UNITED STATES


SECURITIESAND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549


________________________




FORM20-F




 ̈
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, 2009




Or




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




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



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



For the transition period from     to




Commission File No.


________________________




ELBIT VISION SYSTEMSLTD.


(Exact name of Registrant as specified in its charter)


________________________


N/A
ISRAEL(Translation of Registrant’s

name into English)
(Jurisdiction of incorporation

or organization)




7 Bareket Street, P.O.B. 3047, Industrial Park, Caesarea, Israel 38900


(Address of principal executive offices)


________________________




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


None




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


Ordinary Shares, nominal value 1.00 New Israeli Shekel per share


(Title of Class)









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




None


(Title of Class)


________________________




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




69,652,779 Ordinary Shares




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





£ Yes           R 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.





£ Yes           R 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 þ           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).




£ Yes           £ 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 R

International Financial Reporting Standards as issued by

the International Accounting Standards Board o

Other o




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 oItem 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).





£ Yes           R No




2





The following is the Annual Report on Form 20-F for the fiscal year ended December 31, 2009 of  Elbit Vision Systems Ltd. or E.V.S. All references to "E.V.S.", "us", "we", "our" or the "company" refer to E.V.S. and its consolidated subsidiaries.





FORWARD LOOKING STATEMENTS





In addition to historical information, this annual report on Form 20-F contains forward-looking statements. Some of the statements under "Item 3. Risk Factors", "Item 5. Operating and Financial review and Prospects" and elsewhere in this Annual Report, constitute “forward-looking” statements within the meaning of Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or other future financial performance, and are identified by words such as "may", "will", "should", "expect", "scheduled", “project”, “plan”, “intend”, "anticipate", "believe", "estimate", "aim", "potential", or "continue". These forward-looking statements are subject to certain risks, uncertainties and assumptions about us that could cause actual results to differ materially from those reflected in the forward-looking statements.





Assumptions relating to forward-looking statements involve judgment with respect to, among other things, future economic, competitive and market conditions, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. In light of the significant uncertainties inherent in the forward-looking information included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives will be achieved. 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 under Item 3. Risk Factors, Item 5. Operating and Financial Review and Prospects, and elsewhere in this report. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis as of the date hereof. We undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof, except as required by applicable law. In addition to the disclosure contained herein, readers should carefully review any disclosure of risks and uncertainties contained in other documents that we file from time to time with the Securities and Exchange Commission or SEC.





To the extent that this Annual Report contains forward-looking statements, as distinct from historical information, we desire to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and we are therefore including this statement for the express purpose of availing ourselves of the protections of the safe harbor with respect to tall forward-looking statements.





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.





3





PART I

6ITEM 1.
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS
6ITEM 2.
OFFER STATISTICS AND EXPECTED TIMETABLE
6ITEM 3.
KEY INFORMATION
6RISK FACTORS
6RISK FACTORS RELATED TO OUR BUSINESS
7RISK FACTORS RELATED TO OUR ORDINARY SHARES
7RISK RELATED TO DOING BUSINESS IN ISRAEL
14ITEM 4.
INFORMATION ON THE COMPANY
16HISTORY AND DEVELOPMENT OF THE COMPANY
16BUSINESS OVERVIEW
19ORGANIZATIONAL STRUCTURE
29PROPERTY, PLANTS AND EQUIPMENT
30ITEM 4A.
UNRESOLVED STAFF COMMENTS
30ITEM 5.
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
30SELECTED FINANCIAL DATA
30OPERATING RESULTS
34LIQUIDITY AND CAPITAL RESOURCES
39RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC
40TREND INFORMATION
41OFF-BALANCE SHEET ARRANGEMENTS
41TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
42ITEM 6.
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
42DIRECTORS AND SENIOR MANAGEMENT
42COMPENSATION
44BOARD PRACTICES
44EMPLOYEES
47SHARE OWNERSHIP
49ITEM 7.
MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
51MAJOR SHAREHOLDERS
51RELATED PARTY TRANSACTIONS
52ITEM 8.
FINANCIAL INFORMATION
56CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION
56SIGNIFICANT CHANGES
57ITEM 9.
THE OFFER AND LISTING
57OFFER AND LISTING DETAILS
57MARKETS
57ITEM 10.
ADDITIONAL INFORMATION
59MEMORANDUM AND ARTICLES OF ASSOCIATION
59MATERIAL CONTRACTS
63EXCHANGE CONTROLS
64TAXATION
65DOCUMENTS ON DISPLAY
75ITEM 11.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
76FOREIGN CURRENCY EXCHANGE
76INTEREST RATE RISK
77ITEM 12.
DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
77


4
  PART II

77ITEM 13.
DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
77ITEM 14
MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
77ITEM 15.
CONTROLS AND PROCEDURES
77ITEM 16.
[RESERVED]
78ITEM 16A
AUDIT COMMITTEE FINANCIAL EXPERT
78ITEM 16B
CODE OF ETHICS
79ITEM 16C.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
79ITEM 16D.
EXEMPTIONS FROM THE LISTING AND STANDARDS OF AUDIT COMMITTEES
79ITEM 16E.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILLIATED PURCHASERS
79ITEM 16F.
CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT
80ITEM 16G.
CORPORATE GOVERNANCE
80PART III

80ITEM 17
FINANCIAL STATEMENTS
80ITEM 18.
FINANCIAL STATEMENTS
80ITEM 19.
EXHIBITS
80


5





PART I.





ITEM 1.
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS





Not applicable.





ITEM 2.                      OFFER STATISTICS AND EXPECTED TIMETABLE





Not applicable.





ITEM 3.                      KEYINFORMATION





A.
The selected financial data is incorporated by reference to Item 5of 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:





6





Risk factors related to our business:
 ·
history of losses;


·
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:


·
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:





Risk Factors 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 $5.9 million, $6.1million $1.3million, $7.5million and $7.7 million in 2004, 2006, 2007, 2008, and 2009 respectively.




7





In June 2010, we restructured our bank loans from Bank Leumi Le Israel BM and Bank Hapoalim (the "Banks"). Although the terms of the restructure agreement were favorable to the company, there is no guarantee that we will be able to comply with the repayment terms and/or be profitable in the future. Our current assets, together with anticipated cash generated from operations and available credit lines, may be insufficient to meet our cash requirements for working capital and capital expenditures for twelve months from July 2010, and we may have to sell additional equity or debt securities and reorganize our credit facilities in order to continue as a going concern. There is no certainty that we will be successful in these efforts, or complete them in a timely fashion. For more information on the restructuring of our loans with the Bank, see Item 4 - Information on the Company -"Recent Developments – Loans".


We intend to continue pursuing businesses to acquire in order to expand 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 a result, we attempted to penetrate the ultrasonic industrial inspection industries through our purchase, in 2004, of ScanMaster Systems (IRT) Ltd. ("ScanMaster"). Our expectations for ScanMaster were not met and, as a result, in June 2010, we sold ScanMaster (the "ScanMaster Transaction"). Our current business strategy includes selective expansion into other related markets 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,  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”; Item 4- Information on the Company-"Recent Developments- ScanMaster Transaction";and Item 10, “Additional Information - Material Contracts”.





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 2007 and 2008, none of our customers in any area of business accounted for more than 10% of our net sales. In each of 2007 and 2009, we had one customer that accounted for more than 10% of our net sales in the field of automated optical vision inspection. In 2007 we had one customer that accounted for more than 10% of our net sales in the field of non-destructive automated inspection systems. 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.




8





Competition in the automated inspection industry is intense.  If we are unable to distinguish our products as superior to those of our competitors, our business may be seriously harmed.


Several companies working with the textile, non-woven and technical fabric industries have developed products with similar visual inspection or quality monitoring capabilities, such as BarcoVision, IsraVision and Cognex.





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 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 will 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 increases in expenses and/ or reductions 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. 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.


9


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





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.




10





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 these personnel 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 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. We hold 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 these efforts to protect our proprietary information provide only limited protection. Our confidentiality and non-competition agreements may not be enforceable and our proprietary technology may not remain a secret. Others may 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 obtain and use information that we regard as proprietary.For more information,see Item 4, “Information on the Company -- Business Overview -- IntellectualProperty Rights for Textile Industry”.





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. In the first half of 2010, we have received several threatened litigation letters from our suppliers and suppliers of ScanMaster and certain suppliers commenced litigation. Following the ScanMaster Transaction, ScanMaster is in the process of resolving the claims of its suppliers and pursuant to the terms of the ScanMaster Transaction, ScanMaster has agreed to indemnify us for any losses that we incur arising out of claims by ScanMaster suppliers. We are also in the process of resolving all claims brought by our suppliers. If, however, we or Scanmaster are unable to quickly resolve these disputes, such matters may become 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”.





11





Risk Factors Related to Our Ordinary Shares


We may require additional financing.





In the fourth quarter of 2009, our then controlling shareholder, Mivtach Shamir ("Mivtach") through its wholly-owned subsidiary, M.S.N.D. Real Estate Holdings Ltd., invested an aggregate amount of approximately $1.8 million in our company. Mivtach invested approximately $1.2 million in cash and an additional approximately $627,000 through the conversion of outstanding loans plus interest. Mivtach also loaned us an aggregate of approximately $850,000 during the first quarter of 2010, and we have entered into an agreement with Mivtach pursuant to which we will repay the loan over five years in equal quarterly installments, plus interest at the US Dollar annual LIBOR rate.





In June 2010, we restructured our bank debt with our banks. Pursuant to the terms of the restructuring, the banks forgave approximately $2.4 million of our debt and the debt of our former subsidiary, ScanMaster. We will repay debt of $1 million to the banks over a period of five (5) years, and we will repay an additional amount of $600,000 over a period of ten (10) years. The debt restructuring was contingent upon the consummation of the sale of ScanMaster, which was completed in June 2010. The banks' approval was further contingent upon certain commitments made by Yaron Menashe, our chief financial officer and Sam Cohen, our chief executive officer, who, as of June, 2010, hold an aggregate of approximately 47% of our shares. Nevertheless, there is no guarantee that the recent measures taken to restructure our debt will be sufficient to continue running our operations, and we may determine that it is in our best efforts to 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 registered or have an obligation to register, our ability to complete additional debt or equity financing may be very limited. For more information regarding our refinancing, change in controlling shareholders or share registration obligations, see Item 4. "Information on the Company- Recent Developments"and Item 7, "Major Shareholders and Related Party Transactions-Related Party Transacations.





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


As of June 30, 2010:


·
69,652,779 of our shares were outstanding;


·
16,679,412 warrants held by institutions and major shareholders (including our current Chief Executive Officer and Chief Financial Officer; and


·
4,350,463 options held by employees and former employees.





As of June 30, 2010 a total of 90, 607,654 of our ordinary shares were issued and outstanding or convertible into our ordinary shares within 60 days. Of these securities, 43,388,797 are held by affiliates out of which 180,250 have been registered under registration statements which we have filed.





Should the convertible securities be exercised or the registered shares be sold, the increase in the number of our shares in the market 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.




12




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 May 2009 was 18,700 shares. The high and low bid price of our ordinary shares for the last two years has been $0.05 and $0.4, 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.





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 shares:





·
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”.




13





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 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.





Risks Related to Doing Business in Israel





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 2008 and January 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. 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.




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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.




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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.                      INFORMATIONONTHE COMPANY





A.
History and Development of the Company





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. 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, at which time 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. 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. For further information, seeItem 3, “Key Information -- Risk Factors-- Risk Factors Related to Our Ordinary Shares”andItem 9, “The Offer and Listing -- Market and Share Price History”.





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 we acquired two businesses, Panoptes and ScanMaster, which operate in the fields of optical vision and non-destructive ultrasonic inspection application, respectively.




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In September, 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.,





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.





Due to the economic downturn, large capital investment required by the industry coupled with the long payment cycle, in June 2010, we sold ScanMaster and substantially all of the assets of ScanMaster Inc. to a group of purchasers including our former chief executive officer and chairman of the board, David Gal and Ofer Sela, our former executive vice president, R&D Operations.





