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# UNITED STATES 
SECURITIES 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, 2006
| | -------------------------------------------

# Or

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

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

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

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

Commission File No.

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

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

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

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

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

(Title of Class)



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

None 
(Title of Class)

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

29,516,314 Ordinary
Shares

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

o Yes    x No

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

o
Yes    x No

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

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

Yes x         No o

Indicate
by check mark whether the registrant 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.

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

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                | 13
|         | GENERAL RISKS                                              | 18
|        
|ITEM 4.  | INFORMATION ON THE COMPANY                                 | 20
|         | HISTORY AND DEVELOPMENT OF THE COMPANY                     | 20
|         | BUSINESS OVERVIEW                                          | 26
|         | ORGANIZATIONAL STRUCTURE                                   | 43
|         | PROPERTY, PLANTS AND EQUIPMENT                             | 43
|        
|ITEM 4A. | UNRESOLVED STAFF COMMENTS                                  | 43
|        
|ITEM 5.  | OPERATING AND FINANCIAL REVIEW AND PROSPECTS               | 43
|         | SELECTED FINANCIAL DATA                                    | 43
|         | OPERATING RESULTS                                          | 47
|         | LIQUIDITY AND CAPITAL RESOURCES                            | 52
|         | RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC        | 54
|         | TREND INFORMATION                                          | 55
|         | OFF-BALANCE SHEET ARRANGEMENTS                             | 56
|         | TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS              | 56
|        
|ITEM 6.  | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                 | 56
|         | DIRECTORS AND SENIOR MANAGEMENT                            | 56
|         | COMPENSATION                                               | 59
|         | BOARD OF DIRECTORS                                         | 60
|         | EMPLOYEES                                                  | 62
|         | SHARE OWNERSHIP                                            | 64
|        
|ITEM 7.  | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS          | 67
|         | MAJOR SHAREHOLDERS                                         | 67
|         | RELATED PARTY TRANSACTIONS                                 | 70
|        
|ITEM 8.  | FINANCIAL INFORMATION                                      | 71
|         | CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION    | 71
|         | SIGNIFICANT CHANGES                                        | 72
|        
|ITEM 9.  | THE OFFER AND LISTING                                      | 72
|         | OFFER AND LISTING DETAILS                                  | 72
|         | MARKETS                                                    | 72
|        
|ITEM 10. | ADDITIONAL INFORMATION                                     | 74
|         | MEMORANDUM AND ARTICLES OF ASSOCIATION                     | 74
|         | MATERIAL CONTRACTS                                         | 78
|         | EXCHANGE CONTROLS                                          | 79
|         | TAXATION                                                   | 79
|         | DOCUMENTS ON DISPLAY                                       | 90
|        
|ITEM 11. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 91
|         | FOREIGN CURRENCY EXCHANGE                                  | 91
|         | INTEREST RATE RISK                                         | 92
|        
|ITEM 12. | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES     | 92

4

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|PART II   |                                                                         |   
|--------- | ----------------------------------------------------------------------- | --
|ITEM 13.  | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                         | 92
|         
|ITEM 14.  | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS               
|          | AND USE OF PROCEEDS                                                     | 92
|         
|ITEM 15.  | CONTROLS AND PROCEDURES                                                 | 92
|         
|ITEM 16.  | [RESERVED]                                                              | 93
|         
|ITEM 16A. | AUDIT COMMITTEE FINANCIAL EXPERT                                        | 93
|         
|ITEM 16B. | CODE OF ETHICS                                                          | 93
|         
|ITEM 16C. | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                  | 93
|         
|ITEM 16D. | EXEMPTIONS FROM THE LISTING AND STANDARDS OF AUDIT COMMITTEES           | 93
|         
|ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILLIATED PURCHASERS | 94
|         
|PART III  |                                                                         |   
|         
|ITEM 17.  | FINANCIAL STATEMENTS                                                    | 94
|         
|ITEM 18.  | FINANCIAL STATEMENTS                                                    | 94
|         
|ITEM 19.  | EXHIBITS                                                                | 94
|         

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 penetrating new markets;
| | - | --------------------------------------

| |  | difficulty
in protecting intellectual property;
| | - | -----------------------------------------------

| |  | involvement
in litigation.
| | - | --------------------------

|Risks
related to our ordinary shares:
|-------------------------------------

| |  | need
for additional funding;
| | - | ----------------------------

| |  | prohibitively
large number of ordinary shares;
| | - | ----------------------------------------------

| |  | dilution
of ordinary shares;
| | - | ----------------------------

| |  | downward
pressure on share price;
| | - | ---------------------------------

| |  | restricted
ability to acquire with ordinary shares;
| | - | ---------------------------------------------------

| |  | fluctuations
in share price resulting from limited trading volume;
| | - | ------------------------------------------------------------------

| |  | "penny
stock" sale risks;
| | - | -------------------------

| |  | difficulty
of trading on the OTC bulletin board;
| | - | ------------------------------------------------

| |  | volatility
in the stock market.
| | - | -------------------------------

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

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

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

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

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

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

These
risk factors are discussed in further detail below:

# Risks Related to our
Business

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

Except
for 2005, in which we generated net income of $0.611 million, we have not generated net
income on an annual basis since 1997. We incurred net losses of $1.68 million, $0.98
million, $5.9million and $6.1million in 2002, 2003 ,2004 and 2006,
respectively.

7

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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 2007. 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 Systems
(IRT) Ltd. and IRT ScanMaster Systems Inc., or ScanMaster. A significant portion of
ScanMasters revenues are generated by its sales of non-destructive inspection
systems to the aeronautics industry, providing inspection solutions for aircraft engine
forgings, and aerospace structural elements, manufactured from metal and composite
materials. As such, we are substantially dependent upon the strength of these worldwide
industries, and in particular upon the need by manufacturers to make continuing capital
investments in systems and products, such as those marketed and sold by us, for use in
their production and manufacturing processes. This need is a reflection, in turn, of the
worldwide level of demand for the final products produced by the manufacturers to which we
provide our inspection products. Demand for such products is normally a function of the
prevailing global or regional economic environment and 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 ultrasonic industrial inspection industries, our business
strategy includes selective expansion into other automated inspection applications through
the acquisition of additional businesses and technologies. Our future success and growth
depends upon our successful penetration of these new markets.

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

8

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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 2004 and 2005 one of our customers accounted for 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 2004 and 2005, and in 2006 none of our customers accounted for
more than 10% of our revenues, we expect that sales of our products to relatively few
customers could continue to account for a substantial percentage of our net sales in the
foreseeable future. There can be no assurance that we will be able to retain these key
customers or that such customers will not cancel purchase orders, reschedule, or decrease
their level of purchases. Loss or cancellation of business to these customers could
seriously harm our financial results and business.

We
depend on a limited group of subcontractors and suppliers.

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

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

The
marketing and sales cycle for our 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.

9

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Competition
in the automated inspection industry is intense.

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

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

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

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

10

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

As
is the case with many suppliers of equipment to the automotive, transportation, metal and
textile industries, we often receive a deposit upon receipt of an order, a partial payment
upon delivery or installation and final payment pursuant to negotiated payment terms or
final payment after a trial and/or acceptance period for systems sold subject to a trial
period. The time required for installation and trial varies from customer to customer and
may be delayed by a variety of factors, including the customers production cycle,
integration of systems into the customers manufacturing process, required
modifications to the customers production line and the availability of qualified
technicians to monitor system operations. For systems sold without an evaluation period,
revenue is recognized immediately upon installation of the system. For systems sold
subject to a trial period, revenue is recognized upon customer acceptance. The length of
the customers trial and acceptance period generally varies from one to twelve months
after installation. 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.

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.

11

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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.

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

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

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

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

12

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We
may become involved in litigation.

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

# Risks Related to Our
Ordinary Shares

We
may require additional financing.

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. 241,714 of these warrants have been exercised and the remainder have
expired (for more information, see Item 10, Additional Information 
Material Contracts).

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 June 15, 2007, 417,995 shares have been issued pursuant to such warrants, for a
consideration of $146,298 (for more information, see Item 7, Major Shareholders
and Related Party Transactions  Plan of Arrangement and Warrant Offering).

13

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On
June 21, 2007, we executed an agreement intended to amend our agreement with Mivtach
Shamir, dated February 21, 2006, or the Mivtach Agreement. The new agreement, or the
Amendment Agreement, which is still subject to the approval of our shareholders, was
executed between us and M.S.N.D. Real Estate Holdings Ltd., or M.S.N.D, a wholly owned
subsidiary of Mivtach Shamir, to which Mivtach Shamir had assigned their right to receive
shares from us under the Mivtach Agreement. Pursuant to the Amendment Agreement, the terms
of the Mivtach Agreement and the loan therein, are amended, such that in consideration for
M.S.N.D.s undertaking to convert $3,000,000 by no later than August 1, 2007 (a)
M.S.N.D will be issued with 9,523,810 of our ordinary shares; and (b) M.S.N.D will receive
a 4 year warrant to purchase 2,380,952 of our ordinary shares at an exercise price of
$0.45 per share. We have also agreed, subject to shareholder approval, to file a
registration statement covering all the ordinary shares and ordinary shares underlying the
warrants issuable to M.S.N.D pursuant to the Amendment, by no later than July 31, 2007.
M.S.N.D also agreed to waive its rights to exercise at least 3,000,000 ordinary shares
issuable under the Mivtach Agreement, agreeing to exercise no more than 1,000,000 ordinary
shares issuable under the Mivtach Agreement. Following the Amendment Agreement M.S.N.D
will become a holder of more than 25% of our issued and outstanding share capital. For
more information, see Item 4,Information on the Company  Recent
Developments.

In
addition, on June 21, 2007, following the approval of our board of directors and our audit
committee, we executed with Elbit Ltd., or Elbit, an agreement, or the Elbit Agreement,
the consummation of which is subject to the approval of our shareholders. Pursuant to this
agreement Elbit will (i) convert an existing loan to us in the amount of $470,000
(including accrued interest up until March 31, 2007) into 1,492,063 of our ordinary
shares, at a price of $0.315 per share; and (ii) invest in us $250,000 in consideration
for 793,651 of our ordinary shares at a price of $0.315 per share and will receive a 4
year warrant to purchase 396,825 of our ordinary shares at an exercise price of $0.45 per
share. We have also agreed, subject to shareholder approval, to file a registration
statement covering all of the ordinary shares and ordinary shares underlying the warrants
issuable to Elbit pursuant to the Elbit Agreement, no later than July 31, 2007. For more
information, see Item 4,Information on the Company  Recent
Developments.

Additionally,
in April 2007 we executed a share purchase agreement, or the April Investment, which was
consummated with a series of Israeli institutional investors over the period of April to
June 2007, for the purchase of 6,290,941 of our ordinary shares for $0.315 per share, or
an aggregate price of $1,981,646. Pursuant to the transaction, the investors were also
issued warrants to purchase 3,145,472 of our ordinary shares at an exercise price per
share of $0.45, exercisable for a period of 4 years. We have also agreed, , to file a
registration statement covering all of the ordinary shares and ordinary shares underlying
the warrants issuable to the institutional investors pursuant to the April Investment, no
later than June 31, 2007. For more information, see Item 4,Information on
the Company  Recent Developments.

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. This credit line will terminate on June 30, 2007. We also granted Mizrahi a
warrant to purchase up to 571,429 ordinary shares, at an exercise price of $0.77 per
share. In November 2006 our board approved to reduce the exercise price to $0.5 per share.
The number of our ordinary shares which we may issue pursuant to the warrant may increase
upon certain events, as defined in the warrant. For more information, see Item 4,
Information on the Company  Recent Developments.

14

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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 1, 2007. 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 have an obligation to register, our ability
to complete additional debt or equity financing may be very limited.

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

As
of June 15, 2007, 35,811,827 of our shares were outstanding. In addition, 3,765,955 of our
shares are issuable upon the exercise of the warrants distributed to our shareholders
pursuant to the Warrant Distribution, which shares underlying the warrants are currently
included in our outstanding registration statement.

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 CEO and chairman of the
board, options to purchase up to 600,000 of our ordinary shares at an exercise price of
$0.50 per share. One third of the options vested on December 31, 2006, since which time
2.8% of the total shares subject to the option are vesting on a monthly basis. The vesting
of the options will be subject to Mr. Gal serving as the chairman of our board of
directors on the relevant vesting date, and he shall be entitled to exercise the options
up to 5 years after the options have vested. In addition, 4,109,686 of our ordinary shares
are currently issuable to our present and former employees, directors and consultants upon
the exercise of options granted pursuant to our 1996, 2000, 2003 and 2006 employee option
plans, with varying exercise prices, ranging between $0.15 per share and $1.68 per
ordinary share.

In
addition, pursuant to the Amendment Agreement, which is subject to shareholder approval,
M.S.N.D. has undertaken to convert a $3 million loan into 9,523,810 of our ordinary shares
to M.S.N.D. Additionally, 2,380,952 of our ordinary shares are issuable to M.S.N.D. upon
the exercise of a warrant, with an exercise price of $0.45 per share, exercisable for a
period of 4 years. Assuming approval by our shareholders, we have undertaken to file a
registration statement covering all of these ordinary shares and ordinary shares
underlying the warrants, which have not already been registered, by no later than July 31,
2007. Furthermore, 1,000,000 of our ordinary shares are issuable to M.S.N.D. upon the
exercise of a warrant, with an exercise price of $0.5 per share.

15

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In
addition, in consideration for the acquisition of ScanMaster we paid ScanMasters
former shareholders $3 million in cash and agreed to issue them 7,414,213 of our ordinary
shares, of which 4,044,834 are currently held in escrow and are eligible for release.
2,939,192 of these shares were sold to M.S.N.D., as part of an agreement between some of
ScanMasters former shareholders and Mivtach Shamir. In addition, 800,000 ordinary
shares have been issued to Maaragim Enterprises Ltd, or Maaragim, in
connection with the acquisition of Panoptes, and we granted Mizrahi a warrant to purchase
up to 571,429 of our ordinary shares, at an exercise price of $0.77 per share, which our
board consented to reduce to $0.5 per share, in November 2006. Assuming the release of all
of our ordinary shares from escrow, ScanMasters former shareholders will own
approximately 11.3% of our share capital. Assuming the conversion of the convertible loan
and full exercise of the warrant, M.S.N.D. will hold approximately 26.2% of our share
capital. Furthermore, under the Elbit Agreement, which is still subject to shareholder
approval, we will also issue 2,174,603 ordinary shares and warrants to purchase 396,825 of
our ordinary shares. Subject to approval of our shareholders, we have undertaken to file a
registration statement covering all of these ordinary shares and ordinary shares
underlying the warrants issued or issuable to Elbit, that are not currently registered, by
no later than July 31, 2007. Additionally, under the April Investment 3,145,472 of our
ordinary shares are issuable to Israeli Investors upon the exercise of warrants, and we
have undertaken to file a registration statement covering all of the ordinary shares
underlying these warrants by no later than July 31, 2007.

Consequently,
the following securities are registered for re-sale or we have undertaken to register:

| | (a) | 5,099,911
ordinary shares issued under 2004 Private Placement Investments;
| | --- | --------------------------------------------------------------------------

| | (b) | 3,765,955
ordinary shares underlying Warrant Distribution;
| | --- | ----------------------------------------------------------

| | (c) | 1,390,369
ordinary shares issuable to employees under 1996, 2000 employee option
               plans;
| | --- | ------------------------------------------------------------------------------------------------------

| | (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) | 9,523,810
ordinary shares to be issued upon conversion of convertible loan, as
               amended by Amendment Agreement (subject to shareholder approval), and
2,380,952                shares to be issued to M.S.N.D. upon exercise of the warrant
therein. We have                undertaken to file a registration statement covering all
of these ordinary                shares and ordinary shares underlying the warrants by no
later than July 31,                2007 (for more information, see Item 4,Information
onthe Company  Recent Developments);
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (g) | 2,647,643
ordinary shares held by Elbit and with respect to which we have
               undertaken, subject to shareholder approval, to file a registration
statement                covering all of these ordinary shares by no later than July 31,
2007 (for more                information, see Item 4,Information on the
Company                RecentDevelopments);
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (h) | 2,285,714
ordinary shares to be issued under the Elbit Agreement, and 396,825                shares
to be issued to Elbit upon exercise of the warrant (all of which are
               subject to shareholder approval). We have undertaken to file a
registration                statement covering all of these ordinary shares and ordinary
shares underlying                the warrants by no later than July 31, 2007 (for more
information, see Item                4,Information on the Company  Recent
               Developments);
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (i) | 6,290,941
ordinary shares issued under April Investment as well as 3,145,472                shares
to be issued upon exercise of the warrants issued to Israeli                institutional
investors, which we have undertaken to file a registration                statement
covering an aggregate of at least 7,260,000 of these ordinary shares                and
ordinary shares underlying the warrants by no later than July 31, 2007 (for
               more information, see Item 4,Information on the Company
Recent Developments);
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

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

Our
ordinary shares are traded on the Over-the-Counter Bulletin Board. Trading in our ordinary
shares has been limited and there can be no assurance that an active trading market for
our ordinary shares will develop. As a result, this could adversely affect our
shareholders ability to sell our ordinary shares in short time periods, or possibly
at all. Thinly traded ordinary shares can be more volatile than ordinary shares traded in
an active public market. The average daily trading volume of our ordinary shares in June
2007 was 14,281 shares. The high and low bid price of our ordinary shares for the last two
years has been $0.83 and $0.22, respectively. Our ordinary shares have experienced, and
are likely to experience in the future, significant price and volume fluctuations, which
could adversely affect the market price of our ordinary shares without regard to our
operating performance.

