits under the above mentioned law and is taxed at the regular tax rate of 35%, the effective tax rate is the result of a weighted combination of the various applicable rates and tax exemptions, and the computation is made for income derived from each approval on the basis of formulas specified in the law and in the approvals.

	B.	NON – ISRAELI SUBSIDIARIES

		Non-Israeli subsidiaries are taxed based on tax laws in their countries of residence (mainly in the U.S.).

	C.	INCOME BEFORE TAXES ON INCOME


	Year ended December 31,

	2004		2003		2002

Income before taxes on income:
Domestic	$	43,642	$	38,423	$	42,317
Foreign		16,985		11,090		11,977

	$	60,627	$	49,513	$	54,294

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 15 -	INCOME TAXES (CONT.)

	D.	TAXES ON INCOME


	Year ended December 31,

	2004			2003			2002

Taxes on income:
Current taxes:
Domestic	$	7,415		$	12,346		$	11,654
Foreign		7,651			718			6,114

		15,066		$	13,064		$	17,768


Deferred income taxes:
Domestic		709			(4,672	)		(3,561	)
Foreign		(556	)		2,942			(2,059	)

		153			(1,730	)		(5,620	)


Taxes in respect of prior years		—			—			(2,800	)(*)

	$	15,219		$	11,334		$	9,348


	(*)	A reduction of tax expenses due to adjustments of estimated tax provision pursuant to the completion of prior years’ tax assessments in respect of various Group companies with the tax authorities.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 15 -	INCOME TAXES (CONT.)

	E.	DEFERRED INCOME TAXES

		Deferred income taxes reflect the net tax effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of net deferred tax assets and liabilities are as follows:


				Deferred Tax asset (liability)(1)

	Total			Current			Non-current

As of December 31, 2004
Deferred tax assets:
Reserves and allowances	$	12,797		$	13,191		$	(394	)
Inventory		5,376			5,376			—
Net operating loss carryforwards		5,395			149			5,246

		23,568			18,716			4,852
Valuation allowance		(3,445	)		—			(3,445	)

Net deferred tax assets		20,123			18,716			1,407


Deferred tax liabilities:
Property, plant and equipment		(12,999	)		—			(12,999	)
Intangible assets		(10,285	)		2,639			(12,924	)
Available for sale securities		(752	)		(752	)		—

		(24,036	)		1,887			(25,923	)


Net deferred tax assets (liabilities)	$	(3,913	)	$	20,603		$	(24,516	)


As of December 31, 2003
Deferred tax assets:
Reserves and allowances	$	11,149		$	11,187		$	(38	)
Inventory		7,952			7,952			—
Net operating loss carryforwards		6,606			439			6,167

		25,707			19,578			6,129
Valuation allowance		(3,879	)		—			(3,879	)

Net deferred tax assets		21,828			19,578			2,250


Deferred tax liabilities:
Property, plant and equipment		(12,769	)		—			(12,769	)
Intangible assets		(12,067	)		2,330			(14,397	)

		(24,836	)		2,330			(27,166	)


Net deferred tax assets (liabilities)	$	(3,008	)	$	21,908		$	(24,916	)


	(1) The current tax asset is included in other receivables. Noncurrent tax liability is included as a long-term liability.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 15 -	INCOME TAXES (CONT.)

	F.	As of December 31, 2004, The Group’s Israeli subsidiaries have estimated total available carryforward tax losses of approximately $16,700, and the Group’s non-Israeli subsidiaries have estimated available carryforward tax losses of approximately $7,300. These losses can be offset against future taxable profits for an indefinite period. Deferred tax assets in respect of the above carryforward losses amount to approximately $5,400 in respect of which a valuation allowance has been recorded in the amount of approximately $3,400.