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, which was later amended on January 28, 2008. For more information see Item 10, “Additional Information -- Material Contracts”.





Recent Developments





Since January 1, 2009, the company has experienced the following significant developments:





Sale of ScanMaster


In June 2010, pursuant to a series of agreements, we completed the sale of ScanMaster to a group of purchasers led by David Gal, our former chief executive officer and chairman of our board of directors, and Ofer Sela, who previously served as our executive vice president, research and development (the "ScanMaster Transaction").  In connection with the ScanMaster Transaction, we entered into a share purchase agreement (the "ScanMaster SPA") pursuant to which the purchasers purchased all of the issued and outstanding shares of ScanMaster, ScanMaster repaid us an outstanding debt in the amount of approximately $550,000, $200,000 of which was paid directly to our then landlord in connection with our lease termination. For more information, see Exhibit 4.6. Immediately prior to the ScanMaster transaction, ScanMaster transferred to us all of the issued and outstanding share capital of its wholly owned subsidiary Panoptes Ltd, for NIS 1.  We also entered into an asset and liablity re-allocation agreement (the "Re-Allocation Agreement"), with ScanMaster, pursuant to which the two companies agreed to re-allocate their assets and liabilities so that each party will fully own and be fully responsible for its respective business following the sale of ScanMaster. Additionally, we entered into a creditor agreement with ScanMaster (the "Creditor Agreement"), pursuant to which ScanMaster agreed to repay us an additional amount of $675,000 in debt over a period of ten (10) years commencing January 1, 2011, in equal quarterly installments with interest set at the U.S. Dollar annual LIBOR rate (the "Long-Term Debt").  Additionally, under the terms of the Creditor Agreement, should ScanMaster fail to engage in any rail inspection projects for a consecutive two year period within the ten year repayment period, we will forgive up to $450,000 of ScanMaster's Long-Term Debt to the company. For more information on the ScanMaster SPA, the Re-Allocation Agreement and the Creditor Agreement, see Item 7. Major Shareholders and Related Party Transactions (Section B).




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Sale of the assets of IRT ScanMaster Systems Inc.


One of the conditions for the completion of the ScanMaster Transaction was the execution of an agreement with ScanMaster for the sale of all of the assets and liabilities of our US subsidiary IRT ScanMaster Systems Inc. ("Scan Inc."). Pursuant to the agreement we agreed to sell the assets of Scan Inc. to ScanMaster or another entity determined by ScanMaster.  The sale of the assets of Scan Inc. is expected to be completed in the third quarter of 2010.


Restructuring of our Bank Debt





In June 2010, we completed the restructuring of our bank debt to our Banks. Pursuant to the terms of the debt restructuring, the Banks forgave $2.4 million of debt from our company and our former subsidiary ScanMaster. Further, the Banks agreed to a more flexible repayment schedule whereby we will repay approximately $1 million over a period of five (5) years, and will repay an additional $600,000 over a period of ten (10) years. The debt restructuring was contingent upon the sale of ScanMaster, which was completed in June 2010. The debt restructuring was further conditioned upon certain commitments made by Sam Cohen, our chief executive officer, and Yaron Menashe, our chief financial officer. Mr. Menashe and Mr, Cohen each committed to provide a loan to the company in an amount of $50,000, the repayment of which is scheduled to commence on January 1, 2013, provided that we meet certain milestones set by the Banks. Further, Mr. Cohen and Mr. Menashe each agreed to postpone our payment of the first $50,000 of their salaries until July 2011, at which time we shall commence payment of $50,000 in three equal monthly installments to each of Mr. Cohen and Mr. Menashe.





Mivtach Investment and Loan





In the fourth quarter of 2009, our then controlling shareholder, Mivtach, through its wholly-owned subsidiary, M.S.N.D. Real Estate Holdings Ltd., invested an aggregate amount of $1.8 million in our company. Mivtach invested $1.2 million in cash and an additional $627,000 through the conversion of outstanding loans plus interest.





Mivtach also loaned us an aggregate of approximately US$850,000 during the first quarter of 2010, and in June 2010, we executed an agreement with Mivtach pursuant to which we agreed to repay the loan over five years in equal quarterly installments, plus interest at the US Dollar annual LIBOR rate. In the event that prior to the repayment of the loan to Mivtach, a liquidator or receiver is appointed for ScanMaster as part of liquidation proceedings, the remaining debt to Mivtach will be reduced by 50%.





Appointment of Chief Executive Officer





Pursuant to David Gal's resignation as our chief executive officer, on April 27, 2009 our board of directors approved the appointment of Mr. Ran Eisenberg as our chief executive officer. Mr. Eisenberg served as our chief executive officer until February 15, 2010 at which time Mr. Gal Barak was appointed as chief executive officer of the company. In June, 2010, following the closing of the debt restructuring with the Banks and the ScanMaster Transaction, Mr. Barak resigned as our chief executive officer and Sam Cohen commenced his service as our chief executive officer.




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Significant Reduction in Force





In March 2009, due to a decline in our sales coupled with our distressed financial condition, we implemented a reduction in force during which we terminated fifteen of our employees (including certain employee of ScanMaster).  In November 2009, we terminated an additional eleven employees (including certain employees of ScanMaster) and in March 2010, we terminated a further twenty employees (including certain employees of ScanMaster).





Termination of Lease in Kadima





The terms of the lease for our facilities in Kadima were scheduled to terminate in December 2009. In August 2009, we extended the term of this lease until December 2012. In June 2010, we executed an amendment to the lease agreement pursuant to which the term of the lease expired on June 30, 2010. In consideration for the reduced term and as payment for past unpaid rental amounts, we paid the lessor approximately $376,000 out of which approximately $176,000 was paid out of an existing bank guarantee and $200,000 was paid by ScanMaster as part of the debt repayment under the ScanMaster SPA.





New Controlling Shareholders





In June 2010, our former controlling shareholder, Mivtach, transferred all of its holdings in our company in equal parts to each of Messrs. Sam Cohen and Yaron Menashe, Following the transfer of Mivtach's shares and warrants to these individuals, as of June 30, 2010, each of Messrs. Sam Cohen and Yaron Menashe holds 16,368,403 of our ordinary shares. Additionally, Sam Cohen holds warrants to purchase 5,166,496 of our ordinary shares warrants in addition to options to purchase 51,250 of our ordinary shares and Yaron Menashe holds warrants to purchase 5,166,495 of our ordinary shares, and options to purchase129,500 of our ordinary shares.





Our executive offices are located at 7 Bareket Street, Caesarea, Israel, and our telephone number is +972-4-6107600 and fax number +972-4-6107626. Our Web site is www.evs.co.il. Information on our web site is not incorporated by reference in this annual report.





B.
Business Overview





Until June 2010, we operated 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. Following the ScanMaster Transaction and as of June 2010, we operate in one industry, the Automated Optical Inspection Industry.




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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:





●
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.




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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.





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.




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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.





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.




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·
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;


·
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.





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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.





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.





Non-Destructive Automated Inspection Systems (UT) Division





Until June 2010, we operated in the Non-Destructive Automated Inspection Systems industry or UT industry through our subsidiary, ScanMaster. In June 2010, we sold ScanMaster as part of the ScanMaster Transacation and as of the date thereof we no longer operate in the UT industry. The following description of the UT industry relates to the operations of our subsidiary, ScanMaster Ltd., until June 2010:




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The products of ScanMaster., served the high end of a non-destructive testing, or NDT, market. The company’s products enjoyed a high technological barrier to entry that translated 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 were believed to be well positioned in the industry.





ScanMaster made more than 700 equipment installations in 26 countries, for a total 20-year sales volume exceeding $102 million. Typical uses of ScanMaster equipment included 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.





Sales and Markets





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.




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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


Automated Optical Inspection Industry





In 2005,approximately 61.7% of our sales were in the United States, approximately 25% were in Europe, and approximately 13.3% 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 45.6% of our sales were in the United States, approximately 17.7% were in Europe, and approximately 36.7% 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. In 2009,approximately 29.1% of our sales were in the United States, approximately 11.1% were in Europe, and approximately 59.8% were in the Far East. One customer accounted for 12%, 15% and 11% in each of the years, 2005, 2007 and 2009 respectively. No other customers accounted for more than 10% of our net sales in any of the years 2005, 2006, 2007, 2008 or 2009. 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”.


Non-Destructive Automated Inspection Systems





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 26.1% of our sales were in the United States, approximately 51.1% were in Europe, and approximately 22.8% were in the Far East.In 2007,approximately 20.5% of our sales were in the United States, approximately 43.4% were in Europe, and approximately 36.1% were in the Far East. In 2008,approximately 27.7% of our sales were in the United States, approximately 47.3% were in Europe, and approximately 25% were in the Far East. In 2009,approximately 20.2% of our sales were in the United States, approximately 60.8% were in Europe, and approximately 19% were in the Far East. One customer accounted for 12% and 15% of our sales in each of 2005 and 2007 respectively. No other customers accounted for more than 10% of our net sales in any of the years 2005, 2006, 2007, 2008 or 2009. Since the ScanMaster transaction, we are no longer active in the Non-Destructive Automated Inspection segments of the market.




26





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.





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 such as 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, have attempted to penetrate the field of textile inspection. Yet, thus far, such attempts 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.




27





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.





Intellectual Property Rights for Textile Industry





In May 2002, we entered into an agreement with our former principal shareholder Elbit Ltd. 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.





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.




28





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.





Governmental Regulation Affecting the Company





As a company which focuses on research and development and which receives grants from the Government of Israel, we are affected by the terms of the grants that we receive from the Office of the Chief Scientistof the Ministry ofIndustry, Trade and Labor of the Governmentof Israel, or OCS. 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.”





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 three subsidiaries Elbit Vision Systems US, Inc., or EVS US, IRT ScanMaster Systems Inc., and Panoptes. EVS US and IRT ScanMaster Systems Inc. are incorporated in the United States.  EVS US, Inc. is incorporated in the state of Delaware and IRT ScanMaster Systems Inc. is incorporated in the State of New Hampshire.  EVS US predominantly functions as a sales and support center for our products.





Our subsidiary in Holland, EVS BV, had minimal operational activities. As a result, in December 2009, we dissolved this subsidiary.





In connection with the ScanMaster Transaction, in June 2010, we entered into an agreement for the sale of all of the assets of IRT ScanMaster Systems Inc. Pursuant to the agreement we agreed to sell the assets of Scan Inc. to ScanMaster or another entity determined by ScanMaster.  We expect the sale of Scan Inc. to be completed in the third quarter of 2010.





For more information on the ScanMaster Transaction, see Item 4, “Information on the Company -- History and Development of the Company-Recent Developments”.




29





D.
Property, Plants and Equipment





As of June 2010, we moved our facilities from our previous location in Qadima, Israel to Caesarea, Israel. Our new facilities are located at 7 Bareket Street, P.O.B. 3047, Industrial Park, Caesarea, Israel 38900. We do not own any real property. In 2009 and through June 2010 we leased approximately 10,435 square feel at our facilities in Israel, at an annual rent of approximately $432,000. We extended our lease for this facility, which was scheduled to expire in December 2009 until December 14, 2012. In June 2010, we executed an amendment to the lease agreement terminating the lease on June 30, 2010. As of June 30, 2010, we lease approximately 2,560 square feet at our facilities in Israel, at an annual rent of approximately $62,000. Our lease expires in June 2014. 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 4.A.                   UNRESOLVED STAFF COMMENTS





Not applicable.





