As filed with the United States Securities and Exchange Commission on June 29, 2005

UNITED STATES

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, 2004

Commission file number 0-27466

NICE-SYSTEMS LTD.

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

Israel

(Jurisdiction of incorporation or organization)

8 Hapnina Street, P.O. Box 690, Ra’anana 43107, Israel

(Address of principal executive offices)

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

(Title of Class)

(Title of Class)

Yes   ý     No   o

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

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

Item 2.  Offer Statistics and Expected Timetable.

Item 3.  Key Information.

The following selected consolidated financial data as of December 31, 2003 and 2004 and for the years ended December 31, 2002, 2003 and 2004 have been derived from our audited consolidated financial statements. These financial statements have been prepared in accordance with generally accepted accounting principles in the United States, or U.S. GAAP, and audited by Kost, Forer, Gabbay & Kasierer, a member of Ernst & Young Global. The consolidated selected financial data as of December 31, 2000, 2001 and 2002 and for the years ended December 31, 2000 and 2001 has been derived from other consolidated financial statements not included in this annual report and have also been prepared in accordance with U.S. GAAP and audited by Kost, Forer, Gabbay & Kasierer, a member of Ernst & Young Global. The selected consolidated financial data set forth below should be read in conjunction with and are qualified by reference to Item 5, “Operating and Financial Review and Prospects” and the consolidated financial statements and notes thereto and other financial information included elsewhere in this annual report.

On March 31, 2004, we sold the net assets of our COMINT/DF military-related business to ELTA Systems Ltd (“ELTA”) for $4 million in cash. The net assets sold include the intellectual property, fixed assets, inventory, and contracts related to the COMINT/DF product line which includes high performance spectral surveillance and direction finding systems that detect, identify, locate, monitor and record transmission sources. The COMINT/DF business is therefore treated as a discontinued operation in our financial statements.

In 2002, 2003 and 2004, the COMINT/DF business generated revenues of approximately $7.2 million, $6.5 million and $0.8 million, respectively, and net income of approximately $1.4 million, $1.5 million and $3.2 million (including gain on disposition), respectively.

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The following table shows, for each of the months indicated, the high and low exchange rates between New Israeli Shekels and U.S. dollars, expressed as shekels per U.S. dollar and based upon the daily representative rate of exchange as reported by the Bank of Israel:

The following table shows, for periods indicated, the average exchange rate between New Israeli Shekels and U.S. dollars, expressed as shekels per U.S. dollar, calculated based on the average of the exchange rates on the last day of each month during the relevant period as reported by the Bank of Israel: 

On June 27, 2005, the exchange rate was 4.541 NIS per U.S. dollar as reported by the Bank of Israel.

The effect of exchange rate fluctuations on our business and operations is discussed in Item 5,  “Operating and Financial Review and Prospects.” 

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Capitalization and Indebtedness

Not applicable.

Reasons for the Offer and Use of Proceeds

Not applicable. 

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Item 4.    Information on the Company.

NICE offers solutions that consist of multimedia capture, multimedia content analysis and applications. These solutions enable our customers to extract insight from unstructured interactions by capturing the interactions and analyzing the content, thereby enabling improved business decisions or improved security operations. We offer our solutions as products or system solutions to various vertical markets in two major sectors:  1) the Enterprise Interaction sector; and 2) the Public Safety and Security sector.

1) Enterprise Interaction Solutions

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Financial Institutions.   Financial institutions conduct a substantial portion of their business over the telephone and are increasingly relying upon their ability to record, store and retrieve voice data of transactions in a timely, reliable and efficient manner. Brokers and dealers record and store recordings of transactions to provide back-up and verification of such transactions and to guard against risks posed by lost or misinterpreted voice communications or fraud. Our customers in the financial institutions market include ABN AMRO Bank, American Express, Bank of America, Barclays, CIBC Oppenheimer, Citibank, Deutsche Bank, Dresdner Bank, First Chicago NBD, JP Morgan Chase, Goldman Sachs, Lehman Brothers, Morgan Stanley, Sydney Futures Exchange and Tokyo Mitsubishi Bank.

Contact Centers.   Many enterprises are increasingly using dedicated contact centers as their main contact point with their customers. These contact centers are processing and managing high volumes of incoming and outgoing customer interactions. Contact centers have been used extensively in such fields as financial services (banking, credit cards, insurance, investments), telecommunications, retail, health care and travel services. Typically, the contact center is the primary “hub” within an organization for placing or receiving a large volume of customer interactions. Customer service representatives are talking with customers about  issues such as reservations, product information, account information, and problem resolution. As the importance of the contact center increases and more functions and capabilities have been combined, a parallel industry has emerged. This industry creates and supports the systems, software and services that are designed to make these enterprises and the contact center activities within the enterprises efficient, effective and well matched to the broader corporate mission of the enterprise. Also, it is increasingly expected that the contact center be the “eyes and ears” of the enterprise in the market and a prime source of information for the various enterprise departments, such as marketing, sales, legal, finance and operations. The global contact center market is using voice recording solutions and related applications to enable storage of the details of telephone orders and other transactions, supervision of contact center operators and campaigns, and evaluation of salespersons’ efficiency, customer service and training. It is also increasingly being used to extract insight from the recorded interactions to solve business issues and increase the overall enterprise performance. Users of the NICE Perform, NiceUniverse and NiceLog system in this market include AllSec, American Express, Blue Cross Blue Shield, Citibank, DHL, Federal Express, Ford Credit, Home Depot, IBM, Liberty Mutual, National Bank of Canada, Nextel, Nokia, PRC, Spectramind, Telecom New Zealand, Time Warner, Vodafone, Wipro, WPS and Wynn Resorts.

Sales and Marketing; Strategic Relationships

We market, distribute and service our Enterprise Interaction Solutions worldwide, through leading suppliers of complementary products, such as Avaya, independent dealers that predominantly specialize in the voice recording market and contact center and enterprise applications, as well as through our own sales and technical support force in the United States, Canada, Germany, the United Kingdom, France, Spain, Hong Kong, Japan, Singapore, India and Israel.  Most of the sales made by our sales force are made to our distributors, who then install the systems and provide day-to-day support to end-users.

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•              An OEM agreement with IPC Information Systems, Inc. IPC, a leading provider of integrated communications solutions to the financial services community, has embedded a NiceLog platform customized for IPC into IPC’s Alliance MX product line and sells this product as an integral part of the IPC product.

•              An OEM agreement with Etrali S.A., a telecom integrator serving the financial community. Etrali is a European leader of dealer-board systems for trading rooms. Etrali and NICE have closely integrated our products for dealing rooms, which are distributed globally by Etrali S.A.

