---

---

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

---

FORM 20-F

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2003

Commission File No. 1-8201

---

ELBIT VISION SYSTEMS LTD.
(Exact name of Registrant as specified in its charter and
translation of Registrants name into English)

---

Israel(Jurisdiction
of incorporation or organization)

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

---

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

Ordinary Shares, nominal value 1.00 New Israeli Shekel per share

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

None

(Title of Class)

---

Indicate the number of outstanding shares of each of the issuers
classes of capital or common stock as of the close of the period covered by the
annual report: 13,006,466 Ordinary Shares

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

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

| | Item 17o | Item 18x
| | -------- | --------

1

---

---

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

------------

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

------------

2

---

---

|PART I   |                                                            |                                            
|-------- | ---------------------------------------------------------- | -------------------------------------------
|         |                                                            |                                            
|ITEM 1.  | IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS      | 5                                          
|         |                                                            |                                            
|ITEM 2.  | OFFER STATISTICS AND EXPECTED TIMETABLE                    | 5                                          
|         |                                                            |                                            
|ITEM 3.  | KEY INFORMATION                                            | 5                                          
|         | SELECTED FINANCIAL DATA                                    | 5                                          
|         | RISK FACTORS                                               | 5                                          
|         |                                                            | RISK FACTORS RELATED TO OUR BUSINESS       
|         |                                                            | RISK FACTORS RELATED TO OUR ORDINARY SHARES
|         |                                                            | GENERAL RISKS                              
|         |                                                            |                                            
|ITEM 4.  | INFORMATION ON THE COMPANY                                 | 20                                         
|         | HISTORY AND DEVELOPMENT OF THE COMPANY                     | 20                                         
|         | BUSINESS OVERVIEW                                          | 21                                         
|         | ORGANIZATIONAL STRUCTURE                                   | 36                                         
|         | PROPERTY, PLANTS AND EQUIPMENT                             | 36                                         
|         |                                                            |                                            
|ITEM 5.  | OPERATING AND FINANCIAL REVIEW AND PROSPECTS               | 36                                         
|         | SELECTED FINANCIAL DATA                                    | 36                                         
|         | OPERATING RESULTS                                          | 37                                         
|         | LIQUIDITY AND CAPITAL RESOURCES                            | 44                                         
|         | RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC        | 45                                         
|         | TREND INFORMATION                                          | 47                                         
|         | OFF-BALANCE SHEET ARRANGEMENTS                             | 48                                         
|         | TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS              | 49                                         
|         |                                                            |                                            
|ITEM 6.  | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                 | 49                                         
|         | DIRECTORS AND SENIOR MANAGEMENT                            | 49                                         
|         | COMPENSATION                                               | 52                                         
|         | BOARD OF DIRECTORS                                         | 53                                         
|         | EMPLOYEES                                                  | 54                                         
|         | SHARE OWNERSHIP                                            | 56                                         
|         |                                                            |                                            
|ITEM 7.  | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS          | 57                                         
|         | MAJOR SHAREHOLDERS                                         | 57                                         
|         | RELATED PARTY TRANSACTIONS                                 | 60                                         
|         |                                                            |                                            
|ITEM 8.  | FINANCIAL INFORMATION                                      | 62                                         
|         | CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION    | 62                                         
|         | SIGNIFICANT CHANGES                                        | 64                                         
|         |                                                            |                                            
|ITEM 9.  | THE OFFER AND LISTING                                      | 64                                         
|         | OFFER AND LISTING DETAILS                                  | 64                                         
|         | MARKETS                                                    | 64                                         
|         |                                                            |                                            
|ITEM 10. | ADDITIONAL INFORMATION                                     | 66                                         
|         | MEMORANDUM AND ARTICLES
  OF ASSOCIATION                   | 66                                         
|         | MATERIAL CONTRACTS                                         | 69                                         
|         | EXCHANGE CONTROLS                                          | 72                                         
|         | TAXATION                                                   | 72                                         
|         | DOCUMENTS ON DISPLAY                                       | 77                                         
|         |                                                            |                                            
|ITEM 11. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 78                                         
|         | INTEREST RATE RISK                                         | 78                                         
|         | EQUITY PRICE RISK                                          | 79                                         
|         | FOREIGN CURRENCY EXCHANGE RISK                             | 80                                         

3

---

---

|ITEM 12.  | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                         | 80
|--------- | ------------------------------------------------------------------------------ | --
|          |                                                                                |   
|PART II   |                                                                                |   
|          |                                                                                |   
|ITEM 13.  | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                                | 80
|          |                                                                                |   
|ITEM 14.  | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
  PROCEEDS | 80
|          |                                                                                |   
|ITEM 15.  | CONTROLS AND PROCEDURES                                                        | 80
|          |                                                                                |   
|ITEM 16.  | [RESERVED]                                                                     | 80
|          |                                                                                |   
|ITEM 16A. | AUDIT COMMITTEE FINANCIAL EXPERT                                               | 81
|          |                                                                                |   
|ITEM 16B. | CODE OF ETHICS                                                                 | 81
|          |                                                                                |   
|ITEM 16C. | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                         | 81
|          |                                                                                |   
|ITEM 16D. | EXEMPTIONS FROM THE LISTING AND STANDARDS OF AUDIT COMMITTEES                  | 81
|          |                                                                                |   
|ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILLIATED
  PURCHASERS      | 82
|          |                                                                                |   
|PART III  |                                                                                |   
|          |                                                                                |   
|ITEM 17.  | FINANCIAL STATEMENTS                                                           | 82
|          |                                                                                |   
|ITEM 18.  | FINANCIAL STATEMENTS                                                           | 82
|          |                                                                                |   
|ITEM 19.  | EXHIBITS                                                                       | 82

4

---

---

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:

5

---

---

|Risks related to our business:       
|-------------------------------------
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                     
|Risks related to our ordinary shares:
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    
|                                     
|General Risks:                       
|                                    
|                                    
|                                    
|                                    
|                                    
|                                    

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.

6

---

---

We
have not generated net income on an annual basis since 1997. We incurred net
losses of $1.31 million, $1.68 million and $0.98 million in 2001, 2002 and 2003,
respectively. As of December 31, 2003, we had an accumulated deficit of
approximately $18.55 million. We may continue to operate at a loss for the
foreseeable future and we cannot estimate when, or if, we will achieve
profitability. If we continue to have operating losses, there is no certainty
that we will have the financial resources to continue in business.

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 new markets or
in a new application, is lengthy, and can last as long as two years. Even in
existing markets, due to the $8,000 to $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.

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
2001, 2002 and 2003, one of our customers accounted for 21%, 9.5% and 17% of
our net sales respectively. While no other customer accounted for more than 10%
of our net sales in any of 2001, 2002 or 2003, 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.

7

---

---

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. Some of the electronic components included in our microelectronics
products are manufactured exclusively for us by certain suppliers. If any of
these exclusive suppliers stop manufacturing these components we will need to
find alternative suppliers. Our reliance on these suppliers involves several
risks, including a potential inability to obtain adequate supplies of these
components, and reduced control over pricing and timely delivery of these
components. We believe that we maintain a sufficient inventory of
these components to meet our foreseeable needs. However, if one of our single
source suppliers ceases to produce any necessary components, we would have to
transfer the manufacture of such components to another supplier or suppliers.
We estimate that such a transfer would take approximately up to four months and
could delay the production and supply of our products. Any such delay could result in a material interruption in production at
our facility and could have a material adverse effect on our business,
operating results and financial condition.

We
depend on expanding our business into new markets.

While the
majority of our revenues are generated from sales to the textile industry,
these sales have historically been insufficient to generate significant net
profits. Our future success and growth depends upon our successful penetration
of new markets. Following extensive market research, we have determined that
our technology could be relatively easily adapted for use in the
microelectronics industry and that such a transition presents us with a
significant business opportunity. Consequently, we are developing our existing
vision technology so as to adapt it to the requirements of the microelectronics
industry, particularly in the field of wafer inspection for the semi-conductor
industry and for the inspection of liquid crystal display devices, or LCDs. We
have recently released three products for the visual inspection of bare wafers
required for the manufacture of semi-conductors. Furthermore, we recently
acquired a 51.11% holding in Yuravision Co. Ltd., or Yuravision, a South Korean
company, which specializes in the development of automated vision inspection
equipment for the microelectronics and display industries, particularly in the
field of LCD devices. Our total investment in Yuravision, including advances,
is approximately $1.1 million. Should we be unable to anticipate the trends of
the microelectronics industry, or fail to develop products which provide the
necessary standard 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 may not successfully integrate acquired businesses.

Our acquisition of a controlling interest in
Yuravision also presents the challenge of operating a business in a country
with which Israel has had limited business relationships and in which we have
not previously done business. Should we fail to complete the acquisition or
fail to integrate the employees or business of Yuravision in the manner we had
anticipated, or should Yuravision fail to develop or commercialize the
inspection equipment as expected, we may not succeed in penetrating the sectors
of the microelectronics industry that we currently believe are necessary for
our future profitability.

8

---

---

Current
dependence on the worldwide textile industry

While we
have made a strategic decision to diversify our product line and develop
products for the microelectronics industry where we intend to focus our
business in the future, the predominant portion of our revenues are still
generated by our sales of automated visual inspection devices and quality
monitoring systems to textile manufacturers. As such, we are substantially
dependent upon the strength of the worldwide textile industry, 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 textile
manufacturers. Demand for such products is normally a function of the
prevailing global or regional economic environment and is negatively affected
in circumstances of a general economic slow-down such as that which began in
the late part of 2000 and to a large extent continues in effect.

There can
be no assurance as to the future levels of demand for the products produced by
textile manufacturers. This, coupled with our limited ability to reduce expenses
due to the ongoing need for investment in research and development and to
maintain our worldwide customer and support operations, and the difficulties
associated with any such reductions, could, in circumstances of reduced overall
demand, have a material adverse effect on our business and results of
operations.

We rely heavily on sales of I-TEX systems for a
significant part of our revenue.

Sales
of our I-TEX systems account for the majority of our revenues. In addition, we
anticipate that sales of I-TEX systems and related textile systems will
continue to account for a substantial portion of our revenues for the near
term. Accordingly, our business and results of operations are dependent on
sales of I-TEX systems and any decrease in sales of I-TEX systems would have a
material adverse effect on our business and results.

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.

9

---

---

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 textile industry, we often receive
a deposit upon receipt of an order, a partial payment upon delivery or
installation and final payment pursuant to negotiated payment terms or final
payment after a trail and/or acceptance period for systems sold subject to a
trial period. The time required for installation and trial varies from customer
to customer and may be delayed by a variety of factors, including the
customers production cycle, integration of systems into the customers
manufacturing process, required modifications to the customers production line
and the availability of qualified technicians to monitor system operations. For
systems sold without an evaluation period, revenue is recognized immediately
upon installation of the system. For systems sold subject to a trial period,
revenue is recognized upon customer acceptance. The length of the customers
trial and acceptance period generally varies from one to twelve months after
installation. We believe that we may continue to operate at a negative cash
flow for certain periods in the 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 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 of fabrics. 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, 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.

10

---

---

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.

Competition
in the field of automated vision inspection is intense.

Several
companies working with the textile industry have developed products with
similar visual inspection or quality monitoring capabilities, such as Uster
Technologies AG (formally Zelleweger Uster), BarcoVision and Cognex. It is
possible that systems developed by these or other future competitors will prove
more effective than our systems and that
potential customers will prefer them. The competition for the
development and sale of advanced automated vision systems in other industries
and for other applications is also intense. To the extent that providers of
automated vision systems may 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. If we are unable to maintain our
competitive advantage in the textile industry 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. 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. There can be no assurance that our potential
competitors will not develop products that render our products less
competitive.

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

The
technology incorporated in vision 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
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 core 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.

11

---

---

The
microelectronics industry is highly volatile and unpredictable.

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

We intend to continue pursuing businesses to acquire.

Our
business strategy includes selective expansion into other automated vision
applications through the acquisition of businesses and technologies. We plan to
continue to seek opportunities to expand our product line, customer base, and
technical talent through acquisitions in the automated vision industry.
Acquisitions involve numerous risks, including, but not limited to, diversion
of managements attention from other operational matters, the inability to
realize expected synergies resulting from the acquisition, failure to
commercialize purchased technology, and the impairment of acquired intangible
assets resulting from technological obsolescence or lower-than-expected cash
flows from the acquired assets. Acquisitions are inherently risky and the
inability to effectively manage these risks could have a material adverse
effect on our operating results.

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

Our
success depends in 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.

12

---

---

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

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

We
may become involved in litigation.

From time
to time, we may be subject to various claims and lawsuits by competitors,
customers, or other parties arising in the ordinary course of business. Such
matters can be time-consuming, divert managements attention and resources, and
cause us to incur significant expenses. Furthermore, than 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. In November
2002, we filed a claim for damages for the unlawful use of our technology against
our former founder Mr. Hillel Avni and Panoptes Ltd., a company established by
him. In our claim we also requested that the court order a permanent injunction
preventing Panoptes from making any use of our technology. In December 2002,
Panoptes and Mr. Avni filed a counter-claim for damages stating that we had
entered into negotiations with Panoptes in bad faith. Panoptes and Mr. Avni
also requested a permanent injunction against our company. In June 2004, the
Haifa District Court rejected a counter-claim by Panoptes and ordered Panoptes
to pay us damages. Despite the success of our claim against Panoptes, we may
not always be successful in such types of action and we may find it difficult
to maintain a competitive advantage in the field of automated vision inspection
in the textile industry. For more information, see Item 8,Financial Information -- Litigation.

13

---

---

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
1,669,094 of our ordinary shares at various exercise prices. Though a portion
of these warrants have been already exercised, exercise of the remaining
warrants issued pursuant to the Private Placement Investments will provide us
with proceeds of an additional $1,411,108 (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 will be paid in up to five quarterly installments, the last of which is
to be paid by November 2004. Also pursuant to the Plan of Arrangement, we are
distributing 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 $1,464,383 (for more information, see Item 7, Major Shareholders and Related Party
Transactions  Plan of Arrangement and Warrant Offering).In addition, we recently entered into a
Standby Equity Distribution Agreement (or the Standby Equity Distribution
Agreement) with Cornell Capital Partners L.P., or Cornell, pursuant to which we
will be entitled to issue Cornell with advance notices requiring it to
purchase, six days following each advance notice, a number of our ordinary
shares as per our advance notice. Should we utilize our Standby Equity
Distribution Agreement mechanism with Cornell in full over the next two years,
we will receive proceeds of approximately $9,500,000 (for more information, see
Item 10, Additional Information -- Material
Contracts). Nevertheless, the funds described above may not be
sufficient for supporting all of our operations and we may be required to seek
additional financing. We may not, however, be able to obtain additional
financing on terms satisfactory to us, if at all. Recent increases in the
number of our outstanding shares and our substantial losses may also limit our
ability to complete additional debt or equity financing.

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

As of June
24, 2004, 16,472,439 of our shares were outstanding. In addition, 4,183,950 of
our shares are issuable upon the exercise of the warrants distributed to our
shareholders pursuant to the Warrant Distribution. Additionally, pursuant to
the Private Placement Investments, we issued the Investors warrants to purchase
an aggregate of 1,669,094 of our ordinary shares, of which warrants to purchase
1,427,380 shares remain outstanding as follows:

| | 85,800
  shares at an exercise price of $0.68 per share,   
|- | -----------------------------------------------------------
| | 943,825
  shares at an exercise price of $0.85 per share,  
| | 15,102
  shares at an exercise price of $0.98 per share and
| | 382,653
  shares at an exercise price of $1.40 per share.  

14

---

---

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 March 31, 2008, and 3,157,086 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 and
2003 employee option plans, with varying exercise prices, ranging between $0.15
per share and $3 per ordinary share. In addition, pursuant to our Standby
Equity Distribution Agreement with Cornell, we may issue Cornell a currently
unknown number of our ordinary shares in addition to the 148,438 shares already
issued to it in consideration for providing the equity line and the 7,812
shares issued to Newbridge Securities Corporation, or Newbridge, the
broker-dealer retained by us as a placement agent in connection with the
Standby Equity Distribution Agreement. We estimate issuing Cornell approximately
an additional 5,555,555 of our ordinary shares, but we may issue a lesser or
greater number depending on the lowest volume weighted average per share price
of our shares over the five day period following each advance notice. All of
the shares issuable upon the exercise of the employee options are registered
for resale. All of the shares issuable upon the exercise of the employee
options are registered for resale. Following the effective dates of
registration statements filed for the registration of the shares and warrants
issued to the Investors, the shares issued and issuable in connection with the
Standby Equity Distribution Agreement, the Warrants to be distributed pursuant
to the Warrant Distribution and the shares issued and issuable to Altro pursuant
to the Plan of Arrangement, all of the shares currently issued to or reserved
for Cornell, Altro and the Investors and the shares underlying the warrants
referred to above will be registered for resale, and will not be subject to any
contractual restrictions on resale. Future resales of any of these shares, or
the anticipation of such sales, could cause an increase or an anticipated
increase of the number of our shares in the market and therefore could
adversely affect the market price of our ordinary shares and materially impair
our future ability to raise capital through an offering of equity securities
and could result in increased volatility in the price of our shares.

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

We do not know how many ordinary shares,
if any, will be issued to Cornell over the following two years pursuant to the
Standby Equity Distribution Agreement. In addition to 148,438 of our ordinary
shares already issued and 7,812 of our ordinary shares already issued to
Newbridge, one of our pending registration statements described above covers a
further 5,555,555 of our ordinary shares, which will also be available for
resale by Cornell. We have estimated issuing Cornell the additional 5,555,555
of our ordinary shares, based on the maximum number of our ordinary shares that
we currently anticipate issuing to Cornell pursuant to advances made under the
Standby Equity Distribution Agreement. At our recent share price of $0.70, we
would have to issue to Cornell 14,285,714 of our ordinary shares in order to
draw down the entire $10 million available to us under the Standby Equity
Distribution Agreement. Our ability to cause Cornell to advance funds under the
Standard Equity Distribution Agreement is not subject to any minimum volume
weighted average price of our ordinary shares. The lower the price of our
ordinary shares on the market at the time of an advance, the more shares will
be issued to Cornell and the greater dilution will be caused to the interests
of our shareholders.

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

To the extent Cornell sells our ordinary shares, the share price may
decrease due to the additional shares in the market. This could allow Cornell
to be issued more of our shares following an additional advance issued by us,
and any subsequent sale of such greater amounts of our ordinary shares could
further depress the share price. The significant downward pressure on the price
of our ordinary shares as Cornell sells material amounts of our shares could
encourage short sales by Cornell or others. This could place further downward
pressure on the price of our ordinary shares.

15

---

---

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

Our
ordinary shares are traded on the Over-the-Counter Bulletin Board. Trading in
our ordinary shares has been limited and there can be no assurance that an
active trading market for our ordinary shares will develop. As a result, this
could adversely affect our shareholders ability to sell our ordinary shares in
short time periods, or possibly at all. Thinly traded ordinary shares can be more
volatile than ordinary shares traded in an active public market. The average
daily trading volume of our ordinary shares in May 2004 was 26,133 shares. The
high and low bid price of our ordinary shares for the last two years has been
$2.05 and $0.11, 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 3a51-1promulgated under the
Securities Exchange Act of 1934. Penny stocks are stock:

| | With a price
  of less than $5.00 per share;                                                                                                                                                                                                                                                     
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | That are not
  traded on a recognized national exchange;                                                                                                                                                                                                                                       
| | Whose prices
  are not quoted on the NASDAQ automated quotation system; or                                                                                                                                                                                                                       
| | In issuers
  with net tangible assets less than $2.0 million (if the issuer has been in
  continuous operation for at least three years) or $5.0 million (if in
  continuous operation for less than three years), or with average revenues of
  less than $6.0 million for the last three years.

