20-F

20-F 1 zk62578.htm 20-F

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. 000-27974

CIMATRON LTD.

(Exact name of Registrant as specified in its charter and translation of Registrant’s name into English)

Israel

(Jurisdiction of incorporation or organization)

11 Gush Etzion St., Givat Shmuel 54030, Israel

(Address of principal executive offices)

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

None

Securities registered or to be registered pursuant to Section 12(g) of the Act:
Ordinary Shares, nominal value 0.10 New Israeli Shekel per share

(Title of Class)

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

None

(Title of Class)

Indicate the number of outstanding shares of each of the issuer’s classes of capital or
common stock as of the close of the period covered by the annual report:

8,001,270 Ordinary Shares

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


	o	Yes
	x	No

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


	o	Yes
	o	No

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


	o	Yes
	x	No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.


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

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)


	o	Yes
	x	No

We have prepared our consolidated financial statements in United States dollars and in accordance with accounting principles generally accepted in the United States. All references herein to “dollars” or “$” are to United States dollars, and all references to “Shekels” or “NIS” are to New Israeli Shekels.

*********


PART I

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
Not applicable		4

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not applicable		4

ITEM 3. KEY INFORMATION		4

ITEM 4. INFORMATION ON THE COMPANY		7
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS		28

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES		43

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS		53

ITEM 8. FINANCIAL INFORMATION		55

ITEM 9. THE OFFER AND LISTING		56

ITEM 10. ADDITIONAL INFORMATION		57

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		69
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES		71

PART II

ITEM 13. DEFAULTS, DIVIDEND AVERAGES AND DELINQUENCIES		71
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS		71
ITEM 15. CONTROLS AND PROCEDURES		71
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT		72
ITEM 16B. CODE OF ETHICS		72
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES		72
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES		73
ITEM 16E. REPURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS		73

PART III

ITEM 17. FINANCIAL STATEMENTS
Not applicable		73
ITEM 18. FINANCIAL STATEMENTS		73
ITEM 19. EXHIBITS		74

SIGNATURES		75

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

Selected Financial Data

The following selected financial statement of income data for the years ended December 31, 2003, 2004 and 2005, and the balance sheet data as of December 31, 2003, 2004 and 2005 are derived from the financial statements set forth elsewhere in this Report. The selected financial statements of income data for the years ended December 31, 2001 and 2002 and the selected balance sheet data as of December 31, 2001, and 2002, are derived from other audited financial statements not included in this report. The audited financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. The financial statements for the year ended December 31, 2001 were audited by BDO, Ziv & Haft, independent auditors, and the financial statements for the years ended December 31, 2002, 2003, 2004 and 2005 were audited by Brightman Almagor & Co., a member of Deloitte Touche Tohmatsu, independent auditors. All of the financial data set forth below should be read in conjunction with “Item 5 - Operating and Financial Review and Prospects” and the audited financial statements and notes thereto (together, the “Financial Statements”) and other financial information included elsewhere in this annual report.


	December 31,
	2001			2002			2003			2004			2005
	(In thousands of US$, except per share data)
Statement of Income Data:
Revenue:

Products		12,371			11,150			10,448			11,370			8,968
Services		10,583			10,478			11,161			11,793			11,957

Total		22,954			21,628			21,609			23,163			20,925

Cost of revenue:
Products		4,920			3,234			3,056			2,923			3,367
Services		2,394			1,783			1,562			1,678			1,568

Total		7,314			5,017			4,618			4,601			4,935

Gross profit		15,640			16,611			16,991			18,562			15,990
Research and development costs, net		7,626			5,562			5,210			5,554			4,815
Restructuring costs		250			(250	)		-			-			-
Selling, general and administrative expenses		12,711			11,670			12,645			13,962			15,650

Operating loss		(4,947	)		(371	)		(864	)		(954	)		(4,475	)
Financial income (expenses), net		(467	)		428			369			445			(148	)
Other income (expenses)		(81	)		1			203			144			1

Income (loss) before taxes		(5,495	)		58			(292	)		(365	)		(4,622	)
Taxes on income		(163	)		(48	)		(9	)		(23	)		(2	)

Loss after income taxes		(5,658	)		10			(301	)		(388	)		(4,624	)
Company’s equity in results of affiliated company		-			-			-			-			(5	)
Minority interest in results of subsidiary		-			-			-			-			36

Net income (loss)		(5,658	)		10			(301	)		(388	)		(4,593	)

Net income (loss) per share		(0.71	)		*			(0.04	)		(0.05	)		(0.59	)
Weighted average number of shares outstanding		8,001			7,981			7,838			7,835			7,835

* Less than $ 0.01


	December 31,
	2001		2002		2003		2004		2005
	(In thousands of US$)
Balance Sheet Data
Cash and cash equivalents		4,534		4,077		3,124		1,711		2,708
Short-term investments		4,440		4,017		6,358		6,381		2,167

Total cash, cash equivalents and short-term investments		8,974		8,094		9,482		8,092		4,875
Working capital		10,840		10,861		10,639		10,306		4,328
Total assets		22,855		21,371		22,386		20,804		16,442
Total liabilities		8,313		7,212		8,826		7,956		8,456
Shareholders’ equity		14,542		14,159		13,521		12,848		7,982

Risk Factors

This annual report and statements that we may make from time to time may contain forward-looking information. There can be no assurance that actual results will not differ materially from our expectations, statements or projections. Factors that could cause actual results to differ from our expectations, statement or projections include the risks and uncertainties relating to our business described below.

Risks Related to our Business

We face intensive competition in our industry.

The CAD/CAM software industry, characterized by rapid advances in technology and changing customer requirements, is highly competitive. We design, develop, manufacture, market and support a family of modular, high performance, fully integrated, computer-aided design/computer aided manufacturing, or CAD/CAM, software products. Traditionally, our competitors in the CAD/CAM market are at both the high and low end of the market. The lower end of the market consists of dedicated Numerical Control, or NC, programming systems offerings, which have limited or no modeling capability, while the high end of the market, including our Cimatron E and its predecessor, the Cimatron IT, consists of integrated CAD/CAM systems. Many high-end market products are roughly similar to our Cimatron E and IT products.

As the CAD/CAM software industry is highly fragmented and characterized by many relatively small and privately owned companies, we face competition from numerous companies in relation to all of our products. In addition, some of our competitors are more established, benefit from greater market recognition and have greater financial, production and marketing resources than us. We believe that, due to the large number of companies that operate in this market, we do not have a single major competitor or a group of competitors. The principal factors permitting our products to compete successfully against our competitors’ products are:


—	the compatibility of our products with other software applications and existing and emerging industry standards;

—	our ongoing product and feature development;

—	the offering of unique innovative products to the tooling industry;

—	the level of our product breadth and integration;

—	our hardware platform support;

—	the technical expertise and support that we provide;

—	the flexibility of our products;

—	the reputation we maintain among certain independent distributors of our products, to which we refer as Providers; and

—	the relatively low overall price and total cost of ownership of our products combined with the high-end capabilities of our products.

Although we believe that the attributes of our products provide us with a competitive advantage over our competitors, there can be no assurance that the marketplace will consider Cimatron E and its predecessor product, the Cimatron IT, to be superior to existing competing products. In addition, new competitors may arise in each of the markets in which we currently operate. Furthermore, as we enter new geographic markets, we may encounter significant competition from companies that are more established in such markets. Accordingly, there can be no assurance that our existing or future products will successfully compete against our competitors’ products.

We are heavily reliant on the sale of one family of products.

Sales and services related to the Cimatron E product family, including its predecessor, the Cimatron IT, have historically accounted for substantially all of our revenue. If sales of the Cimatron E family were to decline, or fail to continue to grow, or the profit margin on these products were to decrease significantly, our business, financial condition and results of operations would be materially and adversely affected.

Our business depends significantly upon sales by our customers of products in the consumer market. This market is extremely competitive and is highly susceptible to fluctuations in demand.

Our products are designed for use by manufacturers of consumer products or consumer product components. The consumer products market is intensely competitive and price sensitive. Sales of consumer products have historically been dependent upon discretionary spending by consumers. Consumers may defer or alter purchasing decisions based on economic conditions or other factors, and accordingly could reduce demand for products of our customers which are manufactures using our products. Softening consumer demand for consumer products has in the past caused a decline in the demand for our products. As a result of any softening demand for consumer products, there is uncertainty with respect to our expected revenues, and delays or reductions in consumer spending could adversely affect our revenues and operating results.

Two of our shareholders beneficially own a substantial amount of our ordinary shares and may therefore influence our affairs.

In February 2002, two private holding companies, Koonras Technologies Ltd., or Koonras, a subsidiary of Polar Communications Ltd., and DBSI Investments Ltd. or DBSI, consummated a transaction with Zeevi Computers and Technology Ltd., or ZCT, by which they acquired, for approximately $9,900,000, all of our Ordinary Shares previously held by ZCT, representing 64.3% of our share capital (including in this calculation 166,100 of our ordinary shares which we have repurchased and which, pursuant to Israeli law, cannot be voted and possess no rights other than upon liquidation). Following this transaction, each of Koonras and DBSI beneficially owns approximately 33% of our ordinary shares. Koonras and DBSI together are expected to continue to effectively have the ability to control the outcome of most matters submitted to a vote of our shareholders, including the election of members of our board of directors and approval of significant corporate transactions. Koonras and DBSI have entered into an agreement by which, among other matters, they will each appoint one half of our directors, not including our external directors, and vote together at our shareholders’ meetings. The concentration of ownership of our Ordinary Shares by Koonras and DBSI could delay or prevent proxy contests, mergers, tender offers, open-market purchase programs or other purchases of our Ordinary Shares that might otherwise give you the opportunity to realize a premium over the then-prevailing market price of our Ordinary Shares. This concentration of ownership may also adversely affect our share price.

We are subject to several risks as a result of our international sales.

To date, our products have been sold primarily in Europe, the Far East, North America and Israel. We expect that international sales will continue to represent a substantial portion of our business. Companies that engage in international sales are subject to a number of risks, such as:


—	agreements may be difficult to enforce through a foreign company’s legal system;

—	foreign countries could impose additional withholding or other taxes on our income;

—	foreign countries could impose tariffs or adopt other restrictions on foreign trade;

—	fluctuations in exchange rates;

—	changes in general economic conditions in one or more countries could affect product demand;


—	the protection of intellectual property rights in foreign countries may be limited or more difficult to enforce; and

—	difficulties in managing overseas subsidiaries and international operations, including difficulty in retaining or replacing local management.

There can be no assurance that these and similar factors will not have a material adverse effect on our future international sales and, consequently, on our business, future prospects and results of operations.

Many customers of the CAD/CAM industry have migrated their operations to the Far East. In order to remain competitive in the industry, we need to penetrate the Far East markets; operation in these markets subjects us to specific risks.

Many mold, tool, die and fixture makers have migrated or intend to migrate their operations to markets in the Far East, such as China, in order to take advantage of the relatively lower cost of labor available in those markets for their manufacturing activities. We anticipate that this migration will continue. In order to continue to compete in the CAD/CAM software industry, we will need to increase our penetration of these markets. Many of those markets, including China, are characterized by lower prices and by higher usage of pirated copies of software products. While those markets are also often much larger than a number of our traditional markets in Europe, to the extent that we cannot offset the effects of lower prices and higher incidents of pirated software usage, our revenues and profitability may be materially adversely affected.

We are reliant upon independent distributors to market and support our products.

We rely on independent distributors, to whom we refer as Providers, to market, sell, service and support our products worldwide. Generally, our relationships with our Providers are based on agreements with two-year terms (subject to rolling two-year extensions) and which enable Providers to purchase our products at a discounted price. While we have exclusive relationships with certain of our Providers, there can be no assurance that these Providers will give high priority to the marketing and support of our products. In addition, our Providers in Italy and Japan each accounted for more than 5% of our revenues in 2005. In July 2005 we acquired 27.5% of the shares of the Italian Provider and an option to purchase its remaining outstanding shares from its shareholders and granted the Provider’s shareholders an option to require us to purchase 49% of the Provider’s share capital under specific circumstances. See “Item 5. Operating and Financial Review and Prospects – Overview” for additional details regarding the transaction with our Italian Provider and the options received both by us and the Provider’s shareholders. The results of our operations could be adversely affected by changes in the financial condition of a Provider, which could occur rapidly, or to other changes in our current Providers’ business or marketing strategies. There can be no assurance that we will retain our current Providers, nor can there be any assurance that, in the event that we lose any of our Providers, we will be successful in recruiting other highly professional and technically competent Providers to represent us. Any such changes in our distribution channels, especially those in the Far East and Europe, could materially adversely affect our business, operating results and financial condition. See “Item 4 - Information on the Company - Business Overview.”

We have a history of annual and quarterly losses and cannot assure you that we will return to profitability on an annual basis or remain profitable on a quarterly basis in the future.

We incurred net losses of approximately $0.3 million, $0.4 million and $4.6 million in 2003, 2004 and 2005, respectively. We also incurred net losses in each of our fiscal quarters in 2005. Although we had net income of $220,000 in the first quarter of 2006, we cannot be certain that we will return to profitability on an annual basis or maintain profitability on a quarterly basis or, if we do return to profitability on an annual basis, remain profitable in future years.

We may experience significant fluctuations in our quarterly results, which makes it difficult for investors to make reliable period-to-period comparisons and may contribute to volatility in the market price for our ordinary shares.

Our quarterly revenues, gross profits and results of operations have fluctuated significantly in the past and may be subject to continued fluctuation in the future. The following events may cause such fluctuations:


	—	changes in timing of orders, especially large orders, for our products and services;

	—	changes in the prices for our products and services;

	—	adverse economic conditions and international exchange rate and currency fluctuations;

	—	delays in the implementation of our solutions by customers;

	—	changes in the proportion of service and license revenues;

	—	timing of product releases;

	—	changes in the economic conditions of the various industries in which our customers operate;

	—	price and product competition;

	—	increases in selling and marketing expenses, as well as other operating expenses;

	—	technological changes; and

	—	political instability in the Middle East.

A substantial portion of our expenses, including most product development, selling and marketing expenses, must be incurred in advance of when revenue is generated. If our projected revenue does not meet our expectations, we are likely to experience a shortfall in our operating profit relative to our expectations. As a result, we believe that period-to-period comparisons of our historical results of operations are not necessarily meaningful and that you should not rely on them as an indication for future performance. Also, our quarterly results of operations have, on separate occasions, been below the expectations of public market analysts and investors and the price of our ordinary shares subsequently decreased. If that would happen in the future, the price of our ordinary shares will likely decrease again.

Because of our international operations, changes in exchange rates against the U.S. dollar could have a significant effect on our results of operations. In addition, local economic conditions or currency fluctuations could cause customers to decrease or cancel orders or default on payment.

Although part of our revenues are denominated and paid in U.S. dollars, the majority are not so denominated and paid. Therefore we believe that inflation and fluctuations in the U.S. dollar exchange rate may have a material effect on our revenue. In addition, a significant portion of our international sales is denominated in Euros, and in the future additional sales may be denominated in currencies other than U.S. dollars, thereby exposing us to gains and losses on non-U.S. currency transactions. We may choose to limit this exposure by entering into hedging transactions. However, hedging transactions may not prevent exchange-related losses, and our business may be harmed by exchange rate fluctuations. Furthermore, as we seek to expand our sales to regions throughout the world, we might be exposed to risks of customers located in countries suffering from uncertain economic environments such as high inflation and solvency problems. Those issues and devaluation in local currencies of our customers relative to the U.S. dollar where our sales are denominated in U.S. dollars could cause customers to decrease or cancel orders or default on payment.

During 2005, we continued to experience decreases in our revenues from products. If this trend continues, it will likely adversely affect our gross margins and profitability.

Our revenues from the sale of products decreased to approximately $9.0 million in 2005 from approximately $11.4 million in 2004 and approximately $10.5 million in 2003. While our revenues from services increased in 2005 to approximately $12.0 million from approximately $11.8 million in 2004 and approximately $11.2 million in 2003, our gross margin from products is higher than our gross margin from services. This is because our cost of services, which includes expenses of salaries and related benefits of the employees engaged in providing the services, is relatively higher than our cost of products. If the trend of increases in the percentage of our overall revenues comprised by service revenue continues, our gross margins and profitability will likely be adversely affected. In addition, if our revenues from the sale of products continue to decrease, such decrease may adversely effect our future service revenues, as it may result in a smaller user base to purchase service contracts from us.

If we are unable to accurately predict and respond to market developments or demands, or if our products are not accepted in the marketplace, our business will be adversely affected.

It is difficult to predict demand and CAD/CAM market acceptance for our solutions and products. We cannot guarantee that the market for our solutions and products will grow or that they will become widely accepted. If the market for our solutions and products does not develop as quickly as we expect, our future revenues and profitability will be adversely affected. Changes in technologies, industry standards, client requirements and new product introductions by existing or future competitors could render our existing offerings obsolete and unmarketable, or require us to develop new products. If our solutions and products do not achieve or maintain market acceptance or if our competitors release new products that achieve quicker market acceptance, have more advanced features, offer better performance or are more price competitive, our revenues may not grow and may even decline. In addition, if a product we develop and introduce does not achieve market acceptance, we may not be able to recover the costs associated with developing the product, which would have a negative effect on our profitability.

If we are unable to attract, train and retain qualified personnel, we may not be able to achieve our objectives and our business could be harmed.

Our future success depends on our ability to absorb and retain senior employees and to attract, motivate and retain highly qualified professional employees. Competition for these employees can be intense, especially in a number of our key markets and locations, including Israel and Europe. The process of locating, training and successfully integrating qualified personnel into our operations can be lengthy and expensive. The market for the qualified personnel we require is very competitive because of the limited number of people available with the necessary technical and sales skills and understanding of our products and technology. This is particularly true in Israel where competition for qualified personnel is intense. We may not be able to compete effectively for the personnel we need. Any loss of members of senior management or key technical personnel, or any failure to attract or retain highly qualified employees as needed, could materially adversely affect our ability to achieve our research and development and sales objectives.

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

We have entered into non-competition agreements with most of our employees in Israel and we intend to enter into non-competition with the rest of our employees. These agreements prohibit our employees, during the term of their employment with us and after they cease working for us, from competing directly with us or working for our competitors for a limited period. Under current Israeli law, we may be unable to enforce these agreements and it may be difficult for us to restrict our competitors from gaining the expertise our former employees gained while working for us. For example, Israeli courts have recently required employers seeking to enforce non-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 we cannot demonstrate that harm would be caused to us, we may be unable to prevent our competitors from benefiting from the expertise of our former employees.

Any future acquisitions of companies or technologies may distract our management and disrupt our business. In addition, the issuance by us of securities as consideration payable in such acquisitions could be dilutive to our existing shareholders.

One of our strategies is to acquire or make investments in complementary businesses, technologies, services or products if appropriate opportunities arise. For instance, in July 2005 we acquired 27.5% of the shares of our Italian distributor and an option to purchase the remaining outstanding shares of that company from its stockholders, and granted the distributor’s shareholders an option to require us to purchase 49% of the distributor’s share capital under specific circumstances. See “Item 5. Operating and Financial Review and Prospects – Overview” for additional details regarding the transaction with our Italian distributor and the options received both by us and the distributor’s shareholders. We may in the future engage in discussions and negotiations with companies about our acquiring or investing in those companies’ businesses, products, services or technologies. We cannot give assurances that we will be able to identify future suitable acquisition or investment candidates, or, if we do identify suitable candidates, that we will be able to make the acquisitions or investments on commercially acceptable terms or at all. If we acquire or invest in another company, we could have difficulty assimilating that company’s personnel, operations, technology or products and service offerings into our own. The key personnel of the acquired company may decide not to work for us. These difficulties could disrupt our ongoing business, distract our management and employees, increase our expenses and adversely affect our results of operations. In addition, we may incur indebtedness or dilute our existing shareholders by issuing equity securities to pay for any future acquisitions.

We are affected by volatility in the securities markets.

Securities markets have in recent years experienced volatility that has particularly affected the securities of many high-technology companies. This volatility has often been unrelated to the operating performance of these companies, including Cimatron. As a result, we may experience difficulties in securing the additional financing required to effectively operate and grow our business due to the volatility in the price of our shares, resulting in a material adverse affect on our business and results of operations.

Risks Related to Licenses and Intellectual Property

We rely, to a certain extent, on third parties’ software. If we lose the ability to continue to license that software, our business could be materially adversely affected.

To date, most of the software relating to the Cimatron E and Cimatron IT family of products has been developed internally by our research and development staff. However, to accelerate our product development and improve our time to market, we also review opportunities to acquire or license products or technologies from third parties. Mainly, we utilize software tools and engines that we acquire from Spatial Corp., a subsidiary of Dassault Systems, and D-Cubed, for the representation and processing of three dimensional objects and surfaces in order to expedite the continued development of our new Cimatron E product family. In addition, we use software from ModuleWorks GmbH, a German company, for advanced 5-Axis NC calculations. We rely, to a certain extent, upon such third parties’ abilities to enhance their current products and develop new products on a timely and cost-effective basis that will meet changing customer requirements and emerging industry standards or other technological changes. Our business would be disrupted if functional versions of the third party software we rely on were either no longer available to us or no longer offered to us on commercially reasonable terms and we may, as a result, suffer a material adverse effect on our business and operations.

We may not be successful in protecting our intellectual proprietary technology and this could result in the loss of revenue.

We primarily rely on a combination of trade secret, copyright and trademark laws, together with non-disclosure agreements and trademark measures (such as software protection “locks”), to establish and protect proprietary rights in our products. The measures afford only limited protection and, accordingly, there can be no assurance that the steps that we take to protect these proprietary rights will be adequate to provide misappropriation of the technology or independent development of similar technology by others. This is particularly a problem in foreign countries where the laws may not protect our proprietary rights as fully as the laws of the United States do. For instance, we have encountered significant piracy problems in certain jurisdictions, including in Brazil, Taiwan, Israel and China, where the main competition we face is from pirated copies of our products. These problems may increase as many of our customers and their competitors migrate their businesses to lower cost labor markets in the Far East. Despite our best efforts to protect proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary.

We may be subject to litigation to determine the scope of proprietary rights of others.

Significant and protracted litigation may be necessary to protect our intellectual property rights, to determine the scope of the proprietary rights of others or to defend against claims of infringement. We believe that our systems do not infringe upon any existing third-party proprietary rights, and to our knowledge there have been no claims of infringement by us of third-party proprietary rights to date; however, there can be no assurance that any such claims will not be asserted against us in the future. If infringement is alleged, we could be required to discontinue the use of certain software codes or processes, to cease the manufacture, use and sale of infringing products, to incur significant litigation damages, costs and expenses and to develop non-infringing technology or to obtain licenses to the alleged infringing technology. There can be no assurance that we would be able to develop alternative technologies or to obtain such licenses on terms commercially acceptable to us, if at all. See “Item 8 – Financial Information – Legal Proceedings” for information regarding certain proceedings in which we are currently involved.

Risks Related to our Operations in Israel

We may be adversely affected if the rate of inflation in Israel exceeds the rate of devaluation of the New Israeli Shekel against the U.S. dollar.