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

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

| | 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.

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

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

Our
results are affected by volatility in the securities markets.

Due
to the 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.

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From
October 2000 until recently, there was an increase in violence between Israel and the
Palestinians, primarily but not exclusively in the West Bank and Gaza Strip. The election
of representatives of the Hamas militant group in January 2006 to a majority of seats in
the Palestinian Legislative Council as well as the war with the Islamic militant group
Hezbollah in Lebanon in July and August 2006 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. We
cannot give any assurance that security and political conditions will not have such an
effect in the future. Any future armed conflicts or political instability in the region
would likely negatively affect business conditions and harm our results of operations.

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

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

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

19

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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.

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

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

20

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

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

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

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

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

| | Train
wheels and train railways
|- | -------------------------------

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

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

| | 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.

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

In
June 2004, we also purchased Yuravision Co. Ltd., or Yuravision, a company in the
microelectronics and flat-panel display industries. In 2006 our board of directors and
management decided to focus on existing markets rather than continue developing our
microelectronics technologies. As a result, on December 1, 2006, we executed an agreement
with a Korean corporation for the sale of Yuravision.

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

21

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# Recent Developments

Since
January 1, 2006, the following important events have occurred to us:

Sale of Yuravision

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

Amendment to Convertible
Loan Agreement with Mivtach Shamir

On
February 21, 2006, we consummated the Mivtach Agreement. Pursuant to the agreement,
Mivtach Shamir provided us with a two year $3 million loan, which Mivtach Shamir was
entitled at its sole discretion, for a period of 24 months following the provision of the
loan, to convert into 6,000,000 of our ordinary shares, at a price per share of $0.5 (half
the loan 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 is repaid on a
quarterly basis. We also granted Mivtach Shamir a two-year warrant to purchase 4,000,000
of our ordinary shares at an exercise price of $0.5 per share, exercisable only if the
loan was converted. On February 21, 2006, Mivtach Shamir assigned their right to receive
shares from us, under the convertible loan and warrant, to M.S.N.D. On June 21, 2007 we
executed an agreement with M.S.N.D. pursuant to which, the Mivtach Agreement will be
amended, subject to shareholder approval. Pursuant to the Amendment Agreement, the terms
of the Mivtach Agreement and the loan therein, are amended, such that in consideration for
M.S.N.D.s undertaking to convert the full loan amount by no later than August 1,
2007 (a) Mivtach Shamir will be issued with 9,523,810 of our ordinary shares; and (b)
Mivtach Shamir will receive a 4 year warrant to purchase 2,380,952 of our ordinary shares
at an exercise price of $0.45 per share. Mivtach Shamir also agreed to waive its rights to
exercise at least 3,000,000 ordinary shares issuable under the Mivtach Agreement, agreeing
to exercise no more than 1,000,000 ordinary shares issuable under the Amendment Agreement.
Following consummation the Amendment Agreement M.S.N.D, will become a holder of more than
25% of our issued and outstanding share capital. We also entered into a Registration
Rights Agreement with M.S.N.D., undertaking to file a registration statement covering all
of the ordinary shares and ordinary shares underlying the warrants under the Amendment
Agreement, which have not previously been registered, by no later than July 31, 2007.

22

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

Agreement with Elbit

On
June 21, 2007, following the approval of our board of directors and our audit committee,
we executed an agreement with Elbit, or the Elbit Agreement, the consummation of which is
subject to the approval of our shareholders. Pursuant to this agreement Elbit will (i)
convert an existing loan to us in the amount of $470,000 (including accrued interest up
until March 31, 2007) into 1,492,063 of our ordinary shares, at a price of $0.315 per
share; and (ii) invest in us $250,000 in consideration for 793,651 of our ordinary shares
at a price of $0.315 per share and will receive a 4 year warrant to purchase 396,825 of
our ordinary shares at an exercise price of $0.45 per share. At consummation we will pay
all interest accrued on the loan between April 1, 2007 and the closing date.

Within
the framework of the Elbit Agreement, we have, by way of a registration rights agreement,
undertaken to file a registration statement covering all of the ordinary shares and
ordinary shares underlying the warrants issued pursuant to the Elbit Agreement with the
Securities and Exchange Commission by no later that July 31, 2007, or the Registration
Statement.

Amendment to Registration
Rights Agreement with Elbit

Following
the Elbit Agreement, on January 1, 2007, we executed an amendment, or the Amendment, to an
existing registration rights agreement, or the First Elbit Agreement, which was approved
by our shareholders on November 20, 2006, pursuant to which we agreed to register
2,647,643 of our ordinary shares beneficially owned by Elbit prior to the First Elbit
Agreement, or the Original Elbit Shares, by no later than September 30, 2007. Pursuant to
the Amendment, we have undertaken to file a registration statement covering the Original
Elbit Shares, no later than July 31, 2007. In the event that the SEC requires a reduction
in the number of our securities which can be registered in the Registration Statement, and
all or part of the Original Elbit Shares are excluded from the Registration Statement, the
Amendment provides our undertaking to file a further registration statement covering the
Original Elbit Shares as soon as practicably possible after such Original Elbit Shares,
are permitted to be covered by a new registration statement. Additionally, we agreed to
pay Elbit a penalty in the event that it (i) fails to comply with its registration
obligations as described in this paragraph; (ii) fails to respond to any comments on a
registration statement by the SEC within 30-days or (iii) fails to maintain a registration
statement covering the Original Elbit Shares. The penalty will be an amount in cash equal
to 1% of the product of the number of shares required to be covered by the registration
statement which is the subject of the failure, multiplied by US$0.315, for each month
during which the failure continues or a prorated daily amount for a period of less than a
month.

23

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Private Placement with
Israeli Investors

In
June 2007 we completed the April Investment with a group of Israeli institutional
investors, or the Israeli Investors, for the purchase of 6,290,941 of our ordinary shares
for $0.315 per share, of an aggregate price of $1,981,646. Pursuant to the transaction,
the investors were also issued warrants to purchase 3,145,472 of our ordinary shares at an
exercise price per share of $0.45, exercisable for a period of 4 years. We have undertaken
to file a registration statement covering all of the ordinary shares and ordinary shares
underlying the warrants issuable under the April Investment by no later than July 31,
2007. Additionally, we agreed to pay the Israeli Investors a penalty in the event that
they (i) fail to comply with their registration obligations as described in this
paragraph; (ii) fail to respond to any comments on a registration statement by the SEC
within 30-days or (iii) fail to maintain a registration statement covering the shares
underlying the April Investment. The penalty will be an amount in cash equal to 1% of the
product of the number of shares required to be covered by the registration statement which
is the subject of the failure, multiplied by US$0.315, for each month during which the
failure continues or a prorated daily amount for a period of less than a month.

Appointment of External
Director and Option Grant

On
March 16, 2007, the statutory 3 year term of Mr. Zahi Dekel as an external director ended
and at the meeting of our shareholders on April 19, 2007, the shareholders approved the
appointment of Mr. David Schwartz as our new external director. The shareholders also
approved the grant of 30,000 options to each of Mr. David Schwartz and Mr. Yuval Berman
(our currently serving external director), at an exercise price which shall be equal to
the fair market value of the Companys ordinary shares on the date of grant.

Appointment of Chief
Financial Officer

On
December 26, 2006, we announced the appointment of Mr. Yaron Menashe, as our Chief
Financial Officer effective December 26, 2006.

Appointment of Chief
Executive Officer

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
vested on December 31, 2006 and since which time 2.8% of the total shares subject to the
option are vesting on a monthly basis. The vesting of the options is 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.

At
the annual general meeting of our shareholders held on November 20, 2006, our shareholders
approved the appointment of Mr. David Gal as our Chief Executive Officer, in addition to
his service as Chairman of our Board of Directors. Due to his additional responsibilities
as Chief Executive Officer, our audit committee and board of directors approved, subject
to shareholder approval, an increase in the monthly fee payable to MEO Consulting, a
company controlled by Mr. David Gal, of $21,500 plus Value Added Tax to be payable from
January 1, 2007.

24

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Consulting Agreement with
MA&AT

On
November 20, 2006, following shareholder approval, we executed a consulting agreement with
MA&AT, an Austrian company which receives services from, but is not controlled by, Mr.
Nir Alon (a member of our board of directors), which includes the the provision of
consulting services by Mr. Alon to us. Pursuant to the agreement, Mr. Alon will promote
sales of our Automatic Optical Inspection products in China in consideration for: (i) a
monthly fee of $10,000, (ii) a commission on sales made by us of our Automatic Optical
Inspection products in China, unless Mr. Alon was not involved is such sale, as follows:
(A) 1.5% of all proceeds received by us from such sales, or Proceeds, until we receive
Proceeds in an aggregate amount equal up to $2,000,000; (B) 2% of all Proceeds greater
than $2,000,000 until we receive Proceeds in an aggregate amount equal to $4,000,000; and
(C) 5% of all Proceeds greater than $4,000,000, (iii) reimbursement of reasonable expenses
incurred in connection with the performance of the consulting services, and (iv) a car
provided for the purpose of fulfilling the consulting services.

Legal Claim in India

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

Reorganization Plan

On
October 25, 2006 we announced that our board of directors has approved a reorganization
plan for the Company, which included: (i) accepting the resignation of our chief executive
officer, Mr. Menashe Shohat who will remain a member of the board of directors, and
appointing Mr. David Gal, chairman of the board of directors as the chief executive
officer, which appointment is subject to shareholder approval; (ii) recruiting a new chief
operations officer, and other key members of the management team; and (iii) consolidating
all of our and ScanMasters Israeli activities into one location.

Acquisition of Panoptes

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

25

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Loan from Mizrahi Bank

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

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

# B. Business Overview

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

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

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

ScanMaster Ltd. has made more than
600 equipment installations in 26 countries, for a total 12-year sales volume exceeding
$74 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.

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:

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| |  | 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 Body High-speed, precision ultrasonic inspection of bars.
|- | ------------------------------------------------------------------

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

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

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

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

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

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

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

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

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

Product Overview

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

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

| | 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/Mateinnovatively
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.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

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| | 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
200eHigh-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 $2,000,000.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Product
Inspection Systems

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

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

| | SFB-100 High-Speed
Rail Inspection System. A fully integrated ultrasonic inspection car fitted with complete
mechanical hardware such as transducer sled and a sophisticated couplant provision
system. The system includes high volume digital data acquisition, imaging, process and
evaluation. Powerful software features include prediction of the inspected parts
degradation and defect propagation, generation of custom & standard reporting and
analysis. The average net transfer price is $1,300,000.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | SFB-50  A
Train Rail Inspection System, mounted on a multi purposed car (Hi-Rail) or towed by a
service car. Ultrasonic inspection intended for detection, imaging and evaluation of
flaws. The average net transfer price is $350,000.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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Software

| | CSI
SoftwareC-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 600 installations in 26 countries. Each territory is covered by a professional
representative, who is responsible for pre-sale activity through to warranty service. In
addition, the Company conducts its North American operations by way of a fully owned
subsidiary.

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 Kadima, together with our facilities. Together we currently lease 2880 m2.
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.

|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.

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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.

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.

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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.

|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.

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

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

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

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

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

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

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

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

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

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

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

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

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

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The EVS Solution for the
AOI

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

Products

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

IQ-TEX
Family of Products

The IQ-TEX family of automatic web
inspection systems is designed to provide textile manufacturers with a comprehensive
solution to their quality monitoring, grading and cutting needs. IQ-TEX systems detect
numerous types of defects on any unicolor web, including: yarn and weaving faults; holes;
oil, water and dye stains; missing threads; starting marks; broken yarn; and dyeing,
coating and finishing irregularities. They then provide the manufacturer with information
regarding the location, size and shape of the defect. Depending on the model, IQ-TEX
systems can detect defects as small as 0.5 mm on a variety of web widths ranging from 150
to 600 centimeters, at maximum speeds ranging from 10 to 800 meters per minute. In
addition, IQ-TEX systems can be configured to mark defects during inspection and advise
the user as to the most efficient manner to cut web to eliminate unacceptable defects.

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

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Quality
Monitoring Process

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

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

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

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

Models

IQ-TEX systems are currently
available in two basic models: IQ-TEX 2000, I-TEX 2000D, I-TEX Lite and IQ-TEX Lite. Both
models include improved capabilities for the detection of defects, as well as additional
innovative technologies for system styles tuning and defects sorting. The 2 models cover a
full range of applications.

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

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

Modules

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

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

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

| | reviewing
and editing of defect data;
|- | -------------------------------------

| | generation
of management reports;
|- | ---------------------------------

| | archiving
of defect data; and
|- | -----------------------------

| | definition
of points of interest and mandatory cutting points for the cutting table and DMSS system.
|- | ----------------------------------------------------------------------------------------------------

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

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

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

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

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

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

| | contains
a trigger for invisible ink or metallic label defect marking signs; and
|- | --------------------------------------------------------------------------------

| | operates
the roll cutting device following the cut optimization results.
|- | ------------------------------------------------------------------------

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

Accessories

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

Broken
Filaments Analyzer (BFA)

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

The BFA utilizes proprietary
processing and software technology, cameras and lighting systems to inspect glass web in
real-time at speeds exceeding 120 meters per minute. The broken filaments detected by the
BFA are displayed on a monitor that shows the running map of the fabric in real time, and
are recorded for further analysis. The BFA produces a detailed report of each web roll,
showing the broken filaments distribution in the roll, its statistics and the
fabrics grading. The BFA is integrated with the IQ-TEX 100 system, which can be used
for the detection of other defects in glass fabrics, and with the Video Album to provide a
more comprehensive solution to the visual inspection and quality monitoring of glass
fabrics. The BFA can also be used for the detection of surface defects in other fabrics or
webs including airbags and technical fabrics. The list price for the BFA system ranges
between $90,000 and $130,000, depending on the configuration.

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 IQ-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 IQ-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 IQ-TEX system reports or into a separate SVA LITE report. The list price of the
SVA LITE is between $70,000 and $150,000.

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

Sales Network

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

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

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

IQ-TEX
Inspected Standard

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

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Relationships with
Leading Equipment Manufacturers

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

Sales by Principal
Markets and Activities

In 2004, approximately 27.8% of our
consolidated sales were in the United States, approximately 46.9% were in Europe, and
approximately 25.3% were in the Far East. In 2005,approximately 31.48% of our
sales were in the United States, approximately 21.2% were in Europe, and approximately
46.1% were in the Far East.In 2006,approximately 22.8% of our sales were
in the United States, approximately 40.1% were in Europe, and approximately 37.1% were in
the Far East.One customer accounted for 18% and 12% in each of the years, 2004,
and 2005 respectively. No other customers accounted for more than 10% of our net sales in
any of the years 2004, 2005 or 2006. 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. 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
|-- | -------------------------------

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

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

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

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

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

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

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

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

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

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

Significant and protracted litigation
may be necessary to protect our intellectual property rights, to determine the scope of
the proprietary rights of others or to defend against claims of infringement. Item 8,
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.

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.

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# C. Organizational
Structure

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

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

For more information on the
ScanMaster and Panoptes transactions, see Item 4, Information on the Company
 History and Development of the Companyand Item 10, Additional
Information  Material Contracts.