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

Our
ordinary shares were delisted from the NASDAQ SmallCap Market.

On November
19, 2003, our ordinary shares were delisted from the NASDAQ SmallCap Market.
The basis of the delisting was our failure to comply with the $2.5 million
minimum shareholder equity requirement for continued listing on The NASDAQ
SmallCap Market. Since January 2004, our shareholder equity has exceeded this
minimum requirement and we requested a review of the delisting decision. On
April 7, 2004, the NASDAQ Listing and Hearings Review Council, or Council,
rejected our appeal and on April 29, 2004 we were informed that the Council
refused to reconsider its decision. We do not presently intend to further
challenge the decision. We are currently traded on the Over-the-Counter
Bulletin Board. Since delisting, our share price has fallen from $1.76 on
November 18, 2003 to $0.70 on June 23, 2004. The delisting may contribute to a
further deterioration in the liquidity, marketability and price of our ordinary
shares. 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.

16

---

---

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

We
have been and may continue to be negatively affected by the aftermath of September
11 events.

On
September 11, 2001, the United States was subject to terrorist attacks at the
World Trade Center buildings in New York City and at the Pentagon in
Washington, D.C. In response to these terrorist attacks, a United States-led coalition
of nations retaliated against the Taliban regime in Afghanistan. Since this
time, governmental intelligence authorities issue from time to time warnings of
the imminent threat of further attacks against civilian and military
installations. On March 17, 2003, a coalition of countries led by the United
States and the United Kingdom commenced large-scale military action against
Iraq, which resulted in a change in the Iraqi regime. Nevertheless, unrest
continues in Iraq and Afghanistan. These attacks and armed conflicts, as well
as the uncertainty surrounding these issues, have had, and we expect will
continue in the foreseeable future to have, an adverse effect on the global
economy, and could result in a disruption of our business or that of our customers.

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 are expected to increase in the near future. New legislation, such
as the recently enacted Sarbanes-Oxley Act of 2002, will have 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.

17

---

---

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.

Since the
establishment of the State of Israel in 1948, a state of hostility has existed,
varying in degree and intensity, between Israel and the Arab countries. In
addition, Israel and companies doing business with Israel have been the subject
of an economic boycott by the Arab countries. Israel has entered into peace
agreements with Egypt and Jordan, various agreements with certain Arab
countries and the Palestine Liberation Organization and the Palestinian Authority,
and various declarations have been signed in connection with efforts to resolve
some of the economic and political problems in the Middle East. Nevertheless,
there has been a significant escalation in violence since September 2000, which
has continued with varying levels of severity into 2001, 2002, and 2003.
Negotiations between Israeli and Palestinian representatives have ceased in
light of heightened terrorist activity of groups operating within the
Palestinian Authority. The political and security situation in Israel may
result in certain parties, with whom we have entered into contractual
relations, claiming that they are not obligated, pursuant to force majeure
provisions, to perform their commitments under such agreements. 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
preclude us from raising capital. Furthermore, our main facilities are located
in Israel, which is currently experiencing civil unrest, terrorist activity and
military action. 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 events 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 and/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 the results of our operations. While these developments have not had a
material impact on our business, we can give no assurance that they will not
have such an effect in the future.

Furthermore,
all non-exempt male adult permanent residents of Israel under the age of 48 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.

18

---

---

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

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

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

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

Israeli
courts might not enforce judgments rendered outside of Israel.

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

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.

19

---

---

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

A. History and Development of the Company

Elbit Vision Systems Ltd., or EVS, designs,
develops, manufactures, markets and supports automatic visual inspection and
quality monitoring systems for the textile and other fabric industries. Our
systems are designed to increase the accuracy, consistency and speed of the
detection of defects in the manufacturing process of fabrics in order to reduce
labor costs, improve product quality and increase manufacturing efficiency. We
currently market five product lines designed to address the quality monitoring
needs of different sectors within the fabric manufacturing industry: I-Tex, for
the visual inspection and quality monitoring of woven and knitted fabrics;
PRIN-TEX, for the detection of printing defects on fabric; Broken Filaments
Analyzer, for the detection of filament defects in glass fabrics; Shade
Variation Analyzer (or SVA LITE), for the detection of shade inconsistencies in
dyed fabric; and LOOM-TEX, for the automatic visual quality inspection system
that is integrated with the weaving loom and monitors the fabric while weaving.
We adapted our core visual interpretation technologies for other applications,
such as those in the non-woven fabric and printing industries, which have
visual inspection and quality monitoring needs similar to those of the fabric
industry.Potential applications
in the non-woven industry include air filtration media, diapers, surgical
dressings and other non-woven based products.

In the third quarter of 2002, we decided to
leverage our expertise in designing visual inspection systems and expand our
business into the field of machines for the inspection of wafers manufactured
for the microelectronic industry. During 2003, we continued to invest time and
resources in our efforts to expand our business into new areas of production.
We intend these efforts to be ongoing.

As part of this strategy, in June 2004, we
completed an investment in Yuravision Co. Ltd. and a series of purchase
agreements with certain of its shareholders, increasing our holdings in
Yuravision to approximately 51.11%. Yuravision is a South Korean developer of
visual inspection systems for the microelectronics and display industries. The
acquisition of a controlling stake in Yuravision is intended to facilitate our
efforts to penetrate the Flat Panel Display (FPD) and display technology
markets. We anticipate that we will continue acquiring shares in Yuravision
with the goal of increasing our interest to 100% over the next twelve months,
though we have no agreement to do so. See the discussion regarding the
Yuravision Acquisition in Item 3, Key
Information -- Risk Factors -- Risk Factors Related to Our Business
and Item 10, Additional Information --
Material Contracts.

20

---

---

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

The discussions on the investments by Mr. Nir
Alon and/or Altro, the Standby Equity Distribution Agreement and the Private
Placement Investments are incorporated by reference to Item 3, Key Information -- Risk Factors -- Risks
Related to Our Ordinary Shares,toItem 7, Major Shareholders and Related Party
Transactionsand to Item 10,
Additional Information -- Material Contracts.

Our executive offices are located at New
Industrial Park, Building 7, Yoqneam, Israel, and our telephone number is
972-4-993-6400. Our Web site is www.evs.co.il. Information on our Web
site is not incorporated by reference in this annual report.

B. Business Overview

The Textile Industry

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

In recent years, textile 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. Textile 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.                                                                                   

21

---

---

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

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 textile 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 textile industry.

The EVS Solution for
the Textile Industry

We develop sophisticated automatic visual
inspection systems 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.

22

---

---

Products

We currently offer five families of visual
inspection systems: I-TEX, for the visual inspection and quality monitoring of
woven, knitted and non-woven fabrics; PRIN-TEX, for the detection of printing
defects on fabric; Broken Filaments Analyzer, for the detection of broken
filaments defects in glass fabric; SVA LITE, a Shade Variation Analyzer for the
detection of shade inconsistencies in dyed fabric; and LOOM-TEX, for the
automatic visual quality inspection system that is integrated with the weaving
loom and monitors the fabric while weaving

I-TEX
Family of Products

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

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

Quality
Monitoring Process

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

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

23

---

---

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

I-TEX systems are currently available in five
basic models: I-TEX 100, I-TEX 200, I-TEX 2000, I-TEX 2000D and I-TEX Lite.

| |  | The I-TEX 100 is designed for greige and technical web inspection. It
  can be configured for extra-high resolution and for extra-wide fabrics. The
  list price of the basic configuration of the I-TEX 100 ranges between
  $100,000 and $250,000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        | 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 
| |  | The I-TEX 200 is designed for in-process and final inspection of
  unicolored dyed and finished fabric. The list price for the basic
  configuration of the I-TEX 200 is approximately $250,000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | 
| |  | The I-TEX
  2000 is the I-TEX familys high-end product. I-TEX 2000 is a more compact,
  more powerful and more flexible version of I-TEX. It can operate at a maximum
  speed of up to 300 meters per minute. It includes improved capabilities for
  the detection of defects in complex fabrics, such as denim, and high-speed
  configuration for an in-line inspection of non-woven fabric. In October 2003,
  we released a new version of the I-TEX 2000 called I-TEX 2000D. This system
  is capable of performing a double-sided fabric inspection, is equipped with
  special hardware and software for denim inspection and is operated using new
  and user-friendly human interface. The list price for the I-TEX 2000 ranges
  between $350,000 and $550,000, depending on the configuration. | 
| |  | The I-TEX
  Lite is one of the new lines of inspection products of EVS. The system is
  designed for easy and flexible installation on a wide range of web production
  lines such as Non-Woven, Paper, Composite materials, laminated materials etc.
  The system allows EVS to offer solutions to new market segments using its
  vast experience from the textile industry. The list price for the I-TEX Lite
  ranges between $70,000 and $180,000, depending on the configuration.                                                                                                                                                                                                                                                                                                                     | 

24

---

---

Modules

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

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

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

| |  | reviewing and editing of defect data;                                                                 
| | - | ------------------------------------------------------------------------------------------------------
| |   |                                                                                                       
| |  | generation of management reports;                                                                     
| |   |                                                                                                       
| |  | archiving of defect data; and                                                                         
| |   |                                                                                                       
| |  | definition of points of interest and mandatory cutting points for the
  cutting table and DMSS system.

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

| |  | maximizes web rolls selling price;                           
| | - | -------------------------------------------------------------
| |   |                                                              
| |  | reduces the quantity of second and third quality product; and
| |   |                                                              
| |  | consistent fulfillment of customers demands.                

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

| |  | allows for an accurate stop or slowing the table speed on point of
  interest which were defined on the video album such as: selected defects,
  cutting points and mending points;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                                                                      
| |  | contains a trigger for invisible ink or metallic label defect marking
  signs; and                                                                                                   

25

---

---

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

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

Accessories

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

PRIN-TEX
Family of Products

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

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

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

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

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

26

---

---

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

PRIN-TEX 2000 is the new generation of our
printing monitoring systems. It implements improved image understanding
algorithms, specially designed color CCD line cameras, upgraded color displays
and synchronization to the rotary printers screen. PRIN-TEX 2000 provides
better detection performances, better human interface and better ROI results.
We offer PRINT-TEX 2000 in one model or fabric widths of up to 3.2 meters. The
list price of PRINT-TEX 2000 ranges between $170,000 and $250,000.

Broken
Filaments Analyzer

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

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

Shade
Variation Analyzer

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

27

---

---

The
LOOM-TEX

The LOOM-TEX is an automatic visual quality
inspection system that is integrated within the weaving loom and monitors the
fabric while weaving. The system answers the need for real-time detection of
spinning and weaving defects within a short distance of the reed (the movable
frame fitted with metal strips that separates the warp threads in weaving)
during the weaving process and inspects 100% of the fabric. The advantages and
features of the LOOM-TEX include increased yield of first-choice fabrics,
elimination of manual inspection, reduction of the need to cut out running
defects, facilitation of exact fabric length weaving while considering the
actual defect rate, optimization of loom assignment, real-time alarm
notification of major defects and suspension of loom activity when warp and
running defects are detected. The LOOM-TEX inspects 100% of the fabric and
selvedge (the edge of a fabric that is woven so that it will not fray or ravel)
on a wide range of applications including, among others, technical fabrics,
apparel, home furnishing, upholstery, silk and shirting. Detection by the
LOOM-TEX is performed as closely as possible to the reed enabling early
detection of the faults. A real time alarm is activated according to
pre-defined defect parameters capable of stopping the loom upon detection of
major faults. Each looms performance can be viewed during real time,
displaying defect images, roll-defects maps and statistical data. The list
price of the LOOM-TEX ranges between $7,000 and $20,000.

The Microelectronics Industry

We have
adopted a two-year research and development program which aims to develop
add-on devices for the optical inspection of bare wafers in the
microelectronics industry in the near term and stand-alone products for the
longer-term when we expect to see growth in the microelectronics industry.

Most
microchips are built on a bare silicon wafer and include a variety of
components such as transistors and other devices that are connected by multiple
layers of wiring. As the density of the circuit components is increased to
enable greater computing power in the same or smaller area, the complexity of
building the chip also increases, necessitating the formation of smaller
structures and more intricate wiring schemes. To build a chip, the transistors,
capacitors and other circuit components are first created on the surface of the
wafer by performing a series of processes to deposit and remove selected film
layers. Similar processes are then used to build the layers of wiring
structures on the wafer. The quality of a bare wafer will affect the ability to
build the correct circuitry. By constant assessment of the quality of the bare
wafer, a microchip producer can better ensure that the product will suit the
market for which the chips are being produced.

28

---

---

The
production of the bare wafer is a mechanical process requiring several stages,
including the preparation of a carrier block by depositing waxy layers on its
upper -mounting - surface, and polishing (hazing). Currently there is no
method to inspect wafers during the early production process.

The EVS Solution for the Microelectronics
Industry

Due to the
overcapacity caused by the downturn in the microelectronics industry,
manufacturers are reluctant to invest in new capital equipment and their main
concern is to maximize yield using the existing equipment and reduce labor
costs.

Given that
the competition between wafer manufacturers is mainly price versus quality, the
most efficient way to improve the yield is to perform an effective automated
inspection at the end of the wafer production process.

In order to
answer the inspection/monitoring requirements in the industry, we are in the
process of developing a number of proprietary technologies dedicated to the
bare wafer segment. The following products have been submitted by us for patent
registration and are pending approval: the Mounting Wax Monitoring System, the Back Side Inspection System and
the Dynamic Roughness Monitoring System. In spite of their sophistication and novelty, the technologies we are
developing are rather inexpensive, robust and scalable.

Our primary
goal in this segment industry is to produce devices to be added on to existing
machinery. One of the devices will inspect the thick transparent layers (wax)
as they are added to the wafer, and which will monitor the results of the
polishing process. In the longer-term we intend to produce devices that will
inspect the wafers at other stages of the manufacturing process.

As we
improve the performance envelope of our technologies, we foresee additional
applications in the microelectronics industry.

Products

The
Mounting Wax Monitoring System

The Mounting
Wax Monitoring System is an inline solution for bare wafer manufacturing. The
system is installed on the polisher and monitors the wax polishing process by
collecting images while the block rotates on the wax coating spindle. The
images are processed and the result is analyzed. Automatic re-wax is activated
for defects defined as harmful. The correlation criterion between the defects
on wax and the polished wafer can be adjusted by the user. The list price of the Mounting Wax Monitoring System ranges between $19,000 and $50,000.

The
Back Side Inspection System

The Back Side Inspection System is an in line
solution for optical inspection of rough surfaces. The system inspects the back
side of wafers during the production process. Using our unique MuxD (Multiple
Correlated Scattering Detection), etched or polished surfaces are imaged and
processed to reveal artifacts.

29

---

---

The features of the Back Side Inspection
System include:

| | i) Detection
  of defect types on etched or lapped surfaces, such as:                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                     
| |                                                                                                                                     
| |                                                                                                                                     
| | ii)
  Classification  can be defined by the customer regarding the size, shape,
  contrast, sign and position of the inspected area;
| | iii)
  Metrology - with very high capture rate (95%) and classification accuracy
  (> 90%); and                                      
| | iv) Testing
  speed  less than 10 seconds for 200mm wafers.                                                                         
| |                                                                                                                                      

The list price of the Back Side Inspection
System ranges between $80,000 and $100,000

The
Dynamic Roughness Monitoring System

The Dynamic Roughness Monitoring System is
designed for the in-line inspection of the wafer surface roughness at different
stages of the manufacturing process. The list price of the Dynamic Roughness
Monitoring System ranges between $30,000 and $70,000.

Sales and Markets for
Textile Industry

Sales
Network

We market our products through in-house sales
personnel in conjunction with independent sales representatives. As of
May 31, 2004, 5 in-house sales personnel and 19 independent sales
representatives marketed our products. Our independent sales representatives
provide essential pre-and-post sales support for our products in their
territories and account for a substantial percentage of our sales worldwide. We
believe that our sales representatives network will enable us to introduce new
products and to penetrate additional web manufacturers around the world. We
intend to further expand our international sales representatives network by entering
into relationships with additional sales representatives and forming joint
ventures in target markets.

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

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

30

---

---

I-TEX
Inspected Standard

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

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

The Textile Industry
Products.  In 2001, approximately 56.6% of our sales
were in the United States, approximately 31.1% were in Europe and 10.2% were in
the Far East and 2.1% were in the Central America.In 2002, approximately 45% of our sales were in the United
States, approximately 45% were in Europe and approximately 10% were in the Far
East.In 2003, approximately 40%
of our sales were in the United States, approximately 46% were in Europe, and
approximately 14% were in the Far East.One
customer accounted for 21 %, 9.5% and 21% in each of the years 2001, 2002, and
2003 respectively. No other customers accounted for more than 10% of our net
sales in any of the years 2001, 2002, or 2003. 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.

The Microelectronic
Industry Products.  We did not sell any of our products designed
for the microelectronics industry, in 2003.

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 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.

31

---

---

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 published 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.

Manufacturing for
Textile 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 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. Our manufacturing facilities and those of our subcontractors
are in compliance with ISO-9000 standards.
The proprietary cameras and spectrophotometer included in our products are
manufactured by a single source supplier. Some of the electronic components
included in our product are manufactured especially for us by exclusive
suppliers. If any of these exclusive suppliers stop manufacturing these
components we will need to find alternative suppliers. Our reliance on sole
suppliers involves several risks, including a potential inability to obtain
adequate supplies of these components and reduced control over pricing and
timely delivery of these components. We believe that we maintain
a sufficient inventory of these components to meet our foreseeable needs.
However, if our single source supplier ceases to produce these components, we
would have to transfer the manufacture of the components to another supplier or
suppliers. We estimate that such a transfer would take approximately up to six
months and could delay the production and supply of our products, which could harm
our results of operations.

There are four companies that manufacture approximately 80% of wafers
worldwide. The leading companies are located in USA, Europe and Far East. We
are negotiating with several companies across the world for the sale, distribution
and servicing of our products.

32

---

---

Competition in Textile Industry

Over the past few years there have been
several academic and commercial attempts to develop systems that will be
competitive with our I-TEX family of products. Most of those projects did not
reach a commercial stage. Uster Technologies AG (formally Zelleweger Uster)
manufactures a system that offers automatic visual inspection technology
similar to the primary generations of our I-TEX systems. Uster is a provider of
quality control equipment for the textile spinning industry and has greater
financial, production and marketing resources than we do. 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 them. Other potential competitors are small suppliers of
automatic inspection solutions with PC-based or smart camera technologies.
These suppliers, who offer low-cost solutions for low-end applications such as
Non-Woven, are attempting to penetrate the field of textile inspection, yet,
thus far, have not been commercially successful. We are familiar with several
companies that are working on an On Loom automatic inspection solution for
the greige fabric market, including BarcoVision. It is possible that when On
Loom inspection systems are commercially available, they will be competitive
with us in the greige inspection market.

EVS is targeting the Non-Woven industry as a
high potential market for its automatic inspection systems. The main competitor
on this industry is Cognex Corporation - based in the U.S. 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 Non-Woven industry, will
allow us to produce revenues from it. For a discussion of legal proceedings
against Panoptes Ltd., see Item 8, Financial
Information -- Litigation -- Panoptes Litigation.

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

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

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

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

33

---

---

We are not aware of any competition in the
field of wafer inspection for the microelectronic industry.

