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

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# FORM 20-F

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

# Or

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

| | For
the fiscal year ended December 31, 2005
| | -------------------------------------------

# Or

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

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

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

| | For the transition period from ______________ to _______________
| | ----------------------------------------------------------------

Commission File No. 1-8201

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

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

New Industrial Park,
Building 7, Yoqneam, Israel 
(Address of principal
executive offices)

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

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

Ordinary
Shares, nominal value 1.00 New Israeli Shekel per share

(Title of Class)

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:

26,762,217 Ordinary Shares

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

o Yes    x No

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

o Yes    x No

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



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

Yes x             No o

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

# Item 17 o Item 18 x

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

o Yes    x No

2

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

---

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

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|         |                                                            |   
|-------- | ---------------------------------------------------------- | --
|
|
|
|
|PART I   |                                                            |   
|
|ITEM 1.  | IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS      | 6 
|        
|ITEM 2.  | OFFER STATISTICS AND EXPECTED TIMETABLE                    | 6 
|        
|ITEM 3.  | KEY INFORMATION                                            | 6 
|         | SELECTED FINANCIAL DATA                                    | 6 
|         | RISK FACTORS                                               | 6 
|         | RISK FACTORS RELATED TO OUR BUSINESS                       | 7 
|         | RISK FACTORS RELATED TO OUR ORDINARY SHARES                | 14
|         | GENERAL RISKS                                              | 20
|        
|ITEM 4.  | INFORMATION ON THE COMPANY                                 | 22
|         | HISTORY AND DEVELOPMENT OF THE COMPANY                     | 22
|         | BUSINESS OVERVIEW                                          | 25
|         | ORGANIZATIONAL STRUCTURE                                   | 44
|         | PROPERTY, PLANTS AND EQUIPMENT                             | 44
|        
|ITEM 4A. | UNRESOLVED STAFF COMMENTS                                  | 44
|        
|ITEM 5.  | OPERATING AND FINANCIAL REVIEW AND PROSPECTS               | 45
|         | SELECTED FINANCIAL DATA                                    | 45
|         | OPERATING RESULTS                                          | 49
|         | LIQUIDITY AND CAPITAL RESOURCES                            | 54
|         | RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC        | 55
|         | TREND INFORMATION                                          | 56
|         | OFF-BALANCE SHEET ARRANGEMENTS                             | 57
|         | TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS              | 58
|        
|ITEM 6.  | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                 | 58
|         | DIRECTORS AND SENIOR MANAGEMENT                            | 58
|         | COMPENSATION                                               | 61
|         | BOARD OF DIRECTORS                                         | 62
|         | EMPLOYEES                                                  | 65
|         | SHARE OWNERSHIP                                            | 66
|        
|ITEM 7.  | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS          | 69
|         | MAJOR SHAREHOLDERS                                         | 69
|         | RELATED PARTY TRANSACTIONS                                 | 71
|        
|ITEM 8.  | FINANCIAL INFORMATION                                      | 74
|         | CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION    | 74
|         | SIGNIFICANT CHANGES                                        | 75
|        
|ITEM 9.  | THE OFFER AND LISTING                                      | 75
|         | OFFER AND LISTING DETAILS                                  | 75
|         | MARKETS                                                    | 75
|        
|ITEM 10. | ADDITIONAL INFORMATION                                     | 77
|         | MEMORANDUM AND ARTICLES OF ASSOCIATION                     | 77
|         | MATERIAL CONTRACTS                                         | 82
|         | EXCHANGE CONTROLS                                          | 84
|         | TAXATION                                                   | 85
|         | DOCUMENTS ON DISPLAY                                       | 96
|        
|ITEM 11. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 97
|         | INTEREST RATE RISK                                         | 97
|         | FOREIGN CURRENCY EXCHANGE                                  | 98
|         | EQUITY PRICE RISK                                          | 98
|        
|ITEM 12. | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES     | 98
|        
|        

4

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|          |                                                                              |    
|--------- | ---------------------------------------------------------------------------- | ---
|
|
|
|
|PART II   |                                                                              |    
|         
|ITEM 13.  | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                              | 99 
|         
|ITEM 14.  | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS | 99 
|         
|ITEM 15.  | CONTROLS AND PROCEDURES                                                      | 99 
|         
|ITEM 16.  | [RESERVED]                                                                   | 99 
|         
|ITEM 16A. | AUDIT COMMITTEE FINANCIAL EXPERT                                             | 99 
|         
|ITEM 16B. | CODE OF ETHICS                                                               | 99 
|         
|ITEM 16C. | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                       | 99 
|         
|ITEM 16D. | EXEMPTIONS FROM THE LISTING AND STANDARDS OF AUDIT COMMITTEES                | 100
|         
|ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILLIATED PURCHASERS      | 100
|         
|         
|PART III 
|         
|ITEM 17.  | FINANCIAL STATEMENTS                                                         | 100
|         
|ITEM 18.  | FINANCIAL STATEMENTS                                                         | 100
|         
|ITEM 19.  | EXHIBITS                                                                     | 100

5

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# PART I.

|ITEM 1. | IDENTITY
OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
|------- | -----------------------------------------------------

Not applicable.

|ITEM 2. | OFFER
STATISTICS AND EXPECTED TIMETABLE
|------- | ---------------------------------------

Not applicable.

|ITEM 3. | KEY
INFORMATION
|------- | ---------------

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

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|Risks
related to our business:
|------------------------------

| |  | history
of losses;
| | - | ------------------

| |  | dependence
on worldwide industries;
| | - | -----------------------------------

| |  | necessity
of expansion into new markets; pursuit
of business to acquire;
| | - | ------------------------------------------------------------------------

| |  | reliance
on a limited number of key customers;
| | - | ----------------------------------------------

| |  | reliance
on a limited number of key subcontractors and suppliers;
| | - | -----------------------------------------------------------------

| |  | lengthy
sales cycle;
| | - | --------------------

| |  | competitiveness
of automated visual inspection market;
| | - | ------------------------------------------------------

| |  | fluctuations
in the market;
| | - | ---------------------------

| |  | long
payment cycle;
| | - | -------------------

| |  | market
acceptance of products;
| | - | ------------------------------

| |  | flaws
in our manufacturing;
| | - | ---------------------------

| |  | reliance
on international sales; changes
in domestic and foreign regulation;
| | - | ----------------------------------------------------------------------------

| |  | rapid technological change;
| | - | ---------------------------

| |  | additions
or departures of key personnel;
| | - | -----------------------------------------

| |  | difficulty
of integrating and operating acquired business of Panoptes;
| | - | ----------------------------------------------------------------------

| |  | difficulty
of penetrating new markets;
| | - | --------------------------------------

| |  | volatility of microelectronics industry;
| | - | ----------------------------------------

| |  | 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.
| | - | -------------------------------

|General
Risks:
|--------------

| |  | new
regulations for corporate governance;
| | - | -----------------------------------------

| |  | conditions
in Israel;
| | - | ---------------------

| |  | differentials
in the rate of currency exchange and inflation;
| | - | -------------------------------------------------------------

| |  | Israeli
government grants, programs and tax benefits; and
| | - | ---------------------------------------------------------

| |  | enforceability
of foreign judgments by Israeli courts.
| | - | ------------------------------------------------------

These
risk factors are discussed in further detail below:

7

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# Risks Related to our
Business

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

Except
for 2005, in which we generated net income of $0.611 million, we have not generated net
income on an annual basis since 1997. We incurred net losses of $1.68 million, $0.98
million and $ 5.9million in 2002, 2003 and 2004, respectively.

As
part of the implementation of our strategic plan of expansion into new markets and
diversification of our product portfolio, since January 1, 2004 we have acquired three new
businesses: Yuravision Co. Ltd., or Yuravision, ScanMaster Systems (IRT) Ltd. and IRT
ScanMaster Systems Inc., together ScanMaster, and Panoptes Ltd., or Panoptes.

We
believe that our current assets, together with anticipated cash generated from operations
and available credit lines, will be sufficient to meet our cash requirements for working
capital and capital expenditures for at least twelve months from June 2006. Thereafter,
if cash generated from operations is insufficient to satisfy our liquidity requirements,
we may have to sell additional equity or debt securities or seek to obtain additional
credit facilities.

ScanMaster
is heavily dependent upon certain worldwide industries.

The
majority of our revenues are generated by our wholly owned subsidiary, ScanMaster. A
significant portion of ScanMasters revenues are generated by its sales of
non-destructive inspection systems to the aeronautics industry, providing inspection
solutions for aircraft engine forgings, and aerospace structural elements, manufactured
from metal and composite materials. As such, we are substantially dependent upon the
strength of these worldwide industries, and in particular upon the need by manufacturers
to make continuing capital investments in systems and products, such as those marketed and
sold by us, for use in their production and manufacturing processes. This need is a
reflection, in turn, of the worldwide level of demand for the final products produced by
the manufacturers to which we provide our inspection products. Demand for such products is
normally a function of the prevailing global or regional economic environment and is
negatively affected by several factors in recent years: (i) the general global economic
slow-down such as that which began in the late part of 2000; (ii) the events of September
11, 2001; and (iii) the significant increases in the price of oil.

In
addition, we expect to become increasingly dependent on the rail industry as we foresee a
major portion of our revenue in the near future being derived from sales of
ScanMasters non-destructive inspection systems to the rail industry. In this
capacity, an economic downturn in this industry may negatively affect the ability of
manufacturers to make continuous capital investments in our systems and products, which
may materially adversely affect our future operations.

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

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

8

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

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

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 2003, 2004 and 2005 one of our customers accounted for 17%, 18% and 12% of our net
sales respectively. While no other customer in any area of business accounted for more
than 10% of our net sales in any of 2003, 2004 and 2005, we expect that sales of our
products to relatively few customers could continue to account for a substantial
percentage of our net sales in the foreseeable future. There can be no assurance that we
will be able to retain these key customers or that such customers will not cancel purchase
orders, reschedule, or decrease their level of purchases. Loss or cancellation of business
to these customers could seriously harm our financial results and business.

We
depend on a limited group of subcontractors and suppliers.

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

9

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Some
of the electronic components included in our microelectronics products are manufactured
exclusively for us by certain suppliers. If any of these exclusive suppliers stop
manufacturing these components we will need to find alternative suppliers. Our reliance on
these 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 one of our single source suppliers ceases to
produce any necessary components, we would have to transfer the manufacture of such
components to another supplier or suppliers. We estimate that such a transfer would take
approximately up to four months and could delay the production and supply of our products.
Any such delay could result in a material interruption in production at our facility and
could have a material adverse effect on our business, operating results and financial
condition.

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

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

Competition
in the automated inspection industry is intense.

Several
companies working with the textile industry have developed products with similar visual
inspection or quality monitoring capabilities, such as BarcoVision and Cognex. In
addition, a number of companies have developed products with non-destructive inspection
capabilities, such as Krautkramer, Matec SDI, RD Tech, Sonix, Aims and Panametrics.In the microelectronics and LCD flat panel display industries,anumber
of companies have developed products with comparable automated inspection capabilities,
such as Photon Dynamic Inc., Orbotech Ltd. and Macronix Ltd.

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

11

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

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

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

As
is the case with many suppliers of equipment to the microelectronics, automotive,
transportation, metal and textile industries, we often receive a deposit upon receipt of
an order, a partial payment upon delivery or installation and final payment pursuant to
negotiated payment terms or final payment after a trail and/or acceptance period for
systems sold subject to a trial period. The time required for installation and trial
varies from customer to customer and may be delayed by a variety of factors, including the
customers production cycle, integration of systems into the customers
manufacturing process, required modifications to the customers production line and
the availability of qualified technicians to monitor system operations. For systems sold
without an evaluation period, revenue is recognized immediately upon installation of the
system. For systems sold subject to a trial period, revenue is recognized upon customer
acceptance. The length of the customers trial and acceptance period generally varies
from one to twelve months after installation. We believe that we may continue to operate
at a negative cash flow for certain periods in the near future due to these factors. If we
are unable to consistently generate sustained positive cash flow from operations, we must
rely on debt or equity financing.

11

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---



We
cannot guarantee market acceptance of our products.

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

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

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

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

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

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

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

12

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

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

We
may not successfully integrate the recently acquired business of Panoptes.

On
February 21, 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.

The
process of integrating Panoptes into our business is risky and may create unforeseen
operating difficulties and expenses resulting from the diversion of management time from
the ongoing development of our business in order to ensure the successful integration of
the new business. Failure to integrate the operations of Panoptes into our business may
have a material adverse affect on our financial condition and the anticipated benefits of
this acquisition may not be realized. In addition, the integration of Panoptes requires
implementation of controls, procedures and policies appropriate for a public company.

We
may not successfully penetrate the microelectronics and flat-panel display
markets.

In
order for us to obtain significant orders for the automated inspection systems
manufactured by Yuravision, a company of limited resources, in the microelectronics and
flat-panel display industries, it may become necessary for us to cooperate with larger
businesses. Such business partnerships, coupled with additional investments, may enable us
to broaden our client base by developing comprehensive inspection systems for the
microelectronics and flat panel display industries as opposed to supplying our customers
with partial solutions. A failure to form such business alliances may have a material
adverse effect on our financial results.

The
microelectronics industry is highly volatile and unpredictable.

As
a supplier to the microelectronics industry, we will be subject to the business cycles
that characterize this industry, the timing, length and volatility of which, are difficult
to predict. The microelectronics industry has historically been cyclical because of sudden
changes in demand for microelectronics and capacity requirements, including capacity
utilizing the latest technology. These changes affect the timing and amounts of
customers capital equipment purchases and investments in new technology.
Consequently, in the event that we successfully develop our inspection devices for the
industry, these cycles could create pressure on our ability to launch new products, to
market or adapt existing products in a timely manner, which could affect our net sales,
gross margin and net income. Additionally, these cycles could challenge key management,
engineering and other employees, who are vital to our success.

13

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

We
 rely primarily upon a combination of trademark, copyright, know-how, trade secrets and
contractual restrictions to protect our intellectual property rights. In addition, our
employees who have access to confidential information are required to sign
confidentiality and invention assignment agreements. Certain elements of our technology
are licensed from Dr. Ilan Tamches. We have certain exclusive rights to this technology
with respect to the textile industry and certain non-exclusive rights with respect to
other industries. Neither we, nor, to our knowledge, Dr. Tamches, have any patents or
patent applications pending with respect to this technology. We do have a registered
patent in France and patent applications pending in Israel with respect to certain
technology incorporated in the video cameras used by our systems. We also have 3 patents
in Korea for certain technology in the computer vision systems. For our developments in
the microelectronics industry, we have a registered patent in the USA and we have patent
applications pending in the USA for our haze, wax and beam separation analysis inspection
technologies. We believe that such measures provide only limited protection of our
proprietary information, and there is no assurance that our confidentiality and
non-competition agreements will be enforceable and that our proprietary technology will
remain a secret, or that others will not develop similar technology and use this
technology to compete with us. Despite our efforts to protect our proprietary rights,
former employees and other unauthorized parties may attempt to copy aspects of our
products or to obtain and use information that we regard as proprietary. For more
information, see Item 4, Informationon the Company  Business
Overview  Intellectual Property Rights for Textile Industry & Intellectual
Property Rights for ScanMaster.

We
may become involved in litigation.

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

# Risks Related to Our
Ordinary Shares

We
may require additional financing.

Pursuant
to a series of private placement transactions, or Private Placement Investments, in
December 2003 and January 2004 with a group of investors, or the Investors, for an
aggregate purchase price of $3,927,123, we issued an aggregate of 5,099,911 of our
ordinary shares and warrants to purchase 1,844,094 of our ordinary shares at various
exercise prices. Though a portion of these warrants have been already exercised, exercise
of the remaining warrants issued pursuant to the Private Placement Investments will
provide us with proceeds of an additional $1,559,860. (for more information, see Item
10, Additional Information  Material Contracts).

14

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Furthermore,
under a plan of arrangement approved by the Haifa District Court in November 2003, or Plan
of Arrangement, our controlling shareholder Altro Warenhandels GmbH, or Altro, agreed to
purchase 2,000,000 of our ordinary shares for an aggregate purchase price of $700,000
which was paid in five quarterly installments beginning in 2004, the last of which was
made in April 2005. Also pursuant to the Plan of Arrangement, in May 2004 we distributed
to our shareholders warrants to purchase 4,183,950 of our ordinary shares with an exercise
price of $0.35 per ordinary share, or the Warrant Distribution. Should all the warrants
issued pursuant to the Warrant Distribution be exercised, we will receive $1,383,711. As
of May 1st, 2006, 408,653 shares have been issued pursuant to such warrants,
for a consideration of $143,028. (for more information, see Item 7, Major
Shareholders and Related Party Transactions  Plan of Arrangement and Warrant
Offering).

In
addition, in March 2004, we entered into a Standby Equity Distribution Agreement, or the
Standby Equity Distribution Agreement, with Cornell Capital Partners L.P., or Cornell,
pursuant to which we are entitled to issue Cornell with advance notices requiring it to
purchase, six days following each advance notice, a number of our ordinary shares as per
our advance notice. We registered a total of 5,555,555 of our ordinary shares for future
issuance to Cornell under the Standby Equity Distribution Agreement. As of June 15, 2006,
we have issued 1,701,912 of our ordinary shares pursuant to this agreement, for a total of
$733,000. (for more information on both transactions with Cornell, see Item 10,
Additional Information  Material Contracts).

In
addition, on February 21, 2006, we consummated an agreement with Mivtach Shamir Holdings
Ltd., or Mivtach Shamir. Pursuant to this agreement Mivtach Shamir provided us with a two
year $3 million convertible loan (half the loan is being held in escrow subject to our
completion of a certain milestone, or conversion of the loan), which may, at the option of
Mivtach Shamir, be converted into 6,000,000 of our ordinary shares, at a price per share
of $0.5. We will repay the loan in 30 equal monthly installments in the event that Mivtach
Shamir decides not to convert the loan, commencing 25 months after receipt of the loan. We
also granted to Mivtach Shamir a two-year warrant to purchase 4,000,000 of our ordinary
shares at an exercise price of $0.5 per share, exercisable only if Mivtach Shamir converts
the loan. Mivtach Shamir assigned all their rights to receive our shares, under the
convertible loan and warrant, to M.S.N.D. Real Estate Holdings Ltd., or M.S.N.D.

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

We
believe that our current assets, together with anticipated cash generated from operations
and available credit lines, will be sufficient to meet our cash requirements for working
capital and capital expenditures for at least twelve months from April 1, 2006.
Thereafter, 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 financing. We may not, however, be able to obtain additional financing on terms
satisfactory to us, if at all. In addition, given the existing potential for significant
dilution in light of the large number of outstanding convertible securities as well as the
large number of our ordinary shares we have recently registered or are currently
registering, our ability to complete additional debt or equity financing may be very
limited.

15

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

As
of June 15, 2006, 28,570,272 of our shares were outstanding. In addition, 3,771,642 of our
shares are issuable upon the exercise of the warrants distributed to our shareholders
pursuant to the Warrant Distribution. Additionally, pursuant to the Private Placement
Investments, we issued the Investors warrants to purchase an aggregate of 1,844,094 of our
ordinary shares, of which warrants to purchase 1,602,380 shares remain outstanding as
follows:

| |  | 85,800
shares at an exercise price of $0.68 per share;
| | - | ------------------------------------------------------

| |  | 1,118,825
shares at an exercise price of $0.85 per share;
| | - | ---------------------------------------------------------

| |  | 15,102
 shares at an exercise price of $0.98 per share; and
| | - | -----------------------------------------------------------

| |  | 382,653
shares at an exercise price of $1.40 per share.
| | - | -------------------------------------------------------

Furthermore,
35,000 of our ordinary shares are issuable to our former chief executive officer upon the
exercise of a warrant with an exercise price of $0.35 per share, exercisable until May 14,
2008. In addition, in 2005, we issued David Gal, our current chairman of the board,
options to purchase up to 600,000 of our Ordinary Shares at an exercise price of $0.50 per
share. One third of the options shall vest on December 31, 2006 and thereafter 2.8% of the
total shares subject to the option shall vest on a monthly basis. The vesting of the
options will be subject to Mr. Gal serving as the chairman of our board of directors on
the relevant vesting date, and he shall be entitled to exercise the options up to 5 years
after the options have vested. In addition, 5,012,697 of our ordinary shares are currently
issuable to our present and former employees, directors and consultants upon the exercise
of options granted pursuant to our 1996, 2000, 2003 and 2006 employee option plans, with
varying exercise prices, ranging between $0.15 per share and $3 per ordinary share.

In
addition, pursuant to the Standby Equity Distribution Agreement we registered 5,555,555 of
our ordinary shares for future sale to Cornell. The re-sale of a large number of shares by
Cornell may create additional downward pressure on the price of our shares. Furthermore,
as our share price falls, we may need to issue an additional amount of our ordinary shares
to Cornell.

We
estimate this amount of our shares to be sufficient in order to receive the remaining
$600,000available to us under the Standby Equity Distribution Agreement, we may
issue a lesser or greater number depending on the lowest volume weighted average per share
price of our shares over the five day period following each advance notice. In addition,
we may issue 6,000,000 ordinary shares to M.S.N.D. if the $3 million convertible loan is
converted. Additionally, if such convertible loan is converted, the warrant to purchase
4,000,000 ordinary shares becomes exercisable. In addition, in consideration for the
acquisition of ScanMaster we paid ScanMasters former shareholders $3 million in cash
and agreed to issue them 7,414,213 of our ordinary shares, of which 1,718,749 are
currently held in escrow and will be released by March 15, 2007, upon the attainment of
certain milestones. 2,939,192 of these shares were sold to M.S.N.D., as part of an
agreement between some of ScanMasters former shareholders and Mivtach Shamir. In
addition, 800,000 ordinary shares have been issued to Maaragim Enterprises Ltd, or
Maaragim, in connection with the acquisition of Panoptes and we granted Mizrahi a
warrant to purchase up to 571,429 of our ordinary shares, at an exercise price of $0.77
per share. Assuming the release of all of our ordinary shares from escrow,
ScanMasters former shareholders will own approximately 14.6% of our share capital.
Assuming the conversion of the convertible loan and full exercise of the warrant, M.S.N.D.
will hold approximately 27.1% of our share capital.

16

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

| | (a) | 5,099,911
ordinary shares issued under Private Placement Investments as well as
               1,602,380 ordinary shares underlying warrants granted to Private Placement
               Investors;
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | 3,775,297
ordinary shares underlying Warrant Distribution;
| | --- | ----------------------------------------------------------

| | (c) | 1,435,036
ordinary shares issuable to employees under 1996, 2000 employee option
               plans; and
| | --- | ----------------------------------------------------------------------------------------------------------

| | (d) | 35,000 ordinary
shares issuable to former CEO upon exercise of a warrant.
| | --- | -------------------------------------------------------------------------

| | (e) | 4,475,021
ordinary shares for ScanMasters former shareholders;
| | --- | ---------------------------------------------------------------

| | (f) | 2,939,192
ordinary shares for M.S.N.D.;
| | --- | ---------------------------------------

| | (g) | 6,000,000
ordinary shares to be issued upon conversion of convertible loan, and
               4,000,000 shares to be issued to M.S.N.D. upon exercise of the warrant;
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | (i) | 800,000
ordinary shares for Maaragim.
| | --- | --------------------------------------

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

Our
shareholders may be diluted by as a result of the Standby Equity Agreement by more than
we currently anticipate.

As of June 15, 2006, we have issued
1,701,912 ordinary shares to Cornell pursuant to the Standby Equity Distribution Agreement
(of which 148,438 ordinary shares were issued in consideration for providing the Standby
Equity Distribution Agreement and 1,553,474 ordinary shares were issued pursuant to
advance notices delivered under the Standby Equity Distribution Agreement). We do not know
how many additional ordinary shares will be issued to Cornell over the next year pursuant
to the Standby Equity Distribution Agreement. We anticipate 4,002,081 shares to represent
the maximum number of ordinary shares that we may issue to Cornell in the future pursuant
to the Standby Equity Distribution Agreement. At our recent share price of $0.4, we would
need to issue to Cornell 1,500,000 of our ordinary shares in order to draw down the
remaining $600,000 available to us under the Standby Equity Distribution Agreement, which
expires July 1, 2006, and which would represent approximately 2% of our outstanding
ordinary shares upon issuance (assuming the exercise of all of our currently convertible
securities into our ordinary shares). However, our ability to cause Cornell to advance
funds under the Standard Equity Distribution Agreement is not subject to any minimum
volume weighted average price of our ordinary shares. The lower the price of our ordinary
shares on the market at the time of an advance, the more shares will be issued to Cornell
and the greater dilution will be caused to the interests of our shareholders.

17

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Sales
of our  ordinary  shares by Cornell  may cause  downward  pressure  on the price of our
shares.

To
the extent Cornell sells our ordinary shares, our share price may decrease due to the
increasing number of shares in the market. This could allow Cornell to be issued more of
our shares following an additional advance issued by us, and any subsequent sale of such
greater amounts of our ordinary shares could further depress the share price. Since our
ability to cause Cornell to advance funds under the Standard Equity Distribution Agreement
is not subject to any minimum price of our ordinary shares, Cornell may be issued shares
regardless of the low the price of our shares. Furthermore, since under the Standby Equity
Distribution Agreement Cornell will never be entitled to hold more than 9.9% of our
outstanding share capital, in the event of a future required purchase which would bring it
above this threshold percentage, it will sell, prior to the purchase, as many of our
ordinary shares as is required to ensure that its holdings in our company will remain
below the threshold percentage at the time of purchase. In any of these events, the
significant downward pressure on the price of our ordinary shares as Cornell sells
material amounts of our shares could encourage short sales by Cornell or others. This
could place further downward pressure on the price of our ordinary shares.

The
Standby Equity Distribution Agreement could have an adverse effect on our ability to make
acquisitions with our ordinary shares.

We
cannot predict the actual number of our ordinary shares that will be issued pursuant to
the Standby Equity Distribution Agreement, in part, because the purchase price of the
shares will fluctuate based on prevailing market conditions and we have not determined the
total amount of advances we intend to draw. It may be necessary for our shareholders to
approve an increase in our authorized share capital for us to register additional ordinary
shares in order to have sufficient authorized shares available to make acquisitions using
our ordinary shares. As we issue our ordinary shares pursuant to the Standby Equity
Distribution Agreement and promissory note, we may not have sufficient ordinary shares
available to successfully attract and consummate future acquisitions.

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 June
2006 was 43,000 shares. The high and low bid price of our ordinary shares for the last two
years has been $1.4 and $0.37, 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.

18

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

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

| | With
a price of less than $5.00 per share;
|- | ------------------------------------------

| | That
are not traded on a "recognized" national exchange;
|- | --------------------------------------------------------

| | Whose
prices are not quoted on the NASDAQ automated quotation system; or
|- | ------------------------------------------------------------------------

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

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

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

On
November 19, 2003, our ordinary shares were delisted from The Nasdaq SmallCap Market and
are now traded on the OTC Bulletin Board as a result of our failure to comply 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.

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Our
results are affected by volatility in the securities markets.

Due
to the downturn in the world economy over recent years, the securities markets in
general have recently experienced increased volatility, which has particularly affected
the market prices of equity securities of many hi-tech companies, including companies that
have a significant presence in Israel. Although the volatility of these companies
securities has often been unrelated to their operating performance, they, and particularly
those in the fields of communications, software and internet, may 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.

# General Risks

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

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

Conditions
in Israel may affect our operations.

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

From
October 2000 until recently, there was an increase in violence between Israel and the
Palestinians, primarily but not exclusively in the West Bank and Gaza Strip. The election
of representatives of the Hamas movement to a majority of seats in the Palestinian
Legislative Council may create additional unrest and uncertainty. There can be no
assurance that the recent relative calm will continue. Ongoing and revived hostilities
with the Palestinians or Arab countries might require more widespread military reserve
service by some of our employees, which could have an adverse effect on our business. In
addition, several Arab and Muslim countries still restrict business with Israeli
companies. We could be adversely affected by restrictive laws or policies directed towards
Israel or Israeli businesses. The political and security situation in Israel may result in
parties with whom we have contracts claiming that they are not obligated to perform their
commitments under those agreements pursuant to force majeure provisions. Any hostilities
involving Israel or the interruption or curtailment of trade between Israel and its
present trading partners could adversely affect our operations and could make it more
difficult for us to raise capital. Furthermore, many of our facilities are located in
Israel. Since we do not have a detailed disaster recovery plan that would allow us to
quickly resume business activity, we could experience serious disruptions if acts
associated with this conflict result in any serious damage to our facilities. Our business
interruption insurance may not adequately compensate us for losses that may occur and any
losses or damages incurred by us could have a material adverse effect on our business. Any
future armed conflicts or political instability in the region would likely negatively
affect business conditions and harm our results of operations.