# D. Property, Plants and
Equipment

Our facilities, together with
ScanMaster Ltd.s facilities, are located at 1 Hayasur Street, Hasharon Industrial
Park, Kadima, P.O.B. 5030, Israel. We do not own any real property. Together we lease
approximately 9,449 square feet at our facilities in Israel, at an annual rent of
approximately $320,000. Our lease expires in November 2009. 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 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.

|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 year ended December 31, 2002,  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. In 2002,
Luboshitz Kasierer,  which had been a member of the firm Arthur Andersen,  independent public accountants,
became a  member  firm of  Ernst & Young  International.  The  selected  financial  data as of and for the
years  ended   December  31,  2004  and  December  31,  2003,   before  the  effects  of   adjustments  to
retrospectively  reflect the  discontinued  operation  (describes in financial  statements  for year ended
December  31, 2006 (see note 3a)),  is derived  from our  audited  financial  statements,  which have been
audited  by  Kesselman  &  Kesselman,   a  member  firm  of   PricewaterhouseCooper,   independent  public
accountants,  and which are included  elsewhere in this report.  The selected financial data for the years
ended  December 31, 2006 and December 31, 2005 are derived from the  financial  statements  that have been
audited by  Brightman  Almagor & Co., a member of Deloitte  Touche  Tohmatsu,  independent  auditors.  Our
financial  statements  have been prepared in accordance with U.S. GAAP. The financial data set forth below
should  be  read in  conjunction  with  the  financial  statements,  related  notes  and  other  financial
information  contained in this annual report.  For discussion of our  significant  accounting  principles,
see Note 1 of our Consolidated Financial Statements incorporated herein by reference.

43

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|                                                                   | 2006* | 2005* | 2004* | 2003   | 2002
|------------------------------------------------------------------ | ----- | ----- | ----- | ------ | ----
|
|
|
|
|(in U.S. thousand Dollars )                                        |       |       |       |        |     
|Statement of Operations Data:                                      |       |       |       |        |     
|Net sales                                                          |       |       |       | 16,977 |     
|Cost of sales                                                      |       |       |       | 12,236 |     
|Gross profit (loss)                                                |       |       |       | 4,761  |     
|Research and development expenses, net                             |       |       |       | 2,562  |     
|Marketing and selling expenses, net                                |       |       |       | 4,149  |     
|General and administrative expenses                                |       |       |       | 1,870  |     
|Reorganization expenses                                            |       |       |       | 200    |     
|Total operating expenses                                           |       |       |       | 8,781  |     
|Operating profit (loss)                                            |       |       |       | (4,020 | )   
|Other income                                                       |       |       |       | (5     | )   
|Financing income (expenses), net                                   |       |       |       | (1,332 | )   
|Profit (loss) before taxes                                         |       |       |       | (5,357 | )   
|Taxes on income                                                    |       |       |       | 5      |     
|Income (loss) from continuing operations                           |       |       |       | (5,362 | )   
|Loss from operations of discontinued component                     |       |       |       | (180   | )   
|Net loss of disposal of discontinued operation                     |       |       |       | (551   | )   
|Net loss                                                           |       |       |       | (6,093 | )   
|Basic earnings (loss) per share from continuing operations (1)     |       |       |       | (0.186 | )   
|Diluted earnings (loss) per share from continuing operations (1)   |       |       |       | (0.186 | )   
|Basic earnings (loss) per share from discontinued operations (1)   |       |       |       | (0.026 | )   
|Diluted earnings (loss) per share from discontinued operations (1) |       |       |       | (0.026 | )   
|Basic earnings (loss) per share (1)                                |       |       |       | (0.212 | )   
|Diluted earnings (loss) per share (1)                              |       |       |       | (0.212 | )   
|Weighted average number of shares outstanding-Basic (1)            |       |       |       | 28,778 |     
|Weighted average number of shares outstanding-Diluted (1)          |       |       |       | 28,778 |     
|                                                                   |       |       |       |        |     

|                     | 2006 | 2005 | 2004 | 2003    | 2002
|-------------------- | ---- | ---- | ---- | ------- | ----
|
|
|
|
|Balance Sheet Data:  |      |      |      |         |     
|Working capital      |      |      |      | (6,073  | )   
|Total assets         |      |      |      | 19,390  |     
|                     |      |     
|Total liabilities    |      |      |      | 18,389  |     
|Accumulated deficit  |      |      |      | (29,936 | )   
|Shareholders' equity |      |      |      | 1,001   |     

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

*     The
financial data contained in this table has been adjusted to take into account the
discontinued operations of our former subsidiary Yuravision. For further information see
Note 3(a) to our financial statements for the year ending December 31, 2006, contained
elsewhere in this report.

44

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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.

45

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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.

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.

46

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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.

# 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:

47

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| |                                        | 2006* | 2005* | 2004*
| | -------------------------------------- | ----- | ----- | -----
|
|
|
|
| | Net sales                              |       |       |      
| | Cost of sales                          |       |       |      
| | Gross profit                           |       |       |      
| | Research and development expenses, net |       |       |      
| | Marketing and selling expenses, net    |       |       |      
| | General and administrative expenses    |       |       |      
| | Reorganization expenses                |       |       |      
| | Total operating expenses               |       |       |      
| | Operating income (loss)                |       |       |      
| | Other expenses                         |       |       |      
| | Financing expenses, net                |       |       |      
| | Income (loss) before taxes             |       |       |      
| | Income taxes                           |       |       |      
| | Discontinued operation                 |       |       |      
| | Net Income (loss)                      |       |       |      

*     The
financial data contained in this table has been adjusted to take into account the
discontinued operations of our former subsidiary Yuravision. For further information see
Note 3a to our financial statements for the year ending December 31, 2006, contained
elsewhere in this report.

# Year Ended December 31,
2006 Compared with Year Ended December 31, 2005

# Sales

Sales in 2006 decreased by
approximately 13% to $17 million compared with sales of $19.58 million in 2005. This
decrease was primarily attributable to loss of the Indian railways project which took
management attention during 2006.

# 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 72% in 2006 compared with 59.4% in 2005. The increase in
cost of revenues in 2006 is mainly due to the loss of the Indian Project which caused a
one time write off of inventories and other expenses due to the project, we also recorded
an inventory write off in an amount of $400,000 related to parts we used with respect to
the old technology.

# Gross Profit

In 2006 we earned a gross profit of
$4.7 million as compared to a gross profit of $7.9 million in 2005. Gross profit as a
percentage of net sales was 28 % in 2006 as compared to 41.2% in 2005. The decrease in our
gross profit in 2006 is mainly due to the loss of the Indian Project and the one time
inventory write off.

# 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 $2.707 million in 2006 from $2.193 million in 2005, and were offset by Israeli
government grants of $0.145 million in 2006 and $0.154 million in 2005. Net research and
development expenses in 2006 were $2.56 million compared with $2.04 million in 2005. The
increase in the gross research and development expenses was mainly due to the efforts in
integrating the new Panoptes Technology in our vision products. For more information, see
Item 4, History and Development of the Company  Recent Information.

48

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# 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 $4.15 million in 2006, compared to $3.58 million in 2005. The increase in the
marketing and sales expenses was primarily due to efforts we made in increasing our market
share and penetration of new markets with our new Panoptes Technology.

# General and
administrative Expenses

General and administrative expenses
consist of payroll and related expenses, doubtful and bad accounts, professional fees paid
to auditors, legal advisors and other consultants and other related expenses. As a
percentage of net sales, general and administrative expenses increased to 11% in 2006 from
5.7% in 2005. General and administrative expenses in 2006 were $1.87million, compared to
$1.13 million in 2005. The increase in expenses in 2006 was primarily attributable to the
recruiting of new management For more information, see Item 4, History and
Development of the Company  Recent Information.

# Financial Expenses

Financial expenses consist primarily
of interest on our loans from banks and from two of our major shareholders Elbit and
Mivtach Samir. 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 2006 were $1.33 million, compared to financial expenses of $0.43 million in
2005. During 2005 and 2006, we financed our operations using a credit line facility
provided to us by our bank. The increase in financial expenses was primarily due to loan
we received Mivtach Shamir, and the increase of our bank loans in order to finance the
constant growth of our backlog.

# Profit/Loss

In 2006 we recorded net loss of
$6.1million, as compared to a $0.61 million net profit in 2005. This was primarily due to
the decrease in our revenues, loss of the Indian Project and the loss from selling
Yuravision.

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

Sales in 2005 increased by
approximately 88% to $19.6 million compared with sales of $10.4 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 88% to $15.4 million compared with sales of $8.2 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.

49

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Sales of service and spare parts
increased by approximately 88% 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 59.4% in 2005 compared with 77.3% 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
$7.9 million as compared to a gross profit of $2.4 million in 2004. Gross profit as a
percentage of net sales was 40.6% in 2005 as compared to 22.7% 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.

# 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 $2.2 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 $2.0 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 $3.6 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 5.8% in 2005
from 17.5% in 2004. General and administrative expenses in 2005 were $1.1 million,
compared to $1.8 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.

50

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---



# 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 $0.44 million, compared to financial expenses of $0.36 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.

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.

The exchange rate between NIS and the
U.S. Dollar has fluctuated during the past twelve months from a high of NIS 4.524 to the
Dollar to a low of NIS 3.932 to the Dollar. The high and low exchange rates between the
NIS and U.S. Dollar during the six most recent months, as published by the Bank of Israel,
were as follows:

| | MONTH         | HIGH
1 U.S. dollar = | LOW
1 U.S. dollar =
| | ------------- | -------------------- | -------------------
|
|
|
|
| | December 2006 |                      |                    
| | January 2007  |                      |                    
| | February 2007 |                      |                    
| | March 2007    |                      |                    
| | April 2007    |                      |                    
| | May 2007      |                      |                    
| | June 2007     |                      |                    

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

| | Period                              | Exchange Rate
| | ----------------------------------- | -------------
|
|
|
|
| | January 1, 2002 - December 31, 2002 | 4.7363 NIS/$1
| | January 1, 2003 - December 31, 2003 | 4.5124 NIS/$1
| | January 1, 2004 - December 31, 2004 | 4.4833 NIS/$1
| | January 1, 2005 - December 31, 2005 | 4.5026 NIS/$1
| | January 1, 2006 - December 31, 2006 | 4.4565 NIS/$1

During 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%. In 2006, the Israeli economy recorded negative inflation of
approximately 0.1% where the NIS revalued against the U.S. dollar by approximately 8.21%.
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.

# B. Liquidity and Capital
Resources

Prior to our initial public offering,
our principal source of financing for our operations and working capital requirements were
loans from Elbit and grants from the Government of Israel. In July 1996, we raised
approximately $15.7 million, net of expenses, through the initial public offering of our
securities. Since our initial public offering, we have financed our operations primarily
through (i) cash reserves, (ii) cash generated from operations, (iii) grants from the
Government of Israel (iv) the use of a bank credit line (v) receipt of a convertible loan,
and (vi) private placement of our securities. As of December 31, 2006, we had
negative working capital of $6.1 million.

52

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We anticipate that we will continue
to incur significant operating expenses in connection with the development and marketing
of our products. 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
increased to $1 million at the end of 2006 compared to $0.7 million recorded at the end of
2005. Short term restricted deposits decreased to $0.7 million at the end of 2006 compared
to $1.8 million recorded at the end of 2005. The changes were mainly due to loss of the
Indian Project and the withdrawal of the bank guarantees given to RDSO. For more
information, see Item 4, History and Development of the Company  Recent
Information. 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
2006 we had negative cash flow from operational activity of $4.47 million, the negative
cash flow was mainly due to the losses in connection with the Indian Project and the
decrease in our sales.

Our inventories decreased from $4.6
million as of December 31, 2005 to $4 million as of December 31, 2006,
reflecting our close managerial controls on inventories and one time reduction of $0.4
million during 2006 relating the old technology. Inventories as a percentage of revenues
as of December 31, 2006, have remained unchanged compared with 23.3% as of
December 31, 2005.

The discussions regarding the Convertible Loan Agreement with Mivtach Shamir and the
Amendment Agreement, the April Investment, and the Elbit Agreement are hereby incorporated
by reference to Item 4, Information on the Company  Recent
Developments. The discussion on the April Investment is hereby incorporated by
reference also to Item 10 Additional Information  Material
Contracts.

Borrowing

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

Capital Expenditure

The discussion regarding the
ScanMaster and Panoptes acquisitions and the Yuravision acquisition and sale are hereby
incorporated by reference to Item 4, Information on the Company  History
and Development of the Companyand Item 10, Additional Information
 Material Contracts.

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

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

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

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.

As of May 2007, our research and
development staff consisted of 29 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 14 full
time employees, and our research and development staff for the ultrasonic industry
consisted 15 full time employees. In 2004 our gross research and development expenditures
for the web industry were approximately $1.9 million, in 2005 they were $2.3 million and
in 2006 they were $1.4 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 $45,000, $154,000 and $145,000 in each of 2004, 2005, and 2006,
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.

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

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

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

| |                                             | 2006 | 2005 | 2004
| | ------------------------------------------- | ---- | ---- | ----
|
|
|
|
| | (in thousands)                              |      |      |     
| | 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.

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.

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# E. Off-Balance Sheet
Arrangements.

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

# F. Tabular Disclosure of
Contractual Obligations

Our significant financial and
contractual obligations as of December 31, 2006, and the periods in which such
obligations are due are as follows:

|                                     | Payments and Amount of Commitment Expiration Per Period
(U.S. Dollars in thousands)
|------------------------------------ | -----------------------------------------------------------------------------------
|
|
|
|
|Operating Car Lease Obligations      |                                                                                    
|Operating Building Lease Obligations |                                                                                    
|Total commercial commitments         |                                                                                    

G.
          Safe Harbor. Not applicable

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

# A. Directors and Senior
Management

As of May 31, 2007, our directors,
senior managers and key employees were as follows:

| | Name            | Age | Position                                              
| | --------------- | --- | ------------------------------------------------------
|
|
|
|
| | David Gal *     | 51  | Chairman of the Board                                 
| | Ofer Sela*      | 37  | Vice President of research & development              
| | Yaron Menashe*  | 31  | Vice president, Chief Financial Officer and Secretary 
| | Benjamin Mano*  | 61  | Vice President of Sales & Marketing                   
| | Hillel Avni*    | 68  | Vice President of Electronic Inspection Division      
| | Ron Mahler *    | 58  | VP UT Sales and Marketing and Chief Technology Officer
| | Yuval Berman*   | 40  | External Director                                     
| | David Schwartz* | 57  | External Director                                     
| | Menashe Shohat  | 48  | Chief Executive Officer and Director                  
| | Nir Alon        | 44  | Director                                              
| | Linda Harnevo*  | 51  | Director                                              

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

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David Gal  was
appointed as chairman of the board of directors on March 2, 2006. 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.

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

Yaron Menashe has served as our chief financial officer since December 2006. Between the
years2000 and 2003, Mr. Menashe worked as a senior auditor at KPMG. Mr. Menashe holds a bachelors degree in economics and accounting from
the Haifa University, Israel and is a Certified Public Accountant in Israel.

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. Mano holds a B.Sc. in electrical engineering from the Technion.

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

Ron Mahler
served as a marketing consultant and sales manager for ScanMaster  between
the years 1997 and 2006. During these years Mr. Mahler served as a director in
AD&D (currently owned by Elbit Ltd.) and in Be Free Systems Ltd. and as the
Chairman of the Board of Directors of Ensemble Herzeliya. From 1994 until 2006 Mr. Mahler
served as a managing director of U.R. Malram and was involved in several start up
companies as marketing and business manager. Between the years 1991 and 1994 Mr.
Mahler served as a marketing manager of the systems division of IMI. Between the years
1987 and 1991 he served as a marketing director at IMI USA in Washington DC, and
between 1981 and 1987 he was the head of the development department of IMI Weapon
division. Mr. Mahler holds a B.Sc in mechanical engineering from the Technion.

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Menashe Shohatwas our chief executive officer between December, 2004 and November 2006. Mr. Shohat
has spent over eleven years with ScanMaster, serving first as ScanMasters chief
operating officer and later as ScanMasters chief executive officer from 2002 to
2004. Mr. Shohat holds a B.A. in business administration from the Ruppin Academic Center.

Yuval Berman  is
a Founder and Managing Director of the M&A advisory firm U.V.B  Business
Initiatives Ltd. Previously, between 2003 and 2006 Mr. Berman was 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.

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

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

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

Board of Directors

Our
directors, who are not external directors, commence their term when they are elected at
the annual general meeting of our shareholders until the following annual general meeting.
Messrs. David Schwartz and Yuval Berman are our external directors who were elected
to serve for terms of three years commencing April 2007 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.

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# B. Compensation

During 2006, we paid to all our
directors and officers a total of $1.25 million in salaries, fees and bonuses. This does
not include money spent on automobiles made available to our officers, expenses (including
business travel, professional and business association dues and expenses) reimbursed to
officers and other fringe benefits commonly reimbursed or paid by companies in Israel.

In 2006, Mr. Nir Alon received a
monthly compensation of $4,000 until February 2006, when he ceased to serve as chairman of
our board.