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, 2005, 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. 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.
 (in U.S. thousand Dollars )

2009



2008



2007



2006*



2005*Statement of Operations Data:Net sales


12,601



22,100



21,863



16,977



19,579Cost of sales


10,872



14,549



11,308



12,236



11,633Gross profit


1,729



7,551



10,555



4,761



7,946Research and development expenses, net


3,036



4,559



3,313



2,562



2,039Marketing and selling expenses, net


2,643



5,270



4,885



4,149



3,583General and administrative expenses


1,453



2,123



1,338



1,870



1,127Impairment of goodwill


1,553



1,981



-



-



-Reorganization expenses


-



-



-



200



-Total operating expenses


8,685



13,933



9,536



8,781



6,749Operating profit (loss)


(6,956
)


(6,382
)


1,019



(4,020
)


1,197Other income (expenses)


110



(18
)


(1,277
)


(5
)


7Financing expenses, net


(827
)


(1,082
)


(1,081
)


(1,332
)


(437
)Profit (loss) before taxes


(7,673
)


(7,482
)


(1,339
)


(5,357
)


767Taxes on income


4



11



3



5



4Income (loss) from continuing operations


(7,677
)


(7,493
)


(1,342
)


(5,362
)


763Loss from operations of discontinued component


-



-



-



(180
)


(152
)Net loss of disposal of discontinued operation


-



-



-



(551
)


-Net loss


(7,677
)


(7,493
)


(1,342
)


(6,093
)


611Basic earnings (loss) per share from continuing operations(1)


(0.146
)


(0.147
)


(0.034
)


(0.186
)


0.029Diluted earnings (loss) per share from continuing operations(1)


(0.146
)


(0.147
)


(0.034
)


(0.186
)


0.026Basic earnings (loss) per share from discontinued operations(1)


-



-



-



(0.026
)


(0.006
)Diluted earnings (loss) per share from discontinued operations(1)


-



-



-



(0.026
)


(0.005
)Basic earnings (loss) per share(1)


(0.146
)


(0.147
)


(0.034
)


(0.212
)


0.023Diluted earnings (loss) per share(1)


(0.146
)


(0.147
)


(0.034
)


(0.212
)


0.021Weighted average number of shares outstanding-Basic (1)


52,527



50,970



39,393



28,778



26,500Weighted average number of shares outstanding-Diluted (1)


52,527



50,970



39,393



28,778



28,421
 30
  2009


2008


2007


2006


2005Balance Sheet Data:Working capital


522



(4,098
)


1,296



(6,073
)


21Total assets


9,630



17,201



23,506



19,390



22,064Total liabilities


15,059



16,828



15,906



18,389



17,965Accumulated deficit


(46,448
)


(38,771
)


(31,278
)


(29,936
)


(23,843
)Shareholders' equity


(5,429
)


373



7,600



1,001



4,099
  (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.
  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.
  31
 
 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.
 
 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.
 32
 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.
 
 ScanMaster
 
 ScanMaster’s agreements with its customers usually included acceptance testing procedures clause (“ATP”). Each product of ScanMaster had standard performance specifications that were examined in the ATP; usually, the performance specifications were not customized for the specific needs of the customer. Also, unlike in our case, ScanMaster did not grant its customers a trial period in the normal course of business.
  ScanMaster distinguished between sales of new products, in respect of which ScanMaster had no past installation experience and sales of products, in installation of which the company was well experienced. In respect of sales of new products ScanMaster recognized revenues only after the company received the ATP from the customer. In respect of sales of other products, in the installation of which the company was well experienced, the ATP was only a formal procedure, and therefore, the installation of products was a sufficient requirement to recognize revenues.
 
 The agreements with the clients did not include the right of the clients to a refund in the event that the ATP was not to their satisfaction. However, the collection of the final payment from the customer (usually 10% out of the total consideration) was scheduled to coincide with receiving the signed ATP.
  33
  ScanMaster recognized revenues from contracts to sell systems that required significant customization, integration and installation or contracts that included 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 were calculated, as the project progressed, according to the percentage of the contract for the purchase of such system that was completed, taking into account the proportion of the actual labor costs incurred to the total labor costs that were estimated to be incurred over the duration of the contract. Provisions for estimated losses on uncompleted contracts were made when such losses were first determined, in the amount of the estimated loss of the entire contract.
 
 When the services were not considered essential, revenues were allocated using provisions prescribed in EITF 00-21 Revenue Arrangements with Multiple Deliverables to each deliverable. Revenues allocated to professional services were recognized as the services were performed.
 
 ScanMaster provided for warranty costs at the same time as the revenue was recognized. The annual provision was 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.
 
 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:
  2009*



2008*



2007*Net sales


100.0



100.0



100.0Cost of sales


86.3



65.8



51.7Gross profit


13.7



34.2



48.3Research and development expenses, net


24.1



20.6



15.2Marketing and selling expenses, net


21



23.8



22.3General and administrative expenses


11.5



9.6



6.1Impairment of goodwill


12.3



9.0



-Reorganization expenses


-



-



-Total operating expenses


68.9



63.0



43.6Operating income (loss)


(55.2
)


(28.9
)


4.7Other Income (expenses)


0.87



(0.1
)


(5.8
)Financing expenses, net


(6.6
)


(4.9
)


(4.9
)Income loss before taxes


(60.9
)


(33.9
)


(6.1
)Income taxes


-



0.05



0.01Discontinued operation


-



-



-Net loss


(60.9
)


(33.9
)


(6.1
)
 
 *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.
  34
 Year Ended December 31, 2009 Compared with Year Ended December 31, 2008





Sales





Sales in 2009 decreased by approximately 43% to $12.6 million compared with sales of $22.1 million in 2008. We witnessed significant decline in our sales from August 2008 in all industries due to the global economic downturn.


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 86.3% in 2009 compared with 65.8% in 2008. The increase in cost of revenues in 2009 was mainly due to inventory write-off of $ 0.6 million and a purchase price allocation (PPA) write-off in connection with the purchase of ScanMaster of $1.36 million.


Gross Profit





In 2009 our gross profit was $1.7 million as compared to $7.5 million in 2008. Gross profit as a percentage of net sales was 13.7% in 2009 as compared to 34.2% in 2008. The decrease in our gross profit in 2009 was mainly due to a write-off of inventory and PPA, a decrease in our sales during 2009 and the fact that despite our cost-cutting measures, the decrease in fixed costs failed to match the decrease in sales.




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 decrease to $3 million in 2009 from $4.7 million in 2008, and were offset by Israeli government grants of zero in 2009 and $0.15 million in 2008. Net research and development expenses in 2009 were $3 million compared with $4.5 million in 2008. The decrease in the gross research and development expenses was mainly due to the massive manpower reduction during February and November 2009. For more information, seeItem 3, “Key Information -- Risk Factors -- General Risks”.




35




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 $2.6 million in 2009, compared to $5.3 million in 2008. The decrease in the marketing and sales expenses was primarily due to the decrease in our sales during 2009 and as a consequence of the resulting  decrease in our commission expenses.





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 11.5% in 2009 from 9.6% in 2008. General and administrative expenses in 2009 were $1.5 million, compared to $2.1 million in 2008. The increase in expenses in 2009 was primarily attributable to doubtful accounts in the amount of $240 thousand


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 2009 were $0.8 million and in 2008 were$1.1 million. During 2008 and 2009, we financed our operations using a credit line facility provided to us by our bank.





Profit/Loss





In 2009 we recorded net loss of $7.7 million, as compared to a $7.5 in 2008. This was primarily due to a write-off of goodwill, intangible assets and inventory. .





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.





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.




36




Research and Development Costs





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





Sales and Marketing Expenses





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





General and Administrative Expenses


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





Financial Expenses





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




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.




37




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





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”.





The exchange rate between NIS and the U.S. Dollar has fluctuated during the past twelve months from a high of NIS 3.987 to the Dollar to a low of NIS 3.667 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 =January 2010
3.765
3.667February 2010
3.796
3.704March 2010
3.787
3.713April 2010
3.749
3.682May 2010
3.87
3.73June 2010
3.888
3.814





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 RateJanuary 1, 2005 – December 31, 2005
4.4878 NIS/$1January 1, 2006 – December 31, 2006
4.4565 NIS/$1January 1, 2007 – December 31, 2007
4.1080 NIS/$1January 1, 2008 – December 31, 2008
3.59 NIS/$1January 1, 2009 – December 31, 2009
3.923 NIS/$1





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%. In 2009, the rate of inflation of approximately 3.91% and the Dollar revalued against the NIS by approximately 0.21%.




38




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, 2009, we had positive working capital of $0.5 million.





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 decreased to $0.3 million at the end of 2009 compared to $0.4 million recorded at the end of 2008. Short term restricted deposits increased to $1 million at the end of  2009 compared to $0.7 million recorded at the end of 2008. The changes were mainly due to the loss we had during 2009. 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 85% of the guarantee amount. During 2009 we had negative cash flow from operational activity of $2.8 million. The negative cash flow was mainly due to losses we incurred in 2009.




Our inventories decreased from $4 million as of December 31, 2008 to $1.7 million as of December 31, 2009, reflecting the world economic downturn and the decrease in our revenues during 2009. We also wrote off some of our inventory as reflected from our future forecast, for more information please review our Financial Statement for 2009. Inventories as a percentage of revenues as of December 31, 2009, decreased to 13.6% compared with 17.8 as of December 31, 2008.





Borrowing





For information on our existing loans, see Item 4, "Information on the Company – Recent Developments" and Item 10, "Additional Information – Material Contracts."




39




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”.





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 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:





As of June 2010, our research and development staff consisted of 3 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 development, real-time software development, PC software development. In 2009 our gross research and development expenditures for the web industry were approximately $0.86 million, in 2008 they were $1.3 million.





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”.


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.




40




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.





(in thousands)

2009


2008


2007Research and development expenses, net

$
3,036


$
4,559


$
3,313OCS grants


-


$
152


$
141Gross research and development expenditures

$
3,036


$
4,711


$
3,454





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.





The AOI market has 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 2009 we reduced our inventory by $0.6 million due to the anticipated lower demand for our products. 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.




Following the ScanMaster Transaction, we are no longer active in the UT field and our current business is exclusively focused on the automated optical inspection sector. Consequently, we are no longer subject to the adverse effects on our cashflow of a business which is heavily project oriented. However, the result of our renewed focus on the AOI sector means that any fluctuations in that industry will have a disproportionate effect on us as compared to the effect it would have had prior to the ScanMaster Transaction. Nevertheless, based on our experience of this market (with the exception of 2008), we expect the industry to remain relatively stable for the foreseeable future.





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.




41




F.
Tabular Disclosure of Contractual Obligations





Our significant financial and contractual obligations as of December 31, 2009, and the periods in which such obligations are due are as follows:





Payments and Amount of Commitment Expiration Per Period

(U.S. Dollars in thousands)Contractual Obligations

Total

Amounts

Committed


Less than

1 Year


1-3

Years


3-5

Years


Over

5 yearsOperating Car Lease Obligations


491



236



255



-



-Operating Building Lease Obligations


1,261



422



839



-



-Total


1,752



658



1,094



-



-





G.
Safe Harbor





Not applicable.


ITEM 6.                      DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES





A.
Directors and Senior Management





In June 2010, in connection with the ScanMaster Transaction, a majority of our directors and senior managers resigned from the company. As of June 30, 2010, our directors, senior managers and key employees were as follows:





Name

Age

PositionSam Cohen (1)

43

Chief Executive Officer and Chairman of the BoardYaron Menashe (2)

34

Director and Chief Financial OfficerAmos Uzani*

55

External DirectorYaky Yanay

40

DirectorDavid Hanuka

41

Director




(1) As of June 30, 2010, Mr. Cohen holds 16,368,402 of our ordinary shares and warrants to purchase 5,166,496 of our ordinary shares, in addition to options to purchase 51,250 of our ordinary shares, constituting (if all the convertible securities were exercised) 29% of the outstanding ordinary shares of the company.




(2) As of June 30, 2010, Mr. Menashe holds 16,368,402 of our ordinary shares and warrants to purchase 5,166,495 of our ordinary shares, in addition to options to purchase 129,500 of our ordinary shares, constituting (if all the convertible securities were exercised) 29% of the outstanding ordinary shares of the company.





