SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 6-K

Report of Foreign Issuer

Pursuant to Rule 13a-16 or 15d-16

of the Securities Exchange Act of 1934

For the Month of March, 2006

ECI TELECOM LTD.

(Translation of Registrant’s Name into English)

30 Hasivim Street • Petah Tikva 49133 • ISRAEL

(Address of Principal Corporate Offices)

Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F:

Form 20-F x Form 40-F o

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1):____

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7):____

Indicate by check mark whether the registrant by furnishing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities and Exchange Act of 1934:

Yes o No x

If "Yes" is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b): 82-______

Attached hereto and incorporated herein are the Audited Consolidated Financial Statements of the Registrant and Subsidiaries as at December 31, 2005, including Report of Independent Registered Public Accounting Firm.

This report on Form 6-K shall be deemed to be incorporated by reference in the prospectus included in the Registration Statement on Form F-3 (File No. 333-121314) filed with the Securities and Exchange Commission and to be a part thereof from the date on which this report is filed, to the extent not superseded by documents or reports subsequently filed or furnished.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

ECI TELECOM LTD.

(Registrant)

By: /s/ Martin Ossad

Name: Martin Ossad

Title: Corporate Vice President and General Counsel

Dated: March 20, 2006

ECI Telecom Ltd. and Subsidiaries

Consolidated

Financial Statements

As of December 31, 2005

ECI Telecom Ltd. and Subsidiaries

Consolidated Financial Statements as of December 31, 2005

Contents

	Page

Report of Independent Registered Public Accounting Firm


Consolidated Balance Sheets as of
December 31, 2005 and 2004	3


Consolidated Statements of Operations for the Years
ended December 31, 2005, 2004 and 2003	4


Consolidated Statements of Comprehensive Income (Loss) for the
Years ended December 31, 2005, 2004 and 2003	5


Consolidated Statements of Changes in Shareholders’ Equity for the
Years ended December 31, 2005, 2004 and 2003	6


Consolidated Statements of Cash Flows for the
Years ended December 31, 2005, 2004 and 2003	8

Notes to the Consolidated Financial Statements	11

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders

ECI Telecom Ltd.

We have audited the accompanying consolidated balance sheets of ECI Telecom Ltd. and its subsidiaries (“the Company”) as of December 31, 2005 and 2004, and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s Board of Directors and its management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Board of Directors and management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

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

/s/ Somekh Chaikin

Somekh Chaikin

Certified Public Accountants (Israel)

Member firm of KPMG International

Tel-Aviv, Israel.

March 9, 2006

Consolidated Balance Sheets as of December 31

					2005			2004
			Note			$ in thousands			$ in thousands

Assets

Current assets
Cash and cash equivalents	17A	63,828	74,182
Short-term investments	2,17B	41,304	24,714
Receivables:
Trade, net	17C	152,805	142,928
Other	17D	24,751	23,441
Prepaid expenses		3,617	5,982
Work in progress		2,937	3,244
Inventories	3	146,963	175,065

Total current assets		436,205	449,556


Long-term receivables, net	4	8,273	89,975

Long-term deposits and marketable securities	2	139,964	119,359

Assets held for severance benefits	10	25,931	25,182

Investments	5	19,787	26,766


Property, plant and equipment	6
Cost		265,446	259,318
Less - accumulated depreciation		145,855	139,965

		119,591	119,353

Software development costs, net	7	11,999	14,435

Goodwill,	8	39,329	1,039

Other assets, net	9	47,656	9,144

Total assets		848,735	854,809

/s/ Shlomo Dovrat			/s/ Rafi Maor
Shlomo Dovrat			Rafi Maor
Chairman of the Board			President, Chief Executive Officer

March 9, 2006

ECI Telecom Ltd. and Subsidiaries

					2005			2004
			Note			$ in thousands			$ in thousands

Liabilities and Shareholders’ Equity

Current liabilities
Current maturities of long-term debts	17E	—		30,000
Trade payables		56,451		68,364
Other payables and accrued liabilities	17F	120,538		149,648

Total current liabilities		176,989		248,012

Long-term liabilities

Other liabilities		157		—
Liability for employee severance benefits	10	48,340		50,943

Total long-term liabilities		48,497		50,943

Total liabilities		225,486		298,955

Minority interest		4,120		4,086

Commitments and contingencies	11

Shareholders’ equity	12
Ordinary shares NIS 0.12 par value per share, authorized
200,000,000 shares; Issued and outstanding 111,827,822
shares as of December 31, 2005 and 109,391,828 shares as
of December 31, 2004		6,262		6,198
Capital surplus		648,532		642,222
Accumulated other comprehensive income (loss)		8,486		(12,637	)
Accumulated deficit		(44,151	)	(84,015	)

Total shareholders’ equity		619,129		551,768


Total liabilities and shareholders’ equity			848,735			854,809

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

ECI Telecom Ltd. and Subsidiaries

Consolidated Statements of Operations for the Year Ended December 31

2005

2004

2003

Note

$ in thousands, except per share amounts

Revenues	17G		629,918		496,712		392,567
Cost of revenues	17H		367,779		300,971		239,298
Gross profit			262,139		195,741		153,269

Research and development costs, net	17I		87,289		64,870		62,041
Selling and marketing expenses	17J		95,826		78,423		73,643
General and administrative expenses	17K		41,976		35,491		38,956
Recovery of doubtful debt	4C(5	)	(10,356	)	—		—
Amortization of acquisition—related intangible assets			2,902		—		1,773
Impairment of assets	21		—		—		667
Impairment of loans	21		3,000		—		—
Acquired in—process research and development	19B		890		—		—
Restructuring expenses	20		—		2,585		8,394
Operating income (loss)			40,612		14,372		(32,205	)
Financial expenses	17L		(3,656	)	(6,562	)	(8,645	)
Financial income	17L		8,857		9,169		7,902
Other income (expenses), net	17M		1,917		2,693		(5,376	)
Income (loss) from continuing operations
before company’s equity in results of investee
companies, minority interest and taxes on income			47,730		19,672		(38,324	)
Taxes on income	15		(3,454	)	(1,924	)	(2,141	)
Income (loss) from continuing operations before
company’s equity in results of investee companies
and minority interest			44,276		17,748		(40,465	)
Company’s equity in results of investee
companies			(4,285	)	(3,387	)	(4,334	)
Minority interest			(127	)	(305	)	76
Income (loss) from continuing operations			39,864		14,056		(44,723	)

Loss on discontinued operations, net of income tax
(tax benefit) of ($55 thousand) and $38 thousand
for the years ended December 31,2004 and 2003,
respectively	22		—		(3,903	)	(26,317	)
Net income (loss)			39,864		10,153		(71,040	)

Earnings (loss) per ordinary share	17O
Basic earnings (loss) per ordinary share:
Continuing operations		0.36	0.13		(0.41	)

Discontinued operations		—	(0.04	)	(0.24	)
Net earnings (loss) per ordinary share		0.36	0.09		(0.65	)


Diluted earnings (loss) per ordinary share:
Continuing operations		0.34	0.12		(0.41	)

Discontinued operations		—	(0.03	)	(0.24	)
Net earnings (loss) per ordinary share		0.34	0.09		(0.65	)

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

ECI Telecom Ltd. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss) for the Year Ended December 31

		2005			2004			2003
			$ in thousands			$ in thousands			$ in thousands

Net income (loss)	39,864	10,153		(71,040	)
Other comprehensive income (loss):
Changes in fair value of financial instruments, net of taxes (nil)	19,226	(8,303	)	(4,843	)
Realization of gain on available for sale securities, net of taxes (nil)	—	(1,282	)	—
Unrealized holding gains on available for sale
securities arising during the year, net of taxes (nil)	1,897	2,341		1,282

Total other comprehensive income (loss)	21,123	(7,244	)	(3,561	)

Comprehensive income (loss)	60,987	2,909		(74,601	)

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

ECI Telecom Ltd. and Subsidiaries

Consolidated Statements of Changes in Shareholders' Equity

Number

Share

Capital

Accumulated

Total

of shares⁽¹⁾

capital

surplus

other

earnings (deficit)

shareholders’

comprehensive

(Note 15A2)

equity

income (loss

)

Balance at January 1, 2003	107,512,612	6,152	658,425		(1,832	)	(23,128	)	639,617

Changes during 2003 -
Net loss for the year ended December 31, 2003	—	—	—		—		(71,040	)	(71,040	)
Share issuance to employees	424,633	8	647		—		—		655
Employees stock options exercised and paid	100,818	3	263		—		—		266
Amortization of deferred compensation expenses	—	—	3,568		—		—		3,568
Net unrealized gain on available for sale securities	—	—	—		1,282		—		1,282
Changes in fair value of financial instruments	—	—	—		(4,843	)	—		(4,843	)

Balance at December 31, 2003	108,038,063	6,163	662,903		(5,393	)	(94,168	)	569,505

Changes during 2004 -
Net income for the year ended December 31, 2004	—	—	—		—		10,153		10,153
Employees stock options exercised and paid	1,353,765	35	2,445		—		—		2,480
Amortization of deferred compensation expenses	—	—	1,650		—		—		1,650
Net unrealized gain on available for sale securities	—	—	—		2,341		—		2,341
Realization of gain on available for sale securities	—	—	—		(1,282	)	—		(1,282	)
Changes in fair value of financial instruments	—	—	—		(8,303	)	—		(8,303	)
Distribution of shares of a subsidiary as dividend in kind (see Note 1A(4))	—	—	(24,776	)	—		—		(24,776	)

Balance at December 31, 2004	109,391,828	6,198	642,222		(12,637	)	(84,015	)	551,768

⁽¹⁾ Issued and outstanding

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

ECI Telecom Ltd. and Subsidiaries

Consolidated Statements of Changes in Shareholders' Equity (cont’d)

Number

Share

Capital

Accumulated

Total

of shares⁽¹⁾

capital

surplus

other

earnings (deficit)

shareholders’

comprehensive

(Note 15A2)

equity

income (loss

)

Balance at January 1, 2005	109,391,828		6,198	642,222		(12,637	)	(84,015	)	551,768