•              A marketing and developer support agreement with BT Syntegra, British Telecom’s selling and integration company in the trading floor segment.

•              A global partnership with Avaya Inc. Avaya is the leading global provider of enterprise business communication platforms in voice, e-business and data. Avaya and its business partners (or sales partners or dealers) are co-selling our enterprise interaction solutions to their customers globally.

•              A marketing and technical collaboration with Dimension Data, IBM, Philips and Siemens.

•              An OEM and developer support agreement with Alcatel.

•              An alliance program with Aspect Telecommunications to ensure the compatibility of our contact center product line with Aspect’s automatic call distribution systems and to promote this integration through Aspect’s marketing materials.

•              Technical collaboration and development programs with Cisco, Concerto, Ericsson, Genesys, Mitel, NEC, Nortel, Philips and Rockwell.

•              Product integrations with Siebel Systems and Amdocs (Clarify Inc.) in the CRM Space. These integrations with leading CRM providers enable customers to capture and enhance their customers’ entire experience in the contact center from start to finish and to more tightly integrate the functionality delivered by our products into their business environment.

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Products

Our enterprise interaction solutions include recording, monitoring, quality management and business performance management solutions which are designed to capture interactions, analyze them and take action based on this analysis to drive the enterprise performance. They also protect businesses and customers against risks posed by lost or misinterpreted voice or data transmissions and capture and improve contact center agent performance and the customers’ experience. 

Today’s business is characterized by increasing reliance upon interactions conducted via telephony and web-based communications. These means of communication are becoming an important and strategic dimension of business across a broad spectrum of markets. In these business environments, a great deal of information lies hidden within the ever-growing quantities of unstructured multimedia interactions. This information can provide decision makers throughout the enterprise with insights into their marketplace and customer base, and direct access to key business scenarios. Many of these capabilities are not available with traditional transactional-based analytics tools. They are of great value to organizations constantly searching for better ways to understand their market dynamics and customer intent, while operating within the limitations of traditional surveying and data analysis techniques and growing regulatory requirements.

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NICE Perform is our flagship enterprise product. It is an integrated suite of solutions that offers innovative ways for organizations to generate insight from interactions to enhance performance. NICE Perform combines multiple data sources in a fully integrated architecture with a centralized data warehouse, allowing interoperability of all the data sources to address a variety of business issues with a high level of accuracy. The data sources include word spotting, emotion detection, talk pattern analysis, customer surveys, CTI analysis, application activities and business data. With a set of advanced engines, NICE Perform provides multi-dimensional analytics of these data sources. State-of-the-art visualization techniques enable analysts and executives to quickly and easily identify trends, deviations and situations requiring immediate action. All these capabilities are implemented in an advanced application suite that is underpinned by a new series of powerful high density capture and archiving platforms that provide cost-effective reliable processing of multimedia interactions in a format optimized for multi-dimensional analytics.

While providing critical statistical data, NICE Perform goes beyond the scope of transactional analytics to help decision makers understand customer intent and market dynamics, identify current and future trends early enough for proactive management of challenges, opportunities and changes, and enhance corporate governance throughout the enterprise. For example, marketing executives can more effectively track marketing campaigns, analyze causes of success or failure, and quickly adapt to changing market conditions. Finance and legal executives can ensure that company policies are adhered to in all phone conversations across the organization, thereby avoiding costly legal action by spotting and correcting irregularities before they become problems.

NICE Perform also contains all of the contact center quality management capabilities of NiceUniverse described below. In addition, NICE Perform includes advanced online coaching capabilities. These enable supervisors to coach the contact center agents in order to improve their skills and to empower those agents and cover immediate knowledge dispersal matters as needed by the different departments, such as marketing or order administration. 

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Our patented VoIP Capture Unit builds on our NiceLog technology to provide a complete solution to audio storage in Voice over Internet protocol (VoIP) telephony environments. The VoIP Capture Unit provides an IP-recording platform with a wide range of scaleable recording solutions that supports the leading telephony vendors. Our VoIP Capture Units are fully integrated with the NICE product portfolio, making all our applications available for use over VoIP. NICE VoIP Loggers can serve alongside other logger types in a mixed VoIP/non-VoIP environment with the same familiar application software; users are unaware of the voice capture method being used.

NICE VoIP Capture Units can use both packet sniffing and active recording methods for recording VoIP sessions. NICE VoIP active recording solutions integrate with leading vendors such as Avaya, offering centralized recording of distributed environments and other benefits.

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2) Public Safety and Security Solutions

a) Voice Platforms and Applications

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b) Digital Video Platforms and Applications

Customers for our products include the Atlanta Hartsfield International Airport, Bally’s casino in Atlantic City, Bank of England, Casino Cosmopol in Sweden, Chase Manhattan, Dallas Fort Worth International Airport, Dell Computer Corporation, European Space Agency, the Helsinki Railway Station - Finland, the Metropolitan Nashville Airport Authority, Toronto Pearson International Airport, and correctional facilities in Brooklyn, New York, and Rush City, Minnesota.

The market comprised of law enforcement agencies, internal security and intelligence organizations is undergoing rapid changes. In parallel to the growth in the number and severity of threats, new telecommunications services and applications are utilized by public agencies, which need sophisticated solutions to intercept and analyze the intelligence information collected by these services and applications.

Additionally, governments are adopting new legislation and regulating new standards in order to assist the organizations that deal with intelligence. According to these legislations and regulations, telecom service providers are required to install systems that will enable the interception of certain communications and deliver them in real time to the monitoring agencies.

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In the public safety market, we distribute our products worldwide through a network of over 100 national and local independent dealers and distributors that also provide installation and maintenance services.

•              A marketing agreement with Motorola Inc. for the co-marketing and resale of our range of products for the public safety market in North American and international markets.  This relationship includes the appointment of NICE as the only authorized Dimetra Application Partner for Motorola’s trunked radio solutions.

•              We also market and sell systems through major regional or global partners, such as Alcatel, BT, Damovo, Marconi, Nokia and Siemens.

We have a dedicated sales and marketing organization for the NiceTrack system for lawful interception. We market the system worldwide through our direct sales force and through distributors.

Products

a) Voice Platforms and Applications

Through the acquisition of TCS, NICE provides first responders and air traffic control organizations with a full range of recording features for voice, radio and trunked radio, including on-line access to hundreds of hours of recording for a quick response time, a choice of different types of archiving media, and a dubbing capability to edit calls on-line for courtroom presentations. The system enables the organizations to re-construct scenarios, investigate and improve performance. Our products are currently being used in a significant number of air traffic control facilities, including FAA and NAV Canada, as well as large police departments, transportation companies and emergency services command and control centers.