	G.	Reconciliation of the theoretical tax expense, assuming all income is taxed at the statutory rate applicable to income of the Group, and the actual tax expense as reported in the statements of operations, is as follows:


	Year ended December 31,

	2004			2003			2002


Income before taxes as reported in the consolidated statements of operations	$	60,627		$	49,513		$	54,294
Statutory tax rate		35	%		36	%		36	%

Theoretical tax expense	$	21,219		$	17,825		$	19,546
Tax benefit arising from reduced rate as an “Approved Enterprise” and other tax benefits		(7,196	)		(8,391	)		(9,054	)
Tax adjustment in respect of different tax rates for foreign subsidiaries		496			279			(461	)
Operating carryforward losses for which valuation allowance was provided		(434	)		126			2,189
Increase (decrease) in taxes resulting from nondeductible expenses		1,095			993			(263	)
Difference in basis of measurement for financial reporting and tax return purposes		(210	)		846			458
Taxes in respect of prior years		—			—			(2,800	)
Other differences, net		248			(344	)		(267	)

Actual tax expenses	$	15,219		$	11,334		$	9,348

Effective tax rate		25.1	%		22.9	%		17.2	%


	H.	AMENDMENT TO THE INCOME TAX ORDINANCE

		On September 29, 2004, the Israeli Parliament approved the Amendment to the Income Tax Ordinance (No. 140 and Temporary Provision) (the “Amendment”) which reduces the corporate tax rate from 36% to 35% in 2004 and to a rate of 30% in 2007 progressively. The Amendment was signed and published in July 2004 and is therefore considered enacted in July 2004. The adoption of the Amendment did not have a significant effect on the Company’s financial statements.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 16 -	COMMITMENTS AND CONTINGENT LIABILITIES

	A.	ROYALTY COMMITMENTS

		1.	The Company and certain Israeli subsidiaries partially finance their research and development expenditures under programs sponsored by the OCS for the support of research and development activities conducted in Israel. At the time the participations were received, successful development of the related projects was not assured.

			In exchange for participation in the programs by the OCS, the Company and the subsidiaries agreed to pay 2% - 5% of total sales of products developed within the framework of these programs. The royalties will be paid up to a maximum amount equaling 100% to 150% of the grants provided by the OCS, linked to the dollar and for grants received after January 1, 1999, also bearing annual interest at a rate based on LIBOR. The obligation to pay these royalties is contingent on actual sales of the products, and in the absence of such sales payment of royalties is not required.

			In some cases, the Government of Israel participation (through the OCS) is subject to export sales or other conditions. The maximum amount of royalties is increased in the event of production outside of Israel.

			The Company and certain of its subsidiaries may also be obligated to pay certain amounts to the Israeli Ministry of Defense and others on certain sales including sales resulting from the development of certain technologies.

			Royalties expensed amounted to $5,802, $7,812 and $14,471 in 2004, 2003 and 2002, respectively.

		2.	In September 2001, the OCS issued “Regulations for the Encouragement of Research and Development in Industry” (rules for determining the level and payment of royalties) (the “regulations”). The regulations allow large R&D intensive companies to reach certain agreements with the OCS regarding determination of the amount and payment schedule of royalties, subject to certain conditions.

			If the Company elects to adopt the regulations, it will have to record a significant one-time expense resulting from accruing a liability for an absolute amount of royalties.

			In May 2002, El-Op’s Board of Directors approved an arrangement, proposed by the OCS, according to which El-Op pays commencing in 2002, an agreed amount of $10,632 in exchange for a release from all obligations to pay royalties in the future.As a result, El-Op recorded an expense for the agreed amount net of the accrual for royalties previously recorded by El-Op in the amount of $9,801. This expense is included cost of revenues.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 16 -	COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)

	B.	COMMITMENTS IN RESPECT OF LONG-TERM PROJECTS

		In connection with long-term projects in certain countries, the Company and certain subsidiaries undertook to use their respective best efforts to make or facilitate purchases or investments in those countries at certain percentages of the amount of the projects. The companies’ obligation to make or facilitate third parties making such investments and purchases is subject to commercial conditions in the local market, typically without a specific financial penalty. The maximum aggregate undertaking as of December 31, 2004 amounted to $673,000 to be performed over a period of up to 11 years. This amount is typically tied to a percentage (up to 100%) of the amount of a specific contract.