Changes during 2005 -
Net income for the year ended December 31, 2005	—		—	—		—		39,864		39,864
Employees stock options exercised and paid	1,697,867		45	4,254		—		—		4,299
Restricted shares issuance	742,776		19	(19	)					—
Restricted shares forfeited	(9,557	)	—	—		—		—		—
Share issuance	4,908		—	35		—		—		35
Amortization of deferred compensation expenses	—		—	2,040		—		—		2,040
Net unrealized gain on available for sale securities	—		—	—		1,897		—		1,897
Changes in fair value of financial instruments	—		—	—		19,226		—		19,226

Balance at December 31, 2005	111,827,822		6,262	648,532		8,486		(44,151	)	619,129

⁽¹⁾ Issued and outstanding

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

ECI Telecom Ltd. and Subsidiaries

Consolidated Statements of Cash Flows for the Year Ended December 31

	2005			2004			2003
				* Revised
	$ in thousands			$ in thousands			$ in thousands
Cash flows from operating activities

Net income (loss)		39,864			10,153			(71,040	)
Adjustments to reconcile net income (loss) to cash provided by
operating activities:

Depreciation and amortization		36,665			35,827			41,622

Amortization of share based compensation		2,040			1,650			3,568

Loss (gain) on sale of property and equipment		(2,398	)		(716	)		1,362

Impairment of assets		—			—			6,686

Impairment of loans		3,000			—			—

Capital losses (gains), net		(2,096	)		6,419			4,862

Gain from sale of operation		—			(24,186	)		—

Acquired In-process research and development costs		890			—			—

Other - net		1,723			(468	)		7,066

Company’s equity in results of investee companies		4,285			3,387			4,334

Minority interest		127			562			(16,956	)

Loss (gain) from marketable securities		1,648			(1,482	)		(111	)

Decrease in trade receivables (including
non-current maturities of trade receivables)		78,056			19,395			69,069

Decrease (increase) in other receivables		3,565			(6,196	)		9,531

Decrease (increase) in prepaid expenses		3,325			(947	)		(1,410	)

Decrease in work in progress		308			7,254			3,192

Decrease (increase) in inventories		38,127			(57,010	)		24,149

Increase (decrease) in trade payables		(16,759	)		13,986			14,413

Increase (decrease) in other payables and accrued liabilities		(16,068	)		32,706			(23,500	)

Decrease in other long-term liabilities		—			(5,015	)		(2,364	)

Decrease in liability for employee severance benefits		(2,602	)		(779	)		—

Net cash provided by operating activities		173,700			34,540			74,473

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

ECI Telecom Ltd. and Subsidiaries

Consolidated Statements of Cash Flows for the Year Ended December 31 (cont’d)

2005	2004	2003
	* Revised
$ in thousands	$ in thousands	$ in thousands

Cash flows used in investing activities

Investments in deposits, net	2,368		4,454		(22,563	)
Software development costs capitalized	(8,014	)	(11,151	)	(11,364	)
Investment in property, plant and equipment	(21,499	)	(24,293	)	(11,347	)
Proceeds from sale of property, plant and equipment	7,131		1,487		878
Purchase of technology	—		—		(869	)
Acquisition of investee companies	(559	)	(1,212	)	(203	)
Long-terms loans granted	—		(6,000	)	—
Proceeds from realization of an investee company	2,350		—		—
Investment in marketable securities	(37,838	)	(41,382	)	(80,317	)
Changes in assets held for severance benefits	(1,006	)	(751	)	537
Repayment of convertible notes	—		5,400		—
Acquisition of operations (A)	(13,605	)	—		—
Acquisition of newly consolidated subsidiary (B)	(85,923	)	—		—
Proceed from realization of consolidated subsidiary and operations	—		35,000		9,100

Net cash used for investing activities	(156,595	)	(38,448	)	(116,148	)

Cash flows used in financing activities

Repayment of loans from banks	(30,000	)	(30,000	)	(100,000	)
Decrease in short-term credit, net	—		—		(70,012	)
Share issuance	35		—		—
Exercise of stock options	4,299		2,480		921
Disposition of a consolidated subsidiary as dividend in kind	—		(39,981	)	—

Net cash used in financing activities	(25,666	)	(67,501	)	(169,091	)

Effect of change in exchange rate on cash	(1,793	)	216		(508	)

Net decrease in cash and cash equivalents	(10,354	)	(71,193	)	(211,274	)

Cash and cash equivalents at beginning of year	74,182		**145,375		356,649

Cash and cash equivalents at end of year	63,828		74,182		** 145,375

Supplemental disclosures:

Income taxes paid, net of tax refunds	2,897		282		7,158

Interest paid	154		1,518		2,479

The consolidated cash flow statement for the year ended December 31, 2004 has been revised to combine cash flows from discontinued operations with cash flows from continuing operations within each category (previously, all cash flows from discontinued operations were presented, net in one line, within the operating cash flows category).

**	Include $ 18,964 thousand related to discontinued operations.

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

ECI Telecom Ltd. and Subsidiaries

Consolidated Statements of Cash Flows for the Year Ended December 31 (cont’d)

A. Acquisition of operations (see Note 19)

		2005			2004			2003
			$ in thousands			$ in thousands			$ in thousands

Net current assets	5,216		—	—
Liability for unpaid consideration	(250	)	—	—
Property, plant and equipment	580		—	—
Core Technology	4,349		—	—
Goodwill	1,230		—	—
Other intangible assets	2,480		—	—
	13,605		—	—

B. Acquisition of newly consolidated subsidiary (see Note 19)

		2005			2004			2003
			$ in thousands			$ in thousands			$ in thousands

Net current assets (other than cash)	11,055		—	—
Property, plant and equipment	3,155		—	—
Long—term liabilities	(157	)	—	—
Core Technology	33,820		—	—
In-process research and development	890		—	—
Backlog	100		—	—
Goodwill	37,060		—	—
	85,923		—	—

C. Non-cash activities

Purchase of fixed assets	3,049	—	—

Sale of fixed assets in return for shares in investee company	—	—	1,053

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

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 1 - Significant Accounting Policies

Significant accounting policies, applied on a consistent basis are as follows:

A. General

ECI Telecom Ltd. (an Israeli corporation) and subsidiaries ("ECI" or the "Company") provide network and access solutions for digital telecommunications networks. ECI designs, develops, manufactures, markets and supports digital telecommunications solutions for evolving services, including voice, data, video and multimedia, and for building next generation converging networks. ECI's products and platforms are designed to create and manage bandwidth, maximize revenues for network operators, reduce operating expenses, expand capacity, improve performance and enable new revenue-producing services.

The Company focuses its activities on three core businesses, which are organized in three divisions: Broadband Access Division (formerly - Inovia), Optical Networks Division (formerly - Lightscape and Enavis) and Data Networking Division (formerly - Laurel Networks). (For segment reporting, see Note 17G).

In December 2002, the Company transferred part of the NGTS activities to a new company subsequently called Veraz Networks Inc., which was set up with third parties and in which the Company holds approximately 41.5 % of the share capital (33 % on a fully diluted basis).

In April 2003, the Company sold the activities of InnoWave. Accordingly, the results of InnoWave for all periods reported were reclassified as discontinued operation and presented as a single-line item, net of income tax in the statement of operations following the results from continuing operations (see Note 22B).

On March 9, 2004, the Board of Directors of ECI decided, in principle, that ECI would distribute 7.6 million of its shares in ECtel Ltd. (“ECtel”) to ECI's shareholders.

On April 28, 2004, after the Company obtained court approval and the consent of its banks, the Board of Directors declared a distribution of 7.6 million shares of ECtel to the Company's shareholders of record on May 5, 2004. The shares were distributed on May 10, 2004. Before distribution, ECI held approximately 10.5 million, or 58%, of ECtel's shares. After distribution of the shares, ECI holds approximately 16% of ECtel's outstanding shares that are presented in the consolidated balance sheet as an available for sale securities. (see Note 1D).

Accordingly, the results of ECtel for all periods reported were reclassified as discontinued operations and presented as a single-line item, net of income tax in the statement of operations following the results from continuing operations (see Note 22B).

On June 3, 2005, the Company acquired 100% of the outstanding common shares of Laurel Networks, Inc. (“Laurel Networks”) The results of Laurel Networks’ operations have been included in the consolidated financial statements since that date. Laurel Networks is a provider of Next-Generation IP/MPLS Multi Service Edge Routers.

After the transaction Laurel Networks became the Data Networking Division of ECI (see Note 19B).

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 1 - Significant Accounting Policies (cont’d)

A. General (cont’d)

The financial statements have been prepared in conformity with generally accepted accounting principles (GAAP) in the United States of America.

The currency of the primary economic environment in which the operations of the Company and its subsidiaries are conducted is the U.S. dollar (“dollar”).

Most of the Company’s sales are made outside of Israel, in dollars and other non-Israeli currencies (see Note 17G as to geographical distribution). Most purchases of materials and components, as well as most selling and other expenses incurred outside Israel, are in dollars. In view of the foregoing, the dollar has been determined to be the Company’s functional currency.

Transactions and balances denominated in dollars are presented at their original amounts.

Non-dollar transactions and balances have been remeasured into dollars in accordance with the principles set forth in Statement of Financial Accounting Standards (“SFAS”) No. 52“Foreign Currency Translation” of the Financial Accounting Standards Board (FASB).

All exchange gains and losses from remeasurement of monetary balance sheet items denominated in non-dollar currencies are reflected in the consolidated statement of operations when they arise. Such foreign exchange gains and losses are included in the same statement of operations items as those in which the related transactions are included.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These are management’s best estimates based on experience and other relevant data, however, actual results could differ from these estimates.

Principles of consolidation

The consolidated financial statements include those of the Company and all of its subsidiaries.

All intercompany transactions and balances have been eliminated in consolidation.

Cash and cash equivalents

The Company considers all highly liquid investments with a maturity of three months or less at date of purchase, to be cash equivalents (except for held to maturity debt investments).

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 1 - Significant Accounting Policies (cont’d)

Investments

Investee companies

Investments in investee companies, in which the Company has significant influence (affiliated companies) are presented under the equity method, that is, at cost plus the Company’s share of the post-acquisition income or losses.

Investment in entities in which the Company does not have significant influence (“other companies”), are stated as follows:

Marketable securities - as stated in 2 below.

Non-marketable securities - at cost, less any decline in value which is other than temporary.