Intellectual Property Rights for Textile
Industry

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

Neither we, nor, to our knowledge, Dr.
Tamches, have any patents or patent applications pending with respect to this technology.
We do have a patent in France and patent applications pending in Canada,
Germany and 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, Germany, Turkey,
Portugal, Brazil, France, China and Japan, and have filed applications for
registered trademarks for the name I-TEX in India and Italy. We have filed
applications for registered trademarks of the name and design I-TEX Inspected
in Taiwan and South Africa. We have registered trademarks with respect to the
name and a new design I-TEX Inspected in the United States, Mexico, Brazil,
Germany, France, Turkey, Italy, the European Union, China and Taiwan, and have
filed applications for registered trademarks of the name and a new design
I-TEX Inspected in India and South Africa. We also have registered trademarks
with respect to the name PRIN-TEX in Spain, Portugal, France, Turkey and
Japan, and have filed applications for registered trademarks with respect to
the name PRIN-TEX in Italy. We also have a registered trademark with respect
to the name and old design PRIN-TEX in the United States. In addition, we
have a registered trademark with respect to the name KNI-TEX in the United
States and Italy. We also have a registered trademark with respect to the name
EVS in the European Union, Japan and the United States. In  Union and in the United States. Our
trademark rights include rights associated with the use of our trademarks.

34

---

---

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 current patent infringement claim that has
come to our attention.

Sales and Markets for
Microelectronics Industry

Since we are dealing with a very small number
of manufacturers and customers in the microelectronics industry, the sale of
our products is carried out by direct sales to those manufacturers and
customers.

Manufacturing for
Microelectronics Industry

The principal manufacturing and assembly of
our basic systems are conducted by subcontractors. We perform logistical and
purchasing activities, integration and final testing, in-house. Our recently
acquired majority-owned subsidiary, Yuravision, will be involved in the
integration of products. In addition, we perform software installation and
configuration, final hardware configuration, quality control and any special
system customization needed for a particular customer. Production planning is
based upon firm customer commitments and anticipated orders and is generally
planned six months in advance. We engage third party subcontractors to perform
the manufacturing of our systems so that we can focus on strengthening design
and product development while minimizing fixed costs and capital expenditures.
Our engineers work closely with subcontractors to increase manufacturing
yields, lower manufacturing costs and assure high quality. Our manufacturing
facilities and those of our subcontractors are in compliance with ISO-9000
standards.

Competition for
Microelectronics Industry

The market for semiconductor capital equipment is highly competitive.
While there are a number of companies that operate in the microelectronics
industry, we do not believe that any of them compete directly in our field. To
the best of our knowledge, Nanometrics and Nova Measuring Instruments Ltd. are
active in the semiconductor capital equipment industry and KLA-Tencor
Corp., Therma-Wave Inc. and Rudolph Technologies Inc are active in the
photolithography area. Significant competitive factors in the market for
integrated process control systems include technological leadership, system
performance, ease of use, reliability, cost of ownership, technical support and
customer relationships, along with an adequate business model, internal
organization and unique process equipment manufacturer agreements and
partnerships.

35

---

---

Intellectual Property
Rights for Microelectronics Industry

For our developments in the microelectronic
industry, we have already applied for patents for our haze, wax and beam
separation analysis inspection technologies. For further
information, see the discussion regarding intellectual property in Item 3, Key Information -- Risk Factors -- Risk
Factors Relating to our Business.

C. Organizational
Structure

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

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

We recently acquired a controlling interest in
Yuravision Co. Ltd. Yuravision is incorporated in South Korea, and we acquired
it as part of our expansion into the microelectronics and display industries
for which Yuravision manufacturers products. For more information, see Item 4, Information on the Company -- History and
Development of the Companyand Item
10, Additional Information -- Material Contracts.

D. Property,
Plants and Equipment

Our facilities are located at New Industrial
Park in Yoqneam, Israel. We do not own any real property. We lease
approximately 7,000 square feet at our facilities in Israel, at an annual rent
of approximately $120,000. Our lease expires on December 31 2005.  EVS US leases office space in Greenville,
South Carolina, at an annual rent of approximately $30,000.

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

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

The following selected financial data for the
years ended December 31, 2001, 2000 and 1999, which are not set forth elsewhere
in this report, are derived from the financial statements that have been
audited by Luboshitz Kasierer for the said years. Luboshitz Kasierer, during
such years, was a member firm of Arthur Andersen, independent public
accountants. The selected financial data for the year ended December 31, 2002,
is derived from the financial statements set forth elsewhere in this report,
which have been audited by Luboshitz Kasierer. Luboshitz Kasierer is now a
member firm of Ernst & Young International, independent public accountants.
The selected financial data for the year ended December 31, 2003, is derived
from financial statements set forth elsewhere in this report, which have been
audited by Kesselman & Kesselman. Kesselman and Kesselman is a member firm
of PWC International, independent public accountants. 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.

36

---

---

|                                                                 |  | 2003 |         | 2002 |   | 2001    |   | 2000 |         | 1999 |  
|---------------------------------------------------------------- |  | ---- | ------- | ---- | - | ------- | - | ---- | ------- | ---- | -
|(in U.S. thousand Dollars )                                      |  |      |         |      |   |         |   |      |         |      |  
|Statement of Operations Data:                                    |  |      |         |      |   |         |   |      |         |      |  
|Net sales
  (1)                                                  |  | $    | 6,328   |      | $ | 7,228   |   | $    | 9,303   |      | $
|Cost of
  sales                                                  |  |      | 3,748   |      |   | 4,660   |   |      | 6,803   |      |  
|Gross profit
  (loss)                                            |  |      | 2,580   |      |   | 2,568   |   |      | 2,500   |      |  
|Research and
  development expenses, net                         |  |      | 1,431   |      |   | 1,340   |   |      | 1,405   |      |  
|Marketing
  and selling expenses, net                            |  |      | 1,598   |      |   | 1,545   |   |      | 1,625   |      |  
|General and
  administrative expenses                            |  |      | 637     |      |   | 1,404   |   |      | 886     |      |  
|Total
  operating expenses                                       |  |      | 3,666   |      |   | 4,289   |   |      | 3,916   |      |  
|Operating
  loss                                                 |  |      | (1,086  | )    |   | (1,721  | ) |      | (1,416  | )    |  
|Other income                                                     |  |      | 47      |      |   | 9       |   |      | 20      |      |  
|Financing
  income, net                                          |  |      | 60      |      |   | 34      |   |      | 89      |      |  
|loss before
  taxes                                              |  |      | (979    | )    |   | (1,678  | ) |      | (1,307  | )    |  
|Taxes on
  income                                                |  |      | 3       |      |   | 6       |   |      | 6       |      |  
|Net loss
  from continuing operations                            |  |      | (982    | )    |   | (1,684  | ) |      | (1,313  | )    |  
|Cumulative
  effect of change in accounting
  principle, net (1) |  |      |         |      |   |         |   |      |         |      |  
|Net loss                                                         |  |      | (982    | )    |   | (1,684  | ) |      | (1,313  | )    |  
|Basic
  earnings per share, net loss                             |  |      | (0.10   | )    |   | (0.17   | ) |      | (0.13   | )    |  
|Cumulative
  effect of change in accounting
  principle, net     |  |      |         |      |   |         |   |      |         |      |  
|Net Income
  (loss) per share (2)                                |  |      | (0.10   | )    |   | (0.17   | ) |      | (0.13   | )    |  
|Net loss                                                         |  |      |         |      |   |         |   |      |         |      |  
|Net loss per
  share                                             |  |      |         |      |   |         |   |      |         |      |  
|Weighted
  average number of shares
  outstanding (2)            |  |      | 10,175  |      |   | 10,167  |   |      | 9,817   |      |  
|                                                                 |  |      |         |      |   |         |   |      |         |      |  
|                                                                 |  | 2003 |         | 2002 |   | 2001    |   | 2000 |         | 1999 |  
|Balance Sheet Data:                                              |  |      |         |      |   |         |   |      |         |      |  
|Working
  capital                                                |  | $    | 2,507   |      | $ | 1,110   |   | $    | 2,513   |      | $
|Total assets                                                     |  |      | 8,241   |      |   | 6,828   |   |      | 9,339   |      |  
|                                                                 |  |      |         |      |   |         |   |      |         |      |  
|Total liabilities                                                |  |      | 5,865   |      |   | 5,402   |   |      | 6,229   |      |  
|Accumulated
  deficit                                            |  |      | (18,549 | )    |   | (17,567 | ) |      | (15,883 | )    |  
|Shareholders
  equity                                           |  |      | 2,376   |      |   | 1,426   |   |      | 3,110   |      |  

| | (1) | Effective
  January 1, 2000, we changed our revenue recognition policy so that it is now
  in accordance with guideline SAB 101 of the United States Securities and
  Exchange Commission. As a result, revenues in an amount of $4.3 have been
  moved from 2000 to 2001.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (2) | Computed on
  the basis set forth in Note 2. R. to our Consolidated Financial
  Statements.                                                                                                                                                                               

37

---

---

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 annual report. 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.

Critical Accounting
Policies

The preparation of our financial statements
in conformity with the U.S. generally accepted accounting principles requires
us to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amount of revenues and expenses
during the reporting period. These are our managements best estimates based on
experience and historical data. Actual results could differ from those
estimates.

Specific accounting policies we utilize
require higher degrees of judgment than others in their application. These
include revenue recognition on long-term contract work. Our policy and related
procedures for revenue recognition on long-term contract work are summarized
below. In addition, Note 1 to our Consolidated Financial Statements includes
further discussion of our significant accounting policies.

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

38

---

---

With respect to systems sold with
installation requirements, the installation is not considered to be a separate
earnings process; thus, revenue is recognized when delivery has occurred, title
passed to the customer and installation is completed. In cases where our
agreement with the 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 on newly
developed products, usually for several months, in order to evaluate a
prototype systems performance. In cases where the systems performance meets
the customers requirements, it will confirm its order of 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 confirms the order. Until purchased,
these products are recorded as consignment inventory at the lower of cost and
market.

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

We grants our customers support services,
including warranty in respect of products sold; these services are usually
provided for a period of six to twelve months. Upon revenue recognition, we
defer a portion of the sale price and recognize it as service revenue ratable
over the abovementioned period.

Services Rendered

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

A. Operating Results

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

|                                           |                 | 2003 |       | 2002  |  | 2001  |       | 2000 |       | 1999  | 
|------------------------------------------ | --------------- | ---- | ----- | ----- |  | ----- | ----- | ---- | ----- | ----- | 
|                                           | Net sales       |      |       | 100.0 |  |       | 100.0 |      |       | 100.0 | 
|                                           | Cost of
  sales |      |       | 59.2  |  |       | 64.5  |      |       | 73.1  | 
|                                           | Gross profit    |      |       | 40.8  |  |       | 35.5  |      |       | 26.9  | 
|                                           |                 |      |       |       |  |       |       |      |       |       | 
|Research and
  development
  expenses, net |                 |      | 22.6  |       |  | 18.5  |       |      | 15.1  |       | 
|Marketing
  and selling expenses, net      |                 |      | 25.2  |       |  | 21.4  |       |      | 17.5  |       | 
|General and
  administrative expenses      |                 |      | 10.1  |       |  | 19. 4 |       |      | 9.5   |       | 
|Total
  operating expenses                 |                 |      | 57.9  |       |  | 59.3  |       |      | 42.1  |       | 
|Operating
  loss                           |                 |      | (17.2 | )     |  | (23.8 | )     |      | (15.2 | )     | 
|Other
  expenses                           |                 |      | (0.7  | )     |  | (0.1  | )     |      | (0.2  | )     | 
|Financing
  income, net                    |                 |      | (0.9  | )     |  | (0.5  | )     |      | (1.0  | )     | 
|Loss before
  taxes                        |                 |      | (15.5 | )     |  | (23.2 | )     |      | (14.0 | )     | 
|Income taxes                               |                 |      | 0.05  |       |  | 0.08  |       |      | 0.06  |       | 
|Net (loss)                                 |                 |      | (15.5 | )     |  | (23.3 | )     |      | (14.1 | )     | 

39

---

---

Year Ended December
31, 2003 Compared with Year Ended December 31, 2002

Sales

Sales in 2003 decreased by approximately 12.4% to $ 6.328 million
compared with sales of $7.228 million in 2002. This decrease was primarily
attributable to a decrease in sales in USA. Our sales to the USA are mainly to
the textile manufacturers that suffered from competition from producers from
the Far East. Since 1997, approximately 300 textile plants manufacturers closed
their facilities in the USA because of the high cost of labor in the USA
compared to the Far East. While our old line of products was designed to reduce
labor costs for our U.S. clients, the savings did not preclude most of the
textile plants from moving to the Far East, causing significant reductions in
sales.

Cost of Revenues

Cost of sales 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 59.2% in 2003 compared to 64.5% in 2002.This resulted from our
successful reduction of fixed costs and increase of our production efficiency.
Our fixed costs were reduced primarily by a reduction in our workforce and the
execution of a new rental agreement for the lease of our premises, which
reduced our rental expenses by more than $100 thousand. The increase in our
production efficiency was principally attributable to our new line of Lite
products that are significantly cheaper to produce and install, than the
comparable products that preceded them.

Gross Profit

In 2003 we earned a gross profit of $2.580 million as compared to a
gross profit of $2.568 million in 2002. Gross profit as a percentage of net
sales was 40.8% in 2003 as compared to 35% in 2002. This improvement was
primarily due on the one hand to the reduction in fixed costs related to our
operations and on the other to the increase in our production efficiency as
described above.

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 1.83 million in 2003 from $1.49 million in 2002, and
were offset by Israeli government grants of $0.396 million in 2003 and $ 0.15
million in 2002. Net research and development expenses in 2003 were $1.431
million compared with $1.340 million in 2002. The increase in the gross
research and development expenses was mainly for two reasons: the development
of our new on-line products including the: LOOM-TEX, I-TEX Lite and the SVA
Lite, and the development of our new product lines for the microelectronics
industry including the Mounting Wax Monitoring System, Back Side Inspection
System and Dynamic Roughness Monitoring System. In order to develop these new
suites of products, we increased our number of research and development
engineers and invested large amounts in developing prototype systems for beta
site installations. Research and development expenses are charged to income as
incurred.

40

---

---

Sales and Marketing Expenses

Gross marketing and sales expenditures consist primarily of costs
relating to promotion, advertising and trade shows, payroll and related
expenses, sales commissions, travel expenses. Marketing and selling expenses
amounted to $1.598 million in 2003, compared to $1.545 million in 2002. The
increase in the marketing and sales expenses was primarily due to expenses of
the ITMA exhibition in October 2003 in Birmingham, UK, an important textile
industry exhibition that occurs every four years. We also invested in launching
our new on-line products for industrial Web and new products for the
microelectronics industry.

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 10.1% in 2003 from
19.4% in 2002. General and administrative expenses in 2003 were $0.637 million,
compared to $1.404 million in 2002. The decrease in expenses in 2003 was
primarily attributable to a decrease in the provision for doubtful accounts
following our successful collection of accounts that had previously been
considered doubtful and the reduction of our labor force.

Financial Income

Financial income consists primarily of interest earned on our cash
reserves and marketable securities, as well as interest on our loan from one of
our major shareholders (and former sole controlling shareholder) Elbit Ltd., or
Elbit, and currency translation adjustments between U.S. Dollar exchange rate
imposed on our assets and liabilities. Financial income increased to $60
thousand in 2003 from $34 thousand in 2002.

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

Loss

Net loss decreased from $1.68 million in 2002 to $0.98 million in 2003.
This decrease in losses was primarily due a reduction in labor and overhead
costs in 2003 and decrease in allowance for doubtful accounts.

41

---

---

Year Ended December
31, 2002 Compared with Year Ended December 31, 2001

Sales

Sales in 2002 decreased by approximately 22.3% to $ 7.228 million
compared with sales of $9.303 million in 2001. This decrease was primarily
attributable to a decrease in sales in USA.

Cost of Revenues

Cost of sales 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 64.5% in 2002 and 73.1%
in 2001. In 2002 we earned a gross profit of $2.568million as compared to a gross profit of $2.500 million in 2001.
Gross profit as a percentage of net sales was 35.5% in 2002 as compared to
26.9% in 2001. This improvement was primarily due to the reduction in labor
costs and a reduction in the payment of royalties following our renegotiation
of our license agreement with Dr. Ilan Tamches.

Research and development expenses

Net research and development expenses in 2002 were $1.340 million
compared with $1.405 million in 2001. 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 1.49 million in 2002 from
$1.531 million in 2001, and were offset by Israeli government grants of $0.15
million in 2002 and $0.126 million in 2001.

Selling and marketing expenses

Gross marketing and selling 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 $1.545 million in 2002, compared to $1.625 million in 2001,
constituting no material difference in the amount and the nature of the
expenses between the years.

General and administrative expenses

General and administrative expenses consist of payroll and related
expenses, doubtful and bad accounts, professional fees paid to auditors, legal
advisors and other consultants and other related expenses. As a percentage of
net sales, general and administrative expenses increased to 19.4% in 2002 from
9.5% in 2001. General and administrative expenses in 2002 were $1.404 million,
compared to $0.886 million in 2001. The increase in expenses from 2001 to 2002
was primarily attributable to an increase in allowance for doubtful and bad
accounts.

Financial income

Financial income consists primarily of interest earned on our cash
reserves and marketable securities, as well as interest on our loan from Elbit
and currency translation adjustments between U.S. Dollar exchange rate imposed
on our assets and liabilities. Financial income decreased to $0.034 million in
2002 from $0.089 million in 2001.

42

---

---

Net loss

Net loss increased from $1.31 million in 2001 to $1.68 million in 2002.
This increase in losses was primarily due a reduction in sales in 2002 and
increase in allowance for doubtful accounts.

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 4.85 to the Dollar to a low of NIS
4.292 to the Dollar. The high and low exchange rates between the NIS and U.S.
Dollar during the six most recent months, as published by the Bank of Israel,
were as follows:

|LOW 1 U.S. Dollar = | HIGH 1 U.S. Dollar = | MONTH          
|------------------- | -------------------- | ---------------
|4.352               | 4.441                | December
  2003
|4.371               | 4.483                | January 2004   
|4.437               | 4.493                | February
  2004
|4.483               | 4.535                | March 2004     
|4.515               | 4.599                | April 2004     
|4.555               | 4.634                | May 2004       

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:

43

---

---

|Exchange Rate   | Period                               
|--------------- | -------------------------------------
|                |                                      
|4.154 NIS/$1    | January 1,
  1999 - December 31, 1999
|4.067 NIS/$1    | January 1,
  2000 - December 31, 2000
|4.219 NIS/$1    | January 1,
  2001 - December 31, 2001
|4.723 NIS/$1    | January 1,
  2002 - December 31, 2002
|4.5483
  NIS/$1 | January 1,
  2003  December 31, 2003

In 1999, the rate of inflation was approximately 1.3% and the rate of
devaluation was -0.3%. In 2000, the rate of inflation was approximately 0% and
the devaluation rate was -2.7%. During 2001, the rate of inflation was
approximately 1.4% and devaluation rate was 9.3%. In 2002, the rate on
inflation was approximately 6.5% and the rate of devaluation was 7.26%. In
2002, the rate on 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%. 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 2003, 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.

For a discussion comparing the results of our
operations from 2002 to 2001, see pages 28-30 of our annual report on Form 20-F
for the year ending December 31, 2002 filed with the Securities and Exchange
Commission on June 30, 2003, which is hereby incorporated by reference.

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 and (iv) the use of a bank credit line. As
of December 31, 2003, we had working capital of $2.507 million.

We anticipate that we will continue to incur significant operating
expenses in connection with the development and marketing of our products. We
believe that our current assets, together with anticipated cash generated from
operations and available credit lines, will be sufficient to meet our cash
requirements for working capital and capital expenditures for at least twelve months
following the date of this annual report. 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.

44

---

---

Investments

The discussion on the investments by Mr. Nir
Alon and/or Altro and the Plan of Arrangement are both hereby incorporated by
reference to Item 7 Major Shareholders and
Related Party Transactions -- Plan of Arrangement and Warrant Offering.
The discussions regarding the Private Placement Investments and the Standby
Equity Distribution Agreement are both hereby incorporated by reference 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 less the three months. The
interest rates of those loans are according to the market rate.