Our audit committee, board of
directors and shareholders approved the following compensation for our director Ms. Linda
Harnevo, in consideration for her serving as a member of the Companys Audit
Committee and Board of Directors: (i) an annual fee of NIS 18,280 (approximately $4,096),
(ii) payment of NIS 1,220 (approximately $273) per meeting in which she personally
participates, (iii) payment of NIS 732 (approximately $164) per meeting in which she
participates by phone, (iv) reimbursement of out of pocket expenses incurred in connection
with the performance of her services as a director of the Company, (v) linking the above
amounts to the Israeli Consumer Price Index in the same manner that the fees of the
Companys External Directors are linked to such index; payable retroactively from
April 1, 2006, and (vi) options to purchase 30,000 ordinary shares of the Company
exercisable at a price per share of $0.4, vesting quarterly, with the following vesting
schedule: 4,286 ordinary shares vested on September 30, 2006, and 4,286 are vesting at the
end of each fiscal quarter thereafter until March 31, 2008, when all options will be fully
vested.

We paid an aggregate of $30,000 to
our serving external directors in 2006.

On February 21, 2006, our
shareholders approved the payment to David Gal of a monthly compensation of $13,500 plus
Value Added Tax in consideration for his services as the chairman of our board of
directors. Additionally, it was approved to lease an automobile for his use, and supply
him with certain other office related equipment necessary to provide us with his services.
Finally, it was also approved to grant Mr. Gal options to purchase up to 600,000 of our
Ordinary Shares at an exercise price of $0.50 per share. One third of the options shall
vest on December 31, 2006 and thereafter 2.8% of the total shares subject to the option
shall vest on a monthly basis. The vesting of the options will be subject to Mr. Gal
serving as the chairman of our board of directors on the relevant vesting date. Mr. Gal
shall be entitled to exercise the options on the date such options have vested and up to 5
years thereafter. Pursuant to his appointment as Chief Executive Officer, our audit
committee and board of directors approved, subject to shareholder approval, an increase in
the monthly fee payable to MEO Consulting, a company controlled by Mr. David Gal, of
$21,500 plus VAT to be payable from January 1, 2007.

Pension and Retirement
Benefits

We offered no pension or retirement
benefits to our directors and key personnel in 2006.

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# 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 Agreements.

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

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

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

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| | 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.

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.

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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. Schwartz 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.

Our two external directors Messrs.
Schwartz 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

# 2006

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

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# NonDestructive
Automated Inspection Systems Division

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

# AOI Division

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

# 2005

As of December 31, 2005 we employed a
total of 137 full time persons in both of our divisions, as follows:

# NonDestructive Automated
Inspection Systems Division

As of December 31, 2005, we employed
75 full-time persons, out of which 72 were employed in Israel of whom 18 were in research
and development, 7 were in marketing and sales, 2 were in customer support, 39 were in
operations and 6 were in administration and management.

# AOI Division

As of December 31, 2005, we employed
62 full-time persons, out of which 37 were employed in Israel of whom 14 were in research
and development, 2 were in marketing and sales, 3 were in customer support, 12 were in
operations and 6 were in administration and management. 15 of our employees were employed
in Korea, of whom 9 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.

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# 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.

Microelectronics
Division (which was merged into our AOI Division from 2005)

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. 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.

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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, 2007,
options to purchase 104,500 of such ordinary shares were outstanding and the remaining
options have expired. Of the outstanding options, options to purchase 102,500 and 2,000
ordinary shares are fully vested and are exercisable at an exercise price of, $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, 2007, options to purchase 1,285,869 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 166,027 of the
outstanding options have an exercise price of $1 per share and vest monthly over three
years through August 2005 and an additional 7,500 have an exercise price of $1.68 per
share and have already vested. 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, 2007,
options to purchase 2,764,317 of such ordinary shares were outstanding and options to
purchase 5,108,663 ordinary shares were available for future grants. 727,500 of the
outstanding options have an exercise price of $1.25 per share. 44,000 of the outstanding
options have an exercise price of $1.2 per share. 136,500 of the outstanding options have
an exercise price of $0.85 per share. 20,000 of the outstanding options have an exercise
price of $0.83 per share. 309,667 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 123,453 an
exercise price of $0.2 per share. As of May 31, 2007, 2,325,412 of the options were
vested, and the remainder will vest at various dates until December 31, 2008. 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, 2007, options to
purchase 585,000 of such ordinary shares were outstanding and options to purchase
1,415,000 ordinary shares were available for future grants. 345,000 of the outstanding
options have an exercise price of $0.78 per share, 120,000 of the outstanding options have
an exercise price of $0.4 per share, and 120,000 of the outstanding options have an
exercise price of $0.28. As of May 31, 2007, 12,858 of the options were vested, and the
remainder will vest at various dates until February 14, 2011. 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, 2007, 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
|---------------------------------------------------- | ------------------------- | ----------------
|
|
|
|
|Nir Alon (1)(2)(3)(4)(9)                             |                           |                 
|Nir Alon Holdings GmbH (4)                           |                           |                 
|Elbit Ltd. (5)(6)                                    |                           |                 
|M.S. Master Investments (2002) Ltd. (7)              |                           |                 
|M.S.N.D. Real Estate Holdings Ltd. (5)(8)            |                           |                 
|Tamir Fishman Provident and Education Funds Ltd. (9) |                           |                 
|All directors and officers as a group (10)           |                           |                 

The
percentages in this table are based on 35,811,827 of ordinary shares currently issued and
outstanding and options exercisable within 60 days.

(1)       
          3,233,000 of these shares are pledged to Bank Leumi B.M., in order to guarantee
          a credit line for Altro Warenhandels GMBH, or Altro, in the sum of $1,500,000.

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

(3)       
          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 5.6% of our share capital.

(4)       
          Mr. Nir Alon is deemed to be the beneficial owner of all of the shares held by
          Nir Alon Holdings GmbH.

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(5)       
          In an agreement which will be executed by Elbit and Mivtach upon approval of the
          Amendment Agreement and the Elbit Agreement by our shareholders, the parties
          have agreed to vote their shares at meetings of our shareholders at which
          members of the board are to be elected, as follows: (a) to elect to our board
          one director nominated by Mivtach, who shall serve as chairman of our board, and
          (b) to elect to our board one director nominated by Elbit a; provided that the
          party entitled to nominate a director continues to at least hold 7.5% of our
          share capital on a fully diluted basis. A reduction of a partys holdings
          shall only be deemed to occur upon a sale by one of the parties, of our ordinary
          shares. If a party fails to meet the 7.5% threshold it shall lose the right to
          nominate a director and such right shall be granted to the shareholder who at
          such time holds the highest number of our ordinary shares. Additionally, the
          parties to the agreement agreed that in the event that and for as long as
          Mivtach continues to hold at least 15% of our share capital on a fully diluted
          basis, the parties willvote their shares at meetings of our shareholders at
          which members of the board are to be elected as follows: (a) to elect to our
          board two directors nominated by Mivtach, one of whom shall serve as chairman of
          our board, and (b) to elect to our board one director nominated by Elbit. A
          reduction of a partys holdings shall only be deemed to occur upon a sale
          by a shareholder of our ordinary Shares. Notwithstanding the foregoing, at any
          time during the term of the agreement, Elbit may, in its absolute discretion, by
          notice in writing to Mivtach, voluntarily terminate its right to designate a
          director to our board of directors. In such an event the right to designate the
          director to our board of directors shall be granted to Mivtach and Elbit shall
          be obliged to vote its shares in favor of the nominee designated by Mivtach.
          Furthermore, if prior to May 14, 2008, Elbit holds less than the 7.5% threshold
          other than if any reductions in Elbits holdings are as a result of sales
          of our shares by Elbit, Elbit shall maintain its right to designate one member
          of the board, until May 14, 2008. A party whose holdings of our share capital
          falls below 5% of our share capital on a fully diluted basis, shall, as from the
          time of such change, automatically cease to be a party to the agreement.

(6)       
          Includes 1,512,939 shares issuable upon the exercise of an immediately
          exercisable warrant. Elbit is a wholly owned subsidiary of Elron Electronic
          Industries Ltd. (NASDAQ: ELRN). As a result, Elron may be deemed to be the
          beneficial owner of our ordinary shares owned by Elbit. As of June 14, 2007,
          Discount Investment Corporation, or DIC, owned approximately 49% of the
          outstanding shares of Elron and, as a result, DIC may be deemed to be the
          beneficial owner of our ordinary shares owned by Elbit. IDB Holding Corporation,
          or IDBH, owns the majority of the outstanding shares of IDB Development
          Corporation, or IDBD, which, in turn, owns the majority of the outstanding
          shares of DIC and Clal Insurance Enterprises Holdings, or CIEH. As of June 14,
          2007 subsidiaries of CIEH held for their own account a total of 245,586 shares
          of EVS. The CIEH group had no other holdings of EVS shares as of the same date.
            As a result, IDBH may be deemed to be the beneficial owner of our
          ordinary shares owned by Elbit, and our ordinary shares held by subsidiaries of
          CIEH for their own account.

The
address of each of DIC, IDBH and IDBD is The Triangular Tower, 44th Floor, 3 Azrieli
Center, Tel Aviv 67023, Israel. The address of Elbit and Elron is The Triangular Tower,
42nd Floor, 3 Azrieli Center, Tel Aviv 67023, Israel. IDBH, IDBD and DIC are public
companies traded on the Tel Aviv Stock Exchange. Elron is a public company traded on the
Tel Aviv Stock Exchange and on the Nasdaq Global Select Market.

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As
of June 14, 2007, (i) Ganden Holdings Ltd., or Ganden, a private Israeli company
controlled by Nochi Dankner and his sister Shelly Bergman, held, directly and through a
wholly-owned subsidiary, approximately 44.88% of the outstanding shares of IDBH; (ii)
Shelly Bergman, through a wholly-owned company, held approximately 7.23% of the
outstanding shares of IDBH; (iii) Avraham Livnat Ltd., or Livnat, a private Israeli
company controlled by Avraham Livnat, held, directly and through a wholly-owned
subsidiary, approximately 10.38% of the outstanding shares of IDBH; and (iv) Manor
Holdings BA Ltd., or Manor, a private company controlled by Ruth Manor, held, directly and
through a majority-owned subsidiary, approximately 10.37% of the outstanding shares of
IDBH.

Subsidiaries
of Ganden, Livnat and Manor have entered into a shareholders agreement with respect to
their shares of IDBH constituting, respectively, 31.02%, 10.34% and 10.34% of the
outstanding shares of IDBH, for the purpose of maintaining and exercising control of IDBH
as a group. Their additional holdings in IDBH are not subject to the shareholders
agreement. The term of the shareholders agreement expires in May 2023. Based on the
foregoing, Ganden, Manor and Livnat (by reason of their control of IDBH) and Nochi
Dankner, Shelly Bergman, Ruth Manor, and Avraham Livnat (by reason of their control of
Ganden, Manor and Livnat, respectively) may be deemed to share with Elbit the power to
vote and dispose of our ordinary shares held by Elbit, and also to share with subsidiaries
of CIEH the power to vote and dispose of our ordinary shares held by these subsidiaries
for their own account.

Nochi
Dankner is Chairman and Chief Executive Officer of IDBH, the Chairman of IDBD and DIC and
a director of Elron. Isaac Manor (the husband of Ruth Manor) and Zvi Livnat (a son of
Avraham Livnat) are directors of IDBH, IDBD and DIC. Shai Livnat (another son of Avraham
Livnat) is a director of IDBD. Dori Manor (the son of Isaac and Ruth Manor) is a director
of IDBH, IDBD, DIC and Elron. The address of Nochi Dankner is The Triangular Tower, 44th
Floor, 3 Azrieli Center, Tel Aviv 67023, Israel. The address of Shelly Bergman is 9
Mishmar Ezrehi Street, Afeka, Tel Aviv 69697, Israel. The address of Ruth Manor is 26
Hagderot Street, Savyon 56526, Israel. The address of Avraham Livnat is Taavura Junction,
Ramle 72102, Israel.

(7)       
          M.S. Master Investments (2002) Ltd. owns 2,080,944 ordinary shares and has a
          proxy to vote 1,080,944 ordinary shares held by S.R. Master Investment (2002)
          Ltd., 700,540 ordinary shares held by R.D. Master Investment (2002) Ltd. and
          182,405 ordinary shares held by Avner Shacham.

(8)       
          Includes 1,000,000 ordinary shares issuable upon the exercise of a warrant
          exercisable within 60-days (assuming the Amendment Agreement and the
          Registration Rights Agreement with M.S.N.D. are approved by our shareholders).
          M.S.N.D. Real Estate Holdings Ltd. is a fully owned subsidiary of Mivtach-Shamir
          Holdings Ltd.

(9)       
          Includes 715,000 ordinary shares currently issuable upon exercise of a warrant
          by the holder within 60 days.

(10)       
          Includes all of the shares deemed as beneficially owned by Mr. Nir Alon and
          options currently exercisable by directors and officers within 60 days.

As of June 15, 2007, there were a
total of 72 holders of record of our ordinary shares, of which 18 were registered in the
United States. Such United States shareholders were, as of such date, the holders of
record of approximately 37% of our outstanding ordinary shares.

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# Voting Agreements

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

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

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

# B. Related Party
Transactions

Amendment to Convertible
Loan Agreement with Mivtach Shamir

For
information concerning convertible loan agreement, the amendment and the registration
rights agreement, see Item 4 Information on the Company  Recent
Developments.

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Consulting Agreement with
MA&AT

For
information concerning the consulting agreement see Item 4 Information on
the Company  Recent Developments.

Appointment of David Gal
as CEO

For
information concerning David Gals appointment and terms see Item 4
Information on the Company  Recent Developments.

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-F45.

# Export Sales

In 2006, 90.8% of our sales,
amounting to $15,437,000 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.

For
information concerning legal proceedings with RDSO see Item 4 Information on the
Company  Legal Claim.

On
November 15, 2006, Mr. Yoav Kahane, the former VP of Marketing and Sales of EVS submitted
a Statement of Claim to the Labor Court in Nazareth against EVS in which Mr. Kahane claims
that EVS owes him an aggregate of $140,241.06 under EVSs bonus compensation plan. On
December 31, 2006, we filed a Statement of Defense with the Labor Court on behalf of EVS
rejecting Mr. Kahanes claims. The Labor Court has suggested that the parties attempt
to resolve the dispute through mediation. On May 30, 2007, the parties reached and
executed a settlement agreement, pursuant to which we paid Mr. Kahane NIS 275,000. On June
7, 2007, the Nazareth Labor Court approved the settlement agreement.

On
October 10, 2004, ScanMaster received a letter from Bank Hapoalim B.M. (the
Bank) stating that pursuant to a debenture created in favor of the Bank by
ScanMaster, dated May 27, 2004, ScanMaster undertook that it would not enter into any
change of control transactions without first receiving the consent of the Bank. In the
letter the Bank stated that the acquisition of ScanMaster took place without its consent,
and the Bank reserved the right to take any action available to it by law or pursuant to
the debenture agreement. To date, neither EVS nor ScanMaster has received any further
correspondence from the Bank in relation to this matter.

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# 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 2006 is taxable at regular rates of 31%.
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 ($) | Low ($)
|------------------- | -------- | -------
|
|
|
|
|June 2007           |          |        
|                    |          |        
|May 2007            |          |        
|                    |          |        
|April 2007          |          |        
|                    |          |        
|March 2007          |          |        
|                    |          |        
|February 2007       |          |        
|                    |          |        
|January 2007        |          |        
|                    |          |        
|December 2006       |          |        
|                    |          |        
|Fourth quarter 2006 |          |        
|                    |          |        
|Third quarter 2006  |          |        
|                    |          |        
|Second quarter 2006 |          |        
|                    |          |        
|First quarter 2006  |          |        
|                    |          |        
|Fourth quarter 2005 |          |        
|                    |          |        
|Third quarter 2005  |          |        
|                    |          |        
|Second quarter 2005 |          |        
|                    |          |        
|First quarter 2005  |          |        
|                    |          |        
|Year ended 2006     |          |        
|                    |          |        
|Year ended 2005     |          |        
|                    |          |        
|Year ended 2004 (3) |          |        
|                    |          |        
|Year ended 2003 (2) |          |        
|                    |          |        
|Year ended 2002 (1) |          |        

(1)           Traded on the NASDAQ
SmallCap Market throughout the period.

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(2)           Traded on the NASDAQ
SmallCap Market until November 19, 2003, and subsequently           on the
Over-the-Counter Bulletin Board.

(3)           Traded on the
Over-the-Counter Bulletin Board throughout the period, and           continues to trade
there today.