		In the opinion of the Company’s Management, the actual amount of the investments and purchases is anticipated to be less than that mentioned above, since certain investments and purchases can result in reducing the overall undertaking on more than a one-to-one basis.

	C.	LEGAL CLAIMS

		The Company and its subsidiaries are involved in legal claims arising in the ordinary course of business, including claims by employees, consultants and others. Company’s Management, based on the opinion of its legal counsel, believes that the financial impact for the settlement of such claims in excess of the accruals recorded in the financial statements will not have a material adverse effect on the financial position or results of operations of the Group.

	D.	LEASE COMMITMENTS

		The future minimum lease commitments of the Group under various non-cancelable operating lease agreements in respect of premises, motor vehicles and office equipment are as of December 31, 2004 as follows:


2005	$	6,655
2006		5,939
2007		4,547
2008		3,022
2009 and thereafter		13,060

	$	33,223


		Rent expenses for the years ended December 31, 2004, 2003 and 2002 amounted to $6,842, $9,177, and $9,215, respectively.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 16 -	COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)

	E.	PUT OPTION

		Three founding employees (the “Founders”), who collectively hold approximately 32.3% of the outstanding shares of Kinetics Ltd. (“Kinetics”), a 51%-owned Israeli subsidiary, have a put option to jointly sell all of their shares in Kinetics to the Company. Two private investors holding in the aggregate approximately 16.7% of Kinetics’ outstanding shares have “tag along” rights in the event the Founders exercise the put option.

		The put option is exercisable from January 1, 2005 until December 31, 2005 at a price equal to the higher of the Founder’s pro-rata share (corresponding to the Founder’s shareholding percentage) of:

		(1) The value of Kinetics as of the option exercise date as determined by a third party appraiser mutually acceptable to the Founders and to the Company. The appraiser will value Kinetics as if Kinetics had distributed as dividends net profits accumulated up to the option exercise date; or

		(2) $12,077, reduced by 3% per annum, or pro-rata part thereof, for the period beginning on July 1, 2003 and ending on the option exercise date.

		As of December 31, 2004, the fair value of the aforementioned option was immaterial.

	F.	GUARANTEES

		1.	Guarantees in the amount of approximately $380,000 were issued by banks on behalf of Group companies in order to secure certain advances from customers and performance bonds.

		2.	The Company has provided, on a proportional basis to its ownership interest, guarantees for two of its investees in respect of credit lines granted to them from banks amounting to $12,000 (2003- $13,900), of which $11,500 (2003 - $13,400) relates to a 50%-owned foreign investee. The guarantees will exist as long as the credit lines are in effect. The Company would be liable under the guarantee for any debt for which the investee would be in default under the terms of the credit line.

	G.	COVENANTS

		In connection with bank credits and loans, including performance guarantees issued by banks and bank guarantees in order to secure certain advances from customers, the Company and certain subsidiaries are obligated to meet certain financial covenants. Such covenants include requirements for shareholders’ equity, current ratio, operating profit margin, tangible net worth, EBITDA, interest coverage ratio and total leverage. As of December 31, 2004 the Company and its subsidiaries were in full compliance with all covenants.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 16 -	COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)

	H.	CONTRACTUAL OBLIGATIONS

		Substantially all of the purchase commitments relate to obligations under purchase orders and subcontracts entered into by the Company. These purchase orders and subcontracts are typically in a standard format proposed by the Company, with the subcontracts and purchase orders also reflecting provisions from the Company’s applicable prime contract that are appropriate to flow down to subcontractors and vendors. The terms typically included in these purchase orders and subcontracts are consistent with Uniform Commercial Code provisions in the United States for sales of goods, as well as with specific terms called for by its customers in international contracts. These terms include the Company’s right to terminate the purchase order or subcontract in the event of the vendors’ or subcontractors’ default, as well as the Company’s right to terminate the order or subcontract for the Company’s convenience (or if the Company’s prime contractor has so terminated the prime contract). Such purchase orders and subcontracts typically are not subject to variable price provisions. As of December 31, 2004 and 2003 the purchase commitments were $345,000 and $348,400 respectively.

