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# UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

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# FORM 20-F

|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.

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

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|                             |                               
|---------------------------- | ------------------------------
|
|
|
|
|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)

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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)



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

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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:

Yes x          No o

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. GAAP x | International Financial Reporting Standards as issued by | Other o
|            | the International Accounting Standards Board o          

2

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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 17 o          Item 18 o

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

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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 in Item 3, Risk Factors.

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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

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|         |                                                            |   
|-------- | ---------------------------------------------------------- | --
|
|
|
|
|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

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|PART II  
|---------
|ITEM 13. 
|         
|ITEM 14. 
|         
|ITEM 15. 
|         
|ITEM 15T.
|         
|ITEM 16. 
|         
|ITEM 16A.
|         
|ITEM 16B.
|         
|ITEM 16C.
|         
|ITEM 16D.
|         
|ITEM 16E.
|         
|ITEM 16F 
|         
|ITEM 16G 
|         
|PART III 
|         
|ITEM 17. 
|         
|ITEM 18. 
|         
|ITEM 19. 

6

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# 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 to Item 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

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|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

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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, see Item 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,
see Item 4, Information on the Company  History and Development of the
Companyand Item 10, Additional Information  Material
Contracts.

9

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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

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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

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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

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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 use information that we regard as
proprietary. For more information, see Item 4, Information on the  Company
 Business Overview  Intellectual Property Rights for Textile Industry.

13

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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, see Item 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

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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, see Item 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, see
Item 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

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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

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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

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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, see Item 4, Information on the Company  History and
Development of the Company and Item 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

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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

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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, see Item 5,
Operating and Financial Review and Prospects  Operating Results  Impact
of Inflation and Devaluation on Results of Operations, Liabilities and Assets
and Item 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

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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

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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 see Item 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, see Item 3, Key Information  Risk Factors  Risk Factors
Related to Our Ordinary Shares and Item 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

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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, see Item 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 is www.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

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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

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Instrumentation

| | The
i  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.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
RPP3 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.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
RPP4 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.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
UPR-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.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
swi-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.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
U/T Mate can convert a computer into a UT instrument by connecting
UT/Mate to the universal serial bus, or USB, port. UT/Mate innovatively
incorporates powerful features, similar to those available in the upi-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

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| | 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 The
DS-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

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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

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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

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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 with accept-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

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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

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| | 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

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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

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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

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| | 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

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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

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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, see Item 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

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|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

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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. See
Item 5, Operating and Financial Review and Prospects  Research and
Development, Patents and Licenses, etc.

38

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In addition, we receive certain tax
benefits and reduced tax rates from the government of Israel. See Item 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, see Item 4, Information on the Company
 History and Development of the Companyand Item 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.

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|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 |      
|Cost of sales                                   |       |       |       | 14,549 |      
|Gross profit                                    |       |       |       | 7,551  |      
|Research and development expenses, net          |       |       |       | 4,559  |      
|Marketing and selling expenses, net             |       |       |       | 5,270  |      
|General and administrative expenses             |       |       |       | 2,123  |      
|Impairment of goodwill                          |       |       |       | 1,981  |      
|Reorganization expenses                         |       |       |       | -      |      
|Total operating expenses                        |       |       |       | 13,933 |      
|Operating profit (loss)                         |       |       |       | (6,382 | )    
|Other income (expenses)                         |       |       |       | (18    | )    
|Financing expenses, net                         |       |       |       | (1,082 | )    
|Profit (loss) before taxes                      |       |       |       | (7,482 | )    
|Taxes on income                                 |       |       |       | 11     |      
|Income (loss) from continuing operations        |       |       |       | (7,493 | )    
|Loss from operations of discontinued component  |       |       |       | -      |      
|Net loss of disposal of discontinued operation  |       |       |       | -      |      
|Net loss                                        |       |       |       | (7,493 | )    
|Basic earnings (loss) per share from continuing |       |      
|operations(1)                                   |       |       |       | (0.147 | )    
|Diluted earnings (loss) per share from          |       |      
|continuing operations(1)                        |       |       |       | (0.147 | )    
|Basic earnings (loss) per share from            |       |      
|discontinued operations(1)                      |       |       |       | -      |      
|Diluted earnings (loss) per share from          |       |      
|discontinued operations(1)                      |       |       |       | -      |      
|Basic earnings (loss) per share(1)              |       |       |       | (0.147 | )    
|Diluted earnings (loss) per share(1)            |       |       |       | (0.147 | )    
|Weighted average number of shares               |       |      
|outstanding-Basic (1)                           |       |       |       | 50,970 |      
|Weighted average number of shares               |       |      
|outstanding-Diluted (1)                         |       |       |       | 50,970 |      