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Mirra is a small recording system that is particularly suited to simple recording applications in which it can record up to 32 channels of voice traffic from a wide variety of analogue and digital interfaces.  Mirra has been designed to be simple to install, operate and maintain and has been sold to many local, city and state public safety organizations that have a single site operation.  Digitized voice and associated data are stored onto DVD disks that provide a robust and long-term archive medium.  Mirra’s design avoids using an internal hard disk for the operating system and consequently it starts-up very rapidly and avoids the maintenance liabilities associated with hard disks.

Tienna is a large recorder that is designed to form part of a “Renaissance” solution.  Renaissance solutions are used when the customer has a complex requirement typically involving multiple recorders, multiple sites and dual-redundant components in order to provide very high performance and resilience.  Tienna can provide up to 480 channels per unit and multiple units can be interconnected to form a system of many thousands of ports.  Tienna is unique in that it provides dynamic channel allocation between the active ports on the recorder and a greater number of channels on the networks to which it is connected.  This provides a more efficient use of the system’s resources than a permanent 1:1 connection of channels to ports.  Tienna contains internal hard disks for short-term storage but relies upon the Renaissance Centralized Mass Storage Unit (or CMSU) for all medium and long-term storage and for archiving onto tapes.

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b) Digital Video Platforms and Applications

Our NiceVision product line consists of the NiceVision Pro, NiceVision Harmony, NiceVision Alto and NiceVision NVSAT. NiceVision is a state-of-the-art digital video and audio recording system that provides continuous CCTV, recording, archiving, and debriefing capabilities that meet the needs of today’s demanding security environment, including central banks, Fortune 500 companies, transportation facilities, prisons, and casinos.

The NiceVision Pro is a premium solution designed for high-end applications requiring high-frame rate and/or a large number of cameras in a campus environment.  Typical environments for the NiceVision Pro are airports, casinos and ground transportation facilities. The NiceVision Pro accommodates 96 video channels in one single box and can handle storage devices in the range of tera-bytes. These devices are of two types: disk based on-line storage (internal drives or external RAIDs) and tape-based off-line juke box devices.

The NiceVision Harmony is a mid-range digital video recording solution designated for sites accommodating a large number of cameras yet requiring a variety of frame rates per channel, spanning from single frames per second to full frame rate, when required. Typical environments for the NiceVision Harmony are retail shops, certain bank facilities and corporate buildings. The NiceVision Harmony caters for 64 video channels with a preset frame rate shared between groups of channels. The NiceVision Harmony can also support large storage devices like the NiceVision Pro.

The NiceVision Alto is a mid range product that can support eight to 32 video channels using variable frame rates and resolutions. Typical environments for the NiceVision Alto are distributed sites that require high image quality and adjustable level of service to meet different networking channels. The NiceVision Alto runs content analytics to support smart monitoring.

The NiceVision NVSAT is a small scale unit that supports four to eight video channels. It is designed for distributed architectures, where it serves as a smart Codec providing high image quality, level of service and content analytics.

The NiceTrack product line provides law enforcement agencies, internal security services and intelligence organizations with end-to-end solutions for the interception, delivery, monitoring, collection and advanced analysis of telecommunication interactions. In order to create a full perspective of threats, NiceTrack products handle both telephony and Internet data on the same platform. The working environment provides intelligence analysts with a broad intelligence perspective to ensure that crucial information is always delivered to decision makers and operational staff in real-time. NiceTrack also features an open architecture design that offers government agencies the flexibility they need to build an effective intelligence platform

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customized and localized to suit specific operational requirements and methodologies.

NiceTrack, as a lawful interception solution, is fully compliant with the international standards defined by ETSI (under various European legislations) and TIA (under the CALEA legislation).

Dictaphone Acquisition

We completed the acquisition of Dictaphone’s Communications Recordings Systems division (or CRS) on June 1, 2005. CRS is a leading provider of recording, liability and quality management systems for first responders, critical facilities, contact centers and financial trading floors.

CRS’s major products are marketed under the Freedom® trademark. The products include:

•      Freedom Enterprise, which combines state-of-the-art recording technology for full-time or selective recording with advanced tools for optimizing contact center performance in virtually any telephony environment: circuit-switched telephony, VoIP and hybrid environments.

•      Freedom FT, which provides high-level fault-tolerant recording, with a design that eliminates single points of failure and ensures that recordings are captured and accessible when required.

•      Freedom rDT, which works with the Motorola or M/A-COM trunked radio system to record radio communications dynamically and capture trunked radio data. It is a solution aimed at the 9-1-1 first responder market.

CRS operated in most of our existing markets, including contact centers, first responders and financial markets. Most of CRS’s activity has been in the first responder sector, while we have had a stronger position in the contact center and financial market sectors. Most of the division’s operations are concentrated in the United States, with some activity in Europe. At the time of the acquisition by us, CRS had approximately 8,000 customers, including the City of Miami, Comcast, Credit Suisse, Verizon and the U.S. Army.

We intend to continue to support the range of CRS Freedom products for up to five years, and while we will not actively seek to expand the sales of these solutions, we are prepared to meet any market demand for them. At the same time, we will continue to develop our range of solutions for the various market sectors, taking into consideration the requirements of the CRS customer base.

Discontinued Operation - COMINT/DF

On March 31, 2004, we sold the net assets of our COMINT/DF military-related business to ELTA Systems Ltd (“ELTA”) for $4 million in cash. The net assets sold include the

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intellectual property, fixed assets, inventory, and contracts related to the COMINT/DF product line which includes high performance spectral surveillance and direction finding systems that detect, identify, locate, monitor and record transmission sources. The COMINT/DF business is therefore treated as a discontinued operation in our financial statements.

In 2002, 2003 and 2004, the COMINT/DF business generated revenues of approximately $7.2 million, $6.5 million and $0.8 million, respectively, and net income of approximately $1.4 million, $1.5 million and $3.2 million (including gain on disposition), respectively.

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Our systems are generally sold with a warranty for repairs of hardware and software defects and malfunctions, the term of which is usually one year after shipment.  Longer warranty periods are applicable to sales in certain international and government markets. Extended warranty and service coverage is provided in certain instances and is usually made available to customers through our distributors on a contractual basis for an additional charge. Our customers may purchase a renewable maintenance agreement from our dealers or directly from us. The maintenance agreements generally provide for maintenance, upgrades of standard system software and on-site repair or replacement.

