Elbit Vision Systems (EVSNF) 20-F/A 2008 FY Annual report (foreign) (amended)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 20-F/A
(Amendment No. 1)

o REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

Or

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

For the fiscal year ended December 31, 2008

Or

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

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

Date of event requiring this shell company report................................

For the transition period from _______________ to _________________

Commission File No.

ELBIT VISION SYSTEMS LTD.
(Exact name of Registrant as specified in its charter)

N/A	ISRAEL
(Translation of Registrant's	(Jurisdiction of incorporation
name into English)	or organization)

1 Hayasur Street, Hasharon Industrial Park, Qadima 60920, P.O.B. 5030, Israel
(Address of principal executive offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act:
None

Securities registered or to be registered pursuant to Section 12(g) of the Act:
Ordinary Shares, nominal value 1.00 New Israeli Shekel per share
(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None
(Title of Class)

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

50,988,701 Ordinary Shares

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

o Yes    x No

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

o Yes    x No

Note–checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those sections.

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

Yesx Noo

        Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of regulation S-T (&232.405 of this chapter) during the preceding 12 months (or for a shorter period that the registrant was required to submit and pot such files).

o Yes    o No

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

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

        Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

U.S. GAAPx	International Financial Reporting Standards as issued by	Othero
	the International Accounting Standards Boardo

2

If “Other” has been checked in response to the previous question, indicate by check mark which financial statements the registrant has elected to follow:

Item 17o Item 18o

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

o Yes    x No

3

EXPLANATORY NOTE

                 This Amendment No. 1 on Form 20-F/A is being filed to amend Item 15 (Controls and Proceedures) of the Annual Report on Form 20-F for the year ended December 31, 2008 of Elbit Vision Systems Ltd. which was originally filed on July 15, 2009.

                 This Amendment is not intended to revise other information presented in our Annual Report on Form 20-F for the fiscal year ended December 31, 2008 as originally filed and all such other information in the original filing, which remains unchanged. This Amendment does not reflect events occurring after the filing of the original Annual Report on Form 20-F for the year ended December 31, 2008 and does not modify or update the disclosure therein in any way other than as required to reflect the amendments discussed above. For the convenience of the reader, the document has been refiled in its entirety.

This annual report on Form 20-F includes certain “forward-looking” statements within the meaning of Section 21E of the Securities Exchange Act of 1934. The use of the words “projects”, “expects”, “may”, “plans” or “intends”, or words of similar import, identifies a statement as “forward-looking”. There can be no assurance, however, that actual results will not differ materially from our expectations or projections. Factors that could cause actual results to differ from our expectations or projections include the risks and uncertainties relating to our business described in this annual report inItem 3, “Risk Factors”.

We have prepared our consolidated financial statements in United States Dollars and in accordance with accounting principles generally accepted in the United States, as applicable to our consolidated financial statements for all fiscal periods for which financial data is presented herein. All references herein to “Dollars” or “$” are to United States Dollars, and all references to “Shekels” or “NIS” are to New Israeli Shekels.

4

PART I
ITEM 1.	IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS	7
ITEM 2.	OFFER STATISTICS AND EXPECTED TIMETABLE	7
ITEM 3.	KEY INFORMATION	7
	SELECTED FINANCIAL DATA	7
	RISK FACTORS	7
	RISK FACTORS RELATED TO OUR BUSINESS	8
	RISK FACTORS RELATED TO OUR ORDINARY SHARES	14
	GENERAL RISKS	19
ITEM 4.	INFORMATION ON THE COMPANY	21
	HISTORY AND DEVELOPMENT OF THE COMPANY	21
	BUSINESS OVERVIEW	23
	ORGANIZATIONAL STRUCTURE	39
	PROPERTY, PLANTS AND EQUIPMENT	39
ITEM 4A.	UNRESOLVED STAFF COMMENTS	39
ITEM 5.	OPERATING AND FINANCIAL REVIEW AND PROSPECTS	40
	SELECTED FINANCIAL DATA	40
	OPERATING RESULTS	44
	LIQUIDITY AND CAPITAL RESOURCES	48
	RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC	50
	TREND INFORMATION	51
	OFF-BALANCE SHEET ARRANGEMENTS	51
	TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS	52
ITEM 6.	DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES	52
	DIRECTORS AND SENIOR MANAGEMENT	52
	COMPENSATION	55
	BOARD OF DIRECTORS	56
	EMPLOYEES	59
	SHARE OWNERSHIP	61
ITEM 7.	MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS	63
	MAJOR SHAREHOLDERS	63
	RELATED PARTY TRANSACTIONS	66
ITEM 8.	FINANCIAL INFORMATION	68
	CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION	68
	SIGNIFICANT CHANGES	69
ITEM 9.	THE OFFER AND LISTING	69
	OFFER AND LISTING DETAILS	69
	MARKETS	69
ITEM 10.	ADDITIONAL INFORMATION	71
	MEMORANDUM AND ARTICLES OF ASSOCIATION	71
	MATERIAL CONTRACTS	75
	EXCHANGE CONTROLS	77
	TAXATION	77
	DOCUMENTS ON DISPLAY	88
ITEM 11.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	89
	FOREIGN CURRENCY EXCHANGE	89
	INTEREST RATE RISK	90
ITEM 12.	DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES	90

5

PART II
ITEM 13.	DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES	90
ITEM 14.	MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS	90
ITEM 15.	CONTROLS AND PROCEDURES	90
ITEM 15T.	CONTROLS AND PROCEDURES	90
ITEM 16.	[RESERVED]	91
ITEM 16A.	AUDIT COMMITTEE FINANCIAL EXPERT	92
ITEM 16B.	CODE OF ETHICS	92
ITEM 16C.	PRINCIPAL ACCOUNTANT FEES AND SERVICES	92
ITEM 16D.	EXEMPTIONS FROM THE LISTING AND STANDARDS OF AUDIT COMMITTEES	92
ITEM 16E.	PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILLIATED PURCHASERS	93
ITEM 16F	CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT	93
ITEM 16G	CORPORATE GOVERNANCE	93
PART III
ITEM 17.	FINANCIAL STATEMENTS	93
ITEM 18.	FINANCIAL STATEMENTS	93
ITEM 19.	EXHIBITS	93

6

PART I.

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not applicable.

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable.

ITEM 3. KEY INFORMATION

A. The selected financial data is incorporated by reference toItem 5 of this annual report.

B. Not applicable

C. Not applicable

D. Risk Factors

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

RISK FACTORS

        An investment in the securities of Elbit Vision Systems Ltd., or EVS, is speculative and involves a high degree of risk. Therefore, you should not invest in our securities unless you are able to bear a loss of your entire investment. You should carefully consider the following factors as well as the other information contained herein before deciding to invest in our ordinary shares. Factors that could cause actual results to differ from our expectations, statements or projections include the risks and uncertainties relating to our business described below. This annual report and statements that we may make from time to time herein may contain forward-looking information. There can be no assurance that actual results will not differ materially from our expectations, statements or projections. The information in this annual report is complete and accurate as of this date, but the information may change after the date of this annual report.

        The market prices of our ordinary shares have been and may continue to be volatile.

        The market prices of our ordinary shares are subject to fluctuations. The following factors may significantly impact on our ability to achieve expected operating results and growth plan goals and/or affect the market price of our ordinary shares:

7

Risks related to our business:

— history of losses;

— dependence on worldwide industries;

— necessity of expansion into new markets; pursuit of business to acquire;

— reliance on a limited number of key customers;

— reliance on a limited number of key subcontractors and suppliers;

— lengthy sales cycle;

— competitiveness of automated visual inspection market;

— fluctuations in the market;

— long payment cycle;

— market acceptance of products;

— flaws in our manufacturing;

— reliance on international sales; changes in domestic and foreign regulation;

— uncertainty of global economic conditions

— rapid technological change;

— additions or departures of key personnel;

— difficulty of penetrating new markets;

— difficulty in protecting intellectual property;

— involvement in litigation.

Risks related to our ordinary shares:

— need for additional funding;

— prohibitively large number of ordinary shares;

— dilution of ordinary shares;

— downward pressure on share price;

— restricted ability to acquire with ordinary shares;

— fluctuations in share price resulting from limited trading volume;

— "penny stock" sale risks;

— difficulty of trading on the OTC bulletin board;

— volatility in the stock market;

— further decline in share price

General Risks:

— new regulations for corporate governance;

— conditions in Israel;

— differentials in the rate of currency exchange and inflation;

— Israeli government grants, programs and tax benefits; and

— enforceability of foreign judgments by Israeli courts.

        These risk factors are discussed in further detail below:

Risks Related to our Business

        We have a history of losses and may not be profitable in the future.

        Except for 2005, in which we generated net income of $0.611 million, we have not generated net income on an annual basis since 1997. We incurred net losses of $0.98 million, $5.9 million, $6.1 million $1.3 million and $7.5 million in 2003, 2004, 2006, 2007 and 2008, respectively.

8

        We believe that if we are unable to restructure our loans from Bank Leumi Le Israel and Bank Hapoalim, our current assets, together with anticipated cash generated from operations and available credit lines, will be insufficient to meet our cash requirements for working capital and capital expenditures for twelve months from July 2009. In order to continue as a going concern, we may have to sell additional equity or debt securities and reorganize our credit facilities, however there is no certainty that we will be successful in this, or complete it in a timely fashion. For more information on our bank loans, seeItem 4 – Information on the Company –“Recent Developments – Loans”.

        ScanMaster is heavily dependent upon certain worldwide industries.

        The majority of our revenues are generated by our wholly owned subsidiary, ScanMaster Systems (IRT) Ltd. and IRT ScanMaster Systems Inc., or ScanMaster. A significant portion of ScanMaster’s revenues are generated by its sales of non-destructive inspection systems to the aeronautics industry, providing inspection solutions for aircraft engine forgings, and aerospace structural elements, manufactured from metal and composite materials. As such, we are substantially dependent upon the strength of these worldwide industries, and in particular upon the need by manufacturers to make continuing capital investments in systems and products, such as those marketed and sold by us, for use in their production and manufacturing processes. This need is a reflection, in turn, of the worldwide level of demand for the final products produced by the manufacturers to which we provide our inspection products. Demand for such products is normally a function of the prevailing global or regional economic environment and has been negatively affected by the current global economic downturn which may continue to materially adversely affect the demand for our products.

        We intend to continue pursuing businesses to acquire thus expanding our business into new markets.

        In the past, the majority of our revenues were generated from sales to the textile industry, which proved to be insufficient to generate significant net profits. As demonstrated by our penetration into the ultrasonic industrial inspection industries, our business strategy includes selective expansion into other automated inspection applications through the acquisition of additional businesses and technologies. Our future success and growth depends upon our successful penetration of these new markets.

        We plan to continue to seek opportunities to further expand our product line, customer base and technical talent through other acquisitions in the automated inspection industry. Acquisitions inherently involve numerous risks, such as the diversion of management’s attention from other operational matters, the inability to realize expected synergies resulting from the acquisition, failure to commercialize purchased technologies, and the impairment of acquired intangible assets resulting from technological obsolescence or lower-than-expected cash flows from the acquired assets. The inability to effectively manage these risks could have a material adverse effect on our operating results.

        More specifically, should we fail to develop products which provide the necessary standards of inspection, then given the capital investments that we have made in order to penetrate these new markets, such failure could adversely affect our longer-term plans for expanding our business and may even cause the cessation of our business. For further information, seeItem 4, “Information on the Company – History and Development of the Company”andItem 10, “Additional Information – Material Contracts”.

9

        We rely on a small number of customers for a significant portion of our revenues.

        Although the composition of our customers changes from year to year, we expect to continue to receive a significant portion of our revenue from a limited number of customers. In each of 2006, 2007, 2008 none of our customers in any area of business accounted for more than 10% of our net sales. We expect that sales of our products to relatively few customers could continue to account for a substantial percentage of our net sales in the foreseeable future. There can be no assurance that we will be able to retain these key customers or that such customers will not cancel purchase orders, reschedule, or decrease their level of purchases. Loss or cancellation of business to these customers could seriously harm our financial results and business.

        We depend on a limited group of subcontractors and suppliers.

        Certain components and subassemblies included in our products are obtained from a single source or a limited group of suppliers and subcontractors. Our reliance on a single or a limited group of suppliers could result in an inability to obtain adequate supplies of certain components, a reduction in control over pricing and the timely delivery of components, as well as potentially having an adverse affect on the results of our operations and our relations with our customers. There can be no assurance that supplies will be available to us on an acceptable basis. Inability to obtain adequate supplies of components or to manufacture such components internally could have an adverse effect on us. Additionally, a significant increase in the price of one or more of these components or subassemblies could negatively affect the results of our operations.

        The sales cycle for our products is lengthy and there is no guaranty of resulting sales.

        The marketing and sales cycle for our systems in all of the industries in which our various products are sold, especially in recently penetrated markets and in new applications, is lengthy, and can last as long as three years. Even in existing markets, due to the $10,000 to $1,500,000 price range for our systems and possibly significant ancillary costs required for a customer to install the system, the purchase of a system can constitute a substantial capital investment for a customer (which may need more than one machine for its particular proposed application), requiring lengthy consideration and evaluation. In particular, the product must provide a potential customer with a high degree of assurance that it will meet the customer’s needs, successfully interface with the customer’s own manufacturing, production or processing system, and have minimal warranty, safety and service problems. Accordingly, the time lag from initiation of marketing efforts to final sales can be lengthy and expensive, and there is no guaranty that the expenditure of significant time and resources will result in sales.

10

        Competition in the automated inspection industry is intense.

        Several companies working with the textile industry have developed products with similar visual inspection or quality monitoring capabilities, such as BarcoVision and Cognex. In addition, a number of companies have developed products with non-destructive inspection capabilities, such as Krautkramer, Matec SDI, RD Tech, Sonix, Aims and Panametrics.

        It is possible that systems developed by these or other future competitors will prove more effective than our systems and that potential customers will prefer them. The competition for the development and sale of advanced automated inspection systems and non-destructive inspection systems in other industries and for other applications is also intense. To the extent that providers of automated inspection systems may choose to focus on or develop advanced automated inspection technology for the industries for which we attempt to develop products, we could face significant competition in the future. If we are unable to maintain our competitive advantage in the industries in which we operate or are unable to convince potential customers of the superiority of our products in markets in which we seek to compete, our business may be seriously harmed. There can be no assurance that our potential competitors will not develop products that render our products less competitive. Our potential competitors operating in other industries may be more established, benefit from greater market recognition and have greater financial, production and marketing resources than we have.

        Fluctuations in the market may create periodic rises in expenses or falls in demand that would be difficult to offset.

        Historically, our highest level of net sales has been in the fourth quarter of each year. Nevertheless, we have experienced and may in the future experience significant fluctuations in revenues and operating results from quarter to quarter as a result of a number of factors, many of which are outside our control. These factors include the timing of significant orders and shipments, product mix, delays in shipment, installation and/or acceptance of systems, capital spending patterns of customers, customer manufacturing cycles, trade shows, anticipated new product introductions by us or by others, competition and pricing, new product introductions by us or our competitors, the timing of research and development expenditures, expansion of marketing and support operations, changes in material costs, production or quality problems, currency fluctuations, disruptions in sources of supply, regulatory changes and general economic conditions. Moreover, due to the relatively fixed nature of many of our costs, including personnel and facilities costs, we would not be able to reduce costs in any quarter to compensate for any unexpected shortfall in net sales, and such a shortfall would have a proportionately greater impact on our results of operations for that quarter. For example, a significant portion of our quarterly net sales depends upon sales of a relatively small number of high-priced systems. Thus, changes in the number of systems shipped in any given quarter can produce substantial fluctuations in net sales, gross profits and net income from quarter to quarter. These or other factors could have a material adverse effect on our business and operating results.

11

        The long payment cycle in our industry may have a negative effect on our cash flow.

        As is the case with many suppliers of equipment to the automotive, transportation, metal and textile industries, we often receive a deposit upon receipt of an order, a partial payment upon delivery or installation and final payment pursuant to negotiated payment terms or final payment after a trial and/or acceptance period for systems sold subject to a trial period. The time required for installation and trial varies from customer to customer and may be delayed by a variety of factors, including the customer’s production cycle, integration of systems into the customer’s manufacturing process, required modifications to the customer’s production line and the availability of qualified technicians to monitor system operations. For systems sold without an evaluation period, revenue is recognized immediately upon installation of the system. For systems sold subject to a trial period, revenue is recognized upon customer acceptance. The length of the customer’s trial and acceptance period generally varies from one to twelve months after installation. If we are unable to consistently generate sustained positive cash flow from operations, we must rely on debt or equity financing.For further information, see Item 5, “Operating and Financial Review and Prospects – Trend Information”.

        We cannot guarantee market acceptance of our products.

        Our success depends on the acceptance of our products by existing and new customers. Market acceptance of our automated visual and ultrasonic inspection and quality monitoring systems will depend, in large part, on the pricing of the products and our ability to demonstrate the cost and quality advantages of our systems over human visual inspection and quality monitoring. There can be no assurance that we will be able to market our products successfully or that any of our current or future products will be accepted in the marketplace.

        We may have flaws in the design or manufacture of our products.

        If flaws in either the design or manufacture of our products were to occur, including those products of the businesses we have recently acquired, we could experience a rate of failure in our products that could result in significant delays in shipment and material repair or replacement costs. While we engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers and contract manufacturers, there can be no assurance that these actions will be sufficient to avoid a product failure rate that results in substantial delays in shipment, significant repair or replacement costs, or potential damage to our reputation, any of which could have a material adverse effect on our operating results.

        Our international sales could be adversely affected by changes in domestic and foreign regulations.

        Our systems have been sold primarily in the United States, Europe and the Far East. We are subject to the risks inherent in international business activities. These risks include unexpected changes in regulatory requirements, compliance with a wide variety of foreign laws and regulations, import restrictions, tariffs and other trade barriers, staffing and managing foreign operations, transportation delays and seasonal reduction of business activities. Additionally, if for any reason exchange or price controls or other restrictions on conversion of foreign currencies were imposed, our business could be adversely affected.

        General economic conditions may adversely affect the Company's results.

        Current uncertainty in global economic conditions, including the recent disruption in financial and credit markets, pose a risk to the overall economy that could impact demand for our and our customers’ products, as well as our ability to manage commercial relationships with our customers, suppliers and creditors. If the current situation continues or worsens, our business could be negatively impacted, including such areas as reduced demand for our products and services, or supplier or customer disruptions, which could reduce our revenues or our ability to collect our accounts receivable and have a material adverse effect on our financial condition and results of operations.

12

        We may not be successful in keeping pace with the rapid technological changes that characterize our industries.

        The technology incorporated in automated inspection and quality monitoring systems is characterized by rapid changes. Moreover, the emergence of new technologies can rapidly render existing products obsolete and unmarketable. Our ability to continue to anticipate changes in technology and industry standards, and successfully develop and introduce new and enhanced products that can gain market acceptance on a timely basis will be a critical factor in our ability to grow and to remain competitive. In addition, we intend to diversify our business by developing new products based on our own technology. There can be no assurance that we will timely or successfully complete the development of new or enhanced products or successfully manage transitions from one product release to the next, or that our future products will achieve market acceptance.

        We depend on a limited number of key personnel who would be difficult to replace.

        Our success depends in a large part on certain of our personnel, including our sales representatives, executive, research and development personnel and our technical staff, the loss of the services of whom would have a material adverse effect on us. There is considerable competition for the services of such personnel. There can be no assurance that we will be able either to retain our current personnel or acquire additional qualified personnel as and when needed.

        We may not be able to protect our intellectual proprietary rights.

        We rely primarily upon a combination of trademark, copyright, know-how, trade secrets and contractual restrictions to protect our intellectual property rights. In addition, our employees who have access to confidential information are required to sign confidentiality and invention assignment agreements. Certain elements of our technology are licensed from Dr. Ilan Tamches. We have certain exclusive rights to this technology with respect to the textile industry and certain non-exclusive rights with respect to other industries. Since the third quarter of 2006 we have not used this technology. Neither we, nor, to our knowledge, Dr. Tamches, have any patents or patent applications pending with respect to this technology. We do have a registered patent in France and patent applications pending in Israel with respect to certain technology incorporated in the video cameras used by our systems. We believe that such measures provide only limited protection of our proprietary information, and there is no assurance that our confidentiality and non-competition agreements will be enforceable and that our proprietary technology will remain a secret, or that others will not develop similar technology and use this technology to compete with us. Despite our efforts to protect our proprietary rights, former employees and other unauthorized parties may attempt to copy aspects of our products or to obtain and useinformation that we regard as proprietary. For more information, see Item 4, “Information on the Company – Business Overview – Intellectual Property Rights for Textile Industry”.

13

        We may become involved in litigation.

        From time to time, we may be subject to various claims and lawsuits by competitors, customers, or other parties arising in the ordinary course of business. Such matters can be time-consuming, divert management’s attention and resources, and cause us to incur significant expenses. Furthermore, there can be no assurance that the results of any of these actions will not have a material adverse effect on our operating results. Additionally, significant and protracted litigation may be necessary to protect our intellectual property rights, to determine the scope of the proprietary rights of others or to defend against claims of infringement, regardless of whether the claims are valid. For more information, seeItem 8, “Financial Information – Litigation”.

Risks Related to Our Ordinary Shares

        We may require additional financing.

        Mivtach Shamir, our controlling shareholder has tentatively agreed to invest an aggregate amount of $1.8 million as a part of a private placement or rights offering, of which NIS 1,982,000 (approximately $492,000) Mivtach Shamir provided to us by way of a convertible loan during 2009. The terms of the loan conversion and repayment of the remaining investment amount are currently being negotiated by Mivtach Shamir and our management. The remaining investment amount and the conversion of the loan is contingent upon Bank Leumi Le Israel and Bank Hapoalim agreeing to restructure our debt to them such that the repayment of the principal on the loans will be frozen until December 31, 2011. If we do not receive such approval from the banks and we fail to receive the balance of the $1.8 million from Mivtach Shamir, we believe that our current assets, together with anticipated cash generated from operations and available credit lines, will be insufficient to meet our cash requirements for working capital and capital expenditures for twelve months from July 2009.

        On June 21, 2007, we executed an agreement intended to amend our agreement with Mivtach Shamir, dated February 21, 2006, or the Mivtach Agreement. The new agreement, or the Amendment Agreement, which was approved by our shareholders in a meeting of our shareholders held on July 31, 2007, was executed between us and M.S.N.D. Real Estate Holdings Ltd., or M.S.N.D, a wholly owned subsidiary of Mivtach Shamir, to which Mivtach Shamir had assigned their right to receive shares from us under the Mivtach Agreement. Pursuant to the Amendment Agreement, the terms of the Mivtach Agreement and the loan therein, were amended, such that in consideration for M.S.N.D.‘s undertaking to convert $3,000,000 by no later than August 1, 2007, (a) M.S.N.D was issued 9,523,810 of our ordinary shares; and (b) M.S.N.D received a 4-year warrant to purchase 2,380,952 of our ordinary shares at an exercise price of $0.45 per share. M.S.N.D also agreed to waive its rights to exercise warrants into at least 3,000,000 ordinary shares issuable under the Mivtach Agreement, agreeing to exercise warrants into no more than 1,000,000 ordinary shares issuable under the Mivtach Agreement, which warrants expired subsequently on February 21, 2008. Following the Amendment Agreement M.S.N.D has become a holder of more than 25% of our issued and outstanding share capital. We also entered into a registration rights agreement with M.S.N.D., pursuant to which we filed a Registration Statement on Form F-1 on July 31, 2007, covering all the ordinary shares and ordinary shares underlying the warrants issuable to M.S.N.D pursuant to the Amendment.

        In addition, on June 21, 2007, following the approval of our audit committee and board of directors, we executed with Elbit Ltd., or Elbit, an agreement, or the Elbit Agreement. This agreement was approved by our shareholders in a meeting of our shareholders held on July 31, 2007. Pursuant to the Elbit Agreement, Elbit (i) converted an existing loan to us in the amount of $470,000 (including accrued interest up until March 31, 2007) into 1,492,063 of our ordinary shares, at a price of $0.315 per share; and (ii) invested in us $250,000 in consideration for 793,651 of our ordinary shares at a price of $0.315 per share and received a 4-year warrant to purchase 396,825 of our ordinary shares at an exercise price of $0.45 per share. Within the framework of the Elbit Agreement, we have entered into a registration rights agreement, pursuant to which we filed a Registration Statement on Form F-1 on July 31, 2007, covering all of the ordinary shares and ordinary shares underlying the warrants issued pursuant to the Elbit Agreement.

14

        Additionally, in April 2007 we executed a share purchase agreement, or the April Investment, which was consummated with a series of Israeli institutional investors over the period of April to July 2007, for the purchase of 9,465,544 of our ordinary shares for $0.315 per share, or an aggregate price of $2,981,646. Pursuant to the transaction, the investors were also issued warrants to purchase 4,732,772 of our ordinary shares at an exercise price per share of $0.45, exercisable for a period of 4 years, 163,178 of which were exercised during 2008. On July 31, 2007, we filed a Registration Statement on Form F-1, covering all of the ordinary shares and ordinary shares underlying the warrants issuable to the institutional investors pursuant to the April Investment.

        Additionally, in August 2005 and February 2006, we and ScanMaster received a credit line for the aggregate amount of $2,000,000 from Mizrahi Tefahot Bank Ltd., or Mizrahi, which terminated on June 30, 2007. The credit line was secured by a first ranking floating charge on all our assets and all the assets of ScanMaster. We also granted Mizrahi a warrant to purchase up to 571,429 of our ordinary shares, at an exercise price of $0.77 per share, which was later reduced by our board to $0.50 per share. This warrant is exercisable until September 8, 2009. We and ScanMaster also received a credit line from Bank Leumi for the aggregate amount of $2,500,000. The credit line is secured by a first ranking floating charge on all our assets and all the assets of ScanMaster. For more information, seeItem 7, “Major Shareholders and Related Party Transactions – Related Party Transactions.”

        Additionally, at the end of March 2009, following the approval of our audit committee and board of directors, we entered into loan agreements with each of Bank Hapoalim and Bank Leumi Le Israel for the aggregate sum of $600,000 ($300,000 per bank). For more information, seeItem 4, “Information on the Company – Recent Developments.”

        We believe that if we are unable to restructure our loans from Bank Leumi Le Israel and Bank Hapoalim, we will not receive the balance of the proposed investment of $1.8 million from Mivtach Shamir, and our current assets, together with anticipated cash generated from operations and available credit lines, will be insufficient to meet our cash requirements for working capital and capital expenditures for twelve months from July 2009. In order to continue as a going concern, we may sell additional equity or debt securities and seek to obtain additional financing. We may not, however, be able to obtain additional financing on terms satisfactory to us, if at all. In addition, given the existing potential for significant dilution in light of the large number of outstanding convertible securities as well as the large number of our ordinary shares we have recently registered or have an obligation to register, our ability to complete additional debt or equity financing may be very limited.

15

        The large number of shares available for future sale could adversely affect the price of our ordinary shares

        As of May 31, 2009, 50,988,701 of our shares were outstanding.

        In addition, in 2005, we issued David Gal, our former CEO and chairman of the board, options to purchase up to 600,000 of our ordinary shares at an exercise price of $0.50 per share. One third of the options vested on December 31, 2006, since which time 2.8% of the total shares subject to the option are vesting on a monthly basis. The vesting of the options will be subject to Mr. Gal serving as the chairman of our board of directors on the relevant vesting date, and he shall be entitled to exercise the options up to 5 years after the options have vested. In addition, 4,540,352 of our ordinary shares are currently issuable to our present and former employees, directors and consultants upon the exercise of options granted pursuant to our 1996, 2000, 2003 and 2006 employee option plans, with varying exercise prices, ranging between $0.15 per share and $1.68 per ordinary share.

        Additionally, in the event that Mivtach Shamir completes its aggregate investment of $1.8 million and converts its convertible loan with us, additional ordinary shares will be issued to Mivtach Shamir.

        In addition, pursuant to the Amendment Agreement, 2,380,952 of our ordinary shares are issuable to M.S.N.D. upon the exercise of a warrant, with an exercise price of $0.45 per share, exercisable for a period of 4 years. There is an outstanding Registration Statement on Form F-1 covering all of these ordinary shares and the ordinary shares underlying the warrants. During September of 2008, M.S.N.D transferred the right to exercise 1,380,000 ordinary shares covered by this warrant to David Gal.

        In addition, in consideration for the acquisition of ScanMaster we paid ScanMaster’s former shareholders $3 million in cash and agreed to issue them 7,414,213 of our ordinary shares, of which 4,044,834 are currently held in escrow and are eligible for release. 2,939,192 of these shares were sold to M.S.N.D., as part of an agreement between some of ScanMaster’s former shareholders and Mivtach Shamir. In addition, 800,000 ordinary shares have been issued to Ma’aragim Enterprises Ltd, or Ma’aragim, in connection with the acquisition of Panoptes, and we granted Mizrahi a warrant to purchase up to 571,429 of our ordinary shares, at an exercise price of $0.77 per share, which our board consented to reduce to $0.5 per share, in November 2006. Assuming the full exercise of the warrant, M.S.N.D. will hold approximately 25.3% of our share capital. Furthermore, under the Elbit Agreement, we also granted warrants to purchase 396,825 of our ordinary shares. There is an outstanding Registration Statement on Form F-1, covering all of these ordinary shares and ordinary shares underlying the warrants issued or issuable to Elbit. Additionally, under the April Investment 4,732,772 of our ordinary shares are issuable to Israeli Investors upon the exercise of warrants, and are covered by an outstanding Registration Statement on Form F-1.

16

        Consequently, the following securities are registered for re-sale:

(a) 5,099,911 ordinary shares issued under certain private placement investments entered into in 2003 and 2004;

(b) 7,050,869 ordinary shares issuable to employees under 1996, 2000, 2003 and 2006 employee option plans;

(c) 4,475,021 ordinary shares for ScanMaster’s former shareholders;

(d) 9,523,810 ordinary shares issued upon the conversion of a convertible loan, as amended by Amendment Agreement, and 2,380,952 shares to be issued to M.S.N.D. upon exercise of the warrant pursuant to the Amendment Agreement;

(e) 2,647,643 ordinary shares held by Elbit;

(f) 2,285,714 ordinary shares issued under the Elbit Agreement, and 396,825 shares to be issued to Elbit upon exercise of its warrant;

(g) 9,465,544 ordinary shares issued under the April Investment as well as 4,732,772 shares to be issued upon exercise of the warrants issued to Israeli institutional investors;

(h) 571,429 ordinary shares to be issued to Mizrahi upon exercise of its warrant; and

(i) 800,000 ordinary shares for Ma’aragim.

        All of these securities are registered for resale, and are not subject to any contractual restrictions on resale. Future resale of any of these shares, or the anticipation of such sales, could cause an increase or an anticipated increase of the number of our shares in the market and therefore could adversely affect the market price of our ordinary shares and materially impair our future ability to raise capital through an offering of equity securities and could result in increased volatility in the price of our shares.

        Our ordinary shares may be affected by limited trading volume and may fluctuate significantly in price.

        Our ordinary shares are traded on the Over-the-Counter Bulletin Board. Trading in our ordinary shares has been limited and there can be no assurance that an active trading market for our ordinary shares will develop. As a result, this could adversely affect our shareholders’ ability to sell our ordinary shares in short time periods, or possibly at all. Thinly traded ordinary shares can be more volatile than ordinary shares traded in an active public market. The average daily trading volume of our ordinary shares in April 2009 was 25,525 shares. The high and low bid price of our ordinary shares for the last two years has been $0.07 and $0.54, respectively. Our ordinary shares have experienced, and are likely to experience in the future, significant price and volume fluctuations, which could adversely affect the market price of our ordinary shares without regard to our operating performance.

17

        Our Ordinary Shares are deemed to be “Penny Stock” which may make it more difficult for investors to sell their shares due to suitability requirements.

Our ordinary shares are deemed to be “penny stock” as that term is defined in Rule 3a51-1 promulgated under the Securities Exchange Act of 1934. Penny stocks are:

— With a price of less than $5.00 per share;

— That are not traded on a "recognized" national exchange;

— Whose prices are not quoted on the NASDAQ automated quotation system; or

— In issuers with net tangible assets less than $2.0 million (if the issuer has been in continuous operation for at least three years) or $5.0 million (if in continuous operation for less than three years), or with average revenues of less than $6.0 million for the last three years.

        Broker/dealers dealing in penny stocks are required to provide potential investors with a document disclosing the risks of penny stocks. Moreover, broker/dealers are required to determine whether an investment in a penny stock is a suitable investment for a prospective investor. These requirements may reduce the potential market for our ordinary shares by reducing the number of potential investors. This may make it more difficult for our shareholders to sell shares to third parties or to otherwise dispose of them. This could cause our share price to decline.

        Our ordinary shares are currently traded on the OTC Bulletin Board and may be difficult to buy and sell.

        On November 19, 2003, our ordinary shares were delisted from The Nasdaq SmallCap Market and are now traded on the OTC Bulletin Board as a result of our failure to comply with the $2.5 million minimum shareholder equity requirement. Consequently, selling and buying our securities has become more difficult because of delays in the timing of transactions and in obtaining accurate quotations. Furthermore, broker-dealers are subject to an SEC rule that imposes additional sales practice requirements on broker-dealers who sell low-priced securities to persons other than established customers and institutional accredited investors. For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written agreement to the transaction prior to sale. These factors may affect the ability of broker-dealers to sell our ordinary shares and of shareholders to sell our ordinary shares in the secondary market and in turn could result in lower prices and larger spreads in the bid and ask prices for our ordinary shares than might otherwise be obtained. For more information, seeItem 4, “Information on the Company – History and Development of the Company” andItem 9, “The Offer and Listing – Market and Share Price History”.

        Our results are affected by volatility in the securities markets.

        Due to the current downturn in the world economy which began in 2008, the securities’ markets in general have experienced increased volatility, which has particularly affected the market prices of equity securities of many hi-tech companies, including companies that have a significant presence in Israel. Although the volatility of these companies’ securities has often been unrelated to their operating performance, they, and particularly those in the fields of communications, software and internet, have been experiencing and may continue to experience difficulties in raising additional financing required to effectively operate and grow their businesses. Such failure and the volatility of the securities market in general, and in relation to our shares in particular, may affect our ability to raise additional financing in the future.

18

        We may experience a further decline in our share price

        Our share price has declined significantly over the last year and it continues to be affected by the current uncertainty in global economic conditions We cannot assure you that our share price will recover in the coming fiscal year.

General Risks

        Corporate governance scandals and new legislation could increase the cost of our operations.

        As a result of corporate governance scandals and the legislative and litigation environment resulting from those scandals, the costs of being a public company in general have increased. Legislation, such as the Sarbanes-Oxley Act of 2002, have had the effect of increasing the burdens and potential liabilities of being a public reporting company. This and other proposed legislation may increase the fees of our professional advisors and our insurance premiums.

        Conditions in Israel may affect our operations.

        We are incorporated under the laws of, and our corporate offices, research and development operations and production facilities are located in, Israel. Although almost all of our current sales are made to customers outside Israel, we are nonetheless directly influenced by the political, economic and military conditions affecting Israel and the Middle East. Any major hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could have a material adverse effect on our business, financial condition and results of our operations.

        From October 2000 until recently, there was an increase in violence between Israel and the Palestinians, primarily but not exclusively in the West Bank and Gaza Strip. The election of representatives of the Hamas militant group in January 2006 to a majority of seats in the Palestinian Legislative Council, their taking over the Gaza Strip, as well as the war with the Islamic militant group Hezbollah in Lebanon in July and August 2006 have created additional regional unrest and uncertainty. The hostilities with Hamas in the Gaza Strip further significantly escalated in December of 2008 and January of 2009. Ongoing and revived hostilities with the Palestinians or Arab countries might require more widespread military reserve service by some of our employees, which could have an adverse effect on our business. In addition, several Arab and Muslim countries still restrict business with Israeli companies. We could be adversely affected by restrictive laws or policies directed towards Israel or Israeli businesses. The political and security situation in Israel may result in parties with whom we have contracts claiming that they are not obligated to perform their commitments under those agreements pursuant to force majeure provisions. Any hostilities involving Israel or the interruption or curtailment of trade between Israel and its present trading partners could adversely affect our operations and could make it more difficult for us to raise capital. Furthermore, many of our facilities are located in Israel. Since we do not have a detailed disaster recovery plan that would allow us to quickly resume business activity, we could experience serious disruptions if acts associated with this conflict result in any serious damage to our facilities. Our business interruption insurance may not adequately compensate us for losses that may occur and any losses or damages incurred by us could have a material adverse effect on our business. We cannot give any assurance that security and political conditions will not have such an effect in the future. Any future armed conflicts or political instability in the region would likely negatively affect business conditions and harm our results of operations.