Capital
Expenditure

The discussion regarding the Yuravision
Acquisition is hereby incorporated by reference to Item 4, Information on the Company -- History and
Development of the Companyand Item
10, Additional Information -- Material Contracts.

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

Our research and development group focuses on adapting our technologies
to the development of new products for applications in the fabric and
microelectronics 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:

| | The
  development of a visual inspection system for the inspection of woven fabrics
  during weaving. The system is already operating in a few weavers sites for
  final tests before becoming commercial. The system is based on a contact
  sensor, which was specially developed by EVS for an easy integration with the
  loom. It is operated through a central computer connected to a network of
  dedicated computers, each of which is monitoring a number of looms. LOOM-TEX
  will inspect 100% of the fabric, automatically pinpointing faults based on
  learned criteria, and will be capable of being updated in real-time by user
  feedback.
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

45

---

---

| | For our
  developments for the microelectronic industry we have already applied for
  patents for hazing and wax inspection technologies. We currently intend to
  apply for a patent in Israel and Europe. According to a preliminary patent
  search conducted on our behalf no patents will be infringed by developing the
  inspection heads as proposed. For more
  information, see Item 4, Information on
  the Company -- Business Overview --Intellectual Property Rights for Microelectronics
  Industry.
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As of May 1, 2004, our research and development staff working on
products for the textile industry consisted of 11 full-time employees, all of
whom are located in Israel and hold advanced technical degrees. Our research
and development staff for the textile industry, especially for the development
of the LOOM-TEX product, engages in hardware and electro-optics development,
real-time software development, PC software development, manufacturing
engineering, system engineering and customer support engineering. In 2000 our
gross research and development expenditures for the textile industry were
approximately $1.6 million, in 2001 they were approximately $1.5 million, in
2002 they were $1.2 million and in 2003 they were $1.1 million. These
expenditures were partially offset by grants by the Office of the Chief
Scientist of the Ministry of Industry and Trade of the Government of Israel of
approximately $95,000 thousand, $126,000, $150,000 and $396,000 in each of
2000, 2001, 2002 and 2003, respectively.

As of May 31, 2004, our research and development staff working on
adapting our technology for use in the microelectronics industry consisted of
10 full-time employees, all of whom are located in Israel, and hold advanced
technical degrees. Our research and development staff engages in electro-optics
development and real-time software development. In 2003, our gross research and
development expenditures for the microelectronic industry were approximately
$0.73 million. We expect to continue to commit substantial resources to
research and development in the future.

The Government of Israel encourages research and development projects
oriented towards products for export through the Office of the Chief Scientist.
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.

46

---

---

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.

Research and Development Grants

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. In 2003
the OCS approved grant for the Microelectronic development in the amount of
approximately $115,000.

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:

| |                                              | 2003 |   | 2002  |  | 2001 |       | 2000 |   | 1999  | 
| | -------------------------------------------- | ---- | - | ----- |  | ---- | ----- | ---- | - | ----- | 
| | Research and
  development expenses,net      |      | $ | 1,431 |  | $    | 1,340 |      | $ | 1,405 | 
| | OCS grants                                   |      |   | 396   |  |      | 150   |      |   | 126   | 
| | Gross
  research and developmentexpenditures |      |   | 1,827 |  |      | 1,490 |      |   | 1,531 | 

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.

Following extensive market research, we have determined that our
technology could be relatively easily adapted for use in the microelectronics
industry and that such a transition presents us with a significant business
opportunity. Consequently, we are developing our existing vision technology so
as to adapt it to the requirements of the microelectronics industry,
particularly in the field of wafer inspection for the semi-conductor industry
and for the inspection of liquid crystal display devices, or LCDs. In January
2004, we released three products for the visual inspection of bare wafers
required for the manufacture of semi-conductors: the Mounting Wax Monitoring
System, the Back Side Inspection System and the Dynamic Roughness Monitoring
System. Additionally, we are developing technology for the automated visual
inspection of liquid crystal display, or LCD, devices. For more information,
see the discussion regarding Our solution for
the Microelectronics Industry in Item
4, Information on the Company -- Business Overview.

47

---

---

Given the difficulties that we have had over the years in significantly
increasing our revenues from products sold to the textile industry, we intend
to increase the proportion of our sales to the microelectronics industry over
sales to the textile industry over the coming years. To this end, we recently
acquired recently acquired a 51.11% holding in Yuravision, which specializes in
the development of automated vision inspection equipment for the
microelectronics and display industries, particularly in the field of LCD
devices. For further information, see Item 3,
Key Information -- Risk Factors -- Risk Factors Relating to our Business,Item 4, Information on the Company -- History and
Development of the Companyand Item
10, Additional Information -- Material Contracts.

E. Off-Balance Sheet Arrangements

On March 30, 2004, we entered into the Standby Equity Distribution
Agreement with Cornell. Upon execution of the Standby Equity Distribution
Agreement, we issued Cornell with 148,438 of our ordinary shares. Pursuant to
this agreement we will be entitled to issue Cornell with advance notices
requiring it to purchase, six days following each advance notice, a number of
our ordinary shares with a value of up to $300,000 per advance put notice and
up to an aggregate value of $10 million over two years. The price per share
payable by Cornell will be determined by the minimum volume weighted average
price of our ordinary shares during the five day period following our advance
notice to Cornell to purchase our ordinary shares. Cornell will deduct 5% from
the price payable for our ordinary shares as a fee for this service.
Consequently, we do not know how many ordinary shares, if any, will be issued
to Cornell over the following two years, but we have registered 5,555,555 of
our ordinary shares based on the maximum number of our ordinary shares that we
currently anticipate issuing to Cornell pursuant to the Standby Equity
Distribution Agreement, which will be available for resale by Cornell. We may
issue all, part or a greater number of our ordinary shares to Cornell,
depending on the minimum volume weighted average price of our ordinary shares
over the five day period following each advance notice. We will also issue
Cornell a number of our ordinary shares with a value of $150,000, upon the
first to occur of (i) our receipt of an aggregate of $5,000,000 pursuant to the
equity line and (ii) the first advance notice to be made following the first
anniversary of the Standby Equity Distribution Agreement. The number of our
ordinary shares which we will issue to Cornell in this event will be based on
the closing price of our ordinary shares on the public market on the date on
which Cornell purchases our shares under (i) or (ii), whichever is applicable.
Pursuant to the Standby Equity Distribution Agreement, Cornell will never be
entitled to hold more than 9.9% of our outstanding share capital, and
consequently, Cornell has agreed that in the event that a future purchase
pursuant to an advance notice to Cornell would take it above this threshold percentage,
it will sell, prior to the purchase, as many of our ordinary shares as is
required to ensure that at the time of the purchase of our ordinary shares, its
holdings in our company remain below the threshold percentage.

48

---

---

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

F. Tabular Disclosure of Contractual Obligations

Our significant financial and contractual obligations as of
December 31, 2003, and the periods in which such obligations are due are
as follows:

|                                      |  | Payments and Amount of Commitment Expiration
  Per Period
  (U.S. Dollars in thousands) |    
|------------------------------------- |  | --------------------------------------------------------------------------------------- | ---
|                                      |  |                                                                                         |    
|Contractual Obligations               |  | Total
  Amounts
  Committed                                                             |    
|                                      |  |                                                                                         |    
|                                      |  |                                                                                         |    
|Operating
  Car Lease Obligations     |  |                                                                                         | 403
|Operating
  Building LeaseObligations |  |                                                                                         | 373
|Total
  commercial commitments        |  |                                                                                         | 776

G. Safe Harbor.  Not Applicable

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

A. Directors and Senior Management

As of May 31, 2004, our directors, senior managers and key employees
are as follows:

|Name          |  | Age |  | Position                                             
|------------- |  | --- |  | -----------------------------------------------------
|              |  |     |  |                                                      
|              |  |     |  |                                                      
|Nir Alon      |  | 41  |  | Chairman of the Board                                
|Zami Aberman* |  | 50  |  | Chief Executive Officer                              
|Yaky Yanay*   |  | 33  |  | Vice president, Chief Financial Officer and Secretary
|Yoav Kahane*  |  | 31  |  | Vice President of Sales & Marketing                  
|Ilan Laver*   |  | 60  |  | Vice President of Electronic Inspection Division     
|Jossef Barath |  | 53  |  | Director                                             
|Tzvi Piran*   |  | 55  |  | External Director                                    
|Zahi Dekel*   |  | 41  |  | External Director                                    
|Israel Gal*   |  | 52  |  | Director                                             
|Shlomo Alon   |  | 65  |  | Director                                             
|Naomi Livne*  |  | 58  |  | Director                                             

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

49

---

---

Nir
Alon was
appointed chairman of the board of directors in February 2001. 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 Bachelor of Arts degree in social
sciences from Tel-Aviv University. Nir Alon is the son of one of our directors,
Shlomo Alon.

Zami Aberman has 15
years of experience in managing industrial companies, international marketing
of breakthrough technological solutions to automotive, aerospace, metal
industry, and flat panel manufacturing, as well as experience in establishing
and managing start-up companies active in the field of software development, chip
development, advanced system development, flexible automation inspection and
image processing. Mr. Aberman served as the President & CEO of Robomatix
Technologies Ltd. from 1987 until 1996. From 1996, Mr. Aberman founded and
managed hi-tech companies active in various fields. In 1992, Mr. Aberman was
awarded the prestigious Rothschild Prize by the President of the State of
Israel, for the development of a unique, laser based, flexible manufacturing
system for the automotive industry. Mr. Aberman holds a BSc. in Mechanical
Engineering from Ben-Gurion University.

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

Yoav Kahane is our Vice President of Sales & Marketing.
He is responsible for our global strategic sales and currently oversees our
operations in China and those of our U.S. subsidiary. Before joining EVS, Mr.
Kahane was the CEO of Ituran Florida (USA), a company specializing in location
systems using cellular systems. Mr. Kahane holds a BSc. in Biology and a BA in
General Sciences from Tel-Aviv University.

Ilan
Laver served as
general manager at DDIS/BNS between 1995 and 2001, where he founded and managed
an activity in the field of high quality surfaces optical inspection (a
spin-off from Robomatix Technologies Ltd.). From 1993, Mr. Laver served for 2
years as general manager at Robomatix Israel Ltd. where he managed the Israeli
operation in the areas of machine vision, laser robotics and advanced
computing. In 1987, Mr. Laver co-founded and served for 6 years as general
manager at DPA Technologies Israel, a company that focuses on the testing and
inspection of equipment for the electronics industry. From 1984 Mr. Laver
served as product line manger and chief mechanical engineer at Elron Advanced Technologies
Center and managed the development of automated optical inspection and gauging
systems for metal parts industries. From 1982 Mr. Laver served as technical
office manager at IMI, Plant 77 and was mainly involved in the development of
the ground optical guidance system for beam riding missiles. From 1976 he
served as manager of Research &
Development at Laser Industries\MLI where he designed and developed medical
(Laser Industries) and industrial (MLI) laser systems. Prior to that he served
3 years at Elscint Ltd. as mechanical team leader. Mr. Laver holds a BSc. in
Mechanical Engineering from the Technion, Israel Institute of Technology.

50

---

---

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

Tzvi
Piran is and
has been a Professor of Physics at the Hebrew University in Jerusalem since
1986. Prior to that, he served as a visiting professor to various Ivy-League
universities worldwide, including the Universities of Harvard and Columbia in
the United States. He has been a member of the Steering Committee for the
Israel Space Agency since 1999 and the Chairman of the Appointment Committee
for Sciences, Medicine and Agriculture since 2001. Mr. Piran is also the
Founder of the Jerusalem Winter School for Theoretical Physics and was its
Chairman from 1981-1992. He is the author of 11 scientific books, including the
popular Hebrew book - The Big Bang, and of over 200 publications in
scientific journals worldwide. Mr. Piran holds a Bachelors degree in Physics
from Tel-Aviv University, a Masters degree in Space Science from Tel-Aviv
University, a Ph.D in Physics from Hebrew University and completed his post-doctoral
fellowship in Oxford University, England and at the University of Texas in
Austin, Texas. Mr. Piran has informed us that as a result of an opportunity
overseas, he will cease serving on our board of directors from August 1, 2004.

Zahi Dekel worked at
Bank Hapoalim Ltd. from 1995-2003, where he held several posts, including most
recently the manager of the Migdal Haemek branch. From 1987 Mr. Dekel was the
principal of the Naaleh boarding school for children who had emigrated from
the former Soviet Union to Israel, without their parents. Mr. Dekel currently
serves on the regional council of Yoqneam. Mr. Dekel holds a BA in Business
Administration and Economics, and an MA in Education and International
Relations, both from the Hebrew University, Jerusalem.

Israel
Gal is
currently the president and CEO of Espro Information Technologies. From 1993 to
1996, Mr. Gal served as a general director of a subsidiary of the Koor
Industries Group. From 1990 to 1993 Mr. Gal was the Manager of the Bank
Tefachots central branch. From 1970 to 1990, Mr. Gal served in the IDF. His
service included, staff and command positions in IDFs field units and in the
General Staff Headquarters, and the establishment and commanding of an elite
field unit which integrated a warfare system based on especially complex
advanced technologies. Mr. Gal completed his army service with the rank of
Colonel. Mr. Gal holds a Bachelors degree in Economics and Business
Administration from BarIlan University and a Masters degree in Political Science
and International Relations from University of Haifa.

51

---

---

Shlomo
Alon, father
of Nir Alon, was appointed a director on the board of directors of EVS on
August 2001. Since 1999, Mr. Alon has been the Chairman of the Cell-Tel
Wireless, Israel, which specializes in communications. In 1979, Mr. Alon
founded Altro Vienna GmbH, a company that is active in the field of textiles.
From 1961 through 1978, Mr. Alon worked for several different departments in
Koor Maarachot, filling various managerial positions. From 1971 through 1975,
Mr. Alon was the General Manager of Koor Maarachot in Israel and from 1975
until 1978 was General Manager of the Vienna Austria branch of Koor Maarachot.
Mr. Alon holds a BA degree in Economics from Tel-Aviv University.

Naomi Livne
was elected director by our board of directors on November 4, 2001. Since 1993
Mrs. Livne has been working for the Israeli Securities Authorities. From 1989
through 1991, Mrs. Livne worked at the Hebrew University in Jerusalem, filling
the position of Associate Dean of the law faculty. From 1977 through 1987, Mrs.
Livne worked in the Israeli State Attorneys Office, Ministry of Justice, in the
position of a senior deputy state attorney. Mrs. Livne received her LLB in 1977
from the Hebrew University Law School in Jerusalem.

B. Compensation

During 2003, we paid to all our directors and officers a total of
$738,600in salaries, fees and
bonuses, and set aside $44,000in
pension, retirement and similar benefits. 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.

Other than Mr. Meir Amit (one of our former external directors who
resigned from our board of directors in December 2003), Messrs. Zahi Dekel and
Tzvi Piran (our current external directors), Mr. Jossef Barath (who we no
longer employ) and Messrs. Nir Alon and Israel Gal, our directors (who are not
also officers) received no compensation in 2003. At our Annual and General
Meeting of Shareholders in October 2002, our shareholders agreed that Mr.
Israel Gal shall be paid: (i) an annual compensation of approximately $2500;
and (ii) a one time payment of approximately $150 per meeting of the board of
directors or any committee thereof attended, in consideration for his services
as a director, to be applied retroactively from December 1, 2002. Mr. Meir Amit
resigned as an external director in December 2003 and was replaced by Mr. Dekel
at our Extraordinary General Meeting of Shareholders in March 2004. In this
meeting, our shareholders agreed that Mr. Nir Alon, the chairman of the board,
shall be paid a monthly compensation of $3,000 in consideration for his
services as the chairman of our board of directors, payable retroactively from
July 1, 2003. We paid approximately $3,730 in aggregate to Mr. Barath 2003. We
paid an aggregate of $7000 to our serving external directors in 2003.

Pension and
Retirement BenefitsWe offered no pension or retirement benefits to our directors and key
personnel in 2003.

52

---

---

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. Our
articles of association were amended on March 26, 2001 to enable members of the
board to temporarily fill any vacancy on the board until the next annual
general meeting of shareholders. Officers serve at the discretion of the board
of directors. Pursuant to the terms of a shareholders agreement between Altro
and Elbit dated March 2001, Altro is entitled to appoint four directors to the
board of directors and Elbit is entitled to appoint 1 director.

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.

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 Israel Companies Law, which took effect on February 1, 2000,
requires Israeli companies with shares that have been offered to the public in
or outside of Israel to appoint two external directors. No person may be
appointed as an external director if the person or the persons relative,
partner, employer or any entity under the persons control, has or had, on or
within the two years preceding the date of the persons appointment to serve as
external director, any affiliation with the company or any entity controlling,
controlled by or under common control with the company. The term affiliation
includes:

| |  | an
  employment relationship;                                           
| | - | ------------------------------------------------------------------------
| |  | a business
  or professional relationship maintained on a regular basis;
| |  | control; and                                                            
| |  | service as
  an office holder.                                          

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.

53

---

---

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

| | the majority
  of shares voted at the meeting, including at least one-third of the shares
  held by non-controlling shareholders voted at the meeting, vote in favor of
  election of the director; or
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | the total
  number of shares held by non-controlling shareholders voted against the
  election of the director does not exceed one percent of the aggregate voting
  rights in the company.           

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

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

Currently, Messrs. Dekel and Piran 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. Dekel and Piran 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

As of May 31, 2004, we employed 66
full-time persons. Out of such 66, 55 employed in Israel of whom 21 were in
research and development, 8 were in marketing and sales, 5 were in customer
support, 11 were in operations and 10 were in administration and management. In
addition, as of May 31, 2004, our U.S. subsidiary employed 7 full-time persons
(of whom 2 were in sales support and product management, 4 were in technical
support and 1 was in administration) and our European subsidiary employed 4
full-time persons (all of whom were in technical support).

54

---

---

In year 2003, we employed 43 full-time
persons, of whom 16 were in research and development, 4 were in marketing and
sales, 2 were in customer support, 14 were in operations and 7 were in
administration and management. In addition, in 2003, our U.S. subsidiary
employed 8 full-time persons (of whom 3 were in sales support and product
management, 4 were in technical support and 1 was in administration) and our
European subsidiary employed 4 full-time persons (all of whom were in technical
support).

In 2002, we employed 40 full-time persons, of
whom 16 were in research and development, 5 were in marketing and sales, 2 were
in customer support, 11 were in operations and 6 were in administration and
management. In addition, in 2002, our U.S. subsidiary employed 9 full-time
persons (of whom 2 were in sales support and product management, 6 were in
technical support and 1 was in administration) and our European subsidiary
employed 5 full-time persons (all of whom were in technical support).

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.

55

---

---

E. Share Ownership

Of the persons listed above under the caption
Directors, Senior Management and Employees, only Messrs. Nir Alon and Shlomo
Alon beneficially own shares and options exceeding 1% of our outstanding
ordinary shares, since Mr. Nir Alon is the controlling shareholder of Altro,
our majority shareholder, and Mr. Shlomo Alon is his father. Elbit owns
2,647,643 of our ordinary shares (and a warrant to purchase 1,512,900 of our
ordinary shares pursuant to the Warrant Distribution) and is not currently represented by a director on
our board of directors but we anticipate that it will shortly nominate a
replacement for Mr. Victor Halpert
whose resignation was effective on May 11, 2004. The replacement director may,
if an officer of Elbit, be construed to have a beneficial ownership of Elbits
shares.

Employee
Share Option Plans

We maintain the following share option plans
for our employees and the employees of our subsidiaries. In addition to the
discussion below, see Note 8 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, 2004, options to purchase 206,208,of
such ordinary shares were outstanding and options to purchase 275,000 ordinary
shares were available for future grants. Of the outstanding options, options to
purchase 210,000, 82,780 and 59,000 ordinary shares are fully vested and are
exercisable at an exercise price of $3.00, $1.68 and $0.2 per share,
respectively. All of the outstanding options terminate ten years following the
date of grant if not exercised earlier or terminated by reason of termination
of employment.