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The Research and Development Law generally requires that the product developed under an OCS-funded program be manufactured in Israel. However, upon the approval of the OCS, some of the manufacturing volume may be performed outside of Israel, provided that the grant recipient pays royalties at an increased rate, which may be substantial, and the aggregate repayment amount is increased to 120%, 150% or 300% of the grant, depending on the portion of the total manufacturing volume that is performed outside of Israel. Effective April 1, 2003, the Research and Development Law also allows for the approval of grants in cases in which the applicant declares that part of the manufacturing will be performed outside of Israel or by non-Israeli residents and the research committee is convinced that doing so is essential for the execution of the program.  This declaration will be a significant factor in the determination of the Office of the Chief Scientist whether to approve a program and the amount and other terms of

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benefits to be granted.  For example, the increased royalty rate and repayment amount will be required in such cases.

The Research and Development Law also provides that know-how developed under an approved research and development program may not be transferred to third parties in Israel without the approval of the Office of the Chief Scientist.  Such approval is not required for the sale or export of any products resulting from such research or development. The Research and Development Law further provides that the know-how developed under an approved research and development program may not be transferred to any third parties outside Israel.

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

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

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We currently have nine other patents issued in additional countries and over 100 patent applications pending in the United States and other countries.  We believe that the improvement of existing products, and the development of new products are important in establishing and maintaining a competitive advantage. We believe that the value of our products is dependent upon our proprietary software and hardware continuing to be “trade secrets” or subject to copyright or patent protection. We generally enter into non-disclosure and non-compete agreements with our employees and subcontractors. However, there can be no assurance that such measures will protect our technology, or that others will not develop a similar technology or use technology in products competitive with those offered by us. Although we believe that our products do not infringe upon the proprietary rights of third parties, there can be no assurance that one or more third parties will not make a contrary claim or that we will be successful in defending such claim.

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There are a number of competitors in the telecommunications monitoring market, having products competing with our NiceTrack system, the major ones being Raytheon Company, Siemens and Verint Systems Inc. We believe that our solution offers innovations that provide law enforcement agencies the tools and capabilities they require to meet the challenges of today’s advanced telecommunications world, as well as being price competitive.

Organizational Structure

The following is a list of all of our significant subsidiaries, including the name, country of incorporation or residence, and the proportion of our ownership interest in each.

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•                  Our North American headquarters in Rutherford, New Jersey, which occupy approximately 25,000 square feet, with a monthly rental of approximately $66,000.  We also have a warehouse facility in Lyndhurst, New Jersey, which occupies approximately 6,000 square feet, with a monthly rental of approximately $7,000;

•                  Our office in San Diego, California, which occupies approximately 6,250 square feet, with a monthly rental of approximately $17,500 (subleased in its entirety  to a third party);

•                  Our office in Chicago, Illinois, which occupies approximately 1,000 square feet, with a monthly rental of approximately $3,000;

•                  Our office in Denver, Colorado, which occupies approximately 30,775 square feet, with a monthly rental of approximately $58,000;

•                  Our office in Las Vegas, Nevada, which occupies approximately 3,000 square feet, with a monthly rental of approximately $8,000 (subleased in its entirety  to a third party); and

•                  Our office in New York, New York, which occupies approximately 4,300 square feet, with a monthly rental of approximately $10,000.

•                  Our office in Frankfurt, Germany, which occupies approximately 2,850 square feet, with a monthly rental of approximately $4,500;

•                  Our office in London, UK which occupies approximately 1,430 square feet, with a monthly rental of approximately $21,000;

•                  Our office in Southampton, UK which occupies approximately 34,249 square feet, with a monthly rental of approximately $66,000;

•                  Our office in Dublin, Ireland, which occupies approximately 750 square feet, with a monthly rental of approximately $2,200;

•                  Our office in Paris, France which occupies approximately 1,916 square feet, with a monthly rental of approximately  $5,700;

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•                  Our office in Hong Kong, which occupies approximately 4,810 square feet, with a monthly rental of approximately $11,426;

•                  Our office in Tokyo, which occupies approximately 1,485 square feet, with a monthly rental of approximately $6,428; and

•                  Our office in Bangalore, which occupies approximately 1,047 square feet, with a monthly rental of approximately $687.

We believe that our existing facilities are adequate to meet our current and foreseeable needs.

Item 5. Operating and Financial Review and Prospects.

We may from time to time make written or oral forward-looking statements, including in filings with the United States Securities and Exchange Commission (“SEC”), in reports to shareholders and in press releases and investor webcasts. You can identify these forward-looking statements by use of words such as “strategy”, “expects”, “continues”, “plans”, “anticipates”, “believes”, “may”, “estimates”, “intends”, “projects”, “goals”, “targets”, and other words of similar meaning.  You can also identify them by the fact that they do not relate strictly to historical or current facts.

We cannot assure you that any forward-looking statement will be realized, although we believe we have been prudent in our plans and assumptions.  Achievement of future results is subject to risks, uncertainties and inaccurate assumptions.  Should known or unknown risks or uncertainties materialize, or should underlying assumptions prove inaccurate, actual results could vary materially from those anticipated, estimated or projected.  Investors should bear this in mind as they consider forward-looking statements and whether to invest or remain invested in NICE Systems Ltd.’s securities. The forward-looking statements relate to, among other things: operating results; anticipated cash flows; gross margins; adequacy of resources to fund operations; our ability to maintain our average selling prices despite the aggressive marketing and pricing strategies of our competitors; our ability to maintain and develop profitable relationships with our key distribution partners, one of which constitutes 19% of our revenues; the financial strength of our key distribution partners; and the market’s acceptance of our technologies, products and solutions.

In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, we are identifying important factors that, individually or in the aggregate, could cause actual results and outcomes to differ materially from those contained in any forward-looking statements made by us; any such statement is qualified by reference to the following cautionary statements.  Please read the section below entitled “Factors That May Affect Future Results” to review conditions that we believe could cause actual results to differ materially from those contemplated by the forward-looking statements. You should understand that it is not possible to predict or identify all risk factors.  Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our view only as of the date of this annual report. Except as required by law, we undertake no

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obligation to update these forward-looking statements to reflect future events or circumstances or the occurrence of unanticipated events.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes and other financial information included elsewhere in this annual report.

Overview

We develop, market and support integrated, scalable multimedia digital recording platforms, enhanced software applications and related professional services. These solutions capture and analyze unstructured (non-transaction) data, and convert it into actionable knowledge for business and security performance management applications.  Our solutions capture multiple forms of interaction, including voice, fax, email, web chat, radio, and video transmissions over wireline, wireless, packet telephony, terrestrial trunk radio and data networks. The markets from which we currently derive the majority of our revenues and expect to continue to do so in the future are highly competitive.