|                     | 2008 | 2007 | 2006 | 2005    | 2004
|-------------------- | ---- | ---- | ---- | ------- | ----
|
|
|
|
|Balance Sheet Data:  |      |      |      |         |     
|Working capital      |      |      |      | (4,098  | )   
|Total assets         |      |      |      | 17,201  |     
|                     |      |     
|Total liabilities    |      |      |      | 16,828  |     
|Accumulated deficit  |      |      |      | (38,771 | )   
|Shareholders' equity |      |      |      | 373     |     

(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.

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# 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.

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# 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.

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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 00-21 Revenue
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.

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# 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                              |       |       |      
|Cost of sales                          |       |       |      
|Gross profit                           |       |       |      
|Research and development expenses, net |       |       |      
|Marketing and selling expenses, net    |       |       |      
|General and administrative expenses    |       |       |      
|Impairment of goodwill                 |       |       |      
|Reorganization expenses                |       |       |      
|Total operating expenses               |       |       |      
|Operating income (loss)                |       |       |      
|Other expenses                         |       |       |      
|Financing expenses, net                |       |       |      
|Income loss before taxes               |       |       |      
|Income taxes                           |       |       |      
|Discontinued operation                 |       |       |      
|Net loss                               |       |       |      

*     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.

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# 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, see Item 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.

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# 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,
see Item 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

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# 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
in Item 3, Key Information  Risk Factors  General Risks and
Item 11, Quantitative and Qualitative Disclosures about Market Risk  Foreign
Currency Exchange and Interest Rate Risk.

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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 |                      |                    
|January 2009  |                      |                    
|February 2009 |                      |                    
|March 2009    |                      |                    
|April 2009    |                      |                    
|May 2009      |                      |                    

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 to Item 4, Information on the
Company  Business Overview  Governmental Regulation Affecting the
Companyand the discussion regarding political policies is hereby incorporated
by reference to Item 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

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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 to Item 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 to Item 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 to Item 4, Information on the Company  History
and Development of the Companyand Item 10, Additional Information
 Material Contracts.

49

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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, see Item 10, Additional
Information  Taxation.

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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      |      |      | $   
|OCS grants                                  |      |      | $   
|Gross research and development expenditures |      |      | $   

# 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.

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# 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)
|------------------------------------ | -----------------------------------------------------------------------------------
|
|
|
|
|Operating Car Lease Obligations      |                                                                                    
|Operating Building Lease Obligations |                                                                                    
|                                     |                                                                                    
|Total                                |                                                                                    

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.

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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.

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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

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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

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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.

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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.
|- | ----------------------------

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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.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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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.

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# 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.

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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.

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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.

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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.

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|Identity of Person or Group               | Amount Beneficially Owned | Percent of Class
|----------------------------------------- | ------------------------- | ----------------
|
|
|
|
|Nir Alon (1)(2)(3)(9)                     |                           |                 
|Elbit Ltd. (4)(5)                         |                           |                 
|M.S. Master Investments (2002) Ltd. (6)   |                           |                 
|M.S.N.D. Real Estate Holdings Ltd. (4)(7) |                           |                 
|Shavit Capital Entities (8)               |                           |                 
|All directors and officers as a group (9) |                           |                 

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.

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(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.

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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.