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




Sam Cohen joined the company in 2003 and has served as our chief executive officer and Director since June 2010. In 1993 Mr. Cohen was a key figure in the establishment of our U.S. subsidiary where he served as Operations Manager, Technical Director, Regional Sales Manager and Senior Marketing Manager. Prior to joining the company, Mr. Cohen served as VP of Sales and Marketing at OptiTex, a company specializing in innovative 2D and 3D CAD/CAM fashion design software. Mr. Cohen has held R&D roles in several Israeli firms, including Play-Tech and Romtech. Mr. Cohen holds a B.A. in Business Administration from Southern Wesleyan University, USA.




42




Yaron Menashehas served as our chief financial officer since December 2006. Mr. Menashe has served as a Director of the company since June 2010. 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.





Amos Uzaniwas elected to serve as our external director in December 2007. Mr. 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 chief executive officer of Israel Railways Corporation and as Vice President of the Israel Ports and Railways Authority. Between 2002 and 2004 Mr. Uzani served as chief executive officer 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.





Yaky Yanay was elected to our board of directors in July 2010.  From 1999 until 2002, Mr. Yanay worked as a manager at Ernst &Young Israel. From 2002 until 2006, Mr. Yanay served as our chief financial officer. Since 2006, Mr. Yanay has served as the chief financial officer of Pluristem Therapeutics, Inc. (NasdaqCM: PSTI), a biotechnology company specializing in the research, development, of cell therapy products for the treatment of various disorders. Mr. Yanay holds a Bachelor of Business Administration and Accounting from the College of Management and he is a Certified Public Accountant in Israel.




David Hanuka was elected to our board of directors in July 2010. Mr. Hanuka has served as the chief executive officer of Stimatix GI Ltd., an Israeli private company since 2009. From 2006 until 2009, Mr. Hanuka served as the VP, Research and Development of Vision Sciences, Inc. (NasdaqCM: VSCI), a company specializing in the development and manufacture of video endoscope medical devices using imaging technology. From 2003 until 2006, Mr. Hanuka was engaged by CByond Ltd., as its chief operations officer and research and development project manager. From 2000 until 2003, Mr. Hanuka served as research and development project manager and systems engineer at 3DV Systems Ltd. From 1987 until 2000, Mr. Hanuka served in the Israeli navy in various posts, including as a combat ship commander and research and development projects leader. Mr. Hanuka holds a Bachelor of Science degree from Ben-Gurion University and an MBA from the University of Haifa.




43




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. Amos Uzani currently serves as our external director. Mr. Uzani was elected to serve for a three year term commencing December 2007. The company is currently in the process of selecting an external director to replace Mr. David Schwartz who completed a three year term as our external director in April 2010. In October 2009, Ran Eisenberg was appointed as a director of the company to replace David Gal who resigned as a director and as Chairman of the Board of Directors. In February, 2010 Mr. Eisenberg was named Chairman of the board. In conjunction with the ScanMaster Transaction, all of our serving directors, with the exception of Amos Uzni, our external director, resigned from the board as of June 1, 2010. In June 2010, Mr. Sam Cohen and Mr. Yaron Menashe were appointed as members of our board and Mr. Sam Cohen was named Chairman of the board.





B.
Compensation





During 2009, we paid to all our directors and officers a total of $0.9 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.





Upon the closing of the ScanMaster Transaction, Mr. David Gal, our former Chairman of the board and chief executive officer, received a payment of approximately $45,000 in settlement of the amounts due to him in connection with the termination of his engagement by the company in accordance with the terms of his engagement with the company, plus an additional amount of $55,000 in settlement of accrued and unpaid bonuses





Pension and Retirement Benefits




We offered no pension or retirement benefits to our directors and key personnel in 2009





C.
Board Practices





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, our shareholders approved the adoption of new articles of association.





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.




44




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.





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 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 financialdata 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 issuestypical 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.




45




The candidate to serve as an external director must sign a declaration stating that the criteria above have been met, as required by law for the appointment of such candidate as an external director.





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.





The initial term of an external director is three years and may be extended for additional three year terms, subject to certain conditions. 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, Mr. Uzani serves as our external director and we are in the process of locating a second external director to replace Mr. Schwartz who completed his term in April 2010.





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.





Until April 2010, our two external directors Messrs. Schwartz and Uzani served on the audit committee of the board of directors. Currently, Mr. Uzani and Yaky Yanay serves on the audit committee of the board of directors. Once we name a second external director to replace Mr. Schwartz, who completed his term as external director in April 2010, we will appoint such external director to serve on the audit committee of our board of directors.




46




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





In March 2009, due to a decline in our sales coupled with our distressed financial condition, we implemented a reduction in force during which we terminated fifteen of our employees (including certain employee of ScanMaster).  In November 2009, we terminated an additional eleven employees (including certain employees of ScanMaster) and in March 2010, we terminated a further twenty employees (including certain employees of ScanMaster).





Following the ScanMaster Transaction, we experienced a further natural reduction of our workforce.  As a result, as of June 30, 2010, we employ a total of 15 individuals on a full time basis.  Of these individuals, 10 are employees of our company and 5 are engaged as independent contractors. Of these individuals, 9 were employed in Israel, 2 were employed in Europe and 4 were employed in the United States.




2009





As of December 31, 2009, we employed a total of 73 full time persons of which 3 were engaged as independent contractors ,in both of our divisions, as follows:





Non–Destructive Automated Inspection Systems Division





As of December 31, 2009, we employed 52 full-time persons, out of which 49 were employed in Israel of whom 20 were in research and development, 5 were in marketing and sales, 1 was in customer support, 17 were in operations and 4 were in administration and management.





AOI Division





As of December 31, 2009, we employed 21 full-time persons, of which 3 were engaged as independent contractors and 15 were employed in Israel of whom 8 were in research and development, 1 was in marketing and sales, 1 was in customer support, 2 were in operations and 3 were in administration and management.





2008





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




47




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.





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.





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.





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%.




48




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”, Sam Cohen holds 16,368,402 of our ordinary shares and warrants to purchase 5,166,496 of our ordinary shares, in addition to options to purchase 51,250 of our ordinary shares, constituting (if all the convertible securities were exercised) 29% of the outstanding ordinary shares of the company; and Yaron Menashe holds 16,368,402 of our ordinary shares and warrants to purchase 5,166,495 of our ordinary shares, in addition to options to purchase 129,500  of our ordinary shares, constituting (if all the convertible securities were exercised) 29% of the outstanding ordinary shares of the company.





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 June 30, 2010, 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.





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.




49




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 June 30, 2010, options to purchase 789,729 of such ordinary shares were outstanding. 35,000 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 was 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 June 30, 2010, options to purchase 3,223,734 of such ordinary shares were outstanding. 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, 57,500 of the outstanding options have an exercise price of $0.4 per share,   408,750 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 June 30, 2010, 3,216,233 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 Mr. David Gal, our former chairman of the board, were 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.




50


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 June 30, 2010, options to purchase 335,000 of such ordinary shares were outstanding. 25,000 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, 90,000 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 40,000 of the outstanding options have an exercise price of 0.25 per share. As June 30, 2010, 247,500 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 June 30, 2010, 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.





Identity of Person or Group

Amount Beneficially Owned


Percent of ClassSam Cohen (1)(2) (4)


21,586,149



28.83
%Yaron Menashe (1)(3)(4)


21,621,898



28.87
%All directors and officers as a group (5)


43,375,566



54.02
%





The percentages in this table are based on 69,652,779 ordinary shares currently issued and outstanding plus options exercisable within 60 days.





(1) In connection with the company's debt restructuring with its two banks, all of the ordinary shares and warrants held by Mivtach, previously our largest shareholder, were transferred in equal portions to Messrs. Cohen and Menashe. As of June 30, 2010, Mivtach does not hold any shares or warrants in the company.




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(2) Includes 5,166,496 ordinary shares issuable upon the exercise of a warrant exercisable within 60-days and 51,250 ordinary shares issuable upon the exercise of an option exercisable within 60 days.





(3) Includes 5,166,495 ordinary shares issuable upon the exercise of a warrant exercisable within 60-days and 87,000 ordinary shares issuable upon the exercise of an option exercisable within 60 days





(4) Neither Mr. Sam Cohen nor Mr. Yaron Menashe are party to any voting agreement with respect to their share holdings in the company.





(5) Includes all of the shares deemed as beneficially owned by Mr. Cohen and Mr. Menashe and options currently exercisable by directors and officers within 60 days.





As of  December 23, 2009, there were a total of 60 holders of record of our ordinary shares, of which 13 were registered in the United States. Such United States shareholders were, as of such date, the holders of record of approximately 30.6% of our outstanding ordinary shares.
  Voting Agreements





As of June 30, 2010, we are not aware of any voting agreements with respect to the voting rights of our shares.




B.
Related Party Transactions





Share Purchase Agreement





On May 31, 2010, as part of the ScanMaster Transaction, we entered into a  share purchase agreement with ScanMaster, David Gal and Ofer Sela (the "Share Purchase Agreement"). This agreement effectuated the sale of all of the outstanding shares of ScanMaster to certain purchasers for a purchase price of USD $1.  Pursuant to the agreement, ScanMaster agreed to repay us in the amount of USD $347,699for certain outstanding debt owed to us by ScanMaster, plus an additional $200,000 which was paid to our former landlord in connection with the termination of our former lease.





Asset and Liability Re-Allocation Agreement





On May 31, 2010, as part of the Scanmaster Transaction, we eneterd into an Asset and Liability Re-allocation Agreement with ScanMaster.  Pursuant to the terms of this agreement, each of the Company and ScanMaster set forth the re-allocation and separation of the previously jointly-utilized assets of the Company.  As such, each party to the agreement acknowledged such re-allocation schedule and related responsibilities.





Asset Purchase Agreement





In connection with the sale of ScanMaster, on May 31, 2010, ScanMaster and Scan Inc. entered into an asset purchase agreement pursuant to which the parties acknowledged the Company's intention to sell all of the assets held by Scan Inc. to ScanMaster or a third party to be named by ScanMaster.  The agreement contemplated the sale of Scan Inc.'s assets on or before June 30, 2010 following which the Company intended to liquidate and dissolve the subsidiary.




52




Creditor Agreement





In connection with the ScanMaster Transaction, on May 31, 2010, we entered into a creditor agreement with ScanMaster (the "Creditor Agreement") pursuant to which ScanMaster agreed to repay its outstanding debt owed to our company in the amount of USD $ 675,000.  Under the terms of the agreement, ScanMaster is obligated to pay USD $ 675,000 with interest at a rate of annual US Dollar LIBOR per annum plus VAT, in equal quarterly payments over ten (10) years commencing January 1, 2011. Additionally, in the event that ScanMaster's agreement with Israel Railway Ltd. is terminated other than by ScanMaster's initiation, and ScanMaster fails to enter into any agreements for the inspection of rail tracks for a period of two years following the closing of the transaction contemplated in the Creditor Agreement, we shall forgive any unpaid portion of ScanMaster's debt in accordance with the Creditor Agreement, up to a maximum of US $450,000.





Mivtach Investment and Loan





In connection with the refinancing of our debt, on May 26, 2010 we entered into a Loan Agreement with M.S.N.D. Real Estate Holdings Ltd. which set forth the terms and conditions of our debt refinancing. For a description of the Mivtach Investment and Loan, See Item 4. History and Development of the Company-Recent Developments.


Consulting Agreement with Cycloes Ltd. (wholly owned by Sam Cohen)


On June 2, 2010 we agreed in principle to enter into a consulting agreement with Cycloes Ltd., a company wholly owned by Sam Cohen, our chief executive officer (Cycloes Agreement).   Pursuant to the Cycloes Agreement, we will engage Cycloes Ltd. as an independent contractor in order to retain the chief executive officer services of Sam Cohen, upon the following principle terms: (i) a monthly fee of NIS 50,000; (ii) reimbursement of reasonable expenses incurred in connection with the performance of the consulting services; and (iii) a car and mobile phone provided for the purpose of fulfilling the consulting services.


The terms of the Cycloes Agreement will be brought for the approval of our audit committee as soon as our shareholders have appointed an external director, following which the agreement and its terms shall be subject to the approval of our board of directors and shareholders. In June 2010, Mr. Cohen was appointed as a member and chairman of our board of directors.