Our products are based on two types of recording platforms - audio and video - and are used primarily in contact centers, trading floors, public safety organizations, transportation, corporate security, gaming and correctional facilities as well as various government and intelligence agencies.

Our development efforts for our recording platforms are aimed at addressing several trends we see developing in the industry.  The trend towards the proliferation of voice over IP-based networks is leading to a greater requirement for VoIP recording capabilities in financial trading, contact centers and public safety environments.   The continued trend towards replacing analog video recording with digital video recording is leading to the need for network applications in the video recording area. 

We also see the continuation of a trend towards requirements for multimedia recording capabilities, particularly in contact centers (voice, fax, email, chat screen) and public safety (voice, radio, video, data) markets. We are beginning to see this same trend developing in the financial trading sector, and we expect some Homeland Security initiatives in areas such as border control, critical infrastructure security, first responder communications and lawful interception to require multimedia capture platforms as well.

Our software applications enable our customers to capture, store, retrieve and analyze unstructured data (multimedia interactions) and combine them with data from other systems to create actionable knowledge that can be distributed via reports and alerts to all relevant parties to improve performance.

There is growing demand from our customers for software applications that will leverage the wealth of unstructured data captured by the recording platform to improve overall performance.  In turn, as these enhanced software applications are being added, customers are

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considering our systems “mission critical”.   We see an opportunity for applications that analyze the content of unstructured interactions in contact centers for quality monitoring and contact center management as well as for enterprise-wide process improvement and business performance management.  We see a trend towards more software applications in the financial trading environment for compliance monitoring and dispute management to improve business performance.  We see similar trends happening in digital video recording.  We expect video content analysis applications to become increasingly important to building, campus, city center, and infrastructure perimeter security, loss prevention in casinos, retail and warehousing, as well as various homeland security applications to enable proactive security management.

We expect to see an increase in the demand for VoIP recording products, networked video security solutions, and multimedia recording solutions as well as an increase in the proportion of software from quality monitoring and multimedia interaction analytics applications in our product revenue mix and a gradual increase in the amount of professional services and maintenance revenues.

Our products are sold primarily through a global network of distributors, system integrators and strategic partners; a portion of product sales and most services are sold directly to end-users.  One distributor accounted for approximately 19%, 20% and 23% of revenues in 2004, 2003 and 2002, respectively.

Acquisitions

The acquisitions we have made were accounted for as purchases, and, accordingly, the purchase price for each acquisition was allocated to the assets acquired and liabilities assumed based on their respective fair values. The results of operations related to each acquisition are included in our consolidated statement of operations from the date of acquisition.  The following are details for each of these acquisitions:

•                  On June 1, 2005, we consummated an agreement to acquire the assets and assume certain liabilities of Dictaphone’s Communications Recording Systems business for approximately $38.5 million. Dictaphone’s CRS business is a leading provider of liability and quality management systems for first responders, critical facilities, contact centers and financial trading floors.

Among the assets we acquired in the transaction are all of Dictaphone’s rights to receive any damage award or other economic benefit with respect to a violation of any of the rights related to the intellectual property of Dictaphone’s CRS business arising prior to the closing of the transaction.

•                  In November 2002, we consummated an agreement to acquire certain assets and liabilities of Thales Contact Solutions (or TCS), a developer of customer-facing technology for public safety, financial trading and customer contact centers, based in the United Kingdom.  TCS was a unit of Thales Group, one of Europe’s premier electronics companies. In connection with the acquisition, we paid an initial $29.9

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million in cash and issued 2,187,500 ordinary shares to Thales Group at a fair market value of $18.1 million calculated at the date of closing.  As of June 2, 2005, Thales Group holds approximately 4.6% of our outstanding shares. In June 2005, Mr. Timothy Robinson, one of the two Thales executives who were elected to our Board of Directors in November 2002, resigned from our Board.  The acquisition agreement required one nominee of Thales to resign upon the sale of more than half of the shares issued to Thales in the acquisition.

In the fourth quarter of 2002, we recorded a current liability of $2.8 million and a long-term liability of $13.5 million reflecting obligations under a long-term contract we assumed in the TCS acquisition.  In the second quarter of 2003 we completed negotiations to terminate this contract as of November 2004 and to amend the terms in the interim. Under the terms of the amended contract, the cost to the Company was $5.2 million less than the amount provided at the acquisition date and consequently, TCS acquisition goodwill was reduced by this amount.

Under the terms of the agreement, the cash portion of the purchase price was subject to downward adjustment based on the value of net assets at closing and the full year 2002 sales of TCS.  Based on our calculation of the actual value of net assets acquired and 2002 sales of TCS, we reduced the cash portion of the purchase price as of December 31, 2002 by $12.8 million. This amount was presented on our balance sheet as a Related Party Receivable as of December 31, 2002.  Thus, the adjusted purchase price paid, including $4.5 million of capitalized acquisition costs, was recorded as $39.7 million.  Of the $12.8 million adjustment referred to above, Thales paid us $6.6 million in March 2003.

Thales disputed our calculation of the net asset value at closing and the matter was submitted in September 2003 to binding arbitration by an Independent Accountant, in accordance with the terms of the acquisition agreement.  The Independent Accountant determined a higher net asset value at closing than our calculation of the actual value of net assets acquired in the amount of $2.2 million. This additional amount was recorded as additional goodwill in the fourth quarter of 2003. The remaining Related Party Receivable as at December 31, 2003 of $ 4.0 million was paid in January 2004.

Also under the terms of the agreement, contingent cash payments of up to $10.0 million in 2003, $7.5 million in 2004, and $7.5 million in 2005 would be due if certain financial performance criteria are met as part of a three-year earn-out provision related to the sale of a particular product in 2002 through 2004.  The relevant criteria for 2002 through 2004 were not met and therefore no contingent payments will be made under the agreement.

Under the terms of the agreement, the cash portion of the purchase price was subject to adjustment mechanisms and indemnities related to the assets sold to us. On September 8, 2004, we notified Thales of claims in respect of such price adjustment mechanisms, mainly relating to uncollected receivables and inventory. NICE and

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Thales signed a settlement agreement in respect of such claims on February 24, 2005, according to which Thales paid us a total indemnity amount of $2.6 million.

•                  In April 2000, we acquired all of the outstanding capital stock of Centerpoint Solutions Inc. (CPS) for $3.0 million in cash and the issuance of 200,000 ADSs of NICE of which 50,000 were deemed target shares contingent upon the achievement of certain objectives, which were not met.  CPS was a developer of internet-based applications for statistical monitoring, digital recording and automatic customer surveys for contact centers.