19

        Furthermore, all non-exempt male adult permanent residents of Israel under the age of 42 are obligated to perform military reserve duty and may be called to active duty under emergency circumstances. There have been significant call-ups of military reservists in the past, and it is possible that there will be additional call-ups in the future. While we have operated effectively despite these conditions in the past, we cannot assess what impact such conditions may have in the future, particularly if emergency circumstances arise. Our operations could be disrupted by the extended absence of one or more of our executive officers or key employees or a significant number of our other employees due to military service. Any disruption in our operations would harm our business.

        The Israeli rate of inflation may negatively impact our costs if it exceeds the rate of devaluation of the New Israeli Shekel against the U.S. Dollar.

        Most of our sales are made in U.S. Dollars. We occasionally agree to make sales in other currencies, usually the Euro. This exposes us to market risk from changes in foreign exchange rates vis-à-vis the U.S. Dollar. We have recently commenced utilizing foreign currency exchange contracts to mitigate these risks. Under these contracts, increases or decreases in our foreign currency transactions are partially offset by gains and loses on the forward contracts, so as to mitigate the possibility of foreign currency transaction gains and losses. However, our Dollar costs in Israel will increase if inflation in Israel exceeds the devaluation of the NIS against the Dollar or if the timing of such devaluation lags behind inflation in Israel. There can be no assurance that we will not incur losses from such fluctuations. For more information, seeItem 5, “Operating and Financial Review and Prospects – Operating Results – Impact of Inflation and Devaluation on Results of Operations, Liabilities and Assets” andItem 11, “Quantitative and Qualitative Disclosures about Market Risk – Foreign Currency Exchange and Interest Rate Risk”.

        We benefit from certain government programs and tax benefits, which may change or be withdrawn.

        We benefit from certain Israeli government grants, programs and tax benefits. To be eligible for these grants, programs and tax benefits, we must continue to meet certain conditions, including making certain specified investments in fixed assets. If we fail to meet such conditions in the future, we could be required to refund payments under these programs or pay certain taxes. There can be no assurance that such programs and tax benefits will be continued in the future, at their current levels or otherwise. The termination or reduction of certain programs and tax benefits could have a material adverse affect on our business, results of operations and financial conditions.

20

        Israeli courts might not enforce judgments rendered outside of Israel.

        We are incorporated in Israel. Most of our executive officers and directors are non-residents of the United States, and a substantial portion of our assets and the assets of these persons are located outside the United States. Therefore, it may be difficult to enforce a judgment obtained in the United States against any such persons or us. It may also be difficult to enforce civil liabilities under U.S. federal securities laws in original actions instituted in Israel.

        If a foreign judgment is enforced by an Israeli court, it generally will be payable in New Israeli Shekels, which can then be converted into foreign currency at the rate of exchange of such foreign currency on the date of payment. Pending collection, the amount of the judgment of an Israeli court stated in New Israeli Shekels (without any linkage to a foreign currency) ordinarily will be linked to the Israeli consumer price index plus interest at the annual statutory rate prevailing at such time. Judgment creditors bear the risk of unfavorable exchange rates.

ITEM 4. INFORMATION ON THE COMPANY

A.History and Development of the Company

We have historically designed, developed, manufactured, marketed and supported automatic inspection and quality monitoring systems for the textile and other fabric industries.

In the third quarter of 2002, our management took the strategic decision to leverage our expertise in designing visual inspection systems and expand our business into new industrial fields. Since then, we have focused on an overall strategy of expanding our product portfolio and penetrating new markets. As part of this strategy, over the past few years we have acquired two new businesses, Panoptes and ScanMaster, which operate in the fields of optical vision and non-destructive ultrasonic inspection application, respectively.

On September 8, 2004, we completed the acquisition of ScanMaster, a company that develops, manufactures and markets automated ultrasonic inspection and imaging equipment for the aircraft, aerospace, train, rail, pipe, plate and automotive industries. ScanMaster was established in 1986 by a group of researchers and engineers from the Tel Aviv University in Israel. ScanMaster manufactures instruments, transducers and turnkey non-destructive inspection systems for a wide range of industrial applications using ultrasonic technologies and has an installed base of more than five hundred field-proven systems and instruments, including equipment for such inspection applications as:

— Pipe welds and body

— Aircraft engine turbine forging parts

— Power generation turbine rotors and shafts

— Steel, aluminum and titanium alloy plates, bars, tubes and pipes

— Train wheels and train railways

— Diesel engine pistons and pressure vessels

— Aircraft and aerospace structural elements manufactured from composite materials

— Spot welds for the automotive industry

21

        ScanMaster has sold its systems to Boeing, General Electric, Daimler Benz, Wyman Gordon, General Motors, Cummins Diesel, Pratt & Whitney, MAN Technologies, Deutscher Aerospace, MTU, Snechma, Fortech, Volvo Aerospace and Preussagstahl.

        In January 2006, we, together with our subsidiary ScanMaster, consummated the acquisition of the business, assets, and shares of Panoptes, an innovator of machine vision systems for surface inspection, technical fabrics, textiles, glass and other woven materials.

        In June 2004, we also purchased Yuravision Co. Ltd., or Yuravision, a company in the microelectronics and flat-panel display industries. In 2006 our board of directors and management decided to focus on existing markets rather than continue developing our microelectronics technologies. As a result, on December 1, 2006, we executed an agreement with a Korean corporation for the sale of Yuravision, which was later amended on January 28, 2008. For more information seeItem 10, “Additional Information – Material Contracts”.

        Our legal and commercial name is Elbit Vision Systems Ltd. We were established in Israel on September 2, 1992 and organized pursuant to the Israel Companies Ordinance, 1983, which was replaced by the Israeli Companies Law, 1999, or the Companies Law. We commenced independent commercial operations on January 1, 1994, as a subsidiary of Elbit. Prior to such date, our business operated as a division of Elbit. In July 1996, we consummated an initial public offering of 2,000,000 ordinary shares. At such time the ordinary shares were quoted on the NASDAQ National Market. Effective December 29, 2000, our ordinary shares were delisted from the NASDAQ National Market and traded on the Over-the-Counter Bulletin Board until June 21, 2001, when they were transferred to the NASDAQ SmallCap Market. On November 19, 2003, our ordinary shares were delisted from the NASDAQ SmallCap Market and we are currently traded on the Over-the-Counter Bulletin Board. For further information, seeItem 3, “Key Information – Risk Factors – Risk Factors Related to Our Ordinary Shares” andItem 9, “The Offer and Listing – Market and Share Price History”.

Recent Developments

        Since January 1, 2008, the following important events have occurred:

Appointment of Chief Executive Officer

        Pursuant to David Gal’s resignation as the Company’s Chief Executive Officer, on April 27, 2009 our board of directors approved the appointment of Mr. Ran Eisenberg as our Chief Executive Officer.

Loans

        At the end of March of 2009, following the approval of our audit committee and board of directors, we entered into agreements with each of Bank Hapoalim and Bank Leumi Le Israel in order to receive a credit line for $300,000 each. We are currently fully utilizing each of these credit lines. These two loans, which bear a floating interest rate of LIBOR plus 3.5% and LIBOR plus 3.75%, respectively, are due to be repaid in monthly installments by the end of December 2009. We are currently negotiating with the banks in order to freeze repayment of the principal on the loans until December 31, 2011.

22

Mivtach Investment

        Mivtach Shamir, our controlling shareholder has tentatively agreed to invest an aggregate amount of $1.8 million as a part of a private placement or rights offering, of which NIS 1,982,000 (approximately $492,000) Mivtach Shamir provided to us by way of a convertible loan during 2009. For more information, seeItem 3 – Key Information – Risk Factors – Risks Related to Our Ordinary Shares – “We may require additional financing”.

        Our executive offices are located at 1 Haofe Street, Hasharon Industrial Park, Qadima, P.O.B. 5030, 60920, Israel, and our telephone number is 972-9-8661600 and fax number 972-9-8661700. Our Web site iswww.evs-sm.com. Information on our web site is not incorporated by reference in this annual report.

B. Business Overview

We currently operate as two main divisions: the Non–Destructive Automated Inspection Systems Division consisting of ScanMaster’s non-destructive inspection business and the Automated Optical Inspection Industry, or AOI, Division.

I. Non–Destructive Automated Inspection Systems Division

The products of ScanMaster Systems (IRT) Ltd., or ScanMaster Ltd., serve the high end of a non-destructive testing, or NDT, market. The company’s products enjoy a high technological barrier to entry that translates into a limited number of competitors in each application niche. In terms of sensitivity, speed, resolution, data acquisition and processing hardware and software as well as in terms of quality and reliability, the company’s products are believed to be well positioned in the industry.

ScanMaster Ltd. has made more than 700 equipment installations in 26 countries, for a total 20-year sales volume exceeding $102million. Typical uses of ScanMaster equipment include the detection and sizing of defects in forged discs used in jet engines, detection of flaws in pipe weld and pipe full body, periodic inspection of the integrity of train rail, evaluation of the integrity of spot weld bonds in automobiles and detection of bonding defects in composite aerospace structures.

The annual NDT world market for ultra-sonic testing, or UT, equipment is of the order of $500 million in size. The market is divided among North and South America, Europe, and the rest of the world, with each of the three sectors commanding approximately one-third of world sales. Product-wise, the UT market is divided as follows:

— Consumables, which in the main are transducers and accessories with annual sales of the order of $100 million;

— Gauges and small portable instruments with estimated annual sales in the range of $200 million; and

— Full-size instruments, retrofit upgrades of older installed systems and new turn-key inspection systems, altogether comprising an annual turnover of $200 million.

The early years of the current decade saw a rapid expansion of sales of UT equipment to most of the industries (aircraft, railway, steel, automotive and related industries). The annual growth is about 4%-6% of the UT market.

Additionally, the rapid advances made in computerized data acquisition and volumetric ultrasonic imaging are beginning to contribute to a penetration of the gamma and X-ray NDT radiation markets, presently approximately $350 million in size. UT inspection is significantly more attractive, as the equipment is of comparable or lower cost, uses far fewer consumables, poses no radiation hazard, and is amenable to computerized evaluation. It is expected that the inroads made by UT imaging in these markets will increase significantly in the future, as more UT inspection procedures in the aircraft, petroleum and steel industries supplant those originally written for NDT radiation techniques.

23

The years of drastic cost-cutting by many industrial concerns, combined with a dramatic increase in the price-to-performance ratio of off-the-shelf computer and electronic products, has resulted in a significant increase in the sensitivity of these companies to high-priced turn-key NDT machines. This, in turn, has opened a window of opportunity for the manufacturers of inspection equipment which are more attuned to competitive market trends in technology and pricing.

a. Business and Product Overview

Applications

— Tube and Pipe– Inspection of spiral submerged welded pipes and electrical resistance welded pipes, either manually or in automatic operation, in-line or off-line, as well as field inspection of pipe weld, body and pipe and inspection.

— Plate High-speed, automated ultrasonic testing machines for detection, evaluation and documentation of flaws in steel and other metals plates.

— Bar Full Body High-speed, precision ultrasonic inspection of bars.

— Power Generation Efficient and reliable ultrasonic inspection of large, rotary-symmetrical forgings and castings, such as forged compressor and turbine disks employed in stationary gas turbines for electric power production.

— Train Wheels Inspection of train wheels both in the production line and in refurbishing shops. Short set-up time, high inspection throughput.

— In Service Train Rail High-speed train rail inspection with super-fast B-scan display, complete data recording and analysis tools.

— Aircraft Engine Disks Immersion inspection of Titanium and Ni alloy aircraft engine forgings, with full imaging and data processing capabilities.

— Structural Elements Aerospace Immersion, squirter or contact inspection of aircraft and aerospace structural elements manufactured from metal and composite materials, with full imaging and data processing capabilities.

— Automotive Efficient, reliable inspection and evaluation of spot welds in production line.

— Portable Versatile Instrumentation Portable UT instruments for in-doors or field operation.

— Multi-channel Instrumentation Multi-channel full-featured ultrasonic instrument with up to 32 channels and programmable I/O ports.

Product Overview

        Each ScanMaster ultrasonic system is integrated and has a number of core modules, including industrial PC-based digital ultrasonic instrumentation, production-oriented software packages and servo motion control hardware (for those applications requiring robotic manipulation). These modules are integrated in application-specific configurations, which depend on the inspection requirements for speed, number of channels, on-line display and report documentation. ScanMaster maintains in-house electronic and software groups, as well as mechanical and application engineering teams for the design, manufacture and testing of standard or customized systems.

24

        Instrumentation

— Thei – 100 is an advanced instrument for in-factory or mobile inspection. Based on the Windows 2000/XP^®, it provides the operator with a flexible platform for inspection combined with reporting, networking and archiving capabilities. The average net transfer price is $22,000.

— TheRPP3 is a high-performance, programmable single channel, square wave ultrasonic pulser-receiver that serves as a low cost, front-end module for ScanMaster’s ultrasonic instruments. The average net transfer price is $3,500.

— TheRPP4 is a high-performance, programmable multi-channel, square wave ultrasonic pulser-receiver that serves as a front-end module to ScanMaster’s ultrasonic instruments. The average net transfer price is $4,200.

— TheUPR-100 is a high-speed, multi-channel programmable data acquisition system specifically designed for demanding industrial ultrasonic inspection procedures. The average net transfer price is $12,000.

— Theswi-100 is a digital ultrasonic instrument which provides the possibility of computer-assisted decision making with on-line UT signal analysis. An advanced ultrasonic instrumentation for inspection and evaluation of spot welds, providing high throughput, high reliability of detection and full documentation capability. The average net transfer price is $20,000.

— TheU/T Mate can convert a computer into a UT instrument by connectingUT/Mate to the universal serial bus, or USB, port.UT/Mate innovatively incorporates powerful features, similar to those available in theupi-100 instrument. The device is ready to use by plugging it to any PC/Laptop USB port. The average net transfer price is $7,000.

        Transducers

— Transducers High-performance ultrasonic transducers for manual and production-line ultrasonic inspection. The transducer line includes high-sensitivity, high-resolution contact probes, as well as specialty transducers for specific applications. The average net transfer price is $750.

— Spot Weld Transducers The spot weld, or SW, series of 15 and 20MHz transducers is intended for precise and repeatable inspection and evaluation of spot welds in bonded metal sheets. SW Series transducers have signal resolution, with the controlled water column allowing distinct separation of intermediate echoes for evaluation purposes at less than 0.5mm (0.020”) from the entry surface. High-sensitivity piezoelectric elements provide ultrasonic beam penetration into thick metal sheets. The average net transfer price is $900.

        C-Scan Imaging Systems

All the below systems are fully integrated imaging systems including scanning mechanics, motion control, ultrasonic electronics, and data acquisition and processing software. The ultrasonic electronics provide excellent near- surface flaw resolution, exceptional penetration power, and have a high immunity against electromagnetic noise.

— LS-200 and LS 200b Series are immersion ultrasonic inspection systems are rugged, reliable systems for multi shift operation in an industrial environment. The average net transfer price is $220,000-$400,000.

— DS-200i- The DS-200i immersion ultrasonic inspection system is designed for the scanning of oversize parts. It is a rugged, reliable system for multi shift operation in an industrial environment. The high accuracy scanning mechanics have exceptional resolution and repeatability on all the linear and angular axes allowing for scanning of complex parts. The average net transfer price is $600,000.

25

— LS-500 The LS-500 immersion ultrasonic inspection system is a modular design allowing for stretching of the tank and scanner to fit the application. The average net transfer price is $170,000.

— DS-200s TheDS-200s Series of ultrasonic squirter systems complements the DS-200 Series of immersion scanners with the high-end capacity required for non-immersion inspection of large-scale parts manufactured from composite materials. Rugged gantry-mounted bridge with dual search tubes provide high-speed inspection within tight tolerance limits for accuracy, repeatability and resolution. Water squirter inspection in operator-selected pulse-echo (P-E) or thru-transmission (T-T) modes. Optional simultaneous P-E and T-T scanning. The average net transfer price is $700,000.

— LFS – 300 Efficient and reliable ultrasonic inspection of large, rotary-symmetrical forgings and castings, such as forged compressor and turbine disks employed in stationary gas turbines for electric power production. Highly functional and rugged mechanics including a unique servo-driven part rotating platform which allows for chucking parts vertically and accessibility to all surfaces. A selection of special purpose design manipulators mounted on robotic arm can accommodate a high number of transducers allowing enhanced inspection coverage and shorter inspection time. Specially designed transducers are supplied with the systems including: T-R probes with excellent near-surface resolution, high-sensitivity straight and angled longitudinal wave probes and shear wave probes with superior penetration and resolution. The systems are completely integrated and include highly reliable low noise motion control, multi-channel ultrasonic instrumentation and sophisticated motion and data collection software. The average net transfer price is $500,000.

Pipe and plate Inspection

— AS 200e High-speed, automated multi-channel ultrasonic testing machines for detection, classification and documentation of defects in electrical resistance welded pipes (ERW). The average net transfer price is $350,000.

— AS 200s High-speed, automated ultrasonic testing machines for detection, evaluation and documentation of flaws in submerged-arc welded pipes (SAW). The average net transfer price is $450,000.

— AS 200p High-speed, automated ultrasonic testing machines for detection, evaluation and documentation of flaws in steel plates and bars. The average net transfer price is $2,000,000.

        Product Inspection Systems

— AS 280High-speed, precision inspection machines for detection, evaluation and documentation of flaws in large, thick-walled tubulars. The average net transfer price is $700,000.

26

        Train Inspection Systems

— AS 220w Designed for in-service, production line or refurbishment shop type inspections. Fully integrated inspection system. Includes multi-channel ultrasonics, multi axes inspection robot, high load capacity mechanics with multiple transducer heads & advanced software. The average net transfer price is $500,000.

— AS 220a Fully-computerized automated ultrasonic inspection systems for refurbishment shop of train wheel axles. The average net transfer price is $500,000.

— SFB-100 High-Speed Rail Inspection System. A fully integrated ultrasonic inspection car fitted with complete mechanical hardware such as transducer sled and a sophisticated couplant provision system. The system includes high volume digital data acquisition, imaging, process and evaluation. Powerful software features include prediction of the inspected part’s degradation and defect propagation, generation of custom & standard reporting and analysis. The average net transfer price is $1,500,000.

— SFB-50 A Train Rail Inspection System, mounted on a multi purposed car (Hi-Rail) or towed by a service car. Ultrasonic inspection intended for detection, imaging and evaluation of flaws. The average net transfer price is $400,000.

        Software

— CSI Software C-scan Imaging software designed in collaboration with the major engine manufactures. The average net transfer price is $20,000.

— AS-200 The AS-200 software is designed to serve the quality assurance requirements of the heavy industry manufacturer. The average net transfer price is $12,500.

b. Sales and Markets

The market for NDT services is more than twice the size of the equipment market. Worldwide, inspection services, especially those employing UT equipment, encompass a variety of industries, and include the inspection of installed pipelines and fuel storage tanks, fossil fuel and nuclear power generation equipment, aircraft and aircraft engine components, train rail, and oil field tubulars.

Interesting business opportunities in the inspection service industry will present themselves with the establishment of joint ventures between manufacturers of specialized inspection equipment and the traditional suppliers of these services. The combination of strategic forces, when properly planned, is expected to lead to the front-line positioning of companies that offer one or more exclusive inspection services.

To date, ScanMaster Ltd. has made more than 700 installations in 26 countries. Each territory is covered by a professional representative, who is responsible for pre-sale activity through to warranty service. In addition, the Company conducts its North American operations by way of a fully owned subsidiary.

27

There is no real seasonality for ScanMaster’s products, though sales usually increase in the second half of the year as organizations hurry to use their entire allocated budget.

Over the past year, the concentration of ScanMaster’s sales have been to Europe, such that it’s sales breakdown is approximately 28% North America, 47% Europe and 25% to the Far East.

c. Manufacturing

ScanMaster’s facilities are located in Qadima, together with our facilities. Together we currently lease 3180 m². ScanMaster’s systems are manufactured by subcontractors. The final assembly, integration and quality control are conducted by ScanMaster. In addition, ScanMaster performs logistics and purchasing activities. Every system is assembled at ScanMaster, software installed and configured and the specific application is tested. ScanMaster’s manufacturing facilities are in compliance with ISO-9002 standards.

d. Competition

The two leading companies in the UT market are General Electric Inspection Technologies (GEIT) of the United States which includes Krautkramer and Olympus of Japan which includes RD/Tech, Panametrics and Stavely with total annual sales of UT equipment of approximately $100 million each.

Low end – transducers, gauges, portable instruments

The UT sector of the NDT market is served by some 30 companies worldwide. Most are involved in the manufacture of low-end products, including standard transducers and other consumables, gages and portable instruments and simple laboratory scanning systems.

The transducer market in the United States is dominated by three companies, including, Panametrics, Technisonics and Harisonics, with a total of $30 million in annual transducer sales. The transducer market in Europe is dominated by Krautkramer and Karl Deutsche and smaller companies such as Sonatest of UK and Imasonic of France with $30 million in transducer sales.

High end – full-featured instruments and turn-key systems

The market for full-featured UT instruments and turn-key inspection systems for the production line is characterized by a high entry barrier for product development. In the 2000‘s, this field was dominated by four or five manufacturers located in the United States and Germany.

Instruments

Panametrics, Stavely, and RD/Tech as part of Olympus of Japan, Matec and GE-Krautkramer of the United States manufacture full-featured ultrasonic instruments. Panametrics and Matec focus mostly mainly on laboratory and research applications. RD/Tech is strongest in the nuclear power generation industry. Krautkramer focus on the industrial market, while Krautkramer has the largest installed base of full-size instruments.

28

Immersion and squirter-based C-scan imaging systems

The market for this equipment includes the aircraft and aerospace industries, reflecting requirements for the inspection of engine, airframe and aerospace structural sectors, and encompassing part manufacturers, refurbishment shops and in-field inspection.

Panametrics, Matec and SDI offer complete inspection systems for both immersion and squirter inspection of aircraft and aerospace parts. Boeing (formerly known as McDonnell Douglas) manufactures expensive squirter-based systems for the inspection of large composite aircraft panels and domes. Nutronic (part of Krautkremer, or KK) manufactures squirter-based 3D ultrasonic systems.

Production-line GO/NOGO inspection systems

The market for automatic in-line ultrasonic inspection equipment withaccept-rejectdecision-making capability encompasses such applications as full-body pipe, tube and bars, pipe weld, steel plate, train wheels and rail.

Three companies, Krautkramer, Nutronic (acquired by KK), and Karl Deutsche have traditionally dominated the European and Asian markets for tube and bar inspection equipment based on ultrasonic technologies. In the United States, small companies, including Dapco have been key players.

The market for line pipe weld and body inspection equipment has traditionally been dominated by Krautkramer and Karl Deutsche with total annual sales of the order of $12 million.

The market for pipe weld inspection machines has grown significantly since the introduction of the new American Petroleum Institute (API) standards for flaw detection in pipe welds. These standards require a significant increase in flaw detection sensitivity, beyond the capability of most installed equipment. As customers demand adherence to these standards for the supply of pipe, manufacturers are being forced to consider the replacement of outmoded equipment.

Ultrasonic inspection equipment for steel mills

Mitsubishi of Japan, and Krautkramer and Karl Deutsche, are the well-known suppliers of ultrasonic inspection equipment for steel plate mills. The installation of these machines usually cost millions of dollars. There is a distinct cost advantage to inspecting plate on the production line, downstream of the plate trimming equipment, while the plate is still at an elevated temperature. In addition, customer product liability concerns are leading to increasingly stringent product specifications, which may now include 100 percent inspection coverage of the plate surface.

Small companies such as NDT Germany and NDT Canada installed only a few systems.

Train wheel and train rail inspection

A large inspection market exists for in-service train rail inspection. Countries such as the United States and Germany, with 400,000 and 45,000 kilometers of installed train track, respectively, require periodic inspection of the rail, up to several times per year depending on the average track load. The rail inspection market in the United States is dominated by two non-government companies (Sperry and Dapco) which manufacture their own equipment, while in Germany the government-owned Deutsche Bundesbahn, or DB, operates the rail inspection service using equipment purchased from ScanMaster.

29

The main companies which provide rail service inspection and rail inspection equipment are Sperry of the United States, Speno of Switzerland, and Tokimec of Japan.

Failure of a single train wheel in service can have catastrophic consequences for train passengers and crew, cargo and the environment. Therefore, train wheels and axles must be inspected both on the production line and again periodically in-service. Phased array technology is penetrated into this market niche by companies such as Krautkramer and IZFP.

e. Intellectual Property Rights

ScanMaster has registered 1 patent in Israel with respect to certain technology incorporated in the Ultrasound inspection methodology.

II. AOI Division

The automated optical inspection industry has traditionally been a labor-intensive industry. The principle stages of the textile manufacturing process include raw materials production, yarn spinning, fabric-forming, fabric spreading, fabric cutting and fabric finishing. End uses for textiles include fabric for apparel, home textiles, industrial fabric and technical fabric.

In recent years, web manufacturers have successfully incorporated automation technology into their manufacturing process. While automation has permeated virtually every component of the textile manufacturing process, inspection and quality monitoring remain principally labor-intensive operations and consequently can be impediments to greater efficiency and profitability. Web manufacturers inspect fabric in order to:

— determine the quality of the fabric, thereby enabling a determination of its end usage and price;

— locate, label and trace major defects (a requirement in the industry) for rapid identification in later stages of the manufacturing process;

— prevent the reoccurrence of defects caused by manufacturing equipment; and

— reduce rebate payments for textiles delivered with defects.

Fabric inspection can be performed at various stages of the production process and is often performed two to three times during a complete production cycle.

Manual inspection of fabrics is generally performed by running the fabric over a wide table under appropriate lighting. A human inspector is generally expected to detect a variety of defects, including holes of various sizes and shapes, tears, cuts, thick ends, missing threads, width distortion and variations in the fabric density and width, and mark them according to their type and location on the fabric roll. In the case of inspection of printed fabrics, the human inspector is expected to detect defects such as misfits, lint, stick-ins and off-center and narrow prints. Inspectors inspecting dyed fabrics are also expected to detect variations in the color and shades of the dyed fabric. Human inspection of fabrics is unreliable for the following reasons:

30

— the inspection environment is influenced by factors such as the speed at which the fabric passes in front of the inspector, the lighting in the testing area and the distance and angle at which the inspector views the fabric. Differences in inspection environments can lead to varying assessments of fabric quality;

— the accuracy of the inspection is affected by the attention span and fatigue of the human inspector, who is normally expected to view fabrics for a period of several hours;

— perception problems caused by the fatigue of specific nerve cells in the case of patterned and printed material;

— manual inspection is performed by numerous persons worldwide, each with a different perception of product quality; and

— certain technical fabric is produced at a very high speed and therefore defects cannot be observed by the human eye.

These factors have led to inconsistent assessments of fabric quality and have caused fabric inspection to be a time-consuming and costly process. These limitations also make it difficult to establish a reliable industry-wide standard for fabric quality. The limitations of manual inspection, along with the general trend in the web industry towards automation, in order to reduce costs and improve quality, have created an opportunity for an effective automatic visual inspection and quality monitoring systems for various niche markets in the web industry.

The EVS Solution for the AOI

We develop and have acquired sophisticated automatic visual inspection systems for manufacturers of industrial web products. Our systems are designed to overcome the limitations of human visual inspection. Our systems combine high-performance computer processing with unique image processing capabilities based on proprietary vision understanding and interpretation algorithms. The unique image processing capabilities include image acquisition, mathematical transformation, image analysis and learning and decision-making elements. The mathematical algorithms which enable these image interpretations and understanding capabilities are performed by high-speed dedicated parallel processing computers based on specialized architectures which are capable of performing tens, and in some of our products, hundreds of billions of operations per second. These algorithms enable our systems to recognize fabric flaws in real time and to learn the types and severity of the flaws a customer wishes to detect, ignoring flaws that do not fall into such categories. Our systems then analyze detected defects and provide information regarding their nature. Our systems are an integral part of the manufacturing process and can be integrated with the customer’s management information systems, providing valuable information for the production planning process. We believe that our systems enable customers to reduce direct labor, increase manufacturing efficiency and improve product quality.

Products

We currently offer five families of visual inspection systems: IQ-TEX, for the visual inspection and quality monitoring of woven fabric; IQ-TEX Lite, for the visual inspection and quality monitoring of knitted, non-woven, tire cord, film, metal, coated and technical fabrics; Broken Filaments Analyzer (BFA), for the detection of broken filament defects in glass fabric; and On Loom Inspection (OLI), for the automatic visual quality inspection system that is integrated with the weaving loom and monitors selected fabric types such as carbon, tire cord and other high cost technical fabric, while weaving.

31

        IQ-TEX Family of Products

The IQ-TEX family of automatic web inspection systems is designed to provide textile manufacturers with a comprehensive solution to their quality monitoring, grading and cutting needs. IQ-TEX systems detect numerous types of defects on any unicolor web, including: yarn and weaving faults; holes; oil, water and dye stains; missing threads; starting marks; broken yarn; and dyeing, coating and finishing irregularities. They then provide the manufacturer with information regarding the location, size and shape of the defect. Depending on the model, IQ-TEX systems can detect defects as small as 0.5 mm on any web width. The IQ-TEX systems can detect at web speed of up to 800 meters per minute. In addition, IQ-TEX systems can be configured to mark defects during inspection and advise the user as to the most efficient manner to cut web to eliminate unacceptable defects.

The modular design of the IQ-TEX systems enables their use for a wide range of applications throughout the fabric-forming process, including greige, dyed fabrics and finished fabrics, and for inspection of a variety of fabrics including those used for apparel, home textile and technical and industrial textiles. The modular design also enables the configuration of the system to match the manufacturer’s demands with respect to matters such as web width, web speed, desired resolution, auxiliaries, information distribution channels within the plant and grading standards. IQ-TEX systems can be integrated in-line with existing textile production equipment or can be used as off-line stand-alone units to inspect web after manufacturing is complete.

        Quality Monitoring Process

The IQ-TEX quality monitoring process is comprised of three primary phases: the pre-inspection phase, the inspection phase and the post-inspection phase.

Pre-Inspection Phase. The pre-inspection phase is the preliminary learning stage in which a sample of web of acceptable quality is scanned through the system. Based on the information obtained, the system creates a parameters file for the web style to be inspected that defines the statistical features of a “good” web based on the customer’s specifications. The system then uses these parameters to learn what to look for when inspecting the fabric. Once the system has learned the parameters of the sample, the system is ready to begin inspecting the fabric.

Inspection Phase. The system moves the inspected web through the image acquisition unit. The image acquisition unit acquires the image of the web being inspected and transforms video signals of the web into digital signals for processing and analysis. This unit then transfers the web image to the system’s computer. The computer processes the web image and distinguishes between inherent product irregularities and product defects. It then groups product defects according to their size, direction and shape, and grades them in terms of severity. The system displays a map of the defects in real-time, stores the defect image and records information with respect to each defect detected. The system may also be programmed to activate external units such as marking units and alarms upon detection of a defect.

32

Post-Inspection Phase. Following the inspection of the fabric, the system provides an inspection report, which may be printed or archived, containing a record of each defect that has been detected, statistics regarding the type and position of the defect, and the overall grading of the rolls according to pre-defined guidelines. In the in-line mode, the inspection report may be sent directly to the manufacturer’s host computer, thereby enabling an operator to take immediate actions to remedy the cause of the defects or to take actions to eliminate such defects in the future. The images can also be analyzed using the video album workstation described below, enabling customers to identify the cutting points for optimal web yield, and to re-grade the fabric.

Models

IQ-TEX systems are currently available in IQ-TEX model and also in IQ-TEX Lite model. The IQ-TEX model includes improved capabilities for the detection of defects, as well as additional innovative technologies for system styles tuning and defects sorting. The 2 models cover a full range of applications.

— The IQ-TEX is based on the integration of our Smart Video Camera technology into the I-TEX products, mainly for woven textile range applications, such as grey fabric, dyed &finished, denim, Glass fabric (for PCB) etc. The IQ-TEX is a more compact, powerful and flexible version of IQ-TEX, and can operate at a maximum speed of up to 600 meters per minute. It includes improved capabilities for the detection of defects in complex fabrics, such as denim, and high-speed configuration for an in-line inspection of non-woven fabric. The list price for the IQ-TEX ranges between $120,000 and $250,000 depending on the configuration.

— The IQ-TEX Lite is based on the same hardware as is used in the IQ-TEX system. The IQ-TEX Lite has a light mechanical frame (the system is equipped with a camera box), which is designed for easy and flexible installation on a wide range of web production lines such as non-woven, paper, tire cord, film, composite materials, laminated materials, metal, etc. The system allows us to offer solutions to new market segments using our vast experience from the textile industry. The list price for the IQ-TEX Lite ranges between $85,000 and $250,000 depending on the configuration and the web production type.

Modules

We offer the following three modules for defect analysis and cut optimization for our IQ-TEX and IQ-TEX Lite systems: the Video Album workstation, the DMSS (Defect Monitoring Sub System) and the Cut Optimization software.

Video Album Workstation. This module is a stand-alone PC-based station for review and analysis of defect images and data using a Windows-based interface. The images and inspection results are automatically transferred from the system’s computer to the video album workstation via a local area network.

The Video Album workstation enables rapid review of web images and provides visual documentation of defects and over all roll quality. The video album workstation enables review of all recorded information, such as images and data, for each defect. This information enables:

— reviewing and editing of defect data;

33

— generation of management reports;

— archiving of defect data; and

— definition of points of interest and mandatory cutting points for the cutting table and DMSS system.

Cut Optimization.Software that enables the user to cut a large “IQ-TEX Inspected” rollof web into smaller rolls while optimizing the fabric’s yield per class (A, B, C, etc.) according to the user’s specifications. Our Cut Optimization software offers the following benefits:

— maximizes web roll selling price;

— reduces the quantity of second and third quality product; and

— consistent fulfillment of customer's demands.

Smart Table. The Smart Table interfaces the IQ-TEX system with the cutting table and provides users with the following benefits:

— allows for an accurate stop or slowing the table speed at "points of interest" which were defined on the video album such as: selected defects, cutting points and mending points;

— contains a trigger for invisible ink or metallic label defect marking signs; and

— operates the roll cutting device following the cut optimization results.

These modules can be purchased separately or together to form the IQ-TEX Inspected Process, which provides an integrated link between the web-forming and cutting segments of the textile industry.

Accessories

We offer an extensive line of accessories designed to provide, along with the IQ-TEX systems, a comprehensive solution for the web inspection and grading process. These accessories include invisible ink or sticker marking units, alarm sets, ultra violet ink for marking and external connecting devices for marking and measuring.

        Broken Filaments Analyzer (BFA)

The Broken Filaments Analyzer, or the BFA, is a visual inspection system designed for the detection of broken filaments in glass fabrics used for the electronic printed circuit board, or PCB, industry. Broken glass filaments are small filaments that protrude from glass fabric, generally used for the PCB industry. Broken glass filaments are hardly visible to the human eye at low web speeds, and are practically invisible at normal production speeds. They can be as small as a few microns and as short as 0.5 millimeters. Broken glass filaments can cause defects in the lamination of glass fabrics and the production of printed circuit boards, and may short-circuit or disconnect the end product incorporating the PCB. For this reason, it is important to effectively detect broken glass filaments and grade glass web in terms of broken filament content. Human inspectors are unable to effectively detect broken glass filaments.