Marketable securities

The Company classifies its debt securities in one of three categories: Trading, available for sale or held to maturity and its equity securities as trading or available for sale. Trading securities are bought and held principally for the purpose of selling them in the near term. Held-to-maturity debt securities are those securities in which the Company has the ability and intent to hold the security until maturity. All debt securities not included in trading or held to maturity are classified as available for sale.

Trading, and available-for-sale securities are recorded at fair value. Held-to-maturity debt securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. Unrealized holding gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of other comprehensive income until realized. Realized gains and losses from the sale of available-for-sale securities are determined on a specific-identification basis.

A decline in the market value of any available-for-sale or held-to-maturity security below cost, that is deemed to be other than temporary, is recognized as a reduction in carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established.

Premiums and discounts are amortized or accreted over the life of the related held-to-maturity or available-for-sale security as an adjustment to yield, using the effective-interest method. Dividend and interest income are recognized when earned.

Inventories

Inventories are stated at the lower of cost or market. Cost is determined on the moving average basis.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 1 - Significant Accounting Policies (cont’d)

Property, plant and equipment

Assets are stated at cost, less accumulated depreciation.

Depreciation is computed using the straight-line method, over the estimated useful economic life of the assets.

Annual rates of depreciation are as follows:

Buildings	2.5%
Machinery and equipment	10% - 33% (mainly 10%)
Information technology	20% - 33%
Office furniture and equipment	7% - 10%

Leasehold improvements are amortized by the straight-line method over the lesser of the lease term or the estimated useful economic life.

Major renewals and improvements are capitalized, while repairs and maintenance are expensed as incurred.

Upon the sale or retirement of equipment and leasehold improvements, the cost and related accumulated depreciation and amortization are eliminated from the respective accounts and the resulting gain or loss is reflected in the consolidated statements of operations.

Accrued warranty costs

Accrued warranty costs are calculated in respect of products sold and work performed are recognized based on prior experience, and other relevant factors, (See also Note 17F).

Allowance for doubtful debts

The financial statements include an allowance for loss from receivables for which collection is in doubt. In determining the adequacy of the allowance consideration is given the historical experience, aging of the receivable and to information available about specific debtors, including their financial situation, the volume of their operations, and evaluation of the security received from them or their guarantors (see also Note 17C).

Software development costs

The Company capitalizes 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 determination of technological feasibility as defined in the Statement and continues up to the time the software is available for general release to customers, at which time capitalized software costs are amortized to research and development costs on a straight-line basis over the expected life of the related product, generally one to two years. (for 2003 - generally two to three years).

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 1 - Significant Accounting Policies (cont’d)

Software development costs (cont'd)

Software development costs include costs that relate principally to projects which have recently been released or are not yet available for release to customers. Management believes that future revenues related to these projects will be sufficient to realize the amounts capitalized at December 31, 2005, and as such these amounts will be recovered over the lives of the related projects. It is possible, however, that those estimates of future revenues could be adversely impacted if these projects are not finally completed and released in the future or if market acceptance of related technology is not as anticipated by Management. As a result, the recovery of these capitalized software development costs through future revenues could be reduced materially. In such event, the related capitalized software development costs will be written-off.

Business combinations

SFAS No. 141 "Business Combinations" requires that the purchase method be used for all business combinations. Under the purchase method, the cost of an acquisition is allocated to the assets acquired, including identifiable intangible assets and liabilities assumed based on their estimated fair values with the excess of total cost over such aggregate fair value being recognized at goodwill.

Goodwill and other intangible assets

The Company follows SFAS No. 142 "Goodwill and Other Intangible Assets", under to SFAS No. 142, goodwill and intangible assets that have indefinite useful lives are not subject to amortization, but instead tested at least annually for impairment. Intangible assets that have finite useful lives are amortized over their expected useful lives.

Revenue recognition

Revenues from products are recognized when the product has been delivered and when title to the system and risk of loss have been substantially transferred to the customer, provided that collection is reasonably assured. When the sale arrangement includes customer acceptance provisions with respect to network interoperability, revenue is not recognized before the Company has demonstrated that the criteria specified in the acceptance provisions have been satisfied.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 1 - Significant Accounting Policies (cont’d)

Revenue recognition (cont'd)

When a sale involves multiple elements, such as sales of products that include installation and integration services, the entire fee from the arrangement is evaluated under Emerging Issues Task Force (“EITF”) 00-21, "Revenue Arrangements with Multiple Deliverables". In such arrangements, the arrangement consideration is allocated to each respective element based on its relative fair value and recognized when all the following revenue recognition criteria for each element are met: (1) the delivered items have value to the customer on a standalone basis, (2) there is objective and reliable evidence of the fair value of the undelivered items, (3) if the arrangement includes a general right of return, delivery or performance of the undelivered items is probable and substantially in the control of the Company.

The Company makes certain sales through resellers. The Company recognizes revenues from sales to resellers, assuming all other criteria for revenue recognition are met and provided that there is no contractual right of return, either (i) when it receives adequate collateral (which in almost every case is a Letter of Credit) from the reseller to secure payment to the Company, or (ii) in certain instances where the Company has an established ongoing relationship with the reseller and a proven track record of payments, when it receives written evidence of the identity of the end-user and the existence of an agreement by the end-user to purchase the product from the reseller (e.g. a copy of a purchase order) or (iii) in instances where the reseller is a major internationally known corporation and the Company has an established ongoing relationship with such reseller and a proven track record of payments, upon delivery of the products to the reseller. When the collectability from the reseller is not reasonably assured or when the right of return exists, revenue is recognized on a cash basis, provided that the reseller has ultimately sold the products to an end-user or the return privilege has substantially expired.

Revenues from sales involving long-term credit arrangements at less than accepted interest rates are recorded at the present value of the related future cash flows. The difference between the amounts receivable and their present value is recognized as interest income over the period of the receivable by the interest method.

Revenue from software license is generally recognized at the time the software is delivered to the customer, if collection is probable, the fee is fixed or determinable, the Company has no significant obligations remaining under the sales or licensing agreement and no significant customer acceptance requirements exist subsequent to software delivery.

Service revenues from product maintenance contracts and separately priced extended warranty contracts are generally recognized ratably over the contract period, while revenue from software services generally is recognized as the services are performed or, if no pattern of performance is evident, ratably over the period during which such services are performed.

The percentage of completion method of accounting, in accordance with Statement of Position (“SOP”) 81-1 “Accounting for Performance of Construction Type and Certain Production Type Contracts” is used for sales generated from certain contracts, primarily those related to customized network solutions and network build-outs with durations of at least six months. The units-of-delivery method or units-of-work performed method is used to measure progress on each contract. Revenue and cost estimates are revised periodically based on changes in circumstances. Any expected losses on contracts are recognized immediately upon contract signing or as soon thereafter as identified.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 1 - Significant Accounting Policies (cont’d)

Research and development

Research and development costs, net of any grants, are charged to the consolidated statements of operations as incurred. Royalties paid and accrued in respect of the said grants are classified as cost of revenues.

Reclassification

Certain amounts in prior years’ financial statements have been reclassified to conform to the current year’s presentation. (See also Note 22).

Income taxes

The Company accounts for income taxes under SFAS No. 109 “Accounting for Income Taxes”.

Under SFAS 109, deferred tax assets or liabilities are recognized in respect of temporary differences between the tax bases of assets and liabilities and their financial reporting amounts, as well as in respect of tax losses and other deductions which may be deductible for tax purposes in future years, based on tax rates applicable to the periods in which such deferred taxes are expected to be realized. Valuation allowances are established when necessary to reduce deferred tax assets to the amount considered more likely than not to be realized. Deferred tax assets and liabilities are classified as current or non current items in accordance with the nature of the assets or liabilities to which they relate. When there is no underlying assets or liabilities the deferred tax assets and liabilities are classified in accordance with the period of expected reversal.

Deferred taxes have not been recorded in respect of the following matters -

Certain undistributed earnings of foreign consolidated subsidiaries which are taxable upon distribution by way of dividend, as no such dividend distribution intention exists.

Differences between the financial carrying amounts of non monetary assets and liabilities and their tax basis attributable to the rate of change in Israeli Consumer Price Index (which serves as a basis for measurement for tax purposes) and the rate of change in the NIS/US dollar exchange rate, in accordance with paragraph 9 (f) of SFAS 109.

Income tax expense represents the tax payable for the period and the change during the period in deferred tax assets and liabilities.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 1 - Significant Accounting Policies (cont’d)

Derivative financial instruments

SFAS No. 133, "Accounting for Derivative Instruments and Certain Hedging Activities" and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activity, an Amendment of SFAS 133" require that all derivative instruments be recorded on the balance sheet at their respective fair values.

The Company has significant international sales transactions in foreign currencies and has a policy of hedging forecasted and actual foreign currency risk with forward foreign exchange contracts and foreign exchange options. The Company’s forward foreign exchange contracts are primarily denominated in Euro, Pounds Sterling and NIS and are for periods consistent with the terms of the underlying transactions, generally one year or less. Derivative instruments are employed to eliminate or minimize certain foreign currency exposures that can be identified and quantified.

On the date a derivative contract is entered into, the Company designates the derivative as either a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge), or a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge), or a foreign-currency fair-value or cash-flow hedge (foreign currency hedge). For all hedging relationships the Company formally documents the hedging relationship and its risk-management objective and strategy for undertaking the hedge, the hedging instrument, the hedge item, the nature of the risk being hedged, how the hedging instrument’s effectiveness in offsetting the hedged risk will be assessed, and a description of the method of measuring ineffectiveness. This process includes linking all derivatives that are designated as fair-value, cash-flow, or foreign-currency hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of the hedged items.

Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a fair-value hedge, along with the loss or gain on the hedged asset or liability or unrecognized firm commitment of the hedged item that is attributable to the hedged risk, are recorded in operations. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a cash-flow hedge are recorded in other comprehensive income (loss) to the extent that the derivative is effective as a hedge, until operations are affected by the variability in cash flows of the designated hedged item. Changes in the fair value of derivatives that are highly effective as hedges and that are designated and qualify as foreign-currency hedges are recorded in either operations or other comprehensive income (loss), depending on whether the hedge transaction is a fair-value hedge or a cash-flow hedge. The ineffective portion of the change in fair value of a derivative instrument that qualifies as either a fair-value hedge or a cash-flow hedge is reported in operations. Changes in the fair value of derivative trading instruments are reported in current period operations.