20

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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 Japanese Yen and the Euro. This exposes us to market risk from
changes in foreign exchange rates vis-à-vis the U.S. Dollar. We generally utilize
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 Inflation 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.

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.

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

|ITEM 4. | INFORMATION
ON THE COMPANY
|------- | --------------------------

A.
          History and Development of the Company

Elbit Vision Systems Ltd., or
EVS, has historically designed, developed, manufactured, marketed and
supported automatic inspection and quality monitoring systems for the textile and other
fabric industries.

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

On September 8th 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 and automotive industries. ScanMaster was established in 1986 by a group of
researchers and engineers from the Tel Aviv University in Israel. ScanMaster manufactures
instruments, transducers and turnkey non-destructive inspection systems for a wide range
of industrial applications using ultrasonic technologies and has an installed base of more
than five hundred field-proven systems and instruments, including equipment for such
inspection applications as:

| | Pipe
welds and body
|- | -------------------

| | Aircraft
engine turbine forging parts
|- | -------------------------------------

| | Power
generation turbine rotors and shafts
|- | ------------------------------------------

| | Steel,
aluminum and titanium alloy plates, bars, tubes and pipes
|- | ----------------------------------------------------------------

| | Train
wheels and train rails
|- | ----------------------------

| | Diesel
engine pistons and pressure vessels
|- | ------------------------------------------

| | Aircraft
and aerospace structural elements manufactured from composite materials
|- | --------------------------------------------------------------------------------

| | Plastic
pipes for the gas industry
|- | ----------------------------------

| | Spot
welds for the automotive industry
|- | --------------------------------------

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

22

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In
June 2004, we completed an investment in Yuravision Co. Ltd. and a series of purchase
agreements with certain of its shareholders, increasing our holdings in Yuravision to
approximately 51.2%. We also have a legal obligation to purchase an additional 18.8% from
former shareholders of Yuravision. Yuravision is a South Korean developer of visual
inspection systems for the microelectronics and display industries. The acquisition of a
controlling stake in Yuravision is intended to facilitate our efforts to penetrate the
Flat Panel Display (FPD) and display technology markets. See the discussion regarding the
Yuravision Acquisition in Item 3, Key Information  Risk Factors  Risk
Factors Related to Our Business and Item 10, Additional Information
 Material Contracts.

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

# Recent Developments

Appointment of David Gal
as Chairman of the Board

On
March 2, 2006, Mr. Nir Alon ceased serving as the chairman of our board of directors and
was replaced by Mr. David Gal. Mr. Nir Alon continues to serve as a member of our board of
directors. On February 21, 2006 our shareholders approved an agreement which provided for
the terms of compensation for Mr. Gal. Under the agreement, we will pay Mr. Gal a monthly
fee of $13,500 plus Value Added Tax, lease an automobile for his use, and supply him with
certain other office related equipment necessary to provide us with his services. The
agreement concerning Mr. Gals services may be terminated by either party upon
providing 3 months prior written notice, and we shall pay all remuneration for such 3
month notice period. Additionally, we have granted Mr. Gal options to purchase up to
600,000 of our ordinary shares at an exercise price of $0.50 per share. One third of the
options shall vest on December 31, 2006 and thereafter 2.8% of the total shares subject to
the option shall vest on a monthly basis. The vesting of the options will be subject to
Mr. Gal serving as the chairman of our board of directors on the relevant vesting date,
and he shall be entitled to exercise the options up to 5 years after the options have
vested.

23

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Convertible Loan
Agreement with Mivtach Shamir

On
February 21, 2006, we consummated an agreement with Mivtach Shamir Holdings Ltd., or
Mivtach Shamir. Pursuant to the agreement, Mivtach Shamir provided us with a two year $3
million loan, which may, at the option of Mivtach Shamir, for a period of 24 months
following the provision of the loan, be converted into 6,000,000 of our ordinary shares,
at a price per share of $0.5 (half the loan is being held in escrow subject to our
completion of a certain milestone, or conversion of the loan). The interest on the loan
cannot be converted, and will be repaid on a quarterly basis. We will repay the loan in 30
equal monthly installments, with the first installment due on the 27thmonth
following the provision of the loan, in the event that the loan is not converted. We also
granted to Mivtach Shamir a two-year warrant to purchase 4,000,000 of our ordinary shares
at an exercise price of $0.5 per share, exercisable only if the loan is converted. On
February 21, 2006, Mivtach Shamir assigned their right to receive shares from us, under
the convertible loan and warrant, to M.S.N.D.

M.S.N.D.
          also completed the purchase of 2,939,192 of our ordinary shares from three of
          the founders of ScanMaster, in accordance with the provisions of a share
          purchase agreement.

M.S.N.D.
          currently holds approximately 11% of our issued and outstanding share capital
          and assuming the conversion of the loan and the exercise of the warrant, in
          full, will hold approximately 30% of our issued and outstanding share capital,
          becoming our largest shareholder.

Acquisition of Panoptes

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

Loan from Mizrahi Bank

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

Articles of Association

On December 29, 2005, our
shareholders approved an amendment to our articles of association concerning exemption,
insurance and indemnification of our directors and officers. On February 21, 2006, as a
closing condition to the convertible loan agreement with Mivtach Shamir, our shareholders
approved the adoption of new articles of association. These changes were also adopted due
to changes in Israels business and legal environment and the entering into effect of
the Companies Law which replaced the Companies Ordinance. The new articles of association
adopted following our February 21, 2006 shareholders meeting, include the following
changes:

24

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| |  | With
the exception of resolutions which require the affirmative vote of a special majority
pursuant to the Companies Law, all other resolutions shall be passed by an ordinary
majority.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | To
the extent permitted by the Companies Law, the board will have the ability to declare
dividends (in cash or in kind) to shareholders without shareholder approval.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
quorum for shareholders meeting will be the minimum quorum required under applicable law.
| | - | ---------------------------------------------------------------------------------------------

Repayment of Promissory
Note

On August 26, 2004, we signed a
short-term promissory note with Cornell Capital Partners L.P., or Cornell, whereby Cornell
agreed to advance us the sum of $4,000,000. On February 17, 2006, we repaid all
outstanding amounts owed to Cornell, and have thus fulfilled all of our obligations toward
them under the Promissory Note. Following repayment of the Promissory Note, all ordinary
shares and advance notices held in trust to guarantee the loan were returned to us, and
the floating charge on our assets was removed. On April 17, 2006, we also withdrew a
registration statement on Form F-2 which we filed for the registration of 14, 444,445 of
our ordinary shares to guarantee our obligations towards Cornell under the Promissory
Note. The registration statement had not become effective prior to its withdrawal.See
also Item 7, Major Shareholders and Related Party Transactionsand Item
10, Additional Information  Material Contracts.

Our executive offices are located at
New Industrial Park, Building 7, Yoqneam, Israel, and our telephone number is
972-4-993-6400. 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

We currently operate as two main
divisions: the NonDestructive Automated Inspection Systems Division consisting of
ScanMasters non-destructive inspection business and the Automated Optical Inspection
Industry, or AOI, Division (which includes our microelectronics division).

|I. | NonDestructive
Automated Inspection Systems Division
|-- | -----------------------------------------------------

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

ScanMaster Ltd. has made more than
500 equipment installations in 25 countries, for a total 11-year sales volume exceeding
$65 million. Typical uses of ScanMaster equipment include the imaging and assessment of
defects in forged discs used in jet engines, detection of flaws in welded pipe, 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.

25

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The annual NDT world market for
ultra-sonic testing, or UT, equipment is of the order of $400 million in size. The market
is divided among North and South America, Europe, and the rest of the world, with each of
the three sectors commanding approximately one-third of world sales. Product-wise, the UT
market is divided as follows:

| |  | Consumables,
which in the main are transducers and accessories with annual sales of the order of $80
million;
| | - | -------------------------------------------------------------------------------------------------------------

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

| |  | Full-size
instruments, retrofit upgrades of older installed systems and new turn-key inspection
systems, altogether comprising an annual turnover of $120 million.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

|a. | Business
and Product Overview
|-- | -----------------------------

Applications

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

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

| | Bar
Full BodyHigh-speed, precision ultrasonic inspection of bars.
|- | -----------------------------------------------------------------

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

26

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

| | In
Service Train RailHigh-speed train rail inspection with super-fast B-scan
display, complete data recording and analysis tools.
|- | ---------------------------------------------------------------------------------------------------------------------------------

| | Storage
Tank and PipelineMulti-channel, high-speed data acquisition and recording
for inspection of storage tanks and pipelines.
|- | --------------------------------------------------------------------------------------------------------------------------------

| | Aircraft
Engine DisksImmersion inspection of Titanium and Ni alloy aircraft engine
forgings, with full imaging and data processing capabilities.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------

| | Structural
Elements AerospaceImmersion, squirter or contact inspection of aircraft
and aerospace structural elements manufactured from metal and composite materials, with
full imaging and data processing capabilities.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | AutomotiveEfficient, reliable inspection and evaluation of spot welds in production
line.
|- | -----------------------------------------------------------------------------------------

| | Portable
Versatile InstrumentationPortable UT instruments for in-doors or field
operation.
|- | ------------------------------------------------------------------------------------------

| | Multi-channel
InstrumentationMulti-channel full-featured ultrasonic instrument with up
to 32 channels and programmable I/O ports.
|- | ---------------------------------------------------------------------------------------------------------------------------------

Product Overview

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

Instrumentation

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

| | The
RPP3 is a high-performance, programmable single channel, square wave
ultrasonic pulser-receiver that serves as a low cost, front-end module for ScanMasters
ultrasonic instruments. The average net transfer price is $3,500.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
RPP4 is a high-performance, programmable multi-channel, square wave
ultrasonic pulser-receiver that serves as a front-end module to ScanMasters
ultrasonic instruments. The average net transfer price is $4,200.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
swi-100 is a digital ultrasonic instrument which provides the
possibility of computer-assisted decision making with on-line UT signal analysis. An
advanced ultrasonic instrumentation for inspection and evaluation of spot welds,
providing high throughput, high reliability of detection and full documentation
capability. The average net transfer price is $25,000.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | The
U/T Mate can convert a computer into a UT instrument by connecting
UT/Mate to the universal serial bus, or USB, port. UT/Mate innovatively
incorporates powerful features, similar to those available in the upi-100 instrument.
The device is ready to use by plugging it to any PC/Laptop USB port. The average net
transfer price is $13,000.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Transducers

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

| | Spot
Weld Transducers The spot weld, or SW, series of 15 and 20MHz transducers
is intended for precise and repeatable inspection and evaluation of spot welds in bonded
metal sheets. SW Series transducers have signal resolution, with the controlled water
column allowing distinct separation of intermediate echoes for evaluation purposes at
less than 0.5mm (0.020) from the entry surface. High-sensitivity piezoelectric
elements provide ultrasonic beam penetration into thick metal sheets. The average net
transfer price is $1,100.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

C-Scan
Imaging Systems

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

| | LS200-X
 The LS-200X, LS-200, immersion ultrasonic inspection
system is a rugged, reliable system for multi shift operation in an industrial
environment. The average net transfer price is $160,000.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | LS-200
and LS 200bseries are immersion ultrasonic inspection systems are rugged,
reliable systems for multi shift operation in an industrial environment. The average net
transfer price is $300,000.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | DS-200i 
The DS-200i immersion ultrasonic inspection system is designed for the scanning of
oversize parts. It is a rugged, reliable system for multi shift operation in an
industrial environment. The high accuracy scanning mechanics have exceptional resolution
and repeatability on all the linear and angular axes allowing for scanning of complex
parts. The average net transfer price is $500,000.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | LS-500 The
LS-500 immersion ultrasonic inspection system is a modular design allowing for stretching
of the tank and scanner to fit the application. The average net transfer price is
$120,000.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | DS-200s The
DS-200s Series of ultrasonic squirter systems complements the DS-200 Series of
immersion scanners with the high-end capacity required for non-immersion inspection of
large-scale parts manufactured from composite materials. Rugged gantry-mounted bridge
with dual search tubes provide high-speed inspection within tight tolerance limits for
accuracy, repeatability and resolution. Water squirter inspection in operator-selected
pulse-echo (P-E) or thru-transmission (T-T) modes. Optional simultaneous P-E and T-T
scanning. The average net transfer price is $450,000.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | FlexiTrack
II- Portable dual-axis scanners intended for ultrasonic imaging of
materials and components. The average net transfer price is $90,000.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------

Pipe
and plate Inspection

| | AS
200e High-speed, automated multi-channel ultrasonic testing machines for
detection, classification and documentation of defects in electrical resistance welded
pipes (ERW). The average net transfer price is $300,000.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | AS
200s High-speed, automated ultrasonic testing machines for detection,
evaluation and documentation of flaws in submerged-arc welded pipes (SAW). The average
net transfer price is $350,000.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | AS
200p High-speed, automated ultrasonic testing machines for detection,
evaluation and documentation of flaws in steel plates and bars. The average net transfer
price is $1,500,000.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Product
Inspection Systems

| | AS
280High-speed, precision inspection machines for detection, evaluation
and documentation of flaws in large, thick-walled tubulars. The average net transfer
price is $600,000.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Train
Inspection Systems

| | AS
220wDesigned for in-service, production line or refurbishment shop type
inspections. Fully integrated inspection system. Includes multi-channel ultrasonics,
multi axes inspection robot, high load capacity mechanics with multiple transducer heads
& advanced software. The average net transfer price is $450,000.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

29

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| | SFB-50 A
Train Rail Inspection System, mounted on a multi purposed car (Hi-Rail) or towed by a
service car. Ultrasonic inspection intended for detection, imaging and evaluation of
flaws. The average net transfer price is $500,000.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | SRI-
10Single rail ultrasonic inspector for manual inspection and verification of detected
flaws.  The average net transfer price is $65,000.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------

Software

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

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

|b. | Sales
and Markets
|-- | -----------------

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

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

To date, ScanMaster Ltd. has made
more than 500 installations in 25 countries. Each territory is covered by a professional
representative, who is responsible for pre-sale activity through to warranty service. In
addition, the Company conducts its North American operations by way of a fully owned
subsidiary.

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

Over the past year, the concentration
of ScanMasters sales have been to the Far East, such that its sales breakdown
is approximately 25% North America, 40% Europe and 35% to the Far East.

|c. | Manufacturing
|-- | -------------

ScanMasters facilities are
located in Hod Hasharon, a city 15 kilometers north east of Tel Aviv. ScanMaster currently
leases 2,100 m2 in an industrial complex, of which 900 m2 are allocated for
manufacturing purposes. ScanMasters systems are manufactured by subcontractors. The
final assembly, integration and quality control is conducted by ScanMaster. In addition,
ScanMaster performs logistics and purchasing activities. Every system is assembled at
ScanMaster, software installed and configured and the specific application is tested.
ScanMasters manufacturing facilities are in compliance with ISO-9002 standards.

30

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|d. | Competition
|-- | -----------

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

Low
end  transducers, gauges, portable instruments

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

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

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

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

Instruments

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

Immersion and
squirter-based C-scan imaging systems

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

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

31

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Production-line GO/NOGO
inspection systems

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

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

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

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

Ultrasonic inspection
equipment for steel mills

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

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

Train wheel and train
rail inspection

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

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

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

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|e. | Intellectual
Property Rights
|-- | ----------------------------

ScanMaster has registered 2 patents
in Israel with respect to certain technology incorporated in the Ultrasound inspection
methodology.

# II. AOI Division

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

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

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

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

| | prevent
the reoccurrence of defects caused by manufacturing equipment; and
|- | --------------------------------------------------------------------------

| | reduce
rebate payments for textiles delivered with defects.
|- | -----------------------------------------------------------

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

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

Human inspection of fabrics is
unreliable for the following reasons:

| | 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
|- | -------------------------------------------------------------------------------------------------------------------------------------

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

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

The EVS Solution for the
AOI

We develop and have acquired
sophisticated automatic visual inspection systems for manufacturers of industrial web
products, as well as for manufacturers of microelectronic products, primarily in the LCD
market. 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 six families of
visual inspection systems: I-TEX, for the visual inspection and quality monitoring of
woven, knitted and non-woven fabrics; PRIN-TEX, for the detection of printing defects on
fabric; Broken Filaments Analyzer, for the detection of broken filaments defects in glass
fabric; SVA LITE, a Shade Variation Analyzer for the detection of shade inconsistencies in
dyed fabric; LOOM-TEX, for the automatic visual quality inspection system that is
integrated with the weaving loom and monitors the fabric while weaving; and HAWK-I, a
gravure cylinder inspection system, for improving the quality of cylinders.

I-TEX
Family of Products

The I-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. I-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, I-TEX
systems can detect defects as small as 0.5 mm on a variety of web widths ranging from 150
to 600 centimeters, at maximum speeds ranging from 10 to 800 meters per minute. In
addition, I-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.

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The modular design of the I-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. I-TEX systems can be integrated in-line with existing textile
production equipment or can be used as off-line stand-alone units to inspect web after
manufacturing is complete.

Quality
Monitoring Process

The I-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.

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Models

I-TEX systems are currently available
in four basic models: I-TEX 2000, I-TEX 2000D, I-TEX Lite and IQ-TEX.

| |  | The
I-TEX 2000 is the I-TEX familys high-end product. I-TEX 2000 is a more compact,
more powerful and more flexible version of I-TEX. It can operate at a maximum speed of up
to 300 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 I-TEX 2000 ranges between $350,000 and
$550,000, depending on the configuration.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
I-TEX 2000D is a dual surface computerized vision inspection system that automatically
detects, memorizes, shows and further grades weaving and finishing defects on denim
fabrics. It can operate at a maximum speed of up to 100 meters per minute, and can detect
defects as small as 0.5 mm. The list price for the I-TEX 2000D ranges between $350,000
and $550,000, depending on the configuration.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
I-TEX Lite is one of the new lines of inspection products of EVS. The system is designed
for easy and flexible installation on a wide range of web production lines such as
Non-Woven, Paper, Composite materials, laminated materials etc. The system allows EVS to
offer solutions to new market segments using its vast experience from the textile
industry. The list price for the I-TEX Lite ranges between $70,000 and $250,000,
depending on the configuration.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
IQ-TEX is based on the integration of our newly acquired Smart Video Camera technology,
from Panoptes- our newly acquired subsidiary, into the I-TEX products. The IQ-TEX is a
more compact, powerful and flexible version of I-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
$400,000, depending on the configuration.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Modules

We offer the following three modules
for defect analysis and cut optimization for our I-TEX 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 overall 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.
|- | -------------------------------------------------------------------------------------------------------------------

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Cut Optimization.Software
that enables the user to cut a large I-TEX Inspected rollof web into
smaller rolls while optimizing the fabrics yield per class (A; B; C )
according to the users specifications. Our Cut Optimization software offers the
following benefits:

| | maximizes
web rolls selling price;
|- | ----------------------------------

| | reduces
the quantity of second and third quality product; and
|- | -------------------------------------------------------------

| | consistent
fulfillment of customer's demands.
|- | ---------------------------------------------

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

| | allows
for an  accurate  stop or slowing the table  speed on "point 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 I-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 I-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.

PRIN-TEX
Family of Products

PRIN-TEX is an in-line, full-color
fabric defect detection and quality control system designed to detect defects in printed
fabric. It is designed to be mounted on rotary screen printing machines. The system is
capable of processing and analyzing large amounts of data acquired by cameras positioned
over moving printed fabric and comparing this data with data acquired from good repeats of
fabric. The system alerts the operator of printed fabric defects and displays them in
real-time on a video monitor. These features enable the operator to locate the defect and
take required corrective measures during the printing process, thereby significantly
reducing fabric defects and improving yield of quality fabric.

PRIN-TEX systems can detect printed
defects as small as 0.5 mm on an array of fabrics, including woven, knitted and paper.
Defects detectable by PRIN-TEX systems include misfits, lint, stick-ins, insufficient
paste, defects due to damaged or blocked screens, defects due to glue problems and
off-center and narrow prints. The pattern repetitive length for PRIN-TEX is up to 143.6
centimeters with a maximum fabric speed of 70 meters per minute.

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The PRIN-TEX quality monitoring
process is comprised of the calibration phase and the inspection phase.

Calibration Phase. During the
calibration phase, the PRIN-TEX system learns the characteristics of the fabric pattern
and extracts the appropriate pattern parameters. The system provides automatic light or
integration time calibration in order to ensure optimal lighting conditions for the
processing unit based on the type of fabric being inspected. The fabric length generally
required for the automatic calibration is approximately 20 meters.

Inspection Phase. The
inspection phase begins after the calibration phase has been concluded. During this phase,
the system analyzes the determined extracted features and parameters. The system enables
the operator to manipulate the following parameters during the inspection phase:
sensitivity, light intensity, zoom control, left margin vertical marker positioning and
right margin vertical marker positioning.

The system produces detailed reports
of the detected defects in the fabric roll. These reports include information with respect
to date, time, total fabric length, total length of defects on the fabric, fabrics
length of calibration and the inspection starting point. The system also reports location
and dimensions of each defect and shows its image type and nature.

PRIN-TEX 2000 is the new generation
of our printing monitoring systems. It implements improved image understanding algorithms,
specially designed color CCD line cameras, upgraded color displays and synchronization to
the rotary printers screen. PRIN-TEX 2000 provides better detection performances,
better human interface and better ROI results. We offer PRINT-TEX 2000 in one model or
fabric widths of up to 3.2 meters. The list price of PRINT-TEX 2000 ranges between
$150,000 and $250,000.

Broken
Filaments Analyzer

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 I-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 is ranges
between $200,000 and $300,000.

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Shade
Variation Analyzer

The Shade Variation Analyzer (or the
SVA LITE) is an in-line system designed to measure shade variation in textiles during
normal web flow. The SVA LITE is a modular system utilizing calibrated traversing sensors
and proprietary signal-processing algorithms. Sensor readings are compared to readings
received at the beginning of the roll, or at any other user selected point, to detect
side-to-side and beginning-to-end shade variations. The system is designed to be either
fully integrated with I-TEX systems or to operate as an independent stand-alone unit.The SVA LITE can be used in two modes of operation.In the first mode, the SVA
LITE is installed after the dryer of the dyeing range and alerts the user when shade
variation exceeds the preset limits. This enables the operator to modify the process
parameters. In the second mode, the SVA LITE is installed at the exit of a finishing range
together with an I-TEX system or as a stand-alone unit. The results of the inspection can
be used to sort the rolls by their shade or to identify problems during the
dyeing-finishing process. Data from the SVA LITE inspection process can be incorporated
into the I-TEX system reports or into a separate SVA LITE report. The list price of the
SVA LITE is between $70,000 and $150,000.

The
LOOM-TEX

The LOOM-TEX is an automatic visual
quality inspection system that is integrated within the weaving loom and monitors the
fabric while weaving. The system answers the need for real-time detection of spinning and
weaving defects within a short distance of the reed (the movable frame fitted with metal
strips that separates the warp threads in weaving) during the weaving process and inspects
100% of the fabric. The advantages and features of the LOOM-TEX include increased yield of
first-choice fabrics, elimination of manual inspection, reduction of the need to cut out
running defects, facilitation of exact fabric length weaving while considering the actual
defect rate, optimization of loom assignment, real-time alarm notification of major
defects and suspension of loom activity when warp and running defects are detected. The
LOOM-TEX inspects 100% of the fabric and selvedge (the edge of a fabric that is woven so
that it will not fray or ravel) on a wide range of applications including, among others,
technical fabrics, apparel, home furnishing, upholstery, silk and shirting. Detection by
the LOOM-TEX is performed as closely as possible to the reed enabling early detection of
the faults. A real time alarm is activated according to pre-defined defect parameters
capable of stopping the loom upon detection of major faults. Each looms performance
can be viewed during real time, displaying defect images, roll-defects maps and
statistical data. The list price of the LOOM-TEX ranges between $7,000 and $30,000.

The
HAWK-I

The Hawk-i is a gravure cylinder
inspection system is designed to meet the pre-press industry needs, by improving cylinder
quality. The system is designed to detect defects in the engraving process of the gravure
cylinder. The Hawk-i combines high-resolution image acquisition with dedicated image
processing algorithms, designed by EVS. This gravure inspection system offers both
increased productivity compared to manual inspection, as well as all the benefits
associated with reliable and consistent automatic inspection

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This new inspection machine is
designed to save gravure cylinder manufacturers time, accelerate job turnaround and
increase both cylinders quality and the consistency of the printed matter. The new
inspection system has already been successfully implemented by major manufacturer. The
list price for the Hawk-i ranges between $80,000 and $180,000, depending on the
configuration.

|b. | Sales
and Markets for the AOI
|-- | -----------------------------

Sales Network

We market our products through in-house sales personnel in conjunction with independent sales
                 representatives. As of June 15, 2006, 5 in-house sales personnel and 19 independent sales
            representatives marketed our products. 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.

I-TEX
Inspected Standard

A significant portion of our
marketing effort is focused on making web inspection by I-TEX systems, and the
corresponding labeling of the inspected web as I-TEX Inspected, an industry
standard for web quality inspection. We believe that the best way to increase demand for
our I-TEX systems is to convince end-product manufacturers of the benefits of I-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 I-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 I-TEX with leading clothing
manufacturers. Although inspection by I-TEX systems has not yet become an industry
standard, many designers express preference for I-TEX Inspected fabrics. There
can be no assurance that we will be successful in our efforts to make inspection by I-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

In 2003, approximately 40% of our
sales were in the United States, approximately 46% were in Europe, and approximately 14%
were in the Far East.In 2004, approximately 26.3% of our consolidated sales were
in the United States, approximately 44.5% were in Europe, and approximately 29.2% were in
the Far East.In 2005,approximately 29.6% of our sales were in the United
States, approximately 21.2% were in Europe, and approximately 49.2% were in the Far
East.One customer accounted for 17%, 18% and 12% in each of the years 2003, 2004,
and 2005 respectively. No other customers accounted for more than 10% of our net sales in
any of the years 2003, 2004 or 2005. 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 Relating to Our Business  Fluctuations in the Market.

|c. | Manufacturing
for the Web Industry
|-- | ----------------------------------

The principal manufacturing and
assembly of our basic systems are conducted by subcontractors. We perform logistics and
purchasing activities, integration and final testing in-house. In addition, we perform the
software installation and configuration, final hardware configuration, quality control and
any special system customization needed for a particular customer. Production is based
upon firm customer commitments and anticipated orders and is generally planned three to
six 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. The spectrophotometer included in our products are manufactured by a single
source supplier. 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.

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|d. | Competition
in the Web Industry
|-- | -------------------------------

Over the past few years there have
been several academic and commercial attempts to develop systems that will be competitive
with our I-TEX family of products. Most of those projects did not reach a commercial
stage. We believe that the capabilities of our technology, along with our experience in
implementing these technologies and our wide customer base, provide us with a competitive
advantage over potential competitors are small suppliers of automatic inspection solutions
with PC-based or smart camera technologies. These suppliers, who offer
low-cost solutions for low-end applications such as Non-Woven, are attempting to penetrate
the field of textile inspection, yet, thus far, have not been commercially successful. We
are familiar with several companies that are working on an On Loom automatic
inspection solution for the greige fabric market, including BarcoVision. It is possible
that when On Loom inspection systems are commercially available, they will be
competitive with us in the greige inspection market.

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
I-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 I-TEX systems, our business would be seriously harmed.

We are not aware of any automated
visual inspection and quality control systems, in existence or currently under
development, which will compete with the PRIN-TEX family of production.

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.

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|e. | Intellectual
Property Rights for Textile Industry
|-- | -------------------------------------------------

In May 2002, we entered into an
agreement with our former principal shareholder Elbit and Dr. Ilan Tamches, which amended
the license agreement existing between Elbit and us, dated June 12, 1996. According to
this agreement, Elbit transferred to Dr. Ilan Tamches certain elements of our technology,
or Elbit Technology, which we formerly licensed from Elbit, and other elements of our
technology were directly transferred to us by Elbit, or Elbit Modified Technology.
Consequently, we currently license 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.