Employment Agreement with Yaron Menashe





On June 2, 3010 we agreed in principle to enter into a consulting agreement with Yaron Financial Services Ltd., a company wholly owned by Yaron Menashe, our chief financial officer (Yaron Financial Agreement).  Pursuant to the Yaron Financial Agreement, we will engage Yaron Financial Services Ltd. as an independent contractor in order to retain the services of Yaron Menashe as our chief financial officer upon the following principle terms: (i) a monthly fee of NIS 43,000; (ii) reimbursement of reasonable expenses incurred  in connection with the performance of the consulting services; and (iii) a car and mobile phone provided for the purpose of fulfilling the consulting services.




53




The terms of the agreement will be brought for the approval of our audit committee as soon as our shareholders have appointed an external director, following which the agreement and its terms shall be subject to the approval of our board of directors and shareholders. In  June 2010, Mr. Menashe was appointed a member of our board of directors.


Loan Arrangement with Sam Cohen and Yaron Menashe





As a condition to our debt restructuring agreement with our two banks, in June 2010, each of Mr. Sam Cohen and Yaron Menashe undertook two financial commitments toward the company.   Each of Mr. Cohen and Mr. Menashe provided us with a loan in the amount of US $50,000. The repayment of this loan shall occur in one of the following two ways:  (i) commencing July 1, 2012 subject to compliance with the repayment terms of two pre-existing loans; or (ii) Commencing 2013 upon our request, where such request is accompanied by a confirmation letter issued by a certified external auditor confirming the following conditions: (a) existence of net profit for distribution; (b) existence of positive cash flow from ongoing operations; (c) the repayment amount shall not exceed 50% of the net profit for distribution and/or the positive cash flow from ongoing operations, the lower of the two, and in any case shall not exceed the outstanding loan amount; and (d) the auditor's confirmation provides that our tangible share capital is greater than zero.




Further, each of  Messrs. Cohen and  Menashe agreed to the delayed payment by our company of the first US $50,000 of their salary until July 2011, at which time we shall repay each of Mr. Cohen and Mr. Menashe a sum of US $50,000 in three equal monthly installments.





Consulting Agreement with MA&AT





On May 1, 2006, our then subsidiary, ScanMaster, 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 ScanMasterfor a fee. This agreement was approved and ratified by ScanMaster's 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.




54




Following the ScanMaster Transaction neither Mr. Alon nor MA&AT provide any services to the company.





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 and in October 2009, he resigned as director and Chairman of the board.





C.
Interests of Experts and Counsel





Not applicable.




55




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 2009, 96.4% of our sales, amounting to $12.23 million were due to our products being exported outside of Israel.





Litigation


During the period commencing March 2010, we received a number of threatened litigation letters from former employees, employees and suppliers (the "Claimants").  Some of these Claimants have subsequently filed claims against our Company and ScanMaster for the repayment of debts owed to the Claimants.
 
 On February 10, 2010 we entered  into a settlement agreement with Incomac Ltd., a supplier of our company, pursuant to which we agreed to pay Incomac Ltd. NIS 350,000  in settlement of  their claims against our company.  In April 2010, Incomac Ltd. reinitiated legal proceedings with respect to total claims in an amount of approximately NIS 460,000, due to their claim that we breached the terms of the settlement agreement. On June 15, 2010 we finalized a subsequent settlement agreement with Incomac Ltd. with respect to these Proceedings, and a judgment was entered into by the court pursuant to which we are required to pay Incomac NIS 376,720 in full settlement of the claims (the "Incomac Settlement").  As of July 15, 2010, we paid Incomac NIS 300,920.  The remaining settlement amount of NIS 75,800 is payable in August, 2010.
 
 Pursuant to the ScanMaster Transaction, ScanMaster agreed to bear all liability for the disputes with the Claimants relating to the business and operations of ScanMaster, estimated in the amount of NIS 650,000. Additionally, ScanMaster agreed to indemnify us for any damages arising out of any of these claims. It is our understanding that all claims made by the Claimants in respect of the business and operations of ScanMaster have been or are in the process of being settled.
 
 We have settled all claims made by the Claimants in respect of our business and operations.
 
 From time to time we are a party to various litigation  matters incidental to the conduct of our business.  Except as disclosed above, there is no pending or threatened legal proceeding to which we are a party, that, in the opinion of our management, is likely to have a material adverse effect on our future financial results or financial condition.


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 2010 is taxable at regular rates of 31%. See Note 12 to our Consolidated Financial Statements and Item 10, “Additional Information -- Taxation.”




56




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 ANDLISTING





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.




57





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 ($)
Low ($)June 2010
0.07
0.04May 2010
0.07
0.054April 2010
0.079
0.055March 2010
0.08
0.0575February 2010
0.09
0.07January 2010
0.08
0.054Fourth quarter 2009
0.1
0.06Third quarter 2009
0.11
0.065Second quarter 2009
0.14
0.077First quarter 2009
0.16
0.07Fourth quarter 2008
0.29
0.10Third quarter 2008
0.30
0.12Second quarter 2008
0.40
0.26First quarter 2008
0.54
0.25Year ended 2009
0.16
0.06Year ended 2008
0.54
0.10Year ended 2007
0.55
0.27Year ended 2006
0.83
0.22Year ended 2005
0.77
0.44Year ended 2004
1.65
0.37





B.
Plan of Distribution





Not applicable


D.
Selling Shareholders




Not applicable




E.
Dilution





Not applicable





F.
Expenses of the Issue





Not applicable




58




ITEM 10.                   ADDITIONAL INFORMATION




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.




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.




59




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.




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.




60




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:





i.
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.





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





iii.
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.




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.




61




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





TenderOffer. 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.




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”




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Nasdaq Marketplace Rules and Home Country Practices




Not applicable.





C.
Material Contracts





ScanMaster Transaction





A description of the events, terms and conditions related to the sale of our subsidiary, ScanMaster, and the repayment of  its debt of $650,000 to the Company is contained in Item 4. History and Development of the Company- Recent Developments and in Item 7.  Major Shareholders and Related Party Transactionsof this Annual Report which is incorporated herein by reference.


Sale of the Assets of Scan Inc.





A description of the events, terms and conditions related to the sale of the assets of our subsidiary, ScanMaster Inc. iscontained in Item 4. History and Development of the Company- Recent Developments and in Item 7.  Major Shareholders and Related Party Transactionsand such information is incorporated herein by reference.




Debt Restructure Agreement with Bank Leumi Le Israel BM Ltd.





A description of the terms and conditions pertaining to the restructuring of our debt with Bank Leumi Le Israel BM Ltd. is contained in Item 4. History and Development of the Company- Recent Developmentsand is incorporated herein by reference.





Debt Restructure Agreement with Bank Hapoalim Ltd.





A description of the terms and conditions pertaining to the restructuring of our debt to Bank Hapoalim Ltd. is contained in Item 4. History and Development of the Company- Recent Developmentsand is incorporated herein by reference.




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Framework Agreement with Bank Hapoalim Ltd.


On May 27, 2010, we entered into a framework agreement with Bank Hapoalim Ltd. (the "Framework Agreement"), pursuant to which Bank Hapoalim Ltd. (the "Bank"), as part of the ScanMaster Transaction, consented to the sale of ScanMaster, subject to the fulfillment of certain financial restructuring conditions and milestones and subject to our entering into a full debt restructuring agreement with the Bank by June 30, 2010. In addition, the Bank agreed to waive certain outstanding debts owed to the Bank by ScanMaster. The Framework Agreement further set forth the repayment terms of the loans granted by Messrs. Cohen and Menashe to our company.





Mivtach Investment and Loan




A description of the Mivtach Investment and Loan is contained in Item 4. History and Development of the Company-Recent Developmentsof this Annual Report and is incorporated hereto by reference.





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.




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 amended such that the Korean corporation paid us $360,000on February 4, 2008 and paid us the remaining $100,000 owed under the loan in January 2009.  As of January 2009, we have received all payments due to us in connection with the sale of Yuravision.




D.
Exchange Controls





In 1998, the Government of Israel removed the general prohibition against engaging in foreign currency transactions 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.”




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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. 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.





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 were subject to corporate tax at the rate of 26% in the 2009 tax year, and a rate of 25% in the 2010 tax year. The rate is scheduled to be reduced gradually until it is 18% in 2016 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.




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An 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.





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%
7Over 25% but less than 49%
25%
10Over 49% but less than 74%
20%
10Over 74% but less than 90%
15%
1090% or more
10%
10




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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.





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.




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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.





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 higher of a certain percentage of the company’s production assets before the expansion and an 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.




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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.





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.




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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 Grantsless 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.





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.




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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.





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.




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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 January 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.





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.




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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%.





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.




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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 reduced tax rates, as follows:





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.





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.




74




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.




75





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 ANDQUALITATIVE 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, 2009, we had accounts payable in NIS or in funds linked thereto in the amount of $2.6 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 $260 thousand.




76


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, 2009 we had liabilities in the amount of $7.53 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 $37 thousand.





ITEM 12.
DESCRIPTION OF SECURITIES OTHER THAN EQUITYSECURITIES





Not applicable.





PART II





ITEM 13.
DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES





None.





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





None.





ITEM 15.                        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, 2009. 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.
  77




(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. Our 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 our 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]





ITEM 16.A.                    Audit Committee Financial Expert




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




78




ITEM 16.B.
Code ofEthics




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, free of charge, upon written request.


ITEM 16.C.
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, 2008, and December 31, 2009.




2009


2008Audit Fees(1)


35,000



70,000Tax Fees(2)






-All Other Fees(3)


10,380



1,560Audit Related Fees (4)






7,500Total


45,380



79,060




(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 16.D.
Exemptions from the Listing and Standards of Audit Committees




Not applicable.





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





The discussion relating to the transfer of our securities from M.S.N.D to each of Messrs. Sam Cohen and Yaron Menashe is incorporated herein by reference to Item 4. History and Development of the Company- Recent Developments,and "Item 7. Related PartyTransactions”.




79





ITEM 16.F.                    Changes in Registrant's Certifying Accountant





Not applicable.





ITEM 16.G.                   Corporate Governance





Not applicable.





PARTIII





ITEM 17.                        FINANCIAL STATEMENTS





Not applicable.





ITEM 18.                        FINANCIALSTATEMENTS





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 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
Share Purchase Agreement between the Company, ScanMaster Systems (IRT) Ltd. and the Purchaser





4.2
Asset and Liability Re-allocation Agreement between the Company and ScanMaster Systems (IRT) Ltd.





4.3
Asset Purchase Agreement between ScanMaster Systems (IRT) Ltd. and ScanMaster IRT Inc.





4.4
Creditor Agreement between the Company and ScanMaster Systems (IRT) Ltd.





4.5
Loan Agreement between the Company and M.S.N.D. Real Estate Holdings Ltd. dated May 27, 2010.





4.6
Amendment to Lease Agreement between the Company and Yehezkel Yaakobi   (English summary of the Hebrew language agreement.)





4.7
Debt Restructure Agreement between the Company and Bank Leumi LeIsrael Ltd. (English summary of the Hebrew language agreement.)




80




4.8
Framework Agreement between the Company and Bank Hapoalim Ltd. (English summary of the Hebrew language agreement).





4.9
Debt Restructure Agreement between the Company and Bank Hapoalim Ltd. (English summary of the Hebrew language agreement).





4.10
Loan Undertaking between the Company and Sam Cohen dated June 3, 2010.





4.11
Loan Undertaking between the Company and Yaron Menashe dated June 3, 2010.





8.1
List of subsidiaries.





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.





13.1
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.





13.2
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.