34

The BFA utilizes proprietary processing and software technology, cameras and lighting systems to inspect glass web in real-time at speeds exceeding 120 meters per minute. The broken filaments detected by the BFA are displayed on a monitor that shows the running map of the fabric in real time, and are recorded for further analysis. The BFA produces a detailed report of each web roll, showing the broken filaments distribution in the roll, its statistics and the fabric’s grading. The BFA is integrated with the IQ-TEX 100 system, which can be used for the detection of other defects in glass fabrics, and with the Video Album to provide a more comprehensive solution to the visual inspection and quality monitoring of glass fabrics. The BFA can also be used for the detection of surface defects in other fabrics or webs including airbags and technical fabrics. The list price for the BFA system ranges between $100,000 and $150,000, depending on the configuration.

b. Sales and Markets for the AOI

Sales Network

We market our products through in-house sales personnel in conjunction with independent sales representatives. Our independent sales representatives provide essential pre-and-post sales support for our products in their territories and account for a substantial percentage of our sales worldwide. We believe that our sales representatives network will enable us to introduce new products and to penetrate additional web manufacturers around the world. We intend to further expand our international sales representatives network by entering into relationships with additional sales representatives and forming joint ventures in target markets.

We utilize the services of independent sales representatives in Europe, Latin America, and the Far East. Our independent sales representatives do not have the authority to enter into contracts on our behalf or otherwise bind us. To promote our products, we devote significant resources towards participation in the key annual textile equipment trade shows. We also advertise in trade magazines and conduct customer seminars.

We maintain sales and support centers located in the United States, Europe, Asia, and Israel. When a high level of technical expertise is needed, the sales effort is supported by product marketing managers and our engineers who work closely with customers and potential customers to find solutions to their current and future web inspection challenges. We work closely with customers in a continuous improvement process on selected technical aspects of our products. Such improvements often become standard on products sold worldwide. A specified number of training classes are included in the purchase price of our products. Subsequent training is provided for a nominal fee.

“IQ-TEX Inspected” Standard

A significant portion of our marketing effort is focused on making web inspection by IQ-TEX systems, and the corresponding labeling of the inspected web as “IQ-TEX Inspected,” an industry standard for web quality inspection. We believe that the best way to increase demand for our IQ-TEX systems is to convince end-product manufacturers of the benefits of IQ-TEX inspection, in terms of the quality, uniformity and reliability of the inspection. If we are successful in doing so, fashion designers will increasingly demand that the fabrics they purchase from web manufacturers be inspected by IQ-TEX systems. As more and more designers make these demands, web manufacturers will be required to purchase our systems. Our efforts include performing tests of the capabilities of IQ-TEX with leading clothing manufacturers. Although inspection by IQ-TEX systems has not yet become an industry standard, many designers express preference for “IQ-TEX Inspected” fabrics. There can be no assurance that we will be successful in our efforts to make inspection by IQ-TEX an industry standard.

35

Relationships with Leading Equipment Manufacturers

Another important element of our marketing strategy is to establish and strengthen relationships with leading textile equipment manufacturers. These relationships bolster our marketing abilities and assist us in ensuring that our products are technically advanced and designed in conjunction with the development of the textile manufacturers’ web inspection requirements and industry trends.

Sales by Principal Markets and Activities

In 2004, approximately 27.8% of our consolidated sales were in the United States, approximately 46.9% were in Europe, and approximately 25.3% were in the Far East. In 2005, approximately 31.48% of our sales were in the United States, approximately 21.2% were in Europe, and approximately 46.1% were in the Far East. In 2006, approximately 22.8% of our sales were in the United States, approximately 40.1% were in Europe, and approximately 37.1% were in the Far East. In 2007, approximately 29% of our sales were in the United States, approximately 35% were in Europe, and approximately 36% were in the Far East. In 2008, approximately 41.7% of our sales were in the United States, approximately 35.3% were in Europe, and approximately 23% were in the Far East.One customer accounted for 18%, 12% and 15%in each of the years, 2004, and 2005 and 2007 respectively. No other customers accounted for more than 10% of our net sales in any of the years 2004, 2005, 2006, 2007 or 2008. Historically, our highest level of net sales has been in the fourth quarter of each year. Nevertheless, we have experienced and may in the future experience significant fluctuations in revenues and operating results from quarter to quarter as a result of a number of factors, many of which are outside our control. For more information, seeItem 3, “Key Information – Risk Factors – Risk Factors Related to Our Business – Fluctuations in the Market”.

c. Manufacturing for the Web Industry

The principal manufacturing and assembly of our basic systems are conducted by subcontractors. We perform logistics and purchasing activities, integration and final testing in-house. In addition, we perform the software installation and configuration, final hardware configuration, quality control and any special system customization needed for a particular customer. Production is based upon firm customer commitments and anticipated orders and is generally planned one to three months in advance. We contract with third party subcontractors to perform the manufacturing of our systems so that we can focus on design and product development strengths and minimize fixed costs and capital expenditures. Our engineers work closely with subcontractors to increase manufacturing yields, lower manufacturing costs and assure quality. Some of the electronic components included in our product are manufactured especially for us by exclusive suppliers. If any of these exclusive suppliers stop manufacturing these components we will need to find alternative suppliers. Our reliance on sole suppliers involves several risks, including a potential inability to obtain adequate supplies of these components and reduced control over pricing and timely delivery of these components. We believe that we maintain a sufficient inventory of these components to meet our foreseeable needs. However, if our single source supplier ceases to produce these components, we would have to transfer the manufacture of the components to another supplier or suppliers. We estimate that such a transfer would take approximately up to six months and could delay the production and supply of our products, which could harm our results of operations.

36

d. Competition in the Web Industry

We believe that the capabilities of our technology, along with our experience in implementing these technologies and our wide customer base, provide us with a competitive advantage over potential competitors are small suppliers of automatic inspection solutions with PC-based technologies. These suppliers, who offer low-cost solutions for low-end applications such as Non-Woven, are attempting to penetrate the field of textile inspection, yet, thus far, have not been commercially successful.

We are targeting the technical fabric industry as a high potential market for our automatic inspection systems. The main competitor on this industry is Cognex Corporation – based in the United States. Cognex Corporation is specialized on supplying machine vision components for the industry. We believe that our capabilities for supplying “tailor made” solutions for our customers together with the high growth rate of the technical fabric industry, will allow us to produce revenues from it.

The presence of competitors in the textile automatic inspection field may increase awareness of the benefits of automatic fabric inspection, and may help us enlarge our market. However, it is possible that systems developed by these or other future competitors will prove more effective than our IQ-TEX systems or that potential customers will prefer them for other reasons. If we are unable to maintain our technological advantage or are unable to convince potential customers of the superiority of our IQ-TEX systems, our business would be seriously harmed.

Several manufactures of equipment for the fabric manufacturing industry offer products that compete with our Shade Variation Analyzer. Our main competitor is Mahlo GmbH & Co. KG.

The competition for the development and sale of advanced automated vision systems in other industries and for other applications is intense. To the extent providers of automated vision systems choose to focus on or develop advanced automated vision technology for the fabric industry or other industries for which we attempt to develop products, we could face significant competition in the future. Potential competitors may be more established, benefit from greater market recognition and have greater financial, production and marketing resources than we do.

e. Intellectual Property Rights for Textile Industry

In May 2002, we entered into an agreement with our former principal shareholder Elbit and Dr. Ilan Tamches, which amended the license agreement existing between Elbit and us, dated June 12, 1996. According to this agreement, Elbit transferred to Dr. Ilan Tamches certain elements of our technology, or Elbit Technology, which we formerly licensed from Elbit, and other elements of our technology were directly transferred to us by Elbit, or Elbit Modified Technology. Consequently, we licensed the Elbit Technology from Dr. Tamches, its original developer. Pursuant to this agreement, we have certain non-exclusive rights to this technology with respect to the development, production, distribution, modification, use and repair of any of the I-TEX systems, for as long as we continue to produce, distribute, modify, use and repair any I-TEX systems. In consideration for the royalties that we have agreed to pay Dr. Tamches, he has agreed not to license Elbit Technology to any third party that competes with I-TEX systems. Since the third quarter of 2006 we have not used this technology.

37

Neither we, nor, to our knowledge, Dr. Tamches, have any patents or patent applications pending with respect to this technology. We do have a patent in France and patent applications pending in Israel with respect to certain technology incorporated in the video cameras used by our systems. We rely primarily upon a combination of trademark, copyright, know-how, trade secrets and contractual restrictions to protect our intellectual property rights.

Our employees who have access to confidential information are required to sign confidentiality and invention assignment agreements. We believe that such measures provide only limited protection of our proprietary information, and there is no assurance that our proprietary technology will remain a secret or that others will not develop similar technology and use this technology to compete with us. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary.

We have registered trademarks with respect to the name “I-TEX” in the United States, Mexico, Spain, Italy, Turkey, Portugal, Brazil, France, China and Japan, and have filed applications for registered trademarks for the name “I-TEX” in India We have registered trademarks of the name and design “I-TEX Inspected” in Taiwan, South Africa, United States, Mexico, Brazil, Germany, France, Turkey, Italy, China and the European Union. We also have registered trademarks with respect to the name “PRIN-TEX” in Spain, Italy, France, Turkey and Japan. In addition, we have a registered trademark with respect to the name “KNI-TEX” in Italy. We also have a registered trademark with respect to the name “EVS” in the European Union, Japan and the United States. Our trademark rights include rights associated with the use of our trademarks.

Significant and protracted litigation may be necessary to protect our intellectual property rights, to determine the scope of the proprietary rights of others or to defend against claims of infringement.Item 8, “Financial Information – Litigation” below contains a description of a past patent infringement claim.

IV. Governmental Regulation Affecting the Company

        As a company which focuses on research and development and which receives grants in order to do so from the Government of Israel, we are affected by the terms of the grants we have received from the Office of the Chief Scientist, or OCS, of the Ministry of Industry, Trade and Labor of the Government of Israel. Under the terms of these grants, we are responsible to pay royalties based on the net sales of our products. In addition, manufacturing of products developed with these grants must be performed in Israel, or we may be subject to the payment of additional royalties. Approval must be obtained to transfer technologies developed through projects in which the government participates. SeeItem 5, “Operating and Financial Review and Prospects – Research and Development, Patents and Licenses, etc.”

38

In addition, we receive certain tax benefits and reduced tax rates from the government of Israel. SeeItem 10, “Additional Information – Taxation – Effective Corporate Tax Rate”. The entitlement to these benefits is conditional upon our fulfillment of the conditions stipulated by the law, regulations promulgated thereunder and the instruments of approval for the specific investments. In the event of a failure to comply with these conditions, the benefits could be canceled and we would be required to refund the amount of the benefits, in whole or in part, with the addition of linkage differences and interest.

C. Organizational Structure

We own all of the issued and outstanding shares of our five subsidiaries Elbit Vision Systems US, Inc., or EVS US, Elbit Vision Systems B.V., or EVS BV, ScanMaster system (IRT) Ltd., IRT ScanMaster systems Inc., and Panoptes. EVS US and IRT ScanMaster systems Inc. are incorporated in the United States under the Business Corporations Act of the State of Delaware. EVS US and IRT ScanMaster systems Inc. predominantly functions as a sales and support center for our products.

EVS BV is incorporated in Holland. EVS BV predominantly functions as a sales and support center for our products.

For more information on the ScanMaster and Panoptes transactions, seeItem 4, “Information on the Company – History and Development of the Company”andItem 10, “Additional Information – Material Contracts”.

D. Property, Plants and Equipment

Our facilities, together with ScanMaster Ltd.‘s facilities, are located at 1 Haofe Street, Hasharon Industrial Park, Qadima, P.O.B. 5030, Israel. We do not own any real property. Together we lease approximately 10,435 square feet at our facilities in Israel, at an annual rent of approximately $432,000. Our lease expires in December 2009. EVS US leases approximately 5,400 square feet office space in Greenville, South Carolina, at an annual rent of approximately $24,000. This lease expires in October 2010.

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

ITEM 4A. UNRESOLVED STAFF COMMENTS

Not applicable.

39

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Selected Financial Data (Incorporated by reference in Item 3A)

The selected financial data as of and for the year ended December 31, 2004, before the effects of adjustments to retrospectively reflect the discontinued operation (described in financial statements for year ended December 31, 2008 (see note 3a)), is derived from our audited financial statements, which have been audited by Kesselman & Kesselman, a member firm of PricewaterhouseCoopers, independent public accountants, and which are included elsewhere in this report. The selected financial data for the years ended December 31, 2008, December 31, 2007, December 31, 2006 and December 31, 2005 are derived from the financial statements that have been audited by Brightman Almagor & Co., a member of Deloitte Touche Tohmatsu, independent auditors. Our financial statements have been prepared in accordance with U.S. GAAP. The financial data set forth below should be read in conjunction with the financial statements, related notes and other financial information contained in this annual report. For discussion of our significant accounting principles, see Note 2 of our Consolidated Financial Statements incorporated herein by reference.

	2008*			2007*			2006*			2005*			2004*
(in U.S. thousand Dollars )
Statement of Operations Data:
Net sales		22,100			21,863			16,977			19,579			10,399
Cost of sales		14,549			11,308			12,236			11,633			8,040
Gross profit		7,551			10,555			4,761			7,946			2,359
Research and development expenses, net		4,559			3,313			2,562			2,039			2,456
Marketing and selling expenses, net		5,270			4,885			4,149			3,583			3,491
General and administrative expenses		2,123			1,338			1,870			1,127			1,817
Impairment of goodwill		1,981			-			-			-			-
Reorganization expenses		-			-			200			-			-
Total operating expenses		13,933			9,536			8,781			6,749			7,764
Operating profit (loss)		(6,382	)		1,019			(4,020	)		1,197			(5,405	)
Other income (expenses)		(18	)		(1,277	)		(5	)		7			115
Financing expenses, net		(1,082	)		(1,081	)		(1,332	)		(437	)		(365	)
Profit (loss) before taxes		(7,482	)		(1,339	)		(5,357	)		767			(5,655	)
Taxes on income		11			3			5			4			6
Income (loss) from continuing operations		(7,493	)		(1,342	)		(5,362	)		763			(5,661	)
Loss from operations of discontinued component		-			-			(180	)		(152	)		(244	)
Net loss of disposal of discontinued operation		-			-			(551	)		-			-
Net loss		(7,493	)		(1,342	)		(6,093	)		611			(5,905	)
Basic earnings (loss) per share from continuing
operations(1)		(0.147	)		(0.034	)		(0.186	)		0.029			(0.307	)
Diluted earnings (loss) per share from
continuing operations(1)		(0.147	)		(0.034	)		(0.186	)		0.026			(0.307	)
Basic earnings (loss) per share from
discontinued operations(1)		-			-			(0.026	)		(0.006	)		(0.013	)
Diluted earnings (loss) per share from
discontinued operations(1)		-			-			(0.026	)		(0.005	)		(0.013	)
Basic earnings (loss) per share(1)		(0.147	)		(0.034	)		(0.212	)		0.023			(0.32	)
Diluted earnings (loss) per share(1)		(0.147	)		(0.034	)		(0.212	)		0.021			(0.32	)
Weighted average number of shares
outstanding-Basic (1)		50,970			39,393			28,778			26,500			18,724
Weighted average number of shares
outstanding-Diluted (1)		50,970			39,393			28,778			28,421			18,724

	2008			2007			2006			2005			2004
Balance Sheet Data:
Working capital		(4,098	)		1,296			(6,073	)		21			(2,650	)
Total assets		17,201			23,506			19,390			22,064			19,453
Total liabilities		16,828			15,906			18,389			17,965			17,307
Accumulated deficit		(38,771	)		(31,278	)		(29,936	)		(23,843	)		(24,454	)
Shareholders' equity		373			7,600			1,001			4,099			2,146

(1)     Computed on the basis set forth in Note 2. R. to our Consolidated Financial Statements.

*    The financial data contained in this table has been adjusted to take into account the discontinued operations of our former subsidiary Yuravision. For further information see Note 3(a) to our financial statements for the year ending December 31, 2008, contained elsewhere in this report.

40

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and the related notes included elsewhere in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors.

Most of our revenues are generated in U.S. dollars, and a significant portion of our expenses are incurred in U.S. Dollars, or are linked to the U.S. Dollar. Consequently, we use the U.S. Dollar as our functional currency. Transactions and balances originally denominated in U.S. Dollars are presented in the financial statements in their original amounts, and non-Dollar transactions and balances have been translated into U.S. Dollars using the exchange rates in effect on the date of a transaction or balance. Our consolidated financial statements have been prepared in accordance with U.S. GAAP.

The financial statements of our subsidiaries the functional currency of which is the U.S. Dollar, but which are presented in a currency other than U.S. Dollars, have been translated into U.S. Dollars. Monetary balance sheet items have been translated using the exchange rates in effect on the balance sheet date and all non-monetary balance sheet items have been translated using the historical exchange rates in effect on the date of the transaction. Statement of income items have been translated using the average exchange rate for the period presented.

The amounts (in terms of Korean Won) included in the financial statements of Yuravision, drawn up in Korean Won, are dealt with, for the purpose of consolidation as follows:

The operating results and cash flows of Yuravision are translated into U.S. dollars at the exchange rates existing on the dates of the transactions (or at the average exchange rates for the period, where these approximate the actual exchange rates). Balance sheet items, including the balances of fair value adjustments made, and goodwill recognized, on the acquisition of Yuravision, are translated at the exchange rate at the end of the year. Exchange differences arising from the translation of the net investment in Yuravision are carried as a separate item within shareholders’ equity (“differences from translation of foreign currency financial statements of a subsidiary”). Upon disposal of the investment in the Yuravision, these exchange differences will be carried to the income statement, as part of the gain or loss recognized on the disposal.

41

Critical Accounting Policies

The preparation of our financial statements in conformity with the U.S. generally accepted accounting principles requires us 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 amount of revenues and expenses during the reporting period. These are our management’s best estimates based on experience and historical data. Actual results could differ from those estimates.

Specific accounting policies we utilize require higher degrees of judgment than others in their application. These include revenue recognition on long-term contract work. Our policy and related procedures for revenue recognition on long-term contract work are summarized below.

a.Revenue recognition

Revenues from sales of products and supplies are recognized when an arrangement exists, delivery has occurred and title has passed to the customer. The price charged by us or our subsidiaries to the customer is fixed or determinable and collectibility is reasonably assured.

With respect to systems sold with installation requirements, the installation is not considered to be a separate earnings process; thus, revenue is recognized when all of the above criteria are met and installation is completed.

b.Acceptance clause, customers’ support service and warranty

We and our subsidiaries distinguish between revenue recognition in respect of revenue derived from automatic vision inspection products (sold by us) and ultrasonic inspection products (sold by ScanMaster).

The terms of the agreements between us and our customers are substantially different from the terms of the agreements between ScanMaster and its customers. Therefore, the revenue recognition accounting policy applied by each of the companies is different in this case. Set forth bellow are the main accounting policies applied by each of our companies:

The Company

In a case that our agreement with a customer includes an “acceptance” clause, revenue recognition will take place after we receive the “acceptance certificate” from the customer. In some cases, we grant our customers a trial period, usually several months, in order to evaluate the prototype system’s performance. In a case where the systems performance meets the customer’s requirements, it purchases the system at the end of the trial period. We do not recognize sales revenue from products shipped to customers for trial until such products are actually purchased. Until purchased, these products are recorded as consignment inventory at the lower of cost or market.

In some cases, we grant our customers support services, including warranty in respect of products sold; these services are usually provided for a period of six to twelve months. In those cases, upon revenue recognition, we defer a portion of the sale price and recognize it as service revenue ratably over the abovementioned period.

42

ScanMaster

ScanMaster’s agreements with its customers usually include acceptance testing procedures clause (“ATP”). Each product of ScanMaster has standard performance specifications that are examined in the ATP; usually, the performance specifications are not customized for the specific needs of the customer. Also, unlike in our case, ScanMaster does not grant its customers a trial period in the normal course of business.

ScanMaster distinguishes between sales of new products, in respect of which ScanMaster has no past installation experience and sales of products, in installation of which the company is well experienced. In respect of sales of new products ScanMaster recognizes revenues only after the company receives the ATP from the customer. In respect of sales of other products, in the installation of which the company is well experienced, the ATP is only a formal procedure, and therefore, the installation of products is a sufficient requirement to recognize revenues.

The agreements with the clients do not include the right of the clients to a refund in the event that the ATP is not to their satisfaction. However, the collection of the final payment from the customer (usually 10% out of the total consideration) is scheduled to coincide with receiving the signed ATP.

ScanMaster recognizes revenues from contracts to sell systems that require significant customization, integration and installation or contracts that include services considered essential to the functionality of the system, based on the American Institute for of Certified Public Accountant’s Statement of Position 81-1 “Accounting for Performance of Construction – Type and Certain Production – Type Contracts”, or SOP 81-1. Under the SOP revenues are calculated, as the project progresses, according to the percentage of the contract for the purchase of such system that has been completed, taking into account the proportion of the actual labor costs incurred to the total labor costs estimated to be incurred over the duration of the contract. Provisions for estimated losses on uncompleted contracts are made when such losses are first determined, in the amount of the estimated loss of the entire contract.

When the services are not considered essential, revenue are allocated using provisions prescribed in EITF 00-21Revenue Arrangements with Multiple Deliverables to each deliverable. Revenues allocated to professional services are recognized as the services are performed.

ScanMaster provides for warranty costs at the same time as the revenue is recognized. The annual provision is calculated at rates of 0.5%-2% of the sales, based on past experience.

c.Right of return

Neither we, nor our subsidiaries, provide, in the normal course of business, a right of return to our customers. If uncertainties exist, such as the granting of a right of cancellation to the customer, revenue is recognized when the uncertainties are resolved.

43

Services Rendered

Service revenue in respect of our products is recognized ratably over the contractual period, or as services are performed.

A. Operating Results

I. Financial Data

The following table sets forth, for the periods indicated, our selected financial data as a percentage of net sales:

	2008*			2007*			2006*
Net sales		100.0			100.0			100.0
Cost of sales		65.8			51.7			72
Gross profit		34.2			48.3			28
Research and development expenses, net		20.6			15.2			15.1
Marketing and selling expenses, net		23.8			22.3			24.4
General and administrative expenses		9.6			6.1			11
Impairment of goodwill		9.0			-			-
Reorganization expenses		-			-			1.1
Total operating expenses		63.0			43.6			51.7
Operating income (loss)		(28.9	)		4.7			(23.7	)
Other expenses		(0.1	)		(5.8	)		(0.03	)
Financing expenses, net		(4.9	)		(4.9	)		(7.8	)
Income loss before taxes		(33.9	)		(6.1	)		(31.5	)
Income taxes		0.05			0.01			0.03
Discontinued operation		-			-			(4.3	)
Net loss		(33.9	)		(6.1	)		(35.8	)

*     The financial data contained in this table has been adjusted to take into account the discontinued operations of our former subsidiary Yuravision. For further information see Note 3a to our financial statements for the year ending December 31, 2008, contained elsewhere in this report.

Year Ended December 31, 2008 Compared with Year Ended December 31, 2007

Sales

Sales in 2008 increased by approximately 1% to $22.1 million compared with sales of $21.9 million in 2007. We witnessed a growth in sales in the aerospace industry until the fourth quarter while sales in the vision section declined especially during the fourth quarter.

Cost of Revenues

Cost of revenues consists of component costs, hardware costs, technical support costs, royalty payments, compensation costs and overheads related to the production and assembly of our products. Cost of sales as a percentage of net sales was 65.8% in 2008 compared with 51.7% in 2007. The increase in cost of revenues in 2008 was mainly due to inventory write off of $ 1.1 million, reorganization expenses and a decline in the revenues from our vision division which is usually our more profitable division.

44

Gross Profit

In 2008 our gross profit was $7.5 million as compared to $10.5 million in 2007. Gross profit as a percentage of net sales was 34.2% in 2008 as compared to 48.3% in 2007. The decrease in our gross profit in 2008 was mainly due to a write-off of inventory, a decrease in our vision sales and also due to the decrease of the value of the dollar against the NIS during the first half of 2008.

Research and Development Costs

Our research and development expenses consist of our total costs less grants from the Government of Israel. Gross research and development expenditures consist primarily of salaries and related costs of employees engaged in ongoing research and development, and, to a lesser extent, costs of materials, depreciation and other expenditures. Gross research and development expenditures increased to $4.7 million in 2008 from $3.4 million in 2007, and were offset by Israeli government grants of $0.15 million in 2008 and $0.14 million in 2007. Net research and development expenses in 2008 were $4.5 million compared with $3.3 million in 2007. The increase in the gross research and development expenses was mainly due to the decrease in the value of the dollar against the NIS and due to our efforts to penetrate new markets by adjusting our technology to market demand. For more information, seeItem 3, “Key Information – Risk Factors – General Risks”.

Sales and Marketing Expenses

Marketing and sales expenditures consist primarily of costs relating to promotion, advertising and trade shows, payroll and related expenses, sales commissions, travel expenses. Marketing and sales expenses amounted to $5.3 million in 2008, compared to $4.89 million in 2007. The increase in the marketing and sales expenses was primarily due to an increase in sales commissions following the growth in our sales in the NDT market and the decrease in the value of the dollar against the NIS.

General and administrative Expenses

General and administrative expenses consist of payroll and related expenses, doubtful and bad accounts, professional fees paid to auditors, legal advisors and other consultants and other related expenses. As a percentage of net sales, general and administrative expenses increased to 9.6% in 2008 from 6.1% in 2007. General and administrative expenses in 2008 were $2.1 million, compared to $1.34 million in 2007. The increase in expenses in 2008 was primarily attributable to reorganization expenses and provision for doubtful accounts.

Financial Expenses

Financial expenses consist primarily of interest on our loans from banks. Additionally, expenses consist of currency translation adjustments between the U.S. Dollar and NIS exchange rate imposed on our assets and liabilities. Financial expenses in 2008 and in 2007 were $1.08 million. During 2007 and 2008, we financed our operations using a credit line facility provided to us by our bank.

45

Profit/Loss

In 2008 we recorded net loss of $7.5 million, as compared to a $1.3 in 2007. This was primarily due to a write-off of goodwill and inventory and an increase in our expenses due to the decrease in the value of US Dollar against the NIS.

Year Ended December 31, 2007 Compared with Year Ended December 31, 2006

Sales

Sales in 2007 increased by approximately 28.8% to $21.9 million compared with sales of $17 million in 2006. This increase was primarily attributable to the growth in the aerospace industry and the changes we made in our sales and marketing department during our recent internal reorganization.

Cost of Revenues

Cost of revenues consists of component costs, hardware costs, technical support costs, royalty payments, compensation costs and overheads related to the production and assembly of our products. Cost of sales as a percentage of net sales was 51.7% in 2007 compared with 72% in 2006. The decrease in cost of revenues in 2007 was mainly due to cost reduction and efficiency measures taken as a result of the consolidation of our two production sites in Israel and the increase in our sales compared to 2006.

Gross Profit

In 2007 our gross profit was $10.5 million as compared to $4.7 million in 2006. Gross profit as a percentage of net sales was 48.3% in 2007 as compared to 28% in 2006. The increase in our gross profit in 2007 was mainly due to a onetime loss we incurred during 2006 related to the Indian Project; We also increased our gross profit by combining our two production sites in Israel.

Research and Development Costs

Our research and development expenses consist of our total costs less grants from the Government of Israel. Gross research and development expenditures consist primarily of salaries and related costs of employees engaged in ongoing research and development, and, to a lesser extent, costs of materials, depreciation and other expenditures. Gross research and development expenditures increased to $3.454 million in 2007 from $2.707 million in 2006, and were offset by Israeli government grants of $0.141 million in 2007 and $0.145 million in 2006. Net research and development expenses in 2007 were $3.31 million compared with $2.56 million in 2006. The increase in the gross research and development expenses was mainly due to our efforts to penetrate new markets by adjusting our technology to market demand. For more information, seeItem 3, “Key Information – Risk Factors – General Risks”.

Sales and Marketing Expenses

Marketing and sales expenditures consist primarily of costs relating to promotion, advertising and trade shows, payroll and related expenses, sales commissions, travel expenses. Marketing and sales expenses amounted to $4.89 million in 2007, compared to $4.15 million in 2006. The increase in the marketing and sales expenses was primarily due to an increase in sales commissions following the growth in our sales as compared to 2006.

46

General and administrative Expenses

General and administrative expenses consist of payroll and related expenses, doubtful and bad accounts, professional fees paid to auditors, legal advisors and other consultants and other related expenses. As a percentage of net sales, general and administrative expenses decreased to 6.1% in 2007 from 11% in 2006. General and administrative expenses in 2007 were $1.34 million, compared to $1.87 million in 2006. The decrease in expenses in 2007 was primarily attributable to combining our two sites in Israel.

Financial Expenses

Financial expenses consist primarily of interest on our loans from banks and from two of our major shareholders Elbit and Mivtach Shamir. Additionally, expenses consist of currency translation adjustments between the U.S. Dollar and NIS exchange rate imposed on our assets and liabilities. Financial expenses in 2007 were $1.08 million, compared to $1.33 million in 2006. During 2006 and 2007, we financed our operations using a credit line facility provided to us by our bank. The decrease in financial expenses was primarily due to the improvement in our business results, funds raised during 2007 in private placements and capitalization of certain our loans from shareholders.

Profit/Loss

In 2007 we recorded net loss of $1.3 million, as compared to a $6.1 in 2006. This was primarily due to a one time loss during 2006 with regard to the Indian railway project and the increase in our sales in 2007 compared to 2006. We also completed our reorganization plan during 2007 which improved our profitability.

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

For many years prior to 1986, the Israeli economy was characterized by high rates of inflation and devaluation of the Israeli currency against the U.S. Dollar and other currencies. However, since the institution by the Israeli government of an economic recovery program in 1985, inflation, while continuing, has been significantly reduced and until recently the rate of devaluation has substantially diminished. Since the majority of our revenues are denominated and paid in U.S. Dollars, we believe that inflation and fluctuations in the U.S. Dollar exchange rate have no material effect on our revenue. Inflation and U.S. Dollar exchange rate fluctuations, however, have some effect on our expenses and, as a result, on our net income/loss. The cost of our Israel operations, as expressed in U.S. Dollars, is influenced by the extent to which any increase in the rate of inflation in Israel is not offset (or is offset on a lagging basis) by a devaluation of the NIS in relation to the U.S. Dollar. For more information, see the discussion regarding inflation inItem 3, “Key Information – Risk Factors – General Risks” and Item 11, “Quantitative and Qualitative Disclosures about Market Risk – Foreign Currency Exchange and Interest Rate Risk”.

47

The exchange rate between NIS and the U.S. Dollar has fluctuated during the past twelve months from a high of NIS 4.022 to the Dollar to a low of NIS 3.23 to the Dollar. The high and low exchange rates between the NIS and U.S. Dollar during the six most recent months, as published by the Bank of Israel, were as follows:

MONTH	HIGH 1 U.S. dollar =		LOW 1 U.S. dollar =
December 2008		3.981		3.677
January 2009		4.065		3.783
February 2009		4.191		4.012
March 2009		4.245		4.024
April 2009		4.256		4.125
May 2009		4.169		3.958

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

Period	Exchange Rate
January 1, 2004 - December 31, 2004	4.4820 NIS/$1
January 1, 2005 - December 31, 2005	4.4878 NIS/$1
January 1, 2006 - December 31, 2006	4.4565 NIS/$1
January 1, 2007 - December 31, 2007	4.1080 NIS/$1
January 1, 2008 - December 31, 2008	3.59 NIS/$1

In 2004, the rate of inflation of approximately 1.21% and the Dollar devalued against the NIS by approximately 1.61%. In 2005, the rate of inflation was approximately 2.39% and the rate of revaluation was 5.67%. In 2006, the Israeli economy recorded negative inflation of approximately 0.1% where the NIS revalued against the U.S. dollar by approximately 8.21%. In 2007, the rate of inflation of approximately 3.4% and the Dollar devalued against the NIS by approximately 8.97%. In 2008, the rate of inflation of approximately 3.8% and the Dollar devalued against the NIS by approximately 1.14%. As a result of the differential between the rate of inflation and the rate of evaluation of the NIS, we experienced increases in the costs of our Israel operations, as expressed in U.S. Dollars, in 2008.

From time to time, we engage in hedging or other transactions intended to manage the risks relating to foreign currency exchange rate or interest rate fluctuations. Although, we do not undertake such transactions on a regular basis, our management may determine that it is necessary to further minimize such risks.

Governmental Policies Affecting Company Operations

The discussion regarding governmental regulation is hereby incorporated by reference toItem 4, “Information on the Company – Business Overview – Governmental Regulation Affecting the Company”and the discussion regarding political policies is hereby incorporated by reference toItem 3, “Key Information – Risk Factors – General Risks – Conditions in Israel”.

B. Liquidity and Capital Resources

Prior to our initial public offering, our principal source of financing for our operations and working capital requirements were loans from Elbit and grants from the Government of Israel. In July 1996, we raised approximately $15.7 million, net of expenses, through the initial public offering of our securities. Since our initial public offering, we have financed our operations primarily through (i) cash reserves, (ii) cash generated from operations, (iii) grants from the Government of Israel (iv) the use of a bank credit line (v) receipt of a convertible loan, and (vi) private placements of our securities. As of December 31, 2008, we had negative working capital of $4.1 million.

48

We anticipate that we will continue to incur significant operating expenses in connection with the development and marketing of our products. If cash generated from operations is insufficient to satisfy our liquidity requirements, we may sell additional equity or debt securities or seek to obtain additional credit facilities.

Investments

Our cash and cash equivalents decrease to $0.4 million at the end of 2008 compared to $2.2 million recorded at the end of 2007. Short term restricted deposits increased to $0.7 million at the end of 2008 compared to $0.5 million recorded at the end of 2007. The changes were mainly due to the loss we had during 2008. Some of our sales agreements require us to provide a performance guarantee for a period of between six and twelve months. In order to provide such guarantees we are required to deposit between 25% and 60% of the guarantee amount. During 2008 we had negative cash flow from operational activity of $1.8 million. The negative cash flow was mainly due to losses we incurred in 2008.

Our inventories decreased from $5.3 million as of December 31, 2007 to $4 million as of December 31, 2008, reflecting the world economic downturn and the decrease in our revenues in the fourth quarter of 2008. We also wrote off some of our inventory as reflected from our future forecast, for more information please review our Financial Statement for 2008. Inventories as a percentage of revenues as of December 31, 2008, decreased to 17.8% compared with 24.2% as of December 31, 2007.

The discussion regarding the Convertible Loan with Mivtach Shamir is hereby incorporated by reference toItem 4, “Information on the Company – Recent Developments”. The discussion on the April Investment, the Amendment Agreement, the April Investment and the Elbit Agreement are hereby incorporated by reference also toItem 10 “Additional Information – Material Contracts”.

Borrowing

From time to time we use money received from bank loans from several banks to finance our operating activities. Most of the loans are linked to the U.S. Dollars and for a period of three to 30 months. The interest rates of those loans are according to the market rate.

Capital Expenditure

The discussion regarding the ScanMaster and Panoptes acquisitions and the Yuravision acquisition and sale are hereby incorporated by reference toItem 4, “Information on the Company – History and Development of the Company”andItem 10, “Additional Information – Material Contracts”.

49

C.Research and Development, Patents and Licenses, etc.

Our research and development group focuses on adapting our technologies to the development of new products for applications in the web and ultrasonic industries as well as enhancing our existing products. We devote a significant portion of our resources to improving our current systems through enhancements in the areas of sharpness of resolution, processing speed, sensor accuracy and illumination. We also continually work to enhance the ease of use and flexibility of our systems’ software and to develop product add-ons to augment our systems currently in use by customers. These product add-ons are being designed to further integrate our systems into each phase of our customers’ manufacturing process.

We have a number of product and technology initiatives underway at any given time. Our research and development activities have generally resulted in periodic introductions of new products, new auxiliaries and upgrades to our existing products. Current product and technology initiatives include, among others, the following:

For our developments in the Non–Destructive Automated Inspection Systems Division we are expanding our capabilities by developing multi transducers of automatic calibration, different process algorithms and a scanner capable of inspecting in 2.5 dimensions. We are also expanding our capabilities to provide portable Non-Destructive Automated Inspection instruments for automotive and industrial applications.