Our functional currency is the U.S. dollar while a portion of our expenses, principally salaries and the related personnel expenses, are in new Israeli shekels, or NIS. As a result, we are exposed to the risk that the rate of inflation in Israel will exceed the rate of devaluation of the NIS in relation to the U.S. dollar or that the timing of this devaluation lags behind inflation in Israel. This would have the effect of increasing the U.S. dollar cost of our operations. We cannot predict any future trends in the rate of inflation/ deflation in Israel or the rate of devaluation of the NIS against the U.S. dollar. If the U.S. dollar cost of our operations in Israel increases, our U.S. dollar-measured results of operations will be adversely affected.

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

Our principal executive offices and research and development facilities are located in Israel. In addition, a portion of our sales is made to customers in Israel. Accordingly, security, political and economic conditions in Israel may directly affect our business. Over the past several decades, a number of armed conflicts have occurred between Israel and its Arab neighbors. Any hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could affect adversely our operations. From October 2000 until recently, terrorist violence in Israel increased significantly and negotiations between Israel and Palestinian representatives effectively ceased. In February 2006, Hamas, a radical Islamic organization, won the Palestinian Parliament elections. There can be no assurance that the recent relative calm will continue. Increased hostilities, future armed conflicts, political developments in other states in the region, or continued or increased terrorism could make it more difficult for us to conduct our operations in Israel, which could increase our costs and adversely affect our financial results. Furthermore, several countries still restrict business with Israel and Israeli companies. These restrictive laws and policies may limit our ability to sell our products in those countries.

Our operations may be disrupted by the obligation of our personnel to perform military service.

Many of our officers and employees in Israel are obligated to perform annual military reserve duty and may be called to active duty under emergency circumstances. At various times over the last five years, there have been significant call-ups of military reservists, and it is possible that there will be additional call-ups in the future. While we 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. Our operations could be disrupted by the absence for a significant period of one or more of our executive officers or key employees or a significant number of our other employees due to military service. Any disruption in our operations would harm our business.

The government programs and tax benefits that we currently receive require us to meet several conditions and may be terminated or reduced in the future, which would increase our costs and taxes.

We benefit from certain government programs and tax benefits, particularly as a result of tax exemptions and reductions resulting from the approved enterprise status of our manufacturing facilities in Israel. To be eligible for these programs and tax benefits, we must continue to meet conditions, including making specified investments in property and equipment and financing a percentage of investments with share capital. If we fail to meet such conditions in the future, the tax benefits would be canceled and we could be required to refund the tax benefits already received, together with an adjustment based on the Israeli consumer price index and an interest factor. These programs and tax benefits may not be continued in the future at their current levels or at any level. The Israeli government has reduced the benefits available under some of these programs in recent years, and Israeli governmental authorities have indicated that the government may further reduce or eliminate some of these benefits in the future. The termination or reduction of existing programs and tax benefits could increase our expenses, thereby reducing our profits or increasing our losses. In addition, the law and regulations prescribing the benefits provide an expiration date for the grant of new benefits. The expiration date has been extended several times in the past. The expiration date currently in effect is December 31, 2007, and no new benefits will be granted after that date unless the expiration date is extended again. There can be no assurance that new benefits will be available after December 31, 2007, or that existing benefits will be continued in the future at their current levels or at any level.

In connection with research and development grants received from the Office of the Chief Scientist of Israel, or the OCS, we must pay royalties to the OCS on the revenue derived from the sale of products, technologies and services developed with the grant from the OCS. The terms of the OCS grants and the law pursuant to which grants are made may impair our ability to manufacture products or transfer technologies developed using OCS grants outside of Israel. The transfer to a non-Israeli entity of technology developed with OCS funding, including pursuant to a merger or similar transaction, and the transfer of rights related to the manufacture of more than ten percent of a product developed with OCS funding are subject to approval by an OCS committee and to various conditions, including payment by us to the OCS of a percentage of the consideration paid to us or our shareholders in the transaction in which the technology is transferred. In connection with a merger or similar transaction, the amount payable would be a fraction of the consideration equal to the relative amount invested by the OCS in the development of the relevant technology compared to the total investment in our company, net of financial assets that we have at the time of the transaction, but in no event less than the amount of the grant. In addition, in the event that the committee believes that the consideration to be paid in a transaction requiring payment to the OCS pursuant to the provisions of the law described above does not reflect the true value of the technology or the company being acquired, it may determine an alternate value to be used as the basis for calculating the requisite payments. These restrictions may impair our ability to enter into agreements for those products or technologies, without OCS approval. We cannot be certain that any approval of the OCS will be obtained on terms that are acceptable to us, or at all. Furthermore, in the event that we undertake a transaction involving the transfer to a non-Israeli entity of technology developed with OCS funding pursuant to a merger or similar transaction, the consideration available to our shareholders may be reduced by the amounts we are required to pay to the OCS.

In connection with our grant applications, we have made certain representations, including information provided in periodical performance reports, and we have committed to certain performance-based covenants. The funding from the OCS is subject to the accuracy of these representations and covenants and to our compliance with the conditions and restrictions imposed by the OCS. If we fail to comply with any of these conditions or restrictions, we could be required to repay any grants previously received, together with an adjustment based on the Israeli consumer price index and an interest factor in addition to certain other penalties. In addition, if we fail to comply with any of these conditions or restrictions, we would likely be ineligible to receive OCS grants in the future. The inability to receive these grants would result in an increase in our research and development expenses.

We may be required to pay royalties to the OCS in respect of sales since January 1, 2005.

We believe that the majority of products that we have sold since January 1, 2005 are not based on technology developed with funds provided by the OCS and that, accordingly, such sales should not be subject to the payment of royalties to the OCS. Therefore, the royalty reports we submitted to the OCS for the period starting January 1, 2005 and thereafter have reflected significantly reduced royalty obligations in comparison to our royalty reports for the years prior to 2005. In addition, during the second half of 2005 we initiated a process with the OCS in an attempt to obtain the agreement of the OCS with our position and to the cessation of our obligation to pay future royalties. Although we believe we have strong arguments to support our position, we have accrued royalty expenses in our financial reports for the periods from January 1^st, 2005 to March 31^st, 2006, but we have not paid any royalties associated with the products mentioned above to the OCS. In light of the above mentioned facts, we intend to consider our next steps with the OCS and whether further royalty expenses accruals will be necessary. A determination that we are in fact obligated to pay royalties in respect of sales after January 1, 2005, could negatively impact our liquidity and if that determination is made after we cease to accrue for any such royalties on our financial statements, such payments would negatively impact our earnings.

It may be difficult to effect service of process and enforce judgments against directors or officers in Israel.

We are incorporated in Israel. The majority of our executive officers and directors are located outside the United States, and a majority of our assets and the assets of these persons are located outside the United States. Therefore, a judgment obtained against us or any of them in the United States, including one based on the civil liability provisions of the U.S. federal securities laws, may not be collectible in the United States and may not be enforced by an Israeli court. Further, if a foreign judgment is enforced by an Israeli court, it generally will be payable in Israeli currency. It also may be difficult for you to assert U.S. securities law claims in original actions instituted in Israel since Israel is not the most appropriate forum in which to bring such a claim. In addition, even if an Israeli court agreed to hear such a claim, it may determine that Israeli law and not U.S. law is applicable to the claim. If U.S. law is found to be applicable, the content of applicable U.S. law must be proved as a fact, which can be a time-consuming and costly process. Certain matters of procedure will also be governed by Israeli law.


Item 4.	Information on the Company

History and development of the Company

We design, develop, manufacture, market and support a family of modular, high-performance, CAD/CAM software products. Our products provide an integrated design through manufacturing solution for small-to-medium-sized companies and manufacturing divisions of large corporations, and interface easily with other CAD/CAM systems. They offer high-end functionality, especially in the areas of design for manufacturing and manufacturing, at an attractive price/performance ratio. These attributes have made our CAD/CAM products especially popular in the design and manufacturing segments of the CAD/CAM market, particularly among mold, tool, die and fixture makers. We focus our research and development efforts on providing complete design through manufacturing solutions to the specific needs of this market segment. We are committed to providing mold, tool, die and fixture makers with comprehensive, cost-effective CAD/CAM solutions that streamline manufacturing cycles, enable collaboration with outside vendors and shorten delivery time.

In July 2005 we acquired 27.5% of the shares of Microsystem Srl, our Italian distributor, for 575,000 Euro. Under the agreement, we also received an option to acquire up to 100% of Microsystem from Microsystem’s shareholders and Microsystem’s shareholders received an option to require us to purchase 49% of Microsystem’s share capital under specific circumstances. See “Item 5. Operating and Financial Review and Prospects – Overview” for additional details regarding the transaction with Microsystem and the options received both by us and Microsystem’s shareholders. The transaction was designed to significantly enhance Microsystem’s financial position and balance sheet. Under the terms of the agreement, Microsystem’s marketing, sales, and support groups remained in their current offices throughout Italy. Enrico Gardini, Microsystem’s founder, President and CEO has joined our management team.

On June 30, 2005, Zvika Naggan resigned as our President and CEO. Our board of directors accepted his resignation and appointed the then Chief Operating Officer, Dan Haran, as our new President and CEO, effective July 1, 2005.

Our full name is Cimatron Ltd. and we were incorporated under Israeli law in 1982. Our corporate headquarters are located at 11 Gush Etzion Street, Givat Shmuel 54030, Israel. Our telephone number is 972-3-531-2121 and our web site is located at www.cimatron.com. Our U.S. agent is Cimatron Technologies, Inc., with an address at 26800 Meadowbrook Road, Suite 113, Novi, Michigan 48377

Industry Background

Manufacturers worldwide face ever-increasing pressures to produce high-quality and increasingly complex products in the shortest time possible and at minimum cost. To meet these demands and keep pace with market changes, production commitments and the need for product differentiation, companies are increasing their reliance on CAD/CAM software tools to automate the designing, drafting and manufacturing of their products.

The development process for the mechanical design and manufacturing of products generally includes the following steps:


	•	conceptual design of the product and its components;

	•	tool design and detailed design for manufacturing;

	•	creating the toolpath data in the form of numerical control, or NC, codes that provide the instructions for a machine to cut a part according to specifications received; and

	•	manufacturing the product.

The earliest users of CAD/CAM systems were dedicated design and engineering departments of large organizations that could afford the cost and complexity of “high-end” CAD/CAM systems. These systems were used by highly trained designers and engineers, who were responsible for a particular portion of the manufacturing process. The systems also generally operated on mainframe computers or high-end workstations which often required many months to master. To improve efficiency, large corporations that operate with high-cost, highly complex CAD/CAM systems have increasingly outsourced a portion of the design and manufacturing process to subcontractors.

This created a large market need for easier-to-use, less programming-intensive CAD/CAM solutions that operate on different hardware and operating systems and interface with a variety of software systems. In addition, as a result of continuing market pressure and technological changes, including personal computers offering improved price and performance, divisions of large companies also shifted towards CAD/CAM software providing more cost-effective solutions and shorter learning curves which could co-exist in the corporate design and manufacturing environment. However, while many of these systems were designed to provide advanced conceptual design capabilities, they were more limited in their detailed design for manufacturing and toolpath creation capabilities. As a result, they did not meet the needs of users involved in manufacturing the process, such as mold, tool, die and fixture makers.

At the other end of the market were low-cost, dedicated toolpath creation software products, which were limited in their design capabilities. These limitations caused the process of taking data regarding the conceptual design of the product and creating a detailed design for manufacturing to remain largely manual. As a result, subcontractors and manufacturing divisions of large corporations were hampered in their ability to take complex conceptual designs received from the design departments of the manufacturer and produce appropriate molds, tools, dies or fixtures in a timely manner. As a result, an increasing number of these subcontractors and manufacturing divisions have begun or are continuing to seek comprehensive design through manufacturing automation solutions to compete more effectively.

These trends have created a market for an integrated CAD/CAM system which is geared towards small-to medium-sized subcontractors or divisions of large corporations involved in the manufacturing process, particularly mold, tool, die and fixture makers. These users have a unique set of needs that have generally not been met by traditional CAD/CAM systems.

The CAD/CAM software industry that developed in response to these needs is highly fragmented and characterized by many relatively small and privately owned companies. We believe that, due to the large number of companies that operate in this market, we do not have a single major competitor or a group of competitors. The principal factors permitting our products to compete successfully against our competitors’ products are:


	—	the compatibility of our products with other software applications and existing and emerging industry standards;

	—	our ongoing product and feature development;

	—	the offering of unique innovative products to the tooling industry;

	—	the level of our product breadth and integration;

	—	our hardware platform support;

	—	the technical expertise and support that we provide;

	—	the flexibility of our products;

	—	the reputation we maintain among certain independent distributors of our products, to which we refer as Providers; and

	—	the relatively low overall price and total cost of ownership of our products combined with the high-end capabilities of our products.

Business Overview

Principal Operations, Products and Developments

Cimatron E

Cimatron E, our current generation of CAD/CAM solutions for the tooling and production industries, was initially released in September 2001. Since its release, it has achieved rapid market acceptance and to date we have successfully sold copies of the product worldwide. We released our newest version of the Cimatron E (Version 7.0) in August 2005. This product provides comprehensive tools, applications and process-automation solutions for the tooling industry. Cimatron E is designed with the tooling industry in mind, where all stages involved in the tooling process are supported by applications that perform at new levels of speed and flexibility. Version 7.0 introduces such breakthrough solutions as the NC Lite complete shop-floor solution, the first commercially available Micro Milling NC application, and advanced 5-axis milling. Additional CimatronE 7.0 features include enhancements of speed, quality and coverage through dedicated tools and functionality.

Cimatron E encompasses a set of powerful and easy-to-use 3D design tools. The unified solid-surface-wireframe environment allows the user to manipulate important data or create conceptual part designs with equal ease. In the design process, Cimatron E integrates tools to split part geometry, find and implement changes, create electrodes and inserts, and detail tooling components. During manufacturing, Cimatron E implements 2.5 to 5 axis toolpaths using high-speed machining, knowledge of stock remaining and templates to reduce programming and machine time. The mission critical tasks of splitting the model, applying engineering changes, and extracting electrodes and inserts are all handled by Cimatron’s “Quick Tooling” wizard-based applications.

Cimatron E communicates with most other CAD/CAM systems, runs on personal computers, as well as engineering workstations employing Windows based operating systems (which are the primary operating systems used for the personal computer and workstation platforms on which our products are used) and transfers data easily and reliably among different hardware and software environments.

Cimatron E is built around a set of compatible “modules” using a unified database, which can be accessed and modified for all applications. Users can move easily among wireframe, surface and solid models choosing the application most appropriate for a specific job. Cimatron E enables the user to work top-down (i.e., beginning at the conceptual level and moving down to subassemblies and individual parts) or bottom-up (i.e., modeling elements first and then grouping them into assemblies), and permits the user to combine the two approaches. Cimatron E stores product data hierarchically to ensure overall structural integrity of the product and the ability to interface with engineering data management systems. Cimatron E’s CAM applications operate directly on the design model to generate intelligent toolpaths for NC manufacturing processes and enable fast and accurate graphic simulation of NC operations. In addition, Cimatron E includes advanced data exchange interfaces, which enable the transfer of CAD/CAM data between ourselves and other CAD/CAM systems through industry standard interfaces, as well as several dedicated interfaces. Cimatron E offers an intuitive and consistent user interface throughout all applications (e.g., design, drafting and NC). Since all applications have the same look and feel, there is no need for the user to relearn the operation of the system with each module. Cimatron E’s architecture is based upon a software kernel, which includes database utilities, the graphic sub-system and the user interface, which provide the operating environment for all applications. Applications are separate from the software kernel, which facilitates enhancement of the applications, reduces development and maintenance costs and enables efficient technological updates to the system’s components, without affecting the application base.

The Cimatron E product family includes the following basic modules:

Designer Solution

Designer Solution is a CAD-only solution. It provides users with full 3D design and modeling capabilities, as well as fully associative 2D drawing and sketching functions. Designer Solution includes a hybrid 3D wireframe, surfaces and solid modeler, with full assembly support. Designer Solution includes SAT, STL, PFM and one DI optional module (DWG, DXF or VDA).

NC Solution

NC Solution is a manufacturing-only solution. This base solution offers comprehensive milling, drilling, simulation and verification capabilities up to 2.5 axes + 2X Positioning. NC Solution provides access to a wide range of CAD capabilities necessary to undertake any NC job. The system includes tool libraries and a post processor. NC Solution includes SAT, STL, PFM and one DI optional module (DWG, DXF or VDA).

Master Solution

Master Solution is a comprehensive CAD/CAM solution. It includes all features of the Designer Solution and the NC Solution integrated into an end-to-end system, providing the tools and capabilities users need for designing and manufacturing complex CAD/CAM projects. Master Solution includes SAT, STL, PFM and one DI optional module (DWG, DXF or VDA)

Electrode Solution

Electrode Solution includes all the tools necessary to create and design electrodes out of a given part model, including the industry leading QuickElectrode application. Electrode Solution comes complete with a choice of one DI optional module (IGES, STEP or VDA). The Electrode Solution is competitively priced in comparison with a similar general purpose configuration.

Electrode Pro Solution

Electrode Pro Solution includes the tools necessary to create, design and manufacture electrodes, including the industry leading QuickElectrde application and full 3X milling tools. Electrode Pro Solution comes complete with a choice of one DI module (IGES, STEP or VDA). The Electrode Pro Solution is competitively priced in comparison with a similar general purpose configuration.

Student Package

The Cimatron Student Package is a limited Cimatron package for students’ home use. The package covers most of Cimatron E’s capabilities, and enables execution of small non-commercial mold design projects. CAD modules include the following: Wire-frame, Surfacing and Solid part Modeling; Assembly; Drafting; Sketcher; Catalog Tools; QuickSplit; QuickCompare; QuickElectrode; and MoldDesign. CAM modules include 2.5X - 3X milling and 3X simulator. The system includes read-only Data Interface for IGES, VDA, STEP, DXF, and DWG. The package is protected via software mechanism and does not require a hardware protection plug.

View Only System

View Only System provides tools to view and check CAD/CAM projects. The system includes powerful 3D modeling and drafting capabilities, as well as key Cimatron modules, such as QuickSplit, QuickElectrode and viewing of 2.5X - 3X milling, including the 3X simulator. No “save” is possible with a View Only system. The system includes read-only translators to all leading standard formats: DXF, DWG, IGES, STEP, VDA, SAT, STL, and PFM.

In addition to these basic modules, we offer over 20 optional modules for a wide variety of additional applications that allow customers to purchase those components most helpful for their businesses and grant customers greater control over the rate of investment in our products.

Cimatron IT

Cimatron IT, which preceded Cimatron E, is a family of integrated software tools for mechanical engineering and manufacturing automation that is designed to provide a complete solution for the unique needs of the manufacturing segment of the CAD/CAM market, especially those of mold, tool, die and fixture makers. Cimatron IT contains design for manufacturing and NC programming capabilities, along with advanced conceptual design abilities. It is designed to enable users in this market segment to substantially reduce their time to market. Based on our data-to-steel philosophy, Cimatron IT provides advanced data interface, design for manufacturing and NC machining tools which enable users to translate complex part designs into finished molds, tools, dies and fixtures in a timely manner.

QuickConcept

QuickConcept is a preliminary design and review package that allows tool designers and their suppliers to hold virtual review meetings over the Internet in real-time. Multiple users can connect to each other to section, label, dimension and identify points of interest and problem areas of any given tool.

Marketing and Distribution

We employ a broad range of marketing activities to promote our products and develop name recognition and visibility. We use print and online advertising, trade shows, seminars, direct mail, online promotions, and regional marketing development in an effort to further penetrate the tooling segment of the CAD/CAM market. In addition to online promotions, we use the Internet as a marketing tool that increases our visibility in the marketplace, offers downloadable product demonstrations and facilitates communication between our clients and us.

Additionally, we have been increasing our penetration in the niche market of mold, tool, die and fixture makers, in an effort to become the lead supplier of CAD/CAM solutions to this segment of the manufacturing market. Our strategy involves examining the functionality of current and future products through in-depth focus-meetings with mold, tool, die and fixture makers, thereby making customers partners in the development of custom solutions for this niche market.

We distribute our products to end-users in approximately 28 countries in five continents through certain of our subsidiaries (in the United States, the United Kingdom, Canada, Germany, China, France and India), directly in Israel and through a network of 23 independent Providers. Between us, our subsidiaries and our Providers, our family of products is currently supported at over 8,500 customer sites with more than 17,000 installations.

Our sales operations are organized on a regional basis. In each region we appoint a vice president in charge of sales in such region. We believe that this will result in a more efficient sales structure.

Providers

We believe that our Providers are technically competent in the mechanical engineering and manufacturing aspects of CAD/CAM markets and offer a full range of sales, service and support functions. Providers assume overall responsibility for the integrity of each end-user customer’s CAD/CAM system in their respective territories, including selection, installation, training and maintenance. Providers are carefully selected on the basis of their ability to distribute and service our entire product line, with special emphasis on the ability of their engineering and sales teams to provide customer support.

We furnish our Providers with technical guidance and marketing and sales resources. Providers regularly visit our Israeli headquarters, while our employees from various departments visit Provider sites. Our relationship with our Providers is further enhanced by an annual international conference that we organize, regional workshops and cooperative exhibitions, and participation in local user meetings.

Providers serve as an integral part of our marketing and service network around the world. They give our products a local “feel” by (a) offering technical support in the end-user’s native language, (b) being available to attend to customer needs during local business hours, (c) translating our manuals, product and marketing literature into the local language and (d) frequently organizing user programs and seminars. Providers continually develop new ways to adapt and enhance our products to meet their respective customers’ regional and company-specific needs.

A typical agreement with a Provider is for a term of two years (subject to rolling two-year extensions). Our Providers are distributors and our agreements with them enable the Providers to purchase our products at a discounted price. Certain of our Providers act as our exclusive distributors in a single country or region. Other than our Providers in Italy and Japan, no Provider accounted for more than 5% of our total revenue for the year ended December 31, 2005. In July 2005 we acquired 27.5% of our Italian Provider and an option to purchase its remaining outstanding shares from its stockholders.

There can be no assurance that all existing relationships with our Providers will be renewed. We believe that with the exception of our Provider in Japan, the termination of our relationship with a single Provider would not harm us materially; however, the termination of our relationship with several of our Providers at approximately the same time or with our Provider in Japan could seriously harm us. There can be no assurance that, in the event that we lose any of our Providers, we will be successful in recruiting replacement professional and technically competent Providers.

Subsidiaries

Our strategy over the years has been to increase our direct involvement in certain key markets in which we felt the Providers were not maximizing the business opportunities, through the formation or acquisition of marketing and support subsidiaries. In furtherance of this strategy, we have incorporated subsidiaries in France, Japan, United Kingdom, China, as well as India, where we formed a subsidiary at the end of 2005 that started commercial activities during the second quarter of 2006. We have also acquired all of the outstanding voting interests in Cimatron Technologies, Inc., our North American Provider, and have had our German subsidiary, Cimatron GmbH, purchase all of the Cimatron-related business of our German Provider. In December 2002, we also entered into a joint venture in Korea with a third party in which we held 30% as of December 31, 2005. In January 2005 we announced the formation of Cimatron Guangzhou, a new joint venture in Guangzhou, China, with SGV, a distributor of our products since 1998.