15.1
Consent of Deloitte Brightman Almagor, certified public accountants (Israel).




81




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, 2010




ELBIT VISION SYSTEMS LTD.By:
/s/ Sam CohenSam CohenChief Executive Officer




82
 
  ELBIT VISION SYSTEMS LTD.
 (An Israeli Corporation)
  2009 CONSOLIDATED FINANCIAL STATEMENTS
  
  ELBIT VISION SYSTEMS LTD.
 2009 CONSOLIDATED FINANCIAL STATEMENTS
 
 TABLE OF CONTENTS
 
 PageREPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

F - 2CONSOLIDATED FINANCIAL STATEMENTS:Balance sheets as of December 31, 2009 and 2008

F - 3 - F - 4Statements of operations for the year ended December 31, 2009, 2008 and  2007

F - 5Statements of changes in shareholders’ equity for the year endedDecember 31, 2009, 2008 and 2007

F - 6Statements of cash flows for the year ended December 31, 2009, 2008 and 2007

F - 7Notes to Financial Statements

F - 8 - F - 37
  
  REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 To the Board of Directors and
 Shareholders of Elbit Vision Systems Ltd.
 
 We have audited the accompanying consolidated balance sheets of Elbit Vision Systems Ltd. and subsidiaries ("the Company") as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2009.  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, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, 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 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 14, 2010
  F - 2
 
 ELBITVISION SYSTEMS LTD.
 CONSOLIDATED BALANCE SHEETS
 U.S. dollars in thousands
  December 31Note


2009


2008A  s  s  e  t  sCURRENT ASSETS:Cash and cash equivalents





323



409Restricted deposit (short term)


14a



1,030



700Accounts receivable:


15aTrade (net of allowance for doubtful account 2009- $938 ,2008- $685)






3,632



4,872Other






464



616Inventories


4



1,726



3,946T o t a l  current assets






7,175



10,543INVESTMENTS AND LONG-TERM RECEIVABLES:Severance pay fund


8



1,393



1,556Other long-term receivables and investment


5



129



1371,522



1,693PROPERTY AND EQUIPMENT (net of accumulateddepreciation and amortization)


6



373



443OTHER ASSETS (net of accumulated amortization)Goodwill


18



242



1,752Other intangible assets


7



318



2,770560



4,522T o t a l  assets






9,630



17,201
  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 31Note


2009


2008Liabilities and shareholders’ equityCURRENT LIABILITIES:Credit from banks


15c



914



6,388Accounts payable and accruals:Trade






2,283



3,411Deferred income


2i



244



1,526Other


15b



3,212



3,316T o t a l  current liabilities






6,653



14,641LONG-TERM LIABILITIES:Loans and other liabilities (net of current maturities)


9



6,616



-Accrued severance pay


8



1,790



2,187T o t a l  long-term liabilities






8,406



2,187COMMITMENTS AND CONTINGENT LIABILITIES


10T o t a l  liabilities






15,059



16,828SHAREHOLDERS' EQUITY (DEFICIENCY):


11Share capital – ordinary shares of NIS 1 par value (“Ordinary Shares”);Authorized – 120,000,000 Ordinary Shares as of December 31, 2009and 60,000,000 as of December 31, 2008Issued and outstanding:December 31, 2009 – 69,652,779 Ordinary sharesDecember 31, 2008 – 50,988,701 Ordinary shares






15,556



10,679Additional paid-in capital






25,463



28,465Accumulated deficit






(46,448
)


(38,771
)T o t a l  shareholders’ equity (deficiency)






(5,429
)


373T o t a l  liabilities and shareholders’ equity (deficiency)






9,630



17,201
  The accompanying notes are an integral part of the financial statements.
  F - 4
 
 ELBITVISION SYSTEMS LTD.
 CONSOLIDATED STATEMENTS OF OPERATIONS
 U.S. dollars in thousands (except per share data)
 
 Year ended December 31,Note


2009


2008


2007REVENUES:Sale of products





10,715



18,453



18,690Services rendered





1,886



3,647



3,17312,601



22,100



21,863COST OF REVENUES:


15dCost of products sold






8,824



12,358



9,382Cost of services rendered






2,048



2,191



1,92610,872



14,549



11,308GROSS PROFIT






1,729



7,551



10,555RESEARCH AND DEVELOPMENT COSTS –NET


15e



3,036



4,559



3,313SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:Marketing and selling






2,643



5,270



4,885General and administrative






1,453



2,123



1,338Impairment of goodwill


2h



1,553



1,981



-OPERATING INCOME (LOSS)






(6,956
)


(6,382
)


1,019FINANCIAL EXPENSES  - NET


15f



(827
)


(1,082
)


(1,081
)LOSS BEFORE OTHER EXPENSES






(7,783
)


(7,464
)


(62
)OTHER INCOME (EXPENSES)


15g



110



(18
)


(1,277
)LOSS BEFORE TAXES ON INCOME






(7,673
)


(7,482
)


(1,339
)TAXES ON INCOME


12d



4



11



3LOSS FOR THE YEAR






(7,677
)


(7,493
)


(1,342
)LOSS PER SHARE:


2mBasic






(0.146
)


(0.147
)


(0.034
)Diluted






(0.146
)


(0.147
)


(0.034
)WEIGHTED AVERAGE NUMBER OF SHARES USED INCOMPUTATION OF LOSS PER SHARE –BASIC (IN THOUSANDS)






52,527



50,970



39,393DILUTED (IN THOUSANDS)






52,527



50,970



39,393
  The accompanying notes are an integral part of the financial statements.
  F - 5
 
 ELBITVISION SYSTEMS LTD.
 STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
  Share capital


Additional


Other





TotalNumber





paid-in


comprehensive


Accumulated


shareholders’of shares


Amount


Capital*


income


deficit


equityIn thousands


U.S. dollars in thousandsBALANCE – DECEMBER 31, 2006


29,516



5,091



25,846



-



(29,936
)


1,001CHANGES DURING 2007:Loss for the year


















(1,342
)


(1,342
)Issuance of share capital and warrants (note 11a)


21,275



5,538



2,403











7,941BALANCE – DECEMBER 31, 2007


50,791



10,629



28,249



-



(31,278
)


7,600CHANGES DURING 2008:Loss for the year


















(7,493
)


(7,493
)Issuance of share capital and warrants (note 11a)


197



50



216











266BALANCE – DECEMBER 31, 2008


50,988



10,679



28,465



-



(38,771
)


373CHANGES DURING 2009:Loss for the year


















(7,677
)


(7,677
)Conversion of Loan from Shareholder


6,469



1,690



(1,041
)










649Issuance of share capital and warrants (note 11a)


12,196



3,187



(1,961
)










1,226BALANCE – DECEMBER 31, 2009


69,653



15,556



25,463



-



(46,448
)


(5,429
)
  * Net of share issuance costs.
 
  The accompanying notes are an integral part of the financial statements.
  F - 6
 
 ELBITVISION SYSTEMS LTD.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 U.S. dollars in thousands
  Year ended December 31,2009


2008


2007CASH FLOWS FROM OPERATING ACTIVITIES:Net Loss


(7,677
)


(7,493
)


(1,342
)Adjustments to reconcile net loss to netcash used in operating activities:Depreciation and amortization


2,626



1,027



1,241Impairment of goodwill


1,553



1,981



-Amortization of discount on loan from shareholder


-



-



1,212Loss from disposal of property


-



2



-Liability for employee rights upon retirement


(397
)


179



(182
)Changes in operating assets and liabilities:Decrease (increase) in trade accounts receivable


1,240



(134
)


(1,540
)Decrease (increase) in other accounts receivable


152



912



(465
)Increase (decrease) in trade accounts payable


(1,128
)


191



(282
)Deferred income


(1,282
)


(556
)


465Increase (decrease) in other accounts payable


(104
)


687



(965
)Decrease (increase) in inventories


2,220



1,353



(1,331
)Net cash used in operating activities


(2,797
)


(1,851
)


(3,189
)CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of property and equipment


(71
)


(131
)


(296
)Long-term receivables


8



(6
)


400Purchase price adjustment of contingent consideration


-



(204
)


-Redemption of (investment in) restricted deposit


(330
)


(160
)


148Proceeds from disposal of property and equipment


-



5



38Funds severance pay


163



67



268Net cash provided by (used in) investing activities


(230
)


(429
)


558CASH FLOWS FROM FINANCING ACTIVITIES:Issuance of share capital and warrants - net of issuance costs


1,172



-



4,521Short-term credit from bank – net


(5,474
)


421



(761
)Loan from Shareholder


627Long Terms loan granted


6,616



-



-Proceeds from exercise of options and warrants


-



79



-Net cash provided by financing activities


2,941



500



3,760NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS


(86
)


(1,780
)


1,129BALANCE OF CASH AND CASH EQUIVALENTS ATBEGINNING OF YEAR


409



2,189



1,060BALANCE OF CASH AND CASH EQUIVALENTS AT END OF YEAR


323



409



2,189SUPPLEMENTAL DISCLOSURE OF CASH FLOWINFORMATION- cash paid during the year for:Interest paid - net


277



307



704Income taxes paid – net


4



11



3
  The accompanying notes are an integral part of these financial statements.
  F - 7
  ELBITVISION 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 rendering 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 September 2004, the Company 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. During May 2010 we sold all our shares in Scanmaster (see Note 19)
 
 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, 2009, resulted in a net loss of $7,677 thousands. The Company’s ability to continue operating as a “going concern” is dependent on its ability to raise sufficient additional working capital. There is no assurance 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.
 
 In 2009 the Company experienced significant difficulties in sales and incurred heavy losses that led the Company to sale its investment in ScanMaster Ltd. and the Assets and Liablities of ScanMaster Inc. The purchasers paid 250K in cash and undertook to repay the Company the sum of $675K in satisfaction of all remaining debt owed by Scan to the Company, over a period of 10 years in equal quarterly installments starting January 1, 2011.
  In connection with the sale the Company restructured its debt with the Banks. Pursuant to the agreements with the Banks, the Banks forgave part of the debt and the Company remaining debt is $1.4M dollars of which $0.8M dollar is repayable over a period of 5 years starting January 1, 2011 and $0.6M dollar is repayable over a period of 10 years starting July, 31, 2015.
 
 As to Business and Geographical segments – see Note 17.
  F - 8
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 2       -    SIGNIFICANTACCOUNTINGPOLICIES:
 
 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.
  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 subsidiariesare 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 ASC 830-10, "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 - 9
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 2       -    SIGNIFICANTACCOUNTINGPOLICIES (Cont.)
  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.
  g.     Property and equipment
 
 (1)
Property and equipment are stated at cost . Depreciation is calculated by the straight-line method over the estimated useful lives of assets, as follows:
 
 %Machinery and equipment

10-33 (mainly 33%)Office furniture and equipment

6-20Vehicles

15-20
 
 Leasehold improvements are amortized by the straight-line method over the term of the lease, or the estimated useful life of the improvements, whichever is shorter.
 
 (2)
Impairment of long-lived assets – Impairment examinations and recognition are performed and determined based on the provisions of ASC 360-10, “Accounting for the Impairment or Disposal of Long-Lived Assets” ("ASC 360-10"). ASC 360-10 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 ASC 350-20, “Goodwill and Other Intangible Assets” ("ASC 350-10"), 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).
  F - 10
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 2       -     SIGNIFICANTACCOUNTINGPOLICIES (Cont.)
 
 h.     Other assets- Goodwill and Intangible Assets  (Cont.)
 
 The Company has designated December 31 of each year as the date on which it will perform its annual goodwill and impairment test. An impairment of $ 1,981,000 resulted from the annual review performed in the year 2008 and an impairment of $ 1,553,000 resulted from the annual review performed in the year 2009, allocated to the non-destructive automated inspection segment. In 2009 the Group and specifically the non-destructive segment experienced significant difficulties in sales and incurred heavy losses which led the Company to evaluate the goodwill and other intangible associated with the non destructive segment. The result of the evaluation was the write off of the remaining balance of goodwill and intangible assets. As further discussed in Note 19, the Company sold it holding in Scan (the subsidiary operating in the non-destructive segment) to a group of investors led by the Company's former CEO.
  These assets are amortized by the straight-line method over their estimated useful lives. Annual rates of amortization are as follows:
 
 %Technology
10-20Customer relations
10-20Distribution network
10Brand name
8.33
  i.     Revenue recognition:
 
 1)           Sale of products:
 
 a.         General
 
 Revenues from sales of products and supplies are recognized when an arrangement exists, delivery has occurred and title passed to the customer, Group’s price to the customer is fixed or determinable and collectibility is reasonably assured.
 