The Company discontinues hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative expires or is sold, terminated, or exercised, or the derivative is de-designated as a hedging instrument, because it is unlikely that a forecasted transaction will occur, a hedged firm commitment no longer meets the definition of a firm commitment, or management determines that designation of the derivative as a hedging instrument is no longer appropriate.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 1 - Significant Accounting Policies (cont’d)

Derivative financial instruments (cont'd)

When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair-value hedge, the Company continues to carry the derivative on the balance sheet at its fair value and no longer adjusts the hedged asset or liability for changes in fair value. The adjustment of the carrying amount of the hedged asset or liability is accounted for in the same manner as other components of the carrying amount of that asset or liability. When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, the Company continues to carry the derivative on the balance sheet at its fair value, removes any asset or liability that was recorded pursuant to recognition of the firm commitment from the balance sheet, and recognizes any gain or loss in operations. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the Company continues to carry the derivative on the balance sheet at its fair value with subsequent changes in fair value included in operations, and gains and losses that were accumulated in other comprehensive income are recognized immediately in operations. In all other situations in which hedge accounting is discontinued, the Company continues to carry the derivative at its fair value on the balance sheet and recognizes any subsequent changes in its fair value in operations.

Comprehensive income

The Company adopted SFAS No. 130, "Reporting Comprehensive Income", which establishes standards for reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive income consists of net income (loss) and net unrealized gains (losses) on available for sale securities and on the change in the fair value of financial instruments that are used for cash flow hedging, and is presented in the consolidated statement of comprehensive income (loss).

Stock option and restricted shares plans

The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations, including FASB Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation an Interpretation of APB Opinion No. 25" issued in March 2000, to account for its fixed plan stock options. Under this method, compensation cost is recognized only if the market price of the underlying stock at the date of the grant exceeds the exercise price. Any such cost so determined is allocated to compensation expense over the vesting period of the award.

SFAS No. 123, "Accounting for Stock-Based Compensation", established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic value-based method of accounting described above, and has adopted the disclosure requirements of SFAS No. 123. (See Note 12E and 18A).

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 1 - Significant Accounting Policies (cont’d)

Stock option and restricted shares plans (cont'd)

Had compensation expenses for stock options granted under the Company's stock option plan been determined based on the fair value at the grant dates consistent with the fair value accounting method of SFAS No. 123, the Company's net income (loss) and net income (loss) per ordinary share would have been as follows:

For the year ended December 31
	2005	2004	2003
$ in thousands, except per share amounts

Net income (loss), as reported	39,864		10,153		(71,040	)
Add: Stock-based employee compensation
expenses included in reported net
income (loss), net of related tax effects (nil)	2,040		1,650		3,568
Deduct: Total stock-based employee compensation
expense determined under the fair value
method for all awards, net of
related tax effects (nil)	(10,267	)	(10,072	)	(23,450	)

Pro Forma net income (loss)	31,637		1,731		(90,922	)

Basic earnings (loss) per ordinary share ($):
- as reported	0.36	0.09	(0.65	)
- pro forma	0.29	0.02	(0.84	)
Diluted earnings (loss) per ordinary share($):
- as reported	0.34	0.09	(0.65	)
- pro forma	0.27	0.01	(0.84	)

Acquired in-process research and development costs (IPR&D).

Acquired in-process research and development represents the value assigned in a purchase business combination to research and development projects of the acquired business that were commenced, but not yet completed, at the date of acquisition, for which technological feasibility has not been determined and which have no alternative future use in research and development activities or otherwise. In accordance with SFAS No. 2, "Accounting for Research and Development Costs", as interpreted by FASB Interpretation No. 4 “Applicability of FASB Statement No. 2 to Business Combinations Accounted for by the Purchase Method” “amounts assigned to acquired in-process research and development meeting the above criteria are charged to expense at the date of consummation of the purchase business combination”.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 1 - Significant Accounting Policies (cont’d)

Impairment or disposal of long-lived assets

SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future cash flows expected to be generated by the asset or used in its disposal. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. SFAS No 144 requires companies to separately report discontinued operations and extends that reporting to a component of an entity that either has been disposed of (by sale, abandonment, or in a distribution to owners) or is classified as held for sale (See also Notes 21and 22).

Sale of financial assets

SFAS No. 140 - “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, requires that a transfer of financial assets in which control is surrendered, is accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in exchange. (See Note 17P).

Earnings (loss) per Ordinary Share

Basic and diluted earnings (loss) per Ordinary Share are presented in conformity with SFAS No. 128, “Earnings Per Share”. Basic earnings (loss) per Ordinary Share are calculated by dividing the net earning (loss) attributable to Ordinary Shares, by the weighted average number of Ordinary Shares outstanding. For purposes of determining diluted earnings per share, potential common stock includes the effects of dilutive stock options. The effect on the number of shares of such potential common stock is computed using the treasury stock method. Diluted earnings per share excludes the impact of anti dilutive securities, which are those securities resulting in an increase in earnings per share or a decrease in loss per share.

Commitments and contingencies

Liabilities for loss contingencies arising from claims, assessments, litigation, fines and penalties and other sources are recognized when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated.

Impairment of loans

The Company applies the provisions of SFAS No. 114 “Accounting by Creditors for Impairment of a Loan” as amended by SFAS No. 118 “Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures” These standards apply to loans, which are restructured in a troubled debt restructuring, involving modifications of terms of the loans, including those involving a receipt of assets in partial satisfaction of a receivable.

In accordance with SFAS No. 114, a loan is impaired when it is probable, based on current information and events, that the creditor will be unable to collect all amounts (contractual interest and principle payments) due according to the contractual terms of the loan agreement. Impaired loans are written down to the present value of their expected future cash flows, discounted at the loan’s effective interest rate or, alternatively, based on the observable market price of the loan or the fair value of the collateral, if the loan is collateral-dependent.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 1 - Significant Accounting Policies (cont’d)

Employee Severance Benefits

Under Israeli law and labor agreements, the Company is required to make severance and pension payments to their retired or dismissed employees and to employees leaving employment in certain other circumstances. The liability for Employee Severance Benefits is based on salary components as prescribed in the existing labor agreement. The liability for severance pay is calculated on the basis of the latest salary paid to each employee multiplied by the number of years of employment. The liability is covered by the amounts deposited including accumulated income thereon as well as by the unfunded provision.

The US subsidiaries sponsor a section 401(k) defined contribution plan or 401(a) plan which permits its employees to invest up to certain amounts of their compensation (subject to limitation by Internal Revenue Service Regulations) on a pretax basis in certain self-directed investment programs. The subsidiaries may, at the discretion of the Board of Directors, make contributions to the plan.

The provision for severance pay includes amounts related to employees in countries other than Israel and the U.S. and are calculated in accordance with the rules of the country in which they operate.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 2 - Investment Securities and Deposits

December 31		December 31
2005		2004
	$ in thousands		$ in thousands

Short-term:
Short-term deposits (see Note 17B.)	1,540	5,628

Marketable securities:
Available for sale securities*	4,699	-
Held to maturity securities	35,065	19,086

	41,304	24,714
Long-term:
Long-term deposits	12,762	11,659
Available for sale securities*	37,707	10,694
Held to maturity securities	89,495	97,006

	139,964	119,359

* As of December 31, 2005 and 2004, the Company had net unrealized gains on Available for Sale Securities of $ 4,238 and $ 2,341 thousand, respectively.

The amortized cost, gross unrealized holding gains (loss), and fair value of held-to-maturity securities by major security type at December 31, 2005, were as follows:

Gross

Unrealized

Amortized

Holding

Fair

Cost

Gains

Losses

Value

$ in thousands

Held to maturity

U.S. Government agencies

46,919

—

(648

)

46,271

Corporate debt securities

44,844

(610

)

44,254

Other

32,797

—

32,832

124,560

(1,258

)

123,357

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 2 - Investment Securities and Deposits (cont'd)

The amortized cost, gross unrealized holding gains (loss), and fair value of held-to-maturity securities by major security type at December 31, 2004, were as follows:

Gross

Unrealized

Amortized

Holding

Fair

Cost

Gains

Losses

Value

$ in thousands

Held to maturity
U.S. Government agencies	46,925	—	(423	)	46,502
Corporate debt securities	43,338	—	(525	)	42,813
Other	25,829	35	—		25,863

	116,092	35	(948	)	115,178

Maturities of debt securities classified as held-to-maturity were as follows at December 31, 2005:

Amortized		Fair
Cost		value
	$ in thousands		$ in thousands

Held to maturity:
First year	35,065	34,693
Due after one year through five years	88,100	87,223
Due after five years through ten years	1,396	1,441

	124,560	123,357

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 2 - Investment Securities and Deposits (cont'd)

The following table shows the fair value of the Company’s investments in marketable securities with unrealized losses that are not deemed to be other-than-temporarily impaired, and their underlying gross unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.

As of December 31, 2005:

Less than 12 months

12 months or Greater

Total

Unrealized

Total

Unrealized

Fair value

Losses

Fair value

Losses

Fair value

losses

$ in thousands

US Government

Agencies

1,982

44,289

630

46,271

648

Corporate bonds

5,522

144

36,339

466

41,861

610

Total

7,504

162

80,628

1,096

88,132

1,258

As of December 31, 2004:

Less than 12 months

12 months or Greater

Total

Unrealized

Total

Unrealized

Fair value

Losses

Fair value

Losses

Fair value

losses

$ in thousands

US Government
Agencies	40,344	315	6,581	108	46,925	423
Corporate bonds	26,419	377	16,919	148	43,338	525

Total	66,763	692	23,500	256	90,263	948

The unrealized losses on the Company’s investments in US Government Agencies and corporate bonds were caused by interest rate increases. Because the Company has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Company does not consider these investments to be impaired as of December 31, 2005 and 2004.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 3 - Inventories

Consist of the following:

December 31		December 31
2005		2004
	$ in thousands		$ in thousands

Raw materials and components	47,970	39,773
Work in process	23,839	31,983
Finished products	75,154	103,309

	146,963	175,065

Note 4 - Long-Term Receivables, Net of Current Maturities

Consist of the following:

Weighted

average interest

rate as of

December 31

2005

2004

$ in thousands

Long—term receivables (1)

5.3

19,905

186,604

Less deferred interest income (*)

—

Total (2)

19,841

186,604

Less — provision for uncollectible receivable (**)

624

77,252

Less — current maturities

10,944

19,377

8,273

89,975

The receivables are denominated in U.S. dollars.