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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

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|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

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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 and Item 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 and
C. 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, see Item 3, Key Information  Risk Factors
 Risk Factors Related to Our Ordinary Sharesand Item 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.

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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   

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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.

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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.

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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:
| | - | ---------------------------------------------------------------

| |  | 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.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |  | 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.
| | - | -----------------------------------------------------------------------------------------------------

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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.

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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 also Item
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inItem 7 of this Annual Report.

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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in Item 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.

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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inItem 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, see Item 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.

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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%.

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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 at http://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, 2007 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, 2007.

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)         |      |     
|Tax Fees(2)           |      |     
|All Other Fees(3)     |      |     
|Audit Related Fees(4) |      |     
|Total                 |      |     

| | (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 to Item
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 Form 20-F and that it has duly caused and
authorized the undersigned to sign this annual report on its behalf.

July 15, 2009

| |  | ELBIT VISION SYSTEMS LTD.By: /s/ Ran Eisenberg
Ran EisenbergChief 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 andShareholders 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
|------------------------------------------------------------------- |  | -----------
|
|
|
|
|A s s e t s                                                         |  |            
|                                                                    |  |            
|CURRENT ASSETS:                                                     |  |            
|Cash and cash equivalents                                           |  |            
|Restricted deposit (short term)                                     |  |            
|Accounts receivable:                                                |  |            
|Trade (net of allowance for doubtful account 2008- $685, 2007-$677) |  |            
|Other                                                               |  |            
|Inventories                                                         |  |            
|                                                                    |  |            
|T o t a l  current assets                                           |  |            
|                                                                    |  |            
|INVESTMENTS AND LONG-TERM RECEIVABLES:                              |  |            
|Severance pay fund                                                  |  |            
|Other long-term receivables and investment                          |  |            
|                                                                    |  |            
|                                                                    |  |            
|                                                                    |  |            
|PROPERTY AND EQUIPMENT (net of accumulated                          |  |            
|depreciation and amortization)                                      |  |            
|                                                                    |  |            
|OTHER ASSETS (net of accumulated amortization)                      |  |            
|Goodwill                                                            |  |            
|Other intangible assets                                             |  |            
|                                                                    |  |            
|                                                                    |  |            
|                                                                    |  |            
|T o t a l  assets                                                   |  |            
|                                                                    |  |            

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
|----------------------------------------------------------------------- |  | -----------
|
|
|
|
|Liabilities and shareholders' equity                                    |  |            
|CURRENT LIABILITIES:                                                    |  |            
|Credit from banks                                                       |  |            
|Accounts payable and accruals:                                          |  |            
|Trade                                                                   |  |            
|Deferred income                                                         |  |            
|Other                                                                   |  |            
|                                                                        |  |            
|T o t a l current liabilities                                           |  |            
|                                                                        |  |            
|LONG-TERM LIABILITIES:                                                  |  |            
|Loans and other liabilities (net of current maturities)                 |  |            
|Accrued severance pay                                                   |  |            
|                                                                        |  |            
|T o t a l long-term liabilities                                         |  |            
|                                                                        |  |            
|COMMITMENTS AND CONTINGENT LIABILITIES                                  |  |            
|T o t a l  liabilities                                                  |  |            
|                                                                        |  |            
|SHAREHOLDERS' EQUITY:                                                   |  |            
|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                          |  |            
|Additional paid-in capital                                              |  |            
|Accumulated deficit                                                     |  |            
|                                                                        |  |            
|T o t a l  shareholders' equity                                         |  |            
|                                                                        |  |            
|T o t a l  liabilities and shareholders' equity                         |  |            
|                                                                        |  |            