Marketing Representatives

In 1998 we funded the formation and operations of a marketing office in India, which we turned into a subsidiary at the end of 2005, and in February 2001 we opened a marketing office in South Korea. This marketing office is currently inactive as its activities are now undertaken by our Korean JV. The purpose of these offices is to assist our local Providers in educating the market on our products.

Customers

Our end-users are typically small to medium-sized companies involved in the mechanical engineering and manufacturing industry, subcontractors that supply major corporations within the core mechanical engineering and manufacturing industry and departments or divisions within these major corporations. Our customers are located in approximately 28 countries worldwide.

In the years ended December 31, 2005, 2004 and 2003, approximately 42%, 57% and 56%, respectively, of our revenues were from Europe; approximately 5%, 8% and 10%, respectively, of our revenues were from Israel; approximately 34%, 19% and 20%, respectively, of our revenues were from the Far East; approximately 18%, 15% and 13%, respectively, of our revenues were from North America; and approximately 0.8%, 0.7% and 0.5%, respectively, of our revenues were from other countries.

Geographical Breakdown of Our Revenue

The following tables represent a geographical breakdown of our revenues from products and services from the last three years (in thousands of U.S. dollars):


2005

	Products			Services

Geographical Region	Amount	Percent		Amount	Percent

Europe	3,802	42.4	%	6,974	58.3	%
Israel	435	4.9	%	1,204	10.1	%
Far East	3,048	34.0	%	1,576	13.2	%
North America	1,607	17.9	%	2,108	17.6	%
Other	76	0.8	%	95	0.8	%
Total	8,968	100.0	%	11,957	100.0	%


2004

	Products			Services

Geographical Region	Amount	Percent		Amount	Percent

Europe	6,039	53.1	%	7,216	61.2	%
Israel	734	6.5	%	1,206	10.2	%
Far East	3,033	26.7	%	1,373	11.6	%
North America	1,498	13.1	%	1,911	16.2	%
Other	66	0.6	%	87	0.8	%
Total	11,370	100	%	11,793	100	%


2003
	Products			Services

Geographical Region	Amount	Percent		Amount	Percent

Europe	5,394	51.6	%	6,809	61.0	%
Israel	756	7.2	%	1,328	11.9	%
Far East	3,028	29.0	%	1,366	12.2	%
North America	1,240	11.9	%	1,568	14.0	%
Other	30	0.3	%	90	0.8	%
Total	10,448	100	%	11,161	100	%

Other than our Provider agreements and certain maintenance contracts with customers in Israel, we currently have no significant long-term contracts with any customer and sales are generally made pursuant to purchase orders received from distributors.

Potential Fluctuations in Operating Results; Seasonality

Potential Fluctuations in Operating Results

See “Item 3 - Risk Factors - We may experience significant fluctuations in our quarterly results, which makes it difficult for investors to make reliable period-to-period comparisons and may contribute to volatility in the market price for our ordinary shares” for a discussion of factors which may cause annual or quarterly fluctuations in the results of our operations.

Seasonality

We sell our products to corporations and our sales are therefore subject to the fiscal and budgeting cycles of these corporations. Accordingly, a large percentage of our sales occur in the fourth quarter, while sales in the first quarter are relatively slower.

Organizational Structure

Our principal shareholders, Koonras and DBSI, hold2,560,360and 2,573,350 shares, representing approximately 32.68% and 32.84% of our outstanding share capital, respectively. Koonras and DBSI have entered into an agreement by which a number of their shares equal to, or greater than, 25.05% of our issued and outstanding share capital cannot be sold by either party without first offering such holding to the other party. Additionally, under such agreement, in the event that the selling party’s offer is refused, the other party shall then have the right to participate, pro-rata, with the selling party in the sale of his shares to a third party. Additionally, Koonras and DBSI have agreed that they will each appoint half of our directors, not including our external directors required to be appointed under Israeli law and independent directors required to be appointed under the Nasdaq’s listing qualifications, and that they will vote together at our shareholders meetings.

For information about Cimatron’s subsidiaries and its beneficial ownership therein, see Exhibit 8.1.

Property, Plants and Equipment

We do not own any real property. We lease the office premises that we occupy in Givat Shmuel, Israel from a private commercial property owner pursuant to the terms of a lease agreement we entered into in February 2003. Until January 2006 we occupied an aggregate of approximately 2100 square meters at this facility. As of January 10, 2006, we occupy approximately 1,750 square meters at this facility. In 2005, the aggregate annual lease payments for the office premises were approximately $224,000. The initial term of this lease ended on June 30, 2006 and we have exercised our option to extend the lease for an additional three years.

The following table represents a breakdown of our approximate aggregate annual lease payments for office premises worldwide for the year 2005 (in thousands of U.S. Dollars):


ENTITY	LOCATIONS	APPROXIMATE ANNUAL EXPENSE (in thousands of US$)

Headquarters in Israel	Givat Shmuel	224

North American subsidiary	Michigan and Illinois (U.S.)*	78

German subsidiary	Ettlingen, Hamm, Nurenberg, Koln and Ismaning	198

French subsidiary	Oyonnax (Since February 2005 - Lyons)	20

UK subsidiary	Huddersfield	21

Japanese subsidiary	Tokyo	29

Chinese subsidiaries	Beijing Wuxi Chengdu Shanghai Guangzhou Fujian	57


	Total	627

* These offices are responsible for our marketing efforts in Canada as well.

** Offices for our newly formed Indian subsidiary were opened towards the end of 2005, and the annual lease payments for such office in 2006 is expected to be US$12.


Item 5.	Operating and Financial Review and Prospects

Overview

In July 2005 we acquired 27.5% of the shares of Microsystem Srl, our Italian distributor, for 575,000 Euro, and an option, which we refer to as the First Call Option, to acquire up to additional 23.5% of Microsystem from Microsystem’s shareholders. We may exercise this option until June 30, 2007. The exercise price for this option is an aggregate of approximately $600,000. In the event that we exercise the First Call Option in full, we would then also have a second option, which we refer to as the Second Call Option, to acquire up to the remaining 49% of Microsystem’s share capital, for an exercise price of approximately $1.25 million. The Second Call Option is exercisable at any time within a thirty day period, which we refer to as the Second Option Exercise Period, starting on the twelve month anniversary of our exercise of the First Call Option. In addition, in the event that we exercise the First Call Option, the then remaining other shareholders of Microsystem will have an option to require us to purchase, at any time during the Second Exercise Period, 49% of Microsystem’s share capital, for consideration of approximately $1.25 million. We have accounted for the transaction under the equity method and accordingly, as of July 1, 2005 we record our share of Microsystems’s profits or losses in our consolidated financial statements.

Following the appointment of Dan Haran as President and CEO in July 2005, we entered into a cost reduction plan, in order to cut our costs in an attempt to achieve profitability, although, as part of such plan, we increased our sales and marketing expenses. As part of our plan, we terminated the employment of certain R&D and administrative employees and reorganized the activities of our office in Japan. In addition, towards the end of 2005, our European headquarters, which were located in Germany, were closed, and a VP Sales Europe was appointed in our headquarters in Israel. We incurred termination expenses relating to the changes in Germany of approximately $530,000.

We released our newest version of the Cimatron E (Version 7.0) in August 2005. Cimatron E7 was developed on the basis of advanced technology and infrastructure that replaced the infrastructure of the older versions, and includes new elements that did not exist in older versions.

During the fourth quarter of 2005, we evaluated our capitalized software costs and wrote off all the net balance of capitalized costs related to our older products in the amount of approximately $0.8 million.

Revenues

We derive revenues mainly from (a) sale of our products, including software and hardware components, and (b) services which include primarily maintenance fees and the provision of technical support for our software products and, to a lesser extent, fees from the provision of engineering, training, consulting and implementation services. Revenues from sales of our products are generated by a relatively large number of sales and no one customer accounts for a material portion of our revenues. We provide maintenance services pursuant to maintenance contracts, which either provide for annual maintenance fees or for the payment of maintenance fees upon the provision of upgrades to our products. Generally, maintenance contracts are for a one year term. It has been our experience that most of our customers who purchase maintenance contracts elect to receive maintenance services from us on a continuing basis. While customers in most markets do purchase maintenance services from us, our customers in the Far East (other than in Japan) generally do not purchase maintenance but instead purchase product upgrades on a case-by-case basis.

Cost of Revenues

Our cost of revenue consists of five major components: (a) the cost of our Israel-based operations, which include primarily salaries (mostly for technical support personnel), subcontractors and facilities costs, (b) hardware costs in Israel, Germany, France and the U.K., (c) royalties payable to third parties for third party software and maintenance, (d) royalties payable to the Israeli Office of the Chief Scientist and (e) amortization of capitalized software development costs.

Software Development Costs

Costs for the development of new software products and substantial enhancements to existing software products are expensed as incurred until technological feasibility has been established, at which time any additional development costs are capitalized. Based on our product development process, technological feasibility is established upon completion of a working model. Any capitalization of software development costs continues up to the time the software is available for general release to customers. However, during 2003 and 2004 costs incurred between the completion of the working model and the point at which the products were ready for general release have been insignificant. Therefore, all research and development costs incurred in 2003 and 2004 have been expensed. However, in 2005 we capitalized approximately $0.2 million in connection with the development of Cimatron E 7.0.

Primary and Reporting Currency

We market and sell our products and services in Europe, the Far East, North America and Israel and derive a significant portion of our revenues from customers in Europe and Asia. A majority of our revenues in 2003, 2004 and 2005 were from customers in Europe. Since our financial results are reported in U.S. dollars, decreases in the rate of exchange of non-U.S. dollar currencies in which we make sales relative to the U.S. dollar will decrease the U.S. dollar-based reported value of those sales. In 2001, the first quarter of 2002 and throughout 2005, decreases in Euro - U.S. dollar exchange rates adversely affected our results of operation. However, during the last three quarters of 2002, 2003 and the last quarter of 2004 our results of operations benefited from the increase in the Euro - U.S. dollar exchange rates during these periods. To the extent that decreases in exchange rates are not offset by a reduction in our costs, they may in the future materially adversely affect our results of operations.

Our reporting currency is the U.S. dollar while a portion of our expenses, principally salaries and the related personnel expenses, are in new Israeli shekels, or NIS. As a result, we are exposed to the risk that the rate of inflation in Israel will exceed the rate of devaluation of the NIS in relation to the U.S. dollar or that the timing of this devaluation lags behind inflation in Israel. This would have the effect of increasing the U.S. dollar cost of our operations. In 2001, 2002 and 2005, the rate of devaluation of the NIS against the U.S. dollar exceeded the rate of inflation. In 2003, there was on one hand a devaluation of the U.S. dollar against the NIS and on the other hand a deflation. In 2004 there was inflation coupled with a devaluation of the U.S. dollar against the NIS. If the U.S. dollar cost of our operations in Israel increases, our U.S. dollar-measured results of operations will be adversely affected.

See “- Liquidity and Capital Resources – Impact of Inflation and Devaluation on Results of Operation, Liabilities and Assets” for information relating to our policy of hedging against currency fluctuations.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which were prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate these estimates on an on-going basis. We base our estimates on our historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying amount values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe that application of the following critical accounting policies entails the most significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition

We recognize revenues in accordance with the American Institute of Certified Public Accountants Statement of Position 97-2, Software Revenue Recognition, as amended.

Revenues from software license fees are recognized when persuasive evidence of an arrangement exists, the software product covered by written agreement or a purchase order signed by the customer has been delivered, the license fees are fixed and determinable and collection of the license fees is considered probable. When software arrangements involve multiple elements we allocate revenue to each element based on the relative fair values of the elements. Our determination of fair value of each element in multiple element arrangements is based on vendor-specific objective evidence (“VSOE”). We limit our assessment of VSOE for each element to the price charged when the same element is sold separately.

In judging the probability of collection of software license fees we continuously monitor collection and payments from our customers and maintain a provision for estimated credit losses based upon our historical experience and any specific customer collection issues that we have identified. In connection with customers with whom we have no previous experience, we may utilize independent resources to evaluate the creditworthiness of those customers. For some customers, typically those with whom we have long-term relationships, we may grant extended payment terms. We perform on-going credit evaluations of our customers and adjust credit limits based upon payment history and the customer’s current creditworthiness, as determined by our review of their current credit information. If the financial situation of any of our customers were to deteriorate, resulting in an impairment of their ability to pay the indebtedness they incur with us, additional allowances may be required.

Our software products do not require significant customization or modification. Service revenues include consulting services, post-contract customer support and maintenance and training. Consulting revenues are generally recognized on a time and material basis. Software maintenance agreements provide technical customer support and the right to unspecified upgrades on an if-and-when-available basis. Post-contract customer support revenues are recognized ratably over the term of the support period (generally one year) and training and other service revenues are recognized as the related services are provided. Deferred revenues represent mainly amounts received on account of service agreements.

Our sales are made pursuant to standard purchase orders, containing payment terms averaging between 30 - 120 days. For some customers with whom we have longstanding relationships and based on past experience with those customers and the same software products, we may grant payment terms of not over 180 days. Any payment terms that exceed 180 days must be approved by our Chief Financial Officer prior to the signing of any purchase order.

Our arrangements do not include any refund provisions nor are payments subject to milestones. In addition, our arrangements do not contain customer acceptance provisions.

We have no significant expenditures relating to either warranties or post-contract customer support bundled with the initial sale of the software license and, therefore, other than a provision of approximately $60,000, no provision in respect of warranties or post-contract customer support is included in our financial statements.

Allowance for Doubtful Accounts

We evaluate the collectability of our accounts receivable based on a combination of factors. In circumstances where we are aware of a specific customer’s inability to meet its financial obligations to us (e.g. bankruptcy filings, substantial down-grading of credit ratings), we record a specific reserve for bad debts against amounts due to reduce the net recognized receivable to the amount we reasonably believe will be collected. For all other customers, we recognize reserves for bad debts based on the length of time the receivables are past due and on our historical experience in collecting such receivables.

Operating Results


	December 31,

	2003			2004			2005

	In thousands of US$ (except per share data)
Statement of Income Data:
Revenue:

Products		10,448			11,370			8,968
Services		11,161			11,793			11,957

Total		21,609			23,163			20,925

Cost of revenue:
Products		3,056			2,923			3,367
Services		1,562			1,678			1,568

Total		4,618			4,601			4,935

Gross profit		16,991			18,562			15,990

Research and development costs		5,210			5,554			4,815
Selling, general and administrative expenses		12,645			13,962			15,650

Operating loss		(864	)		(954	)		(4,475	)
Financial income (expenses), net		369			445			(148	)
Other income (expenses)		203			144			1

Income (loss) before taxes		(292	)		(365	)		(4,622	)
Taxes on income		(9	)		(23	)		(2	)

Loss after income taxes		(301	)		(388	)		(4,624	)
Company’s equity in results of affiliated company		-			-			(5	)
Minority interest in results of subsidiary		-			-			36

Net income (loss)		(301	)		(388	)		(4,593	)

Net income (loss) per share (basic and diluted)		(0.04	)		(0.05	)		(0.59	)

Weighted average number of shares outstanding		7,838			7,835			7,835


	December 31,

	2003		2004		2005

	In thousands of US$
Balance Sheet Data
Cash and cash equivalents		3,124		1,711		2,708
Short-term investments		6,358		6,381		2,167

Total cash, cash equivalents and short-term investments		9,482		8,092		4,875
Long term marketable investments		-		-		1,309
Working capital		10,639		10,306		4,328
Total assets		22,386		20,804		16,442
Total liabilities		8,865		7,956		8,456
Shareholders’ equity		13,521		12,848		7,982

Revenue

Our total revenues decreased to approximately $20.9 million in 2005 from approximately $23.1 million in 2004 and approximately $21.6 million in 2003. Our revenues from the sale of products decreased to approximately $9.0 million in 2005 from approximately $11.4 million in 2004 and approximately $10.4 million in 2003. The decrease in the sale of products in 2005 was mainly due to a decrease of 37.3% in sales in Europe. In addition, 5% of the decrease in sales revenues was due to the fall in the Euro - dollar exchange rate. As 51% of our 2005 revenues were derived from European countries, changes in the Euro - dollar exchange rate can significantly influence our revenues. Total revenues in 2005 were primarily influenced by mold, tool, die and fixture makers in Europe migrating their operations to low cost labor markets in the Far East, which markets are also characterized by lower prices and by higher usage of pirated copies of software products. While we believe that this trend may continue, we have adjusted our European strategy slightly in order to increasingly focus on penetrating the high end European market, in which such migration is less frequent. In addition, we have increased our sales efforts in China, in order to, among others things, attempt to set off the decreases in Europe. As a percentage of revenues, our revenues from the sale of products increased from approximately 48.4% in 2003 to approximately 49.1% in 2004 and decreased to approximately 42.9% in 2005. Our revenues from services increased in 2005 to approximately $12.0 million from approximately $11.8 million in 2004 and $11.2 million in 2003. The increase in service revenues in 2005 was due to an increase in service contract renewals, the increase in our installed base of Cimatron E users and efforts to restore old customers to maintenance, although such increases were slightly offset by the fall in the Euro - dollar exchange rate. As a percentage of revenues, our revenues from services decreased from approximately 51.6% in 2003 to approximately 50.9% in 2004 and increased to approximately 57.1% in 2005.

Although we had net income of $0.2 million in the first quarter of 2006, we cannot be certain that we will return to profitability on an annual basis or maintain profitability on a quarterly basis or, if we do return to profitability on an annual basis, remain profitable in future years. If the trend of increases in the percentage of our overall revenues comprised by service revenue continues, our gross margins and profitability will likely be adversely affected. In addition, if our revenues from the sale of products continue to decrease, such decrease may adversely effect our future service revenues, as it may result in a smaller user base to purchase service contracts from us. See “Item 3 – Risk Factors –During 2005, we continued to experience decreases in revenues from products. If this trend continues, it will likely adversely affect our gross margins and profitability”.

For a geographical breakdown of our revenue, please refer to “Item 4 – Information on the Company – Geographical Breakdown of our Revenue”.

Cost of Revenue

Cost of revenue increased in 2005 to $4.9 million, from approximately $4.6 million in both 2004 and 2003. The increase resulted from a write-off of capitalized software development expenses of $0.8 million, which was offset by a decrease in all other components of this item, in line with the decrease in product sales. Cost of revenues in 2004 included an increase in royalties to the OCS in the amount of $0.2 million, which offset a decrease in the amount of $0.2 million in salaries and employee benefits.

Gross Profit

Gross profit, as a percentage of total revenue, was 76.4%, 80.1% and 78.7% in 2005, 2004 and 2003, respectively.

Research and Development, Patents and Licenses, etc.

Research and development costs primarily consist of salaries and related costs of employees engaged in ongoing research, design and development activities. Research and development costs were $4.8 million in 2005, $5.6 million in 2004 and $5.2 million in 2003. The decrease in 2005 was due to the cost reduction measures implemented during the year. The increase in 2004 was due to increased investment of resources in the development of Cimatron E version 6.0, as well as to an increase in salary and termination payment expenses and to the operation of a development team in Russia. In addition, the devaluation of the US dollar against the NIS contributed 5% of the 2005 decrease and 24% of the 2004 increase.

Selling, General and Administrative Expenses

Selling expenses consist of costs relating to promotion, advertising, trade shows and exhibitions, compensation (including sales commissions), sales support, travel and travel-related expenses and royalties to the Fund for the Encouragement of Marketing of the Government of Israel, or the Marketing Fund, including all such expenses for our subsidiaries. We did not receive any grants from the Marketing Fund in the years 2003, 2004 or 2005 and do not expect to receive any such grants in the future. General and administrative expenses consist of (a) compensation costs for administration, finance and general management personnel, (b) office maintenance and administrative costs, (c) rent, (d) fees paid for management services to DBSI and Koonras and (e) reserves for doubtful debts.

Selling, general and administrative expenses increased by 12% from $14.0 million in 2004 to $15.6 million in 2005, which increase was due to (a) the implementation of a cost reduction plan, which resulted in increased selling expenses consisting of termination expenses relating to certain operations in Europe and (b) increased selling activities, especially in the U.S and China (including an increase in sales personnel in China). Of the increase in selling, general and administrative expenses, 3% was offset by the fall in the Euro - dollar exchange rate. In 2004, selling, general and administrative expenses increased by 10% from $12.6 million in 2003 to $14.0 million, which increase was due to (a) the relatively high Euro – U.S. dollar exchange rate throughout 2004, which resulted in increase selling expenses consisting of the salaries of the personnel of our European subsidiaries, (b) increased selling activities, especially in the U.S, and (c) organizational changes resulting in termination and severance payments.

Financial Income (Expenses), net

Financial income (expenses), net, consists primarily of interest earned on our cash reserves, gains (losses) from sale of bonds and funds, as well as interest on trade receivables and tax rebates and currency translation adjustments between the U.S. dollar exchange rate imposed on our assets and liabilities. Financial income (expenses), net, were $(0.1 million) in 2005, compared to $0.4 million in 2004 and $0.4 million in 2003, respectively. The increase in financial income (expenses), net, in 2005 was due primarily to the devaluation of the Euro in relation to the U.S. dollar. The increase in financial income in 2004 was due primarily to the revaluation of the Euro in relation to the U.S. dollar

Effective Corporate Tax Rate

We and each of our subsidiaries are subject to corporate taxes in various countries in which we and they operate. We are currently most significantly affected by corporate taxes in Israel where we received a final tax assessment through the tax year ended December 31, 2000. Generally, Israeli companies are subject to corporate tax at the rate of 34% on taxable income and are subject to capital gains tax at a rate of 25% on capital gains (other than gains derived from the sale of listed securities that are taxed at the prevailing corporate tax rates) derived after January 1, 2003. The corporate tax rate was reduced in June 2004, from 36% to 35% for the 2004 tax year, 34% for the 2005 tax year, 31% for the 2006 tax year, 29% for the 2007 tax year, 27% for the 2008 tax year, 26% for the 2009 tax year and 25% for the 2010 tax year. However, the effective tax rate payable by a company that derives income from an approved enterprise (as discussed below) may be considerably less. Our effective tax rate in Israel would have been approximately 34% for the year ended December 31, 2005, had we not incurred tax losses in Israel. We believe that our effective tax rates in the U.S., Germany, France, the U.K., China and Japan would have been approximately 35%, 40%, 33%, 19%, 33% and 31%, respectively, for the year ended December 31, 2005, had we not incurred tax losses in such countries. We believe that we had tax loss carryforwards in Israel in the aggregate amount of $5,894,000 as of the end of 2005. In addition, as of December 31, 2005, we had approximately $6.8 million in net operating loss carryforwards in North America, $1.7 million in Germany, $2.2 million in France and $0.4 million in the U.K. We expect that as our profits increase and our subsidiaries utilize their respective loss carryforwards, particularly in countries with relatively high corporate tax rates, our consolidated effective tax rate will increase.

We have been granted an “Approved Enterprise” status under the Israeli Law for the Encouragement of Capital Investments, 1959 continuously since 1994. The current status term will expire in the earlier of seven years after we begin to generate income subject to preferable taxation under the “Approved Enterprise” status and 2015. Consequently, we are eligible for certain Israeli tax benefits. Income derived from our Approved Enterprise plan is exempt from tax for a period of two years, commencing in the first year in which we generate taxable income from such Approved Enterprise, and is subject to a reduced tax rate of 25% for a further five years, respectively. See Note 13 of the notes to our consolidated financial statements included elsewhere in this annual report.