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

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

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

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

|IV. | Governmental
Regulation Affecting the Company
|--- | ---------------------------------------------

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

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

# C. Organizational
Structure

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

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

Additionally, we own a controlling interest
in Yuravision. For more information on the Yuravision, ScanMaster and Panoptes transactions,
see Item 4, Information on the Company  History and Development of the
Companyand Item 10, Additional Information  Material
Contracts.

# D. Property, Plants and
Equipment

Our facilities are located at New
Industrial Park in Yoqneam, Israel. We do not own any real property. We lease
approximately 19,500 square feet at our facilities in Israel, at an annual rent of
approximately $144,000. Our lease expires in January 2007. EVS US leases approximately
5,400 square feet office space in Greenville, South Carolina, at an annual rent of
approximately $30,000. This lease expires in October 2006.

ScanMaster Ltd.s facilities are
located in Hod Hasharon, Israel. ScanMaster Ltd. leases approximately 18,000 square feet,
at an annual rent of $250,000. ScanMaster Ltd.s lease expires in March 2007.

Yuravisions facilities are
located in Suwon-si, Kyeonggi-do, South Korea. Yuravision leases approximately 11,000
square feet, at an annual rent of $50,000. Yuravisions lease expires in April 2007.

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.

44

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|ITEM 4A. | UNRESOLVED
STAFF COMMENTS
|-------- | -------------------------

Not applicable.

|ITEM 5. | OPERATING
AND FINANCIAL REVIEW AND PROSPECTS
|------- | --------------------------------------------

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

The following consolidated selected
financial data for the years ended December 31, 2002 and 2001, which are not set forth
elsewhere in this report, are derived from the financial statements that have been audited
by Luboshitz Kasierer for the said years. Luboshitz Kasierer, during 2001, was a member of
the firm Arthur Andersen, independent public accountants. In 2002, Luboshitz Kasierer
became a member firm of Ernst & Young International, independent public accountants.
The selected financial data as of and for the years ended December 31, 2004 and December
31, 2003 is derived from our audited financial statements which are included elsewhere in
this report. The selected financial data for the year ended 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 1 of our Consolidated Financial Statements incorporated herein by
reference.

|                                       | 2005 | 2004 | 2003 | 2002    | 2001
|-------------------------------------- | ---- | ---- | ---- | ------- | ----
|
|
|
|
|(in U.S. thousand Dollars )            |      |      |      |         |     
|Statement of Operations Data:          |      |     
|Net sales                              |      |      | $    | 20,791  |     
|Cost of sales                          |      |      |      | 12,223  |     
|Gross profit (loss)                    |      |      |      | 8,568   |     
|Research and development expenses, net |      |      |      | 2,193   |     
|Marketing and selling expenses, net    |      |      |      | 3,765   |     
|General and administrative expenses    |      |      |      | 1,565   |     
|Total operating expenses               |      |      |      | 7,523   |     
|Operating profit (loss)                |      |      |      | 1,045   |     
|Other income                           |      |      |      | 41      |     
|Financing income (expenses), net       |      |      |      | (471    | )   
|Profit (loss) before taxes             |      |      |      | 615     |     
|Taxes on income                        |      |      |      | 4       |     
|Net loss                               |      |      |      | 611     |     
|Basic earnings (loss) per share(1)     |      |      |      | 0.023   |     
|Diluted earnings (loss) per share      |      |      |      | 0.021   |     
|Weighted average number of shares      |      |     
|outstanding-Basic (1)                  |      |      |      | 26,500  |     
|Weighted average number of shares      |      |     
|outstanding-Diluted (1)                |      |      |      | 28,421  |     
|                                       |      |     
|                                       |      |     
|
|
|Balance Sheet Data:                    |      |     
|Working capital                        |      |      | $    | (1,904  | )   
|Total assets                           |      |      |      | 22,064  |     
|Total liabilities                      |      |      |      | 17,965  |     
|Accumulated deficit                    |      |      |      | (23,843 | )   
|Shareholders' equity                   |      |      |      | 4,099   |     

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

45

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# Managements
Discussion and Analysis of Financial Condition and Results of Operations

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

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

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

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

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

# 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.

46

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

a. Revenue recognition

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

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

b.
          Acceptance clause, customers support service and warranty

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

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

The Company

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

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

47

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ScanMaster

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

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

ScanMaster recognizes revenues from
the sale of systems that require significant customization, integration and installation
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. Such accounting rule calculates
revenues, as the project progresses, according to the percentage of the contract for the
purchase of such system that has been completed, taking into account the proportion of the
actual labor costs incurred to the total labor costs estimated to be incurred over the
duration of the contract. Provisions for estimated losses on uncompleted contracts are
made when such losses are first determined, in the amount of the estimated loss of the
entire contract.

Contracts that also provide for
professional services are evaluated to determine whether such services are essential to
the contract. When the services are considered essential, revenue is recognized using the
aforementioned accounting rule. When the services are not considered essential, the
revenue allocated to the professional services is recognized as the services are
performed.

ScanMaster provides for warranty
costs at the same time as the revenue is recognized. The annual provision is calculated at
rates of 1%-3% 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.

48

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# 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:

|                                       | 2005 | 2004 | 2003
|-------------------------------------- | ---- | ---- | ----
|
|
|
|
|Net sales                              |      |      |     
|Cost of sales                          |      |      |     
|Gross profit                           |      |      |     
|                                       |      |     
|Research and development expenses, net |      |      |     
|Marketing and selling expenses, net    |      |      |     
|General and administrative expenses    |      |      |     
|Total operating expenses               |      |      |     
|Operating income (loss)                |      |      |     
|Other expenses                         |      |      |     
|Financing income(expenses), net        |      |      |     
|Income (loss) before taxes             |      |      |     
|Income taxes                           |      |      |     
|Net (loss)                             |      |      |     

# Year Ended December 31,
2005 Compared with Year Ended December 31, 2004 Sales

Sales in 2005 increased by
approximately 90% to $20.7 million compared with sales of $10.9 million in 2004. This
increase was primarily attributable to the consolidation of ScanMasters results
during 2005 which contributed more than $12 million to our consolidated revenues in sales
of our non-destructive technology, or NDT, systems. Sales of systems increased by
approximately 91% to $16.6 million compared with sales of $8.7 million in 2004. This
increase was primarily attributable to the consolidation of ScanMasters results as
well as to the increase in demand for our NDT systems.

Sales of service and spare parts
increased by approximately 86% to $4.1 million compared with sales of $2.2 million in
2004. This increase was primarily attributable to the consolidation of ScanMasters
service and spare parts revenues, thus increasing our customer base.

# 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 58.8% in 2005 compared with 77.9% in 2004. The decrease
in cost of revenues in 2005 is mainly due to the increase in sales and moving beyond our
breakeven point, as well as reducing our fixed costs by integrating part of our operation
with that of ScanMaster, thus reducing the percentage of fixed costs in relation to the
cost of revenues.

# Gross Profit

In 2005 we earned a gross profit of $8.5 million as compared to a gross profit of $2.4 million in 2004. Gross profit as a
percentage of net sales was 41% in 2005 as compared to 22% in 2004. The increase in our
gross profit in 2005 is mainly due to the increase in sales and moving beyond our
breakeven point, as well as reducing our fixed costs by integrating part of our operations
with that of ScanMaster, thus reducing the percentage of fixed costs in relation to the
cost of revenues.

49

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# 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 decreased
to $2.3 million in 2005 from $2.6 million in 2004, and were offset by Israeli government
grants of $0.15 million in 2005 and $0.16 million in 2004. Net research and development
expenses in 2005 were $2.2 million compared with $2.4 million in 2004. The decrease in the
gross research and development expenses was mainly for integrating our research and
development activity with that of ScanMaster.

# 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 selling expenses
amounted to $3.8 million in 2005, compared to $3.5 million in 2004. The increase in the
marketing and sales expenses was primarily due to the consolidation of ScanMasters
marketing and sales during the year.

# General and
administrative Expenses

General and administrative expenses
consist of payroll and related expenses, doubtful and bad accounts, professional fees paid
to auditors, legal advisors and other consultants and other related expenses. As a
percentage of net sales, general and administrative expenses decreased to 7.5% in 2005
from 19.6% in 2004. General and administrative expenses in 2005 were $1.5 million,
compared to $2.1 million in 2004. The decrease in expenses in 2005 was primarily
attributable to the integration of our general and administrative activity with that of
ScanMaster, and the reduction of our operational costs.

# Financial Expenses

Financial expenses consists primarily
of interest on our loans from banks, from Cornell Capital Partners L.P., or Cornell, which
provided us with a promissory loan for the acquisition of ScanMaster, which we have repaid
in full, and from one of our major shareholders (and former principal shareholder) Elbit
Ltd.. 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 2005 were $0.47 million, compared to financial expenses of $0.3 million in
2004. During 2004 and 2005, we financed our operations using a credit line facility
provided to us by our bank. The increase in financial expenses was primarily due to the
promissory loan we received form Cornell Capital for the financing of the ScanMaster
acquisition, and the increase of our bank loans in order to finance the constant growth of
our revenues.

# Profit/Loss

In 2005 we recorded net profit of
$0.6 million, as compared to a $5.9 million net loss in 2004. This was primarily due to
the increase in our revenues and the reduction of operational costs.

50

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# Year Ended December 31,
2004 Compared with Year Ended December 31, 2003

# Sales

Sales in 2004 increased by
approximately 73.2% to $10.9 million compared with sales of $6.3 million in 2003. This
increase was primarily attributable to the acquisition of ScanMaster and expansion to the
NDT industry. Sales were derived from sales to textile and NDT industries. Approximately
37% of our sales in 2004 were derived from the NDT industry.

# 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 77.9% in 2004 compared with 59.2% in 2003.The increase in
cost of revenues in 2004 is mainly due to provision in respect of slow inventory and costs
incurred in year 2004, relating to an efficiency program; in addition, profitability
percentage in 2004 was affected by the sale of ScanMasters and Yuravisions
inventories, for which the accounting principles applied through the acquisition of these
subsidiaries recorded the cost of revenues when realized at the fair market value of those
inventories.

# Gross Profit

In 2004 we earned a gross profit of
$2.4 million as compared to a gross profit of $2.6 million in 2003. Gross profit as a
percentage of net sales was 22% in 2004 as compared to 40% in 2003. The decrease in our
gross profit is mainly due to provision in respect of slow inventory and costs incurred in
year 2004, relating to an efficiency program; in addition, profitability percentage in
2004 was affected by the sale of ScanMasters and Yuravisions inventories, for
which the accounting principles applied through the acquisition of these subsidiaries
recorded the cost of revenues when realized at the fair market value of those inventories.

# 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 $2.6 million in 2004 from $1.8 million in 2003, and were offset by Israeli government
grants of $0.16 million in 2004 and $0.4 million in 2003. Net research and development
expenses in 2004 were $2.4 million compared with $1.4 million in 2003. The increase in the
gross research and development expenses was mainly for consolidating the expenses of our
two subsidiaries we acquired during 2004.

# Sales and Marketing
Expenses

Gross 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
selling expenses amounted to $3.5 million in 2004, compared to $1.6 million in 2003. The
increase in the marketing and sales expenses was primarily due to expenses we had
penetrating the new markets, NDT and microelectronics and for consolidating our
subsidiaries expenses.

51

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# General and
Administrative Expenses

General and administrative expenses
consist of payroll and related expenses, doubtful and bad accounts, professional fees paid
to auditors, legal advisors and other consultants and other related expenses. As a
percentage of net sales, general and administrative expenses increased to 19.6% in 2004
from 10% in 2003. General and administrative expenses in 2004 were $2.1 million, compared
to $0.6 million in 2003. The increase in expenses in 2004 was primarily attributable to
consolidating the expenses of our new subsidiaries.

# Financial Income

Financial income consists primarily
of interest earned on our cash reserves and marketable securities, as well as interest on
our loan from one of our major shareholders (and former principal shareholder) Elbit Ltd.,
  and currency translation adjustments between U.S. Dollar exchange rate imposed
on our assets and liabilities. Financial expenses in 2004 were $297,000, compared to
financial income of $60,000 in 2003. During 2004, we financed our operations using a
credit line facility provided to us by our bank.

Our principal investing activities to
date have been investments in short-term investment-grade securities and the purchase of
equipment, consisting primarily of computer and office equipment and leasehold
improvements.

# Loss

Net loss increased from $0.98 million
in 2003 to $5.9 million in 2004. This increase in losses was primarily due to expenses
related to our efficiency program and a decrease in our profitability percentage affected
by the sale of ScanMasters and Yuravisions inventories, for which the
accounting principles applied through the acquisition of these subsidiaries recorded the
cost of revenues when realized at the fair market value of those inventories.

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

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

52

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The exchange rate between NIS and the
U.S. Dollar has fluctuated during the past twelve months from a high of NIS 4.741 to the
Dollar to a low of NIS 4.405 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:

|LOW 1 U.S. Dollar= | HIGH 1 U.S. Dollar= | MONTH
|------------------ | ------------------- | -----
|
|
|
|
|4.579              |                     |      
|4.577              |                     |      
|4.664              |                     |      
|4.658              |                     |      
|4.503              |                     |      
|4.428              |                     |      

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:

|Exchange Rate | Period                             
|------------- | -----------------------------------
|4.219 NIS/$1  | January 1, 2001 - December 31, 2001
|4.723 NIS/$1  | January 1, 2002 - December 31, 2002
|4.5483 NIS/$1 | January 1, 2003 - December 31, 2003
|4.4823 NIS/$1 | January 1, 2004 - December 31, 2004
|4.515 NIS/$1  | January 1, 2005 - December 31, 2005

During 2001, the rate of inflation
was approximately 1.4% and devaluation rate was 9.3%. In 2002, the rate of inflation was
approximately 6.5% and the rate of devaluation was 7.26%. In 2003, the rate on inflation
was approximately -1.9% and the Dollar devalued against the NIS by 7.55%. In 2004, the
rate of inflation of approximately 1.21% and the Dollar revalued against the NIS by
approximately 1.61%. In 2005, the rate of inflation was approximately 2.39% and the rate
of devaluation was 5.67%. As a result of the differential between the rate of inflation
and the rate of evaluation of the NIS, we experienced increases in the costs of our Israel
operations, as expressed in U.S. Dollars, in 2005, but they did not materially affect our
results of operations in such periods.

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.

53

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# 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 and (v) receipt of a convertible
loan. As of December 31, 2005, we had negative working capital of $1.9 million.

We anticipate that we will continue
to incur significant operating expenses in connection with the development and marketing
of our products. We believe that our current assets, together with anticipated cash
generated from operations and available credit lines, will be sufficient to meet our cash
requirements for working capital and capital expenditures for at least twelve months from.
Thereafter, 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 $0.9 million at the end of 2005 compared to $1.2 million recorded at the end
of 2004. Short term restricted deposits increased to $1.8 million at the end of 2005
compared to $0.8 million recorded at the end of 2004. The changes were mainly due to the
growth of our activity and the use of working capital to finance such growth. Some of our
selling agreements require us to provide a performance guarantee for a period of between
six and twelve months. In order to provide such guarantees we are required to deposit
between 25% and 60% of the guarantee amount. During 2005 we had negative cash flow from
operational activity of $0.4 million, the negative cash flow was mainly due to the
increase in our account receivables which was caused by the ramp up in our activity.

Despite the increased level of
operations during 2005, inventories decreased from $4.7 million as of December 31,
2004 to $4.6 million as of December 31, 2005, reflecting our close managerial
controls on inventories. Inventories as a percentage of revenues decreased to 21.9% as of
December 31, 2005, compared with 42.7% as of December 31, 2004.

Positive cash flow from financing
activities of $0.7 million includes repayment to Cornell Capital Partners LLP of their
outstanding Promissory Note of $1.7 million and receiving a bank loan of $2.3 million.

The discussion on the investments by
Mr. Nir Alon and/or Altro and the Plan of Arrangement are both hereby incorporated by
reference to Item 7 Major Shareholders and Related Party Transactions  Plan
of Arrangement and Warrant Offering. The discussions regarding the Standby
Equity Distribution Agreement and promissory note are both hereby incorporated by
reference to Item 10, Additional Information  Material Contracts.
The discussion regarding the Convertible Loan Agreement with Mivtach Shamir is hereby
incorporated by reference to Item 4, Information on the Company  Recent
Developments.

54

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Borrowing

From time to time we use money
received from bank loans from several banks to finance our operating activities. Most of
the loans are linked to the U.S. Dollars and for a period of three to 18 months. The
interest rates of those loans are according to the market rate.

Capital Expenditure

The discussion regarding the
Yuravision, ScanMaster and Panoptes acquisitions 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 and ultrasonic industries as well as enhancing our existing products. We devote
a significant portion of our resources to improving our current systems through
enhancements in the areas of sharpness of resolution, processing speed, sensor accuracy
and illumination. We also continually work to enhance the ease of use and flexibility of
our systems software and to develop product add-ons to augment our systems currently
in use by customers. These product add-ons are being designed to further integrate our
systems into each phase of our customers manufacturing process.

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

EVSs prepress inspection
product is based on the proprietary technology of AOI Technology which the Company has
developed over the past two years, and is enhanced with features developed at the request
of the manufacturer to meet the needs of the prepress industry.

For our developments in the Prepress
Inspection Industry Division we have devised a visual inspection system for the inspection
of the prepress cylinder. The system is already operating, and was developed as an
Original Equipment Manufacturing, or OEM, product with one of worlds top
prepress system manufacturers.

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

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As of May 2006, our research and
development staff consisted of 37 full-time employees, all of whom are located in Israel
and hold advanced technical degrees. Our research and development staff engages in
hardware, electro-optics and ultrasonic development, real-time software development, PC
software development, manufacturing engineering, system engineering and customer support
engineering. Our research and development staff for the web industry consisted of 18 full
time employees, and our research and development staff for the ultrasonic industry
consisted 19 full time employees. In 2003 our gross research and development expenditures
for the web industry were approximately $1.1 million, in 2004 they were $1.9 million and
in 2005 they were $2.3 million. These expenditures were partially offset by grants by the
OCS of the Ministry of Industry, Trade and Labor of the Government of Israel of
approximately $396,000, $45,000 and $154,000 in each of 2003, 2004, and 2005,
respectively.

# 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.

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)                              | 2005 | 2004 | 2003
|------------------------------------------- | ---- | ---- | ----
|
|
|
|
|Research and development expenses, net      |      |      | $   
|OCS grants                                  |      |      | $   
|Gross research and development expenditures |      |      | $   

# D. Trend Information

Trends and changes in the world
textile industry are having an influence on our markets, customers and sales. World
textile production has transferred to the Far East due to low labor costs. The Far East
market is increasing with large investments in textile machinery (especially in China).
The investments are currently in productive equipment for increasing the production volume
and achieving the demands of Western markets and not in automatic inspection technology.
Our traditional markets in Western Europe and the United States are becoming smaller, with
less willingness for capital expenditures. Unless textile manufacturers in the Far East
begin investing in automatic inspection technology, the growth in our sales revenue may
not keep pace with the growth in the Far East market.

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We anticipate that our NDT business
will provide the majority of our revenues in the short term. While ScanMasters
traditional markets have been in the US and Europe, we expect that in the near future over
60% of its sales will be made in the Far East.

In line with recent developments in
the field of non-destructive inspection systems, it is expected that the demand for
attractively-priced inspection equipment will accelerate in the coming years, as
industrial concerns regarding product reliability and liability take on an increasing
commercial relevance.

# E. Off-Balance Sheet
Arrangements.

The Standby Equity
Distribution Agreement

On
March 30, 2004, we entered into the Standby Equity Distribution Agreement with Cornell.
Upon execution of the Standby Equity Distribution Agreement, we issued Cornell with
148,438 of our ordinary shares. Pursuant to this agreement we will be entitled to issue
Cornell with advance notices requiring it to purchase, six days following each advance
notice, a number of our ordinary shares with a value of up to $300,000 per advance put
notice and up to an aggregate value of $10 million over two years. The price per share
payable by Cornell will be determined by the minimum volume weighted average price of our
ordinary shares during the five day period following our advance notice to Cornell to
purchase our ordinary shares. Cornell will deduct 5% from the price payable for our
ordinary shares as a fee for this service. In addition to the 148,438 ordinary shares, we
also transferred Cornell, out of the 5,555,555 ordinary shares held in escrow pursuant to
the promissory note, a further 869,947 ordinary shares, for which we received proceeds in
the amount of $433,000 which we used to repay part of the promissory note . In a
registration statement which became effective in July 2004 we estimated issuing Cornell an
aggregate of 5,555,555 of our ordinary shares representing the maximum number of our
ordinary shares that we anticipate issuing to Cornell pursuant to the Standby Equity
Distribution Agreement (excluding the 148,438 ordinary shares already issued to Cornell as
a commitment fee). We may issue all, part or a greater number of our ordinary shares to
Cornell, depending on the minimum volume weighted average price of our ordinary shares
over the five day period following each advance notice. We will also issue Cornell a
number of our ordinary shares with a value of $150,000, upon the first to occur of (i) our
receipt of an aggregate of $5,000,000 pursuant to the equity line and (ii) the first
advance notice to be made following the first anniversary of the Standby Equity
Distribution Agreement. The number of our ordinary shares which we will issue to Cornell
in this event will be based on the closing price of our ordinary shares on the public
market on the date on which Cornell purchases our shares under (i) or (ii), whichever is
applicable. Pursuant to the Standby Equity Distribution Agreement, Cornell will never be
entitled to hold more than 9.9% of our outstanding share capital, and consequently,
Cornell has agreed that in the event that a future purchase pursuant to an advance notice
to Cornell would take it above this threshold percentage, it will sell, prior to the
purchase, as many of our ordinary shares as is required to ensure that at the time of the
purchase of our ordinary shares, its holdings in our company remain below the threshold
percentage. At our recent share price of $0.4, we would need to issue to Cornell 1,500,000
of our ordinary shares in order to draw down the remaining $600,000 available to us under
the Standby Equity Distribution Agreement, which expires July 1, 2006, and which would
represent approximately 2% of our outstanding ordinary shares upon issuance (assuming the
exercise of all of our currently convertible securities into our ordinary shares).
However, our ability to cause Cornell to advance funds under the Standard Equity
Distribution Agreement is not subject to any minimum volume weighted average price of our
ordinary shares. The lower the price of our ordinary shares on the market at the time of
an advance, the more shares will be issued to Cornell and the greater dilution will be
caused to the interests of our shareholders.

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As part of the transaction with
Cornell we also retained the services of Newbridge Securities Corporation, or Newbridge, a
registered, unaffiliated broker-dealer as a placement agent and to advise us in connection
with the Standby Equity Distribution Agreement. For its services, Newbridge received a fee
of $10,000 paid in 7,812 of our ordinary shares. Newbridge intends to sell up to 7,812 of
our ordinary shares issued to it as a placement fee. For further information, see Item
3, Key Information  Risk Factors  Risk Factors Relating to our Ordinary
Shares and Item 10, Additional Information  Material Contracts.

# F. Tabular Disclosure of
Contractual Obligations

Our significant financial and
contractual obligations as of December 31, 2005, and the periods in which such
obligations are due are as follows:

|                                     | Payments and Amount of Commitment Expiration Per Period
|------------------------------------ | -------------------------------------------------------
|
|
|
|
|Operating Car Lease Obligations      |                                                        
|Operating Building Lease Obligations |                                                        
|Total commercial commitments         |                                                        

G.
          Safe Harbor. Not applicable

|ITEM 6. | DIRECTORS,
SENIOR MANAGEMENT AND EMPLOYEES
|------- | ------------------------------------------

# A. Directors and Senior
Management

As of May 31, 2006, our directors,
senior managers and key employees were as follows:

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|Name              | Age | Position                                              
|----------------- | --- | ------------------------------------------------------
|
|
|
|
|David Gal         | 50  | Chairman of the Board                                 
|Menashe Shohat    | 47  | Chief Executive Officer and Director                  
|Yaky Yanay*       | 35  | Vice president, Chief Financial Officer and Secretary 
|Benjamin Mano*    | 60  | Vice President of Sales & Marketing                   
|Hillel Avni       | 67  | Vice President of Electronic Inspection Division      
|Silviu Rabinovich | 61  | VP UT Sales and Marketing and Chief Technology Officer
|Jossef Barath     | 55  | Director                                              
|Yuval Berman*     | 38  | External Director                                     
|Zahi Dekel*       | 43  | External Director                                     
|Nir Alon          | 43  | Director                                              
|Linda Harnevo*    |     | Director                                              
|Michel Habib      | 39  | Director                                              

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

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

Menashe Shohatwas appointed our chief executive officer on December 27, 2004, following the
successful completion of the acquisition of ScanMaster. Mr. Shohat has spent over ten
years with ScanMaster, serving first as ScanMasters chief operating officer and as
ScanMasters chief executive officer from 2002 to 2004. Mr. Shohat holds a B.A. in
business administration from the Ruppin Academic Center.

Yaky Yanayhas
served as our chief financial officer since July 2002. From 1999 until 2002, Mr. Yanay
worked as a manager at Ernst &Young Israel. From 1993, he served at the Israeli
Ministry of Foreign affairs. Mr. Yanay holds a B.A. in business administration and
accounting from the College of Management and he is a Certified Public Accountant in
Israel.

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

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Benjamin Mano
served as the chief executive officer of Panoptes between the years 2000 and 2005 and
between the years 1995 and 2000 served as the VP of operations and VP of sales and
marketing for the Rest of the World of EVS. Mr. Mano served as VP of operations for seven
years of Fibronics International Inc. Between the years 1983 and 1988 Mr. Mano served in
Japan as Sitex Japans desk manager, establishing the joint venture company together
with Toyo Inc. Between the years 1973 and 1983 Mr. Mano worked for us in various
capacities. Mr. Mani holds a B.Sc. in electrical engineering from the Technion.

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

Jossef (Yossi)
Barathis one of our founders and has been a director since our inception.
He was president and chief executive officer from inception until May 1998. Mr. Barath is
a member of the board of directors of SADOT Research & Development Fund Ltd. (TASE).
From 1987 to 1990, Mr. Barath served as director of marketing and business
development at Inframetrics, Inc., a subsidiary of Elbit. From 1984 to 1987, he
served as head of marketing of Elbits Ground Systems Division. From 1982 to 1983,
Mr. Barath was the managing director of Elbit Data System Ltd., a British subsidiary
of Elbit. Previously, Mr. Barath served as a research and development officer in the
communications and technology division of the Israeli Defense Forces, or IDF.
Mr. Barath has a B.Sc. in electrical engineering from the Technion and is a graduate
of the Executive Business Program at the Sloan School of Business at Massachusetts
Institute of Technology.

Yuval Berman is
a Co-Founder and Managing Director of the business consulting firm Genesis-UVB. From
1997-2002 Mr. Berman was responsible for business development and investments at The Omega
Group, a publicly traded investment group. Preceding this, Mr. Berman worked for a year in
business development at the Israel Electric Corporation and practiced corporate law for
four years. Mr. Berman received an M.B.A. with Honors from the Universite Libre De
Bruxelles in Belgium. Mr. Berman holds a B.A. in economics and an L.L.B. in law, both from
Tel Aviv University. He is a member of the Israeli Bar.

Zahi Dekel
worked at Bank Hapoalim Ltd. from 1995-2003, where he held several posts, including most
recently the manager of the Migdal Haemek branch. From 1987 Mr. Dekel was the
principal of the Naaleh boarding school for children who had emigrated from the
former Soviet Union to Israel, without their parents. Mr. Dekel currently serves on the
regional council of Yoqneam. Mr. Dekel holds a B.A. in business administration and
economics, and an M.A. in education and international relations, both from the Hebrew
University of Jerusalem.

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

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

Michel Habib was
elected director by our board of directors on March 27, 2005. Michel Habib has served as
Elrons business development manager since 2003. Prior to Elron, he founded Matar
Capital Advisors, a financial advisory firm. In 2001 Mr. Habib established and managed the
investment banking activity of ING Barings in Israel. Mr. Habib is a former partner of MBI
Partners investment bank, and served as vice president of investment banking at Cukierman
& Co. Investment House. During the 90s Mr. Habib was a diplomat in Israels
foreign service, where he served as economic consul in Boston, and earlier as the first
commercial attache in Korea. As Captain (Res.) in the IDF Navy, Mr. Habib was involved in
the development of advanced Naval systems for the Navys elite unit. Mr. Habib holds
an aeronautical engineering degree from the Technion.