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,
|---------------------------------------------- |  | -----------------------
|
|
|
|
|REVENUES:                                      |  |                        
|Sale of products                               |  |                        
|Services rendered                              |  |                        
|                                               |  |                        
|                                               |  |                        
|                                               |  |                        
|COST OF REVENUES:                              |  |                        
|Cost of products sold                          |  |                        
|Cost of services rendered                      |  |                        
|                                               |  |                        
|                                               |  |                        
|                                               |  |                        
|                                               |  |                        
|GROSS PROFIT                                   |  |                        
|RESEARCH AND DEVELOPMENT COSTS - NET           |  |                        
|SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:  |  |                        
|Marketing and selling                          |  |                        
|General and administrative                     |  |                        
|Impairment of goodwill                         |  |                        
|Reorganization expenses                        |  |                        
|                                               |  |                        
|OPERATING INCOME (LOSS)                        |  |                        
|FINANCIAL EXPENSES - NET                       |  |                        
|                                               |  |                        
|                                               |  |                        
|LOSS BEFORE OTHER EXPENSES                     |  |                        
|OTHER EXPENSES                                 |  |                        
|                                               |  |                        
|                                               |  |                        
|LOSS BEFORE TAXES ON INCOME                    |  |                        
|TAXES ON INCOME                                |  |                        
|                                               |  |                        
|LOSS FOR THE YEAR FROM CONTINUED OPERATIONS    |  |                        
|                                               |  |                        
|LOSS FROM OPERATIONS OF DISCONTINUED COMPONENT |  |                        
|NET LOSS ON DISPOSAL OF DISCONTINUED OPERATION |  |                        
|                                               |  |                        
|LOSS FOR THE YEAR                              |  |                        
|                                               |  |                        
|                                               |  |                        
|LOSS PER SHARE FROM CONTINUING OPERATIONS:     |  |                        
|Basic                                          |  |                        
|                                               |  |                        
|Diluted                                        |  |                        
|                                               |  |                        
|LOSS PER SHARE FROM DISCONTINUED OPERATIONS:   |  |                        
|Basic                                          |  |                        
|                                               |  |                        
|Diluted                                        |  |                        
|                                               |  |                        
|LOSS PER SHARE:                                |  |                        
|Basic                                          |  |                        
|                                               |  |                        
|Diluted                                        |  |                        
|                                               |  |                        
|                                               |  |                        
|WEIGHTED AVERAGE NUMBER OF SHARES USED IN      |  |                        
|COMPUTATION OF LOSS PER SHARE -                |  |                        
|BASIC (IN THOUSANDS)                           |  |                        
|                                               |  |                        
|DILUTED (IN THOUSANDS)                         |  |                        
|                                               |  |                        

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
|----------------------------------------------------- | ------------- | --------------------------- | -------------------------- | ------------------- | --------------------------
|
|
|
|
|BALANCE - DECEMBER 31, 2005                           |               |                             |                            | 26,762              |                           
|CHANGES DURING 2006:                                  |               |                            
|Loss for the year                                     |               |                             |                            |                     |                           
|Currency translation differences                      |               |                             |                            |                     |                           
|                                                      |               |                             |                            |                     |                           
|Total comprehensive income                            |               |                             |                            |                     |                           
|Employee stock options exercised and paid             |               |                             |                            | 182                 |                           
|Issuance of share capital and warrants (notes 3b,11a) |               |                             |                            | 2,441               |                           
|Beneficial conversion feature (note 9a(3))            |               |                             |                            |                     |                           
|Warrant exercised and paid                            |               |                             |                            | 131                 |                           
|                                                      |               |                             |                            |                     |                           
|BALANCE - DECEMBER 31, 2006                           |               |                             |                            | 29,516              |                           
|CHANGES DURING 2007:                                  |               |                            
|Loss for the year                                     |               |                             |                            |                     |                           
|Issuance of share capital and warrants (note 11a)     |               |                             |                            | 21,275              |                           
|                                                      |               |                             |                            |                     |                           
|BALANCE - DECEMBER 31, 2007                           |               |                             |                            | 50,791              |                           
|CHANGES DURING 2008:                                  |               |                            
|Loss for the year                                     |               |                             |                            |                     |                           
|Warrant exercised and paid                            |               |                             |                            | 197                 |                           
|                                                      |               |                             |                            |                     |                           
|BALANCE - DECEMBER 31, 2008                           |               |                             |                            | 50,988              |                           
|                                                      |               |                             |                            |                     |                           