The 1996 Share Option Plan is administered by
a committee of the board of directors, which designates the optionees and dates
of grant. The option exercise price is determined by our board of directors.
All recent grants have been made at an exercise price equal 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 is
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.

56

---

---

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, 2004, options to purchase 1,700,108
of such ordinary shares were outstanding and
options to purchase 2,099,096 ordinary
shares were available for future grants. 533,639 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 2001until 2004 inclusive, assuming continuous employment with us through such period.347,750 of the outstanding options have an
exercise price of $0.36 per share.
265,250 of the options referred to above vested equally on January 21,
2002,January 21, 2003 and January 21, 2004, and the remaining 82,500 will vest
on January 21, 2005, assuming continuous
employment with us through such periods.428,200
of the outstanding options have an exercise price of $0.48 per share. 217,800 of the options referred to
above vested equally on March 18, 2003 and March 18, 2004, and the
remaining 210,400 vest equally on March 18, 2005 and March 18, 2006, assuming continuous employment with us through
such periods. 166,352 of the outstanding options have an exercise price of
$0.15 per share and an additional 200,000 an exercise price of $1 per share and
vest monthly over three years through August 2005. All of the outstanding
options terminate ten years following the date of grant if not exercised
earlier. The 2000 Share Option Plan is administered by a committee of the board
of directors, which designates the optionees and dates of grant. The option
exercise price is determined by our board of directors. All recent grants have
been made at an exercise price equal to 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% commencing the beginning of the second year after the
grant and as to an additional 25% in each of the three years thereafter,
assuming continuous employment with us through such periods.

In November 2003, the board of directors
adopted a share option plan pursuant to which 2,000,000 ordinary shares were reserved
for issuance upon the exercise of options to be granted to our directors,
officers, employees and consultants. As of May 31, 2004, options to purchase 924,000
of such ordinary shares were outstanding and
options to purchase 1,056,000 ordinary
shares were available for future grants. 234,000 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. 100,000 of the outstanding options
have an exercise price of $0.75 per
share. 266,000 of the outstanding options, have an exercise price of $0.68 per
share and an additional 304,000 an exercise price of $0.2 per share. All of the
outstanding options terminate ten years following the date of grant if not
exercised earlier. The 2003 Share Option Plan is administered by a committee of
the board of directors, which designates the optionees and dates of grant. The
option exercise price is determined by our board of directors. All recent
grants have been made at an exercise price equal to 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% commencing the beginning of the
second year after the grant and as to an additional 25% in each of the three
years thereafter, assuming continuous employment with us through such periods.

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

A. Major
Shareholders

The following table and notes set forth
information, as of May 31, 2004, 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 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.

57

---

---

|Identity of Person or Group                                                                                    |  | Amount Owned |            | Percent of Class | 
|-------------------------------------------------------------------------------------------------------------- |  | ------------ | ---------- | ---------------- | 
|                                                                                                               |  |              |            |                  | 
|Altro Warenhandels GmbH (1)(2)(3)(4)(5)(6)(7)                                                                  |  |              | 3, 900,000 |                  | 
|Elbit Ltd.(8)
  Advanced Technology Center
  P.O. Box 539
  Haifa, Israel                                      |  |              | 2,647,643  |                  | 
|The Israel
  Phoenix Assurance Co Ltd. (9)(10)Phoenix Building
  53 Derech Hashalom
  Givatayim, 43454, Israel |  |              | 1,275,510  |                  | 
|All
  directors and officers as a group (11)                                                                   |  |              | 4,494,652  |                  | 

|(1) | 3,500,000 of
  these shares are pledged to Bank Leumi B.M., in order to guarantee a credit
  line for Altro in the sum of $1,500,000.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(2) | On August
  16, 2002, Mr. Nir Alon, the chairman of our board of directors, transferred
  all of his shares in our company to Altro, an Austrian company, wholly owned
  by Mr. Nir Alon and a company controlled by members of the Alon family.                                                                                                                                                                                                                                                                                                                                                                                                                        
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(3) | In March
  2001 Elbit and Nir Alon entered into a Shareholders Agreement in which Elbit
  and Nir Alon agreed to vote their shares at meetings of our shareholders for
  the appointment of four members of our board nominated by Nir Alon (including
  the appointment of Nir Alon as chairman of our board), one member of our
  board nominated by Elbit (for as long as Elbit holds at least 7.5% of our
  outstanding share capital), a second member of the board nominated by Elbit
  in the event that the second closing did not take place, and Yossi Barath for
  as long as he was entitled to be appointed director pursuant to the Formation
  Agreement.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(4) | Simultaneously
  with its sale of two million of our outstanding ordinary shares to Mr. Nir
  Alon, Elbit granted an irrevocable proxy to Alon, according to which he was
  granted the right to vote such Proxy Shares until the expiration of eighteen
  months following the second closing of the purchase agreement between them,
  which was due to take place in March 2002, after which the proxy would
  terminate only with respect to the Proxy Shares which Elbit would sell or
  transfer from time to time. The second closing did not take place.                                                                                                        
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(5) | Includes:
  (a) 75,000 ordinary shares which are subject to an option to purchase shares
  granted by Mr. Alon to Mr. Barath on March 29, 2001; The price of the options
  is $1.00 per share.                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(6) | Under the
  Plan of Arrangement approved by the Haifa District Court in November 2003,
  Altro agreed to purchase 2 million of our ordinary shares for an aggregate
  purchase price of $700,000 which will be paid in up to five quarterly
  installments, the last of which is to be paid by November 2004. Pursuant to
  the arrangement, Altro to date has invested $490,000 pursuant to which we
  have issued 400,000 of our ordinary shares. For further discussion of Altros
  investment obligations, see Item 7  Major
  Shareholders and Related Party Transactions  Plan of Arrangement and Warrant
  Offering.                                        
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(7) | Since Mr.
  Nir Alon controls Altro, Mr. Nir Alon may be deemed the beneficial owner of
  all of the shares held by Altro .                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(8) | Pursuant to
  the completion of a merger between Elbit and Elron Electronic Industries Ltd.
  (NASDAQ: ELRN) on May 15, 2002, Elbits shares ceased trading on NASDAQ and
  the TASE at the end of trading on May 15. Following the merger, Elbit became
  a wholly owned subsidiary of Elron. Elrons major shareholder is Discount
  Investment Corporation (Discount), which holds 38.5% of Elrons share
  capital. Discount has not entered into any voting agreements with other
  shareholders nor does it hold a majority on Elrons board of directors.                                                                                                      

58

---

---

|     |                                                                                                                                                                                                                                                                                             
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(9)  | Includes
  warrants to purchase 255,102 of our ordinary shares exercisable within 60
  days of June 30, 2004.                                                                                                                                                                               
|     |                                                                                                                                                                                                                                                                                             
|(10) | Mayers Cars
  and Trucks Co. Ltd. holds approximately 58% of the voting rights in The
  Israel Phoenix Assurance Co. Ltd.. The shares of Mayers Cars and Trucks Co.
  Ltd. are held by Yakov Shahar, Nili Shahar and Yisrael Kez. There is a
  voting agreement between these shareholders.
|     |                                                                                                                                                                                                                                                                                             
|(11) | Includes all
  of the shares deemed as beneficially owned by Mr. Nir Alon and options
  currently exercisable by directors and officers within 60 days.                                                                                                                                     

As of May 31, 2004, there were a total of 56holders of record of our ordinary shares, of which 20 were
registered in the United States. Such United States shareholders were, as of
such date, the holders of record of approximately 27.3% of our outstanding
ordinary shares.

Voting and Right of
First Refusal Agreements

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

Elbit granted an irrevocable proxy to Alon to vote such number of
shares owned by Elbit that represent 10% of the issued and outstanding share
capital of our company from time to time until the expiration of eighteen months
following the second closing of the share purchase agreement between Elbit and
Alon, which was due to take place in March 2002, after which the proxy would
terminate only with respect to shares which Elbit will transfer to third
parties. The second closing did not take place.

In March 2001, Elbit and Nir Alon entered into a Shareholders Agreement
in which Elbit and Nir Alon agreed to vote their shares at meetings of our
shareholders for the appointment of four members of our board nominated by Nir
Alon (including the appointment of Nir Alon as chairman of our board), one
member of our board nominated by Elbit (for as long as Elbit holds at least
7.5% of our outstanding share capital), a second member of the board nominated
by Elbit in the event that the second closing did not take place, and Yossi
Barath for as long as he was entitled to be appointed director pursuant to the
Formation Agreement.

59

---

---

As a result of its holdings in our company
and his voting agreement with Elbit, Altro is in a position to control our
activities and policies, including possessing the voting power to elect a
majority of the members of our board of directors and approve all matters
requiring shareholder approval (except for those matters that must be approved
by a disinterested shareholder vote or a special resolution under Israeli law)
and the ability to generally direct our affairs.

B. Related Party Transactions

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

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

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

Plan
of Arrangement and Warrant Distribution

Our audit committee and board of directors
approved the Plan of Arrangement with Altro that was approved by a special
majority of out shareholders in October 2003, and subsequently by the Haifa
District Court in November 2003, whereby Altros prior commitments to invest
are to be cancelled subject to Altros fulfillment of new investment terms and
a warrant distribution to our shareholders. According to the Plan of
Arrangement, Altro will invest $700,000 in EVS for the purchase of 2 million of
our ordinary shares, payable in up to five quarterly installments, the last of
which is to be paid by November 2004. Following this, Altro is expected to hold
approximately 31.71% of our outstanding shares. As of June 1, 2004, we had
received the first three installments amounting to an aggregate payment of $490,000,
and have therefore issued 400,000 of our ordinary shares under the Plan of
Arrangement.

60

---

---

Pursuant to the Plan of Arrangement, we are
distributing to most of our shareholders warrants to purchase 4,183,950 of our
ordinary shares on a pro rata basis (or the Warrant Distribution). Each warrant
will be exercisable at a price of $0.35 per share and exercisable for four
years from the date of registration thereof. The warrants will be distributed
to all persons who are the registered holders of our ordinary shares on the
Record Date (Record Holders), with the exception of certain shareholders. The
shareholders which will be excluded from the Warrant Distribution are as
follows: Altro, our controlling shareholder, Cornell, Newbridge and those
investors which participated in our December 2003 and January 2004 Private
Placement Investments (other than Meitav Capital (2002) Ltd., with respect to
241,714 of our ordinary shares which it holds having exercised, prior to the
Record Date, a warrant that it received for its financial services in
connection with such investments). All of these shareholders, or collectively,
the Excluded Shareholders, have agreed that they shall not be distributed
warrants pursuant to the Warrant Distribution. This Plan of Arrangement was
approved by our shareholders on October 13, 2003 and by the Haifa District
Court on November 19, 2003.

As of May 31, 2004, Altro owned 23.68% of our
outstanding ordinary shares and Elbit owned 16.07 % of our outstanding ordinary
shares. Following Altros investments, Altro is expected to hold
approximately 30.43%. However, in the event that all the warrants distributed
to our shareholders are exercised pursuant to the Plan of Arrangement, Altro
and Nir Alon will beneficially hold 24.71%
of our outstanding ordinary shares.

We maintain a number of material relationships with Elbit.

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

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

61

---

---

Royalty Payments.  Until
June 30, 2001, Elbit had an obligation to pay royalties to Dr. Ilan
Tamches, the Chief Scientist of Elbit and the original developer of certain
elements of the Elbit Technology. Through June 30, 1996, these royalties were
paid directly by Elbit and were reflected as royalty expenses in our financial
statements. We agreed to pay Elbit all amounts payable pursuant to Elbits
obligations to Dr. Tamches, which relate to our use of the Elbit
Technology. Upon the closing of our initial public offering, we issued 94,624
ordinary shares for nominal consideration to Dr. Tamches in connection
with his agreement to reduce the royalty rate payable to him. Elbit agreed that
it will not take any action that reduces the proportion of Dr. Tamches share
holdings in us, other than the issuance of shares to the public, to a strategic
partner or for capital raising transactions. We believe that this agreement
does not prohibit us from consummating a merger or an acquisition of a
business, product or technology or issuing shares to employees or directors
other than Messrs. Barath and Avni pursuant to the 1996 Share Option Plan and
the 2000 Share Option Plan. However, in the event that we issue employee share
options to Mr. Avni, we will issue a number of options to Dr. Tamches such
that issuances to Mr. Avni will not dilute Dr. Tamches holdings in EVS.
From the date of our initial public offering through June 30, 2001, the
royalties that we paid for the Elbit Technology were not less than $300,000 and
not more than $500,000 per year based on the annual amount of cash receipts
from sales of products in the textile, food and automotive industries. This
royalty rate was payable for five years from the date of the consummation of
our initial public offering (i.e. July 12, 2001) and was subject to adjustment
after such date. We owed Elbit approximately $500,000 for these royalty
payments, of which $367,000 is still outstanding and shall be paid off in
installments. In May 2002, we entered into an agreement with Elbit and Dr.
Tamches, whereby the license agreement was amended such that effective as of
July 1, 2002, Elbit transferred the Elbit Technology to Dr. Tamches and the
certain other technology to us. See Item 10,
Additional Information -- Material Contracts.

C. Interests of
Experts and Counsel.Not
Applicable

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

A. Consolidated Statements and Other Financial Information

Our consolidated financial statements and other financial information
is incorporated herein by reference to pages F1-F30.

Export SalesIn 2003, 100% of our sales, amounting to $6,328,000, 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.

62

---

---

Lemelson
Patent Infringement Claim

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

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

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

To the extent that we are required to indemnify our customers in
connection with the suit, a failure by Elbit to indemnify us, would have a
material adverse affect on our business, results of operations and financial
conditions, the extent of which cannot be calculated.

Panoptes
Litigation

In November 2002, we filed an application for a permanent injunction
against Panoptes Ltd. with the Haifa District Court, in Israel, requiring it to
cease all production and marketing of its current products. We also claimed
damages from Panoptes in the sum of at least approximately $500,000. The claim
which was also brought against Mr. Hillel Avni, the CEO of Panoptes and our
former founder, is based on the fact that Panoptes, which was established by
Mr. Hillel Avni, is marketing products which unlawfully incorporate our
technology and has recruited several of our former employees who were engaged
in the development and marketing of these products. In our claim we also
requested that the court order a permanent injunction preventing Panoptes from
making any use of our technology. Panoptes filed a counter-claim in December
2002, claiming that we had conducted negotiations with Panoptes in bad-faith
and had failed to execute an agreement with Panoptes for the purchase of $4
million of Panoptes products. In its judgment dated June 3, 2004, the Haifa
District Court, rejected the counter-claim by Panoptes and ordered Panoptes to
pay us damages.

63

---

---

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 is taxable at regular rates of 36%. See
Note 9 to our Consolidated Financial Statements and Item 10, Additional Information -- Taxation.

B. Significant Changes

Other than the resolution of the Panoptes litigation described above,
and the Private Placement Investments, the Yuravision Acquisition, the Standby
Equity Distribution Agreement, 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.

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:

64

---

---

|Period                    |  | High |      | Low |  
|------------------------- |  | ---- | ---- | --- | -
|                          |  |      |      |     |  
|May 2004                  |  |      | 1.32 |     |  
|                          |  |      |      |     |  
|April 2004                |  |      | 1.4  |     |  
|                          |  |      |      |     |  
|March 2004                |  |      | 1.4  |     |  
|                          |  |      |      |     |  
|February
  2004           |  |      | 1.5  |     |  
|                          |  |      |      |     |  
|January 2004              |  |      | 1.6  |     |  
|                          |  |      |      |     |  
|December
  2003           |  |      | 1.25 |     |  
|                          |  |      |      |     |  
|First
  quarter 2004      |  |      | 1.60 |     |  
|                          |  |      |      |     |  
|Fourth
  quarter 2003     |  |      | 1.86 |     |  
|                          |  |      |      |     |  
|Third
  quarter 2003      |  |      | 0.47 |     |  
|                          |  |      |      |     |  
|Second
  quarter 2003     |  |      | 0.29 |     |  
|                          |  |      |      |     |  
|First
  quarter 2003 (5)  |  |      | 0.23 |     |  
|                          |  |      |      |     |  
|Fourth
  quarter 2002     |  |      | 0.25 |     |  
|                          |  |      |      |     |  
|Third
  quarter 2002      |  |      | 0.36 |     |  
|                          |  |      |      |     |  
|Second
  quarter 2002 (3) |  |      | 0.52 |     |  
|                          |  |      |      |     |  
|First
  quarter 2002 (2)  |  |      | 0.77 |     |  
|                          |  |      |      |     |  
|Year ended
  2003 (5)     |  |      | 1.86 |     |  
|                          |  |      |      |     |  
|Year ended
  2002 (4)     |  |      | 0.77 |     |  
|                          |  |      |      |     |  
|Year ended
  2001 (3)     |  |      | 0.88 |     |  
|                          |  |      |      |     |  
|Year ended
  2000 (2)     |  |      | 3.56 |     |  
|                          |  |      |      |     |  
|Year ended
  1999 (1)     |  | $    | 2.63 |     | $

|(1) Traded on the NASDAQ
  National Market throughout the period.                                                             
|------------------------------------------------------------------------------------------------------------------------------
|(2) Traded on the NASDAQ
  National Market until December 29, 2000, and subsequently on the
  Over-the-Counter Bulletin Board.
|(3) Traded on the
  Over-the-Counter Bulletin Board until June 21, 2001, and subsequently on the
  NASDAQ SmallCap Market.    
|(4) Traded on the NASDAQ
  SmallCap Market throughout the period.                                                             
|(5) Traded on the NASDAQ
  SmallCap Market until November 19, 2003, and subsequently on the
  Over-the-Counter Bulletin Board.

65

---

---

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 Articles of Association

In February 2000, the Companys Ordinance
(New Version)-1983 was replaced by the Companies Law. Since our articles of
association were approved before the enactment of the Companies Law, they are
not always consistent with the provisions of the new law. In all instances in
which the Companies Law changes or amends provisions in the Companies
Ordinance, and as such, our articles of association are not consistent with the
Companies Law, the provisions of the Companies Law shall apply unless
specifically stated otherwise in the Companies Law. Similarly, in all places
where our articles of association refer to a Section of the Companies Ordinance
that has been replaced by the Companies Law, the articles of association shall
be understood to be referring to the relevant section of the Companies Law.

Our shareholders approved our articles of association on September 2,
1992. Our objectives as stated in our Memorandum of Association are as follows:

| |  | to engage in
  all types of vision systems and optical systems;                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | to engage in
  all types of computers, software, hardware, in the sphere of automation and
  computerization;                                                                                 
| |  | to import,
  export, develop and manufacture all types of instrument software in all the
  optic, electronic and computer spheres, to engage in all types of electronic
  products whatsoever;
| |  | to manage
  service and maintenance stations for the repair of optical systems, computer
  software and electrical products;                                                                  
| |  | to engage in
  software and to market all types of software; and                                                                                                                              
| |  | to do any
  action within the scope of these objectives.                                                                                                                                      

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 of
association may be amended by a resolution carried at a general meeting by 75%
of those whose vote is required. The shareholders rights may not be modified in
any other way unless otherwise expressly provided in the terms of issuance of
the shares.

66

---

---

Our articles of association require that we hold our annual general
meeting of shareholders each year no later than 15 months from the previous
annual meeting, at a time and place determined by the board of directors, upon
service of at least 7 days prior notice to our shareholders or 21 days prior
notice in the event that a special item is to be discussed. No business may be
commenced until a quorum of two or more shareholders holding at least one-third
of the voting rights are present in person or by proxy. Shareholders may vote
in person or by proxy, and will be required to prove title to their shares as
required by the Israel Companies Law pursuant to procedures established by the
board of directors. Resolutions regarding the following matters must be passed
at a general meeting of shareholders:

| |  | amendments
  to our articles of association (other than modifications of shareholders  rights as mentioned above);                                                                                                                                                         
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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 Israel
  Companies Law;                                                                                                                                                                   
| |  | increase or
  reduction of our authorized share capital;                                                                                                                                                                                                                   
| |  | any merger
  as provided in Section 320 of the Israel 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 Israel Companies Law.