B.
          Plan of Distribution. Not applicable

D.
          Selling Shareholders. Not applicable

E.
          Dilution. Not applicable

F.
          Expenses of the Issue. Not applicable

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

# Memorandum and Articles
of Association

A.
          Share Capital.

Not applicable

# B. Memorandum and
Articles of Association

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

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

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

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

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:

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| | amendments
to our articles of association;
|- | ------------------------------------------

| | appointment
or termination of our auditors;
|- | -------------------------------------------

| | appointment
and dismissal of directors, other than temporary directors which may be appointed by
other directors;
|- | -----------------------------------------------------------------------------------------------------------------

| | approval
of acts and transactions requiring general meeting approval under the Companies Law;
|- | ---------------------------------------------------------------------------------------------

| | increase
or reduction of our authorized share capital;
|- | ------------------------------------------------------

| | any
merger as provided in Section 320 of the Companies Law;
|- | -----------------------------------------------------------

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

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

The Israeli Companies Law

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

| | a
merger; or
|- | ------------

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

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

Provisions Restricting
Change in Control of Our Company

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

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

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

# C. Material Contracts

Convertible Loan Agreement with
Mivtach Shamir. Discussions of this agreement, its amendment and the Registration
Rights Agreementare incorporated herein by reference to the discussion under the
caption Information on the Company  Recent DevelopmentsinItem 4 of this Annual Report.

Investment Agreement, Registration
Rights Agreement and Amendment to the Registration Rights Agreement with Elbit.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.

Private Placement with Israeli
Institutional Investors.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.

Consulting Agreement with
MA&AT.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.

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David Gal. Discussions of
appointment of David Gal as CEO and compensation terms are incorporated herein by
reference to the discussion under the caption 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.

# E. Taxation

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

Israeli Tax Considerations

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

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

General Corporate Tax
Structure

Israeli companies are subject to
corporate tax at the rate of 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.

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

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Tax Benefits Prior to the
Amendment

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

A company which qualifies as a
Foreign Investors Company is entitled to an extended benefit period and
to further reductions in the tax rate normally applicable to Approved Enterprises. Subject
to certain conditions, a Foreign Investors Company is a company in which
persons who are not residents in Israel invested more than 25% of its combined
shareholders investment in share capital (in terms of rights to profits, voting and
the appointment of directors) 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 corporate tax at reduced rates for an extended ten-year
(rather than the otherwise applicable seven-year) period as detailed below:

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

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

Prior to the Amendment, a company
owning an Approved Enterprise approved after April 1, 1986 (or prior thereto provided no
government grants 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.

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

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

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

Subject to certain provisions
concerning income subject to the Alternative 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.

Tax Benefits under the
Amendment

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

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

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

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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.

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.

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

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.

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.

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(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:

(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.

86

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

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

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.

87

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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.

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.

88

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

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

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

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

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

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

We received final tax assessments
for the years since our incorporation ending and including December 31, 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.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

89

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

| |  | are
broker-dealers or insurance companies;
| | - | ------------------------------------------

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

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

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

| |  | have
a functional currency that is not the U.S. dollar.
| | - | -------------------------------------------------------

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

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

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

# F. Dividends and Paying
Agents.

Not applicable

G.
          Statement by Experts.

Not applicable

# H. Documents on Display

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

90

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

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

Foreign exchange risk

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

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

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

91

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As
of December 31, 2006, we had accounts payable in NIS or in funds linked thereto in the
amount of $2.4 million. Market risk was estimated as the potential increase in fair value
resulting from a hypothetical 10% decrease in the year-end NIS/Dollar and the Euro/Dollar
exchange rate. Assuming such decrease in the NIS/Dollar and the Euro/Dollar exchange rate,
the fair value of our accounts payable would increase by $266,000.

# Interest rate risk

Our
exposure to market rate risk for changes in interest rates relates primarily to funds
borrowed by us from banks and others. As of December 31, 2006 we had liabilities in the
amount of $8.6 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 $70,000. The increase
in interest rates in 2006 caused an increase in our financial expenses. As of December 31,
2006 we had accounts payable in the amount of $3.5 million.

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

Not
applicable.

# PART II

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

None.

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

None.

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

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.

92

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

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

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

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

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

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

The following table presents fees
for professional audit services rendered by our principal accountants for the audit of
our consolidated annual financial statements for the year ended December 31, 2005,
and Brightman Almagor & Co. for the audit of our consolidated annual financial
statements for the year ended December 31, 2006.

| |                   | 2006 | 2005
| | ----------------- | ---- | ----
|
|
|
|
| | Audit Fees(1)     |      |     
| |                   |      |     
| | Tax Fees(2)       |      |     
| | All Other Fees(3) |      |     
| | Total             |      |     

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

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

| | (3) | All
Other Fees are fees for consulting services rendered by our auditors with respect
to the requests for grants from the Israeli Office of the Chief Scientist.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

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.

93

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

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

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

|4.2 | Agreement
dated January 2, 2006, between the Company and Mivtach Shamir Holdings Ltd.,
 incorporated by reference to our Registration  Statement on Form F-3,          File No.
333-134591, filed with the Commission on May 31, 2006.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.3 | Appendix
to Agreement  dated  February  21,  2006,  between the Company and Mivtach  Shamir
 Holdings  Ltd.,  incorporated  by reference to our  Registration          Statement on
Form F-3, File No. 333-134591, filed with the Commission on May 31, 2006.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.4 | 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., incorporated by reference to our Registration Statement on Form F-3, File No.
333-134591, filed with the Commission on May 31, 2006.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.5 | 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.,  incorporated by reference to our Registration  Statement on Form F-3,
File No. 333-134591,  filed with the Commission on May 31,          2006.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

94

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|4.6 | Securities
Purchase Agreement among the Company and the Buyers as defined therein, dated April 30,
2007.
|--- | --------------------------------------------------------------------------------------------------------

|4.7 | Registration
Rights Agreement among the Company and the Buyers as defined therein, dated April 30,
2007.
|--- | --------------------------------------------------------------------------------------------------------

|4.8 | Form
of Ordinary Share Purchase Warrant issued to the Investor parties to the Securities
Purchase Agreement.
|--- | ------------------------------------------------------------------------------------------------------------

|4.9 | Registration
Rights Agreement between the Company and Elbit Ltd., dated January 1, 2007.
|--- | ----------------------------------------------------------------------------------------

|4.10 | Stock
and Loan Purchase Agreement for the sale of Yuravision Co. Ltd. between the Company and
the Purchaser as defined therein, dated December 4, 2006.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------

|4.11 | Employee
Retention Agreement among the Company and the Purchaser as defined therein, dated
November 29, 2006.
|---- | -------------------------------------------------------------------------------------------------------------

|4.12 | Consulting
Agreement between the Company and MA&AT, dated November 20, 2006.
|---- | ----------------------------------------------------------------------------

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

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

95

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# SIGNATURES

The Registrant hereby certifies that
it meets all of the requirements for filing on Form 20-F and that it has duly caused and
authorized the undersigned to sign this annual report on its behalf.

July 15, 2007

| |  | ELBIT VISION SYSTEMS LTD.By: /s/ David GalDavid GalChief Executive Officer
| |  | ----------------------------------------------------------------------------------------

96

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# ELBIT VISION SYSTEMS
LTD.

(An Israeli Corporation)

2006 CONSOLIDATED
FINANCIAL STATEMENTS



---

---



# ELBIT VISION SYSTEMS
LTD.

2006 CONSOLIDATED
FINANCIAL STATEMENTS

TABLE OF CONTENTS

|                                                                              | Page      
|----------------------------------------------------------------------------- | ----------
|
|
|
|
|REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING                            |           
|FIRM                                                                          | F-2       
|CONSOLIDATED FINANCIAL STATEMENTS:                                           
|Balance sheets as of December 31, 2006 and 2005                               | F-3 - F-4 
|Statements of operations for the year ended December 31, 2006, 2005 and 2004  | F-5       
|Statements of changes in shareholders' equity for the year ended             
|December 31, 2006, 2005 and 2004                                              | F-6       
|Statements of cash flows for the year ended December 31, 2006, 2005 and 2004. | F-7 - F-8 
|Notes to Financial Statements                                                 | F-9 - F-45



---

---



# 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, 2006 and 2005, and the related consolidated statements of
operations, shareholders equity and cash flows for the years 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 year ended December 31, 2004, before the
effects of the retrospective adjustments for the discontinued operations discussed in Note
3a to the financial statements, were audited by other auditors whose reports, dated July
14, 2005, 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. An audit includes
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,
2006 and 2005 and the consolidated results of their operations and their cash flows for
the years then ended, in conformity with U.S. generally accepted accounting principles.

We also have audited the
retrospective adjustments to the 2004 financial statements for the discontinued
operations, as discussed in Note 3a to the financial statements. Our procedures included
(1) comparing the reclassified amounts related to the discontinued operations to the
Companys underlying analysis obtained from management, and (2) testing the
mathematical accuracy of the amounts to the consolidated financial statements. In our
opinion, such retrospective adjustments are appropriate and have been properly applied.
However, we were not engaged to audit, review, or apply any procedures to the 2004
financial statements of the Company other than with respect to the retrospective
adjustments and, accordingly, we do not express an opinion or any other form of assurance
on the 2004 financial statements taken as a whole.

Brightman Almagor & Co.
Certified Public Accountants
A member firm of Deloitte Touche Tohmatsu
Tel Aviv, Israel
June 29, 2007

F - 2

---

---



|
|
|

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the shareholders of ELBIT VISION SYSTEMS LTD.

We have audited the accompanying
consolidated statement of operation, changes in shareholders equity and cash flows
of Elbit Vision Systems Ltd. (the Company) and its subsidiaries for the year
ended December 31, 2004, before the effects of the adjustments to retrospectively reflect
the discontinued operation described in note 3a. 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 revenues included in consolidation constitute
approximately 6% of total consolidated revenues, for the year ended December 31, 2004,
before the effects of the adjustments discussed in note 3a. The financial statements of
the above subsidiary were audited by other independent 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 audit, before the
effects of the adjustments described above, 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 audit and the report of other independent auditors,
provide a reasonable basis for our opinion.

In our opinion, based on our audit,
and the report of other independent auditors, the consolidated financial statements
referred to above, before the effects of the adjustments to retrospectively reflect the
discontinued operation described in note 3a, present fairly, in all material respects, the
consolidated results of operations of the company and its subsidiaries, changes in
shareholders equity and consolidated cash flows for the year ended December 31,
2004, in conformity with accounting principles generally accepted in the United States of
America (the 2004 financial statements before the effects of the adjustments discussed in
note 3a are not presented herein).

We were not engaged to audit, review,
or apply any procedures to the adjustments to retrospectively reflect the discontinued
operation described in note 3a and accordingly, we do not express an opinion or any other
form of assurance about whether such adjustments are appropriate and have properly
applied. Those adjustments were audited by other auditors.

|              |                                    
|------------- | -----------------------------------
|              | /s/ Kesselman & Kesselman          
|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 2006- $936 ,2005- $ 774)        |  |            
|Other                                                                        |  |            
|Inventories                                                                  |  |            
|Assets held for sale                                                         |  |            
|                                                                             |  |            
|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,net of accumulated amortization                                 |  |            
|Goodwill                                                                     |  |            
|Other intangible assets                                                      |  |            
|                                                                             |  |            
|                                                                             |  |            
|                                                                             |  |            
|T o t a l    assets                                                          |  |            
|                                                                             |  |            

The
accompanying notes are an integral part of the financial statements

F - 3

---

---



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

|                                                                        |  | December 31
|----------------------------------------------------------------------- |  | -----------
|
|
|
|
|Liabilities and shareholders' equity                                    |  |            
|CURRENT LIABILITIES:                                                    |  |            
|Credit from banks                                                       |  |            
|Current maturities of loan from shareholder                             |  |            
|Short term loan from banks                                              |  |            
|Credit from Cornell Capital Partners L.P.                               |  |            
|Accounts payable and accruals:                                          |  |            
|Trade                                                                   |  |            
|Deferred income                                                         |  |            
|Other                                                                   |  |            
|Liabilities associated with assets held for sale                        |  |            
|                                                                        |  |            
|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, 2006         |  |            
|60,000,000 ordinary shares as of December 31, 2005                      |  |            
|Issued and outstanding:                                                 |  |            
|December 31, 2006 - 29,516,314 Ordinary shares                          |  |            
|December 31, 2005 - 26,762,217 Ordinary shares                          |  |            
|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 | 2006 | 2005 | 2004
|----------------------------------------------------- | ---- | ---- | ---- | ----
|
|
|
|
|REVENUES:                                             |      |      |      |     
|Sale of products                                      |      |      |      |     
|Services rendered                                     |      |      |      |     
|                                                      |      |      |      |     
|                                                      |      |      |      |     
|                                                      |      |      |      |     
|COST OF REVENUES:                                     |      |      |      | 15d 
|Cost of products sold                                 |      |      |      |     
|Cost of services rendered                             |      |      |      |     
|                                                      |      |      |      |     
|                                                      |      |      |      |     
|                                                      |      |      |      |     
|                                                      |      |     
|GROSS PROFIT                                          |      |      |      |     
|RESEARCH AND DEVELOPMENT COSTS -NET                   |      |      |      | 15e 
|SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:         |      |     
|Marketing and selling                                 |      |      |      |     
|General and administrative                            |      |      |      |     
|Reorganization expenses                               |      |      |      |     
|                                                      |      |      |      |     
|OPERATING INCOME (LOSS)                               |      |      |      |     
|FINANCIAL EXPENSES -NET                               |      |      |      | 15f 
|                                                      |      |      |      |     
|                                                      |      |     
|INCOME (LOSS) BEFORE OTHER INCOME(EXPENSES)           |      |      |      |     
|OTHER INCOME (EXPENSES)                               |      |      |      |     
|                                                      |      |      |      |     
|                                                      |      |     
|INCOME (LOSS) BEFORE TAXES ON INCOME                  |      |      |      |     
|TAXES ON INCOME                                       |      |      |      | 12d 
|                                                      |      |      |      |     
|INCOME (LOSS) FOR THE YEAR FROM CONTINUING OPERATIONS |      |      |      |     
|                                                      |      |      |      |     
|LOSS FROM OPERATIONS OF DISCONTINUED COMPONENT        |      |      |      | 3a  
|NET LOSS ON DISPOSAL OF DISCONTINUED OPERATION        |      |      |      | 3a  
|                                                      |      |      |      |     
|INCOME (LOSS) FOR THE YEAR                            |      |      |      |     
|                                                      |      |      |      |     
|                                                      |      |     
|EARNING (LOSS) PER SHARE FROM CONTINUING OPERATIONS:  |      |      |      | 2n  
|Basic                                                 |      |      |      |     
|                                                      |      |      |      |     
|Diluted                                               |      |      |      |     
|                                                      |      |      |      |     
|LOSS PER SHARE FROM DISCONTINUED OPERATIONS:          |      |      |      | 2n  
|Basic                                                 |      |      |      |     
|                                                      |      |      |      |     
|Diluted                                               |      |      |      |     
|                                                      |      |      |      |     
|EARNING (LOSS) PER SHARE:                             |      |      |      | 2n  
|Basic                                                 |      |      |      |     
|                                                      |      |      |      |     
|Diluted                                               |      |      |      |     
|                                                      |      |      |      |     
|                                                      |      |     
|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. 
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, 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,11a) |               |                                              |                              | 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,11b)                |               |                                              |                              | 183                        |                            |                     | 41                        
|                                                         |               |                                              |                              |                            |                            |                     |                           
|BALANCE - DECEMBER 31, 2005                              |               |                                              |                              | 26,762                     |                            |                     | 4,529                     
|CHANGES DURING 2006:                                     |               |                                             
|Loss for the year                                        |               |                                              |                              |                            |                            |                     |                           
|Currency translation differences                         |               |                                              |                              |                            |                            |                     |                           
|                                                         |               |                                              |                              |                            |                            |                     |                           
|Total comprehensive income                               |               |                                              |                              |                            |                            |                     |                           
|Employee stock options exercised and paid                |               |                                              |                              | 182                        |                            |                     | 40                        
|Issuance of share capital and warrants (notes 3c,11a5))  |               |                                              |                              | 2,441                      |                            |                     | 494                       
|Beneficial conversion feature (note 9a(3))               |               |                                              |                              |                            |                            |                     |                           
|Warrant exercised and paid                               |               |                                              |                              | 131                        |                            |                     | 28                        
|                                                         |               |                                              |                              |                            |                            |                     |                           
|BALANCE - DECEMBER 31, 2006                              |               |                                              |                              | 29,516                     |                            |                     | 5,091                     
|                                                         |               |                                              |                              |                            |                            |                     |                           