Liquidity and Capital Resources

We finance our operations primarily from funds provided by operations and, to a lesser extent, from accumulated cash and cash generated by the sale of our investments. We believe that our accumulated cash, in addition to cash generated from operations and available funds, will be sufficient to meet our cash requirements for working capital and capital expenditures for at least the next 12 months. Thereafter, if cash generated from operations is insufficient to satisfy our liquidity requirements, we may sell additional equity or debt securities or obtain credit facilities.

As of December 31, 2005, we had $6.2 million in cash and marketable investments. During 2005, net cash used in operating activities was $0.2 million. The major component using cash during 2005 was our net loss of $4.6 million from operations. Partially offsetting the use of cash was the non-cash depreciation and amortization of $1.7 million, a decrease in accounts receivable and prepaid expenses of $1.4 million and an increase in trade payables, accrued expenses and other liabilities of $0.9 million. In addition, we generated $3.0 million, which consisted of $2.9 million from proceeds from the maturity of bonds and mutual funds as well as approximately $0.1 million from the sale of property and equipment and the acquisition of a newly-consolidated subsidiary. Furthermore, we utilized a renewable loan in the amount of $$0.5 million from a Swiss bank, which is secured by a deposit in the amount of $$0.5 million. We classify this deposit under long term investments. The loan has a 6 month term and is renewable every 6 months provided that the deposit remains in place. So long as amounts under the loan are outstanding, we are not allowed to use the deposit. The loan is not subordinated to any other debt we have.

In addition to the cash provided by investing activities described above, we invested $0.3 million in bonds, $0.9 million in acquisition of affiliated companies, $0.4 million in the purchase of property and equipment and $0.2 million in capitalized software development costs, resulting in net cash provided by investing activities of $1.2 million.

These transactions caused our aggregate amount of cash and cash equivalents to be $2.7 million as of December 31, 2005 as compared to $1.7 million as of December 31, 2004, and our short-term and long-term marketable investments to be $3.5 million as of December 31, 2005, as compared to $6.4 million as at December 31, 2004.

As of December 31, 2005, our combined cash and cash equivalents and short-term and long-term marketable investments totaled $6.2 million, compared to $8.1 million as of December 31, 2004. This decrease was primarily the result of cash used in operations and for acquisition of affiliated companies. As of December 31, 2005, our working capital was $4.3 million and our total assets were $16.4 million, compared to $10.3 million and $20.8 million, respectively, as of December 31, 2004. The decrease in working capital resulted from a decrease in short-term investments and trade accounts receivable and an increase in other liabilities and accrued expenses, offset by an increase in cash and cash equivalents. The change in total assets resulted from a decrease in short-term investments, trade accounts receivable and other assets (due to an amortization and write-off of software development costs), offset by an increase in cash and cash equivalents.

Our trade receivables, net of allowance for doubtful accounts on December 31, 2005 totaled $4.5 million, compared to $6.1 million on December 31, 2004. The decrease was due to lower sales in 2005. The collection cycle remained unchanged during 2005 compared to 2004. We believe that, generally, the quality of receivables remained unchanged and we will continue our efforts to shorten the collection cycle.

Our capital expenditures for 2005 amounted to approximately $0.5 million and were mostly for the purchase of computers, computer equipment and other office equipment.

Concentration of credit risk. Financial instruments that potentially subject us to concentration of credit risk consist principally of cash and cash equivalents, short-term investments and accounts receivable. Our cash and cash equivalents, short-term investments and long-term investments are invested in deposits with major banks in the United States, Europe and Israel. We believe that the financial institutions holding our cash funds are financially sound, and that minimal credit risk exists with respect to our marketable securities, which consist of debt securities of the Government of Israel and highly rated corporate bonds. Our accounts receivable are generated from a large number of customers located in Europe, Asia, the United States and Israel. We perform ongoing evaluations of our accounts receivable and maintain an allowance for doubtful accounts that we believe is adequate to cover all anticipated losses with respect to our accounts

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

Although part of our revenues are denominated and paid in U.S. dollars, the majority are not so denominated and paid. Therefore we believe that inflation and fluctuations in the U.S. dollar exchange rate may have a material effect on our revenue. The cost of our Israel operations, as expressed in U.S. dollars, is influenced by the extent to which any increase in the rate of inflation in Israel is not offset (or is offset on a lagging basis) by a devaluation of the NIS in relation to the U.S. dollar.

The exchange rate between NIS and the U.S. dollar has fluctuated during the past six months (December 2005 – May 2006) from a low of NIS 4.428 to the dollar to a high of NIS 4.725 to the dollar. The high and low exchange rates between the NIS and U.S. dollar during the six most recent months, as published by the Bank of Israel, were as follows:

MONTH	LOW 1 U.S.Tdollar =	HIGH 1 U.S. dollar =




December 2005	4.579	4.662
January 2006	4.577	4.658
February 2006	4.664	4.725
March 2006	4.658	4.717
April 2006	4.503	4.671
May 2006	4.428	4.522

The average exchange rate, using the average of the exchange rates on the last day of each month during the period, for each of the five most recent fiscal years, was as follows:

Period	Exchange Rate




January 1, 2001 - December 31, 2001	4.219 NIS/$1
January 1, 2002 - December 31, 2002	4.738 NIS/$1
January 1, 2003 - December 31, 2003	4.548 NIS/$1
January 1, 2004 - December 31, 2004	4.478 NIS/$1
January 1, 2005 - December 31, 2005	4.503 NIS/$1

During 2001, the NIS was devalued against the dollar by 9.3%. As a result of the differential between the rate of inflation and the rate of devaluation of the NIS, we experienced increases and decreases in the costs of our Israel operations, as expressed in U.S. dollars, in 2001, but they did not materially affect our results of operations in such periods. In 2002 the rate of inflation was 6.5% and the rate of devaluation of the NIS against the dollar was 7.27%. In 2003, there was on the one hand a devaluation of the U.S. dollar against the NIS and on the other hand a deflation. In 2004 the rate of inflation was approximately 1.2% and the U.S. dollar was devaluated against the NIS by 1.6%. In 2005 the rate of inflation was approximately 2.4% and the U.S. dollar was devaluated against the NIS by 6.4%.

Since our financial results are reported in dollars, fluctuations in the rates of exchange between the dollar and non-dollar currencies may have a material effect on our results of operations. We therefore use currency exchange forward contracts and currency exchange options to hedge the impact of the variability in the exchange rates on future cash flows from certain Euro-denominated transactions, as well as certain NIS-denominated expenses. Our policy is to hedge 50% to 80% of our Euro denominated future cash flows to protect against a reduction in reported operating income arising from decreases in the Euro – U.S. dollar exchange rate and to hedge 60% to 80% of our NIS denominated expenses to protect against an increase in reported expenses arising from increases in the U.S. dollar – NIS exchange rate. However, we may decide not to hedge in accordance with this policy where, in our judgment, the applicable exchange rate is sufficiently low. The counter-parties to our forward contracts and currency exchange options are major financial institutions with high credit ratings. We believe the risk of incurring losses on such forward contracts and currency exchange options related to credit risks is remote and that any losses would be immaterial. As of December 31, 2005, we had currency exchange options to sell up to 1.26 million Euro for a total amount of $1.45 million, and had written currency exchange options to sell up to 0.84 million Euro for a total amount of $1.06 million that were scheduled to expire prior to June 30, 2006. On May 17, 2006 we exercised currency exchange options to sell 210,000 Euro for $264,000, and on June 19, 2006, we exercised currency exchange options to sell 210,000 Euro for $264,000. See “Item 11 - Quantitative and Qualitative Disclosure about Market Risk” for a description of hedging and other similar transactions.

Research and development, patents, licenses, etc.

We conduct our research and development operations primarily in Israel and to a small extent in Germany and Russia. Our research and development efforts have been financed through internal resources and through plans sponsored by the Chief Scientist of the Government of Israel, or the OCS. In the years ended December 31, 2003, 2004 and 2005 our gross research and development expenditures were $5.2 million, $5.5 million and $4.8 million, respectively (24%, 24%, and 23% of total revenues, respectively). Prior to 2001, we were granted royalty-bearing grants from the OCS for research and development activities. Under the provisions of Israeli law in effect until 1996, royalties of 2%-3% of the revenues derived from the sale of software products developed under a research and development program funded by the OCS and certain related services must be paid to the State of Israel. Pursuant to an amendment effected in 1996 effective with respect to OCS plans funded in or after 1994, royalties generally at the rate of 3% during the first three years, 4% over the following three years and 5% in or after the seventh year of the revenues derived in connection with products developed according to such plans are payable to the State of Israel. The maximum aggregate royalties will not exceed 100% (for funding prior to 1994, 100% to 150%) of the U.S. dollar-linked value of the total grants received. Pursuant to an amendment effected in 2000, effective with respect to OCS plans funded in or after 2000, the royalty rates described above were updated to 3% during the first three years and 3.5% in or after the fourth year, of the revenues derived in connection with products developed under such plans. Pursuant to an amendment effected on January 1, 1999, effective with respect to OCS plans approved in or after 1999, funds received from the OCS shall bear annual interest at a rate equal to LIBOR for twelve months. As of December 31, 2005, our contingent liability with respect to such grants was approximately $3 million, contingent upon us generating revenues from sales of products developed with funds provided by the OCS.

We believe that the majority of products that we have sold since January 1, 2005 are not based on technology developed with funds provided by the OCS and that, accordingly, such sales should not be subject to the payment of royalties to the OCS. Therefore, the royalty reports we submitted to the OCS for the period starting January 1, 2005 and thereafter have reflected significantly reduced royalty obligations in comparison to our royalty reports for the years prior to 2005. In addition, during the second half of 2005 we initiated a process with the OCS in an attempt to obtain the agreement of the OCS with our position and to the cessation of our obligation to pay future royalties. Following this application and further correspondence between the OCS and us, the OCS appointed an external professional examiner to examine our claim from a technological point of view. This examiner submitted his report to the OCS during November 2005. In December 2005, the OCS appointed a second professional examiner to submit a second opinion regarding our technological claim. During January 2006 our management met with the OCS in an attempt to, among other things, accelerate the OCS’s treatment of our application. However, to date, we have not received any response from the OCS.

Although we believe we have strong arguments to support our position, we have accrued royalty expenses in the amount of $0.8 million in our financial reports for the periods from January 1^st, 2005 to March 31^st, 2006, but we have not paid to the OCS any royalties associated with the products mentioned above. In light of the above mentioned facts, we intend to consider our next steps with the OCS and whether further royalty expense accruals will be necessary.

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

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


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

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

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

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

In the years ended December 31, 2003, 2004 and 2005, we paid or accrued royalties to the Chief Scientist in the amount of $0.7 million, $0.8 million and $0.7 million, respectively. We intend to consider whether further accruals will be necessary in light of the facts described above concerning our application to the OCS to recognize our claim that we are no longer obligated to pay royalties on sales subsequent to January 1, 2005.

In addition to the Chief Scientist grants, we received grants from the Fund for the Encouragement of Overseas Marketing of the Israeli Government’s Ministry of Industry and Trade, with respect to which we are obligated to pay royalties amounting to 3% to 4% of the incremental exports, up to a maximum of 100% of the grants received. Our contingent liability as of December 31, 2005 with respect to such grants was $0.6 million, contingent upon our incremental exports.

Trend Information

We are subject to various trends and uncertainties in the CAD/CAM business, including changing customer demands, new products developed by competitors, consolidation of operations and the use of cost-cutting measures. Following is a summary of the material trends and uncertainties influencing our operations:

Migration to Far East. Many mold, tool, die and fixture makers have migrated or intend to migrate their operations to markets in the Far East, such as China, in order to take advantage of the relatively lower cost of labor available in those markets for the manufacturing activities. We anticipate that this migration will continue and have expanded our operations in Asia, including in China, in order to increase our share of those growing markets. Many of those markets, including China, are characterized by lower prices and by higher usage of pirated copies of software products. While those markets are also often much larger than a number of our traditional markets in Europe, to the extent that we cannot offset the effects of lower prices and higher incidents of pirated software usage, our revenues and profitability may be adversely affected.

Maintenance Revenues. It has been our experience that most of our customers who purchase maintenance contracts elect to receive maintenance services from us on a continuing basis. While customers in most markets do purchase maintenance services from us, our customers in the Far East (other than in Japan) generally do not purchase maintenance but instead purchase product upgrades on a case-by-case basis. Accordingly, our maintenance revenues may be adversely impacted to the extent that our customer base shifts to those markets in the Far East where customers often do not purchase maintenance and there is no corresponding increase in customers in other markets.

Decrease in prices. The strong competition in the software business generally, and in the CAD/CAM business specifically, has caused prices of products in our industry to decrease. Such decrease in software prices has resulted in a decrease in our revenues and thus in our profits. As a result, we have been forced to employ cost-cutting measures. If the foregoing trend continues, we may have to employ additional cost-reduction measures.

Risk factors. In addition, our results of operations and financial condition may be affected by various other factors discussed in “Item 3 - Key Information - Risk Factors”, including market acceptance of our products, changes in political, military or economic conditions in Israel and in the Middle East, general slowing of local or global economies and decreased economic activity in one or more of our target industries.


E.	OFF-BALANCE SHEET ARRANGEMENTS

Other than as discussed below, we are not party to any off-balance sheet arrangements or subject to any contingent liabilities.

1. With respect to our contingent liability relating to payment of royalties to the OCS, see “ - Research and development, patents, licenses, etc.” above.

2. As consideration for grants received from the Fund for the Encouragement of Overseas Marketing of the Israeli Government’s Ministry of Industry and Trade, we are obligated to pay the Fund royalties amounting to 3% to 4% of the incremental exports, up to a maximum of 100% of the grants received. Our contingent liability as of December 31, 2005 was $0.6 million, contingent upon our incremental exports.


F.	TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

The following table summarizes our contractual obligations and commercial commitments as of December 31, 2005:


	Payments due by Period (US$ in thousands)

Contractual Obligations as of December 31, 2005	Total			Less than 1 Year	1-3 Years	4-5 Years	After 5 Years


Operating Leases		2,766		1,145	1,621	-	-
Purchase Obligations and Commitments		774		774	-	-	-
Other Long-Term Liabilities		2,532	⁽¹⁾	-	-	-	-
Total Contractual Cash Obligations		6,072		1,919	1,621	-	-

(1) Represents a provision for future severance pay obligations.


G.	Safe Harbor

This annual report on Form 20-F contains “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “1934 Act”) (collectively, the “Safe Harbor Provisions’”). These are statements that are not historical facts and include statements about our beliefs and expectations. These statements contain potential risks and uncertainties, and actual results may differ significantly. Forward-looking statements are typically identified by the words “believe,” “expect,” “intend,” “estimate” and similar expressions. Such statements appear in this annual report and include statements regarding the intent, belief or current expectation of the Company or its directors or officers. Actual results may differ materially from those projected, expressed or implied in the forward-looking statements as a result of various factors, including, without limitation, the factors set forth in Item 3 (“Key Information”) under the caption “Risk Factors” (“Cautionary Statements”). Any forward-looking statements contained in this annual report speak only as of the date hereof, and we caution potential investors not to place undue reliance on such 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 to persons acting on our behalf are expressly qualified in their entirety by the Cautionary Statements.


Item 6.	Directors, Senior Management and Employees

Directors and Senior Management

As of the date of this annual report, our directors, senior management and key employees were as follows:


Name	Age	Position


Yossi Ben Shalom	51	Chairman of the Board
Rimon Ben-Shaoul	61	Director
Barak Dotan	38	Director
Kenny Lalo	48	Director
David Golan	65	Director
Ofra Brown	52	External Director
Rami Entin	55	External Director
Dan Haran	48	President and Chief Executive Officer
Ilan Erez	38	Chief Financial Officer

Yossi Ben Shalom is a co-founder of DBSI Investments Ltd. Prior to establishing DBSI Investments, Mr. Ben Shalom served as Executive Vice President and Chief Financial Officer of Koor Industries Ltd. (NYSE:KOR), from 1998 through 2000. Prior to that, he served as Chief Financial Officer of Tadiran Ltd. Mr. Ben Shalom has also been an active director on numerous boards, such as NICE Systems (NASDAQ:NICE), Machteshim Agan, Bank Klali and others. Mr. Ben Shalom holds a bachelor’s degree in economics and a master’s degree in business administration from Tel Aviv University.

Rimon Ben-Shaoul has served since February 2001 as Co-Chairman, President and Chief Executive Officer of Koonras Technologies Ltd. and as a Chairman or member of the boards of various companies of the Polar Investments Group. From June 1997 to February 2001 he served as President and Chief Executive Officer of Clal Industries and Investments Ltd. and served as a member of the board of Clal (Israel) Ltd. and on the board of several of its subsidiaries. From 1985 to June 1997, he served as President and Chief Executive Officer of Clal Insurance Company Ltd., as a member of its board and as Chairman or a member of the board of several of its subsidiaries. Mr. Ben-Shaoul holds a bachelor’s degree in economics and a master’s degree in business administration from Tel Aviv University.

Barak Dotan is a co-founder of DBSI Investments Ltd. Prior to establishing DBSI Investments, Mr. Dotan worked as Product Manager for Jacada (NASDAQ:JCDA), formerly CST and later managed private investments in high-tech and other areas. Mr. Dotan graduated summa cum laude from the Hebrew University of Jerusalem with a bachelor’s degree in computer science and business administration.

Kenny Lalo has served since 2001 as Vice President of Koonras Technologies Ltd. and as a member of the board of several of its affiliates. Mr. Lalo has acted in the capacity of “of-counsel” to the law firm of Eitan, Pearl, Latzer & Cohen-Zedek since 2001. From 1993 to 2001, he served as general counsel and later as Vice President of Clal Industries and Investments Ltd. and as a member of the board of several of its affiliates. From 1986 to 1992, Mr. Lalo was an attorney in Maryland, USA. Mr. Lalo holds an LL.B. from Tel Aviv University, an M.C.L. from Georgetown University and a master’s degree in business administration from Northwestern University, Chicago.

David Golan has been a director on our board since 1992 and is a former Chairman of the board. Mr. Golan is currently an independent businessman and a director. Previously he was an executive director in the Binat Group and served on the board of directors of several public and private companies. From May 1998 to September 2000 Mr. Golan was Managing Director in charge of Zeevi Holdings’ investments, not including ZCT. From March 1997 to May 1998, he was the Chief Executive Officer of Clal Trading Ltd., a subsidiary of the IDB group. From 1992 to March 1997, he was Executive Vice President of Clal Trading. Mr. Golan was formerly president of Gal Weisfield Industries Ltd. Mr. Golan holds a bachelors degree in economics and statistics from Hebrew University in Jerusalem and a master’s degree in business administration from New York University.

Ofra Brown currently serves as the Chief Financial Officer of VIZRT Ltd., a public company traded on the Frankfurt Stock Exchange and on the Oslo Stock Exchange in Norway. From 1999 to 2001, Ms. Brown served as the Chief Financial Officer of BVR Technologies Ltd., a company previously publicly traded on the NASDAQ. From 1978 through 1998 Ms. Brown served as the Credit Manager for Electronic and Hi-Tech Industries – Industrial Development Bank of Israel Ltd. Ms. Brown holds a bachelor’s degree in economics from Tel Aviv University and a master’s degree in business administration from City University of Seattle.

Rami Entin currently serves as a director of ECtel Ltd., a Nasdaq-traded company that develops and markets fraud prevention and revenue assurance solutions for circuit-switched and packet-switched wireline and wireless networks, Maccabee-Dent, which is engaged in the management and operation of dental clinics, and is an external director of Solomon Holdings Ltd., an Israeli publicly traded construction company. Mr. Entin is also a director of Hilan-Tech Ltd. and of Assuta Medical Center in Tel-Aviv, Israel. From 2002 until 2003, Mr. Entin was the chairman of the Hashavim Group, a data center for direct taxation and employment laws and a processor of wages and personnel data. From 1999 until 2001, Mr. Entin was Co-Chief Executive Officer and a director of Hilan-Tech Ltd., where he was in charge of financial, personnel, sales and marketing and Lotus Notes operations. From 1985 until 1999 he was financial manager and a director of Hilan Ltd., where he was in charge of financial and personnel operations. From 1981 until 1985, Mr. Entin worked for Kesselman & Kesselman, an accounting firm, where he served various publicly traded companies engaged in the services and industry fields. Mr. Entin holds a B.A. degree in accounting and economics and an M.B.A. degree from the Tel Aviv University, and is a certified accountant in Israel. He is also a graduate of the Advanced Management Program at Harvard University.

Dan Haran has been our President and Chief Executive Officer since July 2005. Mr. Haran joined Cimatron as Vice President of Marketing and Chief Operating Officer in November 2003 after having been employed by Comverse (Nasdaq:CMVT) where he held several senior management positions, most recently as Chief Operating Officer of the Intelligent Network Division. Prior to Comverse, Mr. Haran managed Medcon Systems, an Israeli-based start-up company.
Mr. Haran holds a bachelor of science degree in computer engineering from the Technion, a master of science degree from the Weitzman Institute, and a master of business administration degree from Tel Aviv University.

Ilan Erez, joined us as VP Finance in May 2005 and became CFO in July, 2005. From 1998 to 2005 Mr. Erez served as the Chief Financial Officer of Silicom Ltd., a NASDAQ listed company engaged in the design, manufacturing and selling of server-networking cards. He also served as VP Operations of Silicom from May 2001 until his departure. From 1996 to 1998 Mr. Erez served as a Controller and assistant to the Chief Executive Officer at Bio-Dar Ltd. From 1994 until 1996 Mr. Erez served as an Auditor at Kesselman & Kesselman, a member of PriceWaterhouseCoopers. Mr. Erez is a Certified Public Accountant in Israel and holds a B.A in Accounting and Economics from the Hebrew University in Jerusalem and an LL.M. in Business Law from Bar-Ilan University.

Arrangements for the election of Directors

Koonras Ltd. and DBSI Investments Ltd., our two largest shareholders (each holding approximately 33% of our share capital), control the outcome of most matters submitted to a vote of our shareholders, including the election of members of our board of directors. Koonras and DBSI have entered into an agreement by which, among other matters, they will each appoint one half of our directors, not including our external directors, and vote together at our shareholders’ meetings.

Compensation

During the year ended December 31, 2005, we paid, in the aggregate, approximately $0.8 million in direct remuneration to our directors and officers for services provided by them to the Company in such capacities, including compensation paid to Zvika Naggan, our former CEO, who resigned in June 2005 and Eli Gendler, our former CFO who left Cimatron in July 2005. The above does not include amounts expended by us for automobiles made available to our officers, expenses (including business travel, professional and business association dues and expenses) reimbursed to officers and other fringe benefits commonly reimbursed or paid by companies in Israel.

Board of Directors

Our Articles of Association provide for a Board of not less than two members. Each director, with the exception of external directors who are elected to serve set periods of time as described below, is elected to serve until the next annual general meeting of shareholders and until his or her successor has been duly elected. Officers serve at the discretion of the Board.