 With respect to systems sold with installation requirements, the installation is not considered to be a separate earnings process; thus, revenue is recognized when all of the above criteria are met and installation is completed.
 
 b.        Acceptance clause, customers’ support service and warranty
 
 The Group distinguishes between revenue recognition in respect of revenue derived from automatic vision inspection products (sold by the Company) and ultrasonic inspection products (sold by ScanMaster).
  The terms of the agreements between the Company and its customers are substantially different from the terms of the agreements between ScanMaster and its customers.  Therefore, the revenue recognition accounting policy applied by each of the companies is different in this case.  Set forth bellow are the main accounting policies applied by each of the companies:
  F - 11
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 2       -    SIGNIFICANTACCOUNTINGPOLICIES (Cont.)
 
 i.     Revenue recognition (Cont.):
 
 1)            Sale of products (Cont.):
 
 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.
  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.
  F - 12
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 2       -     SIGNIFICANTACCOUNTINGPOLICIES (Cont.)
 
 i.     Revenue recognition (Cont.):
  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 ASC 605-35-05 "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 ASC 810-10-45-14 (Formerly EITF 00-1), to the professional services is recognized as the services are performed.
  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, 2009 and 2008 include amounts of revenues that were invoiced and cash was received, but deferred less applicable product and warranty costs.
  F - 13
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 2       -     SIGNIFICANTACCOUNTINGPOLICIES (Cont.)
 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, 2009, 2008 and 2007 were $ 171,000, $ 431,000 and $ 428,000, respectively.
 
 l.     Deferred income taxes
 
 The company accounts for income taxes in accordance with ASC 740-10, “Accounting for Income Taxes” ("ASC 740-10").  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. Total common stock equivalents, related to options and warrants 21,783,514, 13,492,331and 16,862,858 shares for the years 2009, 2008 and 2007, respectively, were excluded from EPS calculation, because the effect of such options and warrants is antidilutive.
 
 
 n.     Stock-based compensation
 
 The Company recognizes $ 76,000 of compensation expenses in 2009 as a result of the application of ASC 718-10. According to "share base compensation" accounting, 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.
  F - 14
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 2       -     SIGNIFICANTACCOUNTINGPOLICIES (Cont.)
 
 
 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, 2009 and 2008, 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:
 
 
 Amendment to Accounting Standards Codification (“ASC”) 815 (SFAS No. 161)
 
 Effective January 1, 2009, the Company adopted the disclosure requirements in the amendment to ASC 815 (added by SFAS No. 161), “Disclosures about Derivative Instruments and Hedging Activities”, which expands disclosures but does not change accounting for derivative instruments and hedging activities. The adoption of the amendment did not have any impact on the consolidated results of operations or financial position of the Company.
 
 ASC 815-40 (EITF 07-5)
 
 
 In June 2008, the FASB Emerging Issues 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 is an amendment to ASC 815-40 Contract in Entity’s Own Equity.
 
 The Company applies this consensus effective January 1, 2009. The adoption of the amendment did not have any impact on the consolidated results of operations or financial position of the Company.
  F - 15
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 2       -     SIGNIFICANTACCOUNTINGPOLICIES (Cont.)
 
 r.     Recently issued accounting pronouncements (Cont.):
  
 ASC 855 (SFAS 165)
 In May 2009, the FASB issued ASC 855 (SFAS No. 165), “Subsequent Events”. ASC 855 establishes general standards of accounting for, and disclosure of, events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this statement sets forth: (1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and (3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. ASC 855 is effective for the interim or annual financial periods ending after June 15, 2009. The adoption of this standard did not have any impact on the consolidated results of operations or financial position of the Company.
  
 s .  Initial adoption of new standards:
 ASC 105 (SFAS 168)
 
 In June 2009, the FASB issued ASC 105, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles”. ASC 105 establishes the “FASB Accounting Standards Codification” (“Codification”), and was officially launched on July 1, 2009, for the purpose of serving as the source of authoritative U.S. generally accepted accounting principles (“GAAP”) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (“SEC”) under the authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. The subsequent issuances of new standards will be in the form of Accounting Standards Updates that will be included in the Codification. In general, the Codification is not expected to change U.S. GAAP. All other accounting literature excluded from the Codification will be considered non-authoritative. ASC 105 is effective for financial statements issued for interim and annual periods ending after September 15, 2009. Effective December 31, 2009, all references made to GAAP in our consolidated financial statements include the new Codification numbering system along with original references.
  F - 16
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 2       -    SIGNIFICANTACCOUNTINGPOLICIES (Cont.)
  t.     Recently Issued Accounting Standards
 
 ASU 2009-13
  In October 2009, the FASB issued “Accounting Standards Update (“ASU”) 2009-13 Multiple Deliverable Revenue Arrangements a consensus of EITF” (formerly topic 08-1) an amendment to ASC 605-25. The update provides amendments to the criteria in Subtopic 605-25 for separating consideration in multiple-deliverable arrangements. The amendments in this update establish a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable will be based on vendor-specific objective evidence if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. The amendments in this update will also replace the term “fair value” in the revenue allocation guidance with the term “selling price” in order to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant.
 
 The amendments will also eliminate the residual method of allocation and require that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The relative selling price method allocates any discount in the arrangement proportionally to each deliverable on the basis of each deliverable's selling price.
  The update will be effective for revenue arrangements entered into or modified in fiscal years beginning on or after June 15, 2010 with earlier adoption permitted. The adoption of this update is not expected to have material impact on the Company’s consolidated financial statements.
  NOTE 3       -    CONSOLIDATED SUBSIDIARIES
 
 
 a.     Acquisition and Disposal of Yuravision
 
 On December 1, 2006, the Company executed an agreement with a Korean corporation for the sale of it investment inYuravision shares in consideration for $950,000  plus the purchase from the Company of its right to receive from Yuravision repayment of an $800,000 loan 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 May 1, 2009.
  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 - 17
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 4       -    INVENTORIES
 
 December 312009


2008$ in thousandsRaw materials


1,255



2,384Work in process


450



1,472Finished products


21



901,726



3,946
  The balances are net of write-down of $1,795,000 and $1,150,000 as of December 31, 2009 and 2008, respectively.
 
 NOTE 5       -     OTHER LONG-TERM RECEIVABLES AND INVESTMENT
 
 December 312009


2008$ in thousandsDeposits on leased vehicle (see also Note 10b2))


68



76Investment (1)


61



61129



137
 
 (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, 2009 the Company holds 4% of  MCL's ordinary shares.
 
 NOTE 6       -    PROPERTYANDEQUIPMENT
 
 a.       Comprised as follows:
  December 312009


2008$ in thousandsMachinery and equipment


2,961



2,891Leasehold improvements


272



271Office furniture and equipment


427



427Vehicles


62



623,722



3,651Less - accumulated depreciation and amortization


3,349



3,208373



443
 
 b.
Depreciation and amortization expenses totaled $ 148,000, $ 173,000, and $222,000, in the years ended December 31, 2009, 2008 and 2007, respectively.
  F - 18
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 7       -     OTHER INTANGIBLE ASSETS
 
 Gross carrying amount

December 31


Accumulated amortization December 312009


2008


2009


2008U.S. dollars in thousands


U.S. dollars in thousandsTechnology


2,828



2,828



2,608



1,385Customer relations


1,599



1,599



1,501



775Distribution network


338



338



338



147Brand name


489



489



489



177Backlog


414



414



414



4145,668



5,668



5,350



2,898
 
 Amortization expenses totaled $ 2,457,000(1), $ 669,000 and $ 659,000, in the years ended December 31, 2009, 2008, and 2007, respectively.
  (1)
the amount is inclusive of impairment in the amount of $2,154,000 relating to the non-destructive segment.
 
 Estimated amortization expense for the following years, subsequent to December 31, 2009:
 
 $ in thousandsYear ended December 31:2010


3182011


-2012


-
  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.
  F - 19
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 9       –    LONG-TERM LIABILITIES – LOANS AND OTHER
 
 a.
Composed as follows:
 
 December 312009


2008$ in thousandsLoans from banks


6,616



-6,616



-
 
 On November 2009 the Company signed new agreements with its bank to restractur its credit facilities which agreed to maintain the Company’s  credit and financing facilities, the banks will delay repayment of the principal on outstanding loans to a four year period commencing on January 1, 2012 by quratly payment including yearly interest rate of Libor +2% .  For amendment of those agreements see Note 19.
  
 b.
The liabilities (net of current maturities) mature in the following years after the balance sheet dates:
 
 December 312009


2008$ in thousands2010


-



-2011


-



-2012


1,716



-2013 and thereafter


4,900



-6,616



-
  See note 19 for the agreement with the banks subsequent to the balance sheet date.
  F - 20
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 10    -      COMMITMENTS ANDCONTINGENTLIABILITIES
 
 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 $76,000, $ 224,000 and $ 266,000 in the years ended December 31, 2009, 2008 and 2007 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, 2009 is approximately $1,003,000.
  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 $ 30,000, $ 17,000 and $ 34,000 in the years ended December 31, 2009, 2008 and 2007, 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.
  F - 21
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED  FINANCIAL STATEMENTS
 NOTE 10    -      COMMITMENTS ANDCONTINGENTLIABILITIES (cont.)
 
 b.
Leasecommitments
 
 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. The company extended the lease agreement for another 3 years starting January 1, 2010.on June 2010 the company ended the agreement (See note 19)



Minimum lease commitments of the Company and the subsidiaries under the above leases, at rates in effect as of December 31, 2009, are as follows:
  $  in thousandsYear ending December 31:2010


4222011


4202012


4201,262
  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 $ 469,000, $ 474,000, and $ 331,000 in the years ended December 31, 2009, 2008 and 2007, respectively.

During May ,2010 The company moved to new facilities (See Note 19).
  2)
The Company leases motor vehicles under long-term operating lease agreements.  The lease agreements expire on various dates ending in 2010 – 2011 (with prior notice of cancellation clauses).

Minimum lease commitments of the Company under the above leases, at rates in effect on December 31, 2009, are as follows:
  $ in thousands2010


2362011


255491
  To secure the amounts due to the lessor, the Company has deposited a total of U.S. $ 61,000.  The deposits are unlinked and presented among other long-term receivables.
  Lease expenses in 2009, 2008 and 2007, amounted to $ 492,000, $ 516,000 and $ 430,000 respectively.
  F - 22
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 10    -      COMMITMENTS ANDCONTINGENTLIABILITIES (cont.)
 
 c.
Guarantees
  As of December 31, 2009, the Company provided guarantees in the aggregate amount of $798,000  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 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.
 
 3)
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.
 
 4)
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)
  F - 23
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 11     -     SHAREHOLDER’ EQUITY (cont.)
 
 a.
Authorized, issued and outstanding shares (cont.)
 
 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.
  5)
In Decmber 2009 the Company issued Mivtach Shamir Holdings Ltd. 18,664,078 ordinary shares for $0.097 per share for a total amount of  $1,810,416.This amount include convertion of Loan received from Mivtach during 2009 in an amount of $627,000.Pursuant to the transaction, Mivtach was also issued warrants to purchase 9,332,039 of the Company's ordinary shares at an exercise price per share  of $0.139, exercisable for a period of 4 years.
  
 
 b.
Shareoptionplans:
 
 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.
  F - 24
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 11     -    SHAREHOLDER’ EQUITY (cont.)
 
 b.
Shareoptionplans (cont.):
 
 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.