* 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 FLOWSU.S. dollars in
thousands

|                                                               | Year ended December 31,
|-------------------------------------------------------------- | -----------------------
|
|
|
|
|CASH FLOWS FROM OPERATING ACTIVITIES:                          |                        
|Net Loss                                                       |                        
|Adjustments to reconcile net loss to net                       |                        
|cash used in operating activities:                             |                        
|Depreciation and amortization                                  |                        
|Impairment of goodwill                                         |                        
|Amortization of discount on loan from shareholder              |                        
|Loss from disposal of property                                 |                        
|Loss from disposal of discontinued operation                   |                        
|Liability for employee rights upon retirement                  |                        
|Changes in operating assets and liabilities:                   |                        
|Decrease (increase) in trade accounts receivable               |                        
|Decrease (increase) in other accounts receivable               |                        
|Increase (decrease) in trade accounts payable                  |                        
|Deferred income                                                |                        
|Increase (Decrease) in other accounts payable                  |                        
|Decrease (increase) in inventories                             |                        
|                                                               |                        
|Net cash used in operating activities                          |                        
|                                                               |                        
|CASH FLOWS FROM INVESTING ACTIVITIES:                          |                        
|Acquisition of subsidiary consolidated for the first time (a)  |                        
|Disposal of subsidiary (b)                                     |                        
|Purchase of property and equipment                             |                        
|Long-term receivables                                          |                        
|Purchase price adjustment of contingent consideration          |                        
|Redemption of (investment in) restricted deposit               |                        
|Proceeds from disposal of property and equipment               |                        
|Funds severance pay                                            |                        
|                                                               |                        
|Net cash provided by (used in) investing activities            |                        
|                                                               |                        
|CASH FLOWS FROM FINANCING ACTIVITIES:                          |                        
|Issuance of share capital and warrants - net of issuance costs |                        
|Short-term credit from bank - net                              |                        
|Proceeds from exercise of options and warrants                 |                        
|Retirement of long-term loan from shareholder                  |                        
|Proceeds from  long-term loans from shareholder                |                        
|Proceeds from  long-term loans from bank                       |                        
|Short-term credit paid to Cornell Capital Partners L.P. - net  |                        
|                                                               |                        
|Net cash provided by financing activities                      |                        
|                                                               |                        
|TRANSLATION DIFFERENCES ON CASH BALANCES OF                    |                        
|CONSOLIDATED SUBSIDIARY                                        |                        
|                                                               |                        
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS           |                        
|BALANCE OF CASH AND CASH EQUIVALENTS AT                        |                        
|BEGINNING OF YEAR                                              |                        
|                                                               |                        
|BALANCE OF CASH AND CASH EQUIVALENTS AT END OF YEAR            |                        
|                                                               |                        
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW                           |                        
|INFORMATION - cash paid during the year for:                   |                        
|Interest paid - net                                            |                        
|                                                               |                        
|Income taxes paid - net                                        |                        
|                                                               |                        

* 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
|----------------------------------------------------------- | -----------------------------
|
|
|
|
|(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)       |                              
|Fixed assets                                                |                              
|Long-term receivables                                       |                              
|Other assets                                                |                              
|Long-term loans and other liabilities                       |                              
|Goodwill arising on acquisition                             |                              
|                                                            |                              
|                                                            |                              
|Less:                                                       |                              
|Issuance of share capital and warrants (see c 2) hereafter) |                              
|                                                            |                              
|                                                            |                              
|                                                            |                              

|                                                      | Year ended December 31, 2006
|----------------------------------------------------- | ----------------------------
|
|
|
|
|(b)     Disposal of subsidiary                        |                             
|                                                      |                             
|Assets and liabilities of the subsidiary at date of   |                             
|disposal:                                             |                             
|Working capital (excluding cash and cash equivalents) |                             
|Fixed assets                                          |                             
|Long-term receivables                                 |                             
|Other assets                                          |                             
|Long-term loans and other liabilities                 |                             
|Goodwill                                              |                             
|                                                      |                             
|                                                      |                             
|Less:                                                 |                             
|Future proceeds from selling the subsidiary           |                             
|                                                      |                             
|                                                      |                             
|                                                      |                             

|(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        |  
| | Office furniture and equipment |  
| | Vehicles                       |  

| | 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           |  
| | Customer relations   |  
| | Distribution network |  
| | Brand name           |  

| | 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

---

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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