(*)

The deferred interest income represents the difference between the original amount of the receivables and their net present value computed, at the transaction date, by the relevant interest rate.

(**)

See Note 4C.

(1)

Long-term receivables ("receivables") consist mainly of receivables resulting from sales of the Company’s products, providing from one to five years credit commencing on the date of signing of the sales contract or the finance agreement related thereto or other date as mentioned in the contract. Such receivables are interest bearing and are payable in quarterly or semi-annual payments. The principal is paid generally after the grant of a grace period. These receivables are partially secured by trade risk insurance policies.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 4 - Long-Term Receivables, Net of Current Maturities (cont'd)

Consist of the following: (cont'd)

(2)

In the opinion of the Company’s management, due to the nature of the customers and their activities, their financial performance, updated financial and business data, previous business relations and existing trade insurance as stated above, as well as provision for doubtful debts, the Company has limited risk exposure in relation to the long-term receivables.

Aggregate maturities are as follows:

		December 31
		2005
			$ in thousands

First year (current maturities)			10,944
Second year			8,227
Third year			675
Fourth year			—
Fifth year			—
Thereafter			59

			19,905

In 2000, the Company and a subsidiary (InnoWave) entered into an agreement for the sale to Global Village Telecom ("GVT"), a Brazilian company, of wireless local loop systems and services. Pursuant to the agreement, the Company agreed to grant GVT long-term financing for the purchase, comprising a line of credit of up to $168 million, based upon the progress of sales. This financing was granted in conjunction with credit made available to GVT by a group of other equipment vendors. The credit was to be repaid during the years 2004 through 2007. The interest payable under the line of credit was variable (ranging from LIBOR plus 6.5% to LIBOR plus 4.5% ). As security for its obligations under the agreement, GVT granted the Company (together with three other major international suppliers) a charge on its license to operate its communications network in Brazil, together with additional security including shareholders’ guarantees and charges on revenue and contracts.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 4 - Long-Term Receivables, Net of Current Maturities (cont'd)

(cont'd)

Due to various business reasons, including a significant devaluation of the Brazilian currency relative to the dollar, commencing December 2002, GVT defaulted in its payments to the Company. Accordingly, during 2002 and 2003, the Company recorded a provision for doubtful debts, in the amount of $34.0 million and $ 6.6 million, respectively with respect to this debt.

Following extensive negotiations, agreements to reschedule GVT's debt repayments were signed in December, 2004 among GVT, its shareholders and its principal creditors, including the Company. These agreements encompassed GVT’s commercial debt to the creditors for the supply of equipment and services, the debt due under certain convertible notes received from GVT’s parent company and accumulated interest on the debts to the closing. As a precondition to the closing of these agreements, the sum of $5.4 million was paid to the Company. The main provisions of the agreements, as regards the Company, are:

All the existing debts were canceled and in place thereof GVT issued to the Company notes in the aggregate sum of approximately $163 million to be paid from 2005 through 2013 at variable rates of interest.

The Company was granted warrants which were convertible, at no further consideration, into shares of GVT's parent company, equating to approximately 2.4% of its outstanding share capital.

According to SFAS No. 114“Accounting by Creditors for Impairment of a Loan”, the carrying amount of the restructured debt was recognized based on the present value of the expected future cash flows discounted at the debt 's original contractual interest rate which, was LIBOR plus 6.5%.

In April 2005, the Company sold the long-term receivables from GVT to ABN Amro Bank for the sum of approximately $ 96 million in cash, plus a contingent amount of approximately $ 3.3 million, resulting in the recognition of a net gain from recovery of doubtful debt of $ 10.4 million (excluding the contingent amount), which was recognized in the year ended December 31, 2005 under income from recovery of doubtful debt.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 5 - Investments

Consist of the following:

December 31		December 31
2005		2004
	$ in thousands		$ in thousands

Affiliated company (A)	11,976	16,259
Loans (B)	3,000	6,000
Other	4,811	4,507

	19,787	26,766

A. The investment in affiliated company is comprised of:

December 31		December 31
2005		2004
	$ in thousands		$ in thousands

Cost of shares	28,223		28,223
Accumulated losses	(16,247	)	(11,964	)

	11,976		16,259

The following table shows the financial information of an affiliated company for the year ended December 31, 2004 (the financial information as of and for the year ended December 31, 2005 is not considered significant and accordingly has not been presented).

		2004
			$ in thousands

Balance sheet information
Current assets	65,832
Total assets	72,345
Current liabilities	40,230
Total liabilities	43,355
Shareholders' equity	28,990

Statement of operations information
Revenues	48,612
Gross profit	36,207
Net loss	(7,996	)

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 5 - Investments (cont'd)

Loans

In December 2004, the Company signed a series of transactions with Chiaro Networks Ltd. ("Chiaro") a developer of infrastructure-class IP/MPLS routing platforms. The transactions consisted of: (1) a loan agreement (2) a call option agreement for the acquisition of Chiaro by the Company and (3) a distribution agreement.

Loan agreement

In December 2004, the Company provided to Chiaro two loans in the aggregate amount of $ 6 million ($ 3 million each loan).

The Company had the right to convert one of the loans at any time into convertible preferred BB shares of Chiaro.

The loans are secured by a first-priority floating charge over substantially all of Chiaro's assets.

During the first half of 2005, the business of Chiaro deteriorated significantly and in January 2006, Chiaro has ceased doing business. Accordingly, Management has determined that the Company may be unable to collect all amounts due according to the contractual terms of the loans agreement and therefore, a provision of $ 3 million in respect thereof has been recorded in the consolidated financial statements for the year ended December 31, 2005. The Company as the sole secured creditor has taken the steps necessary to realize the assets Chiaro had, including cash, tangible assets and intellectual property. The Company believes that the fair market value of Chiaro’s remaining assets is no less than the carrying amount as of December 31, 2005 of Chiaro's debt.

Call option agreement

The Company had the option to acquire Chiaro under terms defined in the agreement. The term of the option was 37.5 months.

Distribution agreement

The Company received exclusive, global distribution rights for Chiaro's products, for a period of 37.5 months from closing.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 6 - Property, Plant and Equipment, Net

Property, plant and equipment as of December 31, 2005 consist of the following:

Freehold

land,

buildings and

Machinery

Office

leasehold

and

Information

furniture and

improvements

equipment

technology

equipment

Other

Total

$ thousands

Cost
Balance at
beginning of year	70,343	120,936	56,638	5,949	5,452	259,318
Acquisitions	111	3,032	365	121	105	3,734
Additions	3,243	15,487	4,799	783	236	24,548
Disposals	5,124	12,457	911	1,007	2,655	22,154
Balance at end
of year	68,573	126,998	60,891	5,846	3,138	265,446

Accumulated
Depreciation and
amortization
Balance at
beginning of year	20,043	70,334	41,033	4,567	3,988	139,965
Depreciation
for the year	1,571	13,415	7,229	556	542	23,313
Disposals	900	12,418	900	987	2,218	17,423
Balance at end
of year	20,714	71,331	47,362	4,136	2,312	145,855

Net book value at
December 31, 2005	47,859	55,667	13,529	1,710	826	119,591

Net book value at
December 31, 2004	50,300	50,602	15,605	1,382	1,464	119,353

Regarding pledge, see Note 14.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 7 - Software Development Costs, Net

Capitalization and amortization of software development costs as of December 31, 2005, and 2004 is as follows:

December 31		December 31
2005		2004
	$ in thousands		$ in thousands

Balance at beginning of year	14,435		16,289
Capitalization of software development costs during the year	8,014		11,151
Amortization and write-offs during the year	(10,450	)	(13,005	)
	11,999		14,435

Note 8 - Goodwill

Consist of the following:

December 31		December 31
2005		2004
	$ in thousands		$ in thousands

Goodwill - Broadband Access Division	1,039		1,039
Goodwill - Data Networking Division	37,036		—
Goodwill - Optical Networks Division	1,230		—

Goodwill (1)	39,329		1,039

(1) Original amount	177,427		139,137
Amortization and write down due to decline in value	(138,098	)	(138,098	)
	39,329		1,039

See Note 19.

Note 9 - Other Assets, Net

December 31		December 31
2005		2004
	$ in thousands		$ in thousands

Core Technology Products (1)	35,423		—
Deferred tax	9,893		9,144
Other intangible assets	2,340		—
	47,656		9,144

(1) Original amount	38,169		—
Amortization *	(2,746	)	—
	35,423		—

* Amortized over the expected useful life of the related products, generally between 7 to 10 years.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 10 - Liability for Employee Severance Benefits

Employees of the Company and of its consolidated subsidiaries in Israel (Israeli companies)

Under Israeli law and labor agreements, the Israeli companies are required to make severance and pension payments to their retired or dismissed employees and to employees leaving employment in certain other circumstances.

The liability in respect of most of its non-senior employees is discharged by participating in a defined contribution pension plan and making regular deposits with a pension fund. The liability deposited with the pension fund is based on salary components as prescribed in the existing labor agreement. The custody and management of the amounts so deposited are independent of the companies and accordingly such amounts funded (included in expenses on an accrual basis) and related liabilities are not reflected in the balance sheet.

In respect of the liability to other employees, individual insurance policies are purchased and deposits are made with recognized severance pay funds.

The liability for severance pay is calculated on the basis of the latest salary paid to each employee multiplied by the number of years of employment. The liability is covered by the amounts deposited including accumulated income thereon as well as by the unfunded provision.

As to the union employees of Tadiran Telecommunication Ltd. (TTL) who are covered by the labor agreements which were in force in TTL, the Company's liability for severance pay is in accordance with such labor agreements.

If the Company terminates the employment of these employees through 2011, they are entitled to additional benefits. After that time, the employees will no longer be eligible for such additional benefits.

The expenses in respect of severance and pension pay (not including expenses in restructuring) for the years ended December 31, 2005, 2004 and 2003 are $ 6,009 thousand, $ 4,008 thousand and $ 5,593 thousand respectively.