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 2007 , 2008 and 2009 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.
 F - 25
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 11     -     SHAREHOLDER’ EQUITY (cont.)
 
 b.
Shareoptionplans (cont.):
 
 1)
The plans (cont.):



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, 2009, 2008 and 2007, and changes during the years ended on those dates, is presented below:
 
 Year ended December 312009


2008


2007Weighted





Weighted





Weightedaverage





average





averageexercise





exercise





exerciseNumber


price


Number


price


Number


priceOptions outstanding at beginning of year


5,410,352



0.69



5,010,352


$
0.79



4,888,686


$
0.83Changes during the year:Granted (1)


-



-



547,500



0.34



350,000



0.42Exercised


-



-



-



-



-



-Forfeited


(251,250
)


0.33



(147,500
)


1.34



(228,334
)


1.19Options outstanding at end of year


5,159,102



0.71



5,410,352



0.69



5,010,352



0.79Options exercisable at year end


4,646,602



0.75



4,402,102


$
0.77



3,962,739


$
0.85Weighted average fair value ofoptions granted during the year (2)


-






$
0.30






$
0.35
  (1)
Options granted in 2008 and 2007 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 2009, with the following weighted average assumptions:
 
 Year ended December 312008


2007Dividend yield


0
%


0
%Expected volatility


126
%


140
%Risk-free interest rate


3.48
%


4.15
%Expected life - in years


6.5



6
  F - 26
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 11     -     SHAREHOLDER’ EQUITY (cont.)
 
 b.
Shareoptionplans(cont.):
 
 2)
Options granted to employees (cont.):
 
 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.
 
 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, 2009:
 
 Options outstanding


Options exercisableWeighted





WeightedNumber


average


Number


averageoutstanding at


remaining


exercisable at


remainingExercise


December 31,


contractual


December 31,


contractualprices


2009


life


2009


life$






Years





Years0.15-0.32



825,055



0.2-8.6



542,555



2.6-7.50.35-0.46



635,250



0.05-8.1



460,250



0.05-80.48-0.70



1,098,297



2.2-8



1,098,297



2.2-80.75-0.85



1,084,334



3.9-7.3



1,084,334



3.9-7.31.00-1.25



1,461,166



0-4.9



1,461,166



0-4.95,159,102







4,646,602
 
 F - 27
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 12     -     TAXESONINCOME
 
 a.
Corporate taxation in Israel
 
 1)
The provision for current taxes of the Company and its Israeli subsidiaries wasdetermined until 2007 in accordance to the provisions of the Income TaxOrdinance and the Income Tax Law (Adjustments for Inflation)-1985, whichestablished the measurement of the sults for tax purposes on a real basispursuant to changes in the CPI.



In February 2008 an amendment to the Israeli tax was approved by the Israeliparliament which determined that the validity of the Adjustments for Inflation Lawwould end in 2007, and, commencing from the 2008, the provisions of the lawwould no longer apply, except for transitional provisions intended to avoiddistortions in the tax computations. In accordance with the amendment, from thetax year of 2008 and thereafter, the adjustment of income for tax purposes to a realmeasurement basis will no longer be calculated.
 
 2)
Tax rates



The income of the Company and ScanMaster Ltd. (other than income from ”approved enterprises”, see b. below) are taxed at the regular rate. Corporate tax rate applicable to companies in Israel in 2009 is 26% which will decrease gradually to 18% in 2016.
  
 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 - 28
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 12     -      TAXESONINCOME (cont.)
  b.
TaxbenefitsundertheLawforthe EncouragementofCapital 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 - 29
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  NOTE 12     -      TAXESONINCOME (cont.)
 
 b.
TaxbenefitsundertheLawforthe EncouragementofCapital 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 undertheLawfortheEncouragementofIndustry (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 312009



2008



2007$ in thousandsLoss before taxes on income


(7,673
)


(7,482
)


(1,339
)Theoretical tax benefit on the above amount


(1,995
)


(2,020
)


(388
)Increase in taxes in respect of tax lossesincurred in the reported year for whichdeferred taxes were not recorded (see f. below)


1,995



2,020



388Other


4



11



3Actual tax expense


4



11



3
 
 Taxes on income included in the statement of operations relate to Company’s subsidiaries.
 
 F - 30
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 12     -      TAXESONINCOME (cont.)
 
 e.
Deferred Taxes
 
 1)
The Company has approximately $ 51 million unutilized carryforward tax losses from prior years.  Therefore, no current tax liability has been provided in 2009 and 2008.
 
 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, 2009


December 31, 2008$ in thousands


$ in thousandsProvision for vacation pay


87



90Accrued severance pay


76



91Carryforward tax losses


859



1,139Research and development costs


373



653Less – valuation allowance


(1,395
)


(1,973
)-



-
 The deferred taxes are computed at the average tax rate of 20% - 25%.
  f.
Carryforward tax losses



Carryforward tax losses of the Company and its subsidiaries aggregate approximately $ 55 million at December 31, 2009.
  g.
Taxassessments



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 - 31
 
  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, 2009, the bank deposits amount to $ 1,030 thousands, out of which $ 132 thousands are linked to the dollar and $ 898 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     -      SUPPLEMENTARYINFORMATION:
 
 a.
Accounts receivable
  December 312009



2008$ in thousands
 
 1)  Trade – allowance for doubtful accounts:Balance at beginning of year


685



677Charged to statement of operations


253



8Write-off of uncollectible amounts


-



-Balance at end of year


938



685
  
 2)  Other:Employees


28



36Prepaid expenses


289



118Israeli Government departments and agencies


147



362Receivables from selling the Yuravision


-



100464



616
  F - 32
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 15     -      SUPPLEMENTARYINFORMATION(Cont.)
  b.
Accounts payable and accruals – other:
  December 312009


2008$ in thousandsEmployees and employee institutions


764



732Israeli Government departments and agencies


1,004



918Provision for vacation and recreation pay


464



550Provision for product warranty


194



255Liability for commissions to agents


286



287Accrued expenses and sundry


500



5743,212



3,316
  c.
Credit from banks
 
 Composed as follows:
  % interest rate


December 31as of


2009


2008December 31, 2009


$ in thousandsUnlinked credit from bank





-



408Short-term loans from banks:Linked to the dollar


2.5



225



4,444Linked to the Euro






689



1,536914



6,388
 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). In May 2010, The Company entered into new agreements for bank credit facilities (see Note 19).
 
 d.
Cost of revenues
 Year ended December 312009


2008


2007$ in thousandsIndustrial operations:Materials consumed


5,348



7,787



5,533Payroll and related expenses


1,520



3,120



2,776Subcontracted work


292



519



247Depreciation and amortization


2,197



571



579Other production expenses


1,440



2,311



1,873Royalties (see Note 10a)


75



241



30010,872



14,549



11,308
  F - 33
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 15     -      SUPPLEMENTARY INFORMATION (cont.):
 
 e.
Research and development expenses:
  Total expenses


3,036



4,711



3,454Less – grants and participations (see Note 10a1)


-



(152
)


(141
)3,036



4,559



3,313
  f.
Financial expenses, net
  Year ended December 312009


2008


2007$ in thousandsIncome:Interest in respect of bankDeposits and securities


3



26



62Exchange differences


-



-



48Other


-



-



-3



26



110Expenses:InterestIn respect of liability to related parties


10



4



360In respect of credit from banks


468



537



747Exchange differences


346



555



-Other


6



12



84830



1,108



1,191(827
)


(1,082
)


(1,081
)
 
 g.
Other expenses
 Year ended December 312009


2008


2007$ in thousandsWrite off of discount on convertible loan

associated with beneficial conversion feature

(see note 9a.(3))


-



-



(1,047
)Other


110



(18
)


(230
)110



(18
)


(1,277
)
 
 NOTE 16     -      RELATED PARTIES
  2009


2008


2007$ in thousandsMarketing and selling


174



250



120General and administrative


138



302



278Financing expenses on long-term loangranted by shareholders - see Note 9a.


10



4



360Other expenses


-



30



1,047
 
 F - 34
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 17     -      BUSINESS AND GEOGRAPHICAL SEGMENTS
 
 a.
General information:
 
 1)
Factors management used to identify the enterprise’s reportable segments
 
 The Company’s reportable segments are strategic business units that offer different products and services.  They are managed separately because each business requires different technology and marketing strategies.  Most of the businesses were acquired as a unit, and the management at the time of the acquisition was retained.
 
 2)
Description of the types of products and services from which each reportable segment derives its revenues
 
 Due to the acquisition in 2004, the internal organizational structure changed; consequently, the company has two reportable segments:
 
 
 (a)
Automatic Vision Inspection segment - design, develop, manufacture and marketing automatic vision inspection and quality monitoring systems, and rendering services related to those systems.
  (b)
Non-destructive Automated Inspection segment - develop, manufacture and market equipment for the ultrasonic inspection of industrial parts and components for the automotive and transportation industries, the metal industry as well as applications for aircraft and jet engine inspection.



Prior to June 2004, the Company operated only in one segment - the Automatic Vision Inspection segment.
  b.
Information about reported segment income or loss and assets:
 
 Measurement of segment income or loss and segment assets
 
 The accounting policies of the segments are the same as those described in the significant accounting policies.  The Company evaluates performance based on profit or loss from operations before income taxes, not including non-recurring gains and losses and foreign exchange gains and losses.
  The Company accounts for inter-segment sales and transfers as if the sales or transfers were to third parties, that is - at current market prices.
  Automatic

Vision

Inspection


Non-

Destructive

Automated

Inspection


Total$ in thousandsYear ended December 31, 2009:Revenues from unaffiliated customers


2,244



10,357



12,601Total Consolidated revenues










12,601Segment Operating loss


(2,327
)


(4,663
)


(6,990
)Unallocated corporate expenses










34Operating loss










(6,956
)Segment assets


2,417



7,206



9,623Other unallocated amounts










6Consolidated assets at the year end










9,629Expenditures for segment assets


-



79



79Total depreciation and amortization


373



3,788



4,162
 
 F - 35
 
  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:
 
 2009


2008


2007$ in thousandsU.S.A.


2,710



6,758



6,341Europe


6,370



10,189



7,756Other (mainly Japan and China)


3,521



5,153



7,76612,601



22,100



21,863
 
 2)
The Company’s long-lived assets by gegraphic areas are as follows:
 
 2009


2008$ in thousandsIsrael


906



4,935U.S.A.


27



30933



4,965
 
 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. In 2009 the Group and specifically the non-destructive segment experienced significant difficulties in sales and incurred heavy losses which led the Company to evaluate the goodwill and other intangible associated with the non destructive segment. The Company assessed the value of the Non-destructive automated inspection segment using expected cash flows, and determined that write off the remaining Goodwill and other intangibles assets.
 
 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.
  F - 36
 
  ELBIT VISION SYSTEMS LTD.
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  NOTE 19     -      SUBSEQUENT EVENTS
 
 a.During May 2010, the Company signed new agreements with Bank Le'umi Le'Israel BM and Bank Hapoalim BM (the "Banks"), for the restructuring of its bank debt. Pursuant to the agreements with the Banks, the Banks will forgive approximately $2.4M of debt from the Company and its subsidiary ScanMaster Systems (IRT) Ltd. ("ScanMaster Ltd."), and have agreed to the repayment of by the Company $1M over 5 years and a further $600K over 10 years.
 
 b.The Copmany sold its Subsidiary Scanmaster Systems (IRT) Ltd. and the  Assets and Liablity of IRT Scanmaster systems Inc. to a group of purchasers led by David Gal, the former CEO and Chairman of the Board of EVS, and Ofer Sela, the Company's former EVP, R&D Operations.  In connection with the sale of Scan, the purchasers paid 250K in Cash and undertake to repay the Company the sum of $675K in satisfaction of all remaining debts, over a period of 10 years in equal quarterly installments with interest at the US Dollar annual LIBOR rate starting January 1, 2011. If ScanMaster Ltd. fails to engage in any projects for the inspection of rail tracks for a period of two years, EVS will forgive all remaining balance of the $675K debt up to a maximum of $450K. In conection to the sale of ScanMaster Ltd. the Company agreed with the lessor to evacute the premise as of June,15, 2010.The Company lease new  facility in Ceasrea.
 
 c. Mivtach also loaned us an aggregate of approximately $850,000 during the first quarter of 2010, and the Company have entered into an agreement with Mivtach pursuant to which the Company will repay the loan over five years in equal quarterly installments, plus interest at the US Dollar annual LIBOR rate.