Board of Directors

Our directors, who are not external
directors, commence their term when they are elected at the annual general meeting of our
shareholders until the following annual general meeting. Messrs. Zahi Dekel and Yuval
Bermanare our external directors who were elected to serve for terms of three
years commencing March and August 2004, respectively.In March 2006 Mr. David Gal
replaced Mr. Nir Alon as chairman of the board. In April 2006, Ms. Linda Harnevo replaced
Ms. Naomi Livni as director. Additionally, in March 2006, Mr. Shlomo Alon and Mr. Silviu
Rabinovich resigned as directors.

# B. Compensation

During 2005, we paid to all our
directors and officers a total of $82 thousands in salaries, fees and bonuses. This does
not include money spent on automobiles made available to our officers, expenses (including
business travel, professional and business association dues and expenses) reimbursed to
officers and other fringe benefits commonly reimbursed or paid by companies in Israel. Our
director Mr. Michel Habib received no compensation in 2005. In March 2004, our
shareholders agreed to pay Mr. Nir Alon, then acting as chairman of the board, a monthly
compensation of $3,000 in consideration for his services as the chairman of our board of
directors, payable retroactively from July 1, 2003. In November 2005 our shareholders
agreed to increase this monthly compensation to $4,000, payable retroactively from May 29,
2005, until February 2006, when Mr. Alon ceased to serve as chairman of our board. In 2005
we paid approximately $6,500 in aggregate to Mr. Barath and approximately $12,000 in
aggregate to Mrs. Livne.

We paid an aggregate of $36,000 to
our serving external directors in 2005.

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On
February 21, 2006, our shareholders approved the payment to David Gal of a monthly
compensation of $13,500 plus Value Added Tax in consideration for his services as the
chairman of our board of directors. Additionally, it was approved to lease an automobile
for his use, and supply him with certain other office related equipment necessary to
provide us with his services. Finally, it was also approved to grant Mr. Gal options to
purchase up to 600,000 of our Ordinary Shares at an exercise price of $0.50 per share. One
third of the options shall vest on December 31, 2006 and thereafter 2.8% of the total
shares subject to the option shall vest on a monthly basis. The vesting of the options
will be subject to Mr. Gal serving as the chairman of our board of directors on the
relevant vesting date. Mr. Gal shall be entitled to exercise the options on the date such
options have vested and up to 5 years thereafter.

Pension and Retirement
Benefits

We offered no pension or retirement
benefits to our directors and key personnel in 2005.

# C. Board of Directors

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

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

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

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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 recently determined in regulations
promulgated by the Israeli Minister of Justice in consultation with the Israeli Securities
Authority. These regulations do not appear to relate to external directors currently
serving. The regulations mandate that a person is deemed to have expertise in
finance and accounting if his or her education, experience and qualifications
provide him or her with expertise and understanding in business matters  accounting
and financial statements, in a way that allows him or her to understand, in depth, the
companys financial statements and to encourage discussion about the manner in which
the financial data is presented.

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

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

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

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

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

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

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

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

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

Currently, Messrs. Dekel and Berman
serve as our external directors.

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

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Our two external directors Messrs.
Dekel and Berman serve on the audit committee of the board of directors.

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

# D. Employees

# 2005

As of May, 31, 2006 we employed a
total of 133 full time persons in both of our divisions, as follows:

# NonDestructive
Automated Inspection Systems Division

As of May 31, 2006, we employed 67
full-time persons, out of which 62 were employed in Israel of whom 20 were in research and
development, 8 were in marketing and sales, 8 were in customer support, 27 were in
operations and 4 were in administration and management.

# AOI Division

As of May 31, 2006, we employed 67
full-time persons, out of which 41 were employed in Israel of whom 18 were in research and
development, 2 were in marketing and sales, 6 were in customer support, 12 were in
operations and 6 were in administration and management. 14 of our employees were employed
in Korea, of whom 8 were in research and development, 2 were in marketing and sales, 1 was
in customer support and 3 were in administration and management.

# 2004

As of December 31, 2004 we employed a
total of 140 full time persons in the three divisions existing at the time, as follows:

# NonDestructive Automated
Inspection Systems Division

As of December, 31, 2004, we employed
63 full-time persons, out of which 56 were employed in Israel of whom 14 were in research
and development, 9 were in marketing and sales, 7 were in customer support, 28 were in
operations and 5 were in administration and management.

# Web Inspection Industry
Division

As of December, 31, 2004, we employed
60 full-time persons, out of which 48 were employed in Israel of whom 19 were in research
and development, 7 were in marketing and sales, 11 were in customer support, 13 were in
operations and 10 were in administration and management.

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Microelectronics
Division (which was merged into our AOI Division)

As of December, 31, 2004, we employed
17 full-time persons. All 17 were employed in Korea, of whom 10 were in research and
development, 3 were in marketing and sales, 1 was in customer support and 3 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%.

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, Messrs. Nir Alon and
Menashe Shohat beneficially own shares and options exceeding 1% of our outstanding
ordinary shares since Mr. Nir Alon is the controlling shareholder of Altro, our majority
shareholder, and Mr. Shohat serves as our CEO. Mr. Shlomo Alon, Nir Alons father,
who served as a member of our board of directors until March 2, 2006, beneficially owns
shares and options exceeding 1% of our outstanding ordinary shares. Elbit owns 2,647,643
of our ordinary shares (and together with Water Technologies Ltd., a fully owned
subsidiary Elbit, holds warrants to purchase 1,512,939 of our ordinary shares pursuant to
the Warrant Distribution) and is currently represented by Mr. Michel Habib on our board of
directors.

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Employee Share Option
Plans

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

In February 1996, the board of
directors adopted a share option plan, or the 1996 Share Option Plan, pursuant
to which 565,720 ordinary shares were reserved for issuance upon the exercise of options
to be granted to our directors, officers, employees, and consultants. As of May 31, 2006,
options to purchase 132,500 of such ordinary shares were outstanding and options to
purchase 377,470 ordinary shares were available for future grants. Of the outstanding
options, options to purchase 28,000, 102,500 and 2,000 ordinary shares are fully vested
and are exercisable at an exercise price of $3.00, $1.68 and $0.2 per share, respectively.
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.

In April 2000, our board of directors
adopted a share option plan pursuant to which 4,500,000 ordinary shares were reserved for
issuance upon the exercise of options to be granted to our directors, officers, employees
and consultants. As of May 31, 2006, options to purchase 1,302,536 of such ordinary shares
were outstanding and options to purchase 2,655,582 ordinary shares were available for
future grants. 523,639 of the outstanding options have an exercise price of $1.169 per
share. All of the options referred to above vested equally on the anniversary of May 24
from 2001 until 2004 inclusive, assuming continuous employment with us through such
period.272,750 of the outstanding options have an exercise price of $0.36 per
share. 295,100 of the outstanding options have an exercise price of $0.48 per share 20,852
of the outstanding options have an exercise price of $0.15 per share and an additional
166,027 an exercise price of $1 per share and vest monthly over three years through August
2005. All of the outstanding options terminate ten years following the date of grant if
not exercised earlier. The 2000 Share Option Plan is administered by a committee of the
board of directors, which designates the optionees and dates of grant. The option exercise
price is determined by our board of directors. All recent grants have been made at an
exercise price equal to or above the fair market value of our shares. The options are
non-assignable except by the laws of descent. The last date on which the options may be
granted is April 2010. The remaining options will be exercisable for a period up to
ten years from the date of grant and will generally vest as to 25-33% commencing the
beginning of the second year after the grant and as to an additional 25-33% in each of the
remaining years thereafter, assuming continuous employment with us through such periods.

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In November 2003, the board of
directors adopted a share option plan pursuant to which 2,000,000 ordinary shares were
reserved for issuance upon the exercise of options to be granted to our directors,
officers, employees and consultants. The number of ordinary shares issuable under the
share option plan is annually increased by 1,500,000 ordinary shares. As of May 31, 2006,
options to purchase 2,962,900 of such ordinary shares were outstanding and options to
purchase 3,416,330 ordinary shares were available for future grants. 757,500 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. 20,000 of the outstanding options have an exercise
price of $0.83 per share. 502,000 of the outstanding options have an exercise price of
$0.8 per share. 595,000 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 and an additional 129,703 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. The 2003 Share Option Plan is
administered by a committee of the board of directors, which designates the optionees and
dates of grant. The option exercise price is determined by our board of directors. All
recent grants, except for the grant to our chairman, Mr. David Gal, have been made at an
exercise price equal to or above the fair market value of our shares. The options are
non-assignable except by the laws of descent. The last date on which the options may be
granted is November 2013. The remaining options will be exercisable for a period up
to ten years from the date of grant and will generally vest as to 25-33% commencing the
beginning of the second year after the grant and as to an additional 25-33% in each of the
remaining years thereafter, assuming continuous employment with us through such periods.

In March 2006, the board of directors
adopted a share option plan pursuant to which 2,000,000 ordinary shares were reserved for
issuance upon the exercise of options to be granted to our directors, officers, employees
and consultants. The number of ordinary shares issuable under the share option plan may be
increased by the board of directors from time to time. As of May 31, 2006, options to
purchase 657,500 of such ordinary shares were outstanding and options to purchase
1,342,500 ordinary shares were available for future grants. The outstanding options have
an exercise price of $0.78 per share. 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.

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|ITEM 7. | MAJOR
SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
|------- | -------------------------------------------------

# A. Major Shareholders

The following table and notes set
forth information, as of June 15, 2006, concerning the beneficial ownership (as defined in
Rule 13d-3 under the Securities Exchange Act of 1934) of ordinary shares by (i) any person
who is known to own at least 5% of our outstanding 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 Class
|------------------------------------------ | ------------------------- | ----------------
|
|
|
|
|Altro Warenhandels GmbH (1)(2)(3)(4)(5)(6) |                           |                 
|Nir Alon Holdings GmbH(3)(6)               |                           |                 
|Elbit Ltd.(3)(7)                           |                           |                 
|Advanced Technology Center                 |                           |                 
|P.O. Box 539                               |                           |                 
|Haifa, Israel                              |                           |                 
|ScanMaster Former Shareholders (3)         |                           |                 
|M.S.N.D. Real Estate Holdings Ltd.(3)      |                           |                 
|All directors and officers as a group (8)  |                           |                 

The percentages in this table are
based on 30,858,785 of ordinary shares currently issued and outstanding and options
exercisable within 60 days.

|(1) | 3,500,000
of these shares are pledged to Bank Leumi B.M., in order to guarantee                a
credit line for Altro in the sum of $1,500,000.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | On
August 16, 2002, Mr. Nir Alon, one of our directors, transferred all of his
               shares in our company to Altro, an Austrian company, controlled by Mr. Nir
Alon                and a company controlled by members of the Alon family.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | See
description of two shareholder agreements (the Interim Agreement and the New
               Shareholders Agreement) in Item 7 Major Shareholders and Related
Party                Transactions Voting and Right of First Refusal
               Agreements.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Includes:
(a) 75,000 ordinary shares which are subject to an option to purchase
               shares granted by Mr. Alon to Mr. Barath on March 29, 2001; The price of
the                options is $1.00 per share.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | In
2004, Altro assigned its rights and obligations under the Plan of Arrangement
               to Nir Alon Holding GmbH, a company controlled by Nir Alon. Nir Alon
Holdings                GmbH completed payment of all the installments and was issued
with 2,000,000 of                our ordinary shares, which amounts to approximately 7.5%
of our share capital.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Since
Mr. Nir Alon controls Altro, Mr. Nir Alon may be deemed the beneficial
               owner of all of the shares held by Altro and Nir Alon Holdings GmbH.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Pursuant
to the completion of a merger between Elbit and Elron Electronic
               Industries Ltd. (NASDAQ: ELRN) on May 15, 2002, Elbits shares ceased
               trading on NASDAQ and the TASE at the end of trading on May 15, 2002.
Following                the merger, Elbit became a wholly owned subsidiary of Elron. IDB
Holding                Corporation Ltd., or IDB, is an Israeli company publicly traded on
the TASE                which through holdings in its subsidiaries may be deemed to be
the beneficial                owner of our ordinary shares held by Elron. IDB through
other of its                subsidiaries may be deemed to be the beneficial owner of a
further 190,586 of                our ordinary shares.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) | Includes
all of the shares deemed as beneficially owned by Mr. Nir Alon and                options
currently exercisable by directors and officers within 60 days.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

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As of May 31, 2006, there were a
total of 58 holders of record of our ordinary shares, of which 19 were registered in the
United States. Such United States shareholders were, as of such date, the holders of
record of approximately 28.3% of our outstanding ordinary shares.

# Voting and Right of
First Refusal Agreements

In 1993, Elbit and certain of our key
executive officers entered into a formation agreement, which was amended in February 1996
and August 1998, and which provided for our formation. Pursuant to the Formation
Agreement, Elbit and Messrs. Yossi Barath and Hillel Avni have agreed to vote the ordinary
shares held by them at all shareholders meetings at which directors are elected for the
appointment of either Mr. Barath or Mr. Avni to our board of directors. The term of this
voting agreement was for the three years after the date of our initial public offering in
July 1996 but it is automatically extended for one-year periods until terminated by either
party with at least six months notice prior to the end of the year-long period. On
December 29, 2005, Elbit provided Mr. Barath and Mr. Avni notice of termination of this
agreement, thus this obligation will expire on June, 29, 2006. In addition, pursuant to
the Formation Agreement, Messrs. Barath and Avni have granted each other mutual rights of
first refusal with respect to the private sale of ordinary shares. These rights of first
refusal do not apply to sales effected through the facilities of the NASDAQ Market System
or other stock exchange or automatic quotation system.

In an agreement signed among Elbit,
M.S. Master Investments (2002) Ltd., or MS, Nir Alon Holding GmbH, Altro Warenhandels
GMBH, or Altro, and Nir Alon, or the Interim Agreement, the parties agreed to vote their
shares, at meetings of our shareholders at which members of the board are to be elected,
as follows: (a) elect to our board two directors nominated by Nir Alon, for as long as
Alon holds at least 1,338,111 of our Ordinary Shares; (b) elect to our board one director
nominated by Elbit, for as long it holds at least 1,338,111 of our Ordinary Shares; (c)
elect to our board one director nominated by MS, for as long it holds at least 1,338,111
of our Ordinary Shares, or has a proxy to vote the 1,080,944 Ordinary Shares of the
Company held by S.R. Master Investment (2002) Ltd., 700,540 Ordinary Shares of the Company
held by R.D. Master Investment (2002) Ltd. and 182,405 shares of the Company held by Avner
Shacham, or the Remaining Shares; and (d) elect to our board one director, who shall also
serve as chairman of the board, who is mutually agreed upon by the parties to such
agreement. In the event Mr. David Gal is not or is no longer elected as chairman of our
board, then the parties to the Interim Agreement agreed to vote their shares, at meetings
of our shareholders at which members of the board are to be elected, as follows: (a) elect
to our board two directors nominated by Alon, one of which shall serve as chairman of our
board, for as long as Alon holds at least 1,338,111 of our Ordinary Shares; (b) elect to
our board one director nominated by Elbit, for as long it holds at least 1,338,111 of our
Ordinary Shares; (c) elect to our board one director nominated by MS, for as long it holds
at least 1,338,111 of our Ordinary Shares or has a proxy to vote the Remaining Shares; and
(d) elect to our board one director who is nominated by a majority of our board. In
addition, Elbit and Nir Alon Holding GmbH agreed to vote their shares so as to elect Yossi
Barath as a member of the board for as long as he is entitled to be appointed director
pursuant to our 1993 Formation Agreement. The Interim Agreement will be terminated
immediately upon the New Shareholders Agreement (as defined below) going into effect.

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In addition, Nir Alon, Nir Alon
Holdings GmbH, Elbit, MS and Mivtach signed a new shareholders agreement, the New
Agreement, which will go into effect immediately upon the written notification by Mivtach
to the other parties prior to February 21, 2008, or the Conversion Period, that the New
Agreement is effective. Under the New Agreement, the parties agreed to vote their shares
following the conversion of Mivtachs and written notification by Mivtach, within the
Conversion Period, to the other parties that the New Agreement is effective, at meetings
of our shareholders at which members of the board are to be elected, as follows: (a) elect
to our board two directors nominated by Mivtach, one of which shall serve as chairman of
our board, (b) elect to our board one director nominated by Nir Alon, (c) elect to our
board one director nominated by Elbit, and (d) elect to our board one director nominated
by MS; provided that the party entitled to nominate a director continues to hold 7.5% of
our share capital on a fully diluted basis or in the case of MS, has a proxy to vote the
Remaining Shares, or the 7.5% Threshold. A reduction of a shareholders holdings
shall only be deemed to occur upon a sale by a shareholder (or for the purposes of MS, a
sale of the Remaining Shares) of our Ordinary Shares. If a shareholder fails to meet the
7.5% Threshold it shall lose the right to nominate a director and such right shall be
granted to the shareholder who at such time holds the highest number of our Ordinary
Shares. Additionally, the parties to the New Agreement agreed to vote their shares at
meetings of our shareholders at which members of the board are to be elected, if there is
no Conversion and Mivtach has notified the other parties of the effectiveness of the New
Agreement within the Conversion Period, as follows: (a) elect to our board two directors
nominated by Nir Alon, one of which shall serve as chairman of our board, (b) elect to our
board one director nominated by Mivtach, (c) elect to our board one director nominated by
Elbit, and (d) elect to our board one director nominated by MS; provided that the party
entitled to nominate a director continues to hold 5% of our share capital on a fully
diluted basis or in the case of MS, has a proxy to vote the Remaining Shares, or the 5%
Threshold. A reduction of a shareholders holdings shall only be deemed to occur upon
a sale by a shareholder (or in the case of MS, a sale of the Remaining Shares) of our
Ordinary Shares. If a shareholder fails to meet the 5% Threshold it shall lose the right
to nominate a director and such right shall be granted to the shareholder who at such time
holds the largest number of our Ordinary Shares. Notwithstanding the foregoing, if prior
to May 14, 2008, Elbit holds less than the 7.5% Threshold or the 5% Threshold, as
applicable, other than if any reductions in Elbits holdings are as a result of sales
of our shares by Elbit, Elbit shall maintain its right to designate one member of the
board, until May 14, 2008.

# B. Related Party
Transactions

We have entered into a number of
material agreements with Nir Alon and Altro.

On February 7, 2001, Mr. Nir Alon,
CEO of Altro, purchased 1,500,000 of our ordinary shares for $1.5 million, constituting
the first tranche of an investment for the purchase of 3 million of our ordinary shares
for $3 million. Concurrently with that investment, Mr. Alon purchased 2 million shares
from our former major shareholder Elbit, for a purchase price of $2 million, which was the
first tranche of his investment for the purchase of 3.5 million of our shares from Elbit.
Mr. Alons commitment to make his second investment in our company and to purchase
the second tranche of shares from Elbit was subject to the fulfillment of certain
conditions, which were not satisfied. Nevertheless, in March 2002, Altro agreed to
complete the second investment in our company (although no similar commitment was made to
purchase the additional shares from Elbit). In August 2002, Mr. Alon transferred all 3.5
million of his shares in our company to Altro, which became our major shareholder.

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Pursuant to an amendment to a Share
Purchase Agreement with us, dated March 18, 2002, we agreed to permit Altro to complete
Mr. Alons commitment to the second stage of the investment for the purchase of the
remaining 1,500,000 ordinary shares from us, which was to be paid in nine monthly
installments commencing March 31, 2002. In May 2002, our audit committee and board of
directors agreed to delay the first four installments, until no later than June 30, 2002
when these installments were to be paid together including payment of interest for such
delayed payments. This investment was not completed, but was replaced by the Plan of
Arrangement. Additionally, in March 2002 we entered into an additional share purchase
agreement with Altro, which was subject to the receipt of shareholder approval, in which
Altro agreed to purchase an additional 1,500,000 of our ordinary shares in March 2004 at a
price per share to be determined upon our fulfillment of certain financial milestones.
This agreement was never approved by our shareholders and was replaced by the Plan of
Arrangement. The discussion regarding the Plan of Arrangement is incorporated herein by
reference to Item 7, Related Party Transactions  Plan of Arrangement and
Warrant Distribution.

Additionally, on February 21, 2006 we
signed a management service agreement with the chairman of our board of directors, David
Gal. Under the terms of the agreement, which is between us and a company controlled by Mr.
Gal, we are to pay a monthly fee of $13,500 plus Value Added Tax, lease an automobile for
the use of Mr. Gal, and supply him with certain other office related equipment necessary
to provide us with his services. The agreement concerning Mr. Gals services may be
terminated by either party upon providing 3 months prior written notice. If terminated, we
shall pay all remuneration for such 3 month notice period. Additionally, we have granted
Mr. Gal, subject to shareholder approval, options to purchase up to 600,000 of our
Ordinary Shares at an exercise price of $0.50 per share. One third of the options shall
vest on December 31, 2006 and thereafter 2.8% of the total shares subject to the option
shall vest on a monthly basis. The vesting of the options will be subject to Mr. Gal
serving as the Chairman of our board of directors on the relevant vesting date. Mr. Gal
shall be entitled to exercise the options on the date such options have vested and up to 5
years thereafter.

Plan of Arrangement and
Warrant Distribution

Our audit committee and board of
directors approved the Plan of Arrangement with Altro that was approved by a special
majority of out shareholders in October 2003, and subsequently by the Haifa District Court
in November 2003, whereby Altros prior commitments to invest were cancelled subject
to Altros fulfillment of new investment terms and a warrant distribution to our
shareholders. According to the Plan of Arrangement, Altro was required to invest $700,000
in EVS for the purchase of 2 million of our ordinary shares, payable in up to five
quarterly installments. Altro assigned its rights and obligations under the Plan of
Arrangement to Nir Alon Holding GmbH, a company wholly owned by Nir Alon. Nir Alon
Holdings GmbH completed payment of all the installments and was issued with 2,000,000 of
our ordinary shares, which amounts to approximately 7.5% of our share capital.

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Pursuant to the Plan of Arrangement,
on May 14, 2004, or the Record Date, we distributed to most of our shareholders warrants
to purchase 4,183,950 of our ordinary shares on a pro rata basis (or the Warrant
Distribution). Each warrant is exercisable at a price of $0.35 per share and exercisable
for four years from the date of registration thereof. The warrants were distributed to all
persons who are the registered holders of our ordinary shares on the Record Date (Record
Holders), with the exception of certain shareholders. The shareholders which agreed to be
excluded from the Warrant Distribution are as follows: Altro, our controlling shareholder,
Cornell, Newbridge and those investors which participated in our December 2003 and January
2004 Private Placement Investments (other than Meitav Capital (2002) Ltd., with respect to
241,714 of our ordinary shares which it holds having exercised, prior to the Record Date,
a warrant that it received for its financial services in connection with such
investments). As of June 15, 2006, of the warrants distributed under the Plan of
Arrangement, 412,308 warrants have been exercised.

As of June 15, 2005, through the
companies he controls, Nir Alon owned 19.2% of our outstanding ordinary shares and Elbit
owned 9.3% of our outstanding ordinary shares. However, in the event that all the
warrants distributed to our shareholders are exercised pursuant to the Plan of
Arrangement, Altro and Nir Alon will beneficially hold 17% of our outstanding ordinary
shares.

Relationships with Elbit

We maintain a number of material
relationships with Elbit.

Formation.
          We commenced independent commercial operations on January 1, 1994, pursuant
          to the Formation Agreement. Prior to such date, we operated as a division of
          Elbit. Pursuant to the Formation Agreement, Elbit retained approximately 78.1%
          of the then outstanding ordinary shares and certain key employees. In addition,
          one of our consultants was issued a number of shares in the aggregate equal to
          approximately 21.9% of the then outstanding ordinary shares pursuant to the 1993
          Share Purchase Plan.

Technology License. Until July
2001, Elbit granted us an exclusive license to exploit Elbits vision interpretation
technology for applications in the textile, food and automotive industries and a
non-exclusive license to exploit applications in other industries, except for military
applications, which remained exclusive to Elbit or its assignee or Elbit Technology. The
license agreement with Elbit was terminated in May 2002, with effect from June 30, 2001,
such that certain technology is now licensed to us by Dr. Ilan Tamches. Elbit will
continue to indemnify us from all claims, demands, or actions alleging that the Elbit
Technology infringes a third party right in a validly issued patent, copyright or trade
secret and any losses, expenses and damages resulting directly there from.

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Royalty Payments. Until June
30, 2001, Elbit had an obligation to pay royalties to Dr. Ilan Tamches, the Chief
Scientist of Elbit and the original developer of certain elements of the Elbit Technology.
Through June 30, 1996, these royalties were paid directly by Elbit and were reflected as
royalty expenses in our financial statements. We agreed to pay Elbit all amounts payable
pursuant to Elbits obligations to Dr. Tamches, which relate to our use of the
Elbit Technology. Upon the closing of our initial public offering, we issued 94,624
ordinary shares for nominal consideration to Dr. Tamches in connection with his
agreement to reduce the royalty rate payable to him. Elbit agreed that it will not take
any action that reduces the proportion of Dr. Tamches share holdings in us, other
than the issuance of shares to the public, to a strategic partner or for capital raising
transactions. We believe that this agreement does not prohibit us from consummating a
merger or an acquisition of a business, product or technology or issuing shares to
employees or directors other than Messrs. Barath and Avni pursuant to the 1996 Share
Option Plan and the 2000 Share Option Plan. However, in the event that we issue employee
share options to Mr. Avni, we will issue a number of options to Dr. Tamches such that
issuances to Mr. Avni will not dilute Dr. Tamches holdings in EVS. From the
date of our initial public offering through June 30, 2001, the royalties that we paid for
the Elbit Technology were not less than $300,000 and not more than $500,000 per year based
on the annual amount of cash receipts from sales of products in the textile, food and
automotive industries. This royalty rate was payable for five years from the date of the
consummation of our initial public offering (i.e. July 12, 2001) and was subject to
adjustment after such date. We owed Elbit approximately $500,000 for these royalty
payments, of which $395,000 is still outstanding and shall be paid off in installments. In
May 2002, we entered into an agreement with Elbit and Dr. Tamches, whereby the license
agreement was amended such that effective as of July 1, 2002, Elbit transferred the Elbit
Technology to Dr. Tamches and the certain other technology to us. See Item 10,
Additional Information  Material Contracts.

C.
          Interests of Experts and Counsel.Not applicable

|ITEM 8. | FINANCIAL
INFORMATION
|------- | ---------------------

# A. Consolidated
Statements and Other Financial Information

Our consolidated financial statements
and other financial information is incorporated herein by reference to pages F1-F47.

# Export Sales

In 2005, 99.3% of our sales,
amounting to $20,639,000 were exported outside of Israel.

# Litigation

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

Lemelson
Patent Infringement Claim

Between May 2000 and February 2001,
we were informed by three of our customers that they were named as three out of the 76
defendants in a patent infringement claim brought by the Lemelson Medical, Education &
Research Foundation, Limited Partnership in the United States District Court in Arizona.
The Lemelson Foundation alleged that these defendants are using various imaging techniques
that infringe on a patent duly assigned to the Lemelson Foundation.

The customers individually requested
that we indemnify them for any loss suffered as a result of the suit, claiming that we are
contractually obliged to indemnify them. Several of our other customers also named in the
suit have not contacted us.

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In light of Elbits obligation
to indemnify us pursuant to our amended License Agreement with Elbit and Dr. Ilan Tamches,
we notified Elbit of these claims and immediately sought full indemnification from Elbit
for any losses, expenses and damages that we may suffer resulting from these claims. Elbit
has informed us by letter that until such time as we meet all applicable evidentiary,
procedural, contractual and other legal requirements relevant to our claim for
indemnification from them, they make no admission as to matters relating to the lawsuit,
nor do they acknowledge any liability under the License Agreement. We have informed our
customers that because the complaint was not specific as to which activities of the
customers were infringing the claimants rights, we could not agree to indemnify or
defend these customers.

To the extent that we are required to
indemnify our customers in connection with the suit, a failure by Elbit to indemnify us,
would have a material adverse affect on our business, results of operations and financial
conditions, the extent of which cannot be calculated. Since February 2001 we have received
no further correspondence relating to the Lemelson claim.