Company's net liability for employee severance benefits is composed as follows:

December 31		December 31
2005		2004
	$ in thousands		$ in thousands

Liability for employee severance benefits	48,340	50,943
Less: Assets held for severance benefits	25,931	25,182

	22,409	25,761

Withdrawals from the funds may be made only for the purpose of disbursement of severance pay.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 10 - Liability for Employee Severance Benefits (cont'd)

Employees of U.S. consolidated subsidiaries (U.S. companies)

The subsidiaries sponsor a section 401(k) defined contribution plan or 401(a) plan which permits its employees to invest up to certain amounts of their compensation (subject to limitation by Internal Revenue Service Regulations) on a pretax basis in certain self-directed investment programs. The subsidiaries may, at the discretion of the Board of Directors, make contributions to the plan. Company contributions with respect to this plan were $ 482 thousand, $ 244 thousand and $ 499 thousand in 2005, 2004 and 2003, respectively.

Employees in the rest of the world

The provision for severance pay includes amounts related to employees in countries other than Israel and the U.S. and are calculated in accordance with the rules of the country in which they operate.

Note 11 - Commitments and Contingencies

Claims and potential claims

Following the reduction in workforce in accordance with the reorganization plan of the Company that was implemented in 2002, claims and demands for higher amounts of severance pay were submitted by certain former employees. Management of the Company believes, based on the opinion of its legal advisors, that the effect, if any, of the results of such claims and demands on the financial position of the Company and the results of its operations, will be immaterial and the provisions which are included in the financial statements in respect thereof are appropriate and sufficient.

The Company conducts negotiations from time to time with international technology companies (“technology companies”) regarding allegations that it is using certain patents owned by the technology companies in its products. Although the Company cannot assess each negotiation for its merit, it estimates that any settlement, if needed, will not have a material adverse effect on the Company's financial position or results of operations.

In December 1999, an agreement was signed with SCI Systems ("SCI") for the sale of a plant which manufactures electronic components. SCI is one of the largest manufacturers of electronic components in the world. As part of the agreement, SCI will, for several years to come, be the subcontractor for part of the manufacturing activities of the Company, on a cost plus basis.

The Company is in dispute with SCI as to the interpretation of certain aspects of the agreement, such as volume commitments; discount terms for large orders; the minimum size of orders; timing; untimely payments etc.

The dispute was referred to an arbitrator in December 2002. As part of the arbitration process, SCI submitted, in April 2003, claims in an aggregate amount of approximately $ 30 million.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 11 - Commitments and Contingencies (cont'd)

Claims and potential claims (cont'd)

The Company rejected the allegations made against it and filed a claim against SCI in an amount of approximately $ 50 million.

Subsequently, the arbitration was put on hold and the parties appointed an independent mediator in an additional attempt to settle this dispute. If the mediation fails, the parties will resume the arbitration process.

In the opinion of the Company's legal counsel, it is not possible at this stage of the proceedings, to evaluate the chances of the Company’s claim as well as the chances of SCI’s claim.

In the opinion of Management, the arbitrator's decision will not have a material adverse effect on the Company's financial position or results of its operation.

Several claims have been submitted against the Company and against consolidated subsidiaries, resulting from ordinary business operations inter alia, for using patents owned by others. The Company's Management based mainly on opinions of its legal advisors, believes that the effect, if any, of the results of such claims on the financial position of the Company and the results of its operations will be immaterial and the provisions which are included in the financial statements in respect thereof are appropriate and sufficient.

In October 1997, an investigation was commenced by the Israeli Comptroller of Restrictive Trade Practices (“comptroller”) regarding alleged price fixing and non-competitive practices among Tadiran Telecommunications Ltd. (“TTL”), Tadiran Ltd (“Tadiran” - the parent company of TTL) and Telrad Telecommunications and Electronics Industries Ltd., a subsidiary of Koor Industries Ltd. (a significant shareholder of the Company and Tadiran Ltd.).

In the 1999 merger agreement between the Company and TTL, Tadiran had agreed to indemnify the Company for damages above $6 million.

In 2004, the Company was informed that the comptroller has ceased the investigation without taking any action against the Company. Accordingly, a provision in the amount of $6 million that was recorded at the time of the acquisition of TTL was reversed and recorded as other income.

In September 2004, following the completion of the investigation by the comptroller mentioned above, a claim was filed against Bezeq (Israel's national telecommunications provider), Koor, TTL, Tadiran and Telrad in the District Court of Tel Aviv-Jaffa. Attached to the claim was a request for certification thereof as a class action, brought in the name of all Bezeq customers against the aforesaid companies, including the Company, in an amount of $ 371 million.

In March 2005 the Company and the other respondents filed their respective answers to the request to certify the claim as a class action. The applicant filed his reply to the respondents’ answers in December 2005.

Management of the Company believes, in light of the advice of its legal counsel, that the allegations against the Company are without merit and therefore no provision was recorded in respect thereto in the financial statements.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 11 - Commitments and Contingencies (cont'd)

Claims and potential claims (cont'd)

In January 2005, the Company was named as a defendant in a purported class action complaint filed in the United States against ECtel, certain officers and directors of ECtel, and ECI. The complaint alleges violations of U.S. Federal Securities Laws by ECtel and breach of fiduciary duties by the individual defendants, in connection with disclosure of ECtel's financial results between April 2001 and April 2003. It also alleges that ECI was the controlling shareholder of ECtel during this period and, as such, influenced and controlled the purported actions by its subsidiary. Damages claimed by the plaintiff have not yet been quantified.

ECI based on the opinion of its legal advisors believes that the allegations made in the complaint with respect to it are without merit, and accordingly no provision in respect thereof has been included in the consolidated financial statements.

Lease commitments

The Company and its consolidated subsidiaries have entered into several operating lease agreements in Israel and abroad. The agreements expire on various dates from 2006 to 2011 (some of which have renewal options) and are in local currencies or linked to the dollar or to the Israeli Consumer Price Index.

Rental expenses under operating leases is charged to expense over the periods of the respective leases by the straight-line method. Future minimum annual rent payments to which the Company and its subsidiaries are committed under the above leases, at rates in effect at December 31, 2005, are as follows:

Year ending December 31

$ in thousands

2006			13,281
2007			11,660
2008			8,747
2009			3,484
2010 and thereafter			2,397

As to rent expense under the Company’s leases, see Note 17N.

Royalty commitments

The Company is committed to pay royalties to the Government of Israel on proceeds from sale of products in the Research and Development of which the government participated by way of grants. The royalties are computed mainly at the rates of 3.5% to 5% of the aggregated proceeds from sale of such products, up to the amount not exceeding 100% of such grants plus interest at Libor rate. As of December 31, 2005, the maximum possible future commitment of the Company is approximately $ 135.3 million (excluding interest). See Note 17H with regard to amounts paid pursuant to these commitments.

The Company is committed to pay royalties to certain parties whose products, patents or technology are incorporated in certain products of the Company. Such royalties are based on sales of systems or a family of products incorporating such products, patents or technology and are paid based either on a fixed rate, a price per unit sold or as a rate of the system or the family of products sale price.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 11 - Commitments and Contingencies (cont'd)

Financial instruments

Derivative financial instruments

The Company has significant international sales transactions in foreign currencies and has a policy of hedging forecasted and actual foreign currency risk with forward foreign exchange contracts and purchased and written options. The Company's forward foreign exchange contracts and purchased options are primarily denominated in Euro, Pounds Sterling and NIS and are for periods consistent with the terms of the underlying transactions, generally one year or less. Derivative instruments are employed to eliminate or minimize certain foreign currency exposures that can be identified and quantified. The Company was exposed to but realized no losses from non-performance by counter parties on these derivatives.

The Company uses foreign currency forward contracts designated as fair value hedges to protect against the foreign currency exchange rate risks related to the remeasurement of firm sales commitments and recognized assets such as accounts receivable. Changes in the fair value of these derivatives are recognized in operations as offsets to the changes in the fair value of the related assets or liabilities.

The Company uses a combination of forwards and purchased and written options designated as cash flow hedges to protect against the foreign currency exchange rate risks inherent in its forecasted revenue denominated in currencies other than the U.S. dollar. The Company's cash flow hedges mature generally within less than a year. For derivative instruments that are designated and qualify as cash flow hedges, the effective portions of the gain or loss on the derivative instruments are initially recorded in accumulated other comprehensive income (loss) as a separate component of shareholders' equity and subsequently reclassified into operations in the period during which the hedged transactions is recognized in operations. The ineffective portion of the gain or loss is reported in financial income or expenses immediately. The effective portion of cash flow and foreign currency hedges is reported in the same financial statement line item as the changes in value of the hedged item. For foreign currency option and forward contracts designated as hedges, hedge effectiveness is measured by comparing the cumulative change in the hedge contract with the cumulative change in the hedged item, both of which are based on forward rates.

Up until February 2005 the Company had used variable-rate debt to finance its operations. The debt obligations exposed the Company to variability in interest payments due to changes in interest rates. Management believes that it is prudent to limit the variability of a portion of its interest payments. To meet this objective, management entered into interest rate swap agreements to manage fluctuations in cash flows resulting from interest rate risk. These swaps change the variable-rate cash flow exposure on the debt obligations to fixed cash flows. Under the terms of the interest rate swaps, the Company received variable interest rate payments and made fixed interest rate payments, thereby creating the equivalent of fixed-rate debt.

Changes in the fair value of interest rate swaps designated as hedging instruments that effectively offset the variability of cash flows associated with variable-rate, long-term debt obligations are reported in accumulated other comprehensive income (loss). These amounts are subsequently recognized in interest expenses as a yield adjustment of the hedged interest payments, in the period in which the related interest affects earnings.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 11 - Commitments and Contingencies (cont'd)

Financial instruments (cont'd)

Derivative financial instruments (cont'd)

The Company has entered into a long term agreement to provide a customized network solution to a customer in Central America. The network build-out will begin in 2006. This transaction will be financed by a commercial bank ("the bank"), in the form of a long-term loan to an intermediate regional bank. The intermediate bank will repay the loan to the bank at a fixed interest rate. As the bank requires the payment of the interest at a floating rate, the Company is to pay or receive the differential between the fixed interest rate paid by the intermediate bank and the floating interest rate required by the bank under the loan agreement.