	I.	In order to secure bank loans and bank guarantees in the amount of $10,019 as of December 31, 2004, certain Group companies recorded fixed charges on most of their machinery and equipment, mortgages on most of their real estate and floating charges on most of their assets.

	J.	A lien on the Group’s Approved Enterprises has been registered in favor of the State of Israel. Grants received in respect of projects which have not yet been approved amount to approximately $220 (see Note 15 (A) (3) above).

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands, except share and per share data)


Note 17 -	SHAREHOLDER’S EQUITY

	A.	SHARE CAPITAL

		Ordinary shares confer upon their holders voting rights, the right to receive dividends and the right to share in equity upon liquidation of the Company.

	B.	2000 EMPLOYEE STOCK OPTION PLAN

		In 2000, the Company adopted an employee stock option plan for employees comprising options to purchase up to 2,500,000 ordinary shares. The exercise price approximates the market price of the shares at the grant date. The plan includes an additional 2,500,000 options to be issued as “phantom” share options that grant the option holders a number of shares reflecting the benefit component of the options exercised, as calculated at the exercise date, in consideration for their par value only. Options vest over a period of one to four years from the date of grant and expire no later than six years from the date of grant.

		Any options which are canceled or forfeited before expiration become available for future grants. As of December 31, 2004, 453,794 options of the Company were still available for future grants.

	C.	“PHANTOM” SHARE OPTIONS

		Until January 1, 2004, the Company applied the provision of APB No. 25, under which the phantom share options were considered to be part a variable awards as defined in APB No. 25, and accordingly the compensation cost of the options was measured at the end of each reporting period and amortized by the accelerated method over the remaining vesting period. Starting January 1, 2004, the Company accounts for its stock based compensation awards under the fair value based method.

	D.	A summary of the Company’s share option activity under the plans is as follows:


	2004					2003					2002

	Number of options			Weighted average exercise price		Number of options			Weighted average exercise price		Number of options			Weighted average exercise price

Outstanding - beginning of the year		3,735,602		$	12.30		4,511,724		$	12.26		5,107,634		$	11.93
Granted		130,500			15.67		13,000			14.91		27,000			14.92
Exercised		(1,666,774	)		12.12		(757,947	)		12.13		(558,901	)		9.45
Forfeited		(69,071	)		12.10		(31,175	)		12.29		(64,009	)		11.33

Outstanding - end of the year		2,130,257		$	12.60		3,735,602		$	12.30		4,511,724		$	12.26

Options exercisable at the end of the year		1,950,903		$	12.36		2,547,196		$	12.23		2,287,790		$	12.18

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands, except share and per share data)

Note 17 -	SHAREHOLDER’S EQUITY (CONT.)

	E.	The options outstanding as of December 31, 2004, have been separated into ranges of exercise prices, as follows:


	Options outstanding						Options exercisable

Exercise price	Number outstanding as of December 31, 2004		Weighted average remaining contractual life (years)		Weighted average exercise price per share		Number outstanding as of December 31, 2004		Weighted average exercise price per share


$10.61-$12.16		1,500		0.82	$	12.16		1,500	$	12.16
$12.18-$18.99		1,050,427		2.17		12.60		960,750		12.36
$12.18-$18.99(*)		1,078,330		2.23		12.59		988,563		12.35

		2,130,257		2.20	$	12.60		1,950,903	$	12.36


	(*) Phantom share options.

		Compensation expense (income) amounted to $3,387, $4,741 and $(926) were recognized during the years ended December 31, 2004, 2003 and 2002, respectively. All the compensation expenses (income) in the years 2002 and 2003 were related to the Phantom share options under the stock option plan. The expenses in 2004 were recorded based on SFAS No. 123 and SFAS No. 148 according to the modified prospective method. The expenses (income) were recorded as follows:


	Year ended December 31,

	2004		2003		2002

Cost of revenues	$	1,863	$	2,608	$	(509	)
R&D and marketing expenses		677		948		(185	)
General and administration expenses		847		1,185		(232	)

	$	3,387	$	4,741	$	(926	)


	F.	The weighted average exercise price and fair value of options granted during the years ended December 31, 2004, 2003 and 2002 were:


	Less than market price

	Year ended December 31,

	2004		2003		2002

Weighted average exercise price	$	15.67	$	14.91	$	14.92
Weighted average fair values on grant date	$	6.62	$	4.63	$	4.31

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands, except share and per share data)


Note 17 -	SHAREHOLDER’S EQUITY (CONT.)