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. A person may not serve as a substitute director for more than one director and may not serve as both director and as a substitute 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. Any substitute director will have all of the rights and obligations of the director appointing him or her, except the power to appoint a substitute (unless the instrument appointing him or her provides otherwise), and the right to remuneration. The substitute director may not act at any meeting at which the director appointing him or her is present. Unless the appointing director limits the time period or scope of any appointment, the appointment is effective for all purposes, but will expire upon the expiration of the appointing director’s term. 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 to appoint at least two external directors.

No person may be appointed as an external director if the person or the person’s relative, partner, employer or any entity under the person’s control, has or had, on or 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.

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, and then at least one external director must be of the other gender.

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 voted at the meeting, vote in favor of election of the director; 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. External directors may be removed only by the same percentage of shareholders as is required for their election, or by a court, in each case 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. Our external directors are Ofra Brown and Rami Entin, who will complete their current terms in May 2008, in accordance with Israeli law.

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

Under recent amendments to the Companies Law, at least one of the external directors serving on a company’s board of directors is required to have “financial expertise” and the other external director or directors are required to have “professional expertise.” A director is deemed to have “professional expertise” if he or she either (i) has an academic degree in economics, business management, accounting, law or public service, (ii) has an academic or other degree or completed another higher education, all in the field of business of the company or relevant for his/her position, or (iii) has at least 5 years experience as either a senior managing officer in the company’s line of business with a significant volume of business, a public office, or a senior position in the company’s main line of business. A director with “financial expertise” is a director that due to his education, experience and skills has a high expertise and understanding in financial and accounting matters and financial statements, in such a manner which allows him to deeply understand the financial statements of the company and initiate a discussion about the presentation of financial data.

Audit Committee

The 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, approving related party transactions as required by law, and reviewing the quarterly and annual balance reports and recommending their approval before our board or directors. An audit committee must consist of at least three directors, including 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.

Under the Nasdaq rules, we are required to have at least three independent directors on the audit committee. In addition, Nasdaq requires that the members of the audit committee (a) not have any relationship to the company that may interfere with the exercise of their independence, and (b) must be financially literate.

Under the Nasdaq rules and the Sarbanes-Oxley Act, the audit committee (i) has the sole authority and responsibility to select, evaluate, and, where appropriate, replace the company’s independent auditors, (ii) is directly responsible for the appointment, compensation and oversight of the work of the independent auditors for the purpose of preparing its audit report or related work, and (iii) is responsible for establishing procedures for (A) the receipt, retention and treatment of complaints received by the company regarding accounting, internal accounting controls or auditing matters, and (B) the confidential, anonymous submission by employees of the company of concerns regarding questionable accounting or auditing matters. The audit committee is required to consult with management but may not delegate these responsibilities. In addition, under the Sarbanes-Oxley Act, the audit committee is responsible, among other things, for the following:


	—	Have the sole authority to review in advance, and grant any appropriate pre-approvals of, (i) all audit and non-audit services to be provided by the independent auditors and (ii) all fees and other terms of engagement;

	—	Review and discuss with management and the independent auditors the company’s quarterly financial statements (including the independent auditors’ review of the quarterly financial statements) prior to any required submission to shareholders, the SEC, any stock exchange or the public;

	—	Review and discuss with management and the independent auditors the company’s annual audited financial statements prior to any required submission to shareholders, the SEC, any stock exchange or the public;

	—	Recommend to the Board, if appropriate, that the company’s annual audited financial statements be included in the company’s annual report;


	—	Review and discuss with management all disclosures made by the company concerning any material changes in the financial condition or operations of the company;

	—	Review disclosures made to the audit committee by the company’s chief executive officer and chief financial officer during their certification process for the company’s annual report about any significant deficiencies in the design or operation of internal controls or material weaknesses therein and any fraud involving management or other employees who have a significant role in the company’s internal controls; and

	—	Review and approve all related-party transactions.

As of the date of this annual report, Mr. David Golan, Ms. Ofra Brown and Mr. Rami Entin are serving as members of our audit committee. Mr. Kenny Lalo serves as a non-voting member of our audit committee.

Internal Auditor

Under the Companies Law, the board of directors must appoint an internal auditor, nominated by 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 Companies Law, the internal auditor may be an employee of the company but not an office holder, or an affiliate, or a relative of an office holder or affiliate, and he may not be the company’s independent accountant or its representative. Ernst & Young – Kost, Forer, Gabbay & Kasierer Business Risk Services serves as our internal auditor.

Nasdaq Listing Requirements

Recently adopted Nasdaq rules enable foreign private issuers, such as ourselves, to comply with the prevalent practice in our jurisdiction of incorporation in place of certain Nasdaq listing requirements. To the extent that we choose to do so, we are required to disclose in our annual reports filed with the Commission each Nasdaq listing requirement that we do not follow and describe the home country practice we follow in lieu of such requirement.

We are not in compliance with Nasdaq Marketplace Rules 4350(c)(4)(B) (requiring companies to adopt a formal written charter or board resolution addressing the company’s nominations process) and 4350(c)(2) (Regularly scheduled meetings of the company’s independent directors). Under Israeli law, the nominations process is conducted by the full board of directors. Similarly, under Israeli law all matters that are subject to the approval of a company’s board of directors are discussed by the full board of directors. In addition, we do not intend to comply (if and when the events underlying such rule become relevant) with the Nasdaq listing requirement of shareholder approval for the establishment of and amendments to stock option or purchase plans (Rule 4350(i)(A)), which matter is not subject to shareholder approval under Israeli law and practice.

Employees

The following table sets forth for the last three financial years, the number of our employees broken down into categories.


Period ending December 31,	2005	2004	2003

Research and Development	59	84	84
Marketing, Sales and Customer Support	125	106	109
Administration Management and Information Systems	20	24	22
Total	204	214	215

As of May 31, 2006, we employed 203 full-time personnel, of whom 59 (most of whom hold advanced technical degrees) were employed in research and development, 125 were employed in marketing, sales and customer support and 19 were employed in various administrative, information systems and management positions. Of these employees, 100 were employed in Israel operations, 21 were employed by our North American subsidiary, 33 were employed by our German subsidiary, 3 were employed by our French subsidiary, 1 was employed by our Japanese subsidiary, 3 were employed by our British subsidiary, 39 were employed by our Chinese subsidiaries, and 3 were employed by our Indian subsidiary. In addition, we employed 14 subcontractors’ or free-lance personnel on average during the year 2005 and as of May 31, 2006 we employed 13 subcontractors’ personnel.

Certain 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 our employees in Israel by order of the Israeli Ministry of Labor. These provisions concern principally the length of the workday; 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 our employees with benefits and working conditions beyond the required minimums. In addition to salary and other benefits, certain of our marketing personnel are paid commissions based on our performance in certain territories worldwide.

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 by the employee for national health insurance. The total payments to the National Insurance Institute are equal to approximately 14.6% of the employee’s wages (up to a specified amount), of which the employee contributes approximately 66% and the employer contributes approximately 34%.

A general practice that we follow, although not legally required, is the contribution of funds on behalf of most of its 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 payments upon retirement or death and securing the severance pay, if legally entitled, upon termination of employment. We decide whether each employee is entitled to participate in the plan, and each employee who agrees to participate contributes an amount equal to 5% of his salary and the employer contributes between 13.3% and 15.8% of his salary.

Share Ownership

1996 Share Option Plan

In January 1996, the Board adopted a share option plan (the “1996 Share Option Plan”) pursuant to which 316,000 Ordinary Shares were reserved for issuance upon the exercise of options to be granted to our directors, officers, employees and consultants. The 1996 Share Option Plan is administered by a committee of the Board, which designates the optionees and dates of grant. The exercise price of an option granted under the 1996 Share Option Plan may be no less than 85% of the fair market value of an Ordinary Share, as determined by that committee on the date that the option is granted. The options are for a 10-year term and are non-assignable except by the laws of descent. The option committee has the authority to amend the terms of option grants, provided that any such amendment is in the best interest of the grantee. In March and April 2000, options to purchase 39,750 shares were exercised. As of May 31, 2006, none of these options were outstanding. All of these options were originally granted with an exercise price of $8.00 per share. In January 1998, the board of directors amended the exercise price of such options to $5.00 per share.

1998 Share Option Plan

In April 1998, the board of directors adopted an additional share option plan (the “1998 Share Option Plan”) pursuant to which 620,000 Ordinary Shares were reserved for issuance upon the exercise of options to be granted to our directors, officers, employees and consultants. The 1998 Share Option Plan is administered by a committee of the Board, which designates the optionees and dates of grant. The exercise price of an option granted under the 1998 Share Option Plan may be no less than 85% of the fair market value of an Ordinary Share, as determined by that committee on the date that the option is granted. Options granted vest over a period determined by the option committee, terminate three years after they become exercisable, and are non-assignable except by the laws of descent. The option committee has the authority to amend the terms of option grants, provided that any such amendment is in the best interest of the grantee. As of May 31, 2006, options to purchase 19,750of such shares were outstanding at a price of $4.00 per share under the 1998 Share Option Plan. These options are exercisable commencing two years after the date of grant at a rate of 25% per year, subject to the continued employment of each employee. The grantee will be responsible for all personal tax consequences of the grant and the exercise thereof.

In October 1999, the option committee approved the grant of options to purchase 160,000 of the Company’s shares at a price of $2.00 per share to the former president and CEO of the Company. All these options expired during September 2005.

In March 2000, the option committee adopted new guidelines for the options to purchase Ordinary Shares reserved for issuance under each of the 1996 Share Option Plan and the 1998 Share Option Plan upon the exercise of options to be granted to our directors, officers, employees and consultants. As a result of the new guidelines, as of May 31, 2006, options to purchase 22,750 of such shares were outstanding at a price of $4.50 per share.

Such options are exercisable commencing two years after the date of grant at a rate of 50% on the second anniversary of the date of grant and 25% in each of the following two years, subject to the continued employment of the grantee.

In August 2003, the board of directors approved the grant of options to purchase 150,000 of the Company’s shares at a price of $2.50 per share to two officers of the Company. These options are exercisable commencing one year after the date of grant at a rate of 25%-33.3% per year, subject to the continued employment of the officers. 50,000 of such options were outstanding as of May 31, 2006. For additional information relating to the stock options granted by us under the 1996 Share Option Plan and the 1998 Share Option Plan, see Note 12(B) to our financial statements included in Item 18.

2004 Share Option Plan

In October 2004, our board of directors and shareholders adopted the 2004 Share Option and Restricted Shares Incentive Plan (“2004 Share Option Plan”) pursuant to which 240,000 Ordinary Shares were reserved for issuance upon the exercise of options to be granted to our directors, officers, employees and consultants. The 2004 Share Option Plan is administered by a committee of the Board, which designates the optionees and dates of grant. The exercise price of an option granted under the 2004 Share Option Plan may be no less than 100% of the fair market value of an Ordinary Share, as determined by that committee on the date that the option is granted. Options granted vest over a period determined by the option committee, terminate ten years from the date of grant, unless otherwise determined by the Board, and are non-assignable except by the laws of descent. The option committee has the authority to amend the terms of option grants, provided that any such amendment is in the best interest of the grantee. In February 2005, 238,500 of such options were granted to employees of the Company at an exercise price of $2.20 per share and with a term of ten years , and in August 2005, the board of directors approved the grant of 32,000 of such options at an exercise price of $2.00 per share to the Company’s Chief Executive Officer. In December 2005 our board of directors increased the 2004 Share Option Plan reserve by an additional 250,000 shares. In May 2006 an additional 189,000 options were granted to Company employees under the 2004 Share Option Plan at an exercise price of $1.75-$2.00 and with a term of five years. As of May 31, 2006, 418,500 of such options were outstanding. These options are exercisable pursuant to a three (3) year vesting schedule as follows: (i) thirty three percent (33%) of the shares covered by the options become exercisable on the first anniversary of the grant date; and (ii) sixteen and one-half percent (16.5%) of the shares covered by the options become exercisable at the end of each subsequent six months period over the course of the following two (2) years, subject to the continued employment of each employee. The grantee will be responsible for all personal tax consequences of the grant and the exercise thereof. We intend to grant additional options under the 2004 Share Option Plan to various of our directors, executive officers and employees.

At May 31, 2006 options to purchase 255,000, 329,000 and 62,000 of our ordinary shares were available for grants to various of our directors, officers, employees and consultants under the 1996, 1998 and 2004 Share Option Plans, respectively.

Repurchase of Our Shares

We purchased 159,600 of our shares in the open market between September 2002 and February 2003 at an average price of $0.95 per share. During 2003, we repurchased 26,000 shares at an average price of $1.04 per share. Under Israeli law, while these shares are considered to be part of our outstanding share capital that can be reissued by us in the future, they are “dormant shares” and as such they cannot be voted and do not provide any other rights, other than upon liquidation.

Beneficial Ownership by Officers and Directors

Messrs. Ben Shalom, Ben Shaoul, Dotan and Lalo may be deemed to have beneficial ownership of an aggregate of 5,133,710 of our shares, representing 65.5% of our issued and outstanding capital share, by virtue of their positions with Polar and DBSI and the voting agreement between Koonras and DBSI described elsewhere in this report.


Item 7.	Major Shareholders and Related Party Transactions

Major Shareholders

The following table sets forth information, as of May 31, 2006, concerning the beneficial ownership (as defined in Rule 13d-3 under the Securities Exchange Act of 1934) of ordinary shares by (i) any person who is known to own at least 5% of the ordinary shares of our company and (ii) all directors and executive officers as a group. The voting rights of our major shareholders do not differ from the voting rights of holders of all our ordinary shares.


Name and Address	Number of Ordinary Shares		Percent of Ordinary Shares

Koonras Ltd. 21 Ha’arba’ah St. Tel-Aviv, Israel	2,560,360		32.68	%
DBSI Investments Ltd. 85 Medinat Hayehudim St. Herzliya, Israel	2,573, 350		32.84	%
All directors and executive officers as a group (11 persons)	5,146,699	(1)	65.7	%

(1) Includes an aggregate of 5,133,710 shares beneficially held by Koonras and DBSI, by virtue of the positions held by certain of our directors on the board of directors of Koonras and DBSI, as to which such individuals disclaim beneficial ownership.

Record Holders

As of May 31, 2006, there were 27 record holders of our ordinary shares, of which 16 represented United States record holders owning an aggregate of approximately 36% of our outstanding ordinary shares.

Related Party Transactions

Services Agreement and Lease Agreement

Until February 2002, our former principal shareholder ZCT, provided us with certain corporate and administrative services, including, but not limited to, executive management, facilities and other such services as were agreed upon from time to time between us and ZCT. The primary executive management services that we received under the agreement represented the services of the chief executive officer and the chief financial officer of ZCT, who did not receive separate fees for such services. Pursuant to such agreement, we shared the expenses relating to the specific services we received from ZCT with the other subsidiaries of ZCT that also received such services from ZCT. For the period of January 1, 2002, through February 21, 2002 we paid ZCT an aggregate of $230,000 for such services and for rent payments for such months.

As of February 21, 2002, ZCT assigned all rights and obligations under the foregoing services agreement to Koonras and DBSI. An assignment of this agreement to Koonras and DBSI was ratified by our shareholders on July 11, 2002. From February 21, 2002 through December 31, 2003 we paid Koonras and DBSI an aggregate of NIS 2,919,500 for these services. Koonras and DBSI will continue to provide these services to the Company for an annual fee of NIS 1,560,000 (linked to the Israeli Consumer Price Index as of July 2002).


Item 8.	Financial Information

Consolidated Statements and Other Financial Information

Our consolidated financial statements and other financial information are included in this annual repot in “Item 18 - Financial Statements”.

Legal Proceedings

In April 2004, Omega – Adem Technologies Ltd., an Israeli privately held company engaged in the development of software, filed a lawsuit against us, claiming that we caused four employees of the plaintiff located in Russia to terminate their employment with the plaintiff and join us. During a period of two years (until March 2003), the plaintiff provided certain services to us. The four employees were among several employees who provided such services. The plaintiff claimed, among other things, that we undertook not to employ Omega’s employees after the termination of the project Omega performed for us. The plaintiff requested the District Court in Tel Aviv, Israel to grant an injunction and a permanent order that would prevent us from hiring the four employees. In June, 2004, the court rejected the plaintiff’s request for an injunction. In September 2004, Omega initiated arbitration proceedings against us pursuant to the services agreement between the parties and submitted to an arbitrator agreed upon between the parties a statement of claim for an amount of $20,000,000 for damages caused to Omega due to the employment of the four employees in question. In November 2004, we submitted a statement of defense denying all of Omega’s claims and asserting, among other things, that we engaged the employees upon expiration of a one-year period following termination of the agreement between us and Omega and that we therefore were allowed to do so. On October 11, 2005 Omega submitted affidavits and on January 25, 2006 we submitted our affidavits. The arbitration process is now at the stage of cross-examinations in front of the arbitrator. We believe that there is no merit to the claim and intend to continue to oppose it vigorously, but we have nevertheless accrued in the fourth quarter of 2005 a sum of $250,000 for this claim.

Dividend Distribution Policy

Certain of our enterprises are Approved Enterprises. In the event of a distribution to shareholders of cash dividends out of earnings subject to the exemption from the payment of corporate tax provided to an Approved Enterprise, the Company will be subject to tax at a rate of 25%. We have not provided deferred taxes on future distributions of tax-exempt earnings, as management and the Board of Directors have determined not to make any distribution that may result in a tax liability for the Company. Accordingly, such earnings have been considered to be permanently reinvested. The tax-exempt earnings may be distributed to shareholders without subjecting the Company to taxes only upon a complete liquidation of the Company.

Significant Changes

Since the date of our consolidated financial statements there has not been a significant change in our Company other then as set forth in the Financial Statements.


Item 9.	The Offer and Listing

Offer and listing details

Our ordinary shares were quoted on the NASDAQ National Market System from March 1996 until April 17, 2001, from which time our ordinary shares have been traded on the NASDAQ SmallCap Market. Through April 16, 2000, we were quoted under the symbol CIMTF and since April 17, 2000 we have been quoted under the symbol CIMT. The Ordinary Shares are not listed on any other stock exchange and have not been publicly traded outside the United States. The table below sets forth the high and low bid prices of the Ordinary Shares, as reported by NASDAQ (on each of the National and SmallCap Markets as applicable) during the indicated fiscal quarters:


Period	High (U.S. $)		Low (U.S. $)

Six most recent months:
May 2006		1.41		1.15
April 2006		1.53		1.40
March 2006		1.49		1.11
February 2006		1.40		1.00
January 2006		1.30		1.04
December 2005		1.14		1.05


Period	High (U.S. $)		Low (U.S. $)


Two most recent full financial years and subsequent periods:
First Quarter 2006		1.49		1.00
Fourth Quarter 2005		1.29		1.05
Third Quarter 2005		1.61		1.14
Second Quarter 2005		1.79		1.12
First Quarter 2005		2.14		1.58
Fourth Quarter 2004		2.38		1.26
Third Quarter 2004		1.99		1.25
Second Quarter 2004		2.65		1.75
First Quarter 2004		2.95		2.05

Five most recent years:
2005		2.14		1.05
2004		2.95		1.25
2003		2.48		0.88
2002		1.49		0.7
2001		1.63		0.51

Markets

Our shares are traded only on the NASDAQ SmallCap Market, where they are listed and traded under the symbol “CIMT”.


Item 10.	Additional Information

Memorandum and Articles of Association

Articles of Association; Israeli Companies Law

In February 2000 the Company’s Ordinance (New Version)-1983 was replaced by the Companies Law. Since our Articles were approved before the enactment of the Companies Law, they are not always consistent with the provisions of the new law. In all instances in which the Companies Law changes or amends provisions in the Companies Ordinance, and as such, our Articles are not consistent with the Companies Law, the provisions of the Companies Law shall prevail unless specifically stated otherwise in the Companies Law. Similarly, in all places that our Articles refer to a section of the Companies Ordinance that has been replaced by the Companies Law, the Articles shall be understood to be referring to the relevant Section of the Companies Law.

Our shareholders approved our Articles of Association in March of 1996. Our objective as stated in our Articles and in our Memorandum of Association is to engage in any lawful activity.

We currently have only one class of securities outstanding, our Ordinary Shares, par value NIS 0.10 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. Our Articles may be amended by a resolution carried at a General Meeting by 75% of the shares present and voting thereon (excluding abstained votes). The shareholders rights may not be modified in any other way unless otherwise expressly provided in the terms of issuance of the shares.

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. No business may be commenced in any annual meeting until a quorum of two or more shareholders holding at least one third of the voting rights are present in person or by proxy. Shareholders may vote in person or by proxy, and will be required to prove title to their shares as required by the Companies Law pursuant to procedures established by the board of directors. Resolutions regarding the following matters must be passed at a general meeting of shareholders:


	—	amendments to our Articles (other than modifications of shareholders rights as mentioned above);

	—	appointment or termination of our auditors;

	—	appointment and dismissal of directors;

	—	approval of acts and transactions requiring general meeting approval under the Companies Law;

	—	increase or reduction of our authorized share capital or the rights of shareholders or a class of shareholders;

	—	any merger as provided in section 320 of the 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 Companies Law.

In addition, the Companies Law provides that an extraordinary meeting of our shareholders shall be convened by the board, 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 our issued share capital and 1% of the voting rights, or by request of one or more shareholders holding at least 5% of the voting rights. Shareholders requesting a special meeting must submit their proposed resolution(s) with their request.

Our Articles provide that our board of directors may from time to time, at their discretion, borrow or secure the payment of any sum of money for the objectives of the Company. Our directors may raise or secure the repayment of such sum in a manner, time and terms as they see fit.

According to our Articles, the board of directors may delegate any authority they have to a committee comprised of members of the board. Any committee to whom the board’s powers were delegated to must abide by the regulations enacted by the board in respect of such delegated powers. In the absence of any such regulations, the committee must abide by our Articles. Our board has currently appointed one committee, which is our Audit Committee as described above in Item 6.

Transactions with Certain Shareholders

The Companies Law codifies the fiduciary duties that “office holders,” including directors and executive officers, owe to a company. An office holder, is defined in the 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 managing director or (ix) any other person assuming the responsibilities of any of the forgoing positions without regard to such person’s title. The duty of care prescribed by the Companies Law requires an office holder to act with the level of care, which a reasonable office holder in the same position would have acted under the same circumstances. The duty of loyalty prescribed by the Companies Law generally requires an office holder to act in good faith and for the good of the company.

The Companies Law requires that an office holder of a company promptly disclose 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, as defined under Israeli law, the office holder must also disclose any personal interest held by the office holder’s spouse, siblings, parents, grandparents, descendants, spouse’s descendants and the spouses of any of the foregoing, or by any corporation in which the office holder is a 5% or greater shareholder, holder of 5% or more of the voting power, director or general manager or in which he or she has the right to appoint at least one director or the general manager. 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 that is not an extraordinary transaction, after the office holder complies with the above disclosure requirement, only board approval is required unless the Articles of Association of the company provide otherwise. The transaction must not be adverse to the company’s interest. If the transaction is an extraordinary transaction, then, in addition to any approval required by the Articles of Association, it must also be approved by the audit committee and by the board of directors, and, under specified circumstances, by a meeting of the shareholders.

Agreements regarding directors’ terms of employment require the approval of the 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:


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

	—	the matter requires approval of the shareholders at a general meeting.