The Company believes that it is prudent to mitigate the exposure to interest rate fluctuations in respect of the above transaction. To meet this objective, in October 2005 the Company entered into interest rate swap agreements to manage fluctuations in cash flows resulting from interest rate changes. Under the terms of the interest rate swaps, the Company will receive floating interest rate payments and will make fixed interest rate payments, which will create a fixed gain on the finance portion of the project.

Changes in the fair value of interest rate swaps designated as hedging instruments that effectively offset the variability of cash flows associated with variable-rate obligations are reported in accumulated other comprehensive income (loss). These amounts are subsequently recorded as interest income (expenses), as a yield adjustment of the hedged interest payments, for the period in which the related interest affects earnings

Fluctuations in the fair value of interest rate swaps designated as hedging instruments that effectively offset the variability of cash flows associated with variable-rate, long-term debt obligations are reported in accumulated other comprehensive income (loss). These amounts subsequently are reclassified into interest expense as a yield adjustment of the hedged interest payments in the same period in which the related interest affects earnings.

Other derivatives not designated as hedging instruments under SFAS No. 133 consist primarily of purchase and written options used to hedge foreign currency cash flows. For derivative instruments not designated as hedging instruments under SFAS No. 133, changes in the fair values are recognized in operations in the period of change.

Fair value hedging transactions

As of December 31, 2005, the Company did not have outstanding currency forward contracts, as a hedge against sales contracts receivable and firm commitments.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 11 - Commitments and Contingencies (cont'd)

Financial instruments (cont'd)

Derivative financial instruments (cont'd)

Anticipated cash flow hedging transactions

As of December 31, 2005, the Company had entered into forward exchange contracts and also purchased and written options as hedges for currency exchange rates for various periods of time. These transactions constitute a future cash flow hedge for sales agreements and for the anticipated backlog of orders.

As of December 31, 2005, the Company had entered into 85 hedge transactions in respect of anticipated sales amounting to $ 183.6 million, (in Euro currency), and $ 17.5 million (in Pounds Sterling currency).

The hedge transactions are shown in the balance sheet at fair value. The fair value of future transactions is based on future exchange rates, as quoted at the balance sheet date.

As of December 31, 2005, the fair value of the cash flow hedging transaction is a net asset of

$ 8.0 million.

Payroll and purchase contracts

As of December 31, 2005, the Company had entered into 77 future cash flow hedge transactions in respect of payroll and purchase contracts amounting to $ 364.9 million (in NIS currency).

As of December 31, 2005, the Company had entered into one future cash flow hedge transaction in respect of purchase contract amounting to $ 2.4 million (in Euro currency).

As of December 31, 2005, the fair value of the cash flow hedging transactions is credit US$ 0.5 million.

Realized/unrealized gain (losses) from hedge transactions

The Company had net realized foreign currency exchange gain (losses) from all hedge transactions of $ 2.5 million, $ (11.0) million and $ (6.9) million in 2005, 2004 and 2003, respectively.

Comprehensive income for the year ended December 31, 2005 includes an unrealized gain of $ 19.2 million relating to the above hedge transactions. As of December 31, 2005 the net unrealized gain on financial instruments is $ 4.2 million. This amount is expected to appear in the consolidated statement of operations for the year ended December 31, 2006.

Interest rate cash flow risk

Interest expense for the years ended December 31, 2005, 2004 and 2003, includes net losses in the amount of $ 38 thousand, $ 294 thousand and $ 502 thousand, respectively, arising from the difference between the fixed interest rate in the interest rate swap agreements and the variable interest rate on the hedged debt obligation.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 11 - Commitments and Contingencies (cont'd)

Financial instruments (cont'd)

Derivative financial instruments (cont'd)

Non-hedging transactions

The financing expenses include an income of $ 0.5 million, a loss of $ 0.2 million and a loss of $ 2.0 million for the years ended December 31, 2005, 2004 and 2003, respectively. These amounts reflect the changes in the time value factor of the derivatives, which are not considered as hedging transactions.

Concentration of credit risks

Financial instruments which expose the Company to risks of credit concentration include cash, deposits, currency hedging transactions, trade and other receivables.

The cash and deposits as well as the hedging transactions are deposited and/or executed through a number of established financial institutions. These financial institutions are located in Israel, the USA and Europe. The policy of the Company is to avoid the risk of making deposits with one financial institution. The Company frequently evaluates the amounts and volume of the transactions executed with each one of the said financial institutions. The exposure in respect of credit to customers is limited due to the large number of customers and their geographical spread.

As to the long-term deposits and customer debts see Note 4. Management of the Company believes that the credit risk is limited since the customers are large suppliers of communications services operating in countries in which this sector is anticipated to grow.

Fair value of the financial instruments

Management estimates that the fair value of the financial instruments is not materially different from the amounts included in the financial statements. In its determination of fair value, management used certain estimates, as described below, which do not necessarily indicate amounts which are recoverable in current market trading

Cash and cash equivalents, short-term investments, trade receivables, other receivables, trade payables, other payables and accrued liabilities - the book value is the same as the fair value due to the short realization period of these instruments.

Long-term receivables and liabilities - the book value is not materially different from the fair value since the Company’s interest rates on its long-term receivables or liabilities are not materially different from those indicated in respect of the related assets and liabilities as of the balance sheet date.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 11 - Commitments and Contingencies (cont'd)

Capital expenditure commitments

The Company in Israel incurs capital expenditures pursuant to “Approved Enterprise” programs. At December 31, 2005, the Company is not committed to invest pursuant to existing programs.

Purchase commitments

At December 31, 2005, the Company has commitments, in amount of $ 63.4 million, covering, primarily, the purchase of materials. (December 31, 2004 - $ 64.7 million).

Guarantees

The Company maintains certain third-party guarantees with banks to support its performance obligations under customer contracts and other contracts that can be demanded in case of material breach of contracts. As of December 31, 2005, these guarantees approximated $ 30,125 thousand.

The Company also maintains other third-party guarantees (primarily with insurance companies) to support its performance obligations under customer contracts and other contracts that can be demanded in case of material breach of contracts. As of December 31, 2005, these guarantees approximated $ 4,502 thousand.

Commitments

In November 2001, the Company sold its information technology unit ("IT") to EDS and signed a five-year outsourcing contract with EDS. Under the agreement, EDS assumed all the IT operations and was required to supply maintenance, support and development services during the term of the agreement, for a sum of between $ 15 and $ 18 million, per year. In 2003 a new five-year agreement replacing the previous agreement was signed with effect through 2007. The Company undertook to pay EDS $ 11.8 million in 2003 and amounts between $ 8.8 million and $ 7.8 million in 2004-2007 (in 2005 and in 2004 the Company paid to EDS $ 8.6 million and $ 8.8 million, respectively).

In addition, for the years ended December 31, 2005, 2004 and 2003, the Company paid EDS $ 1.7 million, $ 3 million and $ 2.2 million, respectively, for additional services.

The Company has an obligation to indemnify the purchasers of certain activities and/or the purchasers of subsidiaries at rates which are stipulated in the sales agreement, should the purchasers be forced to discharge former employees of TTL during a period up to 2011 (see Note 10A(3)) and, therefore, to pay increased severance benefits.

In the opinion of Company management, the provisions for future indemnification, as stated, which are included in the financial statements, are proper and adequate.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 11 - Commitments and Contingencies (cont'd)

Commitments (cont'd)

If the Company dismisses any of the remaining unionized employees who joined from TTL by 2011, it is committed to pay them increased severance benefits or early retirement pensions, depending on age and seniority (see Note 10A(3)). As of December 31, 2005, the maximum amount payable as a result of this commitment is $ 15.0 million. Management does not expect to dismiss any of these employees and therefore no provision in respect thereof has been included in the financial statements.

Commitments to indemnify directors and officers

In 2001, the Board of Directors of ECI resolved to grant ECI's directors and officers at the level of vice president and above, who may serve from time to time, indemnification to the fullest extent permitted by law and approved the form of indemnification letter provided to each such director and officer. The Company has undertaken to indemnify its directors and officers for financial obligations and reasonable litigation costs imposed on them in connection with their duties. The undertaking was limited to categories of events set forth in the indemnification letter and to an amount of $ 15 million per director and officer, per case.

In 2002, the audit committee and the Board of Directors of ECI resolved, to raise the amount of the aforesaid undertaking to a limit of $ 30 million per director per case, but not more than a commitment of $ 225 million in the aggregate for all persons to be indemnified. The aforesaid changes were approved by ECI's shareholders.

Note 12 - Shareholders’ Equity

Authorized, issued and outstanding shares

Authorized
December 31		December 31
	2005		2004
Number of shares

NIS 0.12 par value per ordinary share

200,000,000

200,000,000

The Company’s shares (NIS 0.12 par value each) are traded in the United States and listed on the Nasdaq Stock Market.

For details of the issued share capital see consolidated Statements of Changes in Shareholders’ Equity.

Pursuant to a service agreement with one of the Company's directors, the Company issued to him in 2005, 2004 and 2003 - 1,387, 1,653 and 5,650 Ordinary shares, respectively.

Under service agreements entered into in 2005 with two additional directors, they were issued 3,521 and 3,041 restricted shares, respectively, in that year (the latter amount issued pursuant to the ECI Restricted Share Plan - see Note 12.C.2).

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 12 - Shareholders’ Equity (cont'd)

Dividends

According to the Israeli corporate laws, dividends may be paid by the Company only out of accumulated earnings, or out of net income, in two consecutive years. See Note 15A(3).

Share incentive (stock options and restricted shares plans)

The Company’s current stock option plans are the ECI Telecom Ltd. Key Employee Share Incentive Plan 1991 and the ECI Telecom Ltd. Employee Share Incentive Plan 2002 (together the "ECI Plans"), which were adopted by the shareholders at the Annual General Meetings held respectively on August 29, 1991 and November 19, 2002. The ECI Plans will expire on December 31, 2012.

The ECI Plans provide that options may be granted to any employee, director, consultant or contractor of the Company pursuant to (a) one or more sub-plans designed to benefit from the provisions of Section 102 of the Israeli Income Tax Ordinance (New Version) 1961 and (b) any other share incentive plan approved by the Board of Directors of the Company.