	G.	Computation of basic and diluted net earnings per share:


	Year ended December 31, 2004						Year ended December 31, 2003						Year ended December 31, 2002


	Net income to shareholders of Ordinary shares		Weighted averaged number of shares (*)		Per share amount		Net income to shareholders of ordinary shares		Weighted averaged number of shares (*)		Per share amount		Net income to shareholders of ordinary shares		Weighted averaged number of shares (*)		Per share amount


Basic net earnings	$	52,993		39,952	$	1.33	$	45,945		39,061	$	1.18	$	45,113		38,489	$	1.17

Effect of dilutive securities:
Employee stock options		—		1,089				—		1,169				—		1,374

Diluted net earnings	$	52,993		41,041	$	1.29	$	45,945		40,230	$	1.14	$	45,113		39,863	$	1.13

* In thousands


	H.	TREASURY SHARES

		The Company’s shares held by the Company and its subsidiaries are presented at cost and deducted from shareholder’s equity.

	I.	DIVIDEND POLICY

		Dividends declared by the Company are paid subject to statutory limitations. The Company’s board of directors has determined not to declare dividends out of tax exempt earnings.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 18 -	MAJOR CUSTOMER AND GEOGRAPHIC INFORMATION

	The Group applies Statement of Financial Accounting Standards No. 131, “Disclosures About Segments of an Enterprise and Related Information”, (“SFAS No. 131”). The Group operates in one reportable segment (see Note 1 for a brief description of the Group’s business).

	A.	Revenues are attributed to geographic areas based on location of the end customers as follows:


	Year ended December 31,

	2004		2003		2002

Europe	$	124,130	$	109,409	$	144,862
U.S.		348,509		332,323		267,686
Israel		241,601		255,742		225,674
Others		225,685		200,506		189,234

	$	939,925	$	897,980	$	827,456


	B.	Revenues are generated by the following product lines:


	Year ended December 31,

	2004		2003		2002

Airborne systems	$	367,927	$	373,580	$	372,756
Land vehicles systems		199,224		199,800		135,700
Command, control, communications, computers, intelligence, surveillance and reconnaissance systems (C⁴ISR)		108,925		133,900		122,700
Electro-optical systems		200,322		140,500		148,200
Others		63,527		50,200		48,100

	$	939,925	$	897,980	$	827,456


	C.	Revenues from single customers, which exceed 10% of total revenues in the reported years:


	Year ended December 31,

	2004			2003			2002


IMOD		17	%		21	%		20	%
U.S. Government		10	%		*			*

*Less than 10%

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 18 -	MAJOR CUSTOMER AND GEOGRAPHIC INFORMATION (CONT.)

	D.	Long-lived assets by geographic areas:


	Year ended December 31,

	2004		2003		2002

Israel	$	237,887	$	229,396	$	211,256
U.S.		84,701		81,261		83,814
Others		17,687		18,576		13,660

	$	340,275	$	329,233	$	308,730


Note 19 -	RESEARCH AND DEVELOPMENT COSTS, NET


	Year ended December 31,

	2004			2003			2002

Total expenses	$	86,368		$	65,487		$	62,560
Less – participations		(19,522	)		(10,568	)		(5,550	)

	$	66,846		$	54,919		$	57,010


Note 20 -	FINANCIAL EXPENSES, NET


	Year ended December 31,

	2004			2003			2002

Expenses:
On long-term bank debt	$	(1,544	)	$	(2,215	)	$	(2,765	)
On short-term bank credit and loans		(2,309	)		(2,182	)		(2,435	)
Others		(3,181	)		(3,905	)		(1,899	)

	$	(7,034	)		(8,302	)		(7,099	)