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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

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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

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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

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---

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
| | ----------------------------------- | ----------------------
|
|
|
|
|
| | Revenues                            |                       
| | Cost of revenues                    |                       
| |                                     |                       
| | Gross profit                        |                       
| | Research and development costs, net |                       
| | Marketing and selling expenses      |                       
| | General and administrative expenses |                       
| |                                     |                       
| | Operating loss                      |                       
| | Financial expenses                  |                       
| | Other income                        |                       
| |                                     |                       
| | Net loss of discontinued operation  |                       
| |                                     |                       

| | 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          |                                    
| | Property, plant, and equipment |                                    
| | Intangible assets              |                                    
| |                                |                                    
| | Total assets acquired          |                                    
| |                                |                                    
| | Current liabilities            |                                    
| | Long-term liabilities          |                                    
| |                                |                                    
| | Total liabilities assumed      |                                    
| |                                |                                    
| | Net assets acquired            |                                    
| |                                |                                    

| | 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

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ELBIT VISION SYSTEMS
LTD.
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

NOTE 4  INVENTORIES

| |                   | December 31
| | ----------------- | -----------
|
|
|
|
| | Raw materials     |            
| | Work in process   |            
| | Finished products |            
| |                   |            
| |                   |            
| |                   |            

| | 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
| | ------------------------------------------------ | -----------
|
|
|
|
| | Deposits on leased vehicle (see also Note 10b2)) |            
| | Investment (1)                                   |            
| | Future proceeds from selling the Yuravision      |            
| |                                                  |            
| |                                                  |            
| |                                                  |            

| | (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
| | ------------------------------------------------ |  | -----------
|
|
|
|
| | Machinery and equipment                          |  |            
| | Leasehold improvements                           |  |            
| | Office furniture and equipment                   |  |            
| | Vehicles                                         |  |            
| |                                                  |  |            
| |                                                  |  |            
| | Less - accumulated depreciation and amortization |  |            
| |                                                  |  |            
| |                                                  |  |            
| |                                                  |  |            

| | 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

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ELBIT VISION SYSTEMS LTD.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

# NOTE 7  OTHER INTANGIBLE
ASSETS

| |                      | Gross carrying amount
December 31 | Accumulated amortization
December 31
| | -------------------- | --------------------------------- | ------------------------------------
|
|
|
|
| | Technology           |                                   |                                     
| | Customer relations   |                                   |                                     
| | Distribution network |                                   |                                     
| | Brand name           |                                   |                                     
| | Backlog              |                                   |                                     
| |                      |                                   |                                     
| |                      |                                   |                                     
| |                      |                                   |                                     

| | 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                    |               
| | 2010                    |               
| | 2011                    |               
| | 2012                    |               
| | 2013                    |               

# 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

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ELBIT VISION SYSTEMS LTD.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

# NOTE 9  LONG-TERM
LIABILITIES  LOANS AND OTHER

| | a. | Composed
as follows:
| | -- | --------------------

| |                                | December 31
| | ------------------------------ | -----------
|
|
|
|
| | Loans from banks(1)            |            
| | Other liabilities:             |            
| | Loans from shareholders(2),(3) |            
| |                                |            
| |                                |            
| |                                |            

| | (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

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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                |            
| | 2009                |            
| | 2010                |            
| | 2011 and thereafter |            
| |                     |            
| |                     |            
| |                     |            