In November 2002, we entered into a settlement agreement with Doug Chapiewski, the sole shareholder of CPS, in respect of allegations made against NICE and NICE-Centerpoint Solutions, Inc. of misrepresentation, breach of contract and securities fraud in connection with the acquisition of CPS.  The terms of the settlement agreement, which included 50,000 shares, resulted in a charge to Other Expense, Net of $3.5 million. In December 2003, we received $300,000 from our insurers in respect of the settlement.

Other Developments

•                  We sold the net assets of our COMINT/DF military-related business to ELTA Systems Ltd (“ELTA”) for $4.0 million on March 31, 2004. The net assets sold include the intellectual property, fixed assets, inventory, and contracts related to the COMINT/DF product line which includes high performance spectral surveillance and direction finding systems that detect, identify, locate, monitor and record transmission sources. The COMINT/DF business is therefore treated as a discontinued operation in our financial statements.  In 2002, 2003 and 2004, the COMINT/DF business generated revenues of approximately $7.2 million, $6.5 million and $0.8 million, respectively, and net income of approximately $1.4 million, $1.5 million and $3.2 million (including gain on disposition), respectively.

Off-Balance Sheet Transactions

We have not engaged in nor been a party to off-balance sheet transactions.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States (“US GAAP”). Our significant accounting principles are presented within Note 2 to our Consolidated Financial Statements.  While all the accounting policies impact the financial statements, certain policies may be viewed to be critical. These policies are those that are most important to the portrayal of our financial condition and results of operations. Actual results could differ from those estimates discussed below.

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Management believes that the significant accounting policies which affect its more significant judgments and estimates used in the preparation of the consolidated financial statements and are the most critical to aid in fully understanding and evaluating our reported results include the following:

•                  Revenue recognition

•                  Allowance for doubtful accounts

•                  Inventory valuation

•                  Impairment of long-lived assets

•                  Deferred income taxes

•                  Contingencies

Revenue Recognition. We derive our revenue primarily from two sources: product revenues, which include hardware and software sales, and service revenues, which include, support and maintenance, installation, consulting and training revenue.  Revenue related to sales of our products is generally recognized when persuasive evidence of an agreement exists; the product has been delivered and title and risk of loss have passed to the buyer; the sales price is fixed or determinable; no further obligations exist; and collectibility is probable.  Sales agreements with specific acceptance terms are not recognized as revenue until the customer has confirmed that the product or service has been accepted. 

Revenues from maintenance and professional services are recognized ratably over the contract period or as services are performed.

For arrangements with multiple elements, we allocate revenue to each component of the arrangement using the residual value method based on Vendor Specific Objective Evidence (“VSOE”) of the undelivered elements. This means that we defer the arrangement fee equivalent to the fair value of the undelivered elements until these elements are delivered. Our VSOE used to allocate the sales price to maintenance is based on the renewal percentage.

To assess the probability of collection for revenue recognition, we have an established credit policy that determines, by way of mathematical formulae based on the customers’ financial statements and payment history, the level of open account that is deemed probably collectible for each customer. These credit limits are reviewed and revised periodically on the basis of new customer financial statement information and payment performance.   

We record a provision for estimated sales returns and allowances on product sales in the same period as the related revenues are recorded.  We base these estimates on the historical sales returns ratio and other known factors.  Actual returns could be different from our estimates and current provisions for sales returns and allowances may need to be increased.

Allowance for Doubtful Accounts. We evaluate the collectibility 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, we record a specific allowance against amounts due to reduce the net recognized receivable to the amount we reasonably believe will be

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collected.  For all other customers, we recognize allowances for doubtful accounts based on the length of time the receivables are past due. Insured balances are not reserved.  If the financial condition of one of our significant customers or our customers in general should deteriorate, our revenue growth may be limited and additional allowances may be required.

Inventory valuation. At each balance sheet date, we evaluate our inventory balance for excess quantities and obsolescence.  This evaluation includes analyses of sales levels by product line and projections of future demand.   In addition, we write off inventories that are considered obsolete.  Remaining inventory balances are adjusted to the lower of cost or market value. If future demand or market conditions are less favorable than our projections, additional inventory write-downs may be required and would be reflected in cost of sales in the period the revision is made.

During 2002 we completed the outsourcing of the manufacture of our audio and video product platforms.  Under this arrangement, we take ownership of inventories at the conclusion of the manufacturing process, such inventories representing finished goods or spare parts.   As we largely manufacture to order, we do not tend to accumulate finished goods.  We are, however, liable to purchase above a certain level, which is based on a historical level of orders to the contract manufacturer, excess raw material and subassembly inventories from the contract manufacturer deemed obsolete or slow-moving.  We monitor the levels of the contract manufacturer’s relevant inventories periodically and, if required, will write-off such deemed excess or obsolete inventory.

Impairment of long-lived assets. Our long-lived assets include property and equipment, investment in affiliates, goodwill and other intangible assets.  The fair value of the investment in affiliates is dependent upon the performance of the companies in which we have invested.  In assessing potential impairment of these investments, we consider this factor as well as the forecast financial performance of the investees and other pertinent information.  We record an investment impairment charge when we believe that the investment has experienced a decline in value that is other than temporary.  During 2002, we recognized $229,000 of impairment losses related to our investment in affiliates.  As of December 31, 2004, the carrying value of the Company’s investments in affiliates was $1.2 million.

In assessing the recoverability of our property and equipment, goodwill and other intangible assets, we must make assumptions regarding the estimated future cash flows and other factors to determine the fair value of the respective assets.  If these estimates or their related assumptions change in the future, we may be required to record impairment charges for these assets.

In June 2001, the Financial Accounting Standards Board issued SFAS No. 142 “Goodwill and Other Intangible Assets”. SFAS No. 142 addresses the initial recognition and measurement of intangible assets acquired in a business combination and the accounting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142 provides that intangible assets with finite useful lives will be amortized and that goodwill and intangible assets with indefinite lives will not be amortized, but rather will be tested at least annually for impairment. We adopted SFAS No. 142 beginning January 1, 2002.  Upon adoption of SFAS No. 142, we discontinued

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the amortization of recorded goodwill, which was approximately $3.4 million on an annual basis at that time.  We performed an impairment test of our goodwill as of January 1, 2002 under the transitional provisions of SFAS No. 142; our test did not indicate an impairment of goodwill.  We confirmed that we have only one reporting unit (the Company) to which we allocated all recorded goodwill, as well as all assets and liabilities.