Income:
Interest on cash, cash equivalents and bank deposits		628			309			1,547
Others		1,115			4,397			1,063

		1,743			4,706			2,610

Gain (loss) from exchange rate differences		(561	)		(1,274	)		1,454

	$	(5,852	)	$	(4,870	)	$	(3,035	)

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 21 -	RELATED PARTIES TRANSACTIONS AND BALANCES


	Year ended December 31,

	2004		2003		2002

Income -
Sales to affiliated companies (*)	$	56,346	$	34,674	$	37,924
Participation in expenses	$	2,594	$	1,773	$	902

Cost and expenses -
Supplies and services from affiliated companies (**)	$	16,338	$	21,606	$	10,457
Participation in expenses	$	627	$	1,751	$	1,498
Financial expenses	$	3	$	23	$	110


	December 31,

	2004		2003

Trade receivables and other receivables (*)	$	13,214	$	6,668
Trade payables (**)	$	5,445	$	4,975


	The purchases from our related parties are made at prices and on terms equivalent to those used in transacting business with unrelated parties under similar conditions. The sales to our related parties in respect with government defense contracts are made on the basis of costs incurred.

	(*)	The significant sales include sales of helmet mounted cueing systems purchased from the Company by VSI.
	(**)	Includes electro-optics components and sensors purchased by the Company from SCD and electro-optics products purchased by the Company from Opgal.

Note 22 -	RECONCILIATION TO ISRAELI GAAP

	As described in Note 1, the Company prepares its financial statements in accordance with U.S. GAAP. The effects of the differences between U.S. GAAP and generally accepted accounting principles in Israel (“Israeli GAAP”) on the Company’s financial statements are detailed below.

	A building purchased from Elbit Ltd.

	According to Israeli GAAP, the Company charged to additional paid-in capital reserves the excess of the amount paid over net book value of a building acquired from Elbit Ltd in 1999. According to U.S. GAAP, the entire amount paid is considered as the cost of the building acquired.

	Proportional consolidation method

	According to Israeli GAAP, a jointly controlled company should be included according to the proportional consolidation method. According to U.S. GAAP, the investment in such a company is recorded according to the equity method.

ELBIT SYSTEMS LTD. AND ITS SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONT.)

U. S. dollars (In thousands)


Note 22 -	RECONCILIATION TO ISRAELI GAAP (cont.)

	Tax benefit in respect of options exercised

	According to Israeli GAAP, tax benefits from employee options exercised are recorded as a reduction of tax expense. According to U.S. GAAP, the difference between the above mentioned tax benefits and the benefits recorded in respect of compensation expense in the financial statements are credited to additional paid-in capital.

	Goodwill

	Effective January 1, 2002, the Company adopted SFAS 142, “Goodwill and Other Intangible Assets” according to which goodwill and intangible assets with indefinite lives are no longer amortized periodically but are reviewed annually for impairment (or more frequently if impairment indicators arise). According to Israeli GAAP, all intangibles, including goodwill should be amortized.

	Investment in marketable securities – Tadiran

	Pursuant to SFAS 115, marketable securities which are available-for-sale are presented on the basis of their market value and changes in such value are charged (or credited) to other comprehensive income. According to Israeli GAAP non-current investments in marketable securities are presented at cost

1.	Effect on net income and earnings per share


	Year ended December 31,

	2004			2003		2002

Net income as reported according to U.S. GAAP	$	52,993		$	45,945	$	45,113
Adjustments to Israeli GAAP		(458	)		595		(4,227	)

Net income according to Israeli GAAP	$	52,535		$	46,540	$	40,886


2.	Effect on shareholders’ equity


	As reported		Adjustments			As per Israeli GAAP

As of December 31, 2004
Shareholders’ equity	$	434,700	$	(13,124	)	$	421,576


As of December 31, 2003
Shareholders’ equity	$	432,079	$	(10,367	)	$	421,712

# # # # # # # #

ERNST & YOUNG

Kost Forer Gabbay & Kasierer

Phone: 972-3-6232525

21 Aminadav St.

Fax: 972-3-5622555

Tel-Aviv 67067, Israel