A special meeting of our shareholders shall be convened by the board,
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 10% of
our issued share capital. Shareholders requesting a special meeting must submit
their proposed resolution with their request. Within 21 days of receipt of the
request, the board must convene a special meeting and send out notices setting
forth the date, time and place of the meeting.

Our articles of association provide that our board of directors may
from time to time, at their discretion, borrow or secure the payment of any sum
of money for the fulfillment of our objectives. Our directors may raise or
secure the repayment of such sum in a manner, time and terms as they see fit.

The Israel Companies
Law

The Israel 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 Israel
Companies Law, as a (i) director, (ii) general manager, (iii) chief business
manager, (iv) deputy general manager, (v) vice general manager, (vi) executive
vice president, (vii) vice president, (viii) another manager directly
subordinate to the managing director or (ix) any other person assuming the
responsibilities of any of the forgoing positions without regard to such
persons title.

67

---

---

The Israel 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 business,
not on market terms, or that is likely to have a material impact on the
companys profitability, assets or liabilities.

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

Agreements regarding directors terms of
employment require the approval of the board of directors and the audit
committee. 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 Israel 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. 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 are
present in person or by proxy at the meeting, 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.

68

---

---

In addition, a private placement of
securities that 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, requires
approval by the board of directors and the shareholders of the company. The
regulations to the Israel Companies Law provide certain exceptions. Any
placement of securities that does not fit the above description may be issued
at the discretion of the board of directors.

Under the Israel Companies Law, a shareholder
has a duty to act in good faith towards the company and other shareholders and
refrain from abusing his 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 Israel Companies Law does not describe the
substance of this duty. The Israel 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.

C. Material Contracts

Share Purchase Agreement with Nir Alon.  On March 29, 2001, we entered into a Share
Purchase Agreement with Nir Alon. This agreement and the amendments thereto are
incorporated herein by reference to the discussion under the caption Related Party TransactionsinItem 7 herein above, to Exhibits 4.4 and
4.5 of this annual report and to Note 8A to our consolidated financial
statements included in this annual report.

69

---

---

Registration Rights Agreement.  Concurrent with the Share Purchase Agreement
described above, we entered into a Registration Rights Agreement with Nir Alon
on March 29, 2001. Pursuant to this agreement, we granted Nir Alon certain
registration rights with respect to the ordinary shares of our company that he
owned. Pursuant to the agreement Nir Alon was granted one demand registration
right pursuant to which he may demand that we file a registration under the
Securities Act of 1933, as amended for an amount of securities having an
aggregate price to the public of at least $1,000,000, subject to certain specified
limitations. We also granted Nir Alon certain piggy-back registration rights in
the event that we file any registration statement under the Securities Act for
purposes of effecting an initial public or secondary offering of our securities
to the public. According to the agreement, in the event that we file a
registration on Form F-3, Nir Alon will be notified of such registration and
will be able to participate in such registration subject to certain
limitations. Discussions of this agreement are incorporated by reference to
Exhibit 4.7 to this annual report.

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

Amendment to the License Agreement.  In May
2002, we entered into an agreement with our former principal shareholder, Elbit
and Dr. Ilan Tamches, which amended the license agreement existing between us
and Elbit and dated June 12, 1996, whereby the license agreement was amended
such that effective as of July 1, 2002, Elbit transferred the Elbit Technology
to Dr. Tamches and the Elbit Modified Technology to us. As a result of this
amendment, Dr. Tamches has granted us a non-exclusive rights to the Elbit
Technology with respect to the development, production, distribution,
modification, use and repair of any of the I-TEX systems, for as long as we
continue to produce, distribute, modify, use and repair any I-TEX systems. In
consideration for the royalties that we have agreed to pay Dr. Tamches, he has
agreed not to license such elements of our technology to any third party, which
competes with I-TEX systems. Pursuant to the amendment we have agreed to
pay Dr. Tamches a biannual royalty equal to the lesser of (i) 0.9375% of all
amounts actually received by us in the immediately preceding six months plus
Value Added Tax; or (ii) 1.5% of such part of the amounts actually received by
us generated from the sales of the I-TEX systems in the immediately preceding
six months plus Value Added Tax. Discussions of this agreement are incorporated
herein by reference to Exhibit 4.3 to this annual report.

Private Placement
Investments.  Pursuant to a series of private placement
transactions with a group of investors, or the Investors, in December 2003 and
January 2004, we issued an aggregate of (i) 5,099,911 of our ordinary shares
for an aggregate purchase price of $3,927,123, (ii) warrants to purchase
241,800 and 943,825 of our ordinary shares with an exercise price of $0.68,
$0.85 per ordinary share, respectively, which are exercisable for two years
from December 31, 2003; and (iii) warrants to purchase 100,816 and 382,653 of
our ordinary shares with an exercise price of, $0.98 and $1.4 per ordinary
share, respectively and which are exercisable for two years from January 31,
2004. One of the Investors, Meitav Capital (2002) Ltd., or Meitav, recently
exercised 241,714 warrants for a purchase price of $ 190,080 (156,000 warrants
exercised at $0.68 and 85,714 warrants exercised at $0.98).

Yuravision
Acquisition. In
June 2004, we completed an investment in Yuravision Co. Ltd. and a series of
purchase agreements with certain of its shareholders, increasing our holdings
in Yuravision to approximately 51.11%. Yuravision is a South Korean developer
of visual inspection systems for the microelectronics and display industries.
The acquisition of a controlling stake in Yuravision is intended to facilitate
our efforts to penetrate the Flat Panel Display (FPD) and display technology
markets. We anticipate that we will continue acquiring shares in Yuravision
with the goal of increasing our interest to 100% over the next twelve months,
though we have no agreement to do so. For more information, see Item 3, Key Information -- Risk Factors -- Risk
Factors Relatedto Our Business
and Item 4, Information on the Company --
History and Development of the Company.

70

---

---

Standby
Equity Distribution Agreement.  On March 30, 2004, we entered into the
Standby Equity Distribution Agreement with Cornell. Upon execution of the
Standby Equity Distribution Agreement, we issued Cornell with 148,438 of our
ordinary shares. Pursuant to this agreement we will be entitled to issue
Cornell with advance notices requiring it to purchase, six days following each
advance notice, a number of our ordinary shares with a value of up to $300,000
per advance put notice and up to an aggregate value of $10,000,000 over two
years. The price per share payable by Cornell will be determined by the minimum
volume weighted average price of our ordinary shares during the five day period
following our advance notice to Cornell to purchase our ordinary shares.
Cornell will deduct 5% from the price payable for our ordinary shares as a fee
for this service. Consequently, we do not know how many ordinary shares, if
any, will be issued to Cornell over the following two years, but we have
registered 5,555,555 of our ordinary shares based on the maximum number of our
ordinary shares that we currently anticipate issuing to Cornell pursuant to the
Standby Equity Distribution Agreement, which will be available for resale by
Cornell. We may issue all, part or a greater number of our ordinary shares to
Cornell, depending on the minimum volume weighted average price of our ordinary
shares over the five day period following each advance notice. We will also
issue Cornell a number of our ordinary shares with a value of $150,000, upon
the first to occur of (i) our receipt of an aggregate of $5,000,000 pursuant to
the equity line and (ii) the first advance notice to be made following the
first anniversary of the Standby Equity Distribution Agreement. The number of
our ordinary shares which we will issue to Cornell in this event will be based
on the closing price of our ordinary shares on the public market on the date on
which Cornell purchases our shares under (i) or (ii), whichever is applicable.
Pursuant to the Standby Equity Distribution Agreement, Cornell will never be
entitled to hold more than 9.9% of our outstanding share capital, and
consequently, Cornell has agreed that in the event that a future purchase
pursuant to an advance notice to Cornell would take it above this threshold
percentage, it will sell, prior to the purchase, as many of our ordinary shares
as is required to ensure that at the time of the purchase of our ordinary
shares, its holdings in our company remain below the threshold percentage.

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

71

---

---

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 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.

General Corporate
Tax Structure

In general, Israeli companies are currently subject to company tax at
the rate of 36% of taxable income. According to a proposed amendment to Israeli
tax law, the company tax rate may be reduced in the near future to 35%, and may
be additionally reduced in subsequent tax years. However, as is in our case,
the rate is further reduced for income derived from an Approved Enterprise, as
set forth below.

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, 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 by its physical
characteristics, such as 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.

Taxable income of a company derived from an Approved Enterprise is
subject to Company Tax at a maximum rate of 25% (rather than the ordinary rate
of Company tax as stated above) for 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 (limited to twelve years from
commencement of production or fourteen years from the date of approval,
whichever is earlier) and, under certain circumstances (as further detailed
below), extending to a maximum of ten years from the commencement date. In the
event a company is operating under more than one approval or that its capital
investments are only partly approved, meaning a Mixed Enterprise, its
effective Company Tax rate is the result of a weighted combination of the various
applicable rates.

72

---

---

A company that qualifies as a Foreign Investors Company is entitled
to further reductions in the tax rate normally applicable to Approved
Enterprises. Such benefits will be granted only to enterprises that sought
approval in accordance with the applicable provisions of the Investment Law.
Subject to certain conditions, a Foreign Investors Company is a company
which has 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 made by persons who are not
residents of Israel. The percentage owned by nonresidents of Israel for any tax
year will be determined by the lowest percentage of any of the above rights
held by nonresidents during that year. Such a company will pay Company Tax at
reduced rates for an extended ten-year (rather than the otherwise applicable
seven-year) period and is exempt from any other tax on the income from its
Approved Enterprise:

For a company with foreign investment of:

| |                                 | Company
  Tax
  Rate | 
| | ------------------------------- | -------------------- | 
| |                                 |                      | 
| |                                 |                      | 
| | Over 25% but
  less than 49%    |                      | 
| | 49% or more
  but less than 74% |                      | 
| | 74% or more
  but less than 90% |                      | 
| | 90% or more                     |                      | 

Should our foreign shareholdings exceed 25%, future Approved
Enterprises would qualify for reduced tax rates for an additional three years,
after the seven years mentioned above. However, there can be no assurance that
we will attain approval for additional Approved Enterprises or that the provisions
of this Law will not change or that the above-mentioned shareholding proportion
will be reached for each subsequent year.

It has been recently announced that significant changes in the
Investment Law, including the tax benefits therein, can be expected in the near
future. Nonetheless, the Investment Law provides that terms and benefits
included in any certificate of approval already granted will remain subject to
the provisions of the law as they were on the date of such approval. Therefore,
any future changes in the Investment Law are likely to apply only to
applications approved after such changes are legislated.

73

---

---

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 set forth in the applicable certificate of approval. These conditions
include the filing of periodic reports and the requirement that the minimum
proportion of our paid-up capital to our fixed assets be 30%. In the event that
we do not fulfill these conditions in whole or in part, the benefits can be
cancelled and we may be required to refund the amount of the benefits with the
addition of linkage differences and interest. We believe that our Approved
Enterprises currently operate in compliance with all applicable conditions and
criteria, but there can be no assurance that they will continue to do so 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, or the Research Law, research and development programs
approved by the Research Committee of the Office of the Chief Scientist, or the
Research Committee, are eligible for grants or loans if they meet certain
criteria, in return for the payment of royalties from the sale of the product
developed in accordance with the program. Once a project is approved, the
Office of the Chief Scientist will award grants of up to 50% of the projects
expenditure in return for royalties, usually at rates between 3% to 5% of sales
of products developed with such grants, up to a Dollar-linked amount equal to
100% to 150% of such grants. Grants received under programs approved after
January 1, 1999, are 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.

The terms of these grants prohibit the manufacture outside of Israel
without the prior consent of the Research Committee. Such approval, if granted,
is generally subject to an increase in the total amount to be repaid to the
Office of the Chief Scientist to between 120% and 300% of the amount granted,
depending on the extent of the manufacturing to be conducted outside of Israel.
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.

The Research Law also provides that know-how from the research and
development, which is used to produce the product, may not be transferred to
Israeli third parties without the approval of the Research Committee, and may
not be transferred to non-Israeli third parties at all. 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. Such restriction
does not apply to exports from Israel of products developed with such
technologies. Approval of the transfer may be granted only if the transferee
abides by all of the provisions of the Research Law and regulations promulgated
thereunder, including the restrictions on the transfer of know-how and the
obligation to pay royalties.

There can be no assurance that the consents described above, if
requested, will be granted.

74

---

---

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

The following preferred corporate tax benefits are available to
Industrial Corporations as defined under the Law for the Encouragement of
Industry (Taxes), 1969. We believe that we qualify as an Industrial
Corporation.

| | (a)
  Deduction of purchases of know-how and patents over eight years for tax
  purposes.                                             
| | --------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                       
| | (b)
  Deduction for tax purposes of expenses incurred in connection with certain
  public securities issuances                        
| |                                                                                                                                       
| | (c)
  Accelerated depreciation rates on equipment and buildings.                                                                      
| |                                                                                                                                       
| | (d) Under
  specified conditions, an election to file consolidated tax returns with
  additional related Israeli Industrial Companies.

Taxation under
Inflationary Conditions

Under the Income Tax Law (Inflationary Adjustments), 1985, or the
Inflationary Adjustments Law, results for tax purposes are measured in real
terms, in accordance with the changes in the Israeli consumer price index. The
law also provides for the full taxation of gains from the sale of certain
traded securities, which would otherwise be taxed at a reduced rate when
derived by certain categories of corporate taxpayers. We are taxed under the
Inflationary Adjustments Law.

Israeli Capital
Gains Tax

Israeli law imposes a capital gains tax on the sale of capital assets
by both residents and non-residents of Israel. The law distinguishes between
the Real Gain and the Inflationary Amount. The Real Gain is the excess of
the total capital gain over the Inflationary Amount, computed on the basis of
the increase in the Israeli Consumer Price Index between the date of purchase
and the date of sale. The Inflationary Amount accumulated prior to December 31,
1993 is taxed at a rate of 10% l (reduced in certain cases to no tax for non-residents
if calculated according to the exchange rate of the Dollar instead of the
Israeli CPI), while the Inflationary Amount accumulated following December 31,
1993 is exempt from any capital gains tax. Until the end of the year 2002,
capital gains from the sale of our ordinary shares 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 are deemed to be business income.

75

---

---

As a result of the recent tax reform legislation in Israel, gains from
the sale of our ordinary shares derived from January 1, 2003 and thereafter
will in general be liable to capital gains tax of up to 15%. This will be the
case so long as our securities remain listed for trading on a designated
foreign stock market such as the NASDAQ. However, according to the tax reform
legislation, non-residents of Israel will be generally exempt from any capital
gains tax from the sale of our ordinary shares so long as the gains are not
derived through a permanent establishment that the non-resident maintains in
Israel, and so long as our ordinary shares remain listed for trading as
described above. These provisions dealing with capital gains are not applicable
to any persons whose gains from selling or otherwise disposing of our ordinary
shares are deemed to be business income or whose taxable income is determined pursuant
to the Israeli Income Tax Law (Inflationary Adjustments), 1985; the latter law
would not normally be applicable to non-resident shareholders who have no
business activity in Israel.

Pursuant to the U.S.--Israel Tax Treaty, the sale, exchange or disposition
of ordinary shares by a person who qualifies as a resident of the United States
within the meaning of the U.S.--Israel Tax Treaty and who is entitled to claim
the benefits afforded to such resident under the U.S.--Israel Tax Treaty, or
Treaty U.S. Resident, will, in general, not be subject to the Israeli capital
gains tax, unless such Treaty U.S. Resident holds, directly or indirectly,
shares representing 10% or more of the voting power of the company during any
part of the 12-month period preceding such sale, exchange or disposition. A
sale, exchange or disposition of ordinary shares by a Treaty U.S. Resident who
holds, directly or indirectly, shares representing 10% or more of the voting
power of the company at any time during such preceding 12-month period would be
subject to Israeli tax if not otherwise exempt; however, under the U.S.--Israel
Tax Treaty, such Treaty U.S. Resident would be permitted to claim a credit for
such taxes against the U.S. income tax imposed with respect to such sale, exchange
or disposition, subject to the limitations applicable to foreign tax credits.

Taxation of
Non-Residents

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

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

76

---

---

Effective Corporate Tax Rate

Our effective tax rate in Israel was 0% in
each of the years 2000, 2001, 2002 and 2003 (the regular rate of corporate tax
being 36%). Four of our investment programs have received Approved Enterprise
status under the Investment Law, pursuant to which we have elected to forego
certain Israeli government grants in return for an alternate package of tax
benefits. All of our income has been generated through our Approved Enterprise
programs. The Benefit Period for our first investment program ends in 2003. The
Benefit Period for our second investment program ends in 2004. The Benefit
Period for our third investment program ends in 2006. The Benefit Period for
our forth investment program will commence in the year in which we first
generate taxable income and will continue for a period of ten years. Our first
three investment programs have been ratified by the Israeli Investment Center. The
tax incentives that we receive from the fourth program or that we receive from
future investment programs in accordance with the Investment Law remain subject
to final ratification by the Israel Investment Center, such ratification being
conditional upon fulfillment of all terms of the approved program. The tax
incentives that we receive from the third and fourth programs or that we
receive from future investment programs in accordance with the Investment Law
remain subject to final determination by the Israel Tax Authority, such
determination being conditional upon fulfillment of all terms of the approved
program. In the event we distribute to our
shareholders a cash dividend from tax-exempt income attributable to one or more
of our Approved Enterprises, we would incur a company tax liability of 25% of
the earnings so distributed (the amount of the distribution being deemed
to include the tax thereon). Such a dividend would additionally be liable to 15% withholding tax.

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 $3,000, $6,000,
$6,000 and $38,000, outside of Israel in 2003, 2002, 2001 and 2000,
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, 1999. Our subsidiaries have not received final tax
assessments since their respective incorporations.

F. Dividends and Paying Agents.Not Applicable

G. Statement by Experts.Not Applicable

H. Documents on Display

We are required to file reports and other information with the SEC
under the Securities Exchange Act of 1934 and the regulations thereunder
applicable to foreign private issuers. Reports and other information filed by
us with the SEC may be inspected and copied at the SECs public reference
facilities described below. Although as a foreign private issuer we are not
required to file periodic information as frequently or as promptly as United
States companies, we generally do publicly announce our year-end results
promptly and file periodic information with the SEC under cover of Form 6-K. As
a foreign private issuer, we are also 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 other provisions in Section 16 of the Exchange Act.

77

---

---

You may review a copy of our filings with the SEC, including any
exhibits and schedules, at the SECs public reference facilities in Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
regional offices of the SEC located at 7 World Trade Center, 13th Floor, New
York, New York 10048 and at the Northwestern Atrium Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. You may also obtain copies of such
materials from the Public Reference Section of the SEC, Room 1024, Judiciary
Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed rates. You
may call the SEC at 1-800-SEC-0330 for further information on the public
reference rooms. While as a foreign private issuer we are now required to file
our annual report through the SECs EDGAR system, we are still exempt from
filing our periodic reports through the SECs EDGAR system, consequently they
are not available on the SECs Web site. You may read and copy any reports,
statements or other information that we file with the SEC at the SEC facilities
listed above. These SEC filings are also available to the public from
commercial document retrieval services.