According to the Companies Law, the disclosure requirements discussed above also apply to a controlling shareholder of a public company. In general, extraordinary transactions with a controlling shareholder or in which a controlling shareholder 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. The term “controlling shareholder” is defined as a shareholder who has the ability to direct the activities of a company, other than if this power derives solely from the shareholder’s position on the board of directors or any other position with the company. The definition 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.

The shareholder approval must either include at least one-third of the shares held by disinterested shareholders who are present in person or by proxy at the meeting and who are voting thereon, 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.

In addition, a private placement of securities that (i) includes the issuance of twenty percent or more of the company’s outstanding voting rights (prior to such issuance) in which the consideration, in whole or in part, is not in cash or in registered securities or is not at market value, and as a result of which a person holding five percent of more of the company’s share capital or voting rights will increase or that will cause any person to become, as a result of the issuance, a holder of more than five percent of the company’s outstanding share capital, or (ii) will cause any person to become, as a result of the issuance, a controlling shareholder of the company, requires approval by the board of directors and the shareholders of the company. The regulations to the Companies Law provide certain exceptions. Any placement of securities that does not fit the above description may be issued at the discretion of the Board of Directors.

Under the Companies Law, a shareholder has a duty to act in good faith towards the company and other shareholders 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 transactions that require shareholder approval.

In addition, any controlling shareholder, any shareholder who knows that it possesses the 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 Companies Law does not describe the substance of this duty, except to state that the remedies generally available upon a breach of contract will apply also in the event of a breach of the duty to act with fairness. The 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 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 disinterested directors participating in a duly convened meeting.

Limitation on Ownership of Securities

The ownership and voting of our ordinary shares by non-residents of Israel are not restricted in any way by our articles of association or by the laws of the State of Israel, except for shareholders who are subjects of countries which are in a state of war with Israel.

Mergers and Acquisitions; Anti-Takeover Provisions

The Companies Law includes provisions with respect to the approval of corporate mergers that are applicable to us. These provisions require that the board of directors of each company that is party to the merger approve the transaction. In addition, the shareholders of each company must approve the merger by a vote of 75% of the company’s shares, present and voting on the proposed merger at a shareholders’ meeting. In determining whether the requisite majority has approved the merger, shares held by the other party to the merger or any person holding at least 25% of such other party or otherwise affiliated with such other party are excluded from the vote.

The Companies Law does not require court approval of a merger other than in specified situations. However, upon the request of a creditor of either party to the proposed merger, a court may delay or prevent the merger if it concludes that there exists a reasonable concern that as a result of the merger, the surviving company will be unable to satisfy the obligations of any of the parties of the merger to their creditors.

A merger may not be completed unless at least 50 days have passed from the date that a proposal of the merger was filed with the Israeli Registrar of Companies by each merging company and 30 days from the date that shareholder approval of both merging companies was obtained. The merger proposal may be filed once a shareholder meeting has been called to approve the merger.

The Companies Law also provides that the acquisition of shares in a public company on the open market must be made by means of a tender offer if, as a result of the acquisition, the purchaser would become a 25% shareholder of the company. The rule does not apply if there already is another 25% shareholder of the company. Similarly, the law provides that an acquisition of shares in a public company must be made by means of a tender offer if, as a result of the acquisition, the purchaser would become a 45% shareholder of the company, unless there already is a 45% shareholder of the company.

If, following any acquisition of shares, the purchaser would hold 90% or more of the shares of the company that acquisition must be made by means of a tender offer for all of the target company’s shares. An acquirer who wishes to eliminate all minority shareholders must do so by means of a tender offer and acquire 95% of all shares not held by or for the benefit of the acquirer prior to the acquisition. However, in the event that the tender offer to acquire that 95% is not successful, the acquirer may not acquire tendered shares if by doing so the acquirer would own more than 90% of the shares of the target company.

Material Contracts

Other than the service agreement and lease agreement described in “Item 6 - Major Shareholders and Related Party Transactions – Related Party Transactions,” our current lease agreement described below and the Microsystems investment contract described in “Item 4. History and development of the Company”, all of the contracts that we have entered into over the past two years have been in the ordinary course of our business.

In February 2003, we leased from a private commercial property owner the same office space that we had previously leased from ZCT, under a new lease agreement. The initial term of the lease was three years, expiring in June 30, 2006, following which we exercised our option to extend the lease for an additional three years.

Exchange Controls

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

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

Taxation

The following is a summary of the current tax law applicable to companies in Israel, with special reference to its effect on our subsidiaries and us. The following also contains a discussion of specified Israeli tax consequences to our shareholders and government programs from which we, and some of our subsidiaries, benefit. To the extent that the discussion is based on tax legislation that has not been subject to judicial or administrative interpretation, there can be no assurance 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.

General Corporate Tax Structure

Until 2003, Israeli companies were generally subject to corporate tax at the rate of 36% of their taxable income. However, as a result of legislation adopted in July 2004, tax rates were reduced to 35% for 2004, 34% for 2005, 31% for 2006, 29% for 2007, 27% for 2008, 26% for 2009 and 25% for 2010. However, the effective tax rate payable by a company that derives income from an Approved Enterprise (as further discussed below) may be considerably less. Under the Income Tax Law (Adjustment for Inflation) 1985, income for tax purposes is measured in terms of earnings in NIS adjusted for the increase in the Israeli Consumer Price Index. The difference between the annual changes in the Israeli Consumer Price Index and in the NIS/U.S. Dollar exchange rates causes a difference between taxable income and the income reflected in our financial statements. See note 13D of our financial statements.

Law for the Encouragement of Capital Investments, 1959

Certain of our operations have been granted Approved Enterprise status under the Law for the Encouragement of Capital Investments, 1959, as amended (referred to as 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 (referred to as 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% as stated above) for a period of time termed the benefit period. The benefit period is a period of 7 years commencing with the year in which the Approved Enterprise first generated taxable income. The benefit period is in any event limited to 12 years from the commencement of production or 14 years from the date of approval, whichever is earlier. Under certain circumstances (as further detailed below), the benefits period may extend to a maximum of ten years from the commencement of the benefit period. Notwithstanding the foregoing, taxable income of a company located in certain geographic locations, derived from an Approved Enterprise approved after January 1, 1997, is tax exempt for the first two years of the benefit period and is taxed at a rate of 25% or lower for the remainder 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), its effective Company Tax rate is the result of a weighted combination of the various applicable rates.

A company that qualifies as a “Foreign Investors’ Company” is entitled to further reductions in the tax rate normally applicable to Approved Enterprises. Such benefits will be granted only to enterprises that sought approval no later than December 31, 2002. Subject to certain conditions, a “Foreign Investors’ Company” is a company which has more than 25% of its combined shareholders’ investment in share capital (in terms of rights to profits, voting and the appointment of directors) and in long term shareholders’ loans made by persons who are not residents of Israel. The percentage owned by nonresidents of Israel for any tax year will be determined by the lowest percentage of any of the above rights held by nonresidents during that year. Such a company will pay company tax at reduced rates for an extended ten-year (rather than the otherwise applicable seven-year) period and is exempt from any other tax on the income from its Approved Enterprise:

The table below reflects the tax rates applicable to companies with foreign investments as set forth below:


Foreign Investments	Company 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	%

Should our foreign shareholders exceed 25%, future Approved Enterprises might qualify for reduced tax rates for an additional three years, after the seven years mentioned above. However, there can be no assurance that we will attain approval for additional Approved Enterprises or that the provisions of this Law will be extended without change or that the above-mentioned shareholding proportion will be reached for each subsequent year.

In addition, a company owning an Approved Enterprise may elect (as we have) to forego certain Government grants extended to Approved Enterprises in return for an “alternative package” of tax benefits (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 in part on the geographic location of the Approved Enterprise within Israel, and such company will be eligible for the regular tax benefits under the Investment Law for the remainder of the Benefits Period if any.

A company, such as ours, that has elected the Alternative Package and that subsequently 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 company 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%), 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. In the event, however, that the company also qualifies as a Foreign Investors’ Company, there is no such time limit. 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 the Alternative Package, 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.

The Investment Law also provides that an Approved Enterprise is entitled to accelerated depreciation on its property and equipment that are included in an approved investment program. We have not utilized this benefit.

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 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 CPI linkage differences and interest. See note 13 of our financial statements.

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

Law for the Encouragement of Industrial Research and Development, 1984

Under the Law for the Encouragement of Industrial Research and Development, 1984 (the “Research Law”), research and development programs approved by the Research Committee of the Office of the Chief Scientist (the “Research Committee”) are eligible for grants or loans if they meet certain criteria, in return for the payment of royalties from the sale of the product developed in accordance with the program. Once a project is approved, the Office of the Chief Scientist, or OCS, will award grants of up to 50% of the project’s expenditures in return for royalties, usually at rates between 3% to 5% of sales of products developed with such grants, up to a dollar-linked amount equal to 100% to 150% of such grants. Grants received under programs approved after January 1, 1999, are subject to interest at an annual rate of LIBOR for 12 months applicable to dollar deposits, which will accrue annually based on the LIBOR rate published on the first day of each year.

For information regarding restrictions upon, and conditions to, (a) the manufacture outside of Israel of products using technology developed using OCS funding and (b) the transfer of such technology to a non-Israeli entity whether through the direct transfer of the technology or through a transaction involving the company that received such funding, see “Item 5 – Operating and Financial Review and Prospects - Research and development, patents, licenses, etc.”

Tax Benefits and Grants for Research and Development

Israeli tax law allows, under certain conditions, a tax deduction in the year incurred for expenditures (including capital expenditures) in scientific research and development projects if the expenditures are approved by the relevant Israeli Government Ministry (determined by the field of research) and the research and development is for the promotion of the enterprise and is carried out by or on behalf of the company seeking such deduction. Expenditures not so approved are deductible over a three-year period. However, expenditures made out of proceeds made available to us through government grants are not deductible according to Israeli law.

Law for the Encouragement of Industry (Taxes), 1969

The following preferred corporate tax benefits, among others, are available to Industrial Corporations (including us).


	—	Deduction of purchases of know-how and patents over eight years for tax purposes.

	—	Deduction, for tax purposes, of expenses incurred in connection with certain public securities issuances.

	—	Accelerated depreciation rates on both equipment and buildings.

	—	The right to elect, under specified conditions, to file a consolidated tax return with additional related Israeli industrial companies and an industrial holding company.

Taxation under Inflationary Conditions

The Income Tax Law (Inflationary Adjustments), 1985 (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 are taxed under this law, although the application of certain of the provisions of this law was suspended for the tax years 2000 and 2001 because of the nil rate of inflation in those years.

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, to be deducted from any taxable income, and any excess deduction in that year 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.

The law also provides for the full taxation of gains from the sale of certain traded securities, which would otherwise be taxed at a reduced rate when derived by certain categories of corporate taxpayers.

Capital Gains Tax

Israeli law imposes a capital gains tax on the sale of capital assets by both residents and non-residents of Israel. The law distinguishes between the “Real Gain” and the “Inflationary Amount.” The Real Gain is the excess of the total capital gain over the Inflationary Amount, computed on the basis of the increase in the Israeli Consumer Price Index between the date of purchase and the date of sale. The Inflationary Amount accumulated prior to 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 dollar instead of the Israeli CPI), while the Inflationary Amount accumulated following December 31, 1993 is exempt from any capital gains tax. Until the end of the year 2002, capital gains from the sale of our ordinary shares were generally exempt from Israeli Capital Gains Tax. This exemption did not apply to a shareholder whose taxable income is determined pursuant to the Israeli Income Tax Law (Inflationary Adjustments), 1985, or to a person whose gains from selling or otherwise disposing of our securities are deemed to be business income.

As a result of the recent tax reform legislation in Israel, gains from the sale of our ordinary shares derived from January 1, 2003 and thereafter for individual shareholders will in general be liable to capital gains tax of 20%. With respect to an individual who is a substantial shareholder (which is someone who alone, or together with another person, holds, directly or indirectly, at least 10% in one or all of any of the means of control in the company), the applicable capital gains tax rate will be 25%. This will be the case so long as our securities remain listed for trading on a designated foreign stock market such as the NASDAQ. However, according to the tax reform legislation, non-residents of Israel will be exempt from any capital gains tax from the sale of our ordinary shares so long as the gains are not derived through a permanent establishment that the non-resident maintains in Israel, and so long as our ordinary shares remain listed for trading as described above. These provisions dealing with capital gains are not applicable to persons whose gains from selling or otherwise disposing of our ordinary shares are deemed to be business income or whose taxable income is determined pursuant to the Israeli Income Tax Law (Inflation Adjustments), 1985; the latter law would not normally be applicable to non-resident shareholders who have no business activity in Israel.

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 generally 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 either 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; however, under the U.S.-Israel Tax Treaty, 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 or received in Israel. Such sources of income include passive income such as dividends, royalties and interest, as well as active income from services rendered in Israel. On distributions of dividends other than bonus shares (stock dividends), income tax at the rate of 25% 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 were a company which holds at least 10% of our voting power pursuant to the U.S.-Israel Tax Treaty, except for dividends generated by an Approved Enterprise from which tax is withheld at the rate of 15%. However, as of tax year 2006. the tax rate on dividends to individuals will be reduced to 20% and the withholding rate may be reduced as well. With respect to an individual who is a substantial shareholder (which is someone who alone, or together with another person, holds, directly or indirectly, at least 10% in one or all of any of the means of control in the company), the applicable tax rate will remain 25%.

Documents on Display

We are required to file reports and other information with the 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 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.

This annual report and the exhibits thereto, are available for inspection and copying at the public reference facilities of the Securities and Exchange Commission located a Room 1024, 450 Fifth Street, NW, Washington, D.C. 20549, and the Commission’s regional offices located in New York, New York and Chicago, Illinois. Copies of all or any part of the annual report or other filings may be obtained from these offices after payment of fees required by the Commission. Please call the Commission at 1-800-SEC-0330 for further information. The Exchange Act file number for our Securities and Exchange Commission filing is 1-8201.

The Commission also maintains a website at http://www.sec.gov from which certain filings may be accessed.

All documents referenced herein concerning us are archived and may also be inspected at our head offices located at 11 Gush Etzion Street, Givat Shmuel, Israel. Information about us is also available on our website at http://www.cimatron.com. Such information is not part of this annual report.


Item 11.	Quantitative and Qualitative Disclosures About Market Risks

We are exposed to market risks from changes in foreign currency exchange rates and interest rates, which could impact our results of operations and financial condition. We seek to manage the exposure to these market risks through our regular operating and financing activities and through the use of foreign currency exchange contracts and other financial instruments.

All of such financial instruments are managed and controlled under a program of risk management in accordance with established policies. These policies are reviewed and approved by our Board of Directors. Our treasury operations are subject to an internal audit on a regular basis.

As of December 31, 2005, we had currency exchange options to sell up to 2.52 million Euro for a total amount of $2.9 million, and had written currency exchange options to sell up to 2.1 million Euro for a total amount of $2.7 million that were scheduled to expire prior to December 31, 2006. The total fair value of all such options on December 31, 2005 amounted to an asset of $5,000. All such options are designated as cash flow hedges. On May 17, 2006 we exercised currency exchange options to sell 210,000 Euro for $264,000, and on June 19, 2006, we exercised currency exchange options to sell 210,000 Euro for $264,000.

Interest Rate Risks

Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. We have not used derivative financial instruments in our investment portfolio. As of December 31, 2005, we had financial assets totaling approximately $6.2 million. Fixed rate financial assets, comprised of cash, bank deposits and debt securities, totaled approximately $4.9 million. For the year 2005 we have classified all of our marketable debt securities as “available for sale securities” which exposes the consolidated statement of operations or balance sheets to fluctuations in interest rates. Variable rate financial assets totaled approximately $1.3 million. The net decrease in our earnings for the next year from our variable rate financial assets resulting from a 10% interest rate decrease would be approximately $9,000, holding other variables constant. Assuming an interest rate increase of 10%, the fair value of our fixed-rate marketable debt securities would be reduced by approximately $25,000.

Currency Exchange Rate Risks

Our operating and pricing strategies take into account changes in exchange rates over time. However, there can be no assurance that future fluctuations in the value of foreign currencies will not have a material adverse effect on our business, operating results or financial condition. As of the beginning of 2000, we have been using financial instruments to hedge the following foreign currency exposure risks:

Our Subsidiaries - We operate internationally and our subsidiaries in Germany and France conduct their respective operations in Euros. This exposes us to market risk from changes in foreign exchange rates to the extent that the functional currency of our subsidiaries will decline in value as compared to the U.S. dollar, resulting in a foreign currency exchange rate loss. Assuming an adverse 20% foreign exchange rate fluctuation, we would experience exchange rate losses of approximately $661,000 excluding the effect of our hedging transactions.

Our Providers - Commencing on June 1, 2000 we initiated a Euro denominated price list for all of our Providers in countries whose currency is linked to the Euro. Our revenues from these Providers are therefore exposed to exchange rate differences between the Euro and the United States dollar. Assuming an adverse 20% foreign exchange rate fluctuation, we would experience exchange rate losses from these providers of approximately $907,000 excluding the effect of our hedging transactions.

Expenses in New Israeli Shekels

The cost of our Israel operations, as expressed in U.S. dollars, is influenced by the extent to which any increase in the rate of inflation in Israel is not offset (or is offset on a lagging basis) by a devaluation of the NIS in relation to the U.S. dollar. The inflation rate in Israel was 2.4%, 1.2%, and -1.9% in 2005, 2004 and 2003, respectively. The devaluation (revaluation) of the NIS against the U.S. dollar was 6.4%, (1.6)% and (7.6)% in 2005, 2004, and 2003, respectively. Assuming a 10% devaluation of the U.S. dollar against the NIS, and assuming a maximum deviation of 1% in inflation, we would experience exchange rate losses of approximately $1.0 million excluding the effect of our hedging transactions.

A significant portion of our expenditures is employee compensation-related. Salaries are paid in NIS and may be adjusted for changes in the CPI through salary increases or adjustments. This increases salary expenses in U.S. dollar terms. The devaluation / revaluation of the NIS against the U.S. dollar decreases / increases employee compensation expenditures as expressed in dollars proportionally. Some of our other NIS-based expenses are either currently adjusted to U.S. dollars or are adjusted to the CPI.


Item 12.	Descriptions of Securities Other than Equity Securities

Not Applicable

PART II


Item 13.	Defaults, Dividend Arrearages and Delinquencies

None.


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

None.


Item 15.	Controls and Procedures

(a) Disclosure Controls and Procedures - our management evaluated, with the participation of our principal executive and principal financial officers, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of December 31, 2005. Based on their evaluation, our principal executive and principal financial officers concluded that our disclosure controls and procedures were effective as of December 31, 2005.

(b) Not applicable.

(d) Changes in Internal Control Over Financial Reporting - There has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during 2005, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


Item 16A.	AUDIT COMMITTEE FINANCIAL EXPERT

Our Board of Directors has determined that Ofra Brown qualifies to serve as our audit committee financial expert as well as our external director with “financial expertise” under the Companies Law.


Item 16B.	CODE OF ETHICS

We have adopted a code of ethics that applies to our Chief Executive Officer, Chief Financial Officer, Controller and persons performing similar functions, and which complies with the rules promulgated by the SEC. We will provide to any person, without charge, upon request, a copy of the code of ethics and respond to any questions concerning the code. Requests to receive a copy of the code should be sent to us at our corporate headquarters located at 11 Gush Etzion Street, Givat Shmuel 54030, Israel, Attention: Chief Financial Officer. In addition, we have adopted a code of business conduct that applies to all of our directors, officers and employees, and which complies with the rules of the Nasdaq Capital Market (formerly the Nasdaq SmallCap Market).

The Chairman of our Audit Committee may approve a request by our Chief Executive Officer, Chief Financial Officer, Principal Accounting Officer, Controller or any person performing similar functions for a waiver from the requirements of the code of ethics pertaining to (i) honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationship; (ii) full, fair, accurate, timely and understandable disclosure in reports and documents that we must file with, or submit to, the Securities and Exchange Commission and in other public communications made by us; (iii) compliance with applicable governmental laws, rules and regulations; (iv) the prompt internal reporting of violation of the code to the Chairman of our Audit Committee; and (v) accountability for adherence to the code; provided in each case that the person requesting such waiver provides to our Audit Committee a full disclosure of the particular circumstances relating to such request. The Chairman of our Audit Committee will first determine whether a waiver of the relevant requirements of the code of ethics is required and, if such waiver is required, whether a waiver will be granted. The person requesting such waiver may be required to agree to certain conditions before a waiver or a continuing waiver is granted.

Any amendments to the code of ethics and all waivers from compliance with the code of ethics granted to the persons subject thereto have to be publicly disclosed by us as, and to the extent, required by any applicable law, rule and regulations.


Item 16C.	PRINCIPAL ACCOUNTANT FEES AND SERVICES

Audit and Audit-related Fees

The aggregate fees billed for professional services rendered to us by our principal accountants for the audit of our financial statements and for audit-related services in 2003,2004 and 2005 were $116,000, $69,000 and $73,000, respectively.

Tax Fees

The aggregate fees billed for professional services rendered to us by our principal accountants for tax compliance, tax advice and tax planning in 2003, 2004 and 2005 were $27,000, $37,000 and $18,000, respectively. The services provided to us by our principal accountants in both 2003 and 2004 are related to the preparation and filing of our tax returns with income tax authorities. In addition, in 2005 we received from our principal accountants tax advice with respect to a transfer pricing study.

All Other Fees

We did not receive from our principal accountants any other products or services, other than the services disclosed above, in 2004 and 2005.

Audit Committee Approval

In December 2005, our shareholders approved the engagement of Brightman Almagor & Co., a member of Deloitte Touche Tohmatsu, as our independent auditors for the fiscal year ended December 31, 2005. Such approval followed the approval by our board of directors and audit committee of such engagement.


Item 16D.	EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES - Not applicable

Item 16E.	REPURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFLIATED PURCHASERS – During 2003, we repurchased 26,000 shares at an average price of $1.04 per share.

PART III

Item 17.	Financial Statements

Not Applicable

Item 18.	Financial Statements

See page F-1 through F-25.

Item 19.	Exhibits


1.1	Articles of Association.*

4.1	Services Agreement with Koonras Technologies Ltd. and DBSI Investments Ltd., as assigned to them by Zeevi Computers and Technology Ltd.*.

4.2	Letter of Agreement with Microsystem Srl and all the shareholders of Microsystem Srl dated May 24, 2005, including the First Call Option Agreement, the Second Call Option Agreement, and the Put Option Agreement, and the Shareholders Agreement, all dated July 1, 2005 with Microsystem Srl and all the shareholders of Microsystem Srl.

8.1	List of subsidiaries.

12.1	Certificate of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a)

12.2	Certificate of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a)

13	Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350

14.1	Consent of Independent Public Accountants.

*	Incorporated by reference from our Registration Statement on Form F-1, File No. 333-1484, as amended, filed with the Securities and Exchange Commission on February 16, 1996.

SIGNATURES

Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant certifies that it meets all the requirements for filing on Form 20-F and has duly caused and authorized the undersigned to sign this annual report on its behalf in the City of Givat Shmuel, State of Israel, on this 29^th day of June, 2006.


CIMATRON LTD.