As of May 2009, our research and development staff consisted of 23 full-time employees, all of whom are located in Israel and hold advanced technical degrees. Our research and development staff engages in hardware, electro-optics and ultrasonic development, real-time software development, PC software development, manufacturing engineering, system engineering and customer support engineering. Our research and development staff for the web industry consisted of 4 full time employees, and our research and development staff for the ultrasonic industry consisted 19 full time employees. In 2006 our gross research and development expenditures for the web industry were approximately $1.6 million, in 2007 they were $1.5 million and in 2008 they were $1.3 million. These expenditures were partially offset by grants by the OCS of the Ministry of Industry, Trade and Labor of the Government of Israel of approximately $145,000 in 2006.

Research and Development Grants

The Government of Israel encourages research and development projects oriented towards products for export through the OCS. Since inception, we have received grants from the OCS for the development of various systems and products. Under the terms of these grants, a royalty of 3% to 5% of the net sales of products developed from a project funded by the OCS must be paid, beginning with the commencement of sales of products developed with grant funds and ending when 100% of the dollar value of the grant is repaid. The terms of Israeli government participation also require that the manufacture of products developed with government grants be performed in Israel, unless a special approval has been granted by the OCS. Such approval, if granted, is generally subject to an increase in the total amount to be repaid to the OCS to between 120% and 300% of the amount granted, depending on the extent of the manufacturing to be conducted outside of Israel. Separate Israeli government consent is required to transfer to third parties technologies developed through projects in which the government participates. Such restrictions do not apply to exports from Israel of products developed with such technologies. For more information, seeItem 10, “Additional Information – Taxation”.

50

Pursuant to regulations, effective with regard to OCS grants received under programs approved after January 1, 1999, repayments of such grants will be subject to interest at an annual rate of LIBOR for 12 months applicable to Dollar deposits, which will accrue annually based on the LIBOR rate published on the first day of each year.

Royalty-bearing grants received from the Government of Israel for research and development are offset against our gross research and development expenditures on development of products only for the textile industry.

The following table sets forth net research and development expenses, the grants received from the OCS and the gross research and development expenditures for the periods indicated.

	2008		2007		2006
(in thousands)
Research and development expenses, net	$	4,559	$	3,313	$	2,562
OCS grants	$	152	$	141	$	145
Gross research and development expenditures	$	4,711	$	3,454	$	2,707

D. Trend Information

The current economic downturn has materially affected our business and we expect to continue to witness a decline in the purchase orders for our products. The economic downturn has caused uncertainty in our markets, and may result in further decreases in capital expenditures.

Our NDT division, which has been responsible for the majority of our revenues over recent years, has suffered a significant decrease in orders. The areas which have been most affected by the global economic downturn are the pipe and plate industries, where orders for which have been particularly affected by the collapse of the US automotive industry. Orders from our customers in the aircraft and aerospace industries have also decreased, though to a lesser degree.

We are witnessing increased interest in national infrastructure projects such as railways and while this has not yet resulted in current orders, we expect that this will have a positive impact on our NDT sales in the medium term.

Our AOI division has also been significantly affected by the global downturn with an almost complete cessation of orders in the woven fabric sector. The non-woven sector has also been affected but to a lesser degree. It is difficult to predict at this stage the extent to which our traditional customers will return to purchase our products in significant amounts.

In 2008 we reduced our inventory by $1.15 million due to the anticipated lower demand for our products and the cancellation of the Indian Project. We adjusted our inventory policy to a more conservative method, such that for the most part we acquire inventory per purchase order, thereby reducing our accumulated inventories.

E. Off-Balance Sheet Arrangements.

We do not have any off-balance sheet arrangements which have or are reasonably likely to have a material current or future effect on the financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources, of our company and its subsidiaries.

51

F. Tabular Disclosure of Contractual Obligations

Our significant financial and contractual obligations as of December 31, 2008, and the periods in which such obligations are due are as follows:

	Payments and Amount of Commitment Expiration Per Period (U.S. Dollars in thousands)
Contractual Obligations	Total Amounts Committed		Less than 1 Year		1-3 Years		3-5 Years		Over 5 years
Operating Car Lease Obligations		605		353		252		-		-
Operating Building Lease Obligations		1,333		463		870		-		-
Total		1,938		816		1,122		-		-

G.Safe Harbor.

Not applicable

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A. Directors and Senior Management

As of May 31, 2009, our directors, senior managers and key employees were as follows:

Name	Age	Position
David Gal *	52	Chairman of the Board
Ran Eisenberg*	62	Chief Executive Officer
Ofer Sela*	39	Vice President of research & development and Operations
Yaron Menashe*	33	Vice president, Chief Financial Officer and Secretary
Hillel Avni*	70	Vice President of Electronic Inspection Division
Silviu Rabinovich	64	Vice President of UT Sales and Marketing
Amos Uzani*	54	External Director
David Schwartz *	59	External Director
Nir Alon	45	Director
Linda Harnevo*	53	Director
Victor Josebachvili	54	Director

* Beneficially owns less than 1% of our outstanding ordinary shares.

52

David Gal was appointed as chairman of the board of directors on March 2, 2006, and served as our chief executive officer between the years 2006 and 2009. He served as chairman of the board of directors of Odin Medical Technologies Ltd. since 2005, and from 2001 through 2004 served as its president and chief executive officer. Between 2002 and 2004 Mr. Gal served as the active chairman of the board of directors of MindGuard Medical Technologies Ltd. From 1996 through 2000, Mr. Gal served as the president and chief executive officer of Wizcom Technologies Ltd. From 1991 through 1995, Mr. Gal served as the chief executive officer of Orbotech Inc., headquartered in Boston, USA. From 1989 through 1990, Mr. Gal served as an economic advisor to the Israeli Minister of Finance – Mr. Shimon Peres. Mr. Gal holds a B.A. in economics and business, and an M.B.A. from the Hebrew University of Jerusalem.

Ran Eisenberg was appointed as our Chief Executive Officer on May 1, 2009. Between the years 2004 and 2007 Mr. Eisenberg served as chief executive officer of Waivon Ltd. Mr. Eisenberg served as CEO of Microsense Ltd. between 2001 and 2004. Prior to this role, Mr. Eisenberg served as CEO of Optibase Ltd. between 1994 and 2004. From 1992 through 1994 Mr. Eisenberg served as group vice president of Elbit Ltd. Mr. Eisenberg holds a B.Sc. in aeronautical engineering from the Technion and an M.B.A from the University of California (UCLA).

Ofer Selaserved as the vice president of Research and Development of Advanced Dicing Technology (ADT) Ltd. between the years 2003 and 2007. Prior to this role, between the years 2000 and 2003, Mr. Sela has held various program management positions at Kulicke & Soffa. Between the years 1997 and 2000 Mr. Sela worked in various engineering capacities at Kulicke & Soffa. Mr. Sela holds a B.Sc in mechanical engineering from the Technion and an MBA from Heriot-Watt University. Mr. Sela is a graduate of the Israeli Naval Academy.

Yaron Menashehas served as our chief financial officer since December 2006. Between the years 2000 and 2003, Mr. Menashe worked as a senior auditor at KPMG. Mr. Menashe holds a bachelor’s degree in economics and accounting from the Haifa University, Israel and is a Certified Public Accountant in Israel.

Hillel Avni is one of our founders and served as our vice president of engineering from inception until 1999 and from 2006 following our acquisition of Panoptes. Between 2000 and 2005 Mr. Avni founded and was vice president of research and development of Panoptes. Between 1973 and 1990 he was employed by Elbit, where he served as the manager of digital signal processing computers development from 1987 until 1990, and prior to that, as the project manager for the development of a general purpose real-time image processing system. Mr. Avni holds a B.A. in mathematics and statistics from the Hebrew University of Jerusalem and an M.Sc. in computer science from the Technion.

Silviu Rabinovich was one of the major shareholders of ScanMaster prior to it being acquired by our company and served on our Board of Directors until February 2006. Mr. Rabinovich has spent over fifteen years with ScanMaster, serving as ScanMaster’s VP of Sales and Marketing and Chief Technology Officer. Mr. Rabinovich holds an M.A. in digital signal processing from Tel Aviv University.

53

Amos Uzani served as an attorney at the Haifa’s District Attorney’s Office from 1981-1983. From 1983 and until 1989 he practiced as an attorney. From 1989-1992 Mr. Uzani served as Internal Controller (VP) and from 1992-1996 as VP of Human Resources, both at the Israel Ports and Railways Authority. From 1996 and until December 2001 Mr. Uzani served as CEO of Israel Railways Corporation and as Vice President of the Israel Ports and Railways Authority. Between 2002 and 2004 Mr. Uzani served as CEO of IRS Corporation, a company wholly owned at the time by Mr. Uzani, specializing in handling projects and initiatives in the fields of transportation infrastructure and railway equipment. As of 2005, Mr. Uzani is acting President of Haifa Port. From 1986 Mr. Uzani served as director for the Industrial Buildings Corporation, until its privatization in 1992. From 2006, Mr. Uzani has been serving as an external director for Emilia Group (TASE: EMDV), a company publicly traded on the Tel Aviv Stock Exchange. Mr. Uzani holds a law degree from Bar-Ilan University (Israel), an Executive M.B.A. from Tel-Aviv University (Israel) and is a member of the Israeli BAR.

David Schwartzworked at the accounting offices of Weinstein and Associates from 1975-1978. From 1978 and until 1990 he worked for Tadiran Ltd. in the monetary regulation section. Between 1990 and 2002 Mr. Schwartz worked for Tadiran Consumer Goods Ltd. and its subsidiaries as a manager and controller. As of 2001, Mr. Schwartz is acting chairman of the tax committee for the forum of Industrial Financial Managers in the Industrial Organization. Mr. Schwartz has served as a director, external director, internal auditor and tax and financial advisor for many large companies, including Brightman Almagor Trusts Ltd., Tadiran Consumer Goods Ltd., Ubank Trust Funds Ltd. and Arco holdings Ltd. Mr. Schwartz holds a B.A. in Economics and Accounting from Bar Ilan University.

Nir Alon served as chairman of the board of directors from February 2001 until March 2, 2006. Since 1990, he has been the president of Altro Warenhandels GmbH, a cotton and textile company. From 1986 until 1990, he was part of the management of an Israeli based textile company. Mr. Alon holds a B.A. in social sciences from Tel-Aviv University.

Linda Harnevo was elected director by our board of directors on April 1, 2006. Ms. Harnevo served as chief executive officer of EduConcept Ltd. between the years 1994 and 1996 and chief executive officer of TeamWorks Technology Ltd. between the years 1997 and 2001. She is the founder of RedZebra Ltd. and Global Medical Networks International Ltd., where she currently serves as international chief executive officer. Ms. Harnevo holds a B.Sc. in mathematics, computer science and linguistics from Bar Ilan University, an M.Sc. in mathematics from the Weizmann institute and a Ph.D. in applied mathematics from the Weizmann Institute.

Victor Josebachvili was elected director by our board of directors on September 24, 2007, following the retirement of Mr. Menashe Shohat. Mr. Josebachvili is the founder and Managing Partner of Harbor Hills Partners, LLC (“HHP”), a financial advisory boutique firm and has been advising major US and European multinationals for the last 18 years. Prior to founding HHP Mr. Josebachvili was a Managing Director in JP Morgan’s Global M&A Group. Before joining JP Morgan Chase Mr. Josebachvili held similar positions at Bankers Trust and Citibank. Mr. Josebachvili has a B.Sc. (Cum Laude) degree in industrial engineering from the Technion (Israel Institute of Technology) (1981) and an MBA from Columbia University Graduate School of Business.

54

Board of Directors

Our directors, who are not external directors, commence their term when they are elected at the annual general meeting of our shareholders until the following annual general meeting. Messrs. David Schwartz and Amos Uzaniare our external directors who were elected to serve for terms of three years commencing April 2007 and December 2007, respectively.In September 2007 Mr. Victor Josebachvili replaced Mr. Menashe Shohat as director.

B. Compensation

During 2008, we paid to all our directors and officers a total of $1.167 million in salaries, fees and bonuses. This does not include money spent on automobiles made available to our officers, expenses (including business travel, professional and business association dues and expenses) reimbursed to officers and other fringe benefits commonly reimbursed or paid by companies in Israel.

Our audit committee, board of directors and shareholders approved the following compensation for our director Ms. Linda Harnevo, in consideration for her serving as a member of the Company’s Audit Committee and Board of Directors: (i) an annual fee of NIS 18,280 (approximately $5,523), (ii) payment of NIS 1,220 (approximately $348) per meeting in which she personally participates, (iii) payment of NIS 732 (approximately $209) per meeting in which she participates by phone, (iv) reimbursement of out of pocket expenses incurred in connection with the performance of her services as a director of the Company, (v) linking the above amounts to the Israeli Consumer Price Index in the same manner that the fees of the Company’s External Directors are linked to such index; payable retroactively from April 1, 2006, and (vi) options to purchase 30,000 ordinary shares of the Company exercisable at a price per share of $0.4, vesting quarterly, with the following vesting schedule: 4,286 ordinary shares vested on September 30, 2006, and 4,286 are vesting at the end of each fiscal quarter thereafter until March 31, 2008, when all options will be fully vested.

Following the approval of our audit committee and board of directors, on March 24 2008, our shareholders approved: (A) the following revised terms of compensation for Ms. Harveno: (i) an annual fee of NIS 26,250 (approximately $6,500) + VAT; (ii) payment of NIS 1,360 (approximately $340) + VAT per meeting in which she participates in person; (iii) payment of NIS 816 (approximately $240) + VAT per meeting in which she attends other than in person; (iv) payment of NIS 680 (approximately $170) + VAT per written resolution executed; and (v) reimbursement of out of pocket expenses incurred in connection with the performance of her services as a director of the Company; and (B) the following terms of compensation for our director, Mr. Victor Josebachvili: (i) an annual fee of NIS 26,250 (approximately $6,562) + VAT; (ii) payment of NIS 1,360 (approximately $340) + VAT per meeting in which he participates in person; (iii) payment of NIS 816 (approximately $240) + VAT per meeting in which he attends other than in person; (iv) payment of NIS 680 (approximately $170) + VAT per written resolution executed; (v) reimbursement of out of pocket expenses incurred in connection with the performance of his services as a director of the Company; (vi) reimbursement for a business class return flight to Israel, for flights taken specifically for the attendance of each of 2 meetings of the Board or other Company business related to service as director and if the Company requires attendance of Mr. Josebachvili in Israel for other meetings or special services, it shall fund such attendance, subject to approval by the chairman of the Board; (vii) reimbursement for up to 2 nights of hotel accommodation per working day, in connection with trips taken to Israel specifically for attendance of meetings of the Board or other Company business related to service as director; and (viii) options to purchase 30,000 ordinary shares of the Company par value NIS 1 at an exercise price of $0.32. 12.5% of the options shall vest immediately upon grant, 12.5% will vest on March 31, 2008, and the remainder shall vest quarterly in equal amounts until October 1, 2009 (provided that Mr. Josebachvilli remains a member of the Company’s board of directors, in which case the vesting shall cease upon cessation of his service on the board of directors), and shall be subject to the Company’s Employee Option Plan (2006).

55

We paid an aggregate of $42,550 to our serving external directors in 2008.

On February 21, 2006, our shareholders approved the payment to David Gal of a monthly compensation of $13,500 plus Value Added Tax in consideration for his services as the chairman of our board of directors. Additionally, it was approved to lease an automobile for his use, and supply him with certain other office related equipment necessary to provide us with his services. Finally, it was also approved to grant Mr. Gal options to purchase up to 600,000 of our Ordinary Shares at an exercise price of $0.50 per share. One third of the options shall vest on December 31, 2006 and thereafter 2.8% of the total shares subject to the option shall vest on a monthly basis. The vesting of the options will be subject to Mr. Gal serving as the chairman of our board of directors on the relevant vesting date. Mr. Gal shall be entitled to exercise the options on the date such options have vested and up to 5 years thereafter. Pursuant to his appointment as Chief Executive Officer and following approval of our audit committee and board of directors, our shareholders approved on July 31, 2007, an increase in the monthly fee payable to MEO Consulting, a company controlled by Mr. David Gal, of $21,500 plus VAT to be payable from January 1, 2007. On February 2, 2009 the terms of the agreement with MEO Consulting were further amended by our shareholders such that such that the $21,500 plus VAT shall be made in New Israeli Shekels (NIS) based on a minimum exchange rate of NIS 4.00 to USD 1.00. In April 2009 David Gal resigned as the Company’s Chief Executive Officer. We are currently negotiating the terms of his resignation.

Pension and Retirement Benefits

We offered no pension or retirement benefits to our directors and key personnel in 2008.

C. Board of Directors

Our articles of association provide for a board of directors of no fewer than two and not greater than nine members. On February 21, 2006, as a closing condition to the Convertible Loan Agreement with Mivtach Shamir, our shareholders approved the adoption of new articles of association. These changes were adopted due to changes in Israel’s business and legal environment and the entering into effect of the Companies Law, which replaced the Companies Ordinance. The new articles of association adopted following our February 21, 2006 shareholders’ meeting, include the following changes: (i) with the exception of resolutions which require the affirmative vote of a special majority pursuant to the Companies Law, all other resolutions shall be passed by an ordinary majority; and (ii) to the extent permitted by the Companies Law, the board will have the ability to declare dividends (in cash or in kind) to shareholders without shareholder approval.

56

The Companies Law which entered into effect on February 1, 2000 and was amended most recently in March 2005, requires the board of directors of a public company to determine the number of directors who shall possess accounting and financial expertise, as defined in the regulations promulgated on December 5, 2005, taking into account the type of company, its size, the extent of its activities and the complexity of the company’s operations.For further information on the appointment of directors, please see Item 7, “Major Shareholders and Related Party Transactions – Voting Agreements.”

Our articles of association provide that any director may, by written notice, appoint another person to serve as a substitute director and may cancel such appointment. A person may not serve as a substitute director for more than one director and may not serve both as a director and as a substitute director. Appointment of a substitute director for a member of a committee of the board of directors is only permitted if the substitute is a member of the board of directors and does not regularly serve as a member of such committee. If the committee member being substituted is an external director, such substitute may only be another external director possessing the same expertise as the external director being substituted and may not be a regular member of such committee.

The term of appointment of a substitute director may be for one meeting of the board of directors or for a specified period or until notice is given of the cancellation of the appointment. Any substitute director shall have all of the rights and obligations of the director appointing him or her, except the power to appoint a substitute, unless the instrument appointing him provides otherwise, and the right to remuneration. The substitute director may not act at any meeting at which the director appointing him or her is present. Unless the time period or scope of any appointment is limited by the appointing director, the appointment is effective for all purposes, but will expire upon the expiration of the appointing director’s term. To our knowledge, no director currently intends to appoint any other person as a substitute director, except if the director is unable to attend a meeting of the board of directors.

The Companies Law, requires Israeli companies with shares that have been offered to the public in or outside of Israel to appoint no less than two external directors. No person may be appointed as an external director if the person or the person’s relative, partner, employer or any entity under the person’s control, has or had, on or within the two years preceding the date of the person’s appointment to serve as external director, any affiliation with the company or any entity controlling, controlled by or under common control with the company. The term “affiliation” includes:

— an employment relationship;

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

— control; and

— service as an office holder.

57

        A person shall be qualified to serve as an external director only if he or she possesses accounting and financial expertise or professional qualifications. At least one external director must posses accounting and financial expertise. The conditions and criteria for possessing accounting and financial expertise or professional qualifications were recently determined in regulations promulgated by the Israeli Minister of Justice in consultation with the Israeli Securities Authority. These regulations do not appear to relate to external directors currently serving. The regulations mandate that a person is deemed to have “expertise in finance and accounting” if his or her education, experience and qualifications provide him or her with expertise and understanding in business matters – accounting and financial statements, in a way that allows him or her to understand, in depth, the company’s financial statements and to encourage discussion about the manner in which the financial data is presented.

        The company’s board of directors must evaluate the proposed external director’s expertise in finance and accounting, by considering, among other things, his or her education, experience and knowledge in the following: (i) accounting and auditing issues typical to the field in which the company operates and to companies of a size and complexity similar to such company; (ii) a company’s independent public accountant’s duties and obligations; (iii) preparing company financial statements and their approval in accordance with the Companies Law and the Israeli Securities Law.

        A director is deemed to be “professionally qualified” if he or she meets any of the following criteria: (i) has an academic degree in any of the following professions: economics, business administration, accounting, law or public administration; (ii) has a different academic degree or has completed higher education in a field that is the company’s main field of operations, or a field relevant to his or her position; or (iii) has at least five years experience in any of the following, or has a total of five years experience in at least two of the following: (A) a senior position in the business management of a corporation with significant operations, (B) a senior public position or a senior position in public service, or (C) a senior position in the company’s main field of operations. The board of directors here too must evaluate the proposed external director’s “professional qualification” in accordance with the criteria set forth above.

        The affidavit required by law to be signed by a candidate to serve as an external director must include a statement by such candidate concerning his or her education and experience, if relevant, in order that the board of directors may properly evaluate whether such candidate meets the requirements set forth in the regulations. Additionally, the candidate should submit documents and certificates that support the statements set forth in the affidavit.

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

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

— the majority of shares voted at the meeting, including at least one-third of the shares held by non-controlling shareholders voted at the meeting, vote in favor of election of the director; or

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

58

The initial term of an external director is three years and may be extended for an additional three years. External directors may be removed only by the same percentage of shareholders as is required for their election, or by a court, and then only if the external directors cease to meet the statutory qualifications for their appointment or if they violate their duty of loyalty to the company. Each committee of a company’s board of directors must include at least one external director.

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

Currently, Messrs. Schwartz and Uzani serve as our external directors.

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

Our two external directors Messrs. Schwartz and Uzani serve on the audit committee of the board of directors.

Under the Companies Law, the board of directors must appoint an internal auditor, nominated by the audit committee. The role of the internal auditor is to examine, among other matters, whether the company’s actions comply with the law and orderly business procedure. Under the Companies Law, the internal auditor may be an employee of the company but not an office holder, or an affiliate, or a relative of an office holder or affiliate, and he may not be the company’s independent accountant or its representative.

D. Employees

2008

As of December 31, 2008, we employed a total of 103 full time persons in both of our divisions, as follows:

Non–Destructive Automated Inspection Systems Division

As of December 31, 2008, we employed 70 full-time persons, out of which 66 were employed in Israel of whom 23 were in research and development, 6 were in marketing and sales, 3 were in customer support, 30 were in operations and 4 were in administration and management.

59

AOI Division

As of December 31, 2008, we employed 33 full-time persons, out of which 24 were employed in Israel of whom 10 were in research and development, 2 were in marketing and sales, 2 were in customer support, 5 were in operations and 5 were in administration and management.

2007

As of December 31, 2007 we employed a total of 108 full time persons in both of our divisions, as follows:

Non–Destructive Automated Inspection Systems Division

As of December 31, 2007, we employed 69 full-time persons, out of which 66 were employed in Israel of whom 22 were in research and development, 8 were in marketing and sales, 3 were in customer support, 27 were in operations and 6 were in administration and management.

AOI Division

As of December 31, 2007, we employed 39 full-time persons, out of which 30 were employed in Israel of whom 10 were in research and development, 2 were in marketing and sales, 3 were in customer support, 9 were in operations and 6 were in administration and management.

2006

As of December 31, 2006 we employed a total of 103 full time persons in both of our divisions, as follows:

Non–Destructive Automated Inspection Systems Division

        As of December 31, 2006, we employed 58 full-time persons, out of which 56 were employed in Israel of whom 15 were in research and development, 7 were in marketing and sales, 3 were in customer support, 26 were in operations and 5 were in administration and management.

AOI Division

        As of December 31, 2006, we employed 45 full-time persons, out of which 34 were employed in Israel of whom 14 were in research and development, 2 were in marketing and sales, 3 were in customer support, 9 were in operations and 6 were in administration and management.

        We believe that our success will depend, in large part, on our ability to attract and retain highly-skilled engineering, managerial and sales and marketing personnel. Competition for such personnel is intense.

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

60

        Israeli law generally requires severance pay, which may be funded by Managers’ Insurance described below, upon the retirement or death of an employee or termination of employment without cause (as defined in the law). These payments amount to approximately 8.33% of wages. Furthermore, Israeli employees and employers are required to pay predetermined sums to the National Insurance Institute, which is similar to the United States Social Security Administration. Such amounts also include payments for national health insurance. The payments to the National Insurances Institute are equal to approximately 14.5% of the wages (up to a specified amount), of which the employee contributes approximately 66% and the employer contributes approximately 34%.

        Although not legally required, we contribute funds on behalf of most of our employees to a fund known as “Managers’ Insurance”. This fund provides a combination of savings plan, insurance and severance pay benefits to the employee, giving the employee a lump sum payment upon retirement and securing the severance pay, if legally entitled, upon termination of employment. We decide whether each employee is entitled to participate in the plan, and each employee who agrees to participate contributes an amount equal to 5% of a salary and the employer contributes between 13.3% and 15.8% of a salary.

E. Share Ownership

Of the persons listed above under the caption “Directors, Senior Management and Employees”, Mr. Nir Alon beneficially own shares and options exceeding 1% of our outstanding ordinary shares since Mr. Nir Alon is the controlling shareholder of Altro, our majority shareholder. Mr. Shlomo Alon, Nir Alon’s father, who served as a member of our board of directors until March 2, 2006, beneficially owns shares and options exceeding 1% of our outstanding ordinary shares.

Employee Share Option Plans

We maintain the following share option plans for our employees and the employees of our subsidiaries. In addition to the discussion below, see Note 11 to our consolidated financial statements.

In February 1996, the board of directors adopted a share option plan, or the 1996 Share Option Plan, pursuant to which 565,720 ordinary shares were reserved for issuance upon the exercise of options to be granted to our directors, officers, employees, and consultants. As of May 31, 2009, options to purchase 2,000 of such ordinary shares were outstanding and the remaining options have expired. All of the outstanding options are fully vested and are exercisable at an exercise price of $0.2 per share. All of the outstanding options terminate ten years following the date of grant if not exercised earlier or terminated by reason of termination of employment.

61

The 1996 Share Option Plan is administered by a committee of the board of directors, which designates the optionees and dates of grant. The option exercise price is determined by our board of directors. All recent grants have been made at an exercise price equal or above to the fair market value of our shares. The options are non-assignable except by the laws of succession. The last date on which the options may be granted was February 2006. The remaining options will be exercisable for a period up to ten years from the date of grant and will generally vest at a rate of 50% at the beginning of the third year after the grant and an additional 25% in each of the two years thereafter, assuming continuous employment with us through such periods.

In April 2000, our board of directors adopted a share option plan pursuant to which 4,500,000 ordinary shares were reserved for issuance upon the exercise of options to be granted to our directors, officers, employees and consultants. As of May 31, 2009, options to purchase 1,278,369 of such ordinary shares were outstanding and options to purchase 2,104,794 ordinary shares were available for future grants. 523,639 of the outstanding options have an exercise price of $1.169 per share. All of the options referred to above vested equally on the anniversary of May 24 from 2001 until 2004 inclusive, assuming continuous employment with us through such period.272,750 of the outstanding options have an exercise price of $0.36 per share. 295,100 of the outstanding options have an exercise price of $0.48 per share 20,852 of the outstanding options have an exercise price of $0.15 per share and 166,027 of the outstanding options have an exercise price of $1 per share. All of the outstanding options terminate ten years following the date of grant if not exercised earlier. The 2000 Share Option Plan is administered by a committee of the board of directors, which designates the optionees and dates of grant. The option exercise price is determined by our board of directors. All recent grants have been made at an exercise price equal to or above the fair market value of our shares. The options are non-assignable except by the laws of descent. The last date on which the options may be granted is April 2010. The remaining options will be exercisable for a period up to ten years from the date of grant and will generally vest as to 25-33% commencing the beginning of the second year after the grant and as to an additional 25-33% in each of the remaining years thereafter, assuming continuous employment with us through such periods.

In November 2003, the board of directors adopted a share option plan pursuant to which 2,000,000 ordinary shares were reserved for issuance upon the exercise of options to be granted to our directors, officers, employees and consultants. The number of ordinary shares issuable under the share option plan is annually increased by 1,500,000 ordinary shares. As of May 31, 2009, options to purchase 3,327,484 of such ordinary shares were outstanding and options to purchase 5,437,000 ordinary shares were available for future grants. 727,500 of the outstanding options have an exercise price of $1.25 per share, 44,000 of the outstanding options have an exercise price of $1.2 per share, 136,500 of the outstanding options have an exercise price of $0.85 per share, 15,000 of the outstanding options have an exercise price of $0.83 per share, 300,334 of the outstanding options have an exercise price of $0.8 per share, 7,500 of the outstanding options have an exercise price of $0.78 per share, 625,000 of the outstanding options have an exercise price of $0.75 per share, 25,000 of the outstanding options have an exercise price of $0.70 per share, 153,197 of the outstanding options have an exercise price of $0.68 per share, 600,000 of the outstanding options have an exercise price of $0.5 per share, 60,000 of the outstanding options have an exercise price of $0.4 per share, 30,000 of the outstanding options have an exercise price of $0.37 per share, 30,000 of the outstanding options have an exercise price of $0.35 per share, 450,000 of the outstanding options have an exercise price of $0.28 per share, and an additional 123,453 an exercise price of $0.2 per share. As of May 31, 2009, 3,044,984 of the options were vested, and the remainder will vest at various dates until February 14, 2011. All of the outstanding options terminate ten years following the date of grant if not exercised earlier. The 2003 Share Option Plan is administered by a committee of the board of directors, which designates the optionees and dates of grant. The option exercise price is determined by our board of directors. All recent grants, except for the grant to our chairman, Mr. David Gal, have been made at an exercise price equal to or above the fair market value of our shares. The options are non-assignable except by the laws of descent. The last date on which the options may be granted is November 2013. The remaining options will be exercisable for a period up to ten years from the date of grant and will generally vest as to 25-33% commencing the beginning of the second year after the grant and as to an additional 25-33% in each of the remaining years thereafter, assuming continuous employment with us through such periods.

62

In March 2006, the board of directors adopted a share option plan pursuant to which 2,000,000 ordinary shares were reserved for issuance upon the exercise of options to be granted to our directors, officers, employees and consultants. The number of ordinary shares issuable under the share option plan may be increased by the board of directors from time to time. As of May 31, 2009, options to purchase 802,500 of such ordinary shares were outstanding and options to purchase 945,000 ordinary shares were available for future grants. 100,000 of the outstanding options have an exercise price of 0.49 per share, 100,000 of the outstanding options have an exercise price of 0.46 per share, 230,000 of the outstanding options have an exercise price of $0.4 per share, 30,000 of the outstanding options have an exercise price of 0.32 per share, 50,000 of the outstanding options have an exercise price of 0.28 per share and 292,500 of the outstanding options have an exercise price of 0.25 per share. As of May 31, 2009, 78,750 of the options were vested, and the remainder will vest at various dates until August 7, 2012. All of the outstanding options terminate either ten years following the date of grant if not exercised earlier or 6 months after termination of the employee. The 2006 Share Option Plan is administered by a committee of the board of directors, which designates the optionees and dates of grant. The option exercise price is determined by our board of directors. All recent grants have been made at an exercise price equal to or above the fair market value of our shares. The options are non-assignable except by the laws of descent. The last date on which the options may be granted is March 15, 2016. The remaining options will be exercisable for a period up to ten years from the date of grant and will generally vest as to 25-33% commencing the beginning of the second year after the grant and as to an additional 25-33% in each of the remaining years thereafter, assuming continuous employment with us through such periods.

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

A. Major Shareholders

The following table and notes set forth information, as of May 31, 2009, concerning the beneficial ownership (as defined in Rule 13d-3 under the Securities Exchange Act of 1934) of our securities by (i) any person who is known to own at least 5% of our ordinary shares and (ii) our directors and officers as a group. The voting rights of our major shareholders do not differ from the voting rights of holders of all of our ordinary shares.

63

Identity of Person or Group	Amount Beneficially Owned		Percent of Class
Nir Alon (1)(2)(3)(9)		3,106,436		6.01	%
Elbit Ltd. (4)(5)		5,330,182		10.37	%
M.S. Master Investments (2002) Ltd. (6)		4,044,833		7.93	%
M.S.N.D. Real Estate Holdings Ltd. (4)(7)		14,463,954		29.29	%
Shavit Capital Entities (8)		4,761,905		9.06	%
All directors and officers as a group (9)		5,870,833		11.38	%

The percentages in this table are based on 50,988,701 of ordinary shares currently issued and outstanding and options exercisable within 60 days.

(1)     All of these shares are pledged to Bank Leumi B.M., in order to guarantee a credit line for Nir Alon, in the sum of $1,500,000.

(2)     Includes 75,000 ordinary shares which are subject to an option to purchase shares granted by Mr. Alon to Mr. Barath on March 29, 2001, and 600,000 ordinary shares currently issuable upon the exercise of warrants within 60-days.

(3)     Mr. Nir Alon is deemed to be the beneficial owner of all of the shares held by MA & AT Handels GmbH.

(4)     In an agreement between Elbit and Mivtach, dated July 29, 2007, the parties agreed to vote their shares at meetings of our shareholders at which members of the board are to be elected, as follows: (a) to elect to our board one director nominated by Mivtach, who shall serve as chairman of our board, and (b) to elect to our board one director nominated by Elbit; provided that the party entitled to nominate a director continues to at least hold 7.5% of our share capital on a fully diluted basis. A reduction of a party’s holdings shall only be deemed to occur upon a sale by one of the parties, of our ordinary shares. If a party fails to meet the 7.5% threshold it shall lose the right to nominate a director and such right shall be granted to the party who at such time holds the highest number of our ordinary shares. Additionally, the parties to the agreement agreed that in the event that and for as long as Mivtach continues to hold at least 15% of our share capital on a fully diluted basis, the parties will vote their shares at meetings of our shareholders at which members of the board are to be elected as follows: (a) to elect to our board two directors nominated by Mivtach, one of whom shall serve as chairman of our board, and (b) to elect to our board one director nominated by Elbit. A reduction of a party’s holdings shall only be deemed to occur upon a sale by a shareholder of our ordinary shares. Notwithstanding the foregoing, at any time during the term of the agreement, Elbit may, in its absolute discretion, by notice in writing to Mivtach, voluntarily terminate its right to designate a director to our board of directors. In such an event the right to designate the director to our board of directors shall be granted to Mivtach and Elbit shall be obliged to vote its shares in favor of the nominee designated by Mivtach. A party whose holdings of our share capital falls below 5% of our share capital on a fully diluted basis, shall, as from the time of such change, automatically cease to be a party to the agreement.

64

(5)     Includes 396,825 shares issuable upon the exercise of an immediately exercisable warrant. Elbit is a wholly owned subsidiary of Elron Electronic Industries Ltd. (NASDAQ and TASE: ELRN). As a result, Elron may be deemed to be the beneficial owner of our ordinary shares owned by Elbit. As of May 31, 2009, Discount Investment Corporation Ltd., or DIC, owned approximately 49% of the outstanding shares of Elron and, as a result, DIC may be deemed to be the beneficial owner of our ordinary shares owned by Elbit. IDB Holding Corporation Ltd., or IDBH, owns the majority of the outstanding shares of IDB Development Corporation Ltd., or IDBD, which, in turn, owns the majority of the outstanding shares of DIC. As a result, IDBH may be deemed to be the beneficial owner of our ordinary shares owned by Elbit, and our ordinary shares held by subsidiaries of CIEH for their own account.

(6)     M.S. Master Investments (2002) Ltd. owns 2,080,944 ordinary shares and has a proxy to vote 1,080,944 ordinary shares held by S.R. Master Investment (2002) Ltd., 700,540 ordinary shares held by R.D. Master Investment (2002) Ltd. and 182,405 ordinary shares held by Avner Shacham.

(7)     Includes 2,000,952 ordinary shares issuable upon the exercise of a warrant exercisable within 60-days. M.S.N.D. Real Estate Holdings Ltd. is a fully owned subsidiary of Mivtach-Shamir Holdings Ltd.