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

I. Subsidiary Information.Not Applicable

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

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

Interest Rate Risk

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

Interest Rate Risk on Investments. 
We maintain a strict, conservative investment policy, which ensures the
safety and preservation of our invested funds by limiting default risk, market
risk and reinvestment risk. According to this policy, we invest in bank
deposits and in high-level marketable securities. Our cash and cash equivalent
as of December 31, 2003, consisted primarily of demand deposits. A material
change in yields of the securities in which we invest, and in our liquidity
requirements before the maturity of our investments, may have an effect on our financial
results and cash flow. However, due to the nature of our cash and cash
equivalents and short-term investments, we have concluded that we do not have
material market risk exposure.

78

---

---

Interest Rate Risk on Liabilities.As of December 31,
2003 we had liabilities in the amount of $1,006,000. 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 $100,000. The increase in interest rates in 2003
did not result in any material change to our liabilities. As of December 31,
2003 we had accounts payable in the amount of $651,000. Market risk was
estimated as the potential decrease in fair value resulting from a hypothetical
10% increase in the year-end interest rates. Assuming such increase in the
interest rates, the fair value of our accounts payable would increase by
$61,000. The increase in interest rates in 2003 did not result in any material
change to our accounts payable.Our
accounts receivable are held in foreign currencies and are not linked to any
interest rates. Consequently, the decrease in interest rates in 2003 did not
result in any change to our accounts payable. As of December 31, 2003 we did
not have any hedging transactions that mitigate interest rate fluctuations.

Foreign Currency Exchange and Inflation Risk

Since the majority of our revenues are paid in or linked to U.S.
Dollars and Euro, we believe that a result of inflation and fluctuations in the
NIS/Dollar and the Euro/ Dollar exchange rate might be a material effect on our
revenues. Both inflation in Israel , and fluctuations in the NIS/Dollar and the
Euro/Dollar exchange rate, have some influence on our expenses and thus on our
net income. The cost of our operations in Israel, as expressed in Dollars, is
influenced by the extent to which any increase in the rate of inflation in
Israel is not offset, or is offset, on a lagging basis, by a devaluation of the
NIS in relation to the Dollar.

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

As of December 31, 2003, we had no cash or cash equivalents in New
Israeli Shekels (NIS) or in funds linked thereto (out of $1,789,000 cash and
cash equivalents that we had in total) though we have a credit facility in NIS,
consequently we had no market risk resulting from any increase in the year-end
NIS/Dollar and the Euro/Dollar exchange rate.

79

---

---

Furthermore, as of December 31, 2003, we had no accounts receivable in
New Israeli Shekels (NIS) or in funds linked thereto and consequently we were
not exposed to any market risk resulting from any increase in the year-end
NIS/Dollar and the Euro/Dollar exchange rate.

However, as of December 31, 2003, we had accounts payable in New
Israeli Shekels (NIS) or in funds linked thereto in the amount of $438,964.
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
$43,894.

Equity Price Risk

As of December 31, 2003, we did not have any marketable securities
recorded at a fair value.

|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). Based on that evaluation, which was completed within 90 days
of the filing date of this annual report, our chief executive officers and
chief financial officer, concluded that our disclosure controls and procedures
were effective though we are constantly engaged in the process of improving
these controls and procedures. There have been no significant changes in our
disclosure controls or in other factors that could significantly affect
disclosure controls subsequent to the date of the evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.

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

80

---

---

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

Our
board of directors has determined that Mr. Zahi Dekel is our audit committee
financial expert.

|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 | PrincipalAccountant Fees and Services
|-------- | -------------------------------------

The following table presents fees for professional audit services
rendered by Ernst and Young for the audit of our consolidated annual financial
statements for the year ended December 31, 2002 and PWC for the year ended
31, December 2003.

| |                      |  | 2003  |      | 2002       | 
| | -------------------- |  | ----- | ---- | ---------- | 
| |                      |  | $ 000 |      | Percentage | 
| | Audit
  Fees(1)      |  |       | 52   |            | 
| | Audit-Related
  Fees |  |       | -    |            | 
| | Tax Fees(2)          |  |       | 7    |            | 
| | All Other
  Fees(3)  |  |       | 11.6 |            | 
| | Total                |  |       | 70.6 |            | 

|(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 PWC. Any services provided by PWC 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.

81

---

---

|         |                                                                         
|-------- | ------------------------------------------------------------------------
|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-30.

|ITEM 19. | EXHIBITS.                                                                                                                                                        
|-------- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------
|         |                                                                                                                                                                  
|1.1      | Articles of
  Association, as amended of the Registrant(1)                                                                                                       
|         |                                                                                                                                                                  
|1.2      | Memorandum
  of Association of the Registrant(1)                                                                                                                 
|         |                                                                                                                                                                  
|4.1      | Formation
  Agreement dated July 4, 1993, among Elbit Ltd., Yossi Barath and Hillel Avni(1)(2)                                                                   
|         |                                                                                                                                                                  
|4.2      | Amendment
  Agreement dated October 26, 1998, among Elbit Ltd., Yossi Barath and Hillel
  Avni(3)                                                                
|         |                                                                                                                                                                  
|4.3      | Amendment
  No.1 to License Agreement of June 12, 1996 between Elbit Ltd., Elbit Vision
  Systems Ltd., and Dr. Ilan Tamches, dated May 12, 2002.(4)             
|         |                                                                                                                                                                  
|4.4      | Share
  Purchase Agreement dated February 7, 2001, among Elbit Vision Systems Ltd.,
  Nir Alon and Altro Warenhandels GmbH(3)                                    
|         |                                                                                                                                                                  
|4.5      | Amendment to
  the Share Purchase Agreement of February 7, 2001, among Elbit Vision Systems
  Ltd., Nir Alon and Altro Warenhandels GmbH, dated March 18, 2002(4)
|         |                                                                                                                                                                  
|4.6      | Share
  Purchase Agreement dated March 18, 2002, between Elbit Vision Systems Ltd.
  and Altro Warenhandels GmbH(4)                                              
|         |                                                                                                                                                                  
|4.7      | Registration
  Rights Agreement dated February 7, 2001, between Elbit Vision Systems Ltd.
  and Nir Alon(3)                                                      
|         |                                                                                                                                                                  
|4.8      | Share
  Purchase Agreement dated April 2004, between Elbit Vision Systems Ltd. and
  STIC Angel Investment Partnership No. IV(5)                                 
|         |                                                                                                                                                                  

82

---

---

|     |                                                                                                                                                             
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|4.9  | Share
  Purchase Agreement dated May 18, 2004, between Elbit Vision Systems Ltd. and
  Yuravision Co. Ltd.(5)                                               
|     |                                                                                                                                                             
|4.10 | Share
  Purchase Agreement dated April 2004, between Elbit Vision Systems Ltd. and
  Kuen Yu Liu(5)                                                         
|     |                                                                                                                                                             
|4.11 | Share
  Purchase Agreement dated May 18, 2004, between Elbit Vision Systems Ltd. and
  Professor Whoi Yul Kim and Hoe Choon Kim(5)                          
|     |                                                                                                                                                             
|4.12 | Standby
  Equity Distribution Agreement, dated March 30, 2004, between Cornell Capital
  Partners LLP and Elbit Vision Systems Ltd.(6)                      
|     |                                                                                                                                                             
|4.13 | Placement
  Agent Agreement, dated March 30, 2004, between Cornell Capital Partners LLP,
  Newbridge Securities Corporation and Elbit Vision Systems Ltd.(6)
|     |                                                                                                                                                             
|4.14 | Registration
  Rights Agreement, dated March 30, 2004 between Cornell Capital Partners LLP
  and Elbit Vision Systems Ltd.(6)                               
|     |                                                                                                                                                             
|8.1  | List of
  subsidiaries                                                                                                                                      
|     |                                                                                                                                                             
|10.1 | Consent of Luboshitz Kasierer.                                                                                                                              
|     |                                                                                                                                                             
|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      

---

|(1) | Incorporated
  by reference from our Registration Statement on Form F-1, File No. 333-03080,
  as amended, filed with the Commission on April 2, 1996. 
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------
|(2) | English
  translation or summary from Hebrew original.                                                                                                 
|(3) | Incorporated
  by reference from our Annual Report on Form 20-F for the year ended December
  31, 2000.                                                
|(4) | Incorporated
  by reference from our Annual Report on Form 20-F for the year ended December
  31, 2001.                                                
|(5) | Incorporated
  by reference from our Report of Foreign Issuer on Form 6-K, File No. for the
  month of June, filed with the Commission on June 8, 2004.
|(6) | Incorporated
  by reference from our Registration Statement on Form F-2, File No. 333-11095,
  filed with the Commission on May 3, 2004.               

83

---

---

SIGNATURES

Pursuant to the requirements of Section 12 of the Securities Exchange
Act of 1934, the registrant certifies that it meets all the requirements for
filing on Form 20-F and has duly caused and authorized the undersigned to sign
this annual report on its behalf in the City of Yoqneam, State of Israel, on
this 29th day of June 2004.

ELBIT VISION SYSTEMS LTD.

| | By:                                    | /S/ ZAMI
  ABERMAN | 
| | -------------------------------------- | ------------------ | 
| |                                        |                    | 
| |                                        |                    | 
| | Zami Aberman
  Chief Executive Officer

84



---

---

ELBIT VISION SYSTEMS LTD.

(An Israeli Corporation)

2003 CONSOLIDATED FINANCIAL STATEMENTS

---

---

ELBIT VISION SYSTEMS LTD.

2003 CONSOLIDATED FINANCIAL STATEMENTS

TABLE OF CONTENTS

|                                     | Page                                           
|------------------------------------ | -----------------------------------------------
|REPORT OF INDEPENDENT AUDITORS       | 2                                              
|CONSOLIDATED
  FINANCIAL STATEMENTS: |                                                
|                                     | Balance
  sheets                               
|                                     | Statements
  of operations                     
|                                     | Statements
  of changes in shareholders equity
|                                     | Statements
  of cash flows                     
|                                     | Notes to
  Financial Statements                

The amounts are stated in U.S. dollars ($) in thousands.

---

---

|
|
|

REPORT OF INDEPENDENT
AUDITORS

To the shareholders ofELBIT VISION SYSTEMS LTD.

We have audited the consolidated
balance sheet of Elbit Vision Systems Ltd. (the Company) and its subsidiaries
as of December 31, 2003 and the related consolidated statements of operations,
changes in shareholders equity and cash flows for the year then ended. 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 conducted our audit in accordance
with the standards of the Public Company Accounting Oversight Board (United States) and in
accordance 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
provides a reasonable basis for our opinion.

In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the
consolidated financial position of the Company and its subsidiaries as of
December 31, 2003 and the results of their operations, the changes in
shareholders equity and their cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States of America.

|Haifa, Israel  | Kesselman
  & Kesselman              
|-------------- | -------------------------------------
|March 21, 2004 | Certified
  Public Accountants (Isr.)

2

Kesselman & Kesselman is a member of PricewaterhouseCoopers
International Limited, a company limited by guarantee registered in England and
Wales.

---

---

ELBIT VISION SYSTEMS LTD.

CONSOLIDATED BALANCE SHEETS

|                                                                                  |  |      |  | December 31                 | 
|--------------------------------------------------------------------------------- |  | ---- |  | --------------------------- | 
|                                                                                  |  |      |  |                             | 
|                                                                                  |  | Note |  | 2003                        | 
|                                                                                  |  |      |  |                             | 
|                                                                                  |  |      |  | U.S.
  dollars in thousands | 
|                                                                                  |  |      |  |                             | 
|A  s  s  e  t  s                                                                  |  |      |  |                             | 
|CURRENT
  ASSETS:                                                                 |  |      |  |                             | 
|Cash
  and cash equivalents                                                       |  |      |  | 1,789                       | 
|Restricted
  deposit                                                              |  | 11a  |  | 537                         | 
|Accounts
  receivable:                                                            |  | 12a  |  |                             | 
|Trade                                                                             |  |      |  | 1,021                       | 
|Other                                                                             |  |      |  | 620                         | 
|Inventories                                                                       |  | 2    |  | 3,139                       | 
|                                                                                  |  |      |  |                             | 
|T o t a l 
  current assets                                                       |  |      |  | 7,106                       | 
|                                                                                  |  |      |  |                             | 
|INVESTMENTS
  AND LONG-TERM RECEIVABLES:                                          |  |      |  |                             | 
|Funds
  in respect of employee rights upon retirement                             |  | 5    |  | 622                         | 
|Other
  long-term receivables                                                     |  | 3    |  | 99                          | 
|                                                                                  |  |      |  |                             | 
|                                                                                  |  |      |  | 721                         | 
|                                                                                  |  |      |  |                             | 
|PROPERTY AND EQUIPMENT,
  net of accumulated
       depreciation and amortization |  | 4    |  | 414                         | 
|                                                                                  |  |      |  |                             | 
|T
  o t a l  assets                                                               |  |      |  | 8,241                       | 
|                                                                                  |  |      |  |                             | 

| |                                        
| | ---------------------------------------
| | (Chairman
  of the Board of  Directors)
| |                                        
| |                                        
| | (President,
  Chief Executive  Officer)

3

---

---

|                                                                                              |  |      |  | December
  31               |  
|--------------------------------------------------------------------------------------------- |  | ---- |  | --------------------------- | -
|                                                                                              |  |      |  |                             |  
|                                                                                              |  | Note |  | 2003                        |  
|                                                                                              |  |      |  |                             |  
|                                                                                              |  |      |  | U.S.
  dollars in thousands |  
|                                                                                              |  |      |  |                             |  
|Liabilities and shareholders equity                                                          |  |      |  |                             |  
|CURRENT
  LIABILITIES:                                                                        |  |      |  |                             |  
|Credit
  from banks                                                                           |  | 12c  |  | 1,006                       |  
|Current
  maturities of loan from shareholder                                                 |  | 6    |  | 160                         |  
|Accounts
  payable and accruals:                                                              |  |      |  |                             |  
|Trade                                                                                         |  |      |  | 651                         |  
|Deferred
  revenues                                                                           |  | 1h   |  | 355                         |  
|Other                                                                                         |  | 12b  |  | 2,427                       |  
|                                                                                              |  |      |  |                             |  
|T
  o t a l  current liabilities                                                              |  |      |  | 4,599                       |  
|                                                                                              |  |      |  |                             |  
|LONG-TERM
  LIABILITIES:                                                                      |  |      |  |                             |  
|Liability
  for employee rights upon retirement                                               |  | 5    |  | 979                         |  
|Loan
  from shareholder  net of current maturities                                           |  | 6    |  | 287                         |  
|                                                                                              |  |      |  |                             |  
|T
  o t a l  long-term liabilities                                                            |  |      |  | 1,266                       |  
|                                                                                              |  |      |  |                             |  
|COMMITMENTS
  AND CONTINGENT LIABILITIES                                                      |  | 7    |  |                             |  
|                                                                                              |  |      |  |                             |  
|T
  o t a l  liabilities                                                                      |  |      |  | 5,865                       |  
|                                                                                              |  |      |  |                             |  
|SHAREHOLDERS
  EQUITY:                                                                       |  | 8    |  |                             |  
|Share
  capital - ordinary shares of NIS 1 par value (Ordinary Shares);                     |  |      |  |                             |  
|Authorized
  - 20,000,000 Ordinary Shares as of December 31, 2003
                 and
  2002 |  |      |  |                             |  
|Issued
  and outstanding:                                                                     |  |      |  |                             |  
|December
  31, 2003  13,006,466 Ordinary shares;                                             |  |      |  |                             |  
|December
  31, 2002  10,166,667 Ordinary shares                                              |  |      |  | 1,856                       |  
|Receipts
  on account of shares to be allotted                                                |  |      |  | 140                         |  
|Warrants                                                                                      |  |      |  | 267                         |  
|Additional
  paid-in capital                                                                  |  |      |  | 18,662                      |  
|Accumulated
  deficit                                                                         |  |      |  | (18,549                     | )
|                                                                                              |  |      |  |                             |  
|T
  o t a l shareholders equity                                                              |  |      |  | 2,376                       |  
|                                                                                              |  |      |  |                             |  
|T
  o t a l liabilities and shareholders equity                                              |  |      |  | 8,241                       |  
|                                                                                              |  |      |  |                             |  

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

4

---

---

ELBIT VISION SYSTEMS LTD.

CONSOLIDATED STATEMENTS OF OPERATIONS

|                                                                                                                 |  | Note |  | 2003                                                  |   | 2002   |   | 2001   |  
|---------------------------------------------------------------------------------------------------------------- |  | ---- |  | ----------------------------------------------------- | - | ------ | - | ------ | -
|                                                                                                                 |  |      |  |                                                       |   |        |   |        |  
|                                                                                                                 |  |      |  | U.S.
  dollars in thousands
  (except per share data) |  
|                                                                                                                 |  |      |  |                                                       |  
|                                                                                                                 |  |      |  |                                                       |   |        |   |        |  
|REVENUES:                                                                                                        |  | 12d  |  |                                                       |   |        |   |        |  
|Sale
  of products                                                                                               |  |      |  | 4,043                                                 |   | 4,773  |   | 6,859  |  
|Services
  rendered                                                                                              |  |      |  | 2,285                                                 |   | 2,455  |   | 2,444  |  
|                                                                                                                 |  |      |  |                                                       |   |        |   |        |  
|                                                                                                                 |  |      |  | 6,328                                                 |   | 7,228  |   | 9,303  |  
|                                                                                                                 |  |      |  |                                                       |   |        |   |        |  
|COST OF
  REVENUES:                                                                                              |  | 12e  |  |                                                       |   |        |   |        |  
|Cost
  of products sold                                                                                          |  |      |  | 2,294                                                 |   | 2,723  |   | 4,973  |  
|Cost
  of services rendered                                                                                      |  |      |  | 1,454                                                 |   | 1,937  |   | 1,830  |  
|                                                                                                                 |  |      |  |                                                       |   |        |   |        |  
|                                                                                                                 |  |      |  | 3,748                                                 |   | 4,660  |   | 6,803  |  
|                                                                                                                 |  |      |  |                                                       |   |        |   |        |  
|GROSS
  PROFIT                                                                                                   |  |      |  | 2,580                                                 |   | 2,568  |   | 2,500  |  
|RESEARCH
  AND DEVELOPMENT COSTS
  - net                                                                         |  | 12f  |  | 1,431                                                 |   | 1,340  |   | 1,405  |  
|SELLING,
  GENERAL AND ADMINISTRATIVE EXPENSES:                                                                  |  |      |  |                                                       |   |        |   |        |  
|Marketing
  and selling                                                                                          |  |      |  | 1,598                                                 |   | 1,545  |   | 1,625  |  
|General
  and administrative                                                                                     |  |      |  | 637                                                   |   | 1,404  |   | 886    |  
|                                                                                                                 |  |      |  |                                                       |   |        |   |        |  
|OPERATING
  LOSS                                                                                                 |  |      |  | (1,086                                                | ) | (1,721 | ) | (1,416 | )
|FINANCIAL
  INCOME - net                                                                                         |  | 12g  |  | 60                                                    |   | 34     |   | 89     |  
|OTHER
  INCOME                                                                                                   |  |      |  | 47                                                    |   | 9      |   | 20     |  
|                                                                                                                 |  |      |  |                                                       |   |        |   |        |  
|LOSS
  BEFORE TAXES ON INCOME                                                                                    |  |      |  | (979                                                  | ) | (1,678 | ) | (1,307 | )
|TAXES ON
  INCOME                                                                                                |  | 9e   |  | 3                                                     |   | 6      |   | 6      |  
|                                                                                                                 |  |      |  |                                                       |   |        |   |        |  
|LOSS FOR
  THE YEAR                                                                                              |  |      |  | (982                                                  | ) | (1,684 | ) | (1,313 | )
|                                                                                                                 |  |      |  |                                                       |   |        |   |        |  
|                                                                                                                 |  |      |  |                                                       |   |        |   |        |  
|LOSS PER
  SHARE  BASIC AND DILUTED                                                                             |  | 1o   |  | (0.10                                                 | ) | (0.17  | ) | (0.13  | )
|                                                                                                                 |  |      |  |                                                       |   |        |   |        |  
|                                                                                                                 |  |      |  |                                                       |   |        |   |        |  
|WEIGHTED AVERAGE NUMBER OF SHARES USED INCOMPUTATION OF LOSS PER SHARE  BASIC AND
       DILUTED (IN THOUSANDS) |  |      |  |                                                       |   |        |   |        |  
|                                                                                                                 |  |      |  | 10,175                                                |   | 10,167 |   | 9,817  |  
|                                                                                                                 |  |      |  |                                                       |   |        |   |        |  