# 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 2005 is taxable at regular rates of 35%.
See Note 12 to our Consolidated Financial Statements and Item 10, Additional
Information  Taxation.

# B. Significant Changes

Other than the the Cornell Loan, the
Mivtach Shamir Convertible Loan, the Acquisition of Panoptes, and the Loan from Mizrahi ,
all described in Item 10, Additional Information  Material Contractsbelow, no significant changes have occurred since the date of the consolidated
financial statements included in this annual report.

|ITEM 9. | THE
OFFER AND LISTING
|------- | ---------------------

A.
          Offer and Listing Details and C. Markets

# Market and Share Price
History

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

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

|Period                  | High ($) | Low ($)
|----------------------- | -------- | -------
|
|
|
|
|May 2006                |          |        
|April 2006              |          |        
|March 2006              |          |        
|February 2006           |          |        
|January 2006            |          |        
|December 2005           |          |        
|Fourth quarter 2005     |          |        
|Third quarter 2005      |          |        
|Second quarter 2005     |          |        
|First quarter 2005      |          |        
|Fourth quarter 2004     |          |        
|Third quarter 2004      |          |        
|Second quarter 2004     |          |        
|First quarter 2004 (4)  |          |        
|Fourth quarter 2003 (3) |          |        
|Third quarter 2003 (2)  |          |        
|Second quarter 2003 (2) |          |        
|First quarter 2003 (2)  |          |        
|Year ended 2004 (4)     |          |        
|Year ended 2003 (3)     |          |        
|Year ended 2002 (2)     |          |        
|Year ended 2001 (1)     |          |        

(1)
          Traded on the Over-the-Counter Bulletin Board until June 21, 2001, and
          subsequently on the NASDAQ SmallCap Market. 
(2)
          Traded on the NASDAQ SmallCap Market throughout the period. 
(3)
          Traded on the NASDAQ SmallCap Market until November 19, 2003, and subsequently
          on the Over-the-Counter Bulletin Board.
(4)
          Traded on the Over-the-Counter Bulletin Board throughout the period, and
          continues to trade there today.

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B.
          Plan of Distribution. Not applicable

D.
          Selling Shareholders. Not applicable

E.
          Dilution. Not applicable

F.
          Expenses of the Issue. Not applicable

|ITEM 10. | ADDITIONAL
INFORMATION
|-------- | ----------------------

# Memorandum and Articles
of Association

A.
          Share Capital.

Not applicable

# B. Memorandum and
Articles of Association

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

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

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

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

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.

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

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:

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| |  | A
private placement that meets all of the following conditions:
| | - | ---------------------------------------------------------------

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

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

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

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

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

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

| | any
amendment to the articles of association;
|- | ---------------------------------------------

| | an
increase of the company's authorized share capital;
|- | ------------------------------------------------------

| | a
merger; or
|- | ------------

| | approval
of interested party transactions that require shareholder approval.
|- | ----------------------------------------------------------------------------

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

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Provisions Restricting
Change in Control of Our Company

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

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

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 6A. Directors, Senior Management And Employees
           Directors And Senior Management  Approval of Related Party
          Transactions Under Israeli Law.

Nasdaq Marketplace Rules and
Home Country Practices Not applicable.

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# C. Material Contracts

Plan of Arrangement.Discussions of this agreement are incorporated herein by reference to the discussion
under the caption Related Party Transactions  Plan of Arrangement and
Warrant DistributioninItem 7 of this Annual Report.

Amendment to the License
Agreement. In May 2002, we entered into an agreement with our former principal
shareholder, Elbit and Dr. Ilan Tamches, which amended the license agreement existing
between us and Elbit and dated June 12, 1996, whereby the license agreement was amended
such that effective as of July 1, 2002, Elbit transferred the Elbit Technology to Dr.
Tamches and the Elbit Modified Technology to us. As a result of this amendment, Dr.
Tamches has granted us a non-exclusive rights to the Elbit 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 such elements of our technology to any third party, which
competes with I-TEX systems. Pursuant to the amendment we have agreed to pay Dr. Tamches a
biannual royalty equal to the lesser of (i) 0.9375% of all amounts actually received by us
in the immediately preceding six months plus Value Added Tax; or (ii) 1.5% of such part of
the amounts actually received by us generated from the sales of the I-TEX systems in the
immediately preceding six months plus Value Added Tax. Discussions of this agreement are
incorporated herein by reference to Exhibit 4.3 to this annual report.

Private Placement Investments.
Pursuant to a series of private placement transactions with a group of investors, or the
Investors, in December 2003 and January 2004, we issued an aggregate of (i) 5,099,911 of
our ordinary shares for an aggregate purchase price of $3,927,123, (ii) warrants to
purchase 241,800 and 1,118,825 of our ordinary shares with an exercise price of $0.68,
$0.85 per ordinary share, respectively, which are exercisable for two years from December
31, 2003; and (iii) warrants to purchase 100,816 and 382,653 of our ordinary shares with
an exercise price of, $0.98 and $1.4 per ordinary share, respectively and which are
exercisable for two years from January 31, 2004. One of the Investors, Meitav Capital
(2002) Ltd., or Meitav, has exercised 241,714 warrants for a purchase price of $ 190,080
(156,000 warrants exercised at $0.68 and 85,714 warrants exercised at $0.98).

Yuravision Acquisition. In
June 2004, we completed an investment in Yuravision Co. Ltd. and a series of purchase
agreements with certain of its shareholders, increasing our holdings in Yuravision to
approximately 51.2%. We have a legal obligation to purchase an additional 18.8% from
former share holders of Yuravision. Yuravision is a South Korean developer of visual
inspection systems for the microelectronics and display industries. The acquisition of a
controlling stake in Yuravision is intended to facilitate our efforts to penetrate the
Flat Panel Display (FPD) and display technology markets. For more information, see Item
3, Key Information  Risk Factors  Risk Factors Related to Our
Business and Item 4, Information on the Company  History and
Development of the Company.

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Standby
Equity Distribution Agreement. On March 30, 2004, we entered into the Standby Equity
Distribution Agreement with Cornell. Upon execution of the Standby Equity Distribution
Agreement, we issued Cornell with 148,438 of our ordinary shares. Pursuant to this
agreement we are entitled to issue Cornell with advance notices requiring it to purchase,
six days following each advance notice, a number of our ordinary shares with a value of up
to $300,000 per advance put notice and up to an aggregate value of $10,000,000 over two
years. The price per share payable by Cornell will be determined by the minimum volume
weighted average price of our ordinary shares during the five day period following our
advance notice to Cornell to purchase our ordinary shares. Cornell will deduct 5% from the
price payable for our ordinary shares as a fee for this service. In addition to the
148,438 ordinary shares, we also transferred Cornell, out of the 5,555,555 ordinary shares
held in escrow pursuant to the promissory note, a further 869,947 ordinary shares, for
which we received proceeds in the amount of $433,000 which were used to repay part of the
promissory note . We initially registered 5,555,555 of our ordinary shares for future
issuance to Cornell (excluding 148,438 ordinary shares which we issued to Cornell as a
commitment fee), based upon a good faith estimate that this would represent the maximum
number of shares that we would be required to issue pursuant to advances under the Equity
Distribution Agreement.

We
may issue all, part or a greater number of our ordinary shares to Cornell, depending on
the minimum volume weighted average price of our ordinary shares over the five day period
following each advance notice. We will also issue Cornell a number of our ordinary shares
with a value of $150,000, upon the first to occur of (i) our receipt of an aggregate of
$5,000,000 pursuant to the equity line and (ii) the first advance notice to be made
following the first anniversary of the Standby Equity Distribution Agreement. The number
of our ordinary shares which we will issue to Cornell in this event will be based on the
closing price of our ordinary shares on the public market on the date on which Cornell
purchases our shares under (i) or (ii), whichever is applicable. Pursuant to the Standby
Equity Distribution Agreement, Cornell will never be entitled to hold more than 9.9% of
our outstanding share capital, and consequently, Cornell has agreed that in the event that
a future purchase pursuant to an advance notice to Cornell would take it above this
threshold percentage, it will sell, prior to the purchase, as many of our ordinary shares
as is required to ensure that at the time of the purchase of our ordinary shares, its
holdings in our company remain below the threshold percentage.

As
part of the transaction with Cornell we also retained the services of Newbridge Securities
Corporation, or Newbridge, a registered, unaffiliated broker-dealer as a placement agent
and to advise us in connection with the Standby Equity Distribution Agreement. For its
services, Newbridge received a fee of $10,000 paid in 7,812 of our ordinary shares.
Newbridge intends to sell up to 7,812 of our ordinary shares issued to it as a placement
fee.

Repayment
of Promissory Note.On August 26, 2004, we signed a short-term
promissory note with Cornell Capital Partners L.P., or Cornell, whereby Cornell agreed to
advance us the sum of $4,000,000. On February 17, 2006, we repaid all outstanding amounts
owed to Cornell, and have thus fulfilled all of our obligations toward them under the
Promissory Note. Following repayment of the Promissory Note, all ordinary shares and
advance notices held in trust to guarantee the loan were returned to us, and the floating
charge on our assets was removed. On April 17, 2006, we also withdrew a registration
statement on Form F-2 which we filed for the registration of 14, 444,445 of our ordinary
shares to guarantee our obligations towards Cornell under the Promissory Note. The
registration statement had not become effective prior to its withdrawal.

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ScanMaster Acquisition.On
September 8, 2004 we purchased all of the outstanding securities of ScanMaster Ltd., an
Israeli company, and ScanMaster Inc., a New Hampshire corporation, or ScanMaster. In
consideration for all the securities of ScanMaster we agreed to issue ScanMasters
shareholders with 7,414,213 of our ordinary shares and pay them up to $3 million in cash
of which $2,700,000 was paid directly to them and an additional $300,000 was placed in
escrow until March 1, 2005 to guarantee projected revenues of at least $3,686,400 for
ScanMaster for the period from September 1, 2004 until December 31, 2004. The cash
consideration was released from escrow on March 27, 2005 to ScanMasters
shareholders. All of the shares which we agreed to issue to ScanMasters shareholders
were placed in escrow as follows: (i) an aggregate of 5,695,464 ordinary shares were
placed in escrow subject to an Israeli tax ruling deferring capital gains tax due on the
ordinary shares which were issued to the shareholders of ScanMaster, until their sale by
the shareholders. 430,188 of these shares were released from escrow to the employees of
ScanMaster, and 2,939,192 of these shares were released upon the sale to M.S.N.D., as part
of the agreement with Mivtach Shamir; (ii) 1,718,749 ordinary shares were placed in escrow
until March 15, 2007 as a guarantee for certain representations and undertakings of some
of ScanMasters former shareholders, and upon their release, they will be placed in
escrow subject to the above mentioned tax ruling until their sale.

Assuming the release of all of our
ordinary shares from escrow, ScanMasters former shareholders own approximately 15.5%
of our share capital, and our shareholder equity will exceed to $1.168 million.

Convertible loan agreement with
Mivtach Shamir. Discussions of this agreement are incorporated herein by reference to
the discussion under the caption Information on the Company  Recent
DevelopmentsinItem 4 of this Annual Report.

Acquisition of Panoptes.
Discussions of this agreement are incorporated herein by reference to the discussion under
the caption Information on the Company  Recent DevelopmentsinItem 4 of this Annual Report.

Loan from Mizrahi Bank.Discussions of this agreement are incorporated herein by reference to the discussion
under the caption Information on the Company  Recent DevelopmentsinItem 4 of this Annual Report.

# D. Exchange Controls

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

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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. Since we have never paid dividends on our ordinary
shares, this summary does not discuss the tax consequences in Israel or the United States
that would result from the payment of dividends. To the extent that the discussion is
based on tax legislation that has not been subject to judicial or administrative
interpretation, we cannot assure you that the tax authorities will accept the views
expressed in this summary.

Israeli Tax Considerations

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

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

General Corporate Tax
Structure

Israeli companies are subject to
corporate tax at the rate of 31% of taxable income in the 2006 tax year, 29% in the 2007
tax year, 27% in the 2008 tax year 26% in the 2009 tax year and 25% in the 2010 tax year
and thereafter. However, the effective tax rate payable by a company which derives income
from an Approved Enterprise (as further discussed below) may be considerably less.

Law for the Encouragement
of Capital Investments, 1959

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

85

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

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
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) and in long term shareholders loans, 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 Company Tax at reduced rates for an extended ten-year
(rather than the otherwise applicable seven-year) period as detailed below:

|Level of Foreign Investment | Company Tax Rate | Benefit period (years)
|--------------------------- | ---------------- | ----------------------
|
|
|
|
|Over 0% but less than 25%   |                  |                       
|Over 25% but less than 49%  |                  |                       
|Over 49% but less than 74%  |                  |                       
|Over 74% but less than 90%  |                  |                       
|or more 90%                 |                  |                       

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There can be no assurance that the
above-mentioned shareholding proportion will be reached for each subsequent year.

Prior to the Amendment, a company
owning an Approved Enterprise approved after April 1, 1986 (or prior thereto provided no
government grants or loans 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 track of tax benefits, 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 Route, all dividends are considered to be
attributable to the entire enterprise and the effective tax rate is the result of a
weighted combination of the various applicable tax rates.

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

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

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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 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 a certain percentage of the companys production assets
before the expansion.

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 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 which is a company at least 49% of
which is owned by non-Israeli residents. 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 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 Grants
|------------------------------------------------ | --------------------------------------------------------
|
|
|
|
|less than 50%                                    |                                                         
|between 50% and 90%                              |                                                         
|90% and more                                     |                                                         

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.

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.

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, capital gains, interest and dividends, is derived from an
Industrial Enterprise owned by it. An Industrial Enterprise is
defined as an enterprise whose major activity in a given tax year is industrial production
activity.

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

Taxation under
Inflationary Conditions

The
Income Tax Law (Inflationary Adjustments), 1985, 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:

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(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.

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 and
voting rights) of the company issuing the shares. There will generally be no capital gains
tax on the inflationary surplus. The rate on the gains from publicly traded shares
applicable to gains that were realized before January 1, 2006 was 15%.

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

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

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

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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 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 or deduction for United States Federal income tax purposes for the
amount of such taxes withheld, subject to limitations applicable to foreign tax credits.

Taxation of Non-Residents

Non-residents of Israel are subject
to income tax on income derived from sources in Israel. On distributions of dividends
other than bonus shares (stock dividends), income tax at the rate of 25% (15% for
dividends generated by an Approved Enterprise) is withheld at source, unless a
different rate is provided in a treaty between Israel and the shareholders country
of residence. The U.S.-Israel Tax Treaty provides for a maximum tax of 25% on dividends
paid to a Treaty U.S. Resident. However, under the Investment Law, dividends generated by
an Approved Enterprise are taxed at the rate of 15% and such rate is to be withheld at
source.

Residents of the United States will
generally have taxes in Israel withheld at source. Such persons generally would be
entitled to a credit or deduction 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 2002, 2003 and 2004 (the regular rate of corporate tax being 35%
in 2004).

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

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

|(a) | Reduced
tax rates:
|--- | ------------------

|(i) | The
Company
|--- | -----------

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

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

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.

|(ii) | ScanMaster
Ltd.
|---- | ---------------

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

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

ScanMaster Ltd. has three approved
enterprises; the benefit periods in respect of the first and second enterprises commenced
in 1994 and 1997, respectively.

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The period of tax benefits in
respect of the first approved enterprise has expired. The period of tax benefits in
respect of the second approved enterprise will expire in 2008. The third approved
enterprise has not yet been activated.

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

Our taxes outside Israel are
dependent on operations in each jurisdiction as well as relevant laws and treaties. We
incurred tax expenses in the aggregate amount of approximately $6,000, $3,000 and $6,000,
outside of Israel in 2004, 2003 and 2002, respectively. There can be no assurance that
changes in our operations or applicable tax treaties or laws will not subject us to
taxation. We received final tax assessments for the years since our incorporation ending
and including December 31, 2000. ScanMaster Ltd. received final tax assessments through
the tax year 2001. Our other subsidiaries have not received final tax assessments since
their respective incorporations.

United States Tax
Considerations

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

| |  | a
citizen or resident of the United States;
| | - | -------------------------------------------

| |  | a
 corporation  created or  organized  in the  United  States or under the laws of the
United                   States or any State;
| | - | ------------------------------------------------------------------------------------------------------------------------------------

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

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

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:

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| |  | 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.govthat
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.

96

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---



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

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

I.
          Subsidiary Information.Not applicable

|ITEM 11. | QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
|-------- | -----------------------------------------------------------

Market risk represents the risk of
changes in the value of a financial instrument caused by fluctuations in interest rates,
equity prices and foreign exchange rates.

# Interest Rate Risk

Our exposure to market risk for
changes in interest rates relates primarily to our cash equivalents and investment
portfolio and to our liabilities.

Interest Rate Risk on Investments.We maintain a strict, conservative investment policy, which ensures the safety and
preservation of our invested funds by limiting default risk, market risk and reinvestment
risk. According to this policy, we invest in bank deposits and in high-level marketable
securities. Our cash and cash equivalent as of December 31, 2005, consisted primarily of
demand deposits. A material change in yields of the securities in which we invest, and in
our liquidity requirements before the maturity of our investments, may have an effect on
our financial results and cash flow. However, due to the nature of our cash and cash
equivalents and short-term investments, we have concluded that we do not have material
market risk exposure.

Interest Rate Risk on
Liabilities. As of December 31, 2005 we had liabilities in the amount of $5.4 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 $38 thousands. The increase in
interest rates in 2005 did not result in any material change to our liabilities. As of
December 31, 2005 we had accounts payable in the amount of $7.5 millions. Our accounts
receivable are held in foreign currencies and are not linked to any interest rates.
Consequently, the decrease in interest rates in 2005 did not result in any change to our
accounts payable. As of December 31, 2005 we did not have any hedging transactions that
mitigate interest rate fluctuations.

97

---

---



# Foreign Currency
Exchange and Inflation Risk

Since the majority of our revenues
are paid in or linked to U.S. Dollars and Euro, we believe that a result of inflation and
fluctuations in the NIS/Dollar and the Euro/ Dollar exchange rate might be a material
effect on our revenues. Both inflation in Israel, and fluctuations in the NIS/Dollar and
the Euro/Dollar exchange rate, have some influence on our expenses and thus on our net
income. The cost of our operations in Israel, as expressed in 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 Dollar.

Costs not effectively denominated in
U.S. Dollars are translated to U.S. Dollars, when recorded, at the prevailing exchange
rates for the purposes of our financial statements. Consequently, fluctuations in the
rates of exchange between the Dollar and non-Dollar currencies will affect our results of
operations. An increase in the value of a particular currency relative to the Dollar will
increase the Dollar reporting value for transactions, and a decrease in the value of that
currency relative to the Dollar will decrease the Dollar reporting value for those
transactions. This effect on the Dollar reporting value for transactions is generally only
partially offset by the impact that currency fluctuations may have on costs. Due to the
instability of the foreign currency markets, significant foreign currency fluctuations and
other foreign exchange risks may have a material adverse effect on our business, financial
condition and results of operations. Since our revenues are generated in U.S. Dollars and
currencies other than NIS, and a substantial portion of our expenses is incurred and will
continue to be incurred in NIS, we are exposed to risk by the amount that the rate of
inflation in Israel exceeds the rate of devaluation of the NIS in relation to the Dollar
and other currencies or if the timing of the devaluation lags behind inflation in Israel.
For more information, see the discussion regarding inflation in Item 3, Key
Information  Risk Factors  General Risksand Item 5,
Operating and Financial Review and Prospects  Operating Results  Impact
of Inflation and Devaluation on Results of Operations, Liabilities and Assets.

As of December 31, 2005 we had a
credit facility in NIS, consequently we had no market risk resulting from any increase in
the year-end NIS/Dollar and the Euro/Dollar exchange rate.

As of December 31, 2005, we had
accounts payable in New Israeli Shekels (NIS) or in funds linked thereto in the amount of
$1.6 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 $180,000.

# Equity Price Risk

As of December 31, 2005, we did not
have any marketable securities recorded at a fair value.

|ITEM 12. | DESCRIPTION
OF SECURITIES OTHER THAN EQUITY SECURITIES.
|-------- | -------------------------------------------------------

Not applicable.

98

---

---



# PART II

|ITEM 13. | DEFAULTS,
DIVIDEND ARREARAGES AND DELINQUENCIES.
|-------- | ------------------------------------------------

None.

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

None.

|ITEM 15. | CONTROLS
AND PROCEDURES
|-------- | -----------------------

An evaluation was performed under the
supervision and with the participation of our management, including our chief executive
officers and chief financial officer, of the effectiveness of our disclosure controls and
procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act
of 1934, as amended) as of December 31, 2005. Based on that evaluation, our general
manager and chief financial officer have concluded that our disclosure controls and
procedures are effective in alerting them on a timely basis to material information
relating to us (including our consolidated subsidiaries) required to be included in our
reports filed or submitted under the Exchange Act, and that our disclosure controls and
procedures are effective to ensure that information required to be disclosed in the
reports that we file or submit under the Exchange Act is accumulated and communicated to
our management, including our general manager and chief financial officer, to allow timely
decisions regarding required disclosure.   There have been no changes in internal control over financial reporting during the period covered by
this report that may affect internal control over financial reporting.

|ITEM 16. | [RESERVED]
|-------- | ----------

|ITEM 16A | Audit
Committee Financial Expert
|-------- | --------------------------------

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

|ITEM 16B | Code
of Ethics
|-------- | --------------

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

|ITEM 16C | Principal
Accountant Fees and Services
|-------- | --------------------------------------

The
following table presents fees for professional audit services rendered by our principal
accountants for the audit of our consolidated annual financial statements for the year
ended December 31, 2004, and Brightman Almagor & Co. for the audit of our
consolidated annual financial statements for the year ended December 31, 2005.

|                  | 2005 | 2004
|----------------- | ---- | ----
|
|
|
|
|Audit Fees(1)     |      |     
|                  |      |     
|Tax Fees(2)       |      |     
|All Other Fees(3) |      |     
|Total             |      |     

99

---

---



| | (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.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

Pre-approval Policies and
procedures

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

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

Not applicable.

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

The discussion  relating to the purchase of our
securities by Altro is incorporated herein by reference to Item 7, Major
Shareholders and Related Party Transactions  Related Party Transactions.

# PART III

|ITEM 17. | FINANCIAL
STATEMENTS.
|-------- | ---------------------

Not
applicable.

|ITEM 18. | FINANCIAL
STATEMENTS.
|-------- | ---------------------

See
pages F-1 to F-47.

|ITEM 19. | EXHIBITS.
|-------- | ---------

|1.1 |  | Articles
of Association, as amended of the Registrant(1)
|--- |  | --------------------------------------------------------

|1.2 |  | Memorandum
of Association of the Registrant (2)(3)
|--- |  | --------------------------------------------------

|4.1 |  | Formation
 Agreement  dated  July  4,  1993,  among  Elbit  Ltd.,  Yossi  Barath  and  Hillel
         Avni(2)(3)
|--- |  | -----------------------------------------------------------------------------------------------------------------

|4.2 |  | Amendment
 Agreement  dated  October 26,  1998,  among Elbit  Ltd.,  Yossi  Barath and Hillel
         Avni(4)
|--- |  | --------------------------------------------------------------------------------------------------------------

100

---

---



|4.3 |  | Amendment
 No.1 to License  Agreement  dated June 12, 1996 between  Elbit Ltd.,  Elbit Vision
         Systems Ltd., and Dr. Ilan Tamches, dated May 12, 2002.(5)
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.4 |  | Share
Purchase  Agreement  dated February 7, 2001,  among Elbit Vision Systems Ltd., Nir Alon
         and Altro Warenhandels GmbH(4)
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------

|4.5 |  | Shareholders
 Agreement dated February 21, 2006, among Altro  Warenhandels  GmbH, M.S. Master
         Investments, Elbit Ltd., Nir Alon Holdings GmbH, and Nir Alon(6).
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.6 |  | Shareholders
 Agreement dated February 21, 2006, among M.S. Master  Investments,  Elbit Ltd.,
         Nir Alon Holdings GmbH, Nir Alon and M.S.N.D. Real Estate Holdings. (6)
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.7 |  | Amendment
to the Share  Purchase  Agreement of February 7, 2001,  among Elbit Vision  Systems
         Ltd., Nir Alon and Altro Warenhandels GmbH, dated March 18, 2002 (5)
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.8 |  | Share
Purchase  Agreement  dated March 18, 2002,  between Elbit Vision Systems Ltd. and Altro
         Warenhandels GmbH (5)
|--- |  | ----------------------------------------------------------------------------------------------------------------------------

|4.9 |  | Form
of Warrant  Agreement and Warrant  Certificate  issued to  Shareholders  pursuant to the
         Warrant Distribution (8)
|--- |  | -------------------------------------------------------------------------------------------------------------------------------

|4.10 |  | Share
Purchase  Agreement dated April 2004,  between Elbit Vision Systems Ltd. and STIC Angel
         Investment Partnership No. IV (7)
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------

|4.11 |  | Share
 Purchase  Agreement  dated  May 18,  2004,  between  Elbit  Vision  Systems  Ltd.  and
         Yuravision Co. Ltd. (7)
|---- |  | ------------------------------------------------------------------------------------------------------------------------------

|4.12 |  | Share
 Purchase  Agreement  dated April 2004,  between Elbit Vision  Systems Ltd. and Kuen Yu
         Liu (7)
|---- |  | --------------------------------------------------------------------------------------------------------------

|4.13 |  | Share
 Purchase  Agreement  dated  May 18,  2004,  between  Elbit  Vision  Systems  Ltd.  and
         Professor Whoi Yul Kim and Hoe Choon Kim (7)
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

|4.14 |  | Placement
 Agent  Agreement,  dated March 30, 2004,  between  Cornell  Capital  Partners LLP,
         Newbridge Securities Corporation and Elbit Vision Systems Ltd. (8)
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.15 |  | Registration
 Rights  Agreement,  dated March 30, 2004 between Cornell Capital  Partners LLP
         and Elbit Vision Systems Ltd. (9)
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------

|4.16 |  | Investment
 Agreement,  dated August 26, 2004, between Cornell Capital Partners LLP and Elbit
         Vision Systems Ltd. (9)
|---- |  | ------------------------------------------------------------------------------------------------------------------------------

|4.17 |  | Promissory
 Note dated  August 26,  2004,  between  Cornell  Capital  Partners  LLP and Elbit
         Vision Systems Ltd. (9)
|---- |  | ------------------------------------------------------------------------------------------------------------------------------

|4.18 |  | Security
 Agreement dated August 26, 2004,  between  Cornell  Capital  Partners LLP and Elbit
         Vision Systems Ltd. (9)
|---- |  | ------------------------------------------------------------------------------------------------------------------------------