(8)     Includes 2,383,079 ordinary shares and 1,191,540 warrants owned by Shavit Capital (Cayman) Fund, L.P., 638,318 ordinary shares and 319,159 warrants owned by Shavit Capital Fund (Israel), L.P., and 153,206 ordinary shares and 76,603 warrants owned by Shavit Capital Fund (US) L.P. The warrants are exercisable at the option of the holder within 60 days.

Shavit Capital Fund GP, L.P. is the general partner of Shavit Capital (Cayman) Fund, L.P., Shavit Capital Fund (Israel), L.P. and Shavit Capital Fund (US), L.P. Shavit Capital (GP) Management Ltd. is the general partner of Shavit Capital Fund GP, L.P. and is controlled by entities ultimately controlled by Paul Packer, Leon Recanati and Isi Leibler, each of whom have shared voting and investment control over all the shares held by the Shavit Capital Entities and therefore may be deemed to share beneficial ownership of the shares held by the Shavit Capital Entities. Each of Messrs. Packer, Recanati and Leibler disclaims beneficial ownership of the shares held by the Shavit Capital Entities, except to the extent of his pecuniary interest therein, if any.

(9)     Includes all of the shares deemed as beneficially owned by Mr. Nir Alon and options currently exercisable by directors and officers within 60 days.

As of May 31, 2009, there were a total of 72 holders of record of our ordinary shares, of which 11 were registered in the United States. Such United States shareholders were, as of such date, the holders of record of approximately 35.7% of our outstanding ordinary shares.

Voting Agreements

On June 21, 2007, Altro Warenhandels GmbH, M.S. Master Investments, Elbit Ltd., Nir Alon Holdings GmbH, and Nir Alon, the parties to a shareholders agreement dated February 21, 2006, terminated their shareholders agreement.

On June 21, 2007, M.S. Master Investments, Elbit Ltd., Nir Alon Holdings GmbH, Nir Alon and M.S.N.D. Real Estate Holdings, the parties to a shareholders agreement dated February 21, 2006, terminated their shareholders agreement.

65

In an agreement which Elbit and Mivtach have agreed to execute in the event that the shareholders approve the Amendment Agreement and the Elbit Agreement, the parties will agree to vote their shares at meetings of our shareholders at which members of the board are to be elected, as follows: (a) to elect to our board one director nominated by Mivtach, who shall serve as chairman of our board, and (b) to elect to our board one director nominated by Elbit; provided that the party entitled to nominate a director continues to hold 7.5% of our share capital on a fully diluted basis. A reduction of a party’s holdings shall only be deemed to occur upon a sale by one of the parties, of our ordinary shares. If a shareholder fails to meet the 7.5% threshold it shall lose the right to nominate a director and such right shall be granted to the shareholder who at such time holds the highest number of our ordinary shares. Additionally, the parties to the agreement agreed to vote their shares at meetings of our shareholders at which members of the board are to be elected as follows: (a) to elect to our board two directors nominated by Mivtach, one of whom shall serve as chairman of our board, and (b) to elect to our board one director nominated by Elbit; provided that the party entitled to nominate a director continues to hold 15% of our share capital on a fully diluted basis. A reduction of a party’s holdings shall only be deemed to occur upon a sale by a shareholder of our Ordinary Shares. Notwithstanding the foregoing, if prior to May 14, 2008, Elbit holds less than the 7.5% threshold other than if any reductions in Elbit’s holdings are as a result of sales of our shares by Elbit, Elbit shall maintain its right to designate one member of the board, until May 14, 2008. A party whose holdings of our share capital falls below 5% of our share capital on a fully diluted basis, shall, as from the time of such change, automatically cease to be a party to the agreement. Elbit may, by written notice to Mivtach, voluntarily terminate its right to designate a director to our board of directors. In such case, the right to designate a director, which Elbit terminated, shall be granted to Mivtach and Elbit shall be obliged to vote its shares in favor of the nominee designated by Mivtach. Pursuant to the agreement, the parties also granted each other mutual rights of first offer and tag-along rights with respect to a private sale of our ordinary shares.

B. Related Party Transactions

Consulting Agreement with MA&AT

        On May 1, 2006, we executed a consulting agreement with MA&AT, an Austrian company which receives services from, but is not controlled by, Mr. Nir Alon (a member of our board of directors), which includes the provision of consulting services by Mr. Alon to us for a fee. This agreement was approved and ratified by our shareholders on November 20, 2006.

        On November 1, 2007, we executed a new consulting agreement with MA&AT for the provision of consulting services to us, through its designated representative, Mr. Alon. This agreement superseded and replaced the consulting agreement dated May 1, 2006. Pursuant to the agreement, Mr. Alon will promote sales of our UT Products in Europe (excluding France), India and South Africa in consideration for: (i) a monthly fee of $15,000, (ii) a commission on sales made by us of our UT products in Europe (excluding France), India and South Africa, unless Mr. Alon was not involved is such sale, in an amount of 2% of the net sale price of the products, (iii) an additional commission of 1% of gross profit per UT product, (iv) reimbursement of reasonable expenses incurred in connection with the performance of the consulting services, and (v) a car provided for the purpose of fulfilling the consulting services. The agreement also includes a non-competition provision restricting MA&AT and Mr. Alon from competing with us during the term of the agreement and for a year following the termination of the agreement. This new agreement was approved by our audit committee and board of directors on March 24, 2008.

66

Indemnification Agreements

        On March 24, 2008, following approval by our audit committee and board of directors, our shareholders approved indemnification agreements with each of our current and future directors. The indemnification agreements provide, among other things, for the indemnification of our directors for up to $3 million for each case (in addition to any amounts paid out under an insurance policy) and their exemption from their duty of care in certain circumstances.

Commission to Mr. Nir Alon

        On March 24, 2008, following approval by our audit committee and board of directors, our shareholders approved the payment of a certain commission to Mr. Nir Alon, a director of the Company, equal to five percent (5%) of the aggregate proceeds paid to the Company by UB Precision Co., Ltd., from the sale of all of the shares of Yuravision Co. Ltd., held by the Company, or the Yuravision Shares, and the assignment of creditor’s rights under a certain loan granted to Yuravision. Mr. Alon represented the Company in its search for a purchaser of the Yuravision Shares and in its negotiations with UB Precision.

        Amendment to the Management Services Agreement with MEO Consulting Ltd.

        At a meeting of our shareholders dated February 15, 2006, our shareholders approved an agreement, between us and MEO, pursuant to which we paid MEO, a monthly fee of $13,500 plus Value Added Tax for Mr. Gal’s services as Chairman of our Board of Directors. At the annual general meeting of our shareholders held on November 20, 2006, our shareholders approved the appointment of Mr. Gal as our Chief Executive Officer, in addition to his service as Chairman of our Board of Directors. Due to his additional responsibilities as Chief Executive Officer, our shareholders approved at a meeting held on July 31, 2007 an increase in the monthly fee payable to MEO of $21,500 plus Value Added Tax payable from January 1, 2007 (the “Agreement”). On February 2, 2009, following approval by our audit committee and board of directors, our shareholders approved a further amendment to the Agreement so that payment of the monthly $21,500 plus VAT shall be made in New Israeli Shekels (“NIS”) based on a minimum exchange rate of NIS 4.00 to USD 1.00, such that the Company shall pay MEO the monthly sum of at least NIS 86,000 plus VAT commencing January 1, 2008. In April 2009 David Gal resigned as the Company’s Chief Executive Officer. We are currently negotiating the terms of his resignation.

C. Interests of Experts and Counsel.Not applicable

67

ITEM 8. FINANCIAL INFORMATION

A. Consolidated Statements and Other Financial Information

Our consolidated financial statements and other financial information are incorporated herein by reference to pages F1-F41.

Export Sales

In 2008, 96.6% of our sales, amounting to $21,342,000 were due to our products being exported outside of Israel.

Litigation

Other than the claims described below, we are not a party to any material litigation and are not aware of any pending or threatened litigation that would have a material adverse effect on our business or us.

        Following the cancellation of a contract, or the Indian Project, between ScanMaster and the Research and Design Standards Organization of the Ministry of Railways of India, or RDSO, RDSO demanded the exercise of certain down-payment guarantees and a performance guarantee received from ScanMaster from the State Bank of India, as counter guaranteed by Bank Hapoalim BM, or Hapoalim. As a result, on November 14, 2006, ScanMaster petitioned the Indian court in Lucknow to receive an order to prevent RDSO from exercising the bank guarantees. The court denied ScanMaster’s request, pursuant to which the guarantees were exercised in the amount of $414,125 pursuant to the performance guarantee and $2,481,175 pursuant to the down-payment guarantees.

        On November 7, 2007, we received a letter from the Ministry of Trade, Industry and Labor – Fund for the Encouragement of Marketing Abroad (the “Fund”), claiming that it had failed to pay royalties to the Fund since 1999 in the aggregate amount of $480,818. On November 21, 2007, we sent a letter to the Fund in which we stated that the Fund had not requested any of these royalties for many years despite our written request to clarify the issue. In our letter we stated that a material amount of the royalties could no longer be claimed due to the operation of the statute of limitations and that in any event the Fund may be estopped from making at least part of the claims as a result of its non-response to our inquiry. On December 18, 2007, we met with representatives of the Fund to discuss the issue. We have yet to receive a response to the meeting. On November 4, 2007, the Manufacturers Association of Israel (“MAI”) filed a claim with the Tel-Aviv-Jaffa District Labor Court against our company, claiming we have failed to pay MAI its annual handling fees over the past 7 years and claiming NIS 200,000 (approximately $57,143). On December 11, 2007, the court decided that in the absence of any objections from the parties, the claim would be transferred to the Nazereth District Labor Court. A hearing on the matter has been set for May 20, 2008 at the Nazereth District Labor Court. We are required to file our defense by April 30, 2008. We are currently in discussions with MAI to agree a settlement on this matter

        On August 30, 2007, we received notification of a claim filed with the Court of Prato, Italy, by an Italian customer, Microtex Cottonclub S.p.A. (“Microtex”) for damages in the amount of €139,787.97 (approximately $209,682). According to Microtex, we breached an agreement with Microtex, dated June 30, 2005, by failing to supply it with an iTex 3000 system. On March 12, 2008, Microtex executed a settlement agreement with us pursuant to which we agreed to return to Microtex a €13,200 down-payment made by it for the iTex 3000 and Microtex agreed to withdraw the claim.

68

        On November 15, 2006, Mr. Yoav Kahane, our former VP of Marketing and Sales submitted a Statement of Claim to the Labor Court in Nazareth against our company in which Mr. Kahane claimed that we owed him an aggregate of $140,241.06 under our bonus compensation plan. On December 31, 2006, we filed a Statement of Defense with the Labor Court rejecting Mr. Kahane’s claims. On May 30, 2007, the parties reached and executed a settlement agreement, pursuant to which we paid Mr. Kahane NIS 275,000. On June 7, 2007, the Nazareth Labor Court approved the settlement agreement.

Dividend Distributions

We have never paid any cash dividends on our ordinary shares and we do not intend to pay cash dividends on our ordinary shares in the foreseeable future. Our current policy is to retain earnings for reinvestment in our business.

In the event that we decide to pay a cash dividend from income that is tax exempt under our approved enterprise status, we would be liable for corporate tax on the amount distributed at the rate of up to 25%. Income not derived from an approved enterprise in 2007 is taxable at regular rates of 31%. See Note 12 to our Consolidated Financial Statements andItem 10, “Additional Information – Taxation.”

B. Significant Changes

No significant changes have occurred since the date of the consolidated financial statements included in this annual report.

ITEM 9. THE OFFER AND LISTING

A. Offer and Listing Details andC. Markets

Market and Share Price History

In July 1996, we consummated an initial public offering of 2,000,000 ordinary shares. At such time, our ordinary shares were quoted on the NASDAQ National Market. Our ordinary shares were quoted on the NASDAQ National Market from July 1996. Effective December 29, 2000, our ordinary shares were delisted from the NASDAQ National Market. From that time our shares traded on the Over-the-Counter Bulletin Board until June 21, 2001, when they were transferred to the NASDAQ SmallCap Market. On November 19, 2003 our ordinary shares were delisted from the SmallCap Market and following a seven business day period in which the shares were traded on the Pink Sheets (as a result of an error by the NASDAQ Listings Qualifications Panel), our ordinary shares were listed on the Over-the-Counter Bulletin Board from November 28, 2003. For further information, seeItem 3, “Key Information – Risk Factors – Risk Factors Related to Our Ordinary Shares”andItem 4, “Information on the Company – History and Development of the Company”. From July 1996 until May 4, 1999, our ordinary shares were quoted under the symbol EVSNF. From May 4, 1999, until November 18, 2003, they were quoted under the symbol EVSN, and since November 19, 2003 our ordinary shares have been quoted under the symbol EVSNF.OB. Our ordinary shares are not listed on any other stock exchange and have not been publicly traded outside the United States.

69

The table below sets forth the high and low bid prices of the ordinary shares, as reported by the NASDAQ National Market, NASDAQ SmallCap Market or the Over-the-Counter Bulletin Board as applicable, during the indicated fiscal periods as reported by such exchange:

Period	High ($)	Low ($)
May 2009	0.11	0.09
April 2009	0.11	0.08
March 2009	0.12	0.07
February 2009	0.14	0.08
January 2009	0.16	0.10
December 2008	0.19	0.10
Fourth quarter 2008	0.29	0.10
Third quarter 2008	0.30	0.12
Second quarter 2008	0.40	0.26
First quarter 2008	0.54	0.25
Fourth quarter 2007	0.54	0.35
Third quarter 2007	0.37	0.27
Second quarter 2007	0.38	0.31
First quarter 2007	0.42	0.33
Year ended 2008	0.54	0.10
Year ended 2007	0.55	0.27
Year ended 2006	0.83	0.22
Year ended 2005	0.77	0.44
Year ended 2004	1.65	0.37

70

B. Plan of Distribution.

Not applicable

D. Selling Shareholders.

Not applicable

E. Dilution.

Not applicable

F. Expenses of the Issue.

Not applicable

ITEM 10. ADDITIONAL INFORMATION

Memorandum and Articles of Association

A. Share Capital.

Not applicable

B. Memorandum and Articles of Association

Our shareholders approved our articles of association on February 21, 2006. Our objective as stated in our articles of association is to engage in any lawful act or activity for which companies may be organized under the Israeli Companies Law-1999, as amended.

Currently we have one class of outstanding securities, our ordinary shares, par value NIS 1.00 per share. No preferred shares are currently authorized.

Holders of our ordinary shares have one vote per share, and are entitled to participate equally in the payment of dividends and share distributions and, in the event of our liquidation, in the distribution of property after satisfaction of liabilities to creditors. Our articles may be amended by a resolution carried at a general meeting by a majority of the shares voting on such resolution. The shareholders rights may not be modified in any other way unless otherwise expressly provided in the terms of issuance of the shares.

Our articles of association require that we hold our annual general meeting of shareholders each year no later than 15 months from the last annual meeting, at a time and place determined by the board of directors, upon at least 21 days prior notice to our shareholders. No business may be commenced until a minimum quorum under applicable law, which currently provides for two or more shareholders holding at least one-quarter of the voting rights are present in person or by proxy. A meeting adjourned for lack of a quorum is adjourned to the same day in the following week at the same time and place. At the reconvened meeting, in the event a quorum is not present within half an hour of the time fixed for the meetings commencement, then any two shareholders present shall constitute a quorum, regardless of the number of shares held by them.

71

Shareholders may vote in person or by proxy, and will be required to prove title to their shares as required by the Companies Law pursuant to procedures established by the board of directors. Resolutions regarding the following matters must be passed at a general meeting of shareholders:

— amendments to our articles of association;

— appointment or termination of our auditors;

— appointment and dismissal of directors, other than temporary directors which may be appointed by other directors;

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

— increase or reduction of our authorized share capital;

— any merger as provided in Section 320 of the Companies Law;

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

A meeting of our shareholders shall be convened by our board of directors, at the request of any two directors or one quarter of the officiating directors, or by request of one or more shareholders holding at least 5% of our issued share capital. Within 21 days of receipt of the request, the board must convene a meeting and send out notices setting forth the date, time and place of the meeting.

The Israeli Companies Law

The Companies Law codifies the fiduciary duties that “office holders,” including directors and executive officers, owe to a company. An office holder, is defined in the Companies Law, as a (i) director, (ii) general manager, (iii) chief business manager, (iv) deputy general manager, (v) vice general manager, (vi) any other person assuming the responsibilities of any of the forgoing positions without regard to such person’s title or (vii) another manager directly subordinate to the general manager.

The Companies Law requires that an office holder of a company promptly disclose any personal interest that he or she may have and all related material information known to him or her, in connection with any existing or proposed transaction by the company. In addition, if the transaction is an extraordinary transaction, as defined under Israeli law, the office holder must also disclose any personal interest held by the office holder’s spouse, siblings, parents, grandparents, descendants, spouse’s descendants and the spouses of any of the foregoing, or by any corporation in which the office holder is a 5% or greater shareholder, holder of 5% or more of the voting power, director or general manager or in which he or she has the right to appoint at least one director or the general manager. An extraordinary transaction is defined as a transaction not in the ordinary course of the company’s business, not on market terms, or that is likely to have a material impact on the company’s profitability, assets or liabilities.

In the case of a transaction that is not an extraordinary transaction, after the office holder complies with the above disclosure requirement, only board approval is required unless the articles of association of the company provide otherwise. The transaction must not be adverse to the company’s interest. If the transaction is an extraordinary transaction, then, in addition to any approval required by the articles of association, it must also be approved by the audit committee and by the board of directors, and, under specified circumstances, by a meeting of the shareholders.

72

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

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

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

According to the Companies Law, the disclosure requirements discussed above also apply to a controlling shareholder of a public company. In general, extraordinary transactions with a controlling shareholder or in which a controlling shareholder has a personal interest, and agreements relating to employment and compensation terms of a controlling shareholder require the approval of the audit committee, the board of directors and the shareholders of the company. For this purpose, the term “controlling shareholder” is defined as a shareholder who has the ability to direct the activities of a company, other than if this power derives solely from the shareholder’s position on the board of directors or any other position with the company. The definition also includes shareholders that hold 25% or more of the voting rights if no other shareholder owns more than 50% of the voting rights in the company.

The shareholder approval must either include at least one-third of the shares held by disinterested shareholders who actively participate in the voting process, or, alternatively, the total shareholdings of the disinterested shareholders who vote against the transaction must not represent more than one percent of the voting rights in the company.

Private placements in a public company require approval by a company’s board of directors and shareholders in the following cases:

— A private placement that meets all of the following conditions:

š The private placement will increase the relative holdings of a shareholder that holds five percent or more of the company’s outstanding share capital, assuming the exercise of all of the securities convertible into shares held by that person, or that will cause any person to become, as a result of the issuance, a holder of more than five percent of the company’s outstanding share capital.

š 20 percent or more of the voting rights in the company prior to such issuance are being offered.

š All or part of the consideration for the offering is not cash or registered securities, or the private placement is not being offered at market terms.

— A private placement which results in anyone becoming a controlling shareholder of the public company.

73

In addition, under the Companies Law, certain transactions or a series of transactions are considered to be one private placement. Any placement of securities that does not fit the above description may be issued at the discretion of the board of directors.

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

— any amendment to the articles of association;

— an increase of the company's authorized share capital;

— a merger; or

— approval of interested party transactions that require shareholder approval.

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

Provisions Restricting Change in Control of Our Company

Tender Offer. A person wishing to acquire shares or any class of shares of a publicly traded Israeli company and who would as a result hold over 90% of the company’s issued and outstanding share capital or of a class of shares which are listed, is required by the Companies Law to make a tender offer to all of the company’s shareholders for the purchase of all of the issued and outstanding shares of the company. If the shareholders who do not respond to the offer hold less than 5% of the issued share capital of the company, all of the shares that the acquirer offered to purchase will be transferred to the acquirer by operation of law. The Companies Law provides for an exception regarding the threshold requirement for a shareholder that prior to and following February 2000 holds over 90% of a company’s issued and outstanding share capital. However, the shareholders may petition the court to alter the consideration for the acquisition. If the dissenting shareholders hold more than 5% of the issued and outstanding share capital of the company, the acquirer may not acquire additional shares of the company from shareholders who accepted the tender offer if following such acquisition the acquirer would then own over 90% of the company’s issued and outstanding share capital.

The Companies Law provides that an acquisition of shares of a public company must be made by means of a tender offer if as a result of the acquisition the purchaser would become a 25% or greater shareholder of the company. This rule does not apply if there is already another 25% shareholder of the company. Similarly, the Companies Law provides that an acquisition of shares in a public company must be made by means of a tender offer if as a result of the acquisition the purchaser would become a 45% or greater shareholder of the company, if there is no 45% or greater shareholder of the company.

74

Merger. The Companies Law permits merger transactions if approved by each party’s board of directors and the majority of each party’s shares voted on the proposed merger at a shareholders’ meeting called on at least 21 days’ prior notice. Under the Companies Law, merger transactions may be approved by holders of a simple majority of our shares present, in person or by proxy, at a general meeting and voting on the transaction. In determining whether the required majority has approved the merger, if shares of a company are held by the other party to the merger, or by any person holding at least 25% of the outstanding voting shares or 25% of the means of appointing directors of the other party to the merger, then a vote against the merger by holders of the majority of the shares present and voting, excluding shares held by the other party or by such person, or anyone acting on behalf of either of them, is sufficient to reject the merger transaction. If the transaction would have been approved but for the exclusion of the votes of certain shareholders as provided above, a court may still approve the merger upon the request of holders of at least 25% of the voting rights of a company, if the court holds that the merger is fair and reasonable, taking into account the value of the parties to the merger and the consideration offered to the shareholders. Upon the request of a creditor of either party to the proposed merger, the court may delay or prevent the merger if it concludes that there exists a reasonable concern that, as a result of the merger, the surviving company will be unable to satisfy the obligations of any of the parties to the merger. In addition, a merger may not be executed unless at least 30 days have passed from the receipt of the shareholders’ approval and 50 days have passed from the time that a proposal for approval of the merger has been filed with the Israeli Registrar of Companies. See alsoItem 6, “Directors, Senior Management And Employees – Directors And Senior Management”

Nasdaq Marketplace Rules and Home Country Practices

Not applicable.

C. Material Contracts

Convertible Loan Agreement with Mivtach Shamir.

On February 21, 2006, we consummated the Mivtach Agreement. Pursuant to the agreement, Mivtach Shamir provided us with a two-year $3 million loan, which Mivtach Shamir was entitled at its sole discretion, for a period of 24 months following the provision of the loan, to convert into 6,000,000 of our ordinary shares, at a price per share of $0.5 (half the loan was being held in escrow subject to our completion of a certain milestone, or conversion of the loan). The interest on the loan was repaid on a quarterly basis. We also granted Mivtach Shamir a two-year warrant to purchase 4,000,000 of our ordinary shares at an exercise price of $0.5 per share, exercisable only if the loan was converted. On February 21, 2006, Mivtach Shamir assigned their right to receive shares from us, under the convertible loan and warrant, to M.S.N.D. On June 21, 2007 we executed an agreement with M.S.N.D., which was approved by our shareholders in a meeting of our shareholders held on July 31, 2007, pursuant to which, the Mivtach Agreement was amended, or the Amendment Agreement. Pursuant to the Amendment Agreement, the terms of the Mivtach Agreement and the loan therein, were amended, such that in consideration for M.S.N.D.‘s undertaking to convert the full loan amount by no later than August 1, 2007 (a) Mivtach Shamir will be issued with 9,523,810 of our ordinary shares; and (b) Mivtach Shamir will receive a 4-year warrant to purchase 2,380,952 of our ordinary shares at an exercise price of $0.45 per share. Mivtach Shamir also agreed to waive its rights to exercise warrants into at least 3,000,000 ordinary shares issuable under the Mivtach Agreement, agreeing to exercise warrants into no more than 1,000,000 ordinary shares issuable under the Amendment Agreement, which warrants expired subsequently on February 21, 2008. Following consummation the Amendment Agreement M.S.N.D, has become a holder of more than 25% of our issued and outstanding share capital. We also entered into a Registration Rights Agreement with M.S.N.D., pursuant to which we filed a Registration Statement on Form F-1 on July 31, 2007, covering all of the ordinary shares and ordinary shares underlying the warrants under the Amendment Agreement, which had not previously been registered. M.S.N.D. also completed the purchase of 2,939,192 of our ordinary shares from three of the founders of ScanMaster, in accordance with the provisions of a share purchase agreement.

Agreement with Elbit and the Amendment to Registration Rights Agreement with Elbit

On June 21, 2007, following the approval of our board of directors and our audit committee, we executed an agreement with Elbit, or the Elbit Agreement. This agreement was approved by our shareholders in a meeting of our shareholders held on July 31, 2007. Pursuant to this agreement Elbit (i) converted an existing loan to us in the amount of $470,000 (including accrued interest up until March 31, 2007) into 1,492,063 of our ordinary shares, at a price of $0.315 per share; and (ii) invested in us $250,000 in consideration for 793,651 of our ordinary shares at a price of $0.315 per share and received a 4-year warrant to purchase 396,825 of our ordinary shares at an exercise price of $0.45 per share. At consummation we paid all interest accrued on the loan between April 1, 2007 and the closing date. Within the framework of the Elbit Agreement, pursuant to a registration rights agreement, or the Elbit Registration Rights Agreement, we undertook to file a Registration Statement covering all of the ordinary shares and ordinary shares underlying the warrants issued pursuant to the Elbit Agreement with the Securities and Exchange Commission by no later that July 31, 2007. We filed a Registration Statement on Form F-1 on July 31, 2007, covering all such ordinary shares and ordinary shares underlying Elbit’s warrants.

Following the Elbit Agreement, on January 1, 2007, we executed an amendment, or the Amendment, to the Elbit Registration Rights Agreement, which was approved by our shareholders on November 20, 2006, pursuant to which we agreed to register 2,647,643 of our ordinary shares beneficially owned by Elbit prior to the Elbit Registration Rights Agreement, or the Original Elbit Shares, by no later than September 30, 2007. Pursuant to the Amendment, we filed a Registration Statement on Form F-1 covering the Original Elbit Shares on July 31, 2007.

April Investment.

In July 2007 we completed the April Investment with a group of Israeli institutional investors, or the Israeli Investors, for the purchase of 9,465,544 of our ordinary shares for $0.315 per share, or an aggregate price of $2,981,646. Pursuant to the transaction, the investors were also issued warrants to purchase 4,732,774 of our ordinary shares at an exercise price per share of $0.45, exercisable for a period of 4 years. We filed a Registration Statement on Form F-1 covering all of the ordinary shares and ordinary shares underlying the warrants issuable under the April Investment on July 31, 2007.

Consulting Agreement with MA&AT.Discussions of this agreement are incorporated herein by reference to the discussion under the caption“Major Shareholders and Related Party Transactions – Related Party Transactions”in Item 7 of this Annual Report.

75

David Gal. Discussions of appointment of David Gal as CEO and compensation terms are incorporated herein by reference to the discussion under the caption“Major Shareholders and Related Party Transactions – Related Party Transactions”inItem 7 of this Annual Report.

Acquisition of Panoptes.

On February 21, 2006, together with ScanMaster, we acquired the business, assets, and shares of Panoptes, a company that develops, manufactures and markets machine vision systems for surface inspection, with an accent on technical woven materials, textiles, and glass fabric, or the Panoptes Technology. Panoptes’s machine vision systems inspects fabrics in all stages of production, from on-loom weaving to finished fabric, and produces images, maps and statistical data for all visual defects. In connection with such acquisition, we issued 800,000 of our ordinary shares to Ma’aragim, Panoptes’s previous shareholder, and, subject to certain instances, are obligated to pay cash royalties equaling 3.5% of sales of EVS optical inspection systems between January 1, 2006 and December 31, 2008.

Loan from Mizrahi Bank.

On August 15, 2005 and February 15, 2006, together with ScanMaster we entered into an agreement with Mizrahi Tefahot Bank Ltd., or Mizrahi, pursuant to which both us and ScanMaster received a credit line for the aggregate amount of $2,000,000 from Mizrahi. The credit line is secured by a first ranking floating charge on all of our assets and all the assets of ScanMaster. This credit line will terminate on June 30, 2007. We also granted Mizrahi a warrant to purchase up to 571,429 ordinary shares, at an exercise price of $0.77 per share. In November 2006 our board approved to reduce the exercise price to $0.5 per share. The number of our ordinary shares which we may issue pursuant to the warrant may increase upon certain events, as defined in the warrant.

Sale of Yuravision.

In June 2004, we purchased Yuravision Co. Ltd., or Yuravision, a company in the microelectronics and flat-panel display industries. In 2006 our board of directors and management decided to focus on existing markets rather than continue developing our microelectronics technologies. As a result, on December 1, 2006, we executed an agreement with a Korean corporation for the sale of Yuravision shares in consideration for $950,000, or the Purchase Price, plus the purchase from us of our right to receive from Yuravision repayment of an $800,000 loan, or the Loan Amount in consideration for the full value of the loan. Half of the Purchase Price was paid upon the closing of the transaction on December 15, 2006, and the remaining half of the Purchase Price was to be payable no later than December 1, 2008. The purchaser undertook to pay us half of the Loan Amount by no later than December 1, 2008 and the remaining half, or the Outstanding Payment, by no later than May 1, 2009. The Outstanding Payment was subject to reduction in the event that certain of the employees of Yuravision resigned from Yuravision prior to December 1, 2008. We received a stand by letter of credit from the purchaser guaranteeing payment of the Loan Amount.

76

On January 28, 2008 we entered into a modification agreement amending the December 1, 2006 agreement with the Korean corporation. Pursuant to the modification agreement the Loan Amount was reduced from $800,000 to $460,000, without any further obligation by the Korean corporation for the reduced amount of $340,000. The payment terms of the loan were changed so that the Korean corporation paid us $360,000 by February 4, 2008 and paid us the remaining $100,000 owed under the loan by January 28, 2009. A payment of $360,000 was made by the Korean corporation to us on February 4, 2008. The terms for the payment of the purchase price were not changed.

Loans from Bank Hapoalim, Bank Leumi and Mivtach Shamir.

Discussions of these agreements are incorporated herein by reference to the discussion under the caption“Information on the Company – Recent Developments”in Item 4 of this Annual Report.

D. Exchange Controls

The Government of Israel recently replaced the general prohibition under the Israel Currency Control Law. Pursuant to the new general permit, most transactions in foreign currency are permitted. Any dividends or other distributions paid in respect of ordinary shares and any amounts payable upon the dissolution, liquidation or winding up of our affairs, as well as the proceeds of any sale in Israel of our securities to an Israeli resident are freely repatriable into non-Israeli currencies at the rate of exchange prevailing at the time of conversion, provided that Israeli income tax has been paid on (or withheld from) such payments. Because exchange rates between the NIS and the U.S. Dollar fluctuate continuously, U.S. shareholders will be subject to any such currency fluctuation during the period from when such dividend is declared through the date that the payment is made in U.S. Dollars. For further discussion with respect to such currency fluctuation, seeItem 5, “Operating and Financial Review and Prospects – Impact of Inflation and Devaluation on Results of Operations, Liabilities, and Assets.”

E. Taxation

The following is a summary of the material tax consequences in the United States and Israel to individual and corporate residents of the United States and Israel resulting from the sale of ordinary shares (i) issuable to the selling security holders pursuant to the exercise of the Warrants and (ii) held by the selling security holders. Since we have never paid dividends on our ordinary shares, this summary does not discuss the tax consequences in Israel or the United States that would result from the payment of dividends. To the extent that the discussion is based on tax legislation that has not been subject to judicial or administrative interpretation, we cannot assure you that the tax authorities will accept the views expressed in this summary.

Israeli Tax Considerations

The following is a summary of the current tax law applicable to companies in Israel, with special reference to its effect on us. The following also contains a discussion of specified Israeli Government programs benefiting us. To the extent that the discussion is based on tax legislation that has not been subject to judicial or administrative interpretation, there can be no assurance that the views expressed in the discussion will be accepted by the tax authorities in question. The discussion is not intended, and should not be taken, as legal or professional tax advice and is not exhaustive of all possible tax considerations.

77

WE RECOMMEND THAT IN ADDITION TO REVIEWING THE DISCUSSION BELOW, PROSPECTIVE PURCHASERS OF OUR ORDINARY SHARES CONSULT THEIR OWN TAX ADVISORS CONCERNING THE UNITED STATES, ISRAELI OR OTHER TAX CONSEQUENCES TO THEM, BASED UPON THEIR PARTICULAR CIRCUMSTANCES OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF ORDINARY SHARES, INCLUDING, IN PARTICULAR, THE EFFECT OF ANY FOREIGN, STATE OR LOCAL TAXES.

General Corporate Tax Structure

Israeli companies are subject to corporate tax at the rate of 27% in the 2008 tax year 26% in the 2009 tax year and 25% in the 2010 tax year and thereafter. However, the effective tax rate payable by a company which derives income from an Approved Enterprise (as further discussed below) may be considerably less.

Law for the Encouragement of Capital Investments, 1959

Certain of our facilities have been granted “Approved Enterprise” status under the Law for the Encouragement of Capital Investments, 1959, as amended, or the Investment Law. The Investment Law provides that a capital investment in eligible facilities may, upon application to the Israel Investment Center of the Ministry of Industry and Trade of the State of Israel (referred to as the Investment Center), be designated as an Approved Enterprise. Each certificate of approval for an Approved Enterprise relates to a specific investment program delineated both by its financial scope, including its capital sources and its physical characteristics, for example, the equipment to be purchased and utilized pursuant to the program. The tax benefits derived from any such certificate of approval relate only to taxable income attributable to the specific Approved Enterprise.

A recent amendment to the Investment Law which came into effect as of April 1, 2005, or the Amendment, significantly changed the provisions of the Investment Law. The Amendment limits the scope of enterprises which may be approved by the Investment Center by determining criteria for the approval of a facility as an Approved Enterprise, such as provisions generally requiring that at least 25% of the income of an Approved Enterprise will be derived from export. Additionally, as explained below, the Amendment sets forth major changes in the manner in which tax benefits are awarded under the Investment Law whereby companies no longer require Investment Center approval (and Approved Enterprise status) in order to qualify for tax benefits. However, the Investment Law provides that terms and benefits included in any certificate of approval already granted will remain subject to the provisions of the Investment Law as in effect on the date of such approval. Therefore the tax benefits granted to our Approved Enterprises under the Investment Law will generally not be subject to the provisions of the Amendment.

78

Tax Benefits Prior to the Amendment

In general, taxable income of a company derived from an Approved Enterprise was subject to corporate tax at the maximum rate of 25% rather than the rates stated above (this will also apply to Approved Enterprises approved after the Amendment, as explained below). The 25% corporate tax rate applies for a period of time termed the “benefit period”. The benefit period is a period of seven years commencing with the year in which the Approved Enterprise first generated taxable income. In any event, the benefit period is limited to 12 years from the commencement of production or 14 years from the year of receipt of approval, whichever is earlier. Under certain circumstances (as further detailed below), the benefit period may extend to a maximum of ten years from the commencement of the benefit period. In the event that a company is operating under more than one approval or that only part of its capital investments are approved, or a Mixed Enterprise, its effective Company Tax rate is the result of a weighted combination of the various applicable rates.

A company which qualifies as a “Foreign Investors’ Company” is entitled to an extended benefit period and to further reductions in the tax rate normally applicable to Approved Enterprises. Subject to certain conditions, a “Foreign Investors’ Company” is a company in which persons who are not residents in Israel invested more than 25% of its combined shareholders’ investment in share capital (in terms of rights to profits, voting and the appointment of directors, share capital including long-term shareholders’ loans, and share capital only), as defined in the Investment Law. The percentage owned by nonresidents of Israel for any tax year will be determined by the lowest percentage of any of the above rights held by nonresidents during that year. Such a company will pay corporate tax at reduced rates for an extended ten-year (rather than the otherwise applicable seven-year) period as detailed below:

Level of Foreign Investment	Corporate Tax Rate	Benefit period (years)
Over 0% but less than 25%	25%	7
Over 25% but less than 49%	25%	10
Over 49% but less than 74%	20%	10
Over 74% but less than 90%	15%	10
90% or more	10%	10

There can be no assurance that the above-mentioned shareholding proportion will be reached by us.