F - 23

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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                     |               
| | 2010                     |               
| | 2011                     |               
| |                          |               
| |                          |               
| |                          |               

| | 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 |               
| | 2010 |               
| | 2011 |               
| |      |               
| |      |               
| |      |               

| | 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
|---------------------------------------- | ----------------------------------------
|
|
|
|
|Options outstanding at beginning of year |                                         
|Changes during the year:                 |                                         
|Granted (1)                              |                                         
|Exercised                                |                                         
|Forfeited                                |                                         
|                                         |                                         
|Options outstanding at end of year       |                                         
|                                         |                                         
|Options exercisable at year end          |                                         
|                                         |                                         
|Weighted average fair value of options   |                                         
|granted during the year (2)              |                                         
|                                         |                                         

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
| | ------------------------ | ----------------------
|
|
|
|
| | Dividend yield           |                       
| |                          |                       
| | Expected volatility      |                       
| |                          |                       
| | Risk-free interest rate  |                       
| |                          |                       
| | Expected life - in years |                       
| |                          |                       

| | 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
| | ------------------- | -------------------
|
|
|
|
| |                     | 0.15-0.32          
| |                     | 0.35-0.46          
| |                     | 0.48-0.70          
| |                     | 0.75-0.85          
| |                     | 1.00-1.25          
| |                     |                    
| |                     |                    
| |                     |                    

| | 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
| | ----------------------------------------------- | ----------------------
|
|
|
|
| | Loss before taxes on income                     |                       
| |                                                 |                       
| | Theoretical tax benefit on the above amount     |                       
| | Increase in taxes in respect of tax losses      |                       
| | incurred in the reported year for which         |                       
| | deferred taxes were not recorded (see f. below) |                       
| | Other                                           |                       
| |                                                 |                       
| | Actual tax expense                              |                       
| |                                                 |                       

| | 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
| | ------------------------------ | ----------------- | -----------------
|
|
|
|
| | Provision for vacation pay     |                   |                  
| | Accrued severance pay          |                   |                  
| | Carryforward tax losses        |                   |                  
| | Research and development costs |                   |                  
| | Less - valuation allowance     |                   |                  
| |                                |                   |                  
| |                                |                   |                  
| |                                |                   |                  

| | 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        
| | -- |  |  | -------------------
|
|
|
|
| | a. |  |  | Accounts receivable
| |    |  | 
| |    |  |  | 1)                 
| |    |  | 
| |    |  |  |                    
| |    |  |  |                    
| |    |  |  |                    
| |    |  |  |                    
| |    |  |  |                    
| |    |  |  |                    
| |    |  |  | 2)                 
| |    |  | 
| |    |  |  |                    
| |    |  |  |                    
| |    |  |  |                    
| |    |  |  |                    
| |    |  |  |                    
| |    |  |  |                    
| |    |  |  |                    
| |    |  |  |                    
| |    |  |  |                    

F - 37

---

---

ELBIT VISION SYSTEMS
LTD.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 15  SUPPLEMENTARY
INFORMATION(Cont.)

| | b. | Accounts
payable and accruals  other:
| | -- | --------------------------------------

| |                                             | December 31
| | ------------------------------------------- | -----------
|
|
|
|
| | Employees and employee institutions         |            
| | Israeli Government departments and agencies |            
| | Provision for vacation and recreation pay   |            
| | Provision for product warranty              |            
| | Liability for commissions to agents         |            
| | Accrued expenses and sundry                 |            
| |                                             |            
| |                                             |            
| |                                             |            

| | c. | Credit
from banks
| | -- | -----------------

| | Composed
as follows:
| | --------------------

| |                              | % interest rate
as of
December 31, 2008 | December 31
| | ---------------------------- | --------------------------------------- | -----------
|
|
|
|
| | Unlinked credit from bank    |                                         |            
| | Short-term loans from banks: |                                         |            
| | Linked to the dollar         |                                         |            
| | Linked to the Euro           |                                         |            
| |                              |                                         |            
| |                              |                                         |            
| |                              |                                         |            

| | 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
| | ----------------------------- | ----------------------
|
|
|
|
| | Industrial operations:        |                       
| | Materials consumed            |                       
| | Payroll and related expenses  |                       
| | Subcontracted work            |                       
| | Depreciation and amortization |                       
| | Other production expenses     |                       
| | Royalties (see Note 10a)      |                       
| | Increase in inventories       |                       
| |                               |                       
| |                               |                       
| |                               |                       