* 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

|                                                                                                  | 2006 | 2005 | 2004
|------------------------------------------------------------------------------------------------- | ---- | ---- | ----
|
|
|
|
|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                                                                     |      |      |     
|Amortization of discount on loan from shareholder                                                 |      |      |     
|Loss from disposal of property                                                                    |      |      |     
|Loss from disposal of discontinued operation                                                      |      |      |     
|Liability for employee rights upon retirement                                                     |      |      |     
|Changes in operating assets and liabilities:                                                      |      |     
|Decrease (increase) in trade accounts receivable
                 (including non-current portion) |      |      |     
|Decrease (increase) in other accounts receivable                                                  |      |      |     
|Increase (decrease) in trade account payable                                                      |      |      |     
|Deferred income                                                                                   |      |      |     
|Other                                                                                             |      |      |     
|Decrease in inventories                                                                           |      |      |     
|                                                                                                  |      |      |     
|Net cash provided by (used in) operating activities                                               |      |      |     
|                                                                                                  |      |      |     
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                             |      |     
|Acquisition of subsidiaries consolidated for the first time (a)                                   |      |      |     
|Disposal of subsidiary (b)                                                                        |      |      |     
|Purchase of property and equipment                                                                |      |      |     
|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 provided by (used in) investing activities                                               |      |      |     
|                                                                                                  |      |      |     
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                             |      |     
|Issuance of share capital and warrants - net of issuance costs                                    |      |      |     
|Short-term credit from bank - net                                                                 |      |      |     
|Proceeds from exercise of options and warrants                                                    |      |      |     
|Retirement of long-term loan from shareholder                                                     |      |      |     
|Proceeds from  long-term loans from shareholder                                                   |      |      |     
|Proceeds from  long-term loans from bank                                                          |      |      |     
|Short-term credit received from (paid to) Cornell Capital Partners L.P. - net                     |      |      |     
|                                                                                                  |      |      |     
|Net cash provided by financing activities                                                         |      |      |     
|                                                                                                  |      |      |     
|TRANSLATION DIFFERENCES ON CASH BALANCES OF                                                       |      |     
|CONSOLIDATED SUBSIDIARY                                                                           |      |      |     
|                                                                                                  |      |      |     
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                              |      |      |     
|BALANCE OF CASH AND CASH EQUIVALENTS AT                                                           |      |     
|BEGINNING OF YEAR                                                                                 |      |      |     
|                                                                                                  |      |      |     
|BALANCE OF CASH AND CASH EQUIVALENTS AT END OF YEAR                                               |      |      |     
|                                                                                                  |      |      |     
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW                                                              |      |     
|INFORMATION -cash paid during the year for:                                                       |      |     
|Interest paid - net                                                                               |      |      |     
|                                                                                                  |      |      |     
|Income taxes paid - net                                                                           |      |      |     
|                                                                                                  |      |      |     

* Including cash and cash equivalents
from discontinuing operation.

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

F - 7

---

---



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

|                                                                                         | 2006 | 2004
|---------------------------------------------------------------------------------------- | ---- | ----
|
|
|
|
|(a) Acquisition of subsidiaries consolidated
       for the first time, see also note 3: |      |     
|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 c3 hereafter)                                |      |     
|Legal commitment to acquire 19% of Yuravision Co.                                        |      |     
|Ltd.'s shares (see also Note 3a)                                                         |      |     
|                                                                                         |      |     
|                                                                                         |      |     
|                                                                                         |      |     

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

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

| | 1) | 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           11a5). The said
amount is not reflected in the statement of cash flows for the           year ended
December 31, 2004.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) | Part
of the acquisitions of the subsidiaries was executed through issuance of
               share capital and warrants in an amount equivalent to $ 2,501,000 and
$                543,000 in 2004 and 2006, respectively.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 8

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

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

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

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

| | In
September 2004, the Company also completed the acquisition of the entire shareholding of
ScanMaster Systems (IRT) Ltd. (ScanMaster Ltd.), an Israeli company and IRT
ScanMaster System Inc. (ScanMaster Inc.), a new Hampshire corporation
(collectively  ScanMaster). ScanMaster is engaged in the development,
manufacturing and marketing of equipment for the ultrasonic inspection of industrial
parts and components for the automotive and transportation industries, the metal industry
as well as applications for aircraft and jet engine inspection (see Note 3b).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
January 2006, the Company acquired business, assets and liabilities of Panoptes Ltd.(Panoptes)
and ScanMaster Ltd. acquired 100% of the shares of Panoptes.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Panoptes
Ltd. is principally engaged in the design, development, manufacturing and marketing
automatic vision and quality monitoring systems for surface inspection, especially
textiles, glass fabric and technical woven materials (see Note 3c).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to Business and Geographical segments  see Note 17.
| | -------------------------------------------------------

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

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

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

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

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

F - 9

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

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

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

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

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

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

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

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

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

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

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

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

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

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

F - 10

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

| | g. | Property
and equipment
| | -- | ----------------------

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

| |                                | %
| | ------------------------------ | -
|
|
|
|
| | Machinery and equipment        |  
| | Office furniture and equipment |  
| | Vehicles                       |  

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

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

| | h. | Other
assets- Goodwill and Intangible Assets
| | -- | --------------------------------------------

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

| | Under
FASB Statement No. 142, Goodwill and Other Intangible Assets(SFAS
142), goodwill is not amortized to earnings, but rather is subject to periodic
testing for impairment, at the reporting unit level, at least annually or more frequently
if certain events or indicators of impairment occur. Impairment is the condition that
exists when the carrying amount of goodwill exceeds its implied fair value. Measurement
of an impairment loss is an estimate, performed based on the following: If the fair value
of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is
considered not impaired.  If the carrying amount of the reporting unit goodwill
exceeds the implied fair value of that goodwill, an impairment loss is recognized in an
amount equal to that excess. The Group uses the discounted cash flow method to determine
the fair value of the reporting unit. The Companys reporting units consist of
reportable segments; goodwill is allocated to the Non-destructive automated inspection
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 2006.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 11

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

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

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

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

| |                      | % | 
| | -------------------- | - | 
|
|
|
|
| | Technology           |   | 
| | Customer relations   |   | 
| | Distribution network |   | 
| | Brand name           |   | 

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

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

| | 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 - 12

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

| | j. | Revenue
recognition (Cont.):
| | -- | ----------------------------

| | 1) | Sale
of products: (Cont.)
| | -- | -------------------------

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

| | 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 - 13

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

| | j. | Revenue
recognition (Cont.):
| | -- | ----------------------------

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

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

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

| | The
deferred income balance as of December 31, 2006 and 2005 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, 2006, 2005 and 2004 were $ 470,000, $ 122,000, and $ 132,000, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

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

| | 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
9,322,308, 8,716,907 and 6,262,882 shares for the years 2006 , 2005 and 2004,
respectively, were excluded from EPS calculation, because the effect of such options and
warrants is antidilutive.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 14

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

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

| | In
January 2006, the Company adopted SFAS No. 123(R), Share-Based Payment(SFAS
No. 123(R)), using the modified prospective application method as its transition
method. The Company recognizes $341,000 of compensation expenses in 2006 as a result of
the application of SFAS 123 (R). Until the adoption of SFAS No. 123(R) the Company
accounted for employees and directors stock-based compensation in accordance with
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB
25) and in accordance with FASB Interpretation No. 44 (FIN 44).
Pursuant to these accounting pronouncements, the Company recorded compensation for stock
options granted to employees and directors over the vesting period of the options based
on the difference, if any, between the exercise price of the options and the market price
of the underlying shares at that date.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Had
compensation cost for the Companys stock option plans been determined based on fair
value at the grant dates for all awards made in 2005 and 2004 in accordance with the
provisions of SFAS No. 123 (SFAS 123), as amended by SFAS No. 148 Accounting
for Stock-Based Compensation (SFAS 148), the Companys pro forma
net loss per share would have been as follows:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                            | Year ended December 31
| | ------------------------------------------ | ----------------------
|
|
|
|
| | Net income (loss), as reported             |                       
| | Less - stock-based employee compensation   |                       
| | expense determined under fair value method |                       
| |                                            |                       
| | Pro forma net income (loss)                |                       
| |                                            |                       
| | Earning (loss) per share:                  |                       
| | Basic - as reported                        |                       
| |                                            |                       
| | Diluted - as reported                      |                       
| |                                            |                       
| | Basic - 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, 2006 and 2005, the Group held cash and cash equivalents and
short-term bank deposits, most of which were deposited with major Israeli, European, and
U.S. banks. The Company is of the opinion that the credit risk in respect of these
balances is insignificant.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 15

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

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

| | 1) | In
July 2006, the FASB issued FASB Interpretation No. 48 Accounting for
          Uncertainty in Income Taxes  an interpretation of FASB Statement 109          (FIN
48). FIN 48 prescribes a comprehensive model for recognizing,           measuring
and presenting in the financial statements tax positions taken or           expected to
be taken on a tax return. This Interpretation also provides guidance           on
derecognition, classification, interest and penalties and disclosure
          requirements for uncertain tax positions. FIN 48 is effective for fiscal years
          beginning on or after December 15, 2006 (January 1, 2007, for the Company). The
          provisions of FIN 48 shall be applied to all tax positions upon initial
adoption           of this Interpretation. Only tax positions that meet the more likely
than not           recognition threshold at the effective date may be recognized or
continue to be           recognized upon adoption of this Interpretation. The Company is
of the opinion           that the adoption of FIN 48 is not expected to have a material
effect on the           Companys financial statements.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | In
September 2006, the Securities and Exchange Commission issued Staff           Accounting
Bulletin No. 108, Considering the Effects of Prior Year           Misstatements
when Quantifying Misstatements in Current Year Financial           Statements (SAB
108), which provides interpretive guidance on           the consideration of the
effects of prior year misstatements in quantifying           current year misstatements
for the purpose of a materiality assessment. SAB 108           is effective for fiscal
years ending after November 15, 2006. The company           adopted SAB 108 in these
financial statements and accordingly, follows SAB 108           requirements when
quantifying financial statement misstatements.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
adoption of SAB No.108 did not result in corrections of the Companys financial
statements.
| | -----------------------------------------------------------------------------------------------

| | 3) | In
September 2006, the FASB issued Statement of Financial Accounting Standards           No.
157, Fair Value Measurements (FAS 157). FAS 157           defines
fair value, establishes a framework for measuring fair value in           accordance with
generally accepted accounting principles, and expands           disclosures about fair
value measurements; however, it does not require any new           fair value
measurements. FAS 157 is effective for fiscal years beginning after           November
15, 2007 (January 1, 2008, for the Company). Earlier application is           encouraged,
provided that the reporting entity has not yet issued financial           statements for
that fiscal year, including any financial statements for an           interim period
within that fiscal year. The Company is currently evaluating the           impact of the
provisions of FAS 157 on its financial position and results of           operations.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4) | In
September 2006, the FASB issued Statement of Financial Accounting Standards           No. 158,
Employers Accounting for Defined Benefit Pension and Other           Postretirement
Plans (an amendment of FASB Statements No. 87, 88, 106, and           132R) (FAS
158), requires an employer to: (a) Recognize in its statement of           financial
position an asset for a plans overfunded status or a liability           for a plans
underfunded status; (b) measure a plans assets and           its obligations
that determine its funded status as of the end of the           employers fiscal
year (with limited exceptions); and (c) recognize           changes in the funded
status of a defined benefit postretirement plan in the           year in which the
changes occur.  Those changes will be reported in           comprehensive income of
a business entity and in changes in net assets of a           not-for-profit
organization. The requirement by FAS 158 to recognize the funded           status of a
benefit plan and the disclosure requirements of FAS 158 are           effective as of the
end of the fiscal year ending after December 15, 2006           for entities with
publicly traded equity securities. The requirement to measure           plan assets and
benefit obligations as of the date of the employers fiscal           year-end
statement of financial position is effective for fiscal years ending           after
December 15, 2008. The Company does not expect the adoption of           FAS
158 to have a material effect on the financial position of the company at
          December 31, 2006
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 16

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

| | s. | Recently
issued accounting pronouncements (Cont.):
| | -- | --------------------------------------------------

| | 5) | In
February 2007, the FASB issued FASB No. 159, The Fair Value Option
          for Financial Assets and Financial LiabilitiesIncluding an Amendment of
          FASB Statement No. 115. This standard permits an entity to choose to
          measure many financial instruments and certain other items at fair value. Most
          of the provisions in FASB No. 159 are elective; however, the amendment to
          FASB No. 115, Accounting for Certain Investments in Debt and Equity
          Securities, applies to all entities with available-for-sale and trading
          securities. The fair value option established by FASB No. 159 permits all
          entities to choose to measure eligible items at fair value at specified
election           dates. A business entity will report unrealized gains and losses on
items for           which the fair value option has been elected in earnings (or another
performance           indicator if the business entity does not report earnings) at each
subsequent           reporting date. The fair value option: (a) may be applied
instrument by           instrument, with a few exceptions, such as investments otherwise
accounted for           by the equity method; (b) is irrevocable (unless a new
election date           occurs); and (c) is applied only to entire instruments and
not to portions           of instruments. FASB No. 159 is effective as of the
beginning of an           entitys first fiscal year that begins after November 15,
2007. The           Company does not expect the adoption of FASB No. 159 to have a
material           impact on its consolidated financial statements.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | a. | Acquisition
and Disposal of Yuravision
| | -- | --------------------------------------

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

| | Pursuant
to the term sheet, through 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 represented a holding of app. 19% in Yuravision, should have beed been
purchased in cash payment of $ 306,000 , or by way of swap transaction.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
manner in which the purchase will was made (cash or swap transaction) was about 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 was 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).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 17

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

| | a. | Acquisition
and Disposal of Yuravision (Cont.)
| | -- | ----------------------------------------------

| | Upon
purchase of Yuravision, the Company had fully undertaken upon itself the capital
deficiency Yuravision had as of date of purchase (the minority shareholders of Yuravision
were not committed to bear any losses in excess of their investment). As long as
Yuravision has a capital deficiency, the Company fully presented its share (100%) in the
profits, or losses of Yuravision.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

| |                                     | Year ended December 31
| | ----------------------------------- | ----------------------
|
|
|
|
| | Revenues                            |                       
| | Cost of revenues                    |                       
| |                                     |                       
| | Gross profit                        |                       
| | Research and development costs, net |                       
| | Marketing and selling expenses      |                       
| | General and administrative expenses |                       
| |                                     |                       
| | Operating loss                      |                       
| | Financial income (expenses)         |                       
| | Other income                        |                       
| |                                     |                       
| | Net loss of discontinued operation  |                       
| |                                     |                       

| |                                                        | December 31
| | ------------------------------------------------------ | -----------
|
|
|
|
| | Cash and cash equivalents                              |            
| | Accounts receivable                                    |            
| | Long-term receivables                                  |            
| | Property and equipment, net                            |            
| | Other assets, net                                      |            
| |                                                        |            
| | Total assets held for sale                             |            
| |                                                        |            
| |                                                        |            
| | Credit from banks                                      |            
| | Accounts payable and accruals                          |            
| | Long term liabilities                                  |            
| | Accrued severance pay                                  |            
| |                                                        |            
| | Total liabilities associated with assets held for sale |            
| |                                                        |            

F - 18

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

| | 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 Note1).
| | ------------------------------------------------------------------------------------------------------------------------------------

| | The
Company acquired ScanMaster for total consideration in the amount of $ 8,193,000
(including estimated direct transaction costs amounting to $ 150,000). 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).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 e. below
| | ---------------------------------

F - 19

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

| | c. | Acquisition
of Panoptes Ltd.
| | -- | ----------------------------

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

| | The
total consideration of acquisition of Panoptes Ltd. amounted to $ 622,000 (including
estimated direct transaction costs amounting to $ 79,000). The Company issued 800,000
ordinary shares amounted to $ 543,000 and , subject to certain instances, will 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
(see Note 10a5)). The transaction is subject to the completion of certain customary
closing conditions.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |                                | At January 1, 2006 ($ in
thousands)
| | ------------------------------ | -----------------------------------
|
|
|
|
| | Long-term receivables          |                                    
| | Property, plant, and equipment |                                    
| | Intangible assets              |                                    
| |                                |                                    
| | Total assets acquired          |                                    
| |                                |                                    
| | Current liabilities            |                                    
| | Long-term liabilities          |                                    
| |                                |                                    
| | Total liabilities assumed      |                                    
| |                                |                                    
| | Net assets acquired            |                                    
| |                                |                                    

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

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

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

| | e. | 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, nor is it necessarily indicative of future
results.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                    | 2005 | 2004
| | ---------------------------------- | ---- | ----
|
|
|
|
| | Revenues                           |      |     
| |                                    |      |     
| | Loss                               |      |     
| |                                    |      |     
| | Loss per share - basic and diluted |      |     
| |                                    |      |     