Prior to the Amendment, a company owning an Approved Enterprise approved after April 1, 1986 (or prior thereto provided no government grants had previously been granted regarding such enterprise) was entitled to elect (as we have) to forego certain Government grants extended to Approved Enterprises in return for an “alternative benefits track”, or the Alternative Track. Under the Alternative Track, a company’s undistributed income derived from an Approved Enterprise is exempt from corporate tax for a period of between two and ten years from the first year of taxable income, depending on the geographic location of the Approved Enterprise within Israel, and such company is eligible for the reduced tax rates under the Investment Law for the remainder of the benefit period as mentioned above.

79

The entitlement to the above benefits is conditional upon fulfillment of the conditions stipulated by the law, regulations published thereunder and the instruments of approval for the specific investments in the Approved Enterprise. In the event of failure to comply with these conditions, the benefits may be canceled and a company may be required to refund the amount of the benefits, in whole or in part, with the addition of linkage differences, interest and penalties.

Should we derive income from sources other than the Approved Enterprise during the relevant periods of benefits, such income will be taxable at regular corporate tax rates.

A company that elected the Alternative Track and that subsequently pays a dividend out of income derived from the Approved Enterprise(s) during the tax exemption period will be subject to corporate tax in the year the dividend is distributed in respect of the amount distributed (including the corporate tax thereon), at the rate that would have been applicable had the company not elected the Alternative Route (10%-25%, depending on the level of foreign investment in the company, as explained above). In addition, the dividend recipient is taxed at the reduced rate applicable to dividends from Approved Enterprises (15%), if the dividend is distributed during the tax exemption period or within a specified period thereafter (In the event, however, that the company qualifies as a Foreign Investors’ Company, there is no such time limitation). This tax must be withheld by the company at source, regardless of whether the dividend is converted into foreign currency.

Subject to certain provisions concerning income subject to the Alternative Track, all dividends are considered to be attributable to the entire enterprise and the effective tax rate is the result of a weighted combination of the various applicable tax rates.

The Investment Law also provides that an Approved Enterprise is entitled to accelerated depreciation on its property and equipment that are included in an approved investment program.

Grants and certain other incentives received by a company in accordance with the Investment Law remain subject to final ratification by the Israel Investment Center and final determination by the Israel Tax Authority. Such ratification and determination are conditional upon fulfillment of all of the terms of the approved program.

Tax Benefits under the Amendment

As a result of the Amendment, it is no longer required to acquire Approved Enterprise status in order to receive the tax benefits previously available under the Alternative Track of benefits and therefore companies need not apply to the Investment Center for this purpose. However, the Investment Center will continue to grant Approved Enterprise status to companies seeking governmental grants. A company may claim the tax benefits offered by the Investment Law directly in its tax returns, provided that its facilities meet the criteria for tax benefits set forth in the Amendment, or a Benefited Enterprise. Companies are also entitled to approach the Israeli Tax Authority and request for a pre-ruling regarding their eligibility for benefits under the Amendment. The Amendment includes provisions intended to ensure that a company will not enjoy both government grants and tax benefits for the same investment program.

80

Tax benefits are available under the Amendment to production facilities and to other eligible facilities, which are generally required to derive more than 25% of their business income from export. In order to receive the tax benefits, the Amendment states that the company must make an investment in the Benefited Enterprise exceeding a minimum amount specified in the Investment Law. Such investment may be made over a period of no more than three years concluding at the end of the year in which the company requests to have the tax benefits apply to its Benefited Enterprise, or the Year of Election. Where the company requests to have the tax benefits apply to an expansion of existing facilities, only the expansion will be considered a Benefited Enterprise and the company’s effective tax rate will be the result of a weighted combination of the applicable rates. In the case of an expansion of existing facilities, the minimum investment required in order to qualify as a Benefited Enterprise is determined as the lower of a certain percentage of the company’s production assets before the expansion and a minimal amount of NIS 300,000.

The tax benefits available under the Amendment to qualifying income of a Benefited Enterprise are determined by the geographic location of the Benefited Enterprise in Israel. The Investment Law divides the country into three zones – A, B and all other areas (“Zone C”), so that a Benefited Enterprise operating in Zone A (which generally includes areas remote from the center of Israel) will receive the greatest benefits and Benefited Enterprises in Zone C will receive the least benefits.

The Amendment provides that a company producing income from a Benefited Enterprise in Zone A may elect either that (i) the undistributed income derived from the Benefited Enterprise will be fully tax exempt for the entire benefit period described below, or tax exemption, in which case the ordinary provisions described below concerning the taxation of the company and shareholder for distribution of dividends will apply; or (ii) that the income from its Benefited Enterprise will be subject to corporate tax at a rate of a 11.5%, in which case dividends paid out of such income to a foreign resident will be taxed at a rate of 4% and the company will not be subject to additional tax upon dividend distribution. Further benefits are available in the event of certain large investments by multinational companies. Benefited Enterprises located in Zones B and C will be exempt from tax for six and two years, respectively, and subject to tax at a rate of 10%-25% for the remainder of the benefit period, depending on the extent of foreign investment in the Company, as described above.

Similarly to a company which elected the Alternative Track before the amendment, dividends paid out of income derived by a Benefited Enterprise, or out of dividends received from a company whose income is derived from a Benefited Enterprise, are generally subject to withholding tax at the rate of 15%, such tax being deductible at source. The reduced withholding tax rate of 15% is limited to dividends and distributions out of income derived during the benefit period and actually paid at any time up to 12 years thereafter. A company qualifying for tax benefits under the Amendment which pays a dividend out of income derived by its Benefited Enterprise during the tax exemption period will be subject to corporate tax in respect of the gross amount of the dividend. The rate of such corporate tax will be 25%, which is the rate to which a Benefited Enterprise is generally subject. Such tax rate is lower in the case of a qualified “Foreign Investors’ Company”. The dividend recipient is subject to tax at the rate of 15% on the amount received which tax is deductible at source.

The period for which tax benefits are available under the Amendment is also determined by the geographical location of the Benefited Enterprise in Israel. The benefit period for Benefited Enterprises in Zone A will end on the earlier of (i) a period of ten years from the tax year in which the company first derived taxable income from the Benefited Enterprise, or the Commencement Year; or (ii) twelve years (or in certain cases fourteen years) from the first day of the Year of Election. The benefit period for Benefited Enterprises in Zones B and C will extend until the earlier of (i) seven years from the Commencement Year or (ii) 12 years from the first day of the Year of Election. This period may be extended for Benefited Enterprises owned by a “Foreign Investors’ Company” during all or part of the benefit period.

81

Additionally, the Amendment sets forth a minimal amount of foreign investment required for a company to be regarded as a Foreign Investors’ Company.

There can be no assurance that we will attain approval for additional tax benefits under the Amendment, or receive approval for Approved Enterprises in the future.

Law for the Encouragement of Industrial Research and Development, 1984

Under the Law for the Encouragement of Industrial Research and Development, 1984, commonly referred to as the Research Law, research and development programs that meet specified criteria and are approved by a governmental committee of the OCS are eligible for grants of up to 50% of the project’s expenditures, as determined by the research committee, in exchange for the payment of royalties from the sale of products developed under the program. Regulations under the Research Law generally provide for the payment of royalties to the Chief Scientist of 3-5% on sales of products and services derived from a technology developed using these grants until 100% of the dollar-linked grant is repaid. Our obligation to pay these royalties is contingent on our actual sale of such products and services. In the absence of such sales, no payment is required. Effective for grants received from the Chief Scientist under programs approved after January 1, 1999, the outstanding balance of the grants will be subject to interest at a rate equal to the 12 month LIBOR applicable to dollar deposits that is published on the first business day of each calendar year. Following the full repayment of the grant, there is no further liability for royalties.

        The terms of the Israeli government participation also require that the manufacture of products developed with government grants be performed in Israel. However, under the regulations of the Research Law, if any of the manufacturing is performed outside of Israel, assuming we receive approval from the Chief Scientist for the foreign manufacturing, we may be required to pay increased royalties. The increase in royalties depends upon the extent of the manufacturing volume that is performed outside of Israel as follows:

Extent of Manufacturing Volume Outside of Israel	Royalties to the Chief Scientist as percentage of Grants
less than 50%	120%
between 50% and 90%	150%
90% and more	300%

        A recent amendment to the Research Law has provided that the restriction on manufacturing outside of Israel shall not apply to the extent that plans to so manufacture were declared when applying for funding.

82

        In general, the technology developed with Chief Scientist grants may not be transferred to Israeli third parties without the prior approval of a governmental committee under the Research Law and may not be transferred to non-Israeli third parties. A recent amendment to the Research Law has stressed, that it is not just transfer of know-how that is prohibited, but also transfer of any rights in such know-how. This approval, however, is not required for the export of any final products developed using the grants. Approval of the transfer of technology may be granted in specific circumstances only if the recipient abides by the provisions of the Research Law and related regulations, including the restrictions on the transfer of know-how and the obligation to pay royalties in an amount that may be increased. We cannot assure you that any consent, if requested, will be granted, or if granted, will be on reasonable commercial terms.

The Israeli authorities have indicated that the government may reduce or abolish grants from the Chief Scientist in the future. Even if these grants are maintained, we cannot assure you that we will receive Chief Scientist grants in the future. In addition, each application to the Chief Scientist is reviewed separately, and grants are based on the program approved by the research committee. Generally, expenditures supported under other incentive programs of the State of Israel are not eligible for grants from the Chief Scientist. We cannot assure you that applications to the Chief Scientist will be approved and, until approved, the amounts of any grants are not determinable.

Tax Benefits and Grants for Research and Development

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

Law for the Encouragement of Industry (Taxes), 1969

Under the Law for the Encouragement of Industry (Taxes), 1969, or the Industry Encouragement Law, Industrial Companies (as defined below) are entitled to the following tax benefits:

    (a)        Amortization of purchases of know-how and patents over eight years for tax purposes.

    (b)        The right to elect, under specified conditions, to file a consolidated tax return with other related Israeli Industrial Companies.

    (c)        Amortization of expenses incurred in connection with certain public securities issuances over a three-year period.

    (d)        Tax exemption for shareholders who held shares before a public offering on capital gains derived from the sale (as defined by law) of securities, if realized after more than five years from the public issuance of additional securities of the company. (As of November 1994, this exemption was repealed, however, it applies to some of our shareholders pursuant to a grand-fathering clause; the recent tax reform repealed the grandfathered exemption for any gains accrued from January 1, 2003.)

    (e)        Accelerated depreciation rates on equipment and buildings.

83

Eligibility for benefits under the Industry Encouragement Law is not subject to receipt of prior approval from any governmental authority. Under the Industry Encouragement Law, an “Industrial Company” is defined as a company resident in Israel, at least 90% of the income of which, in any tax year, determined in Israeli currency, exclusive of income from government loans, is derived from an “Industrial Enterprise” owned by it. An “Industrial Enterprise” is defined as an enterprise whose major activity in a given tax year is industrial production activity.

We believe that we currently qualify as an Industrial Company within the definition of the Industry Encouragement Law. No assurance can be given that we will continue to qualify as an Industrial Company or that the benefits described above will be available in the future.

Taxation under Inflationary Conditions

The Income Tax Law (Inflationary Adjustments), 1985, which was effective until 31.12.2007, or the Inflationary Adjustments Law, represents an attempt to overcome the problems presented to a traditional tax system by an economy undergoing rapid inflation. The Inflationary Adjustments Law is characterized by a high degree of complexity and its salient features can be described generally as follows:

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

    (b)        Depreciation deductions on Fixed Assets and losses carried forward are adjusted for inflation based on the increase in the Israeli Consumer Price Index.

In February 2008, the Inflationary Adjustments Law was repealed, effective from 1.1.2008 and therefore companies will be taxed on their income using nominal values.

Capital Gains Tax on Sales of Our Ordinary Shares

Until the end of the year 2002 and provided we maintained our status as an industrial corporation, capital gains from the sale of our securities were generally exempt from Israeli Capital Gains Tax. This exemption did not apply to a shareholder whose taxable income was determined pursuant to the Israeli Income Tax Law (Inflationary Adjustments) 1985, or to a person whose gains from selling or otherwise disposing of our securities were deemed to be business income.

On January 1, 2006 an amendment to the Israeli tax regime became effective, or the 2006 Tax Reform. The 2006 Tax Reform significantly changed the tax rates applicable to income derived from shares.

84

According to the 2006 Tax Reform, an individual is subject to a 20% tax rate on real capital gains derived from the sale of shares, as long as the individual is not a “substantial shareholder” (generally a shareholder with 10% or more of the right to profits, right to nominate a director or voting rights) of the company issuing the shares. There will generally be no capital gains tax on the inflationary surplus.

A substantial shareholder will be subject to tax at a rate of 25% in respect of real capital gains derived from the sale of shares issued by the company in which he or she is a substantial shareholder. The determination of whether the individual is a substantial shareholder will be made on the date that the securities are sold. In addition, the individual will be deemed to be a substantial shareholder if at any time during the 12 months preceding this date he had been a substantial shareholder.

Non-Israeli residents are exempt from Israeli capital gains tax on any gains derived from the sale of shares in an Israeli corporation publicly traded on the TASE and/or on a foreign stock exchange, provided such gains do not derive from a permanent establishment of such shareholders in Israel and that such shareholders did not acquire their shares prior to the issuer’s initial public offering. However, non-Israeli corporations will not be entitled to such exemption if an Israeli resident (i) has a controlling interest of 25% or more in such non-Israeli corporation, or (ii) is the beneficiary of or is entitled to 25% or more of the revenues or profits of such non-Israeli corporation, whether directly or indirectly.

In some instances where our shareholders may be liable to Israeli tax on the sale of their ordinary shares, the payment of the consideration may be subject to the withholding of Israeli tax at the source.

Pursuant to the treaty between the Governments of the United States and Israel with respect to taxes on income, or the U.S.-Israel tax treaty, the sale, exchange or disposition of our ordinary shares by a person who qualifies as a resident of the United States under the treaty and who is entitled to claim the benefits afforded to him by the treaty, will generally not be subject to Israeli capital gains tax. This exemption shall not apply to a person who held, directly or indirectly, shares representing 10% or more of the voting power in our company during any part of the 12-month period preceding the sale, exchange or disposition, subject to certain conditions. A sale, exchange or disposition of our shares by a U.S. resident qualified under the treaty, who held, directly or indirectly, shares representing 10% or more of the voting power in our company at any time during the preceding 12-month period would be subject to Israeli tax, to the extent applicable; however, under the treaty, this U.S. resident would be permitted to claim a credit for these taxes against the U.S. income tax with respect to the sale, exchange or disposition, subject to the limitations in U.S. laws applicable to foreign tax credits.

Taxation of Dividends

Non-residents of Israel are subject to income tax on income accrued or derived from sources in Israel. These sources of income include passive income such as dividends, royalties and interest, as well as non-passive income from services rendered in Israel. On distributions of dividends other than bonus shares, or stock dividends, to Israeli individuals and foreign resident individuals and corporations we would be required to withhold income tax at the rate of 20%. If the income out of which the dividend is being paid is attributable to an Approved Enterprise under the Law for the Encouragement of Capital Investments, 1959, the rate is 15%. A different rate may be provided for in a treaty between Israel and the shareholder’s country of residence. Under the U.S.-Israel tax treaty, if the income out of which the dividend is being paid is not attributable to an Approved Enterprise, then income tax with respect to shareholders that are U.S. corporations holding at least 10% of our voting power in the twelve-month period preceding the distribution of such dividends, is generally required to be withheld at the rate of 12.5%.

85

Residents of the United States will generally have taxes in Israel withheld at source. Such persons generally would be entitled to a credit for United States Federal income tax purposes for the amount of such taxes withheld, subject to limitations applicable to foreign tax credits.

Effective Corporate Tax Rate

Our effective tax rate in Israel was 0% in each of the years 2003, 2004, 2005, 2006,2007 and 2008 (the regular rate of corporate tax being 35% in 2004, 34% in 2005, 31% in 2006 and 29% in 2007).

Under the law, by virtue of the “approved enterprise” status granted to investments in certain assets of ours and ScanMaster Ltd., we are entitled to various tax benefits.

The main tax benefits available to us and ScanMaster Ltd. are:

(a) Reduced tax rates:

(i) The Company

Tax exemption during the period of benefits – 10 years – commencing in the first year in which we earn taxable income from the approved enterprises (provided that the maximum period to which it is restricted by the law has not elapsed).

We have three approved enterprises; the benefit period in respect of the first, second and third enterprises commenced in 1994, 1995, and 1997, respectively. The periods of benefits expired in 2003, 2004 and 2006, respectively.

In the event of distribution of cash dividends from income, which was tax exempt as above, we would have to pay 25% tax in respect of the amount distributed. The amount distributed for this purpose includes the amount of the tax that applies as a result of the distribution.

In 2005, we received from the Investment Center the instrument of approval for its fourth approved enterprise.

86

(ii) ScanMaster Ltd.

During the period of benefits – 7 years – commencing in the first year in which the company earns taxable income from the approved enterprises (provided the maximum period to which it is restricted by law has not elapsed), the following reduced tax rates apply:

Tax exemption on income from approved enterprises in respect of which the companies have elected the “alternative benefits” (involving waiver of investment grants); the length of the exemption period is four years, after which the income from these enterprises is taxable at the rate of 25% for three years.

ScanMaster Ltd. has three approved enterprises; the benefit periods in respect of the first and second enterprises commenced in 1994 and 1997, respectively. The period of tax benefits in respect of the first approved enterprise has expired. The period of tax benefits in respect of the second approved enterprise will expire in 2008. The third approved enterprise has not yet been activated.

On March, 2004 ScanMaster Ltd. was warned by the Investment Center that their second approved enterprise status may be withdrawn, a decision which we plan to appeal in the near future. In the event such approved enterprise status is cancelled, we do not believe that we will be subject to penalties since a grant has not been received and tax benefits were not used.

Our taxes outside Israel are dependent on operations in each jurisdiction as well as relevant laws and treaties. We incurred tax expenses in the aggregate amount of approximately $6,000, $3,000 and $6,000, outside of Israel in 2004, 2003 and 2002, respectively. There can be no assurance that changes in our operations or applicable tax treaties or laws will not subject us to taxation.

We received final tax assessments for the years since our incorporation ending and including December 31, 2002. ScanMaster Ltd. received final tax assessments through the tax year 2002. Our other subsidiaries have not received final tax assessments since their respective incorporations.

United States Tax Considerations

Subject to the limitations described in the next paragraph, the following discussion describes the material U.S. federal income tax consequences resulting from the ownership and disposition of ordinary shares by each person who is a US Holder (as defined below). For purposes of our discussion a U.S. Holder means any holder of ordinary shares who is:

— a citizen or resident of the United States;

— a corporation created or organized in the United States or under the laws of the United States or any State;

— an estate, the income of which is includable in gross income for U.S. federal income tax purposes regardless of its source; or

— a trust, if a court within the United States is able to exercise primary supervision over the administration of the trust and one or more U.S. persons have the authority to control all substantial decisions of the trust or if the trust has validly elected to be treated as a U.S. person under applicable Treasury regulations.

87

The discussion is based on current provisions of the Internal Revenue Code of 1986, or the Code, as amended, current and proposed Treasury regulations promulgated thereunder, and administrative and judicial decisions as of the date hereof, all of which are subject to change, possibly on a retroactive basis. This discussion is not a representation of, nor does it address, all aspects of United States federal income taxation that may be relevant to any particular shareholder based on such shareholder’s individual circumstances. In particular, this discussion considers only U.S. Holders that will own ordinary shares as capital assets at all relevant times and does not address the potential application of the alternative minimum tax or U.S. federal income tax consequences to U.S. Holders that are subject to special treatment, including U.S. Holders that:

— are broker-dealers or insurance companies;

— have elected mark-to-market accounting; are financial institutions or financial services entities;

— hold ordinary shares as part of a straddle, hedge or conversion transaction with other investments;

— own directly, indirectly or by attribution at least 10% of our voting power; or

— have a functional currency that is not the U.S. dollar.

In addition, this discussion does not address any aspect of state, local or non-U.S. tax laws.

Additionally, the discussion does not consider the tax treatment of persons who hold ordinary shares through a partnership or other pass-through entity or the possible application of U.S. federal gift or estate tax.

Each prospective investor is advised to consult such person’s own tax advisor with respect to the specific tax consequences to such person of purchasing, holding or disposing of ordinary shares.

F. Dividends and Paying Agents.

Not applicable

G. Statement by Experts.

Not applicable

H. Documents on Display

We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended, applicable to foreign private issuers and fulfill the obligation with respect to such requirements by filing reports with the Securities and Exchange Commission. You may inspect and copy such material at the public reference facilities maintained by the Securities and Exchange Commission, 100 F Street, N.E., Washington, D.C. 20549. You may also obtain copies of such material from the Securities and Exchange Commission at prescribed rates by writing to the Public Reference Section of the Securities and Exchange Commission, 100 F Street, N.E., Washington, D.C. 20549. Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the public reference room. The Securities and Exchange Commission maintains an Internet website athttp://www.sec.gov that contains reports, proxy statements, information statements and other material that are filed through the Securities and Exchange Commission’s Electronic Data Gathering, Analysis and Retrieval (EDGAR) system. We began filing through the EDGAR system beginning on December 2, 2002.

88

As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of proxy statements, and our officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act. In addition, we are not required under the Exchange Act to file periodic reports and financial statements with the Securities and Exchange Commission as frequently or as promptly as United States companies whose securities are registered under the Exchange Act. However, we generally do publicly announce our year-end results promptly and file periodic information with the SEC under cover of Form 6-K. A copy of each report submitted in accordance with applicable United States law is available for public review at our principal executive offices.

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

I. Subsidiary Information.

Not applicable

ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

        In the course of our normal operations, we are exposed to market risks including fluctuations in foreign currency exchange rates and interest rates.

Foreign Currency Exchange

        The majority of our revenues is generated in, or linked to, U.S. dollars (“Dollars”). In addition, a substantial portion of our costs is incurred in New Israeli Shekels (“NIS”). We believe that the Dollar is the currency of the primary economic environment in which we operate. Thus, our functional and reporting currency is the Dollar.

        Our operating and pricing strategies take into account changes in exchange rates over time. However, there can be no assurance that future fluctuations in the value of foreign currencies will not have an adverse material effect on our business, operating results or financial condition.

        Market risk was estimated as the potential change in fair value resulting from a hypothetical 10% change in the year-end Dollar exchange rate.

        As of December 31, 2008, we had accounts payable in NIS or in funds linked thereto in the amount of $3.4 million. Market risk was estimated as the potential increase in fair value resulting from a hypothetical 10% decrease in the year-end NIS/Dollar and the Euro/Dollar exchange rate. Assuming such decrease in the NIS/Dollar and the Euro/Dollar exchange rate, the fair value of our accounts payable would increase by $340,000.

89

Interest Rate Risk

        Our exposure to market rate risk for changes in interest rates relates primarily to funds borrowed by us from banks and others. As of December 31, 2008 we had liabilities in the amount of $6.388 million. Market risk was estimated as the potential increase in fair value of our liabilities resulting from a hypothetical 10% increase in the year-end interest rate of our liabilities. Assuming such increase in the interest rates, the fair value of our cash and cash equivalents would decrease by approximately $32,000.

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES.

        Not applicable.

PART II

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES.

        None.

ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS.

        None.

ITEM 15. CONTROLS AND PROCEDURES

Not Applicable.

ITEM 15T. CONTROLS AND PROCEDURES

    (a)        Our management, including our former chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2008. Based on such review, our chief executive officer and chief financial officer have concluded that we have in place effective controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure, and is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.

90

    (b)        Our management, under the supervision of our chief executive officer and chief financial officer, is responsible for establishing and maintaining adequate internal control over our financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended. The Company’s internal control over financial reporting is defined as a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes policies and procedures that:

– pertain to the maintenance of records that in reasonable detail accurately and fairly reflect our transactions and asset dispositions;

– provide reasonable assurance that transactions are recorded as necessary to permit the preparation of our financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors; and

– provide reasonable assurance regarding the prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on our financial statements.

        Due to its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

         Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we evaluated the effectiveness of our internal control over financial reporting as of December 31, 2008 based on the framework for Internal Control-Integrated Framework set forth by The Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management concluded that the Company’s internal controls over financial reporting were effective as of December 31, 2008.

        This management report on internal control over financial reporting shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended or otherwise subject to the liabilities of that Section.

        This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Commission that permit us to provide only management’s report in this Annual report.

    (c)        There were no changes in our internal controls over financial reporting identified with the evaluation thereof that occurred during the period covered by this annual report that have materially affected, or are reasonable likely to materially affect our internal control over financial reporting.

ITEM 16. [RESERVED]

91

ITEM 16A Audit Committee Financial Expert

        Our board of directors has determined that Mr. David Schwartz is our audit committee financial expert and is independent in accordance with applicable Securities and Exchange Commission regulations.

ITEM 16B Code of Ethics

        Our board of directors has adopted a code of ethics, which applies to all of our employees, officers and directors, including our chief executive officer, our chief financial officer and our principal accountant. We undertake to provide any person with a copy of our code of ethics upon request.

ITEM 16C Principal Accountant Fees and Services

        The following table presents fees for professional audit services rendered by our principal accountants, Brightman Almagor & Co., for the audit of our consolidated annual financial statements for the years ended December 31, 2007, and December 31, 2008.

	2008		2007
Audit Fees(1)		80,000		70,000
Tax Fees(2)		-		2,500
All Other Fees(3)		1,560		16,200
Audit Related Fees(4)		7,500		-
Total		89,060		88,700

(1) “Audit fees” consist of fees for professional services rendered for the audit of our consolidated financial statements and review of financial statements and services normally provided by the independent auditor in connection with statutory and regulatory filings or engagements.

(2) “Tax fees” are fees for consulting services rendered by our auditors with respect to company tax services and to tax benefits under the Israeli law for encouragement of investment.

(3) “All Other Fees” are fees for consulting services rendered by our auditors with respect to the requests for grants from the Israeli Office of the Chief Scientist and other.

(4) “Audit Related Fees” are fees for reconciliation of our financial reports according to IFRS.

Pre-approval Policies and procedures

The audit committee approves all audit, audit-related services, tax services and other services provided by Brightman Almagor & Co. Any services provided by Brightman Almagor & Co. that are not specially included within the scope of the audit must be pre-approved by our audit committee prior to any engagement.

ITEM 16D Exemptions from the Listing and Standards of Audit Committees

        Not applicable.

92

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

The discussion relating to the purchase of our securities by M.S.N.D is incorporated herein by reference toItem 3,“Risk Factors – Risks Related to Our Ordinary Shares”.

ITEM 16F Changes in Registrant’s Certifying Accountant.

        Not applicable.

ITEM 16G Corporate Governance.

        Not applicable.

PART III

ITEM 17. FINANCIAL STATEMENTS.

        Not applicable.

ITEM 18. FINANCIAL STATEMENTS.

        See pages F-1 to F-41.

ITEM 19. EXHIBITS.

1.1 Articles of Association, as amended, of the Registrant, incorporated by reference to Exhibit A to our Form 6-K, File No. 000-28580, filed with the Commission on January 25, 2006.

1.2 English translation or summary from Hebrew original Memorandum of Association of the Registrant, incorporated by reference to our Registration Statement on Form F-1, File No. 333-03080, as amended, filed with the Commission on April 2, 1996.

4.1 Amendment No.1 to License Agreement dated June 12, 1996, among the Company, Elbit Ltd. and Dr. Ilan Tamches, dated May 12, 2002, incorporated by reference to our Annual Report on Form 20-F for the year ended December 31, 2001.

4.2 Appendix to Agreement dated February 21, 2006, between the Company and Mivtach Shamir Holdings Ltd., incorporated by reference to our Registration Statement on Form F-3, File No. 333-134591, filed with the Commission on May 31, 2006.

4.3 Securities Purchase Agreement among the Company and the Buyers as defined therein, dated April 30, 2007, incorporated by reference to our Annual Report on Form 20-F for the year ended December 31, 2006.

4.4 Registration Rights Agreement among the Company and the Buyers as defined therein, dated April 30, 2007, incorporated by reference to our Annual Report on Form 20-F for the year ended December 31, 2006.

93

4.5 Form of Ordinary Share Purchase Warrant issued to the Investor parties to the Securities Purchase Agreement, incorporated by reference to our Annual Report on Form 20-F for the year ended December 31, 2006.

4.6 Registration Rights Agreement between the Company and Elbit Ltd., dated January 1, 2007, incorporated by reference to our Annual Report on Form 20-F for the year ended December 31, 2006.

4.7 Stock and Loan Purchase Agreement for the sale of Yuravision Co. Ltd. between the Company and the Purchaser as defined therein, dated December 1, 2006, incorporated by reference to our Annual Report on Form 20-F for the year ended December 31, 2006.

4.8 Employee Retention Agreement among the Company and the Purchaser as defined therein, dated November 29, 2006, incorporated by reference to our Annual Report on Form 20-F for the year ended December 31, 2006.

4.9 Consulting Agreement between the Company and MA&AT, dated May 2006, incorporated by reference to our Annual Report on Form 20-F for the year ended December 31, 2006.

4.10 Consulting Agreement between the Company and MA&AT, dated November 1, 2007, superseding and replacing the Consulting Agreement dated May 2006, incorporated by reference to our Annual Report on Form 20-F for the year ended December 31, 2007.

4.11 Modification Agreement between the Company and the Purchaser as defined therein, dated January 28, 2008, amending the Stock and Loan Purchase Agreement, dated December 1, 2006 incorporated by reference to our Annual Report on Form 20-F for the year ended December 31, 2007.

8.1 List of subsidiaries incorporated by reference to our Annual Report on Form 20-F for the year ended December 31, 2006.

10.1 Consent of Deloitte Brightman Almagor, certified public accountants (Israel).

12.1 Certification by Chief Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

12.2 Certification by Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

12.3 Certification by Chief Executive Officer pursuant to 18 U.S.C., Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

12.4 Certification by Chief Financial Officer pursuant to 18 U.S.C., Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

94

SIGNATURES

The Registrant hereby certifies that it meets all of the requirements for filing on amendment no. 1 to Form 20-F/A and that it has duly caused and authorized the undersigned to sign this annual report on its behalf .

December 23, 2010

ELBIT VISION SYSTEMS LTD.


By: /s/ Samuel Cohen
——————————————
Samuel Cohen
Chief Executive Officer

95

ELBIT VISION SYSTEMS LTD.
(An Israeli Corporation)
2008 CONSOLIDATED FINANCIAL STATEMENTS

ELBIT VISION SYSTEMS LTD.
2008 CONSOLIDATED FINANCIAL STATEMENTS

TABLE OF CONTENTS

	Page
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	F - 2
CONSOLIDATED FINANCIAL STATEMENTS:
Balance sheets as of December 31, 2008 and 2007	F - 3 - F - 4
Statements of operations for the year ended December 31, 2008, 2007 and 2006	F - 5
Statements of changes in shareholders' equity for the year ended
December 31, 2008, 2007 and 2006	F - 6
Statements of cash flows for the year ended December 31, 2008, 2007 and 2006	F - 7 - F - 8
Notes to Financial Statements	F - 9 - F - 41

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and
Shareholders of Elbit Vision Systems Ltd.

We have audited the accompanying consolidated balance sheets of Elbit Vision Systems Ltd. (“the Company”) as of December 31, 2008 and 2007, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company's recurring losses from operations and Accumulated deficit raise substantial doubt about its ability to continue as a going concern. Management's plans concerning these matters are also discussed in Note 1 and Note 19 to the financial statements. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

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

Tel Aviv, Israel
July 15, 2009

F - 2

ELBIT VISION SYSTEMS LTD.
CONSOLIDATED BALANCE SHEETS
U.S. dollars in thousands

			December 31
	Note		2008		2007
A s s e t s
CURRENT ASSETS:
Cash and cash equivalents				409		2,189
Restricted deposit (short term)		14a		700		540
Accounts receivable:		15a
Trade (net of allowance for doubtful account 2008- $685, 2007-$677)				4,872		4,738
Other				616		1,428
Inventories		4		3,946		5,299
T o t a l current assets				10,543		14,194
INVESTMENTS AND LONG-TERM RECEIVABLES:
Severance pay fund		8		1,556		1,623
Other long-term receivables and investment		5		137		231
				1,693		1,854
PROPERTY AND EQUIPMENT (net of accumulated
depreciation and amortization)		6		443		490
OTHER ASSETS (net of accumulated amortization)
Goodwill		18		1,752		3,529
Other intangible assets		7		2,770		3,439
				4,522		6,968
T o t a l assets				17,201		23,506

The accompanying notes are an integral part of the financial statements

F - 3

ELBIT VISION SYSTEMS LTD.
CONSOLIDATED BALANCE SHEETS (Cont.)
U.S. dollars in thousands

			December 31
	Note		2008			2007
Liabilities and shareholders' equity
CURRENT LIABILITIES:
Credit from banks		15c		6,388			4,967
Accounts payable and accruals:
Trade				3,411			3,220
Deferred income		2i		1,526			2,082
Other		15b		3,316			2,629
T o t a l current liabilities				14,641			12,898
LONG-TERM LIABILITIES:
Loans and other liabilities (net of current maturities)		9		-			1,000
Accrued severance pay		8		2,187			2,008
T o t a l long-term liabilities				2,187			3,008
COMMITMENTS AND CONTINGENT LIABILITIES		10
T o t a l liabilities				16,828			15,906
SHAREHOLDERS' EQUITY:		11
Share capital - ordinary shares of NIS 1 par value ("Ordinary Shares");
Authorized - 60,000,000 Ordinary Shares as of December 31, 2008
and 2007
Issued and outstanding:
December 31, 2008 - 50,988,701 Ordinary shares
December 31, 2007 - 50,791,382 Ordinary shares				10,679			10,629
Additional paid-in capital				28,465			28,249
Accumulated deficit				(38,771	)		(31,278	)
T o t a l shareholders' equity				373			7,600
T o t a l liabilities and shareholders' equity				17,201			23,506

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

F - 4

ELBIT VISION SYSTEMS LTD.
CONSOLIDATED STATEMENTS OF OPERATIONS
dollars in thousands (except per share data)

			Year ended December 31,
	Note		2008			2007			2006
REVENUES:
Sale of products				18,453			18,690			14,527
Services rendered				3,647			3,173			2,470
				22,100			21,863			16,997
COST OF REVENUES:		15d
Cost of products sold				12,358			9,382			10,367
Cost of services rendered				2,191			1,926			1,869
				14,549			11,308			12,236
GROSS PROFIT				7,551			10,555			4,761
RESEARCH AND DEVELOPMENT COSTS - NET		15e		4,559			3,313			2,562
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:
Marketing and selling				5,270			4,885			4,149
General and administrative				2,123			1,338			1,870
Impairment of goodwill		2h		1,981			-			-
Reorganization expenses				-			-			200
OPERATING INCOME (LOSS)				(6,382	)		1,019			(4,020	)
FINANCIAL EXPENSES - NET		15f		(1,082	)		(1,081	)		(1,332	)
LOSS BEFORE OTHER EXPENSES				(7,464	)		(62	)		(5,352	)
OTHER EXPENSES		15g		(18	)		(1,277	)		(5	)
LOSS BEFORE TAXES ON INCOME				(7,482	)		(1,339	)		(5,357	)
TAXES ON INCOME		12d		11			3			5
LOSS FOR THE YEAR FROM CONTINUED OPERATIONS				(7,493	)		(1,342	)		(5,362	)
LOSS FROM OPERATIONS OF DISCONTINUED COMPONENT		3a		-			-			(180	)
NET LOSS ON DISPOSAL OF DISCONTINUED OPERATION		3a		-			-			(551	)
LOSS FOR THE YEAR				(7,493	)		(1,342	)		(6,093	)
LOSS PER SHARE FROM CONTINUING OPERATIONS:		2m
Basic				(0.147	)		(0.034	)		(0.186	)
Diluted				(0.147	)		(0.034	)		(0.186	)
LOSS PER SHARE FROM DISCONTINUED OPERATIONS:		2m
Basic				-			-			(0.026	)
Diluted				-			-			(0.026	)
LOSS PER SHARE:		2m
Basic				(0.147	)		(0.034	)		(0.212	)
Diluted				(0.147	)		(0.034	)		(0.212	)
WEIGHTED AVERAGE NUMBER OF SHARES USED IN
COMPUTATION OF LOSS PER SHARE -
BASIC (IN THOUSANDS)				50,970			39,393			28,778
DILUTED (IN THOUSANDS)				50,970			39,393			28,778

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

F - 5

ELBIT VISION SYSTEMS LTD.
STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

	Share capital				Additional paid-in Capital*			Other comprehensive income			Accumulated deficit			Total shareholders' equity
	Number of shares		Amount
	In thousands				U.S. dollars in thousands
BALANCE - DECEMBER 31, 2005		26,762		4,529		23,324			89			(23,843	)		4,099
CHANGES DURING 2006:
Loss for the year												(6,093	)		(6,093	)
Currency translation differences									(89	)					(89	)
Total comprehensive income															(6,182	)
Employee stock options exercised and paid		182		40		(1	)								39
Issuance of share capital and warrants (notes 3b,11a)		2,441		494		1,606									2,100
Beneficial conversion feature (note 9a(3))						900									900
Warrant exercised and paid		131		28		17									45
BALANCE - DECEMBER 31, 2006		29,516		5,091		25,846			-			(29,936	)		1,001
CHANGES DURING 2007:
Loss for the year												(1,342	)		(1,342	)
Issuance of share capital and warrants (note 11a)		21,275		5,538		2,403									7,941
BALANCE - DECEMBER 31, 2007		50,791		10,629		28,249			-			(31,278	)		7,600
CHANGES DURING 2008:
Loss for the year												(7,493	)		(7,493	)
Warrant exercised and paid		197		50		216									266
BALANCE - DECEMBER 31, 2008		50,988		10,679		28,465			-			(38,771	)		373

* Net of share issuance costs.