F - 38

---

---

ELBIT VISION SYSTEMS
LTD.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

# NOTE 15 
SUPPLEMENTARY INFORMATION (cont.):

| | e. | Research
and development expenses:
| | -- | ----------------------------------

| |                                                  |  |  | 
| | ------------------------------------------------ |  |  | 
|
|
|
|
| | Total expenses                                   |  |  | 
| | Less - grants and participations (see Note 10a1) |  |  | 
| |                                                  |  |  | 
| |                                                  |  |  | 
| |                                                  |  |  | 

| | f. | Financial
expenses, net
| | -- | -----------------------

| |                                            | Year ended December 31
| | ------------------------------------------ | ----------------------
|
|
|
|
| | Income:                                    |                       
| | Interest in respect of bank                |                       
| | Deposits and securities                    |                       
| | Exchange differences                       |                       
| | Other                                      |                       
| |                                            |                       
| |                                            |                       
| |                                            |                       
| | Expenses:                                  |                       
| | Interest                                   |                       
| | In respect of liability to related parties |                       
| | In respect of credit from banks            |                       
| | Exchange differences                       |                       
| | Other                                      |                       
| |                                            |                       
| |                                            |                       
| |                                            |                       
| |                                            |                       
| |                                            |                       

| | g. | Other
expenses
| | -- | --------------

| |                                                                                                           | Year ended December 31
| | --------------------------------------------------------------------------------------------------------- | ----------------------
|
|
|
|
| | Write off of discount on convertible loan associated with beneficial conversion feature (see note 9a.(3)) |                       
| | Other                                                                                                     |                       
| |                                                                                                           |                       
| |                                                                                                           |                       
| |                                                                                                           |                       

# NOTE 16  RELATED
PARTIES

| |                                        | 2008 | 2007 | 2006
| | -------------------------------------- | ---- | ---- | ----
|
|
|
|
| | Marketing and selling                  |      |      |     
| |                                        |      |      |     
| | General and administrative             |      |      |     
| |                                        |      |      |     
| | Financing expenses on long-term loan   |      |     
| | granted by shareholders - see Note 9a. |      |      |     
| |                                        |      |      |     
| | Other expenses                         |      |      |     
| |                                        |      |      |     

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
| | ------------------------------------ | --------------------------- | ------------------------------------- | -----
|
|
|
|
| | Year ended December 31, 2008:        |                             |                                       |      
| | Revenues from unaffiliated customers |                             |                                       |      
| | Total Consolidated revenues          |                             |                                       |      
| |                                      |                             |                                       |      
| | Segment Operating loss               |                             |                                       |      
| | Unallocated corporate expenses       |                             |                                       |      
| |                                      |                             |                                       |      
| | Operating loss                       |                             |                                       |      
| |                                      |                             |                                       |      
| | Segment assets                       |                             |                                       |      
| | Other unallocated amounts            |                             |                                       |      
| |                                      |                             |                                       |      
| | Consolidated assets at the year end  |                             |                                       |      
| |                                      |                             |                                       |      
| | Expenditures for segment assets      |                             |                                       |      
| |                                      |                             |                                       |      
| | Total depreciation and amortization  |                             |                                       |      
| |                                      |                             |                                       |      

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
| | ------------------------------ | ---- | ---- | ----
|
|
|
|
| | U.S.A.                         |      |      |     
| | Europe                         |      |      |     
| | Other (mainly Japan and China) |      |      |     
| |                                |      |      |     
| |                                |      |      |     
| |                                |      |      |     

| | 2) | The
Companys long-lived assets by gegraphic areas are as follows:
| | -- | ------------------------------------------------------------------

| |        | 2008 | 2007
| | ------ | ---- | ----
|
|
|
|
| | Israel |      |     
| | U.S.A. |      |     
| |        |      |     
| |        |      |     
| |        |      |     

# 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

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---