F - 20

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|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 $ 1,467,000 and $971,000 as of December 31, 2006 and
2005 respectively.
| | ------------------------------------------------------------------------------------------------------------

|NOTE 5 |  | OTHER
LONG-TERM RECEIVABLES
|------ | - | ---------------------------

| |                                                  | December 31
| | ------------------------------------------------ | -----------
|
|
|
| | Deposits on leased vehicle (see also Note 10b2)) |            
| | Loan to other (1)                                |            
| | Future proceeds from selling the Yuravision      |            
| |                                                  |            
| |                                                  |            
| |                                                  |            

| | (1) | 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.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|NOTE 6 |  | PROPERTY
AND EQUIPMENT
|------ | - | ----------------------

| | a. | Comprised
as follows:
| | -- | ---------------------

| |                                                  | December 31
| | ------------------------------------------------ | -----------
|
|
|
| | Machinery and equipment                          |            
| | Leasehold improvements                           |            
| | Office furniture and equipment                   |            
| | Vehicles                                         |            
| |                                                  |            
| |                                                  |            
| | Less - accumulated depreciation and amortization |            
| |                                                  |            
| |                                                  |            
| |                                                  |            

| | b. | Depreciation
and amortization expenses totaled $ 191,000, $ 254,000,           and $225,000,
in the years ended December 31, 2006, 2005 and 2004,           respectively.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 21

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 7 |  | OTHER
INTANGIBLE ASSETS
|------ | - | -----------------------

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

| | Amortization
expenses totaled $ 669,000 $ 436,000, and $ 1,048,000, in the years ended December 31,
2006, 2005, and 2004, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | Estimated
amortization expense for the following years, subsequent to December 31, 2006:
| | ----------------------------------------------------------------------------------------

| |                         | $ in thousands
| | ----------------------- | --------------
|
|
|
| | Year ended December 31: |               
| | 2007                    |               
| | 2008                    |               
| | 2009                    |               
| | 2010                    |               
| | 2011                    |               

|NOTE 8 |  | ACCRUED
SEVERANCE PAY, NET
|------ | - | --------------------------

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

| | Part
of the liability is funded through individual           insurance policies.
| | --------------------------------------------------------------------------------

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

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

| | c. | Severance
pay and defined contribution plan expenses were $ 165,000,           $ 291,000,
and $ 255,000 in the years ended December 31, 2006, 2005,           and 2004,
respectively. The earnings on the amounts funded were $ 102,000,           $ 54,000,
and $ 80,000 for the years ended           December 31, 2006, 2005, and
2004, respectively.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

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

| |                                 | December 31
| | ------------------------------- | -----------
|
|
|
|
| | Loans from banks (1)            |            
| | Other liabilities:              |            
| | Loans from shareholders (2),(3) |            
| |                                 |            
| |                                 |            
| | Less - current maturities:      |            
| | From banks                      |            
| | From shareholder (2)            |            
| |                                 |            
| |                                 |            
| |                                 |            
| |                                 |            
| |                                 |            

| | (1) | On
August 2005 The Company and ScanMaster entered into an agreement with bank Mizrahi,
pursuant to which both the Company and ScanMaster received in 2005 a credit line for the
aggregate amount of $ 2,000,000. The credit line is secured by a first ranking floating
charge on all the Companys assets and all the assets of ScanMaster (see Note 11d).
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | During
the reported years $ 80,000 were repaid in respect of the said loan.
| | ---------------------------------------------------------------------------

| | For
more information, see Note 18.
| | ----------------------------------

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

| | The
Company allocated the proceeds received based on the respective fair values to the notes
and the warrants. Consistent with provisions of EITF 98-5 and 00-27, the Company
evaluated whether the notes contain a beneficial conversion feature (BCF) and
determined that the BCF amount exceeded the amount initially allocated to notes and as a
result the notes initially recorded at nil and are to be amortized over the term of
notes.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | During
June 2007 the loan was converted, see Note 18.
| | -----------------------------------------------------

F - 23

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

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

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

| |                     | December 31
| | ------------------- | -----------
|
|
|
|
| | 2007                |            
| | 2008                |            
| | 2009                |            
| | 2010 and thereafter |            
| |                     |            
| |                     |            
| |                     |            

|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 $ 259,000, $ 286,000 and $ 583,000 in
the years ended December 31, 2006, 2005 and 2004 respectively 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 would 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, 2006
is approximately $ 948,000 (see 1) and 2) above).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

F - 24

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 10 |  | COMMITMENTS
AND CONTINGENT LIABILITIES(Cont.)
|------- | - | ---------------------------------------------

| | a. | Royalties
(Cont.)
| | -- | -----------------

| | 3) | (Cont.)
| | -- | -------

| | The
royalty expenses totaled $ 20,600 and $ 46,000 in the years ended December 31, 2006
and 2005, 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 $ 28,000 and $ 25,000 in the years
          ended December 31, 2006 and 2005, respectively, were included in the
          statements of operations in cost of revenues.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5) | As
part of acquisition of Panoptes Ltd. (see Note 3c.), the Company, subject to
          certain instances, will pay cash royalties equaling 3.5% of sales of EVSs
          optical inspection systems between January 2006 and the end of December 2008 to
          Maaragim Panoptes controlling shareholder. Through 31 December
2006,           the Company paid royalties $ 109,000 to Maaragim.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Lease
commitments
| | -- | -----------------

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

| | Minimum
lease commitments of the Company and the subsidiaries under the above leases, at rates in
effect as of December 31, 2006, are as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------

| |                          | $ in thousands
| | ------------------------ | --------------
|
|
|
|
| | Year ending December 31: |               
| | 2007                     |               
| | 2008                     |               
| | 2009                     |               
| |                          |               
| |                          |               
| |                          |               

| | 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 $ 514,000, $ 540,000, and $ 240,000 in the years ended
December 31, 2006, 2005 and 2004, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------

| | 2) | The
Company leases motor vehicles under long-term operating lease agreements.           The
lease agreements expire on various dates ending in 2007  2009 (with           prior
notice of cancellation clauses).
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 25

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 10 |  | COMMITMENTS
AND CONTINGENT LIABILITIES(Cont.)
|------- | - | ---------------------------------------------

| | b. | Lease
commitments (Cont.)
| | -- | -------------------------

| | Minimum
lease commitments of the Company under the above leases, at rates in effect on December
31, 2006, are as follows:
| | -------------------------------------------------------------------------------------------------------------------------

| |      | $ in thousands
| | ---- | --------------
|
|
|
|
| | 2007 |               
| | 2008 |               
| | 2009 |               
| |      |               
| |      |               
| |      |               

| | To
secure the amounts due to the lessor, the Company has deposited a total of U.S. $ 33,200.
The deposits are unlinked and presented among other receivables and long-term receivables.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Lease
expenses in 2006, 2005 and 2004, amounted to $ 299,000, $ 298,000, and $ 194,000
respectively.
| | ----------------------------------------------------------------------------------------------------

| | c. | Guarantees
| | -- | ----------

| | To
secure the Companys commitment under its sales agreements, the Company provided
guarantees in the amounts $ 913,000 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 2001until
               February 2006, 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 - 26

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 11 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

| | a. | Authorized,
issued and outstanding shares(Cont.)
| | -- | ------------------------------------------------

| | 2) | (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, 2006, warrants to purchase 400,418 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. All
of the said warrant expired unexercised.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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. All of ?the said warrant expired
unexercised.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 11 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

| | a. | Authorized,
issued and outstanding shares(Cont.)
| | -- | ------------------------------------------------

| | (3) | (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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | All
of the said warrant expired unexercised.
| | --------------------------------------------

| | 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. The remaining warrants expired unexercised.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 28

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 11 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

| | a. | Authorized,
issued and outstanding shares (Cont.)
| | -- | -------------------------------------------------

| | (5) | (Cont.)
| | --- | -------

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

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

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

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

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

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

| | In
May 2005, the Company signed an amendment to the Promissory Note, under the new term the
balance of loan will be paid in monthly installments through December 2006, at an
interest rate of Prime+2%.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has included in its accounts interest costs pertaining to the Promissory Note,
based on a computation of the weighted interest in respect of the Promissory Note.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company paid Cornell a commitment fee of five percent (5%) of the principal amount of the
Promissory Note, and a further $ 30,000 to an affiliate of Cornell and other party.
When used for the repayment of the note, proceeds received under the Standby Equity
Distribution Agreement, will not be subject to the 5% commitment fee.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company records in its books of accounts the commitment fees over the period of the
Promissory Note.
| | --------------------------------------------------------------------------------------------------------

F - 29

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 11 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

| | a. | Authorized,
issued and outstanding shares (Cont.)
| | -- | -------------------------------------------------

| | (5) | (Cont.)
| | --- | -------

| | As
securities for repayment of the advance and the Promissory Note, the Company has: (i)
granted Cornell a second ranking floating charge on all of Companys assets (to the
extent permitted under Israeli law) and on the assets of ScanMaster; (ii) issued to a
trustee, 5,555,555 of its ordinary shares which are registered (see above), and (iii)
Issued to Trustee an additional 2,500,000 of Companys restricted ordinary shares.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | It
has also been agreed to reserve an additional 14,444,445 of Companys ordinary
shares for issuance to Cornell pursuant to the Standby Equity Distribution Agreement, and
have agreed to file the registration statement covering these shares.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
part of the transaction with Cornell, the Company also retained the services of Newbridge
Securities Corporation (hereafter  Newbridge), an unaffiliated broker-dealer, as a
placement agent in connection with the Standby Equity Distribution Agreement. The Company
issued Newbridge 7,812 ordinary shares as a placement fee.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of the said shares is app. $ 10,000. The said costs are included in companys
accounts as deferred share issuance costs.
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | Through
December 31, 2005, the Company repaid $ 2,129,000 of the Note in cash and $ 433,000
by the issuance of 869,946 shares to Cornell, as stipulated in the said agreement.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Through
June 2006, the Company issued Cornell with 1,433,527 of its ordinary shares in an amount
equal to $ 569,000.
| | --------------------------------------------------------------------------------------------------------------------

| | On
February 17, 2006, the Company repaid all outstanding amounts owed to Cornell, and have
thus fulfilled all of it obligations toward them under the Promissory Note. Following
repayment of the Promissory Note, all ordinary shares and advance notices held in trust
to guarantee the loan were returned to the Company, and the floating charge on its assets
was removed.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 6) | As
to shares issued in consideration, and as contingent consideration, for the
               purchase of the shareholding in ScanMaster and Panoptes, see Note 3b and
Note                3c, respectively.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 expired on 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 30

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 11 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

| | b. | Share
option plans: (Cont.)
| | -- | ---------------------------

| | 1) | The
plans: (Cont.)
| | -- | ------------------

| | (b) | In
April 2000, the board of directors of the Company adopted the Employee Share
          Option Plan (2000) (hereafter  The 2000 Plan).
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------

| | Under
the 2000 plan, options to purchase an aggregate of 4,500,000 ordinary shares are
available to be awarded to employees, directors or consultants of the Company or any of
its subsidiaries.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the 2000 plan, options usually vest over a period of three or four years from the date of
grant, in equal parts each year.
| | --------------------------------------------------------------------------------------------------------------------------------

| | The
2000 Plan is valid for ten years and will expire on April 3, 2010, except for
options outstanding on that date.
| | -------------------------------------------------------------------------------------------------------------------

| | (c) | In
November 2003, the Board of Directors of the Company adopted the Employee           Share
Option Plan (2003) (hereafter  The 2003 Plan).
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the 2003 plan, options to purchase an aggregate of 2,000,000 ordinary shares are
available to be awarded to employees, directors or consultants of the Company or any of
its subsidiaries.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the 2003 plan, options usually vest over a period of four years from the date of grant,
in equal parts each year.
| | -----------------------------------------------------------------------------------------------------------------------

| | The
2003 Plan is valid for ten years and will expire on November 30, 2013, except
for options outstanding on that date.
| | -----------------------------------------------------------------------------------------------------------------------

| | (d) | In
March 2006, the Board of Directors of the Company adopted the Employee Share
          Option Plan (2006) (hereafter  The 2006 Plan).
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------

| | Under
the 2006 plan, options to purchase an aggregate of 2,000,000 ordinary shares are
available to be awarded to employees, directors or consultants of the Company or any of
its subsidiaries.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the 2006 plan, options usually vest over a period up to ten years following the date of
grant, if not exercised earlier, or 6 months after termination of the employe, will
generally vest as to 25-33% commencing the beginning of the second year after the grant
and as to an additional 25-33% in each of the remaining years thereafter, assuming
continuous employment with the Company through such periods.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
2006 Plan is valid for ten years and will expire on March, 2016, except for options
outstanding on that date.
| | -----------------------------------------------------------------------------------------------------------------

| | The
exercise price of options granted under the 1996, 2000 and 2003 plans is to be not less
than 85% of the fair market value of the ordinary share on the date of grant. All of the
outstanding options from the 1996, 2000 and 2003 plan are to expire no later than 10
years following the date of grant.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Through
December 31, 2005, options to purchase 474,848 shares were exercised. The proceeds from
the exercise amounted to $ 102 thousands.
| | -----------------------------------------------------------------------------------------------------------------------------------------

F - 31

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 11 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

| | b. | Share
option plans: (Cont.)
| | -- | ---------------------------

| | 1) | The
plans: (Cont.)
| | -- | ------------------

| | (d) | (Cont.)
| | --- | -------

| | Through
December 31, 2006, options to purchase 181,797 shares were exercised. The proceeds from
the exercise amounted to $ 43 thousands.
| | ----------------------------------------------------------------------------------------------------------------------------------------

| | The
2000, 2003 and 2006 plans are subject to the terms stipulated by Section 102 of the
Israeli Income Tax Ordinance. Inter alia, these terms provide that the Company will be
allowed to claim, as an expense for tax purposes, the amounts credited to the
employees as a benefit in respect of shares or options granted under the plan.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
amount allowed as an expense for tax purposes, at the time the employee utilizes such
benefit, is limited to the amount of the benefit that is liable to tax as labor income,
in the hands of the employee; all being subject to the restrictions specified in Section
102 of the Income Tax Ordinance.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
aforementioned expense will be recognized in the tax year that the benefit is credited to
the employee.
| | -----------------------------------------------------------------------------------------------------------

| | 2) | Options
granted to employees:
| | -- | -----------------------------

| | (a) | A
summary of the status of the above plans in respect of options granted to
          employees and directors of the Company and its subsidiaries as of
          December 31, 2006, 2005 and 2004, and changes during the years ended on
          those dates, is presented below:
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                          | Year ended December 31
| | ---------------------------------------- | ----------------------
|
|
|
|
| | 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) | 777,500
options granted in 2006 (weighted average exercise price of $0.69 and           fair
value of $ 0.64), 625,000 options granted in 2005 (weighted average
          exercise price of 0.51 and fair value of $ 0.37) and 521,000 options,
          granted in 2004 (weighted average exercise price of $ 0.83 and fair value of $
          0.38), were granted with exercise price that was at market value or above.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 32

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 11 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

| | b. | Share
option plans: (Cont.)
| | -- | ---------------------------

| | 2) | Options
granted to employees: (Cont.)
| | -- | -------------------------------------

| | (a) | (Cont.)
| | --- | -------

| | (2) | The
fair value of each option granted is estimated on the date of grant using           the
Binomial lattice model in 2006 and the Black-Scholes option-pricing model in
          2005 and 2004, with the following weighted average assumptions:
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                          | Year ended December 31
| | ------------------------ | ----------------------
|
|
|
|
| | Dividend yield           |                       
| |                          |                       
| | Expected volatility      |                       
| |                          |                       
| | Risk-free interest rate  |                       
| |                          |                       
| | Expected life - in years |                       
| |                          |                       

| | Dividend
yield  Management used an expected dividend yield based primarily on past experience
applicable as of the grant date.
| | -------------------------------------------------------------------------------------------------------------------------------

| | Expected
volatility  Management estimated volatility based on the historical volatility of
the Companys ordinary shares, being the only traded financial instrument of the
Company, using in most cases daily observations of the Companys price share to
determine the standard deviation.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Risk
free interest rate  The risk-free interest rate is based on the implied yield in
effect at the time of each option grant, based on U.S. Treasury zero-coupon bond issued
with equivalent remaining terms.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Management
estimates forfeiture rates at the date of grant, which are adjusted in subsequent periods
if the actual forfeiture rates differ from those initially estimated. Management uses
historical data to estimate pre-vesting option forfeiture rates and records share-based
compensation expense only for those awards that are expected to vest.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 33