101

---

---



|4.19 |  | Security
Agreement dated August 26, 2004,between Cornell Capital Partners LLP and EVS Inc. (9)
|---- |  | ----------------------------------------------------------------------------------------------

|4.20 |  | Pledge
and Escrow  Agreement dated August 26, 2004,  between  Cornell  Capital  Partners LLP
         and Elbit Vision Systems Ltd. (9)
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------

|4.21 |  | Share
 Purchase  Agreement  dated  August 6, 2004,  by and among Elbit Vision  Systems  Ltd.,
         ScanMaster Systems (IRT) Ltd., and IRT ScanMaster Systems Inc. (10)
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.22 |  | Amendment
to Share  Purchase  Agreement  dated  September 1, 2004, by and among Elbit Vision
         Systems Ltd., ScanMaster Systems (IRT) Ltd., and IRT ScanMaster Systems Inc. (10)
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.23 |  | Amendment
to Investment  Agreement,  dated May 2004, between Cornell Capital Partners LLP and
         EVS Inc. (10)
|---- |  | --------------------------------------------------------------------------------------------------------------------

|4.24 |  | Agreement
 dated  January 2, 2006,  between  Mivtach  Shamir  Holdings  Ltd. and Elbit Vision
         Systems Ltd. (6)
|---- |  | -----------------------------------------------------------------------------------------------------------------------

|4.25 |  | Appendix
to Agreement  dated  February 21, 2006,  between  Mivtach  Shamir  Holdings Ltd. and
         Elbit Vision Systems Ltd. (6)
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------

|4.26 |  | Asset
and Share  Purchase  Agreement  dated December 27, 2005,  among  Panoptes  Ltd.,  Elbit
         Vision Systems Ltd., ScanMaster Systems (IRT) Ltd. and Ma'aragim Enterprises
Ltd. (6)
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.27 |  | Amendment
to Asset and Share  Purchase  Agreement  dated  February 21, 2006,  among  Panoptes
         Ltd.,  Elbit Vision  Systems Ltd.,  ScanMaster  Systems (IRT) Ltd. and Ma'aragim
 Enterprises          Ltd. (6)
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|8.1 |  | List
of subsidiaries (*)
|--- |  | ------------------------

|10.1 |  | Consent
of Kesselman & Kesselman, certified public accountants (Israel) (*)
|---- |  | ---------------------------------------------------------------------------

|10.2 |  | Consent
 of Ernst &  Young,  Hang  Young,  certified  public  accountants  (Republic  of
         Korea) (*)
|---- |  | ------------------------------------------------------------------------------------------------------------

|10.3 |  | Consent
of Deloitte Brightman Almagor, certified public accountants (Israel) (*)
|---- |  | --------------------------------------------------------------------------------

|12.1 |  | Certification
by Chief Executive  Officer pursuant to section 302 of the  Sarbanes-Oxley  Act
         of 2002(*)
|---- |  | -----------------------------------------------------------------------------------------------------------------

|12.2 |  | Certification
by Chief Financial  Officer pursuant to section 302 of the  Sarbanes-Oxley  Act
         of 2002(*)
|---- |  | -----------------------------------------------------------------------------------------------------------------

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

102

---

---



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

---

|(*) | Filed
herewith.
|--- | ---------------

|(1) | Incorporated
by reference from Exhibit A to our Form 6-K, File No. 000-28580,                filed
with the Commission on January 25, 2006.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Incorporated
by reference from our Registration Statement on Form F-1, File No.
               333-03080, as amended, filed with the Commission on April 2, 1996.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | English
translation or summary from Hebrew original.
|--- | ----------------------------------------------------

|(4) | Incorporated
by reference from our Annual Report on Form 20-F for the year ended
               December 31, 2000.
|--- | ------------------------------------------------------------------------------------------------------------------

|(5) | Incorporated
by reference from our Annual Report on Form 20-F for the year ended
               December 31, 2001.
|--- | ------------------------------------------------------------------------------------------------------------------

|(6) | Incorporated
by reference from our Registration Statement on Form F-3, File No.
               333-134591, filed with the Commission on May 31, 2006.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Incorporated
by reference from our Report of Foreign Issuer on Form 6-K, File                No.
000-28580, filed with the Commission on June 8, 2004.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) | Incorporated
by reference from our Registration Statement on Form F-2, File No.
               333-11095, filed with the Commission on May 3, 2004.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------

|(9) | Incorporated
by reference from our Registration Statement on Form F-2, File No.
               333-120034, filed with the Commission on October 28, 2004.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------

|(10) | Incorporated
by reference from our Annual Report on Form 20-F for the year ended
               December 31, 2004.
|---- | ------------------------------------------------------------------------------------------------------------------

103

---

---



# 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.

June 29, 2006

| |  | ELBIT VISION SYSTEMS LTD.By: /S/ MENASHE SHOHAT
Menashe ShohatChief Executive Officer
| |  | ---------------------------------------------------------------------------------------------------

104

---

---

# ELBIT VISION SYSTEMS
LTD.

(An Israeli Corporation)

2005 CONSOLIDATED
FINANCIAL STATEMENTS



---

---



# ELBIT VISION SYSTEMS
LTD.

2005 CONSOLIDATED
FINANCIAL STATEMENTS

TABLE OF CONTENTS

|                                                                                                  | Page          
|------------------------------------------------------------------------------------------------- | --------------
|
|
|
|
|REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMS                                         | F - 2         
|CONSOLIDATED FINANCIAL STATEMENTS:                                                               
|Balance sheets as of December 31,2005 and 2004                                                    | F - 3 - F - 4 
|Statements of operations for the year ended December 31, 2005 ,2004 and 2003                      | F - 5         
|Statements of changes in shareholders' equity for the year ended December 31, 2005, 2004 and 2003 | F - 6         
|Statements of cash flows for the year ended December 31, 2005, 2004 and 2003                      | F- 7 - F - 8  
|Notes to Financial Statements                                                                     | F - 9 - F - 47



---

---



# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

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

We have audited the accompanying
consolidated balance sheet of Elbit Vision Systems Ltd. (the Company) and its
subsidiaries as of December 31, 2005, and the related consolidated statements of
operations, shareholders equity and cash flows for the year then ended. 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 audit.
The financial statements of the Company for the years ended December 31, 2004 and 2003
were audited by other auditors whose report, dated July 14,2005 and March 21, 2004
respectively expressed an unqualified opinion on those statements.

We conducted our audit 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 audit 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 statements presentation. We believe that our audit provides a reasonable basis
for our opinion.

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

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

Tel Aviv, Israel
May 21, 2006

F - 2

---

---



|
|
|

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the shareholders of ELBIT
VISION SYSTEMS LTD.

We have audited the accompanying
consolidated balance sheets of Elbit Vision Systems Ltd. (the Company) and its
subsidiaries as of December 31, 2004 and the related consolidated statements of
operations, changes in shareholders equity and cash flows for each of the two years
ended December 31, 2004. These financial statements are the responsibility of the
Companys Board of Directors and management. Our responsibility is to express an
opinion on these financial statements based on our audit.

We did not audit the financial
statements of a certain subsidiary, whose assets included in consolidation constitute
approximately 2.7% of total consolidated assets as of December 31, 2004, and whose
revenues included in consolidation constitute approximately 6% of total consolidated
revenues for the year ended December 31, 2004. The financial statements of the above
subsidiary were audited by other auditors, whose report has been furnished to us, and our
opinion, insofar as it relates to amounts included for this subsidiary, is based on the
reports of other auditors.

We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United States), and
with auditing standards generally accepted in Israel, including those prescribed by the
Israeli Auditors (Mode of Performance) Regulations, 1973. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant estimates
made by the Companys Board of Directors and management, as well as evaluating the
overall financial statement presentation. We believe that our audits and the report of
other independent auditors provide a reasonable basis for our opinion.

In our opinion, based on our audits
and the report of the other auditors, the consolidated financial statements referred to
above present fairly, in all material respects, the consolidated financial position of the
Company and its subsidiaries as of December 31, 2004 and the results of
operations, changes in shareholders equity and cash flows for each of the two years
ended December 31, 2004, in conformity with accounting principles generally accepted in
the United States of America.

|              |                                    
|------------- | -----------------------------------
|
|
|
|
|Haifa, Israel | Kesselman & Kesselman              
|July 14, 2005 | Certified Public Accountants (Isr.)

F - 2a

---

---



| | n | ERNST & YOUNG HAN YOUNGYeoido Post Office Box 42825-15, Yeoido-dongYoungdeungpo-gu, Seoul 150-010 Korea | n | Phone: 3787-6600, 3787-6800Fax  : 783-5890, 785-6991        786-6956, 786-6957        761-5084, 783-4866
| | - | ------------------------------------------------------------------------------------------------------- | - | --------------------------------------------------------------------------------------------------------

# Report of Independent
Registered Public Accounting Firm

The Board of Directors
and Stockholders of Yuravision Co., Ltd.

We have audited the balance sheet of
Yuravision Co., Ltd. (the Company) as of December 31, 2004, and the related
statements of operations, changes in stockholders deficiency and cash flows for the
seven-month period ended December 31, 2004 (not presented separately herein). 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 audit.

We conducted our audit 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. We were not engaged to
perform an audit of the Companys internal control over financial reporting. Our
audit 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
includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis for our
opinion.

In our opinion, the financial
statements referred to above present fairly, in all material respects, the financial
position of the Company at December 31, 2004 and the results of its operations and its
cash flows for the seven-month period ended December 31, 2004, in conformity with U.S.
generally accepted accounting principles.

As discussed in Note 14 to the
financial statements, the Companys recurring losses from operations and net capital
deficiency raise substantial doubt about its ability to continue as a going concern.
Managements plans as to these matters are also described in Note 14. The 2004
financial statements do not include any adjustments that might result from the outcome of
this uncertainty.

Seoul, Korea
July 8, 2005

F - 2b

---

---



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

|                                                                         |  | December 31
|------------------------------------------------------------------------ |  | -----------
|
|
|
|
|A s s e t s                                                              |  |            
|CURRENT ASSETS:                                                          |  |            
|Cash and cash equivalents                                                |  |            
|Restricted deposit (short term)                                          |  |            
|Accounts receivable:                                                     |  |            
|Trade (net of allowance for doubtful account 2005- $793 ,2004 - $ 1,423) |  |            
|Other                                                                    |  |            
|Inventories                                                              |  |            
|                                                                         |  |            
|T o t a l    current assets                                              |  |            
|                                                                         |  |            
|INVESTMENTS AND LONG-TERM RECEIVABLES:                                   |  |            
|Severance pay fund                                                       |  |            
|Other long-term receivables                                              |  |            
|                                                                         |  |            
|                                                                         |  |            
|                                                                         |  |            
|PROPERTY AND EQUIPMENT,net of accumulated                                |  |            
|depreciation and amortization                                            |  |            
|                                                                         |  |            
|OTHER ASSETS AND DEFERRED CHARGES -     net of accumulated amortization: |  |            
|Goodwill                                                                 |  |            
|Other intangible assets                                                  |  |            
|Deferred charges                                                         |  |            
|                                                                         |  |            
|                                                                         |  |            
|                                                                         |  |            
|T o t a l    assets                                                      |  |            
|                                                                         |  |            

F - 3

---

---



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

|                                                                        |  | December 31
|----------------------------------------------------------------------- |  | -----------
|
|
|
|
|Liabilities and shareholders' equity                                    |  |            
|CURRENT LIABILITIES:                                                    |  |            
|Credit from banks                                                       |  |            
|Current maturities of loan from shareholder                             |  |            
|Credit from Cornell Capital Partners L.P.                               |  |            
|Accounts payable and accruals:                                          |  |            
|Trade                                                                   |  |            
|Deferred income                                                         |  |            
|Other                                                                   |  |            
|                                                                        |  |            
|T o t a l    current liabilities                                        |  |            
|                                                                        |  |            
|LONG-TERM LIABILITIES:                                                  |  |            
|Loans and other liabilities (net of current maturities)                 |  |            
|Loans from Related Parties (net of current maturities)                  |  |            
|Accrued severance pay                                                   |  |            
|                                                                        |  |            
|T o t a l    long-term liabilities                                      |  |            
|                                                                        |  |            
|COMMITMENTS AND CONTINGENT LIABILITIES                                  |  |            
|T o t a l    liabilities                                                |  |            
|                                                                        |  |            
|SHAREHOLDERS' EQUITY:                                                   |  |            
|Share capital - ordinary shares of NIS 1 par value ("Ordinary Shares"); |  |            
|Authorized - 60,000,000 Ordinary Shares as of December 31, 2005         |  |            
|60,000,000 ordinary shares as of December 31, 2005                      |  |            
|Issued and outstanding:                                                 |  |            
|December 31, 2005 - 26,762,217 Ordinary shares;                         |  |            
|December 31, 2004 - 25,681,743  Ordinary shares                         |  |            
|Receipts on account of shares to be allotted                            |  |            
|Warrants                                                                |  |            
|Additional paid-in capital                                              |  |            
|Foreign currency translation adjustment                                 |  |            
|Accumulated deficit                                                     |  |            
|                                                                        |  |            
|T o t a l    shareholders' equity                                       |  |            
|                                                                        |  |            
|T o t a l    liabilities and shareholders' equity                       |  |            
|                                                                        |  |            

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

F - 4

---

---



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

|                                                | Note | 2005 | 2004 | 2003
|----------------------------------------------- | ---- | ---- | ---- | ----
|
|
|
|
|REVENUES:                                       |      |      |      |     
|Sale of products                                |      |      |      |     
|Services rendered                               |      |      |      |     
|                                                |      |      |      |     
|                                                |      |      |      |     
|                                                |      |      |      |     
|COST OF REVENUES:                               |      |      | 15e  |     
|Cost of products sold                           |      |      |      |     
|Cost of services rendered                       |      |      |      |     
|                                                |      |      |      |     
|                                                |      |      |      |     
|                                                |      |      |      |     
|                                                |      |     
|GROSS PROFIT                                    |      |      |      |     
|RESEARCH AND DEVELOPMENT COSTS- NET             |      |      | 15f  |     
|SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:   |      |     
|Marketing and selling                           |      |      |      |     
|General and administrative                      |      |      |      |     
|                                                |      |      |      |     
|OPERATING INCOME (LOSS)                         |      |      |      |     
|FINANCIAL INCOME (EXPENSES)- NET                |      |      | 15g  |     
|                                                |      |      |      |     
|                                                |      |     
|INCOME (LOSS) BEFORE OTHER INCOME (LOSS)        |      |      |      |     
|OTHER INCOME                                    |      |      |      |     
|                                                |      |      |      |     
|                                                |      |     
|INCOME (LOSS) BEFORE TAXES ON INCOME            |      |      |      |     
|TAXES ON INCOME                                 |      |      | 12d  |     
|                                                |      |      |      |     
|INCOME (LOSS) FOR THE YEAR                      |      |      |      |     
|                                                |      |      |      |     
|                                                |      |     
|EARNING (LOSS) PER SHARE - BASIC                |      |      | 2n   |     
|                                                |      |      |      |     
|EARNING (LOSS) PER SHARE -DILUTED               |      |      | 2n   |     
|                                                |      |      |      |     
|                                                |      |     
|WEIGHTED AVERAGE NUMBER OF SHARES USED IN       |      |     
|COMPUTATION OF EARNING (LOSS) PER SHARE - BASIC |      |     
|(IN THOUSANDS)                                  |      |      |      |     
|                                                |      |      |      |     
|DILUTED (IN THOUSANDS)                          |      |      |      |     
|                                                |      |      |      |     

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

F - 5

---

---



ELBIT VISION SYSTEMS
LTD.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY

|                                                          | Share capital | Receipts on
account of
shares to be
allotted | Warrants (see
notes 3a,11a)) | Additional
paid-in
capital | other
comprehensive
income | Accumulated
deficit | Total
shareholders'
equity
|--------------------------------------------------------- | ------------- | -------------------------------------------- | ---------------------------- | -------------------------- | -------------------------- | ------------------- | --------------------------
|
|
|
|
|BALANCE - DECEMBER 31, 2002                               |               |                                              |                              | 10,167                     |                            |                     | 1,208                     
|CHANGES DURING 2003:                                      |               |                                              |                              |                            |                            |                     |                           
|Net loss for the year                                     |               |                                              |                              |                            |                            |                     |                           
|Issuance of share capital and warrants (note 11a)         |               |                                              |                              | 2,769                      |                            |                     | 633                       
|Employee stock options exercised and paid                 |               |                                              |                              | 70                         |                            |                     | 15                        
|Receipts on account of shares to be allotted (note 11a)   |               |                                              |                              |                            |                            |                     |                           
|                                                          |               |                                              |                              |                            |                            |                     |                           
|BALANCE - DECEMBER 31, 2003                               |               |                                              |                              | 13,006                     |                            |                     | 1,856                     
|                                                          |               |                                              |                              |                            |                            |                     |                           
|CHANGES DURING 2004:                                      |               |                                              |                              |                            |                            |                     |                           
|Net loss for the year                                     |               |                                              |                              |                            |                            |                     |                           
|Currency translation differences                          |               |                                              |                              |                            |                            |                     |                           
|                                                          |               |                                              |                              |                            |                            |                     |                           
|Total comprehensive loss                                  |               |                                              |                              |                            |                            |                     |                           
|Employee stock options exercised and paid                 |               |                                              |                              | 393                        |                            |                     | 85                        
|Receipts on account of shares to be allotted (note 11a)   |               |                                              |                              |                            |                            |                     |                           
|Issuance of share capital and warrants (notes 3a,3b,10a)  |               |                                              |                              | 11,957                     |                            |                     | 1,848                     
|Warrant exercised and paid (note 11a)                     |               |                                              |                              | 326                        |                            |                     | 74                        
|                                                          |               |                                              |                              |                            |                            |                     |                           
|BALANCE - DECEMBER 31, 2004                               |               |                                              |                              | 25,682                     |                            |                     | 3,863                     
|CHANGES DURING 2005:                                      |               |                                              |                              |                            |                            |                     |                           
|Net income for the year                                   |               |                                              |                              |                            |                            |                     |                           
|Currency translation differences                          |               |                                              |                              |                            |                            |                     |                           
|                                                          |               |                                              |                              |                            |                            |                     |                           
|Total comprehensive income                                |               |                                              |                              |                            |                            |                     |                           
|Employee stock options exercised and paid                 |               |                                              |                              | 82                         |                            |                     | 18                        
|Receipts on account of shares to be allotted (note 11a)   |               |                                              |                              |                            |                            |                     |                           
|Issuance of share capital and warrants (notes 3a,3b, 11a) |               |                                              |                              | 815                        |                            |                     | 607                       
|Warrant exercised and paid (note 11a)                     |               |                                              |                              | 183                        |                            |                     | 41                        
|                                                          |               |                                              |                              |                            |                            |                     |                           
|BALANCE - DECEMBER 31, 2005                               |               |                                              |                              | 26,762                     |                            |                     | 4,529                     

* Net
of share issuance costs.

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

F - 6

---

---



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

|                                                                    | 2005 | 2004 | 2003
|------------------------------------------------------------------- | ---- | ---- | ----
|
|
|
|
|CASH FLOWS FROM OPERATING ACTIVITIES:                               |      |      |     
|Net income (Loss)                                                   |      |      |     
|Adjustments to reconcile net income (loss) to net                   |      |     
|cash provided by or used in operating activities:                   |      |     
|Depreciation and amortization                                       |      |      |     
|Loss from disposal of property                                      |      |      |     
|Trading marketable securities - net                                 |      |     
|Liability for employee rights upon retirement                       |      |      |     
|Changes in operating assets and liabilities:                        |      |     
|Decrease (increase) in accounts receivable:                         |      |     
|Trade (including non-current portion)                               |      |      |     
|Other                                                               |      |      |     
|Increase (decrease) in accounts payable and accruals:               |      |     
|Trade                                                               |      |      |     
|Deferred revenues                                                   |      |      |     
|Other                                                               |      |      |     
|Decrease in inventories                                             |      |      |     
|                                                                    |      |      |     
|Net cash used in operating activities                               |      |      |     
|                                                                    |      |      |     
|CASH FLOWS FROM INVESTING ACTIVITIES:                               |      |     
|Acquisition of subsidiaries consolidated for the first time (a)     |      |      |     
|Purchase of property and equipment                                  |      |      |     
|Collection of long-term receivables                                 |      |      |     
|Investment in long-term deposits                                    |      |      |     
|Redemption of (investment in) restricted deposit                    |      |      |     
|Proceeds from disposal of property and equipment                    |      |      |     
|Long-term loan granted                                              |      |      |     
|Amounts carried to other assets and deferred charges                |      |      |     
|Funds severance pay                                                 |      |      |     
|                                                                    |      |      |     
|Net cash used in investing activities                               |      |      |     
|                                                                    |      |      |     
|CASH FLOWS FROM FINANCING ACTIVITIES:                               |      |     
|Issuance of share capital and warrants -net of issuance costs       |      |      |     
|Short-term credit from bank - net                                   |      |      |     
|Proceeds from exercise of options and warrants                      |      |      |     
|Receipts on account of shares to be allotted                        |      |      |     
|Retirement of long-term loan from shareholder                       |      |      |     
|Proceeds from long-term loans from bank                             |      |      |     
|Short-term credit received from Cornell Capital Partners L.P. - net |      |      |     
|                                                                    |      |      |     
|Net cash provided by financing activities                           |      |      |     
|                                                                    |      |      |     
|TRANSLATION DIFFERENCES ON CASH BALANCES OF                         |      |     
|CONSOLIDATED SUBSIDIARY                                             |      |      |     
|                                                                    |      |      |     
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                |      |      |     
|BALANCE OF CASH AND CASH EQUIVALENTS AT                             |      |     
|BEGINNING OF YEAR                                                   |      |      |     
|                                                                    |      |      |     
|BALANCE OF CASH AND CASH EQUIVALENTS AT END OF YEAR                 |      |      |     
|                                                                    |      |      |     
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW                                |      |     
|INFORMATION- cash paid during the year for:                         |      |     
|Interest paid - net                                                 |      |      |     
|                                                                    |      |      |     
|Income taxes paid - net                                             |      |      |     
|                                                                    |      |      |     

F - 7

---

---



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

| |     |                                                            | 2004
| | --- | ---------------------------------------------------------- | ----
|
|
|
|
| | (a) | Acquisition of subsidiaries consolidated                   |     
| |     | for the first time, see also note 2:                       |     
| |     | Assets and liabilities of the subsidiaries at date of      |     
| |     | acquisition:                                               |     
| |     | Working capital (excluding cash and cash equivalents)      |     
| |     | Fixed assets                                               |     
| |     | Long-term receivables                                      |     
| |     | Other assets                                               |     
| |     | Long-term loans and other liabilities                      |     
| |     | Goodwill arising on acquisition                            |     
| |     |                                                            |     
| |     |                                                            |     
| |     | Less:                                                      |     
| |     | Issuance of share capital and warrants (see b3) hereafter) |     
| |     | Legal commitment to acquire 19% of Yuravision Co.          |     
| |     | Ltd.'s shares (see also Note 3a)                           |     
| |     |                                                            |     
| |     |                                                            |     
| |     |                                                            |     

| | (b) | Supplementary
information on financing activities not involving cash flow:
| | --- | --------------------------------------------------------------------------

| | 1) | In
2004, the Company repaid $ 273,000, which constitutes part of a loan
          received from Cornell Capital Partner L.P. Repayment was made by way of
issuance           of shares. The said amount is not reflected in the statement of cash
flows for           the year ended December 31, 2004.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | In
2004, the Company issued Cornell Capital Partners L.P. and Newbridge           Securities
Coporation 156,250 of its ordinary shares in an amount equivalent to           $ 200,000
as part of the Standby Equity Distribution Agreement (see Note           11a4).The said
amount is not reflected in the statement of cash flows for the           year ended
December 31, 2004.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) | Part
of the acquisition of the subsidiaries was executed through issuance of           share
capital and warrants in an amount equivalent to $ 2,501,000.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 8

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 1 |  | GENERAL
|------ | - | -------

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

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

| | In
June 2004, the Company expanded its activities and entered into new fields of operations
through the acquisition of 70% of Yuravision Co. Ltd.s (Yuravision)
shares, a South Korean developer of visual inspection software and systems for the
microelectronics industry and display industries. In September 2004, the Company also
completed its acquisition of 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 (see Note 2).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Group relies on a small number of customers for a significant portion of its revenues
(see also Note 17d). As to Business and Geographical segments  see Note 17c.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES:
|------ | - | --------------------------------

| | The
consolidated financial statements are prepared in accordance with accounting principles
generally accepted (GAAP) in the United States of America.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | Use
of estimates in the preparation of financial statements
| | -- | -----------------------------------------------------------

| | The
preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial statements
and the reported amounts of revenues and expenses during the reporting years. Actual
results could differ from those estimates.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 9

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES (Cont.)
|------ | - | ---------------------------------------

| | b. | Financial
statements in U.S dollars
| | -- | -----------------------------------

| | The
currency of the primary economic environment in which operations of the Company and its
subsidiaries are conducted, except for its Korean subsidiary (see c. below), is the U.S.
dollar (the dollar).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | c. | Principles
of consolidation
| | -- | ---------------------------

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

| | All
material inter-company transaction and balances have been eliminated.
| | -------------------------------------------------------------------------

F - 10

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES (Cont.)
|------ | - | ---------------------------------------

| | d. | Cash
Equivalents
| | -- | ----------------

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

| | e. | Allowance
for doubtful accounts
| | -- | -------------------------------

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

| | f. | Inventories
| | -- | -----------

| | Inventories are stated at the lower of cost or market. Cost is determined as follows: 
Raw materials and spare parts  on moving average basis. 
Product 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
| | -- | ----------------------

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

| |                                | %                 
| | ------------------------------ | ------------------
|
|
|
|
| | Machinery and equipment        | 10-33 (mainly 33%)
| | Office furniture and equipment | 6-20              
| | Vehicles                       | 15-20             
| | Building                       | 2.5-5             

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

F - 11

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES (Cont.)
|------ | - | ---------------------------------------

| | h. | Other
assets and deferred charges:
| | -- | ----------------------------------

| | 1) | Goodwill
| | -- | --------

| | In
accordance with FAS No. 142: Goodwill and Other Intangible Assets, goodwill
is not amortized, but rather tested for impairment at least annually. The Companys
reporting units consist of reportable segments; goodwill is allocated to the ultrasonic
inspection segment and the microelectronics and inspection display segment (see also Note
17).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has designated December 31 of each year as the date on which it will perform its
annual goodwill impairment test. No impairment resulted from the annual review performed
in the year 2005.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Other
intangible assets
| | -- | -----------------------

| | These
assets are amortized by the straight-line method over their estimated useful lives.
| | -----------------------------------------------------------------------------------------

| | Annual
rates of amortization are as follows:
| | --------------------------------------------

| |                      | %       | 
| | -------------------- | ------- | 
|
|
|
|
| | Technology           | 10      | 
| | Customer relations   | 8.33    | 
| | Distribution network | 10;16.6 | 
| | Brand name           | 8.33    | 

| | The
backlog is amortized according to revenues, which are derived from specific orders.
| | ---------------------------------------------------------------------------------------

| | 3) | Deferred
charges
| | -- | ----------------

| | Relating
to Standby Equity Distribution Agreement and Promissory Note Agreement, which have been
signed between the company and Cornell Capital Partners L.P. (hereafter  Cornell).
The deferred charges include prepaid issuance costs in 2004, which are carried to
shareholders equity as issuance costs.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | i. | Impairment
of long-lived assets
| | -- | -------------------------------

| | Long-lived
assets held and used by the Group are reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of the assets may not be recoverable.
Under FAS 144, if the sum of the expected future cash flows (undiscounted and without
interest charges) of the long-lived assets is less than the carrying amount of such
assets, an impairment loss would be recognized, and the assets would be written down to
their estimated fair values.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES (Cont.)
|------ | - | ---------------------------------------

| | j. | Revenue
recognition:
| | -- | --------------------

| | 1) | Sale
of products:
| | -- | -----------------

| | a. | General
| | -- | -------

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

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

| | b. | Acceptance
clause, customers support service and warranty
| | -- | ----------------------------------------------------------

| | The
Group distinguishes between revenue recognition in respect of revenue derived from
automatic vision inspection products (sold by the Company) and ultrasonic inspection
products (sold by ScanMaster). The terms of the agreements between the Company and its
customers are substantially different from the terms of the agreements between ScanMaster
and its customers. Therefore, the revenue recognition accounting policy applied by each
of the companies is different in this case. Set forth bellow are the main accounting
policies applied by each of the companies:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company
| | -----------

| | In
case that Companys agreement with the customer includes an acceptanceclause,
revenue recognition will take place after the Company receives the acceptance
certificate from the customer. In some cases, the Company grants its customers a
trial period, usually several months, in order to evaluate prototype the systems
performance. In case that the systems performance meets the customers requirements,
he 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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 13

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES (Cont.)
|------ | - | ---------------------------------------

| | ScanMaster
| | ----------

| | ScanMasters
agreements with its customers usually include acceptance testing procedures clause (ATP).
Each product of ScanMaster has standard performance specifications that are examined in
the ATP; usually, the performance specifications are not customized for the specific
needs of the customer. Also, unlike in 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, in installation of which the company is
well experienced. In respect of sales of new products ScanMaster recognizes revenues only
after the company receives the ATP from the customer. In respect of sales of other
products, in the installation of which the company is well experienced, the ATP is only a
formal procedure, and therefore, the installation of products is a sufficient requirement
to recognize revenues.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ScanMaster
provides for warranty costs at the same time as the revenue is recognized. The annual
provision is calculated at rates of 1%-3% of the sales, based on past experience.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Right
of return
| | -- | ---------------