Under the terms of the ECI Plans, as of December 31, 2005, the Company is authorized to grant options for a total of 32,760,700 shares (increased from 29,760,700 shares following shareholders’ approval on July 14, 2005), subject to anti-dilution adjustment. The option awards are personal and non-assignable and terminate automatically upon termination of employment (except for approved retirement or termination caused by death or disability or as otherwise approved by the Board of Directors or its Remuneration Committee).

Stock option grants during the reporting period

The principal stock option grants made by the Company to its employees, during the year ended December 31, 2005 were as stated below. Unless otherwise stated, these stock options generally vest as follows: 12.5% after six months and 6.25% on the last day of each following quarter over a period of 14 quarters.

On March 28, 2005, the Company granted options for 171,000 shares at an exercise price of $ 7.07 per share.

On May 10, 2005, the Company granted options for 125,000 shares at an exercise price of $ 7.47 per share.

On May 31, 2005, the Company granted options for 1,520,400 shares at an exercise price of $ 8.85 per share.

On June 3, 2005, the Company granted options for 75,000 shares at an exercise price of $ 9.01 per share.

On June 21, 2005, the Company granted options for 32,000 shares at an exercise price of $ 8.48 per share.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 12 - Shareholders’ Equity (cont'd)

Share incentive (stock options and restricted shares plans) (cont'd)

Stock option grants during the reporting period (cont'd)

On July 28, 2005, the Company granted options for 77,000 shares at an exercise price of $ 8.26 per share

On November 20, 2005, the Company granted options for 167,000 shares at an exercise price of $ 8.22 per share.

On November 22, 2005, the Company granted options for 100,000 shares at an exercise price of $ 8.35 per share.

On December 5, 2005, the Company granted options for 100,000 shares at an exercise price of $ 8.42 per share.

On December 7, 2005, the Company granted options for 1,073,250 shares at an exercise price of $ 9.22 per share. The vesting schedule for 373,250 of these options is 50% after 6 quarters and 6.25% on the last day of each following quarter over a period of 8 quarters, and for 655,000 of such options it is 75% after 10 quarters and 6.25% on the last day of each following quarter over a period of 4 quarters.

None of the above stock options were granted at exercise prices below the market price on the date of the grant.

Following approval by the board of directors, the Company’s shareholders approved adjustments to the terms of outstanding stock option awards, in order to preserve the aggregate intrinsic value of such stock options in light of the distribution to shareholders of 7.6 million of the Company's shares in ECtel Ltd. (See Note 21B). On April 30, 2004, immediately prior to the ex-dividend date for the distribution of the ECtel shares, the closing market price of the Company's shares on Nasdaq was $5.60 per share. As a result of the proposed distribution, the opening market price on the business day immediately following, May 3, 2004, was adjusted to $5.36 per share, a reduction of $0.24 per share, or 4.305%. The main provisions of the adjustments are set forth below and applied to stock options granted prior to May 3, 2004:

The exercise price of outstanding stock options granted at an exercise price of less than $5.60 per share, was reduced by 4.305% and rounded upwards to a whole cent.

The exercise price of outstanding stock options granted at an exercise price of, or in excess of, $5.60 per share, was reduced by $0.24 per share.

Additional 462,939 stock options were granted to employees, directors or consultants of the Company who, on May 3, 2004, held stock options with an exercise price of less than $5.60 per share. The number of additional stock options equated to approximately 4.5% of the said stock options held by such grantees at May 3, 2004. The additional stock options are exercisable at a price per share equivalent to the new, reduced exercise price of the original stock options, and in the same proportions and will expire on the same dates as the original stock options.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 12 - Shareholders’ Equity (cont'd)

Share incentive (stock options and restricted shares plans) (cont'd)

Stock option grants during the reporting period (cont'd)

There was no accounting consequence for the above changes made to the exercise price and the number of shares, since the above adjustments meet the criteria set forth in FIN 44, "Accounting for Certain Transactions involving Stock Compensation (an interpretation of APB Opinion No. 25)" as follows:

The aggregate intrinsic value of the award immediately after the change was not greater than the aggregate intrinsic value of the award immediately before the change.

The ratio of the exercise price per share to the market value per share was not reduced.

At the shareholders General Meeting held on July 28, 2005, the Company's shareholders adopted the ECI Telecom Ltd. Employee Restricted Share Incentive Plan (the "ECI Restricted Share Plan"). The ECI Restricted Share Plan will expire on June 4, 2015. Restricted shares issued under the ECI Restricted Share Plan are issued from the same pool of shares available for the issue of stock options under the ECI Plans.

The ECI Restricted Share Plan provides that restricted shares may be granted to any employee, director, consultant or contractor of the Company (the "Participant"). The restricted shares are held in trust on behalf of a Participant until the Participant's interest in such restricted shares vests and they become freely transferable.

Should a Participant cease to remain in the employ or service of the Company, for any reason, while holding unvested restricted shares (except for termination caused by death or as otherwise approved by the Board of Directors or its Remuneration Committee), then those restricted shares shall either (i) be immediately surrendered to the Company for cancellation, or (ii) be immediately sold by the Participant to the Company (for consideration equal to the issue price of such shares), or (iii) shall be treated in any other manner that will assure that the Participants rights in such shares shall cease to exist; and the Participant shall have no further shareholder rights with respect to those restricted shares.

Unless determined otherwise by the Remuneration Committee, the restricted shares shall be fully vested after four years from the date of issuance according to the following schedule: 12.5% shall vest following the lapse of six months from the date of issuance and a further 6.25% shall vest on the last day of each quarter, during 14 consecutive quarters thereafter.

The fair value of the restricted shares as of the date of the issue is amortized over the vesting period.

Restricted shares issued during the reporting period

On July 28, 2005, the Company issued 583,585 restricted shares to its employees. The shares were issued for no consideration. The shares vest and become transferable a follows: 12.5% on November 30, 2005 and a further 6.25% on the last day of each quarter during 14 consecutive calendar quarter thereafter.

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 12 - Shareholders’ Equity (cont'd)

Share incentive (stock options and restricted shares plans) (cont'd)

On November 20, 2005, the Company issued 159,191 restricted shares to its employees and a director. The shares were issued for no consideration. Most of shares vest and become transferable as follows: 50% on November 7, 2006 and a further 6.25% on the last day of each quarter during 8 consecutive calendar quarter thereafter.

Unearned compensation on the grant of the restricted shares as measured at the original grant date, totaling $ 6.1 million, was calculated based on the market value of the shares on the date of grants and is being amortized over the vesting period.

Compensation expense of $ 1,999 thousand was recognized for the restricted shares during the year ended December 31, 2005.

Stock options and restricted shares under the ECI Plans are as follows:

		2005			2004			2003
			Number of shares			Number of shares			Number of shares

Total number authorized at beginning of year	29,760,700		29,760,700		26,760,700
Increase in number authorized during the year	3,000,000		—		3,000,000
Options unexercised at beginning of year	(19,439,184	)	(19,067,545	)	(12,349,747	)
Options exercised till beginning of year	(3,483,565	)	(2,129,800	)	(2,028,982	)
Options granted during the year	(3,449,795	)	*(4,154,481	)	(10,523,271	)
Options cancelled during the year	698,107		2,429,077		3,704,655
Restricted shares granted during the year	(742,776	)	—		—
Restricted shares forfeited during the year	9,557		—		—
Available for future grant at end of year	6,353,044		6,837,951		8,563,355

Options exercised during the year **	1,697,867		1,353,765		100,818

** Average price of options exercised during the year (in $)	2.53	1.83	2.62

Restricted shares vested during the year	115,233	—	—

Options unexercised and unvested restricted shares at the end of year	21,110,991	19,439,184	19,067,545

Options unexercised and unvested restricted shares may be vested as follows (1):
First year or thereafter	17,168,269	16,840,697	16,540,199
Second year or thereafter	1, 920,649	1,328,180	1,911,858
Third year or thereafter	2,022,073	1,270,307	615,488
	21,110,991	19,439,184	19,067,545

(*) Including grants as a result of distribution of ECtel's shares (see C1 and Note 22B).

ECI Telecom Ltd. and Subsidiaries

Notes to the Consolidated Financial Statements as of December 31, 2005

Note 12 - Shareholders’ Equity (cont’d)

Share incentive (stock options and restricted shares plans) (cont’d)

Stock options and restricted shares under the ECI Plans (cont'd)

(1)

To be paid in NIS based on the rate of exchange of the dollar on the date of payment as follows:

		2005			2004			2003
*Dollars per Share ()()			Number of shares			Number of shares			Number of shares

Restricted shares	617,986	—	—
Zero	2,098,362	2,518,982	2,942,728
1.26 - 3.04	1,966,098	2,213,569	2,587,619
3.11	3,921,429	4,673,266	5,124,326
3.12 - 6.91	3,346,718	3,914,886	568,334
7.07 - 8.48	901,574	187,574	30,000
8.85	1,460,400	—	—
9.01 - 9.22	1,148,250	—	—
13.76 - 20.76	711,957	748,991	1,134,842
23.76 - 26.14	175,500	176,500	183,500
26.42	2,902,256	3,075,356	3,985,054
27.27 - 29.29	1,231,010	1,295,610	1,792,292
29.76 - 39.76	629,450	634,450	718,850

	21,110,991	19,439,184	19,067,545

(*)

The dollars per share exercise range figures were adjusted as a result of distribution of ECtel's shares (see C1 and Note 20B).

(**)

As of December 31, 2005, the weighted average exercise price of options was $ 10.20 and the weighted average remaining contractual life of outstanding options was 6 years.

Fair value method

In October 1995 the Financial Accounting Standards Board (FASB) issued SFAS No.123 “Accounting for Stock-based Compensation” which establishes financial accounting and reporting standards for stock-based compensation plans. The statement defines a fair value based method of accounting for employee stock-based compensation awards.

As required by SFAS No. 123, the Company has determined the weighted average fair value per option of stock-based arrangements grants during 2005, 2004 and 2003 to be $ 3.87, $3.40 and $1.70, respectively. The fair values of stock based compensation awards granted were estimated using the “Black - Scholes” option pricing model with the following assumptions.

		Option			Expected			Risk free
Year of grant			Term			volatility

ECI TELECOM LTD/ 6-K