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 11 |  | SHAREHOLDERS EQUITY(Cont.)
|------- | - | ---------------------------

| | b. | Share
option plans: (Cont.)
| | -- | ---------------------------

| | 2) | Options
granted to employees: (Cont.)
| | -- | -------------------------------------

| | (b) | The
following table summarizes certain information about options granted to
          employees and directors of the Company which were outstanding and exercisable
          under the above plans as of December 31, 2006:
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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                |                    
| | 0.75                |                    
| | 0.8                 |                    
| | 0.78                |                    
| | 0.4                 |                    
| | 0.28                |                    
| | 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 571,429 warrants, fully vested to bank Mizrahi with an
exercise price of $0.77 and immediate vesting in favor of loan agreement (see also Note
9). During November 2006, the Companys board of directors approve to change the
exercise price to $0.5.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | All
those warrants were granted above market value and the Company recorded expenses
according to SFAS 123.
| | -----------------------------------------------------------------------------------------------------------

F - 34

---

---



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, 2006, the corporate tax was 31% and it will                gradually
decrease from 29% in 2007 through 25% in 2010.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 %.
| | -----------------------------------------------------------

| | b. | Tax
benefits under the Law for the Encouragement of Capital Investments,           1959
(hereinafter the law)
| | -- | --------------------------------------------------------------------------------------------------------------

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

| | 1) | The
main tax benefits available to the Company and ScanMaster Ltd. are:
| | -- | -----------------------------------------------------------------------

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

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

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

| | The
Company has four approved enterprises; the benefit periods commenced in 1994, 1995, 1997
and 2004, respectively.
| | --------------------------------------------------------------------------------------------------------------------

| | The
periods of benefits for the first, second and third approved enterprise expired in 2003,
2004 and 2006 respectively.
| | ------------------------------------------------------------------------------------------------------------------------

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

F - 35

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 12 |  | TAXES
ON INCOME(Cont.)
|------- | - | ----------------------

| | b. | Tax
benefits under the Law for the Encouragement of Capital Investments,           1959
(hereinafter the law) (Cont.)
| | -- | ----------------------------------------------------------------------------------------------------------------------

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

| | 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 there under and the
certificate of approval for the specific investments in approved enterprises. In the
event of failure to comply with these conditions, the benefits may be canceled, and
ScanMaster Ltd. and the Company may be required to refund the amount of the benefits, in
whole or in part, with the addition of linkage differences to the Israeli CPI and
interest.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
the event of distribution of cash dividends out of income, which was tax exempt as above,
the companies would have to pay the 25% tax in respect of the amount distributed. For this
purpose, the amount distributed includes the amount of the tax that applies as a result of
the distribution.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Tax
benefits under the Law for the Encouragement of Industry (Taxes), 1969
| | -- | --------------------------------------------------------------------------

| | The
Company and ScanMaster Ltd. are industrial companies as defined by this law
and as such are entitled to certain tax benefits, consisting mainly of accelerated
depreciation as prescribed by regulations published under the Inflationary Adjustments
Law, amortization of patents and certain other intangible property, and the right to
claim public issuance expenses.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Taxes
on income:
| | -- | ----------------

| | 1) | Income
(loss) before taxes on income is composed as follows:
| | -- | ------------------------------------------------------------

| |                     | 2006 | 2005 | 2004
| | ------------------- | ---- | ---- | ----
|
|
|
|
| | Israeli companies   |      |      |     
| | Subsidiaries abroad |      |      |     
| |                     |      |      |     
| |                     |      |      |     
| |                     |      |      |     

F - 36

---

---



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 2006, 2005, and 2004.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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 b1) (a) above.
          Accordingly, no deferred tax assets have been included in these financial
          statements in respect of the Companys carryforward tax losses.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | ScanMaster
has unutilized carryforward tax losses from prior years, exceeding           other
temporary differences. Valuation allowance has been provided in full, for           all
deferred taxes relating to the above tax losses and temporary differences;
          Accordingly no tax benefits have been included in these financial statements,
as           follows:
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                | December 31, 2006 | December 31, 2005
| | ------------------------------ | ----------------- | -----------------
|
|
|
|
| | Provision for vacation pay     |                   |                  
| | Accrued severance pay          |                   |                  
| | Carryforward tax losses        |                   |                  
| | Research and development costs |                   |                  
| | Less - valuation allowance     |                   |                  
| |                                |                   |                  
| |                                |                   |                  
| |                                |                   |                  

| | The
deferred taxes are computed at the average tax rate of 25%  39%.
| | ---------------------------------------------------------------------

F - 37

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ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 12 |  | TAXES
ON INCOME(Cont.)
|------- | - | ----------------------

| | f. | Carryforward
tax losses
| | -- | -----------------------

| | Carryforward
tax losses of the Company and its subsidiaries aggregate approximately $ 30 million
at December 31, 2006.
| | ----------------------------------------------------------------------------------------------------------------------

| | g. | Tax
assessments
| | -- | ---------------

| | Final
tax assessments have been received by the Company through the tax year 2002. ScanMaster
Ltd received final tax assessments through the tax year 2001.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------

|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, 2006, the bank deposits amount to $ 688 thousands, out of which $ 576 thousands
are linked to the dollar and $ 112 thousands are linked to the Euro;The deposits are
for a period of one Month.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | The
Company and Scanmaster have registered floating charges on all of their
               assets in favor of banks (see Notes 9, 15c).
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------

F - 38

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ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 15 |  | SUPPLEMENTARY
INFORMATION:
|------- | - | --------------------------

| |    |  | December 31
| | -- |  | -----------
|
|
|
|
| | a. |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            
| |    |  |            

| |    |                                             | 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                           |            
| |    | Accrued expenses and sundry                 |            
| |    |                                             |            
| |    |                                             |            
| |    |                                             |            

F - 39

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 15 |  | SUPPLEMENTARY
INFORMATION(Cont.)
|------- | - | --------------------------------

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

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

| |                              | % interest rate
as of
December 31, 2006 | December 31
| | ---------------------------- | --------------------------------------- | -----------
|
|
|
|
| | Unlinked credit from bank    |                                         |            
| | Short-term loans from banks: |                                         |            
| | Linked to the dollar         |                                         |            
| | Linked to the Euro           |                                         |            
| |                              |                                         |            
| |                              |                                         |            
| |                              |                                         |            

| | In
2003, the Company entered into agreements for bank credit facilities, pursuant to which
the Company may, from time to time, borrow an aggregate amount of up to $ 3,430,000;
to secure the credit facilities, the Company registered a floating fixed charge on
certain bank deposits in favor of the said banks (see Note 14).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Cost
of revenues
| | -- | ----------------

| |    |                                                   | Year ended December 31
| | -- | ------------------------------------------------- | ----------------------
|
|
|
|
| |    | Industrial operations:                            |                       
| |    | Materials consumed                                |                       
| |    | Payroll and related expenses                      |                       
| |    | Subcontracted work                                |                       
| |    | Depreciation and amortization                     |                       
| |    | Other production expenses                         |                       
| |    | Royalties (see Note 10a)                          |                       
| |    | Decrease (increase)  in inventories:              |                       
| |    | Finished products                                 |                       
| |    | Products in process                               |                       
| |    |                                                   |                       
| |    |                                                   |                       
| |    |                                                   |                       
| | e. | Research and development expenses:                |                       
| |    | Total expenses                                    |                       
| |    | Less - grants and participations, see Note 10a1). |                       
| |    |                                                   |                       
| |    |                                                   |                       
| |    |                                                   |                       

F - 40

---

---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 15 |  | SUPPLEMENTARY
INFORMATION(Cont.)
|------- | - | --------------------------------

| | f. | 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 parties |                       
| | In respect of credit from banks            |                       
| | In respect of credit from Cornell          |                       
| | Exchange differences                       |                       
| | Other                                      |                       
| |                                            |                       
| |                                            |                       
| |                                            |                       
| |                                            |                       
| |                                            |                       

|NOTE 16 |  | RELATED
PARTIES
|------- | - | ---------------

| |                                       | 2006 | 2005 | 2004
| | ------------------------------------- | ---- | ---- | ----
|
|
|
|
| | Marketing and selling                 |      |      |     
| |                                       |      |      |     
| | General and administrative            |      |      |     
| |                                       |      |      |     
| | Financing expenses on long-term loan  |      |     
| | granted by shareholder - see Note 9a. |      |      |     
| |                                       |      |      |     

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

F - 41

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---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 17 |  | BUSINESS
AND GEOGRAPHICAL SEGMENTS(Cont.)
|------- | - | -----------------------------------------

| | 2) | Description
of the types of products and services from which each reportable           segment
derives its revenues
| | -- | -------------------------------------------------------------------------------------------------------------------

| | Due
to the acquisition in 2004, the internal organizational structure changed; consequently,
the company has two reportable segments:
| | -------------------------------------------------------------------------------------------------------------------------------------

| | (a) | Automatic
Vision Inspection segment  design, develop, manufacture and           marketing
automatic vision inspection and quality monitoring systems, and           rendering
services related to those systems.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | Non-destructive
Automated Inspection segment  develop, manufacture and           market equipment
for the ultrasonic inspection of industrial parts and           components for the
automotive and transportation industries, the metal industry           as well as
applications for aircraft and jet engine inspection.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Prior
to June 2004, the Company operated only in one segment  the Automatic Vision
Inspection segment.
| | -------------------------------------------------------------------------------------------------------

| | b. | Information
about reported segment income or loss and assets:
| | -- | -------------------------------------------------------------

| | Measurement
of segment income or loss and segment assets
| | --------------------------------------------------------

| | The
accounting policies of the segments are the same as those described in the significant
accounting policies. The Company evaluates performance based on profit or loss from
operations before income taxes, not including non-recurring gains and losses and foreign
exchange gains and losses.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company accounts for inter-segment sales and transfers as if the sales or transfers were
to third parties, that is  at current market prices.
| | --------------------------------------------------------------------------------------------------------------------------------------------------

| |                                      | Automatic
Vision
Inspection | Non-
Destructive
Automated
Inspection | Total
| | ------------------------------------ | --------------------------- | ------------------------------------- | -----
|
|
|
|
| | Year ended December 31, 2006:        |                             |                                       |      
| | Revenues from unaffiliated customers |                             |                                       |      
| | Total Consolidated revenues          |                             |                                       |      
| |                                      |                             |                                       |      
| | Segment Operating loss               |                             |                                       |      
| | Unallocated corporate expenses       |                             |                                       |      
| |                                      |                             |                                       |      
| | Operating loss                       |                             |                                       |      
| |                                      |                             |                                       |      
| | Segment assets                       |                             |                                       |      
| | Other unallocated amounts            |                             |                                       |      
| |                                      |                             |                                       |      
| | Consolidated assets at the year end  |                             |                                       |      
| |                                      |                             |                                       |      
| | Expenditures for segment assets      |                             |                                       |      
| |                                      |                             |                                       |      
| | Total depreciation and amortization  |                             |                                       |      
| |                                      |                             |                                       |      

F - 42

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---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 17 |  | BUSINESS
AND GEOGRAPHICAL SEGMENTS(Cont.)
|------- | - | -----------------------------------------

| | c. | Geographic
information
| | -- | ----------------------

| | 1) | The
Companys revenues by geographic areas (based on locaton of customers)           are
as follows:
| | -- | ----------------------------------------------------------------------------------------------------

| |                                | 2006 | 2005 | 2004
| | ------------------------------ | ---- | ---- | ----
|
|
|
|
| | U.S.A.                         |      |      |     
| | Europe                         |      |      |     
| | Other (mainly Japan and China) |      |      |     
| |                                |      |      |     
| |                                |      |      |     
| |                                |      |      |     

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

| |        | 2006 | 2005
| | ------ | ---- | ----
|
|
|
|
| | Israel |      |     
| | U.S.A. |      |     
| |        |      |     
| |        |      |     
| |        |      |     

| | d. | Major
customers
| | -- | ---------------

| | The
following customers accounted or 10% for more of the Companys sales:
| | -------------------------------------------------------------------------

| |            | 2006 | 2005
| | ---------- | ---- | ----
|
|
|
|
| | Customer A |      |     

F - 43

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---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 18 |  | SUBSEQUENT
EVENTS
|------- | - | -----------------

| | a. | Private
placement with Israeli investors
| | -- | ----------------------------------------

| | In
June 2007 the Company completed the April Investment with a group of Israeli
institutional investors, or the Israeli Investors, for the purchase of its
6,290,941ordinary shares for $0.315 per share, of an aggregate price of $1,981,646.
Pursuant to the transaction, the investors were also issued warrants to purchase
3,145,472 of the Companys ordinary shares at an exercise price per share of $0.45,
exercisable for a period of 4 years. The Company has undertaken to file a registration
statement covering all of its ordinary shares and ordinary shares underlying the warrants
issuable under the April Investment by no later than July 31, 2007. Additionally, the
Company agreed to pay the Israeli Investors a penalty in the event that they (i) fail to
comply with their registration obligations as described in this paragraph; (ii) fail to
respond to any comments on a registration statement by the SEC within 30-days or (iii)
fail to maintain a registration statement covering the shares underlying the April
Investment. The penalty will be an amount in cash equal to 1% of the product of the
number of shares required to be covered by the registration statement which is the
subject of the failure, multiplied by US$0.315, for each month during which the failure
continues or a prorated daily amount for a period of less than a month.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Agreement
with Elbit
| | -- | --------------------

| | On
June 21, 2007, following the approval of the board of directors and the audit committee,
the Company executed an agreement with Elbit, or the Elbit Agreement, the consummation of
which is subject to the approval of the shareholders. Pursuant to this agreement Elbit
will (i) convert an existing loan to the Company in the amount of $470,000 (including
accrued interest) into 1,492,063 ordinary shares, at a price of $0.315 per share; and
(ii) invest in the Company $250,000 in consideration for 793,651 ordinary shares at a
price of $0.315 per share and will receive a 4 year warrant to purchase 396,825 ordinary
shares at an exercise price of $0.45 per share.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Within
the framework of the Elbit Agreement, the Company has, by way of a registration rights
agreement, undertaken to file a registration statement covering all of its ordinary
shares and ordinary shares underlying the warrants issued pursuant to the Elbit Agreement
with the Securities and Exchange Commission by no later that July 31, 2007, or the
Registration Statement.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | c. | Amendment
to Convertible Loan Agreement with Mivtach Shamir
| | -- | -----------------------------------------------------------

| | In
February 2006, the Company issued notes to Mivtach Shamir Holdings Ltd. (Mivtach)
for $3 million (half of which will be held in escrow until the occurrence of certain
events). The notes are convertible at the option of Mivtach into 6,000,000 ordinary
shares of EVS, at a price per share of $0.50. Repayment of the notes will be in 30 equal
monthly installments commencing two years after the notes issuance or on the date that
Mivtach decides not to convert the notes, whichever is sooner. The Company also granted
to Mivtach a two-year warrant to purchase 4,000,000 of the Companys ordinary shares
at an exercise price of $0.50 per share, exercisable only if Mivtach converts the notes.
.. On June 21, 2007 the Company executed an agreement with M.S.N.D. pursuant to which, the
Mivtach Agreement will be amended, subject to shareholder approval.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 44

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---



ELBIT VISION SYSTEMS
LTD. 
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|NOTE 18 |  | SUBSEQUENT
EVENTS (Cont.)
|------- | - | -------------------------

| | c. | Amendment
to Convertible Loan Agreement with Mivtach Shamir(Cont.)
| | -- | ------------------------------------------------------------------

| | Pursuant
to the Amendment Agreement, the terms of the Mivtach Agreement and the notes therein, are
amended, such that in consideration for M.S.N.D.s undertaking to convert the full
amount by no later than August 1, 2007 (a) Mivtach will be issued with 9,523,810 of the
Companys ordinary shares; and (b) Mivtach will receive a 4 year warrant to purchase
2,380,952 of the Companys ordinary shares at an exercise price of $0.45 per share.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Mivtach
also agreed to waive its rights under the warrants to exercise at least 3,000,000
ordinary shares, agreeing to exercise no more than 1,000,000 ordinary shares issuable
under the Amendment Agreement. Following consummation the Amendment Agreement M.S.N.D,
will become a holder of more than 25% of the Companys issued and outstanding share
capital. The Company also entered into a Registration Rights Agreement with M.S.N.D.,
undertaking to file a registration statement covering all of the ordinary shares and
ordinary shares underlying the warrants under the Amendment Agreement, which have not
previously been registered, by no later than July 31, 2007.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | M.S.N.D.
currently holds approximately 26.2% of the Companys issued and
          outstanding share capital.
| | -------------------------------------------------------------------------------------------------------------

F - 45

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---