	By: /s/ Dan Haran

	Name: Dan Haran

	Title: President and Chief Executive Officer

CIMATRON LIMITED

CONSOLIDATED FINANCIAL STATEMENTS

TABLE OF CONTENTS


	Page


Report of Independent Registered Public Accounting Firm	F-2

Consolidated Financial Statements:

Balance Sheets as of December 31, 2005 and 2004	F-3

Statements of Operations for the years ended December 31, 2005, 2004 and 2003	F-4

Statement of Shareholders’ Equity and Comprehensive Income (Loss) for the years ended December 31, 2005, 2004 and 2003	F-5

Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003	F-6

Notes to the Consolidated Financial Statements	F-7- F-26

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of
Cimatron Limited

We have audited the accompanying consolidated balance sheets of Cimatron Limited and subsidiaries (the “Company”) as of December 31, 2005 and 2004 and the related consolidated statements of operations, shareholders’ equity and comprehensive income (loss) and cash flows for each of the three years in the period ended December 31, 2005. These consolidated 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 consolidated subsidiaries, whose revenues constitute approximately 46% of consolidated total revenues for the year ended December 31, 2003. Those financial statements were audited by other auditors, whose reports have been furnished to us, and our opinion, insofar as it relates to amounts included for those companies, is based solely on the reports of such 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. The Company is not required to have, nor were we engaged to perform, an audit of its 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, as well as evaluating the overall financial statements presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, based on our audits and the reports of the other auditors, the consolidated financial statements referred to above 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 each of the three years in the period ended December 31, 2005 in conformity with U.S. generally accepted accounting principles.

Brightman Almagor & Co.
Certified Public Accountants
A member firm of Deloitte Touche Tohmatsu

Tel-Aviv, Israel
March 12, 2006

F-2

CIMATRON LIMITED

CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)


	December 31,

	2 0 0 5			2 0 0 4

ASSETS

Current assets
Cash and cash equivalents	$	2,708		$	1,711
Short-term investments (Note 3)		2,167			6,381
Trade accounts receivable (Note 4)		4,541			6,130
Other accounts receivable and prepaid expenses (Note 5)		774			712
Inventory		62			60

Total current assets		10,252			14,994


Long-term investments (Note 3)		2,195			-


Deposits with insurance companies and severance pay funds (Note 10)		2,219			2,946


Property and equipment (Note 6)
Cost		5,321			5,478
Less - accumulated depreciation		4,325			4,405

Property and equipment, net		996			1,073


Other assets
Software development costs, net (Note 7)		193			1,204
Goodwill, net		587			587

Total other assets		780			1,791


Total assets	$	16,442		$	20,804


LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities
Short-term bank credit	$	501		$	500
Related parties		304			99
Trade payables		663			778
Other liabilities and accrued expenses (Note 8)		3,977			3,131
Deferred revenues		479			180

Total current liabilities		5,924			4,688


Long-term liabilities
Accrued severance pay (Note 9)		2,532			3,268


Minority interest		4			-


Contingent liabilities and commitments (Note 10)

Shareholders’ equity
Share capital (Note 11):
Ordinary shares of NIS 0.10 par value (Authorized - 19,950,000 shares, issued and outstanding - 8,001,270 shares at December 31, 2005 and 2004)		264			264
Additional paid-in capital		13,417			13,417
Accumulated other comprehensive loss:
Foreign currency translation adjustments		(478	)		(299	)
Unrealized loss on available for-sale securities		(202	)		(266	)
Unrealized gain on derivative instruments		(158	)		-
Accumulated deficit		(4,702	)		(109	)

		8,141			13,007
Treasury stock, at cost; 166,100 shares at December 31, 2005 and 2004		(159	)		(159	)

Total shareholders’ equity		7,982			12,848


Total liabilities and shareholders’ equity	$	16,442		$	20,804

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

F-3

CIMATRON LIMITED

CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)


	Year ended December 31,

	2 0 0 5			2 0 0 4			2 0 0 3

Revenues (Note 14a):
Products	$	8,968		$	11,370		$	10,448
Services		11,957			11,793			11,161

Total		20,925			23,163			21,609


Cost of revenues (Note 14b):
Products		3,367			2,923			3,056
Services		1,568			1,678			1,562

Total		4,935			4,601			4,618


Gross profit		15,990			18,562			16,991

Research and development expenses, net		4,815			5,554			5,210
Selling, general and administrative expenses (Note 14c)		15,650			13,962			12,645


Operating loss		(4,475	)		(954	)		(864	)

Financial income (expenses), net		(148	)		445			369
Other income		1			144			203


Loss before income taxes		(4,622	)		(365	)		(292	)

Income taxes (Note 12)		(2	)		(23	)		(9	)


Loss after income taxes		(4,624	)		(388	)		(301	)

Company’s equity in results of affiliated company		(5	)		-			-

Minority interest in results of subsidiary		36			-			-


Net loss	$	(4,593	)	$	(388	)	$	(301	)


Net loss per share (basic and diluted)	$	(0.59	)	$	(0.05	)	$	(0.04	)


Weighted average number of shares outstanding (basic and diluted)		7,835			7,835			7,838

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

F-4

CIMATRON LIMITED

STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)
(in thousands)


	Share capital		Additional paid-in capital		Accumulated other comprehensive income (loss)			Retained earnings (accumulated deficit)			Treasury stock			Comprehensive income (loss)			Total shareholders’ equity

Balance at January 1, 2003	$	264	$	13,417	$	30		$	580		$	(132	)				$	14,159
Changes during the year ended December 31, 2003:
Net loss									(301	)					(301	)		(301	)
Unrealized loss on available-for-sale securities						(97	)								(97	)		(97	)
Unrealized gain on derivative instruments						120									120			120
Foreign currency translation adjustment						(333	)								(333	)		(333	)
Investment in treasury stock												(27	)					(27	)

Total comprehensive loss														$	(611	)

Balance at December 31, 2003		264		13,417		(280	)		279			(159	)					13,521

Changes during the year ended December 31, 2004:
Net loss									(388	)					(388	)		(388	)
Unrealized loss on available-for-sale securities						(222	)								(222	)		(222	)
Unrealized loss on derivative instruments						(174	)								(174	)		(174	)
Foreign currency translation adjustment						111									111			111

Total comprehensive loss														$	(673	)

Balance at December 31, 2004		264		13,417		(565	)		(109	)		(159	)					12,848

Changes during the year ended December 31, 2005:
Net loss									(4,593	)					(4,593	)		(4,593	)
Unrealized loss on available-for-sale securities						64									64			64
Unrealized loss on derivative instruments						(158	)								(158	)		(158	)
Foreign currency translation adjustment						(179	)								(179	)		(179	)

Total comprehensive loss														$	(4,866	)

Balance at December 31, 2005	$	264	$	13,417	$	(838	)	$	(4,702	)	$	(159	)				$	7,982

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

F-5

CIMATRON LIMITED

CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)


	Year ended December 31,

	2 0 0 5			2 0 0 4			2 0 0 3


CASH FLOWS - OPERATING ACTIVITIES

Net loss	$	(4,593	)	$	(388	)	$	(301	)

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		1,676			820			859
Increase (decrease) in accrued severance pay		(736	)		(179	)		473
Gain from sale of property and equipment, net		(13	)		(71	)		(2	)
Loss (gain) from sale and devaluation (revaluation) of bonds and funds		284			(2	)		58
Company’s equity in results of affiliated company		5			-			-
Minority interest in results of subsidiary		(36	)		-			-

Changes in assets and liabilities:
Decrease (increase) in accounts receivable and prepaid expenses		1,354			(416	)		855
Decrease (increase) in inventory		(11	)		13			19
Decrease (increase) in deposits with insurance companies and severance pay fund		727			99			(407	)
Increase in debts to related parties		205			2			13
Increase (decrease) in trade payables, accrued expenses and other liabilities		935			(797	)		(115	)

Net cash provided by (used in) operating activities		(203	)		(919	)		1,452


CASH FLOWS - INVESTING ACTIVITIES
Investment in bonds		(250	)		(577	)		(3,138	)
Proceeds from sale and redemption of bonds		2,935			334			642
Purchase of property and equipment		(429	)		(505	)		(538	)
Proceeds from sale of property and equipment		27			221			44
Acquisition of affiliated companies		(891	)		-			43
Capitalization of software development costs		(193	)		-			-
Acquisition of newly consolidated subsidiary		40			-			-

Net cash provided by (used in) investing activities		1,239			(527	)		(2,947	)


CASH FLOWS - FINANCING ACTIVITIES
Short-term bank credit		-			-			500
Investment in treasury stock		-			-			(27	)

Net cash provided by financing activities		-			-			473


Net increase (decrease) in cash and cash equivalents		1,036			(1,446	)		(1,022	)
Effect of exchange rate changes on cash		(39	)		33			69
Cash and cash equivalents at beginning of year		1,711			3,124			4,077

Cash and cash equivalents at end of year	$	2,708		$	1,711		$	3,124


Supplemental information:
Cash paid during the year for income taxes	$	29		$	173		$	25


Appendix A - Non-cash transactions

Purchase of property on credit	$	36		$	38		$	28

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

F-6

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 1 –	GENERAL

	Cimatron Limited (“the Company”) designs, develops, manufactures, markets and supports a family of modular CAD/CAM software products which offer integrated design-through-manufacturing solutions for small to medium-sized companies. The Company’s products have been sold to end-users in numerous industries, including automotive, aviation and aerospace, household goods, mold and die making, machinery and tools, and telecommunications. The Company markets its line of products through distributors and through its subsidiaries located in different countries.

NOTE 2 –	SIGNIFICANT ACCOUNTING POLICIES

	The financial statements are prepared in conformity with U.S. generally accepted accounting principles (“GAAP”).

	A.	Use of estimates in preparation of financial statements

		The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions in determining the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

	B.	Financial statements in U.S. dollars

		The reporting currency of the Company is the U.S. dollar (“dollar”).

		The dollar is the functional currency of the Company and its subsidiaries in the United States and Canada. Transactions and balances originally denominated in dollars are presented at their original amounts. Non-dollar transactions and balances are remeasured into dollars in accordance with the principles set forth in Statement of Financial Accounting Standards (“SFAS”) No. 52 “Foreign Currency Translation” (“SFAS No. 52”). All exchange gains and losses from remeasurement of monetary balance sheet items resulting from transactions in non-dollar currencies are recorded in the statement of operations as they arise.

		The financial statements of certain subsidiaries whose functional currency is other than the dollar are translated into dollars in accordance with the principles set forth in SFAS No. 52. Assets and liabilities have been translated at year-end exchange rates; results of operations have been translated at average exchange rates. The translation adjustments have been reported as a separate component of shareholders’ equity.

	C.	Principles of consolidation

		The consolidated financial statements include the financial statements of the Company and all of its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

	D.	Cash and cash equivalents

		Cash equivalents consist of short-term, highly liquid investments that are readily convertible into cash with original maturities of three months or less.

F-7

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 2 –	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	E.	Marketable debt securities

		The Company accounts for its investments in marketable securities in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”).

		Management determines the appropriate classification of the Company’s investments in marketable debt securities at the time of purchase and reevaluates such determinations at each balance sheet date. Debt securities for which the Company does not have the intent or ability to hold to maturity are classified as available-for-sale.

		As of December 31, 2005 and 2004 all marketable debt securities are designated as available-for-sale and accordingly are stated at fair value, with the unrealized gains and losses reported in shareholders’ equity under accumulated other comprehensive income (loss). Realized gains and losses on sales of investments, as determined on a specific identification basis, are included in the consolidated statement of operations.

	F.	Fair value of financial instruments

		The financial instruments of the Company consist mainly of cash and cash equivalents, short-term investments, current and non-current accounts receivable, accounts payable and long-term liabilities. In view of their nature, the fair value of the financial instruments included in working capital of the Company is usually identical or close to their carrying amounts.

	G.	Concentrations on credit risk

		Financial instruments which potentially subject the Company to concentration of credit risk consist principally of cash and cash equivalents, and accounts receivable. The Company’s cash and cash equivalents are invested primarily in deposits with major banks worldwide. Management believes that the financial institutions that hold the Company’s investments are financially sound, and accordingly, minimal credit risk exists with respect to these investments. The Company’s trade receivables are derived from sales to customers located primarily in the U.S., Europe, Asia and Israel. The allowance for doubtful accounts is provided with respect to all balances deemed doubtful of collection.

	H.	Allowance for doubtful accounts

		The allowance for doubtful accounts is computed on the specific identification basis for accounts, the collection of which, in management’s estimation, is doubtful.

	I.	Inventory

		Inventory is presented at the lower of cost or market. Cost is determined by the “first in, first out” method.

F-8

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 2 –	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	J.	Property and equipment

		Property and equipment are stated at cost. Depreciation is computed using the “straight-line” method, over the estimated useful life of assets, as follows:

		Computers and software	3	years
		Furniture and office equipment	6.5 - 16.5	years
		Vehicles	6.5	years

		Leasehold improvements are amortized over the shorter of the life of the respective lease or the service life of the improvements.

	K.	Impairment of long-lived assets

		The Company regularly reviews whether facts and circumstances exist which indicate that the carrying amount of assets may not be recoverable. The Company assesses the recoverability of the carrying amount of its long-lived assets based on expected undiscounted cash flows. If an asset’s carrying amount is determined to be not recoverable, the Company recognizes an impairment loss based upon the difference between the carrying amount and the fair value of such assets, in accordance with SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”).

	L.	Software development costs

		The Company capitalized certain software development costs in accordance with SFAS No. 86 “Accounting for Costs of Computer Software to be Sold, Leased or Otherwise Marketed”. Capitalization of software development costs begins upon the establishment of technological feasibility and continues up to the time the software is available for general release to customers, at which time capitalized software costs are amortized to product development expenses on the “straight-line” basis over the expected life of the related product which is greater than the ratio that current gross revenues for a product bear to the total of current and anticipated future gross revenues, generally five years.

		Management periodically reviews the carrying amount of capitalized software development costs, and if impairment is determined to have occurred, the Company writes off the respective carrying amount to expenses. Management believes that future revenues related to capitalized software development costs will be sufficient to realize the carrying amounts of such costs at December 31, 2005 and, as such, these amounts will be recovered over the lives of the related projects. The estimates of anticipated future revenues and remaining useful life of the Company’s products are subject to risk inherent in the software industry, such as changes in technology and customer perceptions.

F-9

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 2 –	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	M.	Stock-based -Compensation

		The Company accounts for employee stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”) and in accordance with FASB Interpretation No. 44. Pursuant to these accounting pronouncements, the Company records compensation for stock options granted to employees over the vesting period of the options based on the difference, if any, between the exercise price of the options and the market price of the underlying shares at the date of grant.

		Deferred compensation is amortized to compensation expense over the vesting period of the options.

		Had compensation cost for the Company’s option plans been determined on the basis of the fair value at the grant dates in accordance with the provisions of SFAS No. 123 “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148 “Accounting for Stock-Based compensation” (“SFAS No. 148”), the Company’s pro forma net loss and pro forma basic and diluted net loss per share would have been as follows:


	Year ended December 31,

	2 0 0 5			2 0 0 4			2 0 0 3

Pro forma net loss:
Net loss for the year, as reported	$	(4,593	)	$	(388	)	$	(301	)
Deduct - stock-based compensation determined under APB 25		-			-			-
Add - stock-based compensation determined under SFAS 123		(77	)		(70	)		(90	)

	$	(4,670	)	$	(458	)	$	(391	)


Pro forma basic and diluted loss per share:
As reported	$	(0.59	)	$	(0.05	)	$	(0.04	)


Pro forma	$	(0.60	)	$	(0.06	)	$	(0.05	)

F-10

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 2 –	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	M.	Stock-based compensation (Cont.)

		Data in respect of the stock option plans

		For purposes of estimating fair value in accordance with SFAS No. 123, the Company utilized the Black-Scholes option-pricing model. The following assumptions were used for grants in 2003 and 2005, respectively: a dividend yield of 0.0% for both years ; weighted average expected volatility of 96% and 51%; weighted average risk-free interest rates of 3.3% and 3.5%; and weighted average expected lives of 4 years and 6 years. No grants were made in 2004.

		Because additional option grants are expected to be made each year, and due to the factors described above, the above proforma disclosures are not necessarily representative of proforma effects of reported net income for future years.

	N.	Revenue recognition

		The Company recognizes revenues in accordance with the American Institute of Certified Public Accountants (“AICPA”) Statement of Position 97-2, “Software Revenue Recognition”, as amended.

		Revenues from software license fees are recognized when persuasive evidence of an arrangement exists, the software product covered by written agreement or a purchase order signed by the customer has been delivered, the license fees are fixed and determinable and collection of the license fees is considered probable. When software arrangements involve multiple elements the Company allocates revenue to each element based on the relative fair values of the elements. The Company’s determination of fair value of each element in multiple element arrangements is based on vendor-specific objective evidence (“VSOE”). The Company limits its assessment of VSOE for each element to the price charged when the same element is sold separately.

		Service revenues include consulting services, post-contract customer support and training. Consulting revenues are generally recognized on a time and material basis. Software maintenance agreements provide technical customer support and the right to unspecified upgrades on an if-and-when-available basis. Post-contract customer support revenues are recognized ratably over the term of the support period (generally one year) and training and other service revenues are recognized as the related services are provided. Deferred revenues represent mainly amounts received on account of service agreements.

		The Company has no significant expenditures relating to either warranties or post-contract customer support bundled with the initial sale of the software license and, therefore, no provision in respect thereof is included in the financial statements.

		The Company’s sales are made pursuant to standard purchase orders, containing payment terms ranging between 30 - 120 days. For some customers with whom the Company has long-standing relationships and based on past experience with those customers and the same software products, the Company may grant payment terms of not over 180 days. Any payment terms that are above 180 days must be approved by the Company’s Chief Financial Officer, prior to signing any purchase order.

F-11

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 2 –	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	N.	Revenue recognition (Cont.)

		The Company’s arrangements do not include any refund provisions nor are payments subject to milestones. In addition, the Company’s arrangements do not contain customer acceptance provisions.

	O.	Research and development costs

		Research and development costs are expensed as incurred.

	P.	Advertising costs

		Advertising costs are charged to expenses, as incurred.

	Q.	Deferred income taxes

		Deferred income taxes are provided for temporary differences between the assets and liabilities, as measured in the financial statements and for tax purposes, at the tax rates expected to be in effect when these differences reverse, in accordance with SFAS No. 109 “Accounting for Income Taxes” (“SFAS No. 109”).

	R.	Net loss per ordinary share

		Basic and diluted net loss per share have been computed in accordance with SFAS No. 128 “Earning per Share” using the weighted average number of ordinary shares outstanding. Basic loss per share excludes any dilutive effect of options and warrants. A total of 0, 12,000 and 3,000 incremental shares were excluded from the calculation of diluted net loss per ordinary share for 2005, 2004 and 2003, respectively due to the anti-dilutive effect.

	S.	Derivative financial instruments

		The Company’s primary objective for holding derivative financial instruments is to manage mainly currency market risks. The Company transacts business in various currencies other than the U.S. dollar, primarily the Euro and NIS. The Company has established forecasted transaction risk management programs to protect against volatility of future cash flows caused by changes in exchange rates. It uses currency forward contracts and currency options in these risk management programs. These programs reduce, but do not always entirely eliminate, the impact of currency exchange movements.

		In accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended, the Company recognizes all derivative instruments as either assets or liabilities on the balance sheet at fair value. Fair values of currency forward contracts and currency options are based on quoted market prices or pricing models using current market rates. The accounting for gains or losses from changes in fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship as well as on the type of hedging relationship.

F-12

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 2 –	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	S.	Derivative financial instruments (Cont.)

		The Company’s accounting policies for these instruments are based on whether they meet the criteria for designation as hedging transactions, either as cash flow or fair value hedges. The criteria for designating a derivative as a hedge include the instrument’s effectiveness in risk reduction and one-to-one matching for the derivative instrument to its underlying transaction. Gains and losses on derivatives that are not designated as hedges for accounting purposes are recognized currently in earnings, and generally offset changes in the value of assets and liabilities.

		The Company’s outstanding derivative instruments as of the balance sheet date are included in other receivables and other accrued liabilities.

		Currency forward contracts and currency options, which generally expire within 12 months and are used to hedge exposures to variability in expected future foreign-denominated cash flows, are designated as cash flows hedges. For these derivatives, the effective portion of the gain or loss is reported as a component of other comprehensive income in shareholders’ equity and is reclassified into earnings in the same period or periods during which the hedged transaction affects earnings, and within the same income statement line item.

		The ineffective portion of the gain or loss on the derivative in excess of the cumulative change in the present or future cash flows of the hedged item, if any, is recognized in financial income (expenses) net during the period of change.

		The carrying amount of foreign currency forward contracts and foreign currency options outstanding at December 31, 2005 and 2004 is $154 and $154, respectively. As of the balance sheet dates, the fair value of these contracts approximates their carrying amount.

	T.	Recently issued accounting pronouncements

		In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123(R). SFAS No. 123(R) requires employee share-based equity awards to be accounted for under the fair value method, and eliminates the ability to account for these instruments under the intrinsic value method prescribed by APB Opinion No. 25 and allowed under the original provisions of SFAS No. 123. SFAS No. 123(R) requires the use of an option pricing model for estimating fair value, which is then amortized to expense over the service periods. Had the Company adopted SFAS 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net income and income per share above. SFAS No. 123(R) allows for either prospective recognition of compensation expense or retrospective recognition. In the first quarter of 2006, the Company began to apply the prospective recognition method and implemented the provisions of SFAS No. 123(R). In January 2005, the SEC issued SAB No. 107, which provides supplemental implementation guidance for SFAS No. 123(R). SFAS No. 123(R) will be effective for the Company beginning in the first quarter of fiscal 2006.

F-13

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 2 –	SIGNIFICANT ACCOUNTING POLICIES (Cont.)

	T.	Recently issued accounting pronouncements

		In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections.” SFAS No. 154 replaces APB Opinion No. 20. “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. The Company does not expect the adoption of SFAS No. 154 will have any material impact on its consolidated financial statements.

		In November 2005, the FASB issued FSP FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP 115-1 and 124-1”), which clarifies when an investment is considered impaired, whether the impairment is other than temporary, and the measurement of an impairment loss. It also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP 115-1 and 124-1 are effective for all reporting periods beginning after December 15, 2005. At December 31, 2005, the Company had no unrealized investment losses that had not been recognized as other-than-temporary impairments in its available-for-sale securities. The Company does not anticipate that the implementation of these pronouncements will have a significant impact on its financial position or results of operations.

NOTE 3 –	SHORT-TERM AND LONG-TERM INVESTMENTS

	A.	Short-term investments


	December 31,

	2 0 0 5		2 0 0 4

Comprised as follows:
Marketable securities - Corporate bonds	$	2,167	$	6,381


	B.	Long-term investments


	December 31,

	2 0 0 5		2 0 0 4

Comprised as follows:
Marketable securities - Corporate bonds (1)	$	1,309	$	-

Investment in affiliated companies:
Microsystem Srl (2)		870		-
Other		16		-

		886		-

	$	2,195	$	-

F-14

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 3 –	SHORT-TERM AND LONG-TERM INVESTMENTS (Cont.)