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

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

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

| | When
services are not considered essential, the revenue allocable to the software services is
recognized as the services are performed.
| | ---------------------------------------------------------------------------------------------------------------------------------------

F - 14

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES (Cont.)
|------ | - | ---------------------------------------

| | 2) | Services
rendered
| | -- | -----------------

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

| | 3) | Deferred
income
| | -- | ---------------

| | The
deferred income balance as of December 31, 2005 and 2004 include amounts of revenues
that were invoiced and cash was received, but deferred less applicable product and warranty
costs.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | k. | 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | l. | Advertising
expenses
| | -- | --------------------

| | Advertising
expenses are expenses as in incurred. Advertising expenses for the years ended December
31, 2005, 2004 and 2003 were $ 122,000, $ 132,000, and $ 45,000, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | m. | Deferred
income taxes
| | -- | ---------------------

| | Deferred
income taxes are provided for temporary differences between the assets and liabilities,
as measured in the financial statements and for tax purposes, at tax rates expected to be
in effect when these differences reverse, in accordance with SFAS No. 109 Accounting
for Income Taxes (SFAS 109).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | n. | Earning
(loss) per share (EPS)
| | -- | --------------------------------

| | Basic EPS is computed based on the
weighted average number of shares outstanding during each year. 3,707,000 ordinary shares,
which were issued and were placed in escrow (see Note 3b) were reflected in basic and
diluted EPS shares. Total common stock equivalents, related to options and warrants,
1,921,496 were reflected in diluted EPS for the year ended December 31, 2005. Total common
stock equivalents, related to options and warrants 8,716,907, 6,262,882 and 2,592,000
shares for the years 2005, 2004 and 2003, respectively, were excluded from EPS
calculation, because the effect of such options and warrants is antidilutive.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 15

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES (Cont.)
|------ | - | ---------------------------------------

| | o. | Stock-based
compensation
| | -- | ------------------------

| | 1) | The
Company accounts for employees and directors stock-based compensation in
          accordance with Accounting Principles Board Opinion No. 25 Accounting for
          stock Issued to Employees (APB 25) and in accordance with
FASB           Interpretation No. 44 (FIN 44). Pursuant to these accounting
          pronouncements, the Company records 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. Deferred compensation is amortized
          to compensation expense over the vesting period of the options.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | The following table illustrates the
effect on income (loss) and income (loss) per share assuming the Company had applied the
fair value recognition provisions of FAS No. 123, to its stock-based employee
compensation:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                            | Year ended December 31
| | ------------------------------------------ | ----------------------
|
|
|
|
| | Net income (loss), as reported             |                       
| | Add - stock-based employee compensation    |                       
| | expense determined under fair value method |                       
| |                                            |                       
| | Pro forma net income (loss)                |                       
| |                                            |                       
| | Earning (loss) per share:                  |                       
| | Basic and diluted - as reported            |                       
| |                                            |                       
| | Diluted - as reported                      |                       
| |                                            |                       
| | Basic and diluted - pro forma              |                       
| |                                            |                       
| | Diluted - pro forma                        |                       
| |                                            |                       

| | As
to information about the stock option plans and assumptions used in calculating the pro
forma information, see Note 11b.
| | ---------------------------------------------------------------------------------------------------------------------------

| | p. | Comprehensive
income
| | -- | --------------------

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

| | q. | Reclassification
| | -- | ----------------

| | Certain
comparative figures have been reclassified to conform to the current year Presentation.
| | -----------------------------------------------------------------------------------------------

| | r. | Consentration
of credit risk
| | -- | ----------------------------

| | As
of December 31, 2005 and 2004, the Group held cash and cash equivalents and
short-term bank deposits, most of which were deposited with major Israeli, European, Far
East, and U.S. banks. The Company is of the opinion that the credit risk in respect of
these balances is insignificant.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 16

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES (Cont.)
|------ | - | ---------------------------------------

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

| | s. | Recently
issued accounting pronouncements:
| | -- | ------------------------------------------

| | 1) | FAS
123 (Revised 2004) Share-based Payment
| | -- | ------------------------------------------

| | In
December 2004, the Financial Accounting Standards Board (FASB) issued the
revised Statement of Financial Accounting Standards (FAS) No. 123,
Share-Based Payment (FAS 123R), which addresses the accounting for share-based
payment transactions in which the Company obtains employee services in exchange for (a)
equity instruments of the Company or (b) liabilities that are based on the fair value of
the Companys equity instruments or that may be settled by the issuance of such
equity instruments. This Statement eliminates the ability to account for employee
share-based  payment
transactions using APB Opinion No. 25, Accounting for Stock Issued to Employees, and
requires instead that such transactions be accounted for using the grant-date fair value
based method. This Statement will be effective as of the beginning of the first interim
or annual reporting period that begins after January 1, 2006. This Statement applies to
all awards granted or modified after the Statements effective date. In addition,
compensation cost for the unvested portion of previously granted awards that remain
outstanding on the Statements effective date shall be recognized on or after the
effective date, as the related services are rendered, based on the awards grant-date
fair value as previously calculated for the pro-forma disclosure under FAS 123.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company estimates that the cumulative effect of adopting FAS 123R, based on the awards
outstanding as of December 31, 2005, will not have a material effect on the Companys
financial statements.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company expects that upon the adoption of FAS 123R, the Company will apply the modified
prospective application transition method. Under such transition method, upon the
adoption of FAS 123R, the Companys financial statements for periods prior to the
effective date of the Statement will not be restated.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
March 2005, the SEC issued Staff Accounting Bulletin No. 107, Share-Based Payment (SAB
No. 107). SAB No. 107 provides guidance on the initial implementation of FAS No.
123(R). In particular, the statement includes guidance related to share-based payment
awards with non-employees, valuation methods and selecting underlying assumptions such as
expected volatility and expected term. It also provides guidance on the classification of
compensation expense associated with share-based payment awards and accounting for the
income tax effects of share-based payment awards upon the adoption of FAS No. 123(R). The
Company is currently assessing the guidance provided in SAB No. 107 in connection with
the implementation of FAS No. 123(R).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | FAS
151 Inventory Costs  an amendment of ARB 43, Chapter 4
| | -- | -----------------------------------------------------------

| | In
November 2004, the FASB issued FAS No. 151, Inventory Costs  an amendment of
ARB 43, Chapter 4 (FAS 151). This Statement amends the guidance in ARB No. 43,
Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts
of idle facility expense, freight, handling costs, and wasted material.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 17

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 2 |  | SIGNIFICANT
ACCOUNTING POLICIES (Cont.)
|------ | - | ---------------------------------------

| | This
Statement requires that those items be recognized as current-period charges. In addition,
this Statement requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. This Statement
will be effective for inventory costs incurred during fiscal years beginning after June
15, 2005 (January 1, 2006 for the Company). Earlier application of FAS 151 is permitted.
The provisions of this Statement shall be applied prospectively. The Company does not
expect this Statement to have a material effect on the Companys financial
statements or its results of operations.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) | FAS
154  Accounting Changes and Error Corrections
| | -- | --------------------------------------------------

| | In
May 2005, the FASB issued FAS No. 154, Accounting Changes and Error Corrections.
FAS No. 154 is a replacement of Accounting Principles Board Opinion (APB) No.
20 and FASB Statement No. 3. FAS No. 154 provides guidance on the accounting for and
reporting of accounting changes and error corrections. It establishes retrospective
application as the required method for reporting a change in accounting principle. FAS
No. 154 also requires that a change in depreciation, amortization, or depletion method
for long-lived, nonfinancial assets be accounted for as a change in accounting estimate
effected by a change in accounting principle. The Statement carries forward the guidance
contained in APB No. 20 for reporting the correction of an error in previously issued
financial statements and a change in accounting estimate.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | FAS
No. 154 is effective for accounting changes and corrections of errors made in fiscal
years beginning after December 15, 2005 (January 1, 2006 for the Company). The Company
does not expect this standard to have a material effect on the Companys financial
statements or results of operations.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 3 |  | CONSOLIDATED
SUBSIDIARIES
|------ | - | -------------------------

| | a. | Acquisition
of Yuravision
| | -- | -------------------------

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

| | Pursuant
to the term sheet, through May 31, 2004, the Company entered into a series of purchase
agreements with some of Yuravisions shareholders. Under those agreements, the
Company purchased 51% of Yuravisions shares for an aggregate amount of $ 1,014,000,
in cash and has a legal commitment to purchase additional 19% of Yuravision shares.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
said shares, which represent a holding of app. 19% in Yuravision, shall be purchased in
cash payment of $ 306,000 , or by way of swap transaction.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the swap transaction, the company is to purchase these shares in consideration for the
issuance of 320,547 company shares (at a conversion rate of 0.955455).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 18

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 3 |  | CONSOLIDATED SUBSIDIARIES (Cont.)
|------ | - | ---------------------------------

| | As
of December 31, 2005, the company recorded in its books of accounts an
investment representing the holding of app. 70% in Yuravision and recorded the said
liability to purchase the shares as a short-term liability.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
manner in which the purchase will be made (cash or swap transaction) is to be determined
by the sellers. In addition to the cash payment, the Company issued to one of Yuravisions
shareholders warrants to purchase 50,000 of the Companys shares, at an exercise
price of $ 0.75; the warrants are exercisable for a period of two years from the date of
issuance.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
weighted fair value of the warrants granted was $ 0.6. The said fair value was determined
in accordance with the Black&Scholes model, based on the following assumptions:
dividend yield  0%; expected volatility  146%; risk free interest  2.1%;
expected life  1 year.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
results of Yuravisions operations have been included in the consolidated financial
statements as from June 1, 2004. Upon purchase of Yuravision, the Company has fully
undertaken upon itself the capital deficiency Yuravision had as of date of purchase (the
minority shareholders of Yuravision are not committed to bear any losses in excess of
their investment). As long as Yuravision has a capital deficiency, the Company fully
presents its share (100%) in the profits, or losses of Yuravision.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the purchase agreements: the Company is to acquire the remaining 30% of Yuravisions
shares. The acquisition of the remaining 30% will be carried out either by cash payment
or by share swap transaction. Under the share swap transaction, the Company will offer
7.209 of its ordinary shares at a nominal value of NIS 1.0 per share in consideration for
each of the shares of Yuravision at a par value of Korean Won 5000 per share, held at
that time by the shareholders of Yuravision. Under the cash transaction, the Company will
acquire Yuravisions shares for a purchase price of U.S. $ 6.8885 per share. As
part of the cash payment or swap transaction, the Company has undertaken to issue to
Yuravisions shareholders warrants to purchase 575,000 of the Companys shares,
at an exercise price of $ 0.75; the warrants will be exercisable for a period of two
years from the date of issuance.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
purchase of the remaining 30% of Yuravisions shares is dependent upon the seller approval
for the completion of the transaction. Therefore, this purchase has not yet been
reflected in the companys books of accounts as of December 31, 2004.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2005, the sellers did not exercise their option relating the selling of
their holding in Yuravision.
| | -----------------------------------------------------------------------------------------------------------------------

| | The
Company and the remaining shareholders of Yuravision are negotiating the terms for
implementing the agreement to purchase the remaining 30% of Yuravisions shares.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 19

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 3 |  | CONSOLIDATED SUBSIDIARIES (Cont.)
|------ | - | ---------------------------------

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

| |                                | At June 1, 2004
($ in thousands)
| | ------------------------------ | --------------------------------
|
|
|
|
| | Current assets                 |                                 
| | Long-term receivables          |                                 
| | Property, plant, and equipment |                                 
| | Intangible assets              |                                 
| | Goodwill                       |                                 
| |                                |                                 
| | Total assets acquired          |                                 
| | Current liabilities            |                                 
| | Long-term liabilities          |                                 
| |                                |                                 
| | Total liabilities assumed      |                                 
| |                                |                                 
| | Net assets acquired            |                                 
| |                                |                                 

| | Of
the $ 508,000 of acquired intangible assets, $ 279,000 were assigned to current
technology, which represents patent and other intellectual properties (3 years useful
life); $148,000 were assigned to distribution networks (6 years useful life), and the
remaining $ 81,000 were assigned to backlog Yuravision has; the $ 1,332,000 of
goodwill, was assigned to the micro electronics and display inspection segment.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to pro forma data  see c. below.
| | ------------------------------------

| | b. | Acquisition
of ScanMaster
| | -- | -------------------------

| | In
September 2004, the Company acquired 100% of the shares of ScanMaster (as to the nature
of operations of ScanMaster  see Note 1)).
| | --------------------------------------------------------------------------------------------------------------------------------------

| | The
Company acquired ScanMaster for total consideration in the amount of $ 8,193,000
(including estimated direct transaction costs amounting to $ 151,000). The consideration
for the acquisition of ScanMaster consisted of $ 3,000,000 in cash and 7,414,213 ordinary
shares of the Company, which represented approximately 27.9% of the issued and
outstanding share capital of the Company after giving effect to the issuance. The value
of the shares issued was calculated based upon the average of the closing prices per
Companys shares for the period of two days before through two days after the
announcement of the agreement. For the purposes of the financial statements as of
December 31, 2004, the acquisition cost was recorded at the amount of $ 5,680,000,
after eliminating a consideration of $ 2,521,000 in shares, which are considered as
contingent consideration, and are placed in escrow as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | An
aggregate of 3,707,106 ordinary shares were placed in escrow as follows: (i) 1,718,749
ordinary shares  until March 15, 2007, as a guarantee for certain representations
and undertakings of some of ScanMasters former shareholders (mainly for certain
issues with respect to the Israeli Tax Authorities) and (ii) an aggregate of 1,988,357
ordinary shares  until June 1, 2005, to guarantee certain projected revenues of
ScanMaster for the period from September 1, 2004 until March 31, 2005 (The said
shares were released from escrow in May 2005).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 20

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 3 |  | CONSOLIDATED SUBSIDIARIES (Cont.)
|------ | - | ---------------------------------

| | A
cash amount of $300,000, which was placed in escrow to guarantee certain projected
revenues of ScanMaster for the period from September 1, 2004 until December 31, 2004, was
paid in March 2005.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
results of ScanMasters operations have been included in the consolidated financial
statements as from September 8, 2004.
| | -----------------------------------------------------------------------------------------------------------------------------

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

| |                                | At September 8, 2004 ($ in
thousands)
| | ------------------------------ | -------------------------------------
|
|
|
|
| | Current assets                 |                                      
| | Long-term receivables          |                                      
| | Property, plant, and equipment |                                      
| | Intangible assets              |                                      
| | Goodwill                       |                                      
| |                                |                                      
| | Total assets acquired          |                                      
| |                                |                                      
| | Current liabilities            |                                      
| | Long-term liabilities          |                                      
| |                                |                                      
| | Total liabilities assumed      |                                      
| |                                |                                      
| | Net assets acquired            |                                      
| |                                |                                      

| | Of
the $ 4,153,000 of acquired intangible assets, $ 1,802,000 were assigned to
current technology, which represents patent and other intellectual properties (10 years
useful life); $ 1,110,000 were assigned to customer relations (12 years useful
life), $ 338,000 were assigned to distribution networks (10 years useful life), $ 489,000
were assigned to ScanMasters brand name (12 years useful life) and $ 414,000
were assigned to backlog; $ 964,000 representing the goodwill, was assigned to the
non-destructive automated inspection segment.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to proforma data, see c. below.
| | ----------------------------------

F - 21

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 3 |  | CONSOLIDATED SUBSIDIARIES (Cont.)
|------ | - | ---------------------------------

| | The
pro forma financial information is not necessarily indicative of the combined results
that would have been attained had the acquisitions taken place at the beginning of 2004
and 2003, nor is it necessarily indicative of future results.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                   | 2004 | 2003
|---------------------------------- | ---- | ----
|
|
|
|
|Revenues                           |      |     
|                                   |      |     
|Loss                               |      |     
|                                   |      |     
|Loss per share - basic and diluted |      |     
|                                   |      |     

| | d. | As
to deferred income taxes in respect of the assets acquired and liabilities
          assumed at the date of the above acquisition, see Note 12e.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 4 |  | INVENTORIES
|------ | - | -----------

| |                    | December 31
| | ------------------ | -----------
|
|
|
|
| | Raw materials      |            
| | Spare parts        |            
| | Work in process    |            
| | Finished products* |            
| |                    |            
| |                    |            
| |                    |            

| | *
Mainly systems in trial by customers (see Note 2j)).
| | ------------------------------------------------------

| | The
balance are net of write-down of $ 971,000 and $1,473,000  December 31, 2005 and 2004.
| | ------------------------------------------------------------------------------------------

|NOTE 5 |  | OTHER
LONG-TERM RECEIVABLES
|------ | - | ---------------------------

| |                                                    | December 31
| | -------------------------------------------------- | -----------
|
|
|
|
| | Deposits on leased vehicle (see also Note 10b2)(b) |            
| | Loan to employees(1)                               |            
| | Loan to other(2)                                   |            
| | Prepaid expenses                                   |            
| |                                                    |            
| |                                                    |            
| |                                                    |            

| | (1) | The
loans are mainly denominated in NIS and linked to the Israeli CPI.
| | --- | ----------------------------------------------------------------------

| | (2) | Representing
a loan to a company, convertible into 8% of this companys           share capital.
The loan is denominated in dollars, with no interest. The Company           can convert
the loan into share capital after December 31, 2003. On July           22, 2004, the
Company requested, pursuant to the loan agreement, to convert the           loan to
197,217 shares of the Company. To date, the conversion of the loan has           not yet
been executed. The Company assures that the said conversion will be           completed
by the end of 2006.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 6 |  | PROPERTY
AND EQUIPMENT
|------ | - | ----------------------

| | a. | Comprised
as follows:
| | -- | ---------------------

| |                                                  | December 31
| | ------------------------------------------------ | -----------
|
|
|
|
| | Machinery and equipment                          |            
| | Leasehold improvements                           |            
| | Office furniture and equipment                   |            
| | Vehicles                                         |            
| | Land and buildings                               |            
| |                                                  |            
| |                                                  |            
| | Less - accumulated depreciation and amortization |            
| |                                                  |            
| |                                                  |            
| |                                                  |            

| | b. | Depreciation
and amortization expenses totaled $ 338,000, $ 269,000,           and $
238,000, in the years ended December 31, 2005, 2004 and 2003,
          respectively.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 7 |  | OTHER
ASSETS AND DEFERRED CHARGES
|------ | - | ---------------------------------

| | a. | Intangible
assets:
| | -- | ------------------

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

| | Amortization
expenses totaled $ 548,000, and $ 611,000, in the years ended December 31,
2005, and 2004, respectively.
| | ---------------------------------------------------------------------------------------------------------------------

| | Estimated
amortization expense for the following years, subsequent to December 31, 2005:
| | ----------------------------------------------------------------------------------------

| |                         | $ in thousands
| | ----------------------- | --------------
|
|
|
|
| | Year ended December 31: |               
| | 2006                    |               
| | 2007                    |               
| | 2008                    |               
| | 2009                    |               
| | 2010                    |               

F - 23

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 7 |  | OTHER
ASSETS AND DEFERRED CHARGES(Cont.)
|------ | - | ----------------------------------------

| | b. | Deferred
charges*
| | -- | -----------------

| |                               | Gross carrying amount
December 31 | Accumulated amortization
December 31
| | ----------------------------- | --------------------------------- | ------------------------------------
|
|
|
|
| | Share issuance costs(1)       |                                   |                                     
| | Commitment fees - related to  |                                   |                                     
| | credit provided by Cornell(2) |                                   |                                     
| |                               |                                   |                                     
| |                               |                                   |                                     
| |                               |                                   |                                     

| | * | Relating
to Standby Equity Distribution Agreement and Promissory Note Agreement signed between the
Company and Cornell  see also (notes 2h3 and 11a5).
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | (1) | Prepaid
share issuance costs
| | --- | ----------------------------

| | These
include direct issuance costs and part of the commitment fees paid to Cornell, allocated
to future issuances (see note 11a5)). The said costs will be carried to companys
shareholders equity as issuance costs upon the issuance of shares to Cornell, under
the Standby Equity Distribution Agreement.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | Commitment
fees
| | --- | ---------------

| | The
said costs are amortized over the period of the Promissory Note, in proportion to the
balance outstanding and are carried to financial expenses. The said costs are composed as
follows: (i) an amount of $ 230,000, which have been deducted from the amount of the
Promissory Note that was granted to the company, as of August 26, 2004. (ii) an
allocation of 40% of the commitment fees paid to Cornell, under the above agreement.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 24

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

| | The
Company liability for severance pay is fully provided for. 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 these plans, contributions are based on specific percentages
of           pay.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Severance
pay and defined contribution plan expenses were $ 291,000,           $ 255,000,
and $ 160,000 in the years ended December 31, 2005, 2004,           and 2003,
respectively. The earnings on the amounts funded were $ 140,000,           $ 80,000,
and $ 54,000 for the years ended           December 31, 2005, 2004, and
2003, respectively.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 25

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

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

| |                                      | December 31
| | ------------------------------------ | -----------
|
|
|
|
| | Loans from banks(1)                  |            
| | Other liabilities:                   |            
| | Loan from shareholder(2)             |            
| | Income received in advance           |            
| |                                      |            
| |                                      |            
| | Less - current maturities:           |            
| | From banks                           |            
| | From shareholder (see also Note 15c) |            
| |                                      |            
| |                                      |            
| |                                      |            
| |                                      |            
| |                                      |            

| | (1) | On
August 2004 The Company and ScanMaster entered into an agreement with bank Mizrahi,
pursuant to which both the Company and ScanMaster received a credit line for the
aggregate amount of $2,000,000. The credit line is secured by a first ranking floating
charge on all our assets and all the assets of ScanMaster.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Yuravision
has loan that linked to the Korean Won and bear weighted average annual interest rates of
6.9%. The Korea Technology Credit Guarantee Fund has provided a guarantee amounting to $ 106,000
in respect of the said loans.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

| | In
2004, $ 80,000 were repaid in respect of the said loan.
| | ----------------------------------------------------------

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

| |                     | December 31
| | ------------------- | -----------
|
|
|
|
| | 2006                |            
| | 2007                |            
| | 2008                |            
| | 2009 and thereafter |            
| |                     |            
| |                     |            
| |                     |            

F - 26

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 10 |  | COMMITMENTS
AND CONTINGENT LIABILITIES
|------- | - | --------------------------------------

| | a. | Royalties
| | -- | ---------

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

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

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

| | Royalty
expenses to the Government of Israel totaled $286,000 $ 583,000, $ 213,000 in the
years ended December 31, 2005, 2004 and 2003 and are included in the statements of
operations among cost of revenues.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During December 2005 the Company
reached a settelment with the OCS (office chief scientist) according to which
the OCS will withdraw its request to extend the royalties payment form 3.5% to 4.5% on
part of the received grants. As a result of the settelment the Company reversed the OCS
allowance by $ 822,000.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
maximum royalty amount payable by the Company to the Government of Israel at December 31, 2005
is approximately $ 997,000 (see (1) and (2) above).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 10 |  | COMMITMENTS
AND CONTINGENT LIABILITIES(Cont.)
|------- | - | ---------------------------------------------

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

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

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

| | The royalty expenses totaled
$ 46,000 and $ 27,000 in the years ended December 31, 2005 and
2004 respectively, and are included in the statements of operations in cost of
revenues.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (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 in respect of royalties paid to the
          said supplier amounted to totaled $ 25,000 and $ 14,000 in the years
          ended December 31, 2005 and 2004, respectively ,were included in the
          statements of operations in cost of revenues.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | Lease
commitments
| | -- | -----------------

| | 1) | The
premises occupied by the Company and certain subsidiaries are rented under
          various operating lease agreements. The lease agreements for the premises
expire           in 2006-2007.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Minimum
lease commitments of the Company and the subsidiary under the above leases, at rates in
effect on December 31, 2005, are as follows:
| | --------------------------------------------------------------------------------------------------------------------------------------------

| |                          | $ in thousands
| | ------------------------ | --------------
|
|
|
|
| | Year ending December 31: |               
| | 2006                     |               
| | 2007                     |               
| | 2008                     |               
| |                          |               
| |                          |               
| |                          |               

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

| | Rental
expenses totaled $ 540,000, $ 240,000, and $ 150,000 in the years ended
December 31, 2005, 2004 and 2003, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------

| | (2) | The
Company leases motor vehicles under long-term operating lease agreements.           The
lease agreements expire on various dates ending in 2006  2008 (with           prior
notice of cancellation clauses).
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 28

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 10 |  | COMMITMENTS
AND CONTINGENT LIABILITIES(Cont.)
|------- | - | ---------------------------------------------

| | Minimum
lease commitments of the Company under the above leases, at rates in effect on December
31, 2005, are as follows:
| | -------------------------------------------------------------------------------------------------------------------------

| |      | $ in thousands
| | ---- | --------------
|
|
|
|
| | 2006 |               
| | 2007 |               
| | 2008 |               
| |      |               
| |      |               
| |      |               

| | To
secure the amounts due to the lessor, the Company has deposited a total of U.S. $ 47,000.
Equal to three-month lease payments. The deposits are unlinked and presented among other
receivables and long-term receivables.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Lease
expenses in 2005, 2004 and 2003, amounted to $ 298,000, $ 194,000, and $ 154,000.
| | ---------------------------------------------------------------------------------------

| | c. | Guarantees
| | -- | ----------

| | To secure the Companys commitment under its sales agreements, the Company provided guarantees in
        the amounts $3,498,000  to its customers.  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 over the counter market under the symbol EVSNF.OB.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | In
March 2001, Mr. Alon, the Companys chairman, as from March 2001,
               purchased 1,500,000 of its ordinary shares at a price per share of $1.00.
At                that time, Mr. Alon also agreed to complete a second investment in
which he                would purchase by no later than March 15, 2002, an additional
1,500,000 shares                at a price per share of $1.00; provided that the Companys
financial                results for 2001 met certain minimum thresholds. In March 2002,
the Company                agreed to permit Altro Warenhandelsgesmbh (hereafter  Altro),
an Austrian                company controlled by Mr. Alon, to complete the second
investment in nine equal                monthly installments commencing March 2002. In
May 2002, the Company deferred                payment of the first four of these
installments until no later than                June 30, 2002. This investment was
not done by Altro.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
a plan of arrangement (hereafter  the arrangement) between the Company, its
shareholders and Altro, approved by the Companys shareholders in October 2003 and
the District Court of Haifa in November 2003, the Company agreed to cancel Altros
prior commitment to invest in the Company and replace it with new investment terms, and
at the same time grant warrant to purchase shares to the other shareholders. According to
the plan of arrangement, Altro will purchase 2,000,000 of the Companys ordinary
shares for a purchase price of $0.35 per share, payable in up to five quarterly
installments to be completed by November 2004.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 29

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 11 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

| | Through
December 31, 2004, the Company received from Altro an amount of $564,000 (net of issuance
costs amounting to $ 30,000) in respect of 1,500,000 shares issued to Altro.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
April 2005, the Company received $ 106,000 in respect of the completion of the
transaction.
| | ----------------------------------------------------------------------------------------------

| | Also,
pursuant to the arrangement, in 2004, the Company distributed, without consideration,
warrants to purchase 4,183,950 of its ordinary shares to all of its shareholders on a pro
rata basis (other than Altro, Mr. Alon and a group of investors which purchased the
Companys shares in private placements which occurred in December 2003 and January
2004 (see 3) and 4) below. Each warrant is exercisable for a period of four years
following the grant date 14 May , 2004, at a price of $0.35 per share.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of the said warrants granted was $ 0.1 per warrant. The fair value was determined in
accordance with the Black & Scholes model, based on the following assumptions:
dividend yield  0%, expected volatility  137%, risk free interest 1.91%,
expected life  2 years.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Through
December 31, 2005, warrants to purchase 268,221 shares were exercised by one of the said
shareholders.
| | --------------------------------------------------------------------------------------------------------------

| | 3) | In
December 2003 and in January 2004, the Company entered into shares and           warrants
purchase agreements with several private investors. Under these           agreements, the
Company issued to the said investors 3,569,299 shares of           NIS 1 par value
at a price of $0.68 per share and 1,067,325 warrants. Each           warrant entitles its
holder to purchase one ordinary share of NIS 1 par value at           the exercise price,
payable in cash, of $ 0.85; the warrants are exercisable for           a period of 24
months from date of issuance, which was further extended to June 30, 2006.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
this agreement, the Company received $ 2,276,360 (net of issuance costs of $ 150,640), in
respect of the shares and warrants, issued as above (of which $ 1,765,000  net
of issuance costs of $ 150,640  were received through December 31, 2003).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
said private investors participating in the issuance of shares and warrants as above, did
not participate in the warrant distribution Arrangement mentioned in 2) above.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
part of the issuance, the Company issued 293,300 warrants to consultants and providers of
financial services (245,300 warrants were issued in December 2003 and 48,000 warrants
were issued in January 2004). The said warrants were issued to consultants and service
providers in respect of their assistance in the said capital raising. 51,500 warrants
have the same terms as the warrants issued to the investors as above, and 241,800
warrants are exercisable at a price of $ 0.68 per share, for a period of 24 months from
date of issuance, which was further extended to June 30, 2006.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 30