By October 1, 2002, our stock price had declined significantly from January 1, 2002, at which point our market capitalization, based on our stock price, was below book value.  The price of our ADSs on January 2, 2002 was $17.04 per ADS and declined to $8.47 per ADS on October 1, 2002.  We determined the fair value of the Company based on relative market multiples for comparable businesses and a discounted cash flow model.  This evaluation indicated that an impairment might exist.  We then performed Step 2 under SFAS No. 142 in which an amount of the impairment loss, if any, must be measured.  Four categories of intangible assets were identified as being separable from goodwill in accordance with SFAS No. 141 “Business Combinations.”  These included: trade names; an in-place distribution network; technology based intangible assets and maintenance contracts.  In valuing the NICE trade name a relief from royalty method was used.  Under this method, the value of a trade name reflects the savings realized by owning the trade name.  The value of the intangible asset under the relief from royalty method is dependent upon the following factors: the selected royalty rate, the revenues expected to be generated from the underlying intellectual property, the discount rate and the expected life of the intellectual property.   The value of our distribution network was determined through the use of the cost approach.  Using this method, the value of the distribution network is estimated as the after-tax direct costs that a potential acquirer would avoid spending in recreating a similar functional distribution network.  The value of the intangible asset under the cost method is dependent upon the estimated direct cost of establishing a new distributor relationship.  Qualifying technology-based intangible assets consist of current and core technology and technologies that were under development at the valuation date.  The current and core technology was valued using a derivation of the income approach, namely the excess earnings method.  This method is used to analyze the earnings contribution of an intangible asset. Under this method, the excess earnings that an intangible asset generates are calculated over the intangible asset’s expected life and discounted to the present to calculate the fair value of the intangible asset.  Excess earnings are defined as the residual earnings after providing for appropriate returns on the other identified contributing assets.  The value under the excess earnings method is dependent upon the following factors: the expected revenues generated by the intangible asset, the expected after-tax earnings on those revenues, the charges (or returns) required on other contributing assets and the discount rate. Our maintenance contracts, which are intangible assets under the contractual-legal criterion of SFAS No. 141, were valued using the excess earnings method.  In determining the applicable discount rate to be used to estimate the fair value of our net assets, we calculated a market-derived rate based on the estimated weighted average cost of capital for the Company. In determining the cost of equity for the Company, we used a standard methodology based on the capital asset pricing model and analyzed selected guideline companies, industry data and factors specific to NICE. We expect to use a similar decision process in the future.

Following these analyses, we compared the carrying amount of goodwill to the implied

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fair value of the goodwill and determined that an impairment loss existed. A non-cash charge totaling $28.3 million was recorded in the fourth quarter of 2002 to write down goodwill to its fair value under the caption “Goodwill impairment”.  The valuation of long-lived assets requires significant estimates and assumptions.  These estimates contain management’s best estimates, using appropriate and customary assumptions and projections at the time.  If different estimates or projections were used, it is reasonably possible that our analysis would have generated materially different results.

In the fourth quarter of 2004, we performed our annual test on the remaining goodwill per SFAS No. 142 requirements applying the same methodologies as those used in the prior year. No additional impairment was found to exist.  

We will continue to perform an impairment test at least annually and on an interim basis should circumstances indicate that an impairment loss may exist.  The outcome of such testing may lead to the recognition of an impairment loss.

Deferred income taxes.  We record income taxes using the asset and liability approach.  Deferred income tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective income tax bases, and net operating loss and tax credit carryforwards.  Our financial statements contain fully reserved tax assets which have arisen as a result of net operating losses, primarily incurred in 2001 and 2002, as well as other temporary differences between book and tax accounting.  Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have considered future taxable income, prudent and feasible tax planning strategies and other available evidence in determining the need for a valuation allowance.  We evaluate all of these factors to determine whether it is more likely than not that some portion or all of the deferred income tax assets will not be realized.  As a result of uncertainty of realization of losses in future periods, we have continued to record a full valuation allowance, which was approximately $9.4 million as at December 31, 2004.  The establishment and amount of the valuation allowance requires significant estimates and judgment and can materially affect our results of operations.  If the realization of deferred tax assets in the future is considered more likely than not, an adjustment to the deferred tax assets would increase net income in the period such determination was made. 

Our effective tax rate may vary from period to period based on changes in estimated taxable income or loss, changes to the valuation allowance, changes to state or foreign tax laws, future expansion into geographic areas with varying country, state and local income tax rates, deductibility of certain costs and expenses by jurisdiction and as a result of acquisitions, divestitures and reorganizations.

Contingencies.  From time to time, we are defendant or plaintiff in various legal actions, which arise in the normal course of business.  We are required to assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses.  A determination of the amount of reserves required for these contingencies, if any, which would be

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charged to earnings, is made after careful and considered analysis of each individual action together with our legal advisors.  The required reserves may change in the future due to new developments in each matter or changes in circumstances, such as a change in settlement strategy.  A change in the required reserves would affect our earnings in the period the change is made.

Results of Operations

The following table sets forth selected consolidated income statement data for NICE for each of the three years ended December 31, 2004, 2003 and 2002 expressed as a percentage of total revenues. Figures may not add due to rounding.

* percent of related revenue

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YEARS ENDED DECEMBER 31, 2004 and 2003

REVENUES

Our total revenues rose approximately 13% to $252.6 million in 2004 from $224.3 million in 2003. Enterprise Interaction Solutions revenues were $194.1 million in 2004, an increase of 13% from the prior year, and revenues from sales to the public safety and security market were $58.5 million, an increase of 11% from the prior year.  We believe that our growth in revenues was due principally to market share gains in these markets and market growth. 

The increase in product revenues was due primarily to higher sales of our audio recording platforms and applications to contact centers/trading floors and public safety institutions.  There can be no assurance that we will continue to experience market share gains, or that our new products will be broadly accepted, or that given weak fiscal spending, we will continue to report growth in our platform and related software applications.

The increase in services revenues was generated by an increasing portion of our installed base engaging us for maintenance services and higher installation and training revenues related mainly to the increase in product sales to the enterprise market.  Service revenues represented 28% of total revenues compared with approximately 25% in 2003.  Although we typically generate lower profit margins on services than on products, our strategy is to continue to grow our global services business, which we believe increases the competitiveness of our product offerings, and thus expect services to represent a growing portion of total revenues in the future. Our long-term target is for services to represent approximately 30% of total revenues. 

Revenues in 2004 in the Americas, which includes the United States, Canada and Latin and South America, rose 3% to $121.6 million from $118.6 million in 2003.  The increase was largely attributable to higher post-contract support. Sales to Europe, Middle East and Africa (“EMEA”) rose 26% to $93.2 million in 2004 from $73.8 million in 2003.  The increase was due mainly to higher sales to the enterprise market and post-contract support.  Sales to Asia-Pacific (“APAC”) increased 19% to $37.8 million in 2004 from $31.8 million in 2003 due mainly to higher sales to the enterprise market in the region.