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

F - 6

ELBIT VISION SYSTEMS LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS
U.S. dollars in thousands

	Year ended December 31,
	2008			2007			2006
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss		(7,493	)		(1,342	)		(6,093	)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization		1,027			1,241			1,411
Impairment of goodwill		1,981			-			-
Amortization of discount on loan from shareholder		-			1,212			285
Loss from disposal of property		2			-			48
Loss from disposal of discontinued operation		-			-			551
Liability for employee rights upon retirement		179			(182	)		118
Changes in operating assets and liabilities:
Decrease (increase) in trade accounts receivable		(134	)		(1,540	)		283
Decrease (increase) in other accounts receivable		912			(465	)		443
Increase (decrease) in trade accounts payable		191			(282	)		1,003
Deferred income		(556	)		465			(897	)
Increase (Decrease) in other accounts payable		687			(965	)		(2,212	)
Decrease (increase) in inventories		1,353			(1,331	)		591
Net cash used in operating activities		(1,851	)		(3,189	)		(4,469	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of subsidiary consolidated for the first time (a)		-			-			-
Disposal of subsidiary (b)		-			-			120
Purchase of property and equipment		(131	)		(296	)		(130	)
Long-term receivables		(6	)		400			(101	)
Purchase price adjustment of contingent consideration		(204	)		-			-
Redemption of (investment in) restricted deposit		(160	)		148			1,122
Proceeds from disposal of property and equipment		5			38			30
Funds severance pay		67			268			(258	)
Net cash provided by (used in) investing activities		(429	)		558			783
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of share capital and warrants - net of issuance costs		-			4,521			964
Short-term credit from bank - net		421			(761	)		2,281
Proceeds from exercise of options and warrants		79			-			77
Retirement of long-term loan from shareholder		-			-			(27	)
Proceeds from long-term loans from shareholder		-			-			1,556
Proceeds from long-term loans from bank		-			-			547
Short-term credit paid to Cornell Capital Partners L.P. - net		-			-			(1,449	)
Net cash provided by financing activities		500			3,760			3,949
TRANSLATION DIFFERENCES ON CASH BALANCES OF
CONSOLIDATED SUBSIDIARY		-			-			(89	)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(1,780	)		1,129			174
BALANCE OF CASH AND CASH EQUIVALENTS AT
BEGINNING OF YEAR		2,189			1,060			886	*
BALANCE OF CASH AND CASH EQUIVALENTS AT END OF YEAR		409			2,189			1,060
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION - cash paid during the year for:
Interest paid - net		307			704			415
Income taxes paid - net		11			3			5

* Including cash and cash equivalents from discontinuing operation.

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

F - 7

ELBIT VISION SYSTEMS LTD.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Cont.)

	Year ended December 31, 2006
	U.S. dollars in thousands
(a)     Acquisition of subsidiary consolidated
for the first time, see also note 3:
Assets and liabilities of the subsidiary at date of
acquisition:
Working capital (excluding cash and cash equivalents)		(1,033	)
Fixed assets		59
Long-term receivables		12
Other assets		1,514
Long-term loans and other liabilities		(9	)
Goodwill arising on acquisition		-
		543
Less:
Issuance of share capital and warrants (see c 2) hereafter)		(543	)
		-

	Year ended December 31, 2006
	U.S. dollars in thousands
(b)     Disposal of subsidiary
Assets and liabilities of the subsidiary at date of
disposal:
Working capital (excluding cash and cash equivalents)		346
Fixed assets		(284	)
Long-term receivables		(193	)
Other assets		(148	)
Long-term loans and other liabilities		232
Goodwill		(1,039	)
		(1,086	)
Less:
Future proceeds from selling the subsidiary		966
		(120	)

(c) Supplementary information on financing activities not involving cash flow:

1) During 2007 $ 1,168,000 worth of shares were released from escrow and $ 1,970,000 long term loan from shareholders were converted into share capital (see Notes 9 a.(2),(3) and 11 a.(4),(5)).

2) During 2006 part of the acquisition of the subsidiary was made through issuance of share capital in an amount equivalent to $ 543,000.

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

F - 8

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – GENERAL

Elbit Vision Systems Ltd. (the “Company”) is an Israeli corporation, which, together with its subsidiaries (the “Group”), is principally engaged in the design, development, manufacturing and marketing automatic vision and ultrasonic inspection and quality monitoring systems, and rending services related to those systems.

Elbit Vision Systems Inc. (“EVS Inc.”) incorporated in Delaware U.S.A. and Elbit Vision Systems B.V. (“EVS BV”) incorporated in the Netherlands are wholly-owned subsidiaries, engaged in the selling and marketing of the Company’s products worldwide.

In June 2004, the Company expanded its activities and entered into new fields of operations through the acquisition of 70% of Yuravision Co. Ltd.‘s (“Yuravision”) shares, a South Korean developer of visual inspection software and systems for the microelectronics industry and display industries. This investment was sold during December 2006 and therefore presented as discontinued operation in the financial statements (see Note 3a).

In September 2004, the Company also completed the acquisition of the entire shareholding of ScanMaster Systems (IRT) Ltd. (“ScanMaster Ltd.”), an Israeli company and IRT ScanMaster System Inc. (“ScanMaster Inc.”), a new Hampshire corporation (collectively – “ScanMaster”). ScanMaster is engaged in the development, manufacturing and marketing of equipment for the ultrasonic inspection of industrial parts and components for the automotive and transportation industries, the metal industry as well as applications for aircraft and jet engine inspection.

In February 2006, the Company acquired business, assets and liabilities of Panoptes Ltd.(“Panoptes”) and ScanMaster Ltd. acquired 100% of the shares of Panoptes. Panoptes Ltd. is principally engaged in the design, development, manufacturing and marketing automatic vision and quality monitoring systems for surface inspection, especially textiles, glass fabric and technical woven materials (see Note 3b).

As to Business and Geographical segments – see Note 17.

The Company has sustained significant operating losses in recent periods, which has led to a significant reduction in its cash reserves. As reflected in the accompanying financial statements, the Company's operations for the year ended December 31, 2008, resulted in a net loss of $7,493 thousands. The Company's ability to continue operating as a “going concern” is dependent on its ability to raise sufficient additional working capital. As disclosed in Note 19, management has been attempting to raise capital from banks, current stockholders and potential investors and plans to continue these efforts.The Company expects to use the raised proceeds for working capital purposes.Nevertheless, there are no assurances that the Company will be able to return to positive cash flow before it requires additional cash, which raises substantial doubts about the ability of the Company to continue as a going concern.

NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES:

The consolidated financial statements are prepared in accordance with accounting principles generally accepted (“GAAP”) in the United States of America.

a. Use of estimates in the preparation of financial statements

The preparation of financial statements in conformity with GAAP 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 dates of the financial statements and the reported amounts of revenues and expenses during the reporting years. Actual results could differ from those estimates.

Estimates and assumptions which, in the opinion of management, are significant to the underlying amounts included in the financial statements and for which it would be reasonably possible that future events or information could change those estimates include: (i) impairment assessments of goodwill and long-lived assets; (ii) realization of deferred income tax assets; and (iii) provisions for obsolete and slow moving inventory. These estimates are discussed further throughout the accompanying notes.

F - 9

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES (Cont.)

b. Functional Currency and Financial Statements in U.S. Dollars

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

Virtually all sales by the Company and its subsidiaries are made outside Israel in non-Israeli currencies, mainly the dollar. Most purchases of materials and components are made in dollars or in Israeli currency under contracts linked to the dollar. In addition, most marketing and service costs are incurred outside Israel, primarily in dollars, through the Company’s wholly-owned non-Israeli subsidiaries. Thus, the functional currency of the Company and its subsidiaries is the dollar.

Transactions in currencies other than each company’s functional currency are translated based on the average currency exchange rates in accordance with the principles set forth in Statement of Financial Accounting Standards (“SFAS”) No. 52, “Foreign Currency Translation”. All gains and losses from translation of monetary balance sheet items and transactions denominated in currencies other than the functional currency are recorded in the statements of income as financial income, net as they arise.

c. Principles of consolidation

The consolidated financial statements include the financial statements of the company and its wholly-owned subsidiaries.

All material inter-company transactions and balances have been eliminated.

d. Cash Equivalents

Cash equivalent consist of short-term highly liquid investments, that are readily convertible into cash with original maturities when purchased of three month or less.

e. Allowance for doubtful accounts

The allowance for doubtful accounts has been made on the specific identification basis.

f. Inventories

Inventories are stated at the lower of cost or market. Cost is determined as follows: Raw materials and spare parts – on moving average basis. Products in process and finished products – on basis of production costs.

Inventories are written-down for estimated obsolescence, based on assumptions about future demand and market conditions.

F - 10

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES (Cont.)

g. Property and equipment

(1) Property and equipment are stated at cost. Depreciation is calculated by the straight-line method over the estimated useful lives of assets, as follows:

	%
Machinery and equipment		10-33 (mainly 33%)
Office furniture and equipment		6-20
Vehicles		15-20

Leasehold improvements are amortized by the straight-line method over the term of the lease, or the estimated useful life of the improvements, whichever is shorter.

(2) Impairment of long-lived assets – Impairment examinations and recognition are performed and determined based on the provisions of FASB Statement No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets” (“SFAS 144”). SFAS 144 requires that long-lived assets and certain identifiable assets held for use be reviewed for impairment on a periodic basis, or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of an asset to be held and used is determined by a comparison of the carrying amount of the asset and the amount of undiscounted future net cash flows to be generated by the asset or assets group. In the event that an asset is considered to be impaired, an impairment charge is recorded in the amount by which the carrying amount of the asset exceeds its estimated fair value.

h. Other assets- Goodwill and Intangible Assets

(1) Goodwill

Under FASB Statement No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), goodwill is not amortized to earnings, but rather is subject to periodic testing for impairment, at the reporting unit level, at least annually or more frequently if certain events or indicators of impairment occur. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. Measurement of an impairment loss is an estimate, performed based on the following: If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired.  If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The Group uses the discounted cash flow method to determine the fair value of the reporting unit. The Company’s reporting units consist of reportable segments; goodwill is allocated to both segments (see also Note 17).

The Company has designated December 31 of each year as the date on which it will perform its annual goodwill impairment test. An impairment of $ 1,981,000 resulted from the annual review performed in the year 2008, allocated to the non-destructive automated inspection segment.

F - 11

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES (Cont.)

h. Other assets- Goodwill and Intangible Assets (Cont.)

(2) Other intangible assets

These assets are amortized by the straight-line method over their estimated useful lives. Annual rates of amortization are as follows:

	%
Technology		10-20
Customer relations		10-20
Distribution network		10
Brand name		8.33

i. Revenue recognition:

1) Sale of products:

a. General

Revenues from sales of products and supplies are recognized when an arrangement exists, delivery has occurred and title passed to the customer, Group’s price to the customer is fixed or determinable and collectibility is reasonably assured.

With respect to systems sold with installation requirements, the installation is not considered to be a separate earnings process; thus, revenue is recognized when all of the above criteria are met and installation is completed.

b. Acceptance clause, customers’ support service and warranty

The Group distinguishes between revenue recognition in respect of revenue derived from automatic vision inspection products (sold by the Company) and ultrasonic inspection products (sold by ScanMaster).

The terms of the agreements between the Company and its customers are substantially different from the terms of the agreements between ScanMaster and its customers. Therefore, the revenue recognition accounting policy applied by each of the companies is different in this case. Set forth bellow are the main accounting policies applied by each of the companies:

The Company

In case that Company’s agreement with the customer includes an “acceptance”clause, revenue recognition will take place after the Company receives the “acceptance certificate” from the customer. In some cases, the Company grants its customers a trial period, usually several months, in order to evaluate prototype of the system’s performance. In case that the systems performance meets the customer’s requirements, it purchases the system at the end of the trial period. The Company does not recognize sales revenue from products shipped to customers for trial until such products are actually purchased. Until purchased, these products are recorded as consignment inventory at the lower of cost or market.

ScanMaster

ScanMaster’s agreements with its customers usually include acceptance testing procedures clause (“ATP”). Each product of ScanMaster has standard performance specifications that are examined in the ATP; usually, the performance specifications are not customized for the specific needs of the customer.

F - 12

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES (Cont.)

i. Revenue recognition (Cont.):

1) Sale of products (Cont.):

b. Acceptance clause, customers’ support service and warranty (Cont.)

ScanMaster (Cont.)

Also, unlike in the case of the company, ScanMaster does not grant its customers a trial period in the normal course of business. The agreements with the clients do not include the right of the clients to a refund in case the ATP is not to their satisfaction. However, the collection of the final payment from the customer (usually 10% out of the total consideration) is dependent upon receiving the signed ATP.

ScanMaster distinguishes between sales of new products, in respect of which ScanMaster has no past installation experience and sales of products, installation of which the company is well experienced. In respect of sales of new products ScanMaster recognizes revenues only after the company receives the ATP from the customer. In respect of sales of other products, in the installation of which the company is well experienced, the ATP is only a formal procedure, and therefore, the installation of products is a sufficient requirement to recognize revenues.

ScanMaster provides for warranty costs at the same time as the revenue is recognized. The annual provision is calculated at rates of 0.5%-2% of the sales, based on past experience.

c. Right of return

The Group does not provide, in the normal course of business, a right of return to its customers. If uncertainties exist, such as the granting to the customer of a right of cancellation, revenue is recognized when the uncertainties are resolved.

d. Revenues from systems that require significant customization, integration and installation are recognized based on SOP 81-1 “Accounting for Performance of Construction – Type and Certain Production – Type Contracts”, using contract accounting on the percentage of completion method, based on the relationship of actual labor costs incurred, to total labor costs estimated to be incurred over the duration of the contract. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are first determined, in the amount of the estimated loss on the entire contract.

Arrangements that include professional services are evaluated to determine whether those services are essential to the functionality of other elements of the arrangement. When services are considered essential, revenue under the arrangement is recognized using contract accounting.

When services are not considered essential, the revenue allocable, based on the criteria prescribed in EITF 00-1, to the professional services is recognized as the services are performed.

F - 13

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES (Cont.)

i. Revenue recognition (Cont.):

2) Services rendered

Service revenue in respect of the Group’s products is recognized ratably over the contractual period, or as services are performed.

3) Deferred income

The deferred income balance as of December 31, 2008 and 2007 include amounts of revenues that were invoiced and cash was received, but deferred less applicable product and warranty costs.

j. Research and development

Research and development expenses net of third party grants, are expensed as incurred. The Company has no obligation to repay the grants if sales are not generated.

k. Advertising expenses

Advertising expenses are expensed as in incurred. Advertising expenses for the years ended December 31, 2008, 2007 and 2006 were $ 431,000, $ 428,000 and $ 470,000, respectively.

l. Deferred income taxes

The company accounts for income taxes in accordance with FASB Statement No. 109, “Accounting for Income Taxes” (“SFAS 109”). Deferred income taxes are determined by the asset and liability method based on the estimated future tax effects attributable to temporary differences between income tax bases of assets and liabilities and their reported amounts in the financial statements, and to carryforwards for tax losses and deductions. Deferred tax balances are computed using the enacted tax rates to be in effect at the time when these differences are expected to reverse, as they are known at the balance sheet date.

Deferred tax assets and liabilities are classified as current or non-current according to the classification of the respective asset or liability, or the expected reversal date of the specific temporary difference, if not related to a specific asset or liability.

Valuation allowances in respect of deferred tax assets are established when it is more likely than not that all or a portion of the deferred income tax assets will not be realized.

m. Earning (loss) per share (“EPS”)

Basic EPS is computed based on the weighted average number of shares outstanding during each year. 1,718,749 ordinary shares, which were issued and were placed in escrow were reflected in basic and diluted EPS shares for the year ended December 31, 2006. Total common stock equivalents, related to options and warrants 13,492,331, 16,862,858 and 9,322,308 shares for the years 2008 , 2007 and 2006, respectively, were excluded from EPS calculation, because the effect of such options and warrants is antidilutive.

F - 14

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES (Cont.)

n. Stock-based compensation

In January 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment”(“SFAS No. 123(R)”), using the modified prospective application method as its transition method. The Company recognizes $ 188,000 of compensation expenses in 2008 as a result of the application of SFAS 123 (R). Until the adoption of SFAS No. 123(R) the Company accounted for employees and directors stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and in accordance with FASB Interpretation No. 44 (“FIN 44”). Pursuant to these accounting pronouncements, the Company recorded compensation for stock options granted to employees and directors over the vesting period of the options based on the difference, if any, between the exercise price of the options and the market price of the underlying shares at that date.

As to information about the stock option plans and assumptions see Note 11b.

o. Comprehensive income

In addition to income (loss), other comprehensive income includes exchange differences arising from the translation of the net investment in subsidiary.

p. Reclassification

Certain comparative figures have been reclassified to conform to the current year presentation.

q. Consentration of credit risk

As of December 31, 2008 and 2007, the Group held cash and cash equivalents and short-term bank deposits, most of which were deposited with major Israeli, European, and U.S. banks. The Company is of the opinion that the credit risk in respect of these balances is insignificant.

The Group performs ongoing credit evaluations of its customers for the purpose of determining the appropriate allowance for doubtful accounts. In respect of sales to customers in emerging economies, the Group requires letters of credit from banks.

r. Recently issued accounting pronouncements:

FSP 142-3

In April 2008, the FASB issued FASB Staff Position 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”). FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets”(“SFAS 142”). The objective of FSP 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R), “Business Combinations”, and other U.S. generally accepted accounting principles. FSP 142-3 will be effective beginning in fiscal year 2010. The Company is currently evaluating the impact that FSP 142-3 will have, if at all, on its consolidated financial statements and disclosures.

FSP EITF 03-6-1

In June 2008, the FASB issued FASB Staff Position No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities”(“FSP EITF 03-6-1”). FSP EITF 03-6-1 establishes that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities as defined in Emerging Issues Task Force (“EITF”) Issue No. 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128", and should be included in the computation of earnings per share pursuant to the two-class method as described in Statement of Financial Accounting Standards No. 128, “Earnings per Share”.

F - 15

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES (Cont.)

r. Recently issued accounting pronouncements (Cont.):

FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior-period earnings per share data presented shall be adjusted retrospectively to conform to the provisions of FSP EITF 03-6-1. Early application is not permitted. The Company is currently evaluating the impact that the adoption of FSP EITF 03-6-1 will have on its consolidated financial statements but believes that its effect will be immaterial due to immaterial use of instruments within the scope of the FSP.

EITF Issue No. 07-5

In June 2008, the FASB Emerging Items Task Force reached a consensus on EITF Issue No. 07-5, “Determining Whether an Instrument (or an Embedded Feature) Is Indexed to an Entity’s Own Stock”. The Consensus was reached on the following three issues:

1.        The way an entity should evaluate whether an instrument (or embedded feature) is indexed to its own stock.

2.        The way the currency in which the strike price of an equity-linked financial instrument (or embedded equity-linked feature) is denominated affects the determination of whether the instrument is indexed to an entity’s own stock.

3.        The way an issuer should account for market-based employee stock option valuation instruments.

This consensus will affect entities with (1) options or warrants on their own shares (not within the scope of Statement 150), including market-based employee stock option valuation instruments; (2) forward contracts on their own shares, including forward contracts entered into as part of an accelerated share repurchase program; and (3) convertible debt instruments and convertible preferred stock. Also affected are entities that issue equity-linked financial instruments (or financial instruments that contain embedded equity-linked features) with a strike price that is denominated in a foreign currency.

The consensus is effective for fiscal years (and interim periods) beginning after December 15, 2008. The consensus must be applied to outstanding instruments as of the beginning of the fiscal year in which the issue is adopted as a cumulative-effect adjustment to the opening balance of retained earnings for that fiscal year. Early application is not permitted.

The Company is currently evaluating the effect of EITF 07-5 and has not yet determined the impact of the consensus on its financial position or results of operations.

FSP FAS 157-4

In April 2009 the FASB issued FASB staff position 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly”. This FSP applies to all assets and liabilities within the scope of accounting pronouncements that require or permit fair value measurements, except as discussed in paragraphs 2 and 3 of statement 157. The FSP is Effective for interim and annual reporting periods ending after June 15, 2009, and shall be applied prospectively.

FSP FAS 157-4 relates to determining fair values when there is no active market or where the price inputs being used represent distressed sales. It reaffirms what Statement 157 states is the objective of fair value measurement – to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements under current market conditions. Specifically, it reaffirms the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become inactive.

FSP FAS 157-4 provides guidance on (1) estimating the fair value of an asset or liability (financial and nonfinancial) when the volume and level of activity for the asset or liability have significantly decreased and (2) identifying transactions that are not orderly.

The Company is currently evaluating the impact that this FSP will have, if at all, on its consolidated financial statements and disclosures but believes that its effect will be immaterial.

F - 16

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES (Cont.)

s. Initial adoption of new standards:

FAS 157-3

In October 2008, the FASB staff issued Staff Position (FSP) No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.”The FSP amends Statement 157 by incorporating “an example to illustrate key considerations in determining the fair value of a financial asset” in an inactive market. The FSP is effective upon issuance and should be applied to prior periods for which financial statements have not been issued.

The FSP’s illustrative example and associated guidance clarifies various application issues raised by preparers of financial statements. With regard to the measurement principles of Statement 157, the FSP emphasizes the following:

Objective of Fair Value – The objective of a fair value measurement is to determine the price that would be received to sell an asset in an orderly transaction that is not a forced liquidation or distressed sale between market participants as of the measurement date. This objective does not change even when there is little, if any, market activity for an asset as of the measurement date.

Distressed Transactions – “Even in times of market dislocation, it is not appropriate to conclude that all market activity represents forced liquidations or distressed sales. However, it is also not appropriate to automatically conclude that any transaction price is determinative of fair value.” The evaluation of whether individual transactions are forced (that is, whether one of the parties is forced or otherwise compelled to transact) depends on the facts and circumstances and may require the use of significant judgment.

Relevance of Observable Data – Observable market data may require significant adjustment to meet the objective of fair value. “For example, in cases where the volume and level of trading activity in the asset have declined significantly, the available prices vary significantly over time or among market participants, or the prices are not current, the observable inputs might not be relevant and could require significant adjustment.” If the adjustment is significant, the measurement would be considered Level 3.

The Company’s Assumptions and Nonperformance and Liquidity Risks – The use of the Company’s internal “assumptions about future cash flows and appropriately risk-adjusted discount rates” is acceptable when relevant observable market data does not exist. In addition, such assumptions or techniques must incorporate adjustments for nonperformance and liquidity risks that market participants would consider in valuing the asset.

Third Party Pricing Quotes – Quotes and information obtained from brokers or pricing services “are not necessarily determinative if an active market does not exist for the financial asset” being measured. In addition, “an entity should place less reliance on quotes that do not reflect actual market transactions.”

The adoption of FSP FAS 157-3 did not have any significant impact on the consolidated results of operations or financial position of the Company

F - 17

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 – CONSOLIDATED SUBSIDIARIES

a. Acquisition and Disposal of Yuravision

On December 2, 2003, the Company signed a term sheet (the validity of which was extended on February 16, 2004) to acquire 100% of the shares of Yuravision (as to the nature of operation of Yuravision, see Note 1).

Pursuant to the term sheet, through June 30, 2004, the Company entered into a series of purchase agreements with some of Yuravision’s shareholders. Under those agreements, the Company purchased 51% of Yuravision’s shares for an aggregate amount of $ 1,014,000, in cash and has a legal commitment to purchase additional 19% of Yuravision shares.

The total cost of acquisition amounted to $ 1,484,000 (including legal fees and other direct costs of $ 134,000, and the aggregate fair value of the warrants issued to Yuravision’s shareholder of $ 30,000).

On December 1, 2006, the Company executed an agreement with a Korean corporation for the sale of Yuravision shares in consideration for $950,000, or the Purchase Price, plus the purchase from the Company of its right to receive from Yuravision repayment of an $800,000 loan, or the Loan Amount in consideration for the full value of the loan. Half of the Purchase Price was paid upon the closing of the transaction on December 15, 2006, and the remaining half of the Purchase Price will be payable no later than December 1, 2008. The purchaser has undertaken to pay the Company half of the Loan Amount by no later than December 1, 2008 and the remaining half, or the Outstanding Payment, by no later than May 1, 2009.

The Company have received a stand by letter of credit from the purchaser guaranteeing payment of the Loan Amount.

Consideration for assignment of the Loan was subject to reduction in the event that certain key employees of Yuravision terminated their employment; provided that the Korean corporation was unable to find replacements using the services of an employment agency. Subsequently, all of the key employees terminated their employment with Yuravision, however, the Company claimed that the Korean corporation did not diligently use the services of the employment agency in order to find replacements.

On January 28, 2008 the Company entered into a modification agreement amending the December 1, 2006 agreement with the Korean corporation. Pursuant to the modification agreement the Loan Amount was reduced from $800,000 to $460,000, without any further obligation by the Korean corporation for the reduced amount of $340,000. The payment terms of the loan were changed so that the Korean corporation paid to the Company $360,000 on February 4, 2008 and paid the remaining $100,000 owed under the loan in January 2009. The terms for the payment of the purchase price were not changed.

F - 18

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3 – CONSOLIDATED SUBSIDIARIES (cont.)

a. Acquisition and Disposal of Yuravision (cont.)

Yuravision is classified as discontinued operation in the consolidated financial statements and its results of operation and financial position are separately reported for all periods presented. Summarized financial information for Yuravision is as follows:

	Year ended December 31
	2006
	$ in thousands
Revenues		707
Cost of revenues		345
Gross profit		362
Research and development costs, net		207
Marketing and selling expenses		48
General and administrative expenses		319
Operating loss		(212	)
Financial expenses		(66	)
Other income		98
Net loss of discontinued operation		(180	)

b. Acquisition of Panoptes Ltd.

In February 2006, the Company acquired business, assets and liabilities of Panoptes Ltd., and its subsidiary acquired 100% of the shares of Panoptes Ltd. Panoptes Ltd. is principally engaged in the design, development, manufacturing and marketing automatic vision and quality monitoring systems for surface inspection, especially textiles, glass fabric and technical woven materials.

The total consideration of acquisition of Panoptes Ltd. amounted to $ 622,000 (including estimated direct transaction costs amounting to $ 79,000). The Company issued 800,000 ordinary shares amounted to $ 543,000 and , subject to certain instances, paid cash royalties equaling 3.5% of sales of EVS optical inspection systems between January 2006 and the end of December 2008 to Ma’aragim Panoptes’ controlling shareholder (see Note 10a5)).

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:

	At January 1, 2006 ($ in thousands)
Long-term receivables		12
Property, plant, and equipment		59
Intangible assets		1,514
Total assets acquired		1,585
Current liabilities		(954	)
Long-term liabilities		(9	)
Total liabilities assumed		(963	)
Net assets acquired		622

Of the $ 1,514,000 of acquired intangible assets, $ 1,025,000 were assigned to current technology, which represents patent and other intellectual properties (5 years useful life); $ 489,000 were assigned to customer relations (5 years useful life).

F - 19

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4 – INVENTORIES

	December 31
	2008		2007
	$ in thousands
Raw materials		2,384		2,962
Work in process		1,472		1,482
Finished products		90		855
		3,946		5,299

The balances are net of write-down of $1,150,000 and $463,000 as of December 31, 2008 and 2007, respectively.

NOTE 5 – OTHER LONG-TERM RECEIVABLES AND INVESTMENT

	December 31
	2008		2007
	$ in thousands
Deposits on leased vehicle (see also Note 10b2))		76		70
Investment (1)		61		61
Future proceeds from selling the Yuravision		-		100
		137		231

(1) On July 22, 2004, the Company converted a convertible loan that had been granted to Micro Components Ltd. (“MCL”) into 197,217 ordinary shares of MCL. As of December 31, 2008 the Company holds 4% of MCL’s ordinary shares.

NOTE 6 – PROPERTY AND EQUIPMENT

a. Comprised as follows:

	December 31
	2008	2007
	$ in thousands
Machinery and equipment	2,891	2,791
Leasehold improvements	271	254
Office furniture and equipment	427	418
Vehicles	62	62
	3,651	3,525
Less - accumulated depreciation and amortization	3,208	3,035
	443	490

b. Depreciation and amortization expenses totaled $ 173,000, $ 222,000, and $191,000, in the years ended December 31, 2008, 2007 and 2006, respectively.

F - 20

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 7 – OTHER INTANGIBLE ASSETS

	Gross carrying amount December 31				Accumulated amortization December 31
	2008		2007		2008		2007
	U.S. dollars in thousands				U.S. dollars in thousands
Technology		2,828		2,828		1,385		1,000
Customer relations		1,599		1,599		775		566
Distribution network		338		338		147		113
Brand name		489		489		177		136
Backlog		414		414		414		414
		5,668		5,668		2,898		2,229

Amortization expenses totaled $ 669,000, $ 659,000 and $ 669,000, in the years ended December 31, 2008, 2007, and 2006, respectively.

Estimated amortization expense for the following years, subsequent to December 31, 2008:

	$ in thousands
Year ended December 31:
2009		669
2010		669
2011		366
2012		366
2013		366

NOTE 8 – ACCRUED SEVERANCE PAY, NET

a. The Company’s liability for severance pay is calculated in accordance with Israeli law based on the latest salary paid to employees and the length of employment in the Company.

Part of the liability is funded through individual insurance policies.

The policies are assets of the company and, under labor agreement subject to certain limitation, they may be transferred to ownership of the beneficiary employees.

b. A U.S. subsidiary provides defined contribution plan for the benefit of its employees. Under this plan, contributions are based on specific percentages of pay.

c. Severance pay and defined contribution plan expenses were $ 441,000, $ 14,000 and $ 165,000 in the years ended December 31, 2008, 2007, and 2006, respectively. The earnings (losess) on the amounts funded were ($ 111,000), $ 52,000, and $ 102,000 for the years ended December 31, 2008, 2007, and 2006, respectively.

F - 21

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 9 – LONG-TERM LIABILITIES – LOANS AND OTHER

a. Composed as follows:

	December 31
	2008		2007
	$ in thousands
Loans from banks(1)		-		1,000
Other liabilities:
Loans from shareholders(2),(3)		-		-
		-		1,000

(1) In August 2005 the Company entered into an agreement with bank Mizrahi, pursuant to which the Company received in 2005 a credit line for the aggregate amount of $ 2,000,000 (see Note 11c).

In June 2007 the Company terminated the abovementioned agreement and entered into a new agreement with bank Leumi for a credit line amounted to $ 2,500,000. The credit line is secured by a first ranking floating charge on all of the Company’s assets and all the assets of ScanMaster.

(2) During 2003, the Company and Elbit Ltd. (a shareholder), reached an agreement, whereby the Company’s debt to Elbit Ltd. of $ 400,000 and accrued interest thereon that was due in 2003, will have the following terms:

a. The loan will bear annual interest of Libor+2% (formerly Libor+0.5%) payable quarterly.

b. The loan is repayable in quarterly installments of $ 40,000 each, commencing in the third quarter of 2003, but only if the cash flows provided by Company’s operating activities in the quarter preceding the payment exceeds $ 50,000.

On June 21, 2007, the Company executed an agreement with Elbit Ltd., pursuant to this agreement Elbit Ltd. (i) converted the loan to the Company in the amount of $470,000 (including accrued interest) into 1,492,063 ordinary shares, at a price of $0.315 per share; and (ii) invested in the Company $250,000 in consideration for 793,651 ordinary shares at a price of $0.315 per share and received a 4 year warrant to purchase 396,825 ordinary shares at an exercise price of $0.45 per share.

F - 22

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 9 – LONG-TERM LIABILITIES – LOANS AND OTHER (cont.)

a. Composed as follows (cont.)

(3) In February 2006, the Company issued notes to Mivtach Shamir Holdings Ltd. (“Mivtach”) for $3 million (half of which will be held in escrow until the occurrence of certain events). The notes were convertible at the option of Mivtach into 6,000,000 ordinary shares of EVS, at a price per share of $0.50. Repayment of the notes was in 30 equal monthly installments commencing two years after the notes issuance or on the date that Mivtach decides not to convert the notes, whichever is sooner. The Company also granted to Mivtach a two-year warrant to purchase 4,000,000 of the Company’s ordinary shares at an exercise price of $0.50 per share, exercisable only if Mivtach converts the notes.

The Company allocated the proceeds received based on the respective fair values to the notes and the warrants. Consistent with provisions of EITF 98-5 and 00-27, the Company evaluated whether the notes contain a beneficial conversion feature (“BCF”) and determined that all proceeds should be allocated to the BCF and the notes initially recorded at nil. The amount of discount is to be amortized over the term of notes.

As of December 31, 2006 the company recorded in its financial reports a long term loan of $ 342,000, representing the amortized discount to date.

On June 21, 2007 the Company signed an agreement with Mivtach pursuant to which, Mivtach converted the full amount of the convertible notes into (a) 9,523,810 of the Company’s ordinary shares; and (b) received a 4 year warrant to purchase 2,380,952 of the Company’s ordinary shares at an exercise price of $0.45 per share. As a result of the conversion, the unamortized discount, created as a resullt of the allocation of the proceeds to the BCF, was accelerated and recognized in earnings.

b. The liabilities (net of current maturities) mature in the following years after the balance sheet dates:

	December 31
	2008		2007
	$ in thousands
2008		-		1,000
2009		-		-
2010		-		-
2011 and thereafter		-		-
		-		1,000

F - 23

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 10 – COMMITMENTS AND CONTINGENT LIABILITIES

a. Royalties

1) The Company is committed to pay royalties to the Government of Israel based on proceeds from sales of products in the research and development of which the Government participates by way of grants. At the time the grants were received, successful development of the related projects was not assured.

In the case of failure of a project that was partly financed as above, the Company is not obligated to pay any such royalties.

Under the terms of the Company’s funding from the Israeli Government, royalties of 3%-5% are payable on sales of products developed from a project so funded, up to 100% of the amount of the grant received by the Company (dollar linked); as from January 1, 2001 – with the addition of an annual interest rate based on Libor.

Royalty expenses to the Government of Israel totaled $ 224,000, $ 266,000 and $ 259,000 in the years ended December 31, 2008, 2007 and 2006 respectively and are included in the statements of operations among cost of revenues.