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 11 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

| | The
Company has divided the amount raised from issuance, as above, between shareholdersequity
components: share capital, additional paid-in capital and warrants. The warrants granted
to the said private investors were recorded in shareholders equity at their fair
value. Also, the value of the warrants issued to consultants and providers of financial
services was offset from the premium component. The weighted average fair value of
warrants granted was $ 0.25. The said weighted average fair value of all warrants
was determined in accordance with the Black & Scholes model, based on the following
assumptions: dividend yield  0%, expected volatility  137%, risk free
interest rate 1.31%, expected life  1 year.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
May 2004, warrants to purchase 156,000 shares at an exercise price of $0.68 were
exercised by one of the said consultants.
| | -----------------------------------------------------------------------------------------------------------------------------

| | 4) | In
January and February 2004, the Company issued to several private investors
          1,530,612 shares at a price of $0.98 per share and 382,653 warrants for a total
          consideration of $ 1,330,000 (net of issuance costs amounting to
          $ 170,000). Each warrant is exercisable to one ordinary share of NIS 1
          par value, at an exercise price of $ 1.40 per share. The warrants are
          exercisable for a period of 24 months, commencing in the date of issuance, which was further extended to June 30, 2006.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
part of the issuance as above, the Company issued 100,816 warrants to consultants and
providers of financial services. The said warrants were issued to consultants and service
providers in respect of their assistance in the said capital raising.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
said warrants are exercisable at a price of $ 0.98 per share for a period of 24
months from the date of issuance, which was further extended to June 30, 2006..
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has divided the amount raised from issuance, as above, between shareholdersequity
components: share capital, additional paid-in capital and warrants. The warrants granted
to the said private investors were recorded in shareholders equity at their fair
value. Also, the value of the warrants issued to consultants and providers of financial
services was offset from the premium component. The weighted average fair value of
warrants granted was $ 0.42. The said weighted average fair value of all warrants
was determined in accordance with the Black & Scholes model, based on the following
assumptions: dividend yield  0%, expected volatility  137%, risk free
interest rate 1.31%, expected life  1 year.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
May 2004, warrants to purchase 85,714 shares at an exercise price of $ 0.98 were
exercised by one of the said consultants.
| | -----------------------------------------------------------------------------------------------------------------------------

| | 5) | In
March 2004, the Company entered into a Standby Equity Distribution Agreement
          with Cornell. Pursuant to this agreement, the Company will be entitled to issue
          Cornell with put notices requiring it to purchase, six days following each put
          notice, a number of Companys ordinary shares with a value of up to
          $ 300,000 per put notice and up to an aggregate value of $ 10,000,000
          over two years. The price per share payable by Cornell will be determined based
          on the minimum price of Companys shares during the five days period
          following Companys put notice to Cornell to purchase Companys
          shares. Under the said agreement, the Company agrees to pay Cornell commitment
          fees, which were defined as follows:
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 31

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 11 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

| | b) | Upon
execution of the Agreement, the Company issued Cornell with 148,438 of its
               ordinary shares in an amount equal to $ 190,000. As to the accounting
               treatment applied to the said costs.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

| | In May 2005, the Company signed an amendment to the Promissory Note, under the
                       new term the balance of loan will be paid in monthly installments through
                       December 2006, at an interest rate of Prime+2%.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has included in its accounts interest costs pertaining to the Promissory Note,
based on a computation of the weighted interest in respect of the Promissory Note.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company paid Cornell a commitment fee of five per cent (5%) of the principal amount of
the Promissory Note, and a further $ 30,000 to an affiliate of Cornell and other
party. When used for the repayment of the note, proceeds received under the Standby
Equity Distribution Agreement, will not be subject to the 5% commitment fee.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company records in its books of accounts the commitment fees over the period of the
Promissory Note.
| | --------------------------------------------------------------------------------------------------------

| | As
securities for repayment of the advance and the Promissory Note, the Company has: (i)
granted Cornell a second ranking floating charge on all of Companys assets (to the
extent permitted under Israeli law) and on the assets of ScanMaster; (ii) issued to a
trustee, 5,555,555 of its ordinary shares which are registered (see above), and (iii)
Issued to Trustee an additional 2,500,000 of Companys restricted ordinary shares.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | It
has also been agreed to reserve an additional 14,444,445 of Companys ordinary
shares for issuance to Cornell pursuant to the Standby Equity Distribution Agreement, and
have agreed to file the registration statement covering these shares.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 32

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 11 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

| | As
part of the transaction with Cornell, the Company also retained the services of Newbridge
Securities Corporation (hereafter  Newbridge), an unaffiliated broker-dealer, as a
placement agent in connection with the Standby Equity Distribution Agreement. The Company
issued Newbridge 7,812 ordinary shares as a placement fee.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of the said shares is app. $ 10,000. The said costs are included in companys
accounts as deferred share issuance costs.
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | Through
December 31, 2005, the Company repaid $ 2,129,000 of the Note in cash and $ 433,000
by the issuance of 869,946 shares to Cornell, as stipulated in the said agreement.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 6) | As
to shares issued in consideration, and as contingent consideration, for the
               purchase of the shareholding in ScanMaster, see Note 3b.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Share
option plans:
| | -- | -------------------

| | 1) | The
plans:
| | -- | ----------

| | (a) | In
February 1996, the Companys board of directors adopted the           Companys
Employee Share Option Plan (1996) (hereafter  The 1996           Plan). Under the
1996 plan, 565,720 options can be granted to directors,           employees and
consultants of the Company and its subsidiaries. Each option can           be exercised
into one ordinary share of the Company.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
1996 plans is valid for ten years and will expire February 2006, except for option awards
outstanding on that date.
| | -----------------------------------------------------------------------------------------------------------------------

| | Under
the 1996 Plan, options usually vest as follows: 50%  two years after the effective
date of grant; 75%  after three years; and 100%  after four years.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | In
April 2000, the board of directors of the Company adopted the Employee Share
          Option Plan (2000) (hereafter  The 2000 Plan).
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------

| | Under
the 2000 plan, options to purchase an aggregate of 4,500,000 ordinary shares are
available to be awarded to employees, directors or consultants of the Company or any of
its subsidiaries. Under the 2000 plan, options usually vest over a period of three or
four years from the date of grant, in equal parts each year.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
2000 Plan is valid for ten years and will expire on April 3, 2010, except for
options outstanding on that date.
| | -------------------------------------------------------------------------------------------------------------------

| | (c) | In
November 2003, the Board of Directors of the Company adopted the Employee           Share
Option Plan (2003) (hereafter  The 2003 Plan).
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the 2003 plan, options to purchase an aggregate of 2,000,000 ordinary shares are
available to be awarded to employees, directors or consultants of the Company or any of
its subsidiaries.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 33

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 11 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

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

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

| | Through
December 31, 2005, options to purchase 474,848 shares were exercised. The proceeds from
the exercise amounted to $ 102 thousands.
| | -----------------------------------------------------------------------------------------------------------------------------------------

| | The
2000 and 2003 plans are subject to the terms stipulated by Section 102 of the Israeli
Income Tax Ordinance. Inter alia, these terms provide that the Company will be allowed to
claim, as an expense for tax purposes, the amounts credited to the employees as a benefit
in respect of shares or options granted under the plan, as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | These
plans are designed to be governed by the terms stipulated by Section 102 of the Israeli
Income Tax Ordinance. Inter alia, these terms provide that the company will be allowed to
claim, as an expense for tax purposes, the amounts credited to the employees as a benefit
in respect of shares or options granted under the plan.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
amount allowed as an expense for tax purposes, at the time the employee utilizes such
benefit, is limited to the amount of the benefit that is liable to tax as labor income,
in the hands of the employee; all being subject to the restrictions specified in Section
102 of the Income Tax Ordinance.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
aforementioned expense will be recognized in the tax year that the benefit is credited to
the employee.
| | -----------------------------------------------------------------------------------------------------------

F - 34

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 11 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

| | 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, 2005, 2004 and 2003, and changes during the years ended on
          those dates, is presented below:
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                         | Y e a r   e n d e d   D e c e m b e r   3 1
|---------------------------------------- | -------------------------------------------
|
|
|
|
|Options outstanding at beginning of year |                                            
|Changes during the year:                 |                                            
|Granted (1)                              |                                            
|Exercised                                |                                            
|Forfeited                                |                                            
|                                         |                                            
|Options outstanding at end of year       |                                            
|                                         |                                            
|Options exercisable at year end          |                                            
|                                         |                                            
|Weighted average fair value of           |                                            
|options granted during the year (2)      |                                            
|                                         |                                            

| | (1) | 625,000
options granted in 2005 (weighted average exercise price of $0.51 and           fair
value of $ 0.37), 521,000 options granted in 2004 (weighted average
          exercise price of 0.83 and fair value of $ 0.38) and 500,000 options,
          granted in 2003 (weighted average exercise price of $ 0.77 and fair value of $
          0.22), were granted with exercise price that was above market value. All other
          grants were made at market value, or near market value exercise price.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | The
fair value of each option granted is estimated on the date of grant using           the
Black-Scholes option-pricing model with the following weighted average
          assumptions:
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                          | Year ended December 31
| | ------------------------ | ----------------------
|
|
|
|
| | Dividend yield           |                       
| |                          |                       
| | Expected volatility      |                       
| |                          |                       
| | Risk-free interest rate  |                       
| |                          |                       
| | Expected life - in years |                       
| |                          |                       

F - 35

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 10 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

| | (b) | The
following table summarizes certain information about options granted to
          employees which were outstanding and exercisable under the above plans as of
          December 31, 2005:
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Options outstanding | Options exercisable
| | ------------------- | -------------------
|
|
|
|
| | 3.00                |                    
| | 1.68                |                    
| | 1.169               |                    
| | 0.36                |                    
| | 0.48                |                    
| | 0.15                |                    
| | 1                   |                    
| | 0.2                 |                    
| | 0.85                |                    
| | 0.68                |                    
| | 0.83                |                    
| | 1.25                |                    
| | 0.75                |                    
| | 0.8                 |                    
| | 1.2                 |                    
| | 0.7                 |                    
| | 0.5                 |                    
| |                     |                    
| |                     |                    
| |                     |                    

| | c. | Dividends
| | -- | ---------

| | In
the event the Company declares cash dividends, such dividends will be paid in Israeli
currency. Under current Israeli regulations, any cash dividend in Israeli currency paid
in respect of ordinary shares purchased by non-residents of Israel with non-Israeli
currency may be freely repatriated in such non-Israeli currency, at the rate of exchange
prevailing at the time of conversion.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Options
issued to consultants
| | -- | -----------------------------

| | In
May 2005, the Company issued to advisors 50,000 warrants, fully vested with an exercise price
of $1 and 125,000 with vesting period of three years and an exercise price of $0.8.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
September 2005, the Company issue 571,428 warrants, fully vested to bank Mizrahi with an
exercise price of $0.77 and immediate vesting in favor of loan agreement see Note 8.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | All
those warrants were granted above market value and the Company recorded expenses
according to SFAS 123.
| | -----------------------------------------------------------------------------------------------------------

F - 36

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 12 |  | TAXES
ON INCOME
|------- | - | ---------------

| | a. | Corporate
taxation in Israel
| | -- | ----------------------------

| | 1) | Measurement
of results for tax purposes under the Income Tax (Inflationary           Adjustments)
Law, 1985 (the Inflationary Adjustments Law)
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the Inflationary Adjustments Law, results for tax purposes are measured in real terms,
having regard to the changes in the Israeli Consumer Price Index (hereafter  CPI).
The Company and ScanMaster Ltd. are taxed under this law.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
explained in Note 2, the financial statements are measured in dollars. The difference
between the changes in the Israeli CPI and in the exchange rate of the dollar relative to
Israeli currency, both on annual and cumulative bases, creates a difference between
taxable income and income reflected in these financial statements.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Paragraph
9(f) of FAS 109, Accounting for Income Taxes, prohibits the recognition of
deferred tax liabilities or assets that arise from differences between the financial
reporting and tax bases of assets and liabilities that are measured from the local
currency into dollars using historical exchange rates, and that result from changes in
exchange rates or indexing for tax purposes. Consequently, the abovementioned differences
were not reflected in the computation of deferred tax assets and liabilities.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Tax
rates
| | -- | ---------

| | a) | The
income of the Company and ScanMaster Ltd. (other than income from                approved
enterprises, see b. below) are taxed at the regular rate.                Through to
December 31, 2005, the corporate tax was 34%. In July 2004, an
               amendment to the Income Tax Ordinance was enacted. One of the provisions
of this                amendment is that the corporate tax rate is to be gradually
reduced from 36% to                25%, in the following manner: the rate for 2005 will
be 34%, in 2006  31%,                in 2007  29% , 2008  27% , 2009
 26%, 2010  25% and                thereafter.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Pursuant
to another amendment to the Income Tax Ordinance, which became effective in 2003, capital
gains are taxed at a reduced rate of 25% from January 1, 2003, instead of the
regular corporate tax rate at which such gains were taxed until the aforementioned date.
The aforesaid amendment stipulates that with regard to the sale of assets acquired prior
to January 1, 2003, the reduced tax rate will be applicable only for the gain
allocated to capital gains earned after the implementation of the amendment, which will
be calculated, as prescribed by said amendment.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | Subsidiaries
outside Israel
| | -- | ---------------------------

| | 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 29 %.
| | -----------------------------------------------------------

| | Company
incorporated in Republic of Korea  tax rate of 29.7% on taxable income in excess of
100,000 Korean Won (tax rate of 16.5% apply below 100,000 Korean Won).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 37

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 12 |  | TAXES
ON INCOME(Cont.)
|------- | - | ----------------------

| | b. | Tax
benefits under the Law for the Encouragement of Capital Investments, 1959 (hereinafter
 the law)
| | -- | -----------------------------------------------------------------------------------------------------

| | Under
the law, by virtue of the approved enterprise status granted to investments
in certain assets the Company and ScanMaster Ltd. are entitled to various tax benefits.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1) | The
main tax benefits available to the Company and ScanMaster Ltd. are:
| | -- | -----------------------------------------------------------------------

| | (a) | Reduced
tax rates:
| | --- | ------------------

| | (i) | The
Company
| | --- | -----------

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

| | The
Company has four approved enterprises; the benefit period in respect of the first, second
and third enterprises commenced in 1994, 1995, 1997 and 2004, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
periods of benefits for the first and second approved enterprise expired in 2003 and 2004,
respectively.
| | ------------------------------------------------------------------------------------------------------------

| | The
periods of benefits for the third approved enterprises will expire in 2006.
| | -------------------------------------------------------------------------------

| | 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 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).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | ScanMaster
Ltd. has three approved enterprises; the benefit periods in respect of the first and
second enterprises commenced in 1994 and 1997, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
period of tax benefits in respect of the first approved enterprise has expired.
| | -----------------------------------------------------------------------------------

F - 38

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 12 |  | TAXES
ON INCOME(Cont.)
|------- | - | ----------------------

| | The
period of tax benefits in respect of the second approved enterprise will expire in 2008.
The third approved enterprise has not yet been activated.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | (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 thereunder and the
certificate of approval for the specific investments in approved enterprises. In the
event of failure to comply with these conditions, the benefits may be canceled, and
ScanMaster Ltd. and the Company may be required to refund the amount of the benefits, in
whole or in part, with the addition of linkage differences to the Israeli CPI and
interest.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
the event of distribution of cash dividends out of income, which was tax exempt as above,
the companies would have to pay the 25% tax in respect of the amount distributed. For
this purpose, the amount distributed includes the amount of the tax that applies as a
result of the distribution.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Tax
benefits under the Law for the Encouragement of Industry (Taxes), 1969
| | -- | --------------------------------------------------------------------------

| | The
Company and ScanMaster Ltd. are industrial companies as defined by this law
and as such are entitled to certain tax benefits, consisting mainly of accelerated
depreciation as prescribed by regulations published under the Inflationary Adjustments
Law, amortization of patents and certain other intangible property, and the right to
claim public issuance expenses.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Taxes
on income:
| | -- | ----------------

| | 1) | Income
(loss) before taxes on income is composed as follows:
| | -- | ------------------------------------------------------------

| |                     | 2005 | 2004 | 2003
| | ------------------- | ---- | ---- | ----
|
|
|
|
| | Israeli companies   |      |      |     
| | Subsidiaries abroad |      |      |     
| |                     |      |      |     
| |                     |      |      |     
| |                     |      |      |     

F - 39

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 12 |  | TAXES
ON INCOME(Cont.)
|------- | - | ----------------------

| | 2) | 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 (see d1 above), and
the actual expense:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                 | Year ended December 31
| | ----------------------------------------------- | ----------------------
|
|
|
|
| | Income (Loss) before taxes on income            |                       
| |                                                 |                       
| | Theoretical tax benefit on the above amount     |                       
| | Increase in taxes in respect of tax losses      |                       
| | incurred in the reported year for which         |                       
| | deferred taxes were not recorded (see f. below) |                       
| | Other                                           |                       
| |                                                 |                       
| | Actual tax expense                              |                       
| |                                                 |                       

| | Taxes
on income included in the statement of operations relate to Companys subsidiaries.
| | -----------------------------------------------------------------------------------------

| | e. | Deferred
Taxes
| | -- | --------------

| | 1) | The
Company has unutilized carryforward tax losses from prior years. Therefore,           no
current tax liability has been provided in 2005, 2004, and 2003. Virtually           all
the Companys temporary differences are in respect of carryforward tax
          losses. The Company expects that during the period in which its tax losses are
          utilized, its income would be tax exempt, as described in b(a)1) above.
          Accordingly, no deferred tax assets have been included in these financial
          statements in respect of the Companys carryforward tax losses.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | ScanMaster
and Yuravision also have 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 expenses have been included in these           financial
statements, as follows:
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 40

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 12 |  | TAXES
ON INCOME(Cont.)
|------- | - | ----------------------

| |                                | December 31, 2005 | December 31, 2004
| | ------------------------------ | ----------------- | -----------------
|
|
|
|
| | Provision for vacation pay     |                   |                  
| | Accrued severance pay          |                   |                  
| | Carryforward tax losses        |                   |                  
| | Research and development costs |                   |                  
| | Other                          |                   |                  
| | Less - valuation allowance     |                   |                  
| |                                |                   |                  
| |                                |                   |                  
| |                                |                   |                  

The deferred taxes are computed at the average tax rate of 27%  39%.

| | f. | Carryforward
tax losses
| | -- | -----------------------

| | Carryforward
tax losses of the Company and its subsidiaries aggregate approximately $ 21 million
at December 31, 2005.
| | ----------------------------------------------------------------------------------------------------------------------

| | g. | Tax
assessments
| | -- | ---------------

| | Final
tax assessments have been received by the Company through the tax year 2000. ScanMaster
Ltd. and Yuravision received final tax assessments through the tax year 2001 and 1999,
respectively.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 41

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

|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 2r).
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2005, the bank deposits amount to $ 1,810 thousands, out of which $ 1,632 thousands
are linked to the dollar and $ 178 thousands are linked to the Euro;The deposits are
for a period of one Month.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | The
Company has registered floating charges on all of its assets in favor of
               banks, lease companies and Cornell (see Notes 9, 10a2, 11a5 and 15c).
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 15 |  | SUPPLEMENTARY
INFORMATION:
|------- | - | --------------------------

| |                                                | December 31
| | ---------------------------------------------- | -----------
|
|
|
|
| | a.              Accounts receivable            |            
| |                                                |            
| | 1) Trade - allowance for doubtful accounts:    |            
| | Balance at beginning of year                   |            
| | Charged to general and administrative expenses |            
| | Write-off of uncollectible amounts             |            
| | Add - allowance for doubtful accounts in       |            
| | respect of the acquired subsidiaries (Note 3)  |            
| |                                                |            
| | Balance at end of year                         |            
| |                                                |            
| | 2) Other:                                      |            
| | Employees                                      |            
| | Prepaid expenses                               |            
| | Israeli Government departments and agencies    |            
| | Advance to suppliers                           |            
| | Sundry                                         |            
| |                                                |            
| |                                                |            
| |                                                |            

F - 42

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 15 |  | SUPPLEMENTARY
INFORMATION(Cont.)
|------- | - | --------------------------------

| |                                                        | December 31
| | ------------------------------------------------------ | -----------
|
|
|
|
| | b.              Accounts payable and accruals - other: |            
| |                                                        |            
| | Employees and employee institutions                    |            
| | Israeli Government departments and agencies            |            
| | Provision for vacation and recreation pay              |            
| | Provision for product warranty                         |            
| | Liability for commissions to agents                    |            
| | Customer advances                                      |            
| | Commitment to acquire 19% of Yuravision's shares       |            
| | (see Note 3a))                                         |            
| | Accrued expenses and sundry                            |            
| |                                                        |            
| |                                                        |            
| |                                                        |            
| | c.               Credit from banks                     |            

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

| |                                 | % interest rateas ofDecember 31, 2005 | December 31
| | ------------------------------- | ------------------------------------- | -----------
|
|
|
|
| | Unlinked credit from bank       |                                       |            
| | Short-term loans from banks:    |                                       |            
| | Linked to the dollar            |                                       |            
| | Linked to the Euro              |                                       |            
| | Current maturities of long-term |                                       |            
| | loan from banks                 |                                       |            
| |                                 |                                       |            
| |                                 |                                       |            
| |                                 |                                       |            

| | 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 $ 1,750,000;
to secure the credit facilities, the Company registered a floating fixed charge on
certain bank deposits in favor of the said banks (see Note 14a).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 43

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 15 |  | SUPPLEMENTARY
INFORMATION(Cont.)
|------- | - | --------------------------------

| |                                             | December 31
| | ------------------------------------------- | -----------
|
|
|
|
| | d.              Deferred income             |            
| | Revenues to be recognized in future periods |            
| | Applicable product costs                    |            
| | Warranty and other costs                    |            
| | Deferred customer support services          |            
| |                                             |            
| |                                             |            
| |                                             |            
| |                                             |            
| | e.              Cost
of revenues            |            

| |  | 
| |  | 

| |                                                      | Year ended December 31
| | ---------------------------------------------------- | ----------------------
|
|
|
|
|
| | Industrial operations:                               |                       
| | Materials consumed                                   |                       
| | Payroll and related expenses                         |                       
| | Subcontracted work                                   |                       
| | Depreciation and amortization                        |                       
| | Other production expenses                            |                       
| | Royalties (see Note 10a)                             |                       
| | Decrease (increase)  in inventories:                 |                       
| | Finished products                                    |                       
| | Products in process                                  |                       
| |                                                      |                       
| |                                                      |                       
| |                                                      |                       
| |                                                      |                       
| | f.                Research and development expenses: |                       
| | Total expenses                                       |                       
| | Less - grants and participations, see Note 10a1).    |                       
| |                                                      |                       
| |                                                      |                       
| |                                                      |                       
| |                                                      |                       
| | g.                Financial income (expenses)        |                       

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

F - 44

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 16 |  | RELATED
PARTIES
|------- | - | ---------------

| |                                        | 2005 | 2004 | 2003
| | -------------------------------------- | ---- | ---- | ----
|
|
|
|
| | Financing expenses on long-term loan   |      |      |     
| | granted by shareholder - see Note 11a. |      |      |     
| |                                        |      |      |     

|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 acquisitions in 2004, the internal organizational structure changed;
                         consequently, the company has three 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.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (c) | Microelectronics
and Display Inspection segment  develop visual           inspection software and
systems for the microelectronics industry and display           industries.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 45

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 17 |  | BUSINESS
AND GEOGRAPHICAL SEGMENTS(Cont.)
|------- | - | -----------------------------------------

|                                     | AutomaticVisionInspection | Non-DestructiveAutomatedInspection | Microelectronicsand DisplayInspection | Total
|------------------------------------ | ------------------------- | ---------------------------------- | ------------------------------------- | -----
|
|
|
|
|Year ended December 31, 2005:        |                           |                                    |                                       |      
|Revenues from unaffiliated customers |                           |                                    |                                       | 7,505
|Total Consolidated revenues          |                           |                                    |                                       |      
|                                     |                           |                                    |                                       |      
|Segment Operating income (loss)      |                           |                                    |                                       | 1,264
|Unallocated corporate expenses       |                           |                                    |                                       |      
|                                     |                           |                                    |                                       |      
|Operating income                     |                           |                                    |                                       |      
|                                     |                           |                                    |                                       |      
|Segment assets                       |                           |                                    |                                       | 5,835
|Other unallocated amounts            |                           |                                    |                                       |      
|                                     |                           |                                    |                                       |      
|Consolidated assets at the year end  |                           |                                    |                                       |      
|                                     |                           |                                    |                                       |      
|Expenditures for segment assets      |                           |                                    |                                       | 166  
|                                     |                           |                                    |                                       |      
|Total depreciation and amortization  |                           |                                    |                                       | 167  
|                                     |                           |                                    |                                       |      

| | c. | Geographic
information
| | -- | ----------------------

| | 1) | The
Companys revenues by geographic areas (based on locaton of customers)           are
as follows:
| | -- | ----------------------------------------------------------------------------------------------------

| |                                | 2005 | 2004 | 2003
| | ------------------------------ | ---- | ---- | ----
|
|
|
|
| | U.S.A                          |      |      |     
| | Europe                         |      |      |     
| | Other (mainly Japan and China) |      |      |     
| |                                |      |      |     
| |                                |      |      |     
| |                                |      |      |     

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

| |                   | 2005 | 2004
| | ----------------- | ---- | ----
|
|
|
|
| | Israel            |      |     
| | U.S.A             |      |     
| | Republic of Korea |      |     
| |                   |      |     
| |                   |      |     
| |                   |      |     

| | d. | Major
customers
| | -- | ---------------

| | The
following customers accounted or 10% for more of the Companys sales:
| | -------------------------------------------------------------------------

| |            | 2005 | 2004
| | ---------- | ---- | ----
|
|
|
|
| | Customer A | 12%  |     
| | Customer B |      | 18% 

F - 46

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 18 |  | SUBSEQUENT
EVENTS
|------- | - | -----------------

| | 1. | In
January 2006, the Company acquired business, assets and shares of Panoptes
               Ltd. ; Panoptes Ltd. is principally engaged in the design, development,
               manufacturing and marketing automatic vision and quality monitoring
                systems for surface inspection, especially textiles, glass fabric
and technical                woven materials.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company will issue 800,000 shares and pay cash royalties equaling 3.5% of sales of EVS
optical inspection systems between January 2006 and the end of December 2008 to Maaragim
Panoptes controlling shareholder. The transaction is subject to the completion of
certain customary closing conditions.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
February 2006, the Company received convertible loan from Mivtach Shamir
               Holdings Ltd. Mivtach Shamir will provide the Company with a two year $3
million                loan (half of which will be held in escrow until the occurrence of
certain                events), which may, at the option of Mivtach Shamir, be converted
into 6,000,000                ordinary shares of EVS, at a price per share of $0.50. The
Company will repay                the loan in 30 equal monthly installments in the event
that Mivtach Shamir                decides not to convert the loan. The Company also
granted to Mivtach Shamir a                two-year warrant to purchase 4,000,000 of the
Companys ordinary shares at                an exercise price of $0.50 per share,
exercisable only if Mivtach Shamir                converts the loanUnder the terms of the
amendment, the remainder of the loan.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | On
February 17, 2006, the Company repaid all outstanding amounts owed to
               Cornell, and have thus fulfilled all of it obligations toward them under
the                Promissory Note. Following repayment of the Promissory Note, all
ordinary shares                and advance notices held in trust to guarantee the loan
were returned to the                Company, and the floating charge on its assets was
removed.
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F - 47

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