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COST OF REVENUES:

The slight increase in cost of product revenues was due mainly to the higher sales volume.  The increase in cost of services revenue was due principally to higher labor, subcontractor and material costs associated with the growth in product installations and maintenance contracts.

GROSS PROFIT

The improvement in gross profit on product revenues was due primarily to the higher sales volume, product cost reductions and a higher proportion of software in the product mix. The improvement in gross profit margin on services revenue reflects improved staff utilization and efficiencies.   On a forward-looking basis, we expect our gross margins to increase gradually to the extent that we are successful in realizing the benefit of a growing proportion of software applications in our product revenue mix, higher volume and improved efficiencies in our global service operations.

EXPENSES

Research and Development, Net.  Research and development expense, before capitalization of software development costs and grants, increased to $27.5 million in 2004 from $26.4 million in 2003 and represented 10.9% and 11.8% of revenues in 2004 and 2003, respectively.  The increase in gross outlays was due mainly to the increase of R&D labor costs.

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Software development costs capitalized were $1.3 million in 2004 compared with $2.3 million in 2003. Amortization of capitalized software development costs, included in cost of product revenues, was $4.1 million and $5.7 million in 2004 and 2003, respectively.

Selling and Marketing Expenses.  The increase in selling and marketing expenses was due primarily to an increase in our corporate and regional sales and marketing efforts and higher sales commissions resulting mainly from the increase in sales.  Selling and marketing expenses represented 24.6% of total revenues in 2004 compared with 23.9% in 2003.  We expect that we will continue to leverage our global sales and distribution infrastructure and will increase our corporate and regional marketing efforts in the future. 

General and Administrative Expenses.  The increase in general and administrative expenses in 2004 was due principally to increase in labor costs and depreciation expenses.  General and administrative expenses represented 12.4% of total revenues in 2004 compared with 13.3% in 2003. On a forward-looking basis, general and administrative expenses, while increasing on an absolute dollar basis, are expected to decline as a percentage of total revenues. 

OTHER SPECIAL CHARGES:

Restructuring.   In December 2002 we adopted a restructuring plan, which involved the phased reduction of approximately 75 of our 1,077 staff members and consolidation of certain offices.  Some of the involuntary reductions were effected in December 2002 and, in accordance with SFAS No. 146, a liability of $282,000 was recorded as of December 31, 2002 related to those terminations. This liability was utilized as of June 30, 2003. The remaining reductions in force and facility closures were implemented during 2003.  We included in our results for 2003 costs of approximately $1.9 million, which related primarily to involuntary terminations and facility closures. 

Legal Settlement. In June 2000, Dictaphone Corporation, one of our competitors, filed a patent infringement claim relating to certain technology embedded in some of our products.  The claim was for damages for past infringement and enjoinment of any continued infringement of Dictaphone patents.  In the fourth quarter of 2003, we reached a settlement with Dictaphone in which both parties agreed to dismiss all claims and counterclaims connected with the aforementioned patent infringement claim. The terms of the settlement call for us to pay Dictaphone $10 million of which approximately $4.8 million was paid by our insurance carrier in December 2003 and the balance was paid by us, except for the final installment in the amount of $333,335.  This amount is required to be paid by us by June 30, 2005, subject to certain events

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which could result in a reduced payment by us. As a result, a charge of approximately $5.2 million was recorded in the last quarter of 2003.  The companies also agreed to grant each other a worldwide, royalty-free, perpetual license to certain of their patents including the disputed patents. The companies further agreed to enter into enforcement proceedings with respect to both companies’ patent portfolios and to share any proceeds from these actions.  As a result of our acquisition of the CRS division of Dictaphone on June 1, 2005, the agreement with respect to patents was terminated since we acquired the relevant patents.

FINANCIAL AND OTHER INCOME

Financial Income, Net.  The increase in financial income, net reflects a higher average cash balance and higher prevailing average interest rates in 2004 compared with 2003.

Other Income (Expense), Net.  Other income, net was $0.1 million in 2004 compared with $0.3 million in 2003. In 2003, we recorded $0.3 million of income reflecting amounts received from our insurance carrier in respect of the Chapiewski settlement.  In 2004, other income represented a capital gain recognized upon the disposal of fixed assets. 

Taxes on Income.  In 2004, we recorded a provision for income taxes of $2.3 million compared with $1.2 million in 2003. The increase was primarily related to operating profits recorded at certain distribution subsidiaries.

Net Income (Loss) from Continuing Operations. Net income from continuing operations was $21.3 million in 2004 compared with $5.6 million in 2003. The increase in 2004 resulted primarily from the increase in revenues and gross margin.

Net Income from Discontinued Operations.  As discussed above under “Other Developments”, on March 31, 2004 we sold the assets of our COMINT/DF military-related business to ELTA for $4 million in cash. Net income from this discontinued operation was approximately $3.2 million (including gain on disposition) and $1.5 million for 2004 and 2003, respectively.

YEARS ENDED DECEMBER 31, 2003 and 2002    

REVENUES

Total revenues from the enterprise market were $171.4 million in 2003, an increase of 41% from the prior year.  Total revenues from the public safety and security market were $52.8 million, an increase of 60% from the prior year.  We believe that our growth in revenue was due principally to market share gains in the enterprise and public safety and security markets following the acquisition of TCS in November 2002, and continued penetration of our digital

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video platform in the security market.

The increase in product revenues was due primarily to higher sales of our audio recording platforms and applications to enterprise and public safety markets related mainly to the inclusion for a full year of the operations of TCS and market share gains. 

The increase in services revenues reflects an increasing portion of our installed base engaging us for maintenance services and higher installation and training revenues related mainly to the increase in product sales to enterprise market.   

Revenues in 2003 in the Americas rose 36% to $118.6 million from $86.9 million in 2002.  The increase was largely attributable to higher sales of enterprise solution and post-contract support. Sales to EMEA rose 55% to $73.8 million in 2003 from $47.7 million in 2002.  The increase was due mainly to the inclusion for a full year of the operations of TCS and favorable currency movements.  Sales to APAC increased 54% to $31.8 million in 2003 from $20.7 million in 2002 due mainly to higher sales to the enterprise market in Japan, Australia/New Zealand and India.

COST OF REVENUES:

The increase in cost of product revenues in 2003 was due mainly to higher sales volume. The increase in cost of services revenue was due principally to higher labor, subcontractor and material costs associated with the inclusion of TCS activities for a full year and with the growth in product installations and maintenance contracts.

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GROSS PROFIT