2) The Company and ScanMaster Ltd. are committed to pay royalties to the Government of Israel in respect of marketing expenses in which the Government participated by way of grants. At the time the grants were received, successful development of the related projects was not assured. In the case of failure of a project that was partly financed as above, the Company is not obligated to pay any such royalties. The royalties are payable at the rate of 4% of the increase in export sales, up to the amount of the dollar-linked grant received. No royalties were paid in the reported years to the Government of Israel.

On November 7, 2007, the Company received a letter from the Ministry of Trade, Industry and Labor – Fund for the Encouragement of Marketing Abroad (the “Fund”), claiming that it had failed to pay royalties to the Fund since 1999 in the aggregate amount of $480,818. On November 21, 2007, the Company sent a letter to the Fund in which it stated that the Fund had not requested any of these royalties for many years despite the Company’s written request to clarify the issue. In its letter the Company stated that a material amount of the royalties could no longer be claimed due to the operation of the statute of limitations and that in any event the Fund may be estopped from making at least part of the claims as a result of its non-response to the Company’s inquiry. On December 18, 2007, the Company met with representatives of the Fund to discuss the issue. The Company have yet to receive a response to the meeting. The Company recorded an allowance of $ 90,000 on acount of this claim.

The maximum royalty amount payable the Company expect to pay to the Government of Israel under 1 and 2 above ,at December 31, 2008 is approximately $ 919,000.

3) Effective upon its initial public offering on July 3, 1997, the Company agreed to pay Elbit Ltd. (“Elbit”) royalties in an amount dependent upon the sales of the Company’s vision system products in the textile, automotive and food industries.

The royalties will in turn be paid in full by Elbit to the original developer of certain elements of the technology licensed by the Company from Elbit.

In 2002, the Company and Elbit amended the abovementioned agreement, effective as of July 1, 2001; pursuant to the agreement the royalties would be paid directly to the developer, twice a year, at a rate of 0.9375%-1.5% of sales of certain products in the immediately preceding six months.

The royalty expenses totaled $ 20,600 in the year ended December 31, 2006, and are included in the statements of operations in cost of revenues.

No expenses were recorded in the years ended December 31, 2008 and 2007.

F - 24

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 10 – COMMITMENTS AND CONTINGENT LIABILITIES (cont.)

a. Royalties (cont.)

4) ScanMaster Ltd. signed an agreement with a supplier, whereunder the supplier assisted Scanmaster Ltd. to complete a development of one of the Company’s products. The supplier is also entitled to receive royalties from the product’s sales. The royalty expenses amounted to $ 17,000, $ 34,000 and $ 28,000 in the years ended December 31, 2008, 2007 and 2006, respectively, were included in the statements of operations in cost of revenues.

5) As part of acquisition of Panoptes Ltd. (see Note 3b.), the Company, subject to certain instances, will pay cash royalties equaling 3.5% of sales of EVS’s optical inspection systems between January 2006 and the end of December 2008 to Ma’aragim Panoptes’ controlling shareholder. The Company paid to Ma’aragim royalties $ 204,000, $ 155,000 and $ 109,000 during the years ended December 31, 2008, 2007 and 2006, respectively.

b. Lease commitments

1) The premises occupied by the Company and certain subsidiaries are rented under various operating lease agreements. The lease agreements for the premises expire in 2009 with extended options for another 3 years.

Minimum lease commitments of the Company and the subsidiaries under the above leases, at rates in effect as of December 31, 2008, are as follows:

	$ in thousands
Year ending December 31:
2009		463
2010		406
2011		464
		1,333

The rental payments for the premises in Israel, which constitute most of the above amounts, are payable in Israeli currency linked to the US Dollar.

Rental expenses totaled $ 474,000, $ 331,000, and $ 514,000 in the years ended December 31, 2008, 2007 and 2006, respectively.

2) The Company leases motor vehicles under long-term operating lease agreements. The lease agreements expire on various dates ending in 2009 – 2011 (with prior notice of cancellation clauses).

Minimum lease commitments of the Company under the above leases, at rates in effect on December 31, 2008, are as follows:

	$ in thousands
2009		353
2010		192
2011		60
		605

To secure the amounts due to the lessor, the Company has deposited a total of U.S. $ 76,000. The deposits are unlinked and presented among other long-term receivables.

Lease expenses in 2008, 2007 and 2006, amounted to $ 516,000, $ 430,000 and $ 299,000 respectively.

F - 25

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 10 – COMMITMENTS AND CONTINGENT LIABILITIES (cont.)

c. Guarantees

As of December 31, 2008, the Company provided guarantees in the aggregate amount of $1,828,000 to its customers in order to secure the Company’s commitments under its sales agreements. The guarantees are usually secured by cash advances received from the said customers.

NOTE 11 – SHAREHOLDER’ EQUITY

a. Authorized, issued and outstanding shares

1) The Company’s Ordinary Shares are traded in the United States on the OTC Bulletin Board market under the symbol EVSNF.OB.

2) In March 2004, the Company entered into a Standby Equity Distribution Agreement with Cornell. Pursuant to this agreement, the Company will be entitled to issue Cornell with put notices requiring it to purchase, six days following each put notice, a number of Company’s ordinary shares with a value of up to $ 300,000 per put notice and up to an aggregate value of $ 10,000,000 over two years.

The price per share payable by Cornell will be determined based on the minimum price of Company’s shares during the five days period following Company’s put notice to Cornell to purchase Company’s shares. Under the said agreement, the Company agrees to pay Cornell commitment fees, which were defined as follows:

a) For each notice, Cornell will deduct 5% from the price payable for Company’s ordinary shares, as a commitment fee.

b) Upon execution of the Agreement, the Company issued Cornell with 148,438 of its ordinary shares in an amount equal to $ 190,000.

c) Upon the first to occur of (i) receipt by the Company of an aggregate of more than $5,000,000 from Cornell pursuant to the Agreement; and (ii) the first put notice to be provided by the Company following the first anniversary of the execution of the Agreement, the Company will issue to Cornell a number of its ordinary shares with a value of $ 150,000, calculated in accordance with the minimum closing bid price of Company shares on the public market on which its shares shall be traded at such time, on the day on which the Company is required to issue the ordinary shares.

In a registration statement, which was declared effective on July 7, 2004, or the Initial Registration Statement, the Company registered 5,555,555 of its ordinary shares for future issuance to Cornell.

On August 26, 2004, the Company signed a short-term Promissory Note with Cornell whereby Cornell agreed to advance the sum of $4,000,000 to the Company as a loan for the acquisitions of ScanMaster and Yuravision (see Note 3). This amount is repayable by no later than May 9, 2005, or immediately following an event of default, as defined in the agreement. According to the terms of the note, interest shall commence accruing from the 121st day following the execution of the note at a rate equal to one percent (1%) per month. From the 211th day following the execution of the note, interest shall accrue at a rate equal to two percent (2%) per month. Under the terms of the Promissory Note, the Company has agreed to repay the note either in cash or through the net proceeds to be received by it under the Standby Equity Distribution Agreement.

F - 26

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11 – SHAREHOLDER’ EQUITY (cont.)

a. Authorized, issued and outstanding shares (cont.)

2) Cont.

c) Cont.

In May 2005, the Company signed an amendment to the Promissory Note, under the new term the balance of loan will be paid in monthly installments through December 2006, at an interest rate of Prime+2%.

The Company has included in its accounts interest costs pertaining to the Promissory Note, based on a computation of the weighted interest in respect of the Promissory Note.

The Company paid Cornell a commitment fee of five percent (5%) of the principal amount of the Promissory Note, and a further $ 30,000 to an affiliate of Cornell and other party. When used for the repayment of the note, proceeds received under the Standby Equity Distribution Agreement, will not be subject to the 5% commitment fee.

The Company records in its books of accounts the commitment fees over the period of the Promissory Note.

As securities for repayment of the advance and the Promissory Note, the Company has: (i) granted Cornell a second ranking floating charge on all of Company’s assets (to the extent permitted under Israeli law) and on the assets of ScanMaster; (ii) issued to a trustee, 5,555,555 of its ordinary shares which are registered (see above), and (iii) Issued to Trustee an additional 2,500,000 of Company’s restricted ordinary shares.

It has also been agreed to reserve an additional 14,444,445 of Company’s ordinary shares for issuance to Cornell pursuant to the Standby Equity Distribution Agreement, and have agreed to file the registration statement covering these shares.

As part of the transaction with Cornell, the Company also retained the services of Newbridge Securities Corporation (hereafter – Newbridge), an unaffiliated broker-dealer, as a placement agent in connection with the Standby Equity Distribution Agreement. The Company issued Newbridge 7,812 ordinary shares as a placement fee.

The fair value of the said shares is app. $ 10,000. The said costs are included in company’s accounts as deferred share issuance costs.

Through December 31, 2005, the Company repaid $ 2,129,000 of the Note in cash and $ 433,000 by the issuance of 869,946 shares to Cornell, as stipulated in the said agreement.

Through June 2006, the Company issued Cornell with 1,433,527 of its ordinary shares in an amount equal to $ 569,000.

On February 17, 2006, the Company repaid all outstanding amounts owed to Cornell, and have thus fulfilled all of it obligations toward them under the Promissory Note. Following repayment of the Promissory Note, all ordinary shares and advance notices held in trust to guarantee the loan were returned to the Company, and the floating charge on its assets was removed.

F - 27

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11 – SHAREHOLDER’ EQUITY (cont.)

a. Authorized, issued and outstanding shares (cont.)

3) In June 2007 the Company completed a transaction with a group of Israeli institutional investors, for the purchase of its 9,465,544 ordinary shares for $0.315 per share, of an aggregate price of $2,981,646. Pursuant to the transaction, the investors were also issued warrants to purchase 4,732,774 of the Company’s ordinary shares at an exercise price per share of $0.45, exercisable for a period of 4 years.

4) On June 21, 2007, following the approval of the Company’s board of directors and the Company’s audit committee, the Company executed an agreement with Elbit Ltd., or the Elbit Agreement. This agreement was approved by the Company’s shareholders in a meeting held on July 31, 2007. Pursuant to this agreement Elbit Ltd.(i) converted an existing loan to the Company in the amount of $470,000 (including accrued interest up until March 31, 2007) into 1,492,063 ordinary shares, at a price of $0.315 per share; and (ii) invested $250,000 in consideration for 793,651 of the Company’s ordinary shares at a price of $0.315 per share and received a 4-year warrant to purchase 396,825 of the Company’s ordinary shares at an exercise price of $0.45 per share. At consummation the Company paid all interest accrued on the loan between April 1, 2007 and the closing date.

5) On February 21, 2006, the Company consummated the Mivtach Agreement. Pursuant to the agreement, Mivtach Shamir Holdings Ltd. (“Mivtach”) provided the Company with a two-year $3 million loan, which Mivtach Shamir was entitled at its sole discretion, for a period of 24 months following the provision of the loan, to convert into 6,000,000 of the Company’s ordinary shares, at a price per share of $0.5 (half the loan was being held in escrow subject to the completion of a certain milestone, or conversion of the loan). The interest on the loan was repaid on a quarterly basis. Mivtach was also granted a two-year warrant to purchase 4,000,000 of the Company’s ordinary shares at an exercise price of $0.5 per share, exercisable only if the loan was converted. On February 21, 2006, Mivtach assigned their right to receive shares from the Company, under the convertible loan and warrant, to M S N D Real Estate Holding Ltd. (“M.S.N.D.”). On June 21, 2007 the Company executed an agreement with M.S.N.D., which was approved by the Company’s shareholders in a meeting held on July 31, 2007, pursuant to which, the Mivtach Agreement was amended, or the Amendment Agreement. Pursuant to the Amendment Agreement, the terms of the Mivtach Agreement and the loan therein, were amended, such that in consideration for M.S.N.D.‘s undertaking to convert the full loan amount by no later than August 1, 2007 (a) Mivtach will be issued with 9,523,810 of ordinary shares; and (b) Mivtach will receive a 4-year warrant to purchase 2,380,952 of the Company’s ordinary shares at an exercise price of $0.45 per share. Mivtach also agreed to waive its rights to exercise at least 3,000,000 ordinary shares issuable under the Mivtach Agreement, agreeing to exercise no more than 1,000,000 ordinary shares issuable under the Amendment Agreement, which warrants expired on February 21, 2008. Following consummation the Amendment Agreement M.S.N.D, has become a holder of more than 25% of the Company’s issued and outstanding share capital.

M.S.N.D. also completed the purchase of 2,939,192 of the Company’s ordinary shares from three of the founders of ScanMaster, in accordance with the provisions of a share purchase agreement.

During September 2008, M.S.N.D. transferred the right to exercise 1,380,000 ordinary shares to David Gal, the Company's former CEO.

F - 28

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11 – SHAREHOLDER’ EQUITY (cont.)

b. Share option plans:

1) The plans:

(a) In February 1996, the Company’s board of directors adopted the Company’s Employee Share Option Plan (1996) (hereafter – The 1996 Plan). Under the 1996 plan, 565,720 options can be granted to directors, employees and consultants of the Company and its subsidiaries. Each option can be exercised into one ordinary share of the Company. The 1996 plan was valid for ten years and expired in February 2006, except for option awards outstanding on that date.

Under the 1996 Plan, options usually vest as follows: 50% – two years after the effective date of grant; 75% – after three years; and 100% – after four years.

(b) In April 2000, the board of directors of the Company adopted the Employee Share Option Plan (2000) (hereafter – The 2000 Plan).

Under the 2000 plan, options to purchase an aggregate of 4,500,000 ordinary shares are available to be awarded to employees, directors or consultants of the Company or any of its subsidiaries.

Under the 2000 plan, options usually vest over a period of three or four years from the date of grant, in equal parts each year.

The 2000 Plan is valid for ten years and will expire on April 3, 2010, except for options outstanding on that date.

(c) In November 2003, the Board of Directors of the Company adopted the Employee Share Option Plan (2003) (hereafter – The 2003 Plan).

Under the 2003 plan, options to purchase an aggregate of 2,000,000 ordinary shares are available to be awarded to employees, directors or consultants of the Company or any of its subsidiaries.

Under the 2003 plan, options usually vest over a period of four years from the date of grant, in equal parts each year.

The 2003 Plan is valid for ten years and will expire on November 30, 2013, except for options outstanding on that date.

(d) In March 2006, the Board of Directors of the Company adopted the Employee Share Option Plan (2006) (hereafter – The 2006 Plan).

Under the 2006 plan, options to purchase an aggregate of 2,000,000 ordinary shares are available to be awarded to employees, directors or consultants of the Company or any of its subsidiaries.

Under the 2006 plan, options usually exercisable over a period up to ten years following the date of grant, if not exercised earlier, or 6 months after termination of the employee, will generally vest as to 25-33% commencing the beginning of the second year after the grant and as to an additional 25-33% in each of the remaining years thereafter, assuming continuous employment with the Company through such periods.

F - 29

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11 – SHAREHOLDER’ EQUITY (cont.)

b. Share option plans (cont.):

1) The plans (cont.):

The 2006 Plan is valid for ten years and will expire in March, 2016, except for options outstanding on that date.

The exercise price of options granted under the 1996, 2000 and 2003 plans is to be not less than 85% of the fair market value of the ordinary share on the date of grant. All of the outstanding options from the 1996, 2000 and 2003 plan are to expire no later than 10 years following the date of grant.

During 2006 options to purchase 183,797 shares were exercised. The proceeds from the exercise amounted to $ 43 thousands.

During 2007 and 2008 no options were exercised.

The 2000, 2003 and 2006 plans are subject to the terms stipulated by Section 102 of the Israeli Income Tax Ordinance. Inter alia, these terms provide that the Company will be allowed to claim, as an expense for tax purposes, the amounts credited to the employees as a benefit in respect of shares or options granted under the plan.

The amount allowed as an expense for tax purposes, at the time the employee utilizes such benefit, is limited to the amount of the benefit that is liable to tax as labor income, in the hands of the employee; all being subject to the restrictions specified in Section 102 of the Income Tax Ordinance.

The aforementioned expense will be recognized in the tax year that the benefit is credited to the employee.

2) Options granted to employees:

(a) A summary of the status of the above plans in respect of options granted to employees and directors of the Company and its subsidiaries as of December 31, 2008, 2007 and 2006, and changes during the years ended on those dates, is presented below:

	Y e a r  e n d e d  D e c e m b e r  3 1
	2008					2007					2006
	Number			Weighted average exercise price		Number			Weighted average exercise price		Number			Weighted average exercise price
Options outstanding at beginning of year		5,010,352		$	0.79		4,888,686		$	0.83		4,551,596		$	0.86
Changes during the year:
Granted (1)		547,500			0.34		350,000			0.42		777,500			0.69
Exercised		-			-		-			-		(183,797	)		0.21
Forfeited		(147,500	)		1.34		(228,334	)		1.19		(256,613	)		1.21
Options outstanding at end of year		5,410,352			0.69		5,010,352			0.79		4,888,686			0.83
Options exercisable at year end		4,402,102		$	0.77		3,962,739		$	0.85		3,663,176		$	0.90
Weighted average fair value of options
granted during the year (2)	$	0.30				$	0.35				$	0.64

F - 30

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11 – SHAREHOLDER’ EQUITY (cont.)

b. Share option plans (cont.):

2) Options granted to employees (cont.):

(1) Options granted in 2008, 2007 and 2006 were granted with exercise price that was at market value or above.

(2) The fair value of each option granted is estimated on the date of grant using the Black-Scholes option-pricing model in 2008 and 2007 and the Binomial lattice model in 2006, with the following weighted average assumptions:

	Year ended December 31
	2008			2007			2006
Dividend yield		0	%		0	%		0	%
Expected volatility		126	%		140	%		102	%
Risk-free interest rate		3.48	%		4.15	%		4.7	%
Expected life - in years		6.5			6			6

Dividend yield – Management used an expected dividend yield based primarily on past experience applicable as of the grant date.

Expected volatility – Management estimated volatility based on the historical volatility of the Company’s ordinary shares, being the only traded financial instrument of the Company, using in most cases daily observations of the Company’s price share to determine the standard deviation.

Risk free interest rate – The risk-free interest rate is based on the implied yield in effect at the time of each option grant, based on U.S. Treasury zero-coupon bond issued with equivalent remaining terms.

Management estimates forfeiture rates at the date of grant, which are adjusted in subsequent periods if the actual forfeiture rates differ from those initially estimated. Management uses historical data to estimate pre-vesting option forfeiture rates and records share-based compensation expense only for those awards that are expected to vest.

F - 31

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11 – SHAREHOLDERS’ EQUITY (Cont.)

b. Share option plans (Cont.):

2) Options granted to employees (Cont.):

(b) The following table summarizes certain information about options granted to employees and directors of the Company which were outstanding and exercisable under the above plans as of December 31, 2008:

Options outstanding						Options exercisable
Exercise prices		Number outstanding at December 31, 2008		Weighted average remaining contractual life		Number exercisable at December 31, 2008		Weighted average remaining contractual life
$				Years				Years
	0.15-0.32		968,805		3.58-9.60		417,555		3.58-8.75
	0.35-0.46		722,750		2.06-9.12		342,750		2.06-8.94
	0.48-0.70		1,173,297		3.20-9.01		1,098,297		3.20-9.01
	0.75-0.85		1,084,334		4.89-8.29		1,084,334		4.89-8.29
	1.00-1.25		1,461,166		1.39-5.95		1,461,166		1.39-5.95
			5,410,352				4,404,102

c. Options issued to consultants

In September 2005, the Company issued 571,429 warrants, fully vested to bank Mizrahi with an exercise price of $0.77 and immediate vesting in favor of loan agreement (see also Note 9). During November 2006, the Company’s board of directors approved to change the exercise price to $0.5.

All those warrants were granted above market value and the Company recorded expenses according to SFAS 123. The warrants will expire in September 8, 2009.

F - 32

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 12 – TAXES ON INCOME

a. Corporate taxation in Israel

1) Measurement of results for tax purposes under the Income Tax (Inflationary Adjustments) Law, 1985 (the “Inflationary Adjustments Law”)

Under the Inflationary Adjustments Law, results for tax purposes are measured in real terms, having regard to the changes in the Israeli Consumer Price Index (hereafter – CPI). The Company and ScanMaster Ltd. are taxed under this law.

On February 26, 2008, the Israeli Parliament ratified the third reading of the Income Tax Law (“Inflation Adjustments”) (Amendment 20) (Limitation of Term of Validity) –2008 (hereinafter: “The Amendment”), pursuant to which the application of the inflationary adjustment law will terminate in tax year 2007 and as of tax year 2008, the law will no longer apply, other than transition regulations whose intention is to prevent distortions in tax calculations.

According to the amendment, in tax year 2008 and thereafter, the adjustment of revenues for tax purposes will no longer be considered on a real-term basis for measurement. Moreover, the linkage to the CPI of the depreciated sums of fixed assets and carryover losses for tax purposes will be discontinued, in a manner whereby these sums will be adjusted until the CPI at the end of 2007 and their linkage to the CPI will end as of that date. 

As explained in Note 2, the financial statements are measured in dollars. The difference between the changes in the Israeli CPI and in the exchange rate of the dollar relative to Israeli currency, both on annual and cumulative bases, creates a difference between taxable income and income reflected in these financial statements.

Paragraph 9(f) of FAS 109, “Accounting for Income Taxes”, prohibits the recognition of deferred tax liabilities or assets that arise from differences between the financial reporting and tax bases of assets and liabilities that are measured from the local currency into dollars using historical exchange rates, and that result from changes in exchange rates or indexing for tax purposes. Consequently, the abovementioned differences were not reflected in the computation of deferred tax assets and liabilities.

2) Tax rates

a) The income of the Company and ScanMaster Ltd. (other than income from “approved enterprises”, see b. below) are taxed at the regular rate. For 2008 the corporate tax rate was 27% and it will gradually decrease from 26% in 2009 to 25% in 2010.

b) Non Israeli subsidiaries

Subsidiaries that are incorporated outside of Israel are assessed for tax under the tax laws in their countries of residence. The principal tax rates applicable to subsidiaries outside Israel are as follows:

Company incorporated in the USA – tax rate of 39%.

Company incorporated in tne Netherlands – tax rate of 20%.

F - 33

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 12 – TAXES ON INCOME (cont.)

b. Tax benefits under the Law for the Encouragement of Capital Investments, 1959 (hereinafter – the law)

Under the law, by virtue of the “approved enterprise” status granted to investments in certain assets the Company and ScanMaster Ltd. are entitled to various tax benefits.

1) The main tax benefits available to the Company and ScanMaster Ltd. are:

(a) Reduced tax rates:

(i) The Company

Tax exemption during the period of benefits – 10 years – commencing in the first year in which the Company earns taxable income from the approved enterprises (provided that the maximum period to which it is restricted by the law has not elapsed).

The Company has four approved enterprises; the benefit periods commenced in 1994, 1995, 1997 and 2004, respectively.

The periods of benefits for the first, second and third approved enterprise expired in 2003, 2004 and 2006, respectively.

In the event of distribution of cash dividends from income, which was tax exempt as above, the Company would have to pay 25% tax in respect of the amount distributed. The amount distributed for this purpose includes the amount of the tax that applies as a result of the distribution.

(ii) ScanMaster Ltd.

Tax exemption during the period of benefits – 7 years – commencing in the first year in which ScanMaster earns taxable income from the approved enterprises (provided that the maximum period to which it is restricted by the law has not elapsed).

Tax exemption on income from approved enterprises in respect of which ScanMaster have elected the “alternative benefits” (involving waiver of investment grants); the length of the exemption period is four years, after which the income from these enterprises is taxable at the rate of 25% for three years.

ScanMaster Ltd. has three approved enterprises; the benefit periods in respect of the first and second enterprises commenced in 1994 and 1997, respectively.

The period of tax benefits in respect of the first approved enterprise has expired.

The period of tax benefits in respect of the second approved enterprise expired in 2008. The third approved enterprise has not yet been activated.

In March 2004 ScanMaster Ltd. received a warning from the Investment Center that the instrument of approval of the second approved enterprise might be cancelled. ScanMaster Ltd. plans to appeal the Investment Center’s decision in the near future. ScanMaster Ltd. has not utilized its tax benefits in respect of this enterprise. In case that the said approved enterprise will be cancelled, the Company estimates that it will not be required to be subject to penalties.

F - 34

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 12 – TAXES ON INCOME (cont.)

b. Tax benefits under the Law for the Encouragement of Capital Investments, 1959 (hereinafter – the law) (cont.)

(b) Accelerated depreciation

The Company is entitled to claim accelerated depreciation in respect of equipment used by the approved enterprises during five tax years.

(c) Conditions for entitlement of the benefits

The entitlement to the above benefits is conditional upon the Company fulfilling the conditions stipulated by the above law, regulations published there under and the certificate of approval for the specific investments in approved enterprises. In the event of failure to comply with these conditions, the benefits may be canceled, and ScanMaster Ltd. and the Company may be required to refund the amount of the benefits, in whole or in part, with the addition of linkage differences to the Israeli CPI and interest.

In the event of distribution of cash dividends out of income, which was tax exempt as above, the companies would have to pay the 25% tax in respect of the amount distributed. For this purpose, the amount distributed includes the amount of the tax that applies as a result of the distribution.

c. Tax benefits under the Law for the Encouragement of Industry (Taxes), 1969

The Company and ScanMaster Ltd. are “industrial companies” as defined by this law and as such are entitled to certain tax benefits, consisting mainly of accelerated depreciation as prescribed by regulations published under the Inflationary Adjustments Law, amortization of patents and certain other intangible property, and the right to claim public issuance expenses.

d. Reconciliation of Income Taxes

Following is a reconciliation of the theoretical tax expense, assuming all income is taxed at the statutory corporate tax rate applicable to Israeli corporations, and the actual expense:

	Year ended December 31
	2008			2007			2006
	$ in thousands
Loss before taxes on income		(7,482	)		(1,339	)		(5,357	)
Theoretical tax benefit on the above amount		(2,020	)		(388	)		(1,661	)
Increase in taxes in respect of tax losses
incurred in the reported year for which
deferred taxes were not recorded (see f. below)		2,020			388			1,661
Other		11			3			5
Actual tax expense		11			3			5

Taxes on income included in the statement of operations relate to Company’s subsidiaries.

F - 35

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 12 – TAXES ON INCOME (cont.)

e. Deferred Taxes

1) The Company has approximately $ 32 million unutilized carryforward tax losses from prior years. Therefore, no current tax liability has been provided in 2008 and 2007.

Virtually all the Company’s temporary differences are in respect of carryforward tax losses. Accordingly, no deferred tax assets have been included in these financial statements in respect of the Company’s carryforward tax losses.

2) ScanMaster has unutilized carryforward tax losses from prior years, exceeding other temporary differences. Valuation allowance has been provided in full, for all deferred taxes relating to the above tax losses and temporary differences; Accordingly no tax benefits have been included in these financial statements, as follows:

	December 31, 2008			December 31, 2007
	$ in thousands			$ in thousands
Provision for vacation pay		90			87
Accrued severance pay		91			42
Carryforward tax losses		1,139			858
Research and development costs		653			417
Less - valuation allowance		(1,973	)		(1,404	)
		-			-

The deferred taxes are computed at the average tax rate of 26% – 27%.

f. Carryforward tax losses

Carryforward tax losses of the Company and its subsidiaries aggregate approximately $ 46 million at December 31, 2008.

g. Tax assessments

The tax assessments of the Company and ScanMaster Ltd. through the tax year 2003 are deemed final.

NOTE 13 – FINANCIAL INSTRUMENTS AND RISK MANAGEMENT

a. General

The Company operates internationally, which gives rise to exposure to market risks, mainly from changes in foreign exchange rates.

b. Fair value of financial instruments

The fair value of financial instruments included in working capital is usually identical or close to their carrying amount. The fair value of long-term receivables also approximate the carrying amounts, since they bear interest at rates close to prevailing market rates.

F - 36

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 14 – LIABILITIES SECURED BY PLEDGES AND RESTRICTION PLACED IN RESPECT OF LIABILITIES

a. The Group has registered fixed charge on bank deposits in favor of certain banks. The bank deposits are used to secure a credit line granted to the Company by the banks, and as collateral for guarantees provided to its customers (see Note 2q).

As of December 31, 2008, the bank deposits amount to $ 700 thousands, out of which $ 121 thousands are linked to the dollar and $ 579 thousands are linked to the Euro; The deposits are for a period of one Month.

b. The Company and Scanmaster have registered floating charges on all of their assets in favor of banks (see Notes 9, 15c).

NOTE 15 – SUPPLEMENTARY INFORMATION:

			December 31
			2008		2007
			$ in thousands
a.	Accounts receivable
	1)	Trade -allowance for doubtful accounts:
		Balance at beginning of year		677		936
		Charged to statement of operations		8		(84	)
		Write-off of uncollectible amounts		-		(175	)
		Balance at end of year		685		677
	2)	Other:
		Employees		36		60
		Prepaid expenses		118		378
		Israeli Government departments and agencies		362		324
		Receivables from selling the Yuravision		100		360
		Advance to agent		-		275
		Sundry		-		31
				616		1,428

F - 37

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 15 – SUPPLEMENTARY INFORMATION(Cont.)

b. Accounts payable and accruals – other:

	December 31
	2008		2007
	$ in thousands
Employees and employee institutions		732		535
Israeli Government departments and agencies		918		1,005
Provision for vacation and recreation pay		550		588
Provision for product warranty		255		218
Liability for commissions to agents		287		108
Accrued expenses and sundry		574		175
		3,316		2,629

c. Credit from banks

Composed as follows:

	% interest rate as of December 31, 2008		December 31
			2008		2007
			$ in thousands
Unlinked credit from bank		7		408		504
Short-term loans from banks:
Linked to the dollar		5		4,444		3,793
Linked to the Euro		5		1,536		670
				6,388		4,967

In 2003, the Company entered into agreements for bank credit facilities, pursuant to which the Company may, from time to time, borrow an aggregate amount of up to $ 3,930,000. As of December 31, 2008 the Company uses $ 3,916,000 of the said credit; to secure the credit facilities, the Company registered a first ranking floating charge on all of the Company’s assets and all the assets of ScanMaster and a floating fixed charge on certain bank deposits in favor of the said banks (see Note 14).

d. Cost of revenues

	Year ended December 31
	2008		2007		2006
	$ in thousands
Industrial operations:
Materials consumed		7,787		4,202		5,636
Payroll and related expenses		3,120		2,776		2,745
Subcontracted work		519		247		253
Depreciation and amortization		571		579		579
Other production expenses		2,311		1,873		2,267
Royalties (see Note 10a)		241		300		287
Increase in inventories		-		1,331		469
		14,549		11,308		12,236

F - 38

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 15 – SUPPLEMENTARY INFORMATION (cont.):

e. Research and development expenses:

Total expenses	4,711		3,454		2,707
Less - grants and participations (see Note 10a1)	(152	)	(141	)	(145	)
	4,559		3,313		2,562

f. Financial expenses, net

	Year ended December 31
	2008			2007			2006
	$ in thousands
Income:
Interest in respect of bank
Deposits and securities		26			62			44
Exchange differences		-			48			-
Other		-			-			9
		26			110			53
Expenses:
Interest
In respect of liability to related parties		4			360			460
In respect of credit from banks		537			747			695
Exchange differences		555			-			215
Other		12			84			15
		1,108			1,191			1,385
		(1,082	)		(1,081	)		(1,332	)

g. Other expenses

	Year ended December 31
	2008			2007			2006
	$ in thousands
Write off of discount on convertible loan associated with beneficial conversion feature (see note 9a.(3))		-			(1,047	)		-
Other		(18	)		(230	)		(5	)
		(18	)		(1,277	)		(5	)

NOTE 16 – RELATED PARTIES

	2008		2007		2006
	$ in thousands
Marketing and selling		250		120		92
General and administrative		302		278		322
Financing expenses on long-term loan
granted by shareholders - see Note 9a.		4		360		29
Other expenses		30		1,047		-

F - 39

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17 – BUSINESS AND GEOGRAPHICAL SEGMENTS

a. General information:

1) Factors management used to identify the enterprise’s reportable segments

The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. Most of the businesses were acquired as a unit, and the management at the time of the acquisition was retained.

2) Description of the types of products and services from which each reportable segment derives its revenues

Due to the acquisition in 2004, the internal organizational structure changed; consequently, the company has two reportable segments:

(a) Automatic Vision Inspection segment – design, develop, manufacture and marketing automatic vision inspection and quality monitoring systems, and rendering services related to those systems.

(b) Non-destructive Automated Inspection segment – develop, manufacture and market equipment for the ultrasonic inspection of industrial parts and components for the automotive and transportation industries, the metal industry as well as applications for aircraft and jet engine inspection.

Prior to June 2004, the Company operated only in one segment – the Automatic Vision Inspection segment.

b. Information about reported segment income or loss and assets:

Measurement of segment income or loss and segment assets

The accounting policies of the segments are the same as those described in the significant accounting policies. The Company evaluates performance based on profit or loss from operations before income taxes, not including non-recurring gains and losses and foreign exchange gains and losses.

The Company accounts for inter-segment sales and transfers as if the sales or transfers were to third parties, that is – at current market prices.

	Automatic Vision Inspection			Non- Destructive Automated Inspection			Total
	$ in thousands
Year ended December 31, 2008:
Revenues from unaffiliated customers		6,406			15,694			22,100
Total Consolidated revenues								22,100
Segment Operating loss		(1,884	)		(4,311	)		(6,195	)
Unallocated corporate expenses								(187	)
Operating loss								(6,382	)
Segment assets		3,683			13,502			17,185
Other unallocated amounts								16
Consolidated assets at the year end								19,252
Expenditures for segment assets		37			96			133
Total depreciation and amortization		392			2,431			2,823

F - 40

ELBIT VISION SYSTEMS LTD.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17 – BUSINESS AND GEOGRAPHICAL SEGMENTS (cont.)

c. Geographic information

1) The Company’s revenues by geographic areas (based on locaton of customers) are as follows:

	2008		2007		2006
	$ in thousands
U.S.A.		6,758		6,341		4,178
Europe		10,189		7,756		7,370
Other (mainly Japan and China)		5,153		7,766		5,449
		22,100		21,863		16,997

2) The Company’s long-lived assets by gegraphic areas are as follows:

	2008		2007
	$ in thousands
Israel		4,935		7,437
U.S.A.		30		21
		4,965		7,458

NOTE 18 – GOODWILL

As part of the acquisition of ScanMaster, the Company recognized goodwill of approximately $3.6 million relating to the Non-destructive automated inspection division.  During 2008, the Company assessed the value of the Non-destructive automated inspection division and determined that based on the general current financial condition and the specific state of this division it would be appropriate to write-off approximately $2 million of the value of the goodwill acquired in the ScanMaster acquisition.

As a result of a purchase price adjustment, relating to the acquisition of Panoptes, the Company recognized goodwill of approximately $0.2 million during 2008.

NOTE 19 – SUBSEQUENT EVENTS

At the end of March of 2009, following the approval of the Company’s audit committee and board of directors, the Company entered into agreements with each of Bank Hapoalim and Bank Leumi Le Israel in order to receive a credit line for $300,000 each. These two loans, which bear a floating interest rate of LIBOR plus 3.75% and LIBOR plus 3.5%, respectively, are due to be repaid in monthly installments by the end of December 2009.

Mivtach Shamir (the Company's controlling shareholder) has tentatively agreed to invest an aggregate amount of $1.8 million as a part of a private placement or rights offering, of which NIS 1,982,000 (approximately $492,000) Mivtach Shamir provided to the Company by way of a convertible loan during 2009. The terms of the loan conversion and repayment of the remaining investment amount are currently being negotiated by Mivtach Shamir and the Company's management. The remaining investment amount and the conversion of the loan is contingent upon Bank Leumi Le Israel and Bank Hapoalim agreeing to restructure the Company's debt to them such that the repayment of the principal on the loans will be frozen until December 31, 2011. If the Company does not receive such approval from the banks and fail to receive the $1.3 million from Mivtach Shamir, the Company believes that its current assets, together with anticipated cash generated from operations and available credit lines, will be insufficient to meet the Company's cash requirements for working capital and capital expenditures for twelve months from July 2009.

F - 41