	B.	Long-term investments (Cont.)

		(1)	Comprised of structured bonds, which are debt instruments whose cash flows are linked to the movement in interest rates. The structured notes were issued by financial institutions. The notes typically contain embedded option components such as caps, calls, and floors. Contractual cash flows for principal from such structured notes can vary in timing throughout the life of the structured notes. Interest income resulting from investment in structured notes is accounted for based on the guidance provided in EITF No. 96-12, “Recognition of Interest Income and Balance Sheet Classification of Structured Notes”. Under this guidance the retrospective method is used for recognizing interest income.

		(2)	In July 2005, the Company completed the acquisition of 27.5% of the share capital of Microsystem Srl, its Italian distributor, for a consideration of $694. The Company has an option (First Call Option) to acquire up to additional 23.5% of Microsystem’s share capital until June 30, 2007, for an additional consideration of approximately $600. If the Company exercises the First Call Option, it will have a second option (Second Call Option), at any time within a thirty days period (Second Exercise Period) starting at the expiration of twelve months from the exercise of the First Call Option to acquire up to the remaining 49% of Microsystem’s share capital, for an additional consideration of approximately $1,250. If the Company exercises the First Call Option, the then remaining other shareholders of Microsystem will have an option to sell to the Company at any time during the Second Exercise Period 49% of Microsystem’s share capital, for a consideration of approximately $1,250.

			The Company’s investment in Microsystem is comprised as follows:


	December 31,

	2 0 0 5


Cost (including related expenses)	$	878
Equity in earnings		(5	)
Translation adjustments		2

	$	870


		Aggregate maturities of marketable securities are as follows:


	December 31,

	2 0 0 5


Eight years	$	1,068
Thirteen years		241

	$	1,309


	C.	As of December 31, 2005 and 2004 all the investments in marketable securities are classified in accordance with SFAS No. 115 as available-for-sale.
		Unrealized gain (loss) on available-for-sale securities of $64 and $(222) for the year ended December 31, 2005 and 2004, respectively, were recorded in other comprehensive loss.

F-15

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 4 –	TRADE ACCOUNTS RECEIVABLE


	December 31,

	2 0 0 5			2 0 0 4


Accounts receivable	$	6,235		$	7,447
Less - allowance for doubtful accounts		(1,694	)		(1,317	)

	$	4,541		$	6,130


NOTE 5 –	OTHER ACCOUNTS RECEIVABLE AND PREPAID EXPENSES


	December 31,

	2 0 0 5		2 0 0 4


Prepaid expenses		241		346
Derivative instruments		5		-
Interest receivable		66		113
Other		462		253

	$	774	$	712


NOTE 6 –	PROPERTY AND EQUIPMENT


	December 31,

	2 0 0 5		2 0 0 4

Cost:
Computers and software	$	3,940	$	3,965
Office furniture and equipment		926		961
Vehicles		-		103
Leasehold improvements		455		449

		5,321		5,478

Accumulated depreciation:
Computers and software		3,373		3,395
Office furniture and equipment		660		688
Vehicles		-		96
Leasehold improvements		292		226

		4,325		4,405


Property and equipment, net	$	996	$	1,073

F-16

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 7 –	SOFTWARE DEVELOPMENT COSTS, NET


	December 31,

	2 0 0 5			2 0 0 4


Capitalized software development costs	$	9,353		$	9,160
Government grants		(3,495	)		(3,495	)
Accumulated amortization (*)		(5,665	)		(4,461	)

	$	193		$	1,204


	(*)	All capitalized modules were amortized over six years. Beginning with 2006, all capitalized modules will be amortized over five years.

		Amortization expenses for the years ended December 31, 2005, 2004 and 2003, were $401, $401 and $402, respectively, and were charged to operations.

		The Company released its newest version of Cimatron E (Version 7.0) (“Cimatron E7”) in August 2005. Cimatron E7 was developed on the basis of advanced technology and infrastructure that replaced the infrastructure of the older versions, and includes new elements that did not exist in older versions.
		During the fourth quarter of 2005 the Company evaluated its capitalized software costs and wrote off all the net balance of capitalized costs related to its older products in the amount of $803, and capitalized $193 of costs related to the development of Cimatron E7.

NOTE 8 –	ACCRUED EXPENSES AND OTHER LIABILITIES


	December 31,

	2 0 0 5		2 0 0 4


Employees and related liabilities	$	1,951	$	1,831
Derivative instruments		158		154
Accrued expenses		994		623
Accrued royalties		718		367
Taxes to government institutions		154		156
Others		2		-

	$	3,977	$	3,131

F-17

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 9 –	ACCRUED SEVERANCE PAY (DEPOSITS WITH INSURANCE COMPANIES AND SEVERANCE PAY FUNDS)

	The Company’s liability for severance pay is calculated pursuant to Israeli severance pay law based on the most recent salary of the employee multiplied by the number of years of employment as of the balance sheet date. Employees are entitled to one month’s salary for each year of employment or a portion thereof.

	The Company’s liability for all of its employees is funded by monthly deposits with severance pay funds and insurance policies. An accrual is set up for any unfunded amount.
	The deposited funds include profits accumulated up to the balance sheet date. The deposited funds may be withdrawn only upon the fulfillment of the obligation pursuant to Israeli severance pay law or labor agreements. The value of the deposited funds is based on the cash surrender value of the policies.

NOTE 10 –	CONTINGENT LIABILITIES AND COMMITMENTS

	A.	In consideration of grants by the Chief Scientist of the Ministry of Industry and Trade of the Government of Israel (the “Chief Scientist”), the Company is obligated to pay the Chief Scientist, in respect of awarded grants, royalties of 3.5% of sales of products developed with funds provided by the Chief Scientist, until the dollar-linked amount is equal to 100% of the grants payments received by the Company plus Libor interest rate (the Libor interest rate applies to grants received since January 1999). The Company’s contingent liability as of December 31, 2005 is approximately $3,000 contingent upon the Company generating revenues from sales of products developed with funds provided by the Chief Scientist.

		The Company believes that the majority of products that it has sold since January 1, 2005 are not based on technology developed with funds provided by the OCS and that, accordingly, such sales should not be subject to the payment of royalties to the OCS. Therefore, the royalty reports that the Company submitted to the OCS for the period starting January 1, 2005 and thereafter have reflected significantly reduced royalty obligations in comparison to its royalty reports for the years prior to 2005. In addition, during the second half of 2005 the Company initiated a process with the OCS in an attempt to obtain the agreement of the OCS with its position and to the cessation of its obligation to pay future royalties. Although the Company believes it has strong arguments to support its position, the Company accrued royalty expenses in its financial reports for the periods from January 1^st, 2005 to December 31^st, 2005, but has not paid to the OCS any royalties associated with the products mentioned above.

	B.	Regarding commitments in respect of the “Approved Enterprise”, see Note 13a.

	C.	In consideration of grants received from the Fund for the Encouragement of Overseas Marketing of the Israeli Government’s Ministry of Industry and Trade (the “Fund”), the Company is obligated to pay the Fund royalties amounting to 3% to 4% of the incremental exports, up to a maximum of 100% of the grants received.
		The Company’s contingent liability as of December 31, 2005 is $558, contingent upon the Company’s incremental exports.

F-18

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 10 –	CONTINGENT LIABILITIES AND COMMITMENTS (Cont.)

	D.	The Company uses technology in respect of which it is obligated to pay minimum annual royalties in the amount of $774, until 2007.

	E.	Lease commitments

		The premises of the Company and its subsidiaries are leased under various operating lease agreements, which expire on various dates.
		Rent expenses for the years ended December 31, 2005, 2004 and 2003, were approximately $627, $661 and $722, respectively.
		The Company leases its motor vehicles under cancelable operating lease agreements for periods through 2008.
		The minimum payment under these operating leases, upon cancellation of these lease agreements, amounted to $722 as of December 31, 2005.

		Future minimum lease commitments under operating leases as of December 31, 2005 are as follows:


Year ended December 31,
2006	$	1,145
2007		875
2008		625
2009		121
2010 and thereafter		-

	$	2,766


	F.	Legal claim

		In April 2004, Omega – Adem Technologies Ltd., an Israeli privately held company engaged in the development of software, filed a lawsuit against Cimatron, claiming that Cimatron caused four employees of the plaintiff located in Russia to terminate their employment with the plaintiff and join Cimatron. During a period of two years (until March 2003), the plaintiff provided certain services to Cimatron. The four employees were among several employees who provided such services to Cimatron. The plaintiff claimed, among other things, that Cimatron undertook not to employ Omega’s employees after the termination of the project Omega performed for Cimatron. The plaintiff requested the District Court in Tel Aviv, Israel to grant an injunction and a permanent order that would prevent Cimatron from hiring the four employees. In June, 2004, the court rejected the plaintiff’s request for an injunction. However, in September 2004, Omega initiated arbitration proceedings against Cimatron pursuant to the services agreement between the parties and submitted to an arbitrator agreed upon between the parties a statement of claim for an amount of $20,000,000 for damages caused to Omega due to the employment of the four employees in question. In November 2004, Cimatron submitted a statement of defense denying all of Omega’s claims and asserting, among other things, that Cimatron engaged the -employees only following the expiration of a year following the conclusion of Cimatron’s relationship with Omega and that Cimatron therefore was allowed to do so. On October 11, 2005 Omega submitted affidavits and on January 25, 2006 the Company submitted its affidavits. The parties have submitted a joint request to the District Court seeking to dismiss the request for an injunction. Cimatron believes that there is no merit to the claim and intends to oppose it vigorously, but nevertheless accrued in the fourth quarter of 2005 an amount of $250,000 for this claim.

F-19

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 11 –	SHAREHOLDERS’ EQUITY

	A.	Share issuance

		The Company’s shares are traded in the United States and are listed on the Nasdaq SmallCap Market.

	B.	Share Option Plans

		In January 1996, the Company’s Board of Directors adopted a share option plan (the “1996 Share Option Plan”) pursuant to which 316,000 Ordinary Shares were reserved for issuance upon the exercise of options to be granted to directors, officers, employees and consultants of the Company. The 1996 Share Option Plan is administrated by a committee of the Board, which designates the optionees and dates of grant.
		The exercise price of an option granted under the 1996 Share Option Plan may be no less than 85% of the fair market value of an Ordinary Share, as determined by that committee on the date that the option is granted. The options are for a 10-year term and are non-assignable except by the laws of inheritance.
		The option committee has the authority to amend the terms of option grants, provided that any such amendment is in the best interest of the grantees. In March and April 2000, options to purchase 39,750 shares were exercised. As of December 31, 2005, options to purchase 21,000 of such shares were outstanding. All of these options were originally granted with an exercise price of $8.00 per share. In January, 1998, the Board of Directors amended the exercise price of such options to $5.00 per share.
		These outstanding options are, subject to the continued employment of each employee, exercisable commencing two years after the date of grant at a rate of 25% per year. The grantee is responsible for all personal tax consequences of the grant and the exercise thereof.

		In April 1998, the Board of Directors adopted an additional share option plan (the “1998 Share Option Plan”) pursuant to which 620,000 Ordinary Shares were reserved for issuance upon the exercise of options to be granted to directors, officers, employees and consultants of the Company. The 1998 Share Option Plan is administrated by a committee of the Board, which designates the optionees and dates of grant. The exercise price of an option granted under the 1998 Share Option Plan may be no less than 85% of the fair market value of an Ordinary Share, as determined by that committee on the date that the option is granted. Options granted vest over a period determined by the option committee, terminate three years after they become exercisable, and are non-assignable except by the laws of inheritance. The option committee has the authority to amend the terms of option grants, provided that any such amendment is in the best interest of the grantee.

		As of December 31, 2005, options to purchase 19,750 of such shares were outstanding at a price of $4.00 per share under the 1998 Share Option Plan. These options are exercisable commencing two years after the date of grant at a rate of 25% per year, subject to the continued employment of each employee. The grantee will be responsible for all personal tax consequences of the grant and the exercise thereof.

F-20

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 11 –	SHAREHOLDERS’ EQUITY (Cont.)

	B.	Share Option Plan (Cont.)

		In October 1999, the option committee approved the grant of options to purchase 160,000 of the Company’s shares at a price of $2.00 per share to the former president and CEO of the Company. All such options expired unexercised in 2005.

		In March 2000, the option committee adopted new guidelines for the options to purchase Ordinary Shares reserved for issuance under both the 1996 Share Option Plan and the 1998 Share Option Plan upon the exercise of options to be granted to directors, officers, employees and consultants of the Company. Such options are exercisable commencing two years after the date of grant at a rate of 50% on the second anniversary of the date of grant and 25% in each of the following two years, subject to the continued employment of each employee. As of December 31, 2005, options to purchase 45,500 of such shares were outstanding at a price of $4.50 per share.

		In August 2003 the Company’s Board of Directors approved the grant of options to purchase 150,000 of the Company’s shares at a price of $2.50 per share to two officers in the Company. These options are exercisable commencing one year after the date of grant at a rate of 25%-33.3% per year, subject to the continued employment of the officers. 50,000 of such options were outstanding at December 31, 2005.

		In October 2004, the Board of Directors adopted an additional share option plan (the “2004 Share Option Plan”) pursuant to which 240,000 Ordinary Shares were reserved for issuance upon the exercise of options to be granted to directors, officers, employees and consultants of the Company. The exercise price of an option granted under the Share Option Plan may be no less than 100% of the fair market value of an Ordinary Share, as determined by that committee on the date that the option is granted. The options may be exercised over a 10-year term unless determined otherwise by the Board. The grantees will be responsible for all personal tax consequences of the grant and the exercise thereof. In February 2005, 238,500 of such options were granted to employees of the Company at an exercise price of $2.20 per share, and in August 2005, the board of directors approved the grant of 32,000 of such options at an exercise price of $2.00 per share to the Company’s Chief Executive Officer. 239,500 of such options were outstanding at December 31, 2005. In December 2005 our Board of Directors increased the 2004 Share Option Plan reserve by an additional 250,000 shares. The Company intends to grant additional options under the 2004 Share Option Plan to various directors, executive officers and employees of the Company.

		At December 31, 2005 options to purchase 255,000, 329,000 and 250,500 of Company shares were available for grants to directors, officers, employees and consultants of the Company under the 1996, 1998 and 2004 Share Option Plans, respectively.

F-21

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 11 –	SHAREHOLDERS’ EQUITY (Cont.)

	B.	Share Option Plan (Cont.)

		A summary of the status of the Company’s stock option plan as of December 31, 2005, 2004 and 2003, and changes during the years ending on those dates, is presented below:


	Year ended December 31,

	2 0 0 5					2 0 0 4					2 0 0 3

	(in thousands)

	Shares			Weighted average exercise price		Shares			Weighted average exercise price		Shares			Weighted average exercise price

Outstanding at beginning of year		488,250		$	3.04		635,000		$	3.33		520,000		$	3.62
Granted		270,500		$	2.18		-			-		150,000		$	2.50
Exercised		-			-		-			-		-			-
Cancelled		(383,000	)	$	2.72		(146,750	)	$	4.28		(35,000	)	$	4.07

Outstanding at year end		375,750		$	2.75		488,250		$	3.04		635,000		$	3.33

Options exercisable at year end		111,250		$	4.06		392,417		$	3.18		473,160		$	3.56

Weighted average fair value of options granted during the year	$	0.88					-				$	1.11


		The following table summarizes information about stock options outstanding at December 31, 2005:


	Options outstanding						Option exercisable

Range of exercise prices	Number of shares outstanding at December 31, 2005		Weighted average remaining contractual life (years)		Weighted average exercise price		Number of shares exercisable at December 31, 2005		Weighted average exercise price

$2.00 to $3.00		289,500		9.3	$	2.23		25,000	$	2.50
$3.01 to $4.00		19,750		0.85	$	4.00		19,750	$	4.00
$4.01 to $5.00		66,500		1.68	$	4.66		66,500	$	4.66

		375,750						111,250

F-22

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 12 –	INCOME TAXES

	A.	The Law for Encouragement of Capital Investments, 1959 (hereafter: “the law”)

		Since 1994, the Company’s operations have “approved enterprise” status under the law. Reduced tax rates apply to the Company’s income from the approved enterprise (which is determined in accordance with the increase in the Company’s revenue during the first year of its having the abovementioned status as compared to the year before).

		In April 2001 the Company was granted “approved enterprise” status, subject to the following terms:
		Tax exemption for 2 years, commencing in the first year the Company generates taxable income. For the remainder of the benefit period - 5 years - a reduced tax rate of 25%.
		The period of tax benefits for this approved enterprise will expire in 2015 or earlier, depending on whether the Company generates taxable income from this approved enterprise.

		Income derived from sources other than “approved enterprise” is taxable at the ordinary corporate tax rate. On July 25, 2005 an amendment to the Israeli tax law was approved by the Israeli parliament, which reduces the tax rates imposed on Israeli companies to 31% for 2006. This amendment states that the corporate tax rate will be further reduced in subsequent tax years as follows: in 2007 29%, in 2008 27%, in 2009 26% and thereafter 25%. This change does not have a material effect on the Company’s financial statements.

		In the event of a distribution of cash dividends to shareholders of earnings subject to the exemption, the Company will be liable to tax at a rate of 25%. The Company has not provided deferred taxes on future distributions of tax-exempt earnings, as management and the Board of Directors have determined not to make any distribution that may result in a tax liability for the Company. Accordingly, such earnings have been considered to be permanently reinvested. The tax-exempt earnings may be distributed to shareholders without subjecting the Company to taxes only upon a complete liquidation of the Company.

		The tax benefits and grants described above are subject to fulfillment of the conditions stipulated by the Law for Encouragement of Capital Investments, 1959, as amended, the regulations promulgated thereunder and the criteria set forth in the certificate of approval. The entitlement to the benefits is subject to completion and final approval by the Investment Center, such approval being subject to fulfillment of all terms of the approved program. In the event of failure by an enterprise to comply with these conditions, the tax benefits could be cancelled, in whole or in part, and the enterprise would be required to refund the amount of cancelled benefits, including interest.
		The completion of the Company’s first, second and third approved enterprises has received final approval by the Investment Center.

F-23

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 12 –	INCOME TAXES (Cont.)

	B.	Comprised as follows:


	Year ended December 31,

	2 0 0 5			2 0 0 4			2 0 0 3


Income (loss) before taxes on income:
Israel	$	(3,285	)	$	807		$	1,611
Non-Israeli		(1,337	)		(1,172	)		(1,903	)

	$	(4,622	)	$	(365	)	$	(292	)


Current taxes	$	(2	)	$	(12	)	$	(9	)
Tax in respect of prior years		-			(11	)		-

	$	(2	)	$	(23	)	$	(9	)


	C.	Deferred tax assets (liabilities), consist of the following:


	December 31,

	2 0 0 5			2 0 0 4


Deferred tax assets:
Loss carryforwards	$	5,838		$	4,251
Other cumulative temporary differences, net		223			666

		6,061			4,917

Deferred tax liabilities:
Software development costs		(66	)		(361	)


Valuation allowance		(5,995	)		(4,556	)



Deferred tax, net	$	-		$	-


		In accordance with SFAS No. 109, deferred tax assets are to be recognized for the anticipated tax benefits associated with net operating loss carryforwards, and deductible temporary differences, unless it is more likely than not that some or all of the deferred tax assets will not be realized. The adjustment is made through a valuation allowance.

		Since the realization of the net operating loss carryforwards and deductible temporary differences of the Company and the subsidiaries is less than likely, a valuation allowance has been established for the amounts of the related tax benefits.

F-24

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 12 –	INCOME TAXES (Cont.)

		As of December 31, 2005, the Company has approximately $5,894 of Israeli net operating loss carryforwards. The Israeli loss carryforwards have no expiration date.

		Tax loss carryforwards of a U.S. subsidiary totaling $6,759 expire between 2011 and 2023.

	D.	Under the Income Tax Law (Adjustments for Inflation) 1985, income for tax purposes is measured in terms of earnings in NIS, adjusted for the changes in the C.P.I. Following is a reconciliation of income taxes calculated at the statutory tax rate in Israel to the actual income tax in the financial statements:


	Year ended December 31,

	2 0 0 5			2 0 0 4			2 0 0 3


Loss before income taxes as reported in the consolidated statements of operations	$	(4,622	)	$	(365	)	$	(292	)
Statutory tax rate		34	%		35	%		36	%
Income taxes under statutory tax rate	$	(1,571	)	$	(128	)	$	(105	)

Increase (decrease) in taxes:
Disallowed deductions, net		278			41			44
Tax in respect of prior year		-			11			-
Increase in valuation allowance		1,439			99			70
Other		(144	)		-			-

Income taxes in the statements of operations	$	2		$	23		$	9


	E.	Tax assessments

		The Company has been issued final tax assessments by the Israeli income tax authorities through tax year ended December 31, 2000.
		Certain subsidiaries of the Company received tax assessments through the tax year ended December 31, 2004.

NOTE 13 –	TRANSACTIONS WITH RELATED PARTIES

	A.	In February 2002, Koonras Technologies Ltd., a subsidiary of Polar Investments Ltd. (“Koonras”) and DBSI Investments Ltd. (“DBSI”) consummated a transaction with Zeevi Computers and Technology Ltd. (“ZCT”), by which they acquired all of Ordinary Shares of the Company previously held by ZCT.

	B.	The following transactions with Koonras and DBSI are included in the financial statements:


	Year ended December 31,

	2 0 0 5		2 0 0 4		2 0 0 3


Management fees	$	349	$	353	$	359

F-25

CIMATRON LIMITED

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)


NOTE 14 –	SELECTED STATEMENTS OF OPERATIONS DATA

	A.	Revenues


		Year ended December 31,

		2 0 0 5			2 0 0 4			2 0 0 3

Revenue by geographical region:
Israel		$	1,639		$	1,939		$	2,084
Europe (1)			10,776			13,255			12,203
Far East (2)			4,624			4,407			4,394
North America			3,715			3,409			2,808
Others			171			153			120

		$	20,925		$	23,163		$	21,609

(1)	Includes:
	Italy	$	2,423		$	2,703		$	2,453
	Germany	$	6,600		$	7,782		$	7,065

(2)	Includes:
	Japan	$	2,404		$	2,443		$	2,334

Revenue through major distributors, as a percentage of total revenues:
Distributor (A)			12	%		12	%		11	%
Distributor (B)			10	%		9	%		9	%


	B.	Cost of revenues


	Year ended December 31,

	2 0 0 5			2 0 0 4		2 0 0 3


Hardware and software	$	1,442		$	1,731	$	1,726
Salaries and employee benefits		1,051			1,120		1,306
Amortization and write-off of capitalized software development costs		1,204			401		402
Royalties to the Chief Scientist		721			791		586
Depreciation		24			27		49
Other		504			524		545

		4,946			4,594		4,614
Decrease (increase) in inventory		(11	)		7		4

	$	4,935		$	4,601	$	4,618


	C.	Selling, general and administrative expenses


	Year ended December 31,

	2 0 0 5		2 0 0 4		2 0 0 3


Marketing costs	$	417	$	664	$	690
Selling expenses		11,674		10,668		9,054
General and administrative expenses		3,356		2,442		2,702
Depreciation		203		188		199

	$	15,650	$	13,962	$	12,645


		Advertising expenses for the years ended December 31, 2005, 2004 and 2003 were approximately $87, $157 and $195, respectively.

F-26