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

5

---

---

ELBIT VISION SYSTEMS LTD.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS
EQUITY

|                                                         |  | Share
  capital    |  | Receipts
  on
  account of
  shares to be
  allotted |  | Warrants
  (see note 8a3)) |  | Additional
  paid-in
  capital |  | Accumulated
  deficit |  | Total
  shareholders
  equity |  
|-------------------------------------------------------- |  | ------------------ |  | ---------------------------------------------------- |  | -------------------------- |  | ------------------------------ |  | --------------------- |  | ------------------------------ | -
|                                                         |  |                    | 
|                                                         |  | Number
  of shares |  | Amount                                               | 
|                                                         |  |                    |  |                                                      |  |                            |  |                                |  |                       |  |                                |  
|                                                         |  | In
  thousands     |  | U.S.
  dollars in thousands                          | 
|                                                         |  |                    |  |                                                      | 
|BALANCE AT
  JANUARY 1, 2001                             |  | 8,667              |  | 852                                                  |  |                            |  |                                |  | 16,728                |  | (14,570                        | )
|CHANGES
  DURING 2001:                                   |  |                    |  |                                                      |  |                            |  |                                |  |                       |  |                                |  
|Loss                                                     |  |                    |  |                                                      |  |                            |  |                                |  |                       |  | (1,313                         | )
|Issuance
  of share capital (note 8a)                    |  | 1,500              |  | 356                                                  |  |                            |  |                                |  | *1,057                |  |                                |  
|                                                         |  |                    |  |                                                      |  |                            |  |                                |  |                       |  |                                |  
|BALANCE AT
  DECEMBER 31, 2001                           |  | 10,167             |  | 1,208                                                |  |                            |  |                                |  | 17,785                |  | (15,883                        | )
|                                                         |  |                    |  |                                                      |  |                            |  |                                |  |                       |  |                                |  
|CHANGES
  DURING 2002 -                                  |  |                    |  |                                                      |  |                            |  |                                |  |                       |  |                                |  
|loss                                                     |  |                    |  |                                                      |  |                            |  |                                |  |                       |  | (1,684                         | )
|                                                         |  |                    |  |                                                      |  |                            |  |                                |  |                       |  |                                |  
|BALANCE AT
  DECEMBER 31, 2002                           |  | 10,167             |  | 1,208                                                |  |                            |  |                                |  | 17,785                |  | (17,567                        | )
|                                                         |  |                    |  |                                                      |  |                            |  |                                |  |                       |  |                                |  
|CHANGES
  DURING 2003:                                   |  |                    |  |                                                      |  |                            |  |                                |  |                       |  |                                |  
|Loss                                                     |  |                    |  |                                                      |  |                            |  |                                |  |                       |  | (982                           | )
|Issuance
  of share capital and warrants (note 8a)       |  | 2,769              |  | 633                                                  |  |                            |  | *267                           |  | *865                  |  |                                |  
|Employee
  stock options exercised and paid              |  | 70                 |  | 15                                                   |  |                            |  |                                |  | 12                    |  |                                |  
|                                                         |  |                    |  |                                                      |  |                            |  |                                |  |                       |  |                                |  
|Receipts
  on account of shares to be allotted (note 8a) |  |                    |  |                                                      |  | 140                        |  |                                |  |                       |  |                                |  
|                                                         |  |                    |  |                                                      |  |                            |  |                                |  |                       |  |                                |  
|BALANCE AT
  DECEMBER 31, 2003                           |  | 13,006             |  | 1,856                                                |  | 140                        |  | 267                            |  | 18,662                |  | (18,549                        | )
|                                                         |  |                    |  |                                                      |  |                            |  |                                |  |                       |  |                                |  

* Net
of share issuance costs.

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

6

---

---

ELBIT VISION SYSTEMS LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                                                       |  | 2003                        |   | 2002   |   | 2001   |  
|------------------------------------------------------------------------------------------------------ |  | --------------------------- | - | ------ | - | ------ | -
|                                                                                                       |  |                             |   |        |   |        |  
|                                                                                                       |  | U.S.
  dollars in thousands |  
|                                                                                                       |  |                             |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                                                  |  |                             |   |        |   |        |  
|Loss                                                                                                   |  | (982                        | ) | (1,684 | ) | (1,313 | )
|Adjustments
  to reconcile loss to net
            cash provided by
  or used in operating activities: |  |                             |   |        |   |        |  
|Depreciation
  and amortization                                                                        |  | 238                         |   | 256    |   | 312    |  
|Trading
  marketable securities - net                                                                  |  |                             |   | 812    |   | (812   | )
|Liability
  for employee rights upon retirement                                                        |  | 228                         |   | 155    |   | (6     | )
|Capital
  loss (gain) from disposal of property and equipment                                          |  | (6                          | ) | 4      |   | (13    | )
|Exchange
  differences on long-term receivables                                                        |  |                             |   | 2      |   | 15     |  
|Accrued
  interest on loan from related party                                                          |  | 9                           |   | 12     |   |        |  
|Changes
  in operating assets and liabilities:                                                         |  |                             |   |        |   |        |  
|Decrease
  (increase) in accounts receivable:                                                          |  |                             |   |        |   |        |  
|Trade
  (including non-current portion)                                                                |  | (342                        | ) | 516    |   | 372    |  
|Other                                                                                                  |  | (207                        | ) | (111   | ) | 240    |  
|Increase
  (decrease) in accounts payable and accruals:                                                |  |                             |   |        |   |        |  
|Trade                                                                                                  |  | 39                          |   | (339   | ) | (354   | )
|Deferred
  revenues                                                                                    |  | (955                        | ) | (701   | ) | (504   | )
|Other                                                                                                  |  | 136                         |   | 46     |   | (57    | )
|Decrease
  in inventories                                                                              |  | 72                          |   | 940    |   | 854    |  
|                                                                                                       |  |                             |   |        |   |        |  
|Net
  cash used in operating activities                                                                |  | (1,770                      | ) | (92    | ) | (1,266 | )
|                                                                                                       |  |                             |   |        |   |        |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                                                  |  |                             |   |        |   |        |  
|Purchase
  of property and equipment                                                                   |  | (156                        | ) | (49    | ) | (56    | )
|Collection
  of long-term receivables                                                                  |  | 43                          |   | 24     |   |        |  
|Investment
  in long-term deposits                                                                     |  | (5                          | ) | (8     | ) | (13    | )
|Investment
  in restricted deposit                                                                     |  | (537                        | ) |        |   |        |  
|Proceeds
  from disposal of property and equipment                                                     |  | 43                          |   | 1      |   | 63     |  
|Long-term
  loan granted                                                                               |  | (61                         | ) |        |   |        |  
|Funds
  in respect of employee rights upon retirement                                                  |  | (191                        | ) | (5     | ) | (17    | )
|                                                                                                       |  |                             |   |        |   |        |  
|Net
  cash used in investing activities                                                                |  | (864                        | ) | (37    | ) | (23    | )
|                                                                                                       |  |                             |   |        |   |        |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                                                  |  |                             |   |        |   |        |  
|Issuance
  of share capital and warrants -net of issuance costs                                        |  | 1,765                       |   |        |   | 1,413  |  
|Short-term
  credit from bank  net                                                                    |  | 1,006                       |   |        |   | (73    | )
|Proceeds
  from exercise of options                                                                    |  | 27                          |   |        |   |        |  
|Receipts
  on account of shares to be allotted                                                         |  | 140                         |   |        |   |        |  
|Discharge
  of loan from related party                                                                 |  |                             |   |        |   | (100   | )
|                                                                                                       |  |                             |   |        |   |        |  
|Net
  cash provided by financing activities                                                            |  | 2,938                       |   | -,-    |   | 1,240  |  
|                                                                                                       |  |                             |   |        |   |        |  
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                                   |  | 304                         |   | (129   | ) | (49    | )
|BALANCE
  OF CASH AND CASH EQUIVALENTS AT
       BEGINNING OF
  YEAR                                   |  | 1,485                       |   | 1,614  |   | 1,663  |  
|                                                                                                       |  |                             |   |        |   |        |  
|BALANCE OF CASH AND CASH EQUIVALENTS AT
       END OF YEAR                                             |  | 1,789                       |   | 1,485  |   | 1,614  |  
|                                                                                                       |  |                             |   |        |   |        |  
|SUPPLEMENTAL
  DISCLOSURE OF CASH FLOW
       INFORMATION
  - cash paid during the year for:           |  |                             |   |        |   |        |  
|Interest
  paid                                                                                        |  | 20                          |   | -,-    |   | 1      |  
|                                                                                                       |  |                             |   |        |   |        |  
|Income
  taxes paid  net                                                                              |  | 16                          |   | 15     |   | 23     |  
|                                                                                                       |  |                             |   |        |   |        |  

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

7

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES:

| | The significant accounting
  policies, applied on a consistent basis are as follows:
| | ------------------------------------------------------------------------------------
| |                                                                                     
| | a.                                                                                  
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     
| |                                                                                     

8

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued):

| |    |                                                                                                                                                                                                                                                                                                 | (b)                                                                        | The exchange rate of the
  U.S. dollar at December 31, 2003 was NIS 4.379 (December 31, 2002  NIS
  4.737, December 31, 2001  NIS 4.416).
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                 |                                                                            |                                                                                                                                            
| | b. | Principles
  of consolidation                                                                                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                
| |    | The consolidated financial
  statements include the accounts of the Company and its wholly-owned
  subsidiaries.                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                
| |    | Intercompany balances and
  transactions have been eliminated in consolidation. Profits from intercompany
  sales, not yet realized outside of the Company and its subsidiaries, have also
  been eliminated.                                                                                  
| |    |                                                                                                                                                                                                                                                                                                
| | c. | Cash equivalents                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                
| |    | The Company considers all
  highly liquid investments, which include short-term bank deposits (up to
  three months from the date of deposit) that are not restricted as to
  withdrawal or use, to be cash equivalents.                                                                       
| |    |                                                                                                                                                                                                                                                                                                
| | d. | Concentration
  of credit risks and allowance for doubtful accounts                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                
| |    | As of December 31,
  2003 and 2002, the Company 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 allowance for doubtful
  accounts is determined for specific debts doubtful of collection.                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                
| | e. | Inventories                                                                                                                                                                                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                
| |    | Inventories are valued 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. | Property and equipment                                                                                                                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                
| |    | These assets are stated at
  cost and are depreciated by the straight-line method over their estimated
  useful lives.                                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                
| |    | Annual rates of
  depreciation are as follows:                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                 |                                                                            | %                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                 |                                                                            |                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                 | Machinery
  and equipment                                                  | 10-33 (mainly 33%)                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                 | Office
  furniture and equipment                                           | 6-10                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                 | Vehicles                                                                   | 15                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                
| |    | 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.                                                                                                                     

9

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued):

| | g. | Impairment
  of long-lived assets                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | The Company has adopted FAS No.144, Accounting for the Impairment or Disposal
  of Long-Lived Assets,
  effective January 1, 2002.  FAS 144
  requires that long-lived assets held and used by an entity be 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.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | The adoption of FAS 144
  did not have any material impact on the consolidated financial position and
  consolidated results of operations of the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | h. | Revenue
  recognition:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | 1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    | 2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

10

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued):

| | i. | Research and development                                                                                                                                                                                     
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                              
| |    | Research and development
  expenses are charged to income as incurred. 
  Government funding for development of approved projects is recognized
  as a reduction of expenses as the related cost is incurred.
| |    |                                                                                                                                                                                                              
| | j. | Shipping
  and handling costs                                                                                                                                                                                
| |    |                                                                                                                                                                                                              
| |    | Shipping and handling
  costs, which amounted to $110,000, $58,000 and $57,000 for the years ended
  December 31, 2003, 2002 and 2001, respectively, are included in selling
  expenses.                     
| |    |                                                                                                                                                                                                              
| | k. | Advertising
  expenses                                                                                                                                                                                       
| |    |                                                                                                                                                                                                              
| |    | Advertising expenses are
  charged to income as incurred. 
  Advertising expenses for the years ended December 31, 2003, 2002 and
  2001 were $45,000, $18,000 and $2,000, respectively.                     
| |    |                                                                                                                                                                                                              
| | l. | Comprehensive
  income                                                                                                                                                                                       
| |    |                                                                                                                                                                                                              
| |    | The Company has no
  comprehensive income components other than net loss.                                                                                                                                    
| |    |                                                                                                                                                                                                              
| | m. | Deferred
  income taxes:                                                                                                                                                                                     
| |    |                                                                                                                                                                                                              
| |    | 1)                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                              
| |    | 2)                                                                                                                                                                                                           

11

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued):

| | n. | Stock-based
  compensation
| | -- | --------------------------
| |    |                           
| |    | 1)                        
| |    |                           
| |    | 2)                        

| |                                                                                             |  | Year ended
  December 31                   |      
| | ------------------------------------------------------------------------------------------- |  | ------------------------------------------ | -----
| |                                                                                             |  |                                            |      
| |                                                                                             |  | 2003                                       |      
| |                                                                                             |  |                                            |      
| |                                                                                             |  | $ in
  thousands (except per
  share data) |      
| |                                                                                             |  |                                            |      
| | Loss
  as reported                                                                          |  |                                            | 982  
| | Add
  - stock-based employee compensation
       expense determined under fair value method |  |                                            | 145  
| |                                                                                             |  |                                            |      
| | Pro
  forma loss                                                                            |  |                                            | 1,127
| |                                                                                             |  |                                            |      
| | Loss
  per share:                                                                           |  |                                            |      
| | Basic
  and diluted - as reported                                                           |  | $                                          | 0.10 
| |                                                                                             |  |                                            |      
| | Basic
  and diluted - pro forma                                                             |  | $                                          | 0.11 
| |                                                                                             |  |                                            |      

| |    | As to information about
  the stock option plans and assumptions used in calculating the pro forma
  information, see note 8b.                                                                                                                                                                                                                                                                                                                         
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | o. | Loss per
  share (LPS)                                                                                                                                                                                                                                                                                                                                                                                                                               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | Basic LPS is computed
  based on the weighted average number of shares outstanding during each
  year.  All stock options and warrants
  were not reflected in diluted LPS for all periods presented, because the
  effect of such options and warrants is antidilutive.  Total common stock equivalents, related to
  options and warrants outstanding is 2,592,000, 2,000,000 and 1,509,000 shares
  for the years 2003, 2002 and 2001, respectively.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | p. | Reclassification                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    | Certain comparative
  figures have been reclassified to conform to the current year presentation.                                                                                                                                                                                                                                                                                                                                                      

12

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES (continued):

| | q. | Recently
  issued accounting pronouncements:
| | -- | --------------------------------------------
| |    |                                             
| |    | 1)                                          
| |    |                                             
| |    |                                             
| |    |                                             
| |    |                                             
| |    | 2)                                          
| |    |                                             
| |    |                                             
| |    |                                             
| |    |                                             
| |    |                                             
| |    |                                             

13

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 2  INVENTORIES:

| |                     |  | December
  31    | 
| | ------------------- |  | ---------------- | 
| |                     |  |                  | 
| |                     |  | 2003             | 
| |                     |  |                  | 
| |                     |  | $ in
  thousands | 
| |                     |  |                  | 
| | Raw materials*      |  | 744              | 
| | Spare parts         |  | 786              | 
| | Work in process     |  | 556              | 
| | Finished products** |  | 1,053            | 
| |                     |  |                  | 
| |                     |  |                  | 
| |                     |  | 3,139            | 
| |                     |  |                  | 

| | *  | In
  the year ended December 31, 2001, the Company recorded a
  writedown in the amount of $ 220 thousands (2002 and 2003  nil).
| | -- | ---------------------------------------------------------------------------------------------------------------------------------
| | ** | Mainly
  systems in trial by customers (see note 1h1)).                                                                          

NOTE 3 
OTHER LONG-TERM RECEIVABLES

| |                                                     |  | December 31      |   
| | --------------------------------------------------- |  | ---------------- | --
| |                                                     |  |                  |   
| |                                                     |  | 2003             |   
| |                                                     |  |                  |   
| |                                                     |  | $ in
  thousands |   
| |                                                     |  |                  |   
| | Deposits on leased vehicle
  (see also note 7a2)(b) |  |                  | 26
| | Loan to employees (see
  also note 7b1))(1)         |  |                  | 12
| | Loan to other(2)                                    |  |                  | 61
| | Non-current trade
  receivable                      |  |                  |   
| |                                                     |  |                  |   
| |                                                     |  |                  | 99
| |                                                     |  |                  |   

| |  |  | (1) | The loans are mainly
  denominated in NIS and linked to the Israeli CPI.                                                                                                                                                                                                                                                 
| |  |  | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |  |     |                                                                                                                                                                                                                                                                                                                          
| |  |  | (2) | Representing a loan to a
  company; the loan is 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.  The Company has not
  yet resolved whether to convert the loan or not.

NOTE 4 - PROPERTY AND EQUIPMENT:

| | a. | Composition of assets,
  grouped by major classifications, is as follows:
| | -- | -------------------------------------------------------------------------

| |                                                           |  | December 31      | 
| | --------------------------------------------------------- |  | ---------------- | 
| |                                                           |  |                  | 
| |                                                           |  | 2003             | 
| |                                                           |  |                  | 
| |                                                           |  | $ in
  thousands | 
| |                                                           |  |                  | 
| | Machinery and equipment                                   |  | 1,762            | 
| | Leasehold improvements                                    |  | 452              | 
| | Office furniture and
  equipment                          |  | 399              | 
| | Vehicles                                                  |  | 43               | 
| |                                                           |  |                  | 
| |                                                           |  | 2,656            | 
| |                                                           |  |                  | 
| | Less - accumulated
  depreciation
       and amortization |  | 2,242            | 
| |                                                           |  |                  | 
| |                                                           |  |                  | 
| |                                                           |  | 414              | 
| |                                                           |  |                  | 

| | b. | Depreciation and
  amortization expenses totaled $ 238,000, $ 256,000 and $ 312,000,
  in the years ended December 31, 2003, 2002 and 2001, respectively.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------

14

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 5 - LIABILITY FOR EMPLOYEE RIGHTS UPON RETIREMENT:

| | a. | Israeli law generally
  requires the payment of severance pay upon dismissal of an employee or upon
  termination of employment in certain other circumstances.  The severance pay liability of the Company
  to its Israeli employees is based upon the number of years of service and the
  latest monthly salary.  The liability
  is partly covered by regular deposits with recognized pension funds, deposits
  with severance pay funds and purchases of insurance policies.  Under labor agreements, these deposits and
  insurance policies are in the employees names and are, subject to certain
  limitations, the property of the employees.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | The Company may only make
  withdrawals from the funds for the purpose of paying severance pay.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |    | The liability for employee
  rights upon retirement covers the severance pay liability of the Company and
  its Dutch subsidiary in accordance with labor agreements in force and based
  on salary components, which, in managements opinion, create entitlement to
  severance pay.  The Company records
  the obligation as if it was payable at each balance sheet date on an
  undiscounted basis.                                                                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | b. | The 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 $160,000, $176,000 and $195,000 in the years
  ended December 31, 2003, 2002 and 2001, respectively.  The earnings on the amounts funded were
  $54,000 for the year ended December 31, 2003.                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | d. | The Company expects to
  contribute in 2004 $185,000 to the insurance companies and provident fund, in
  respect of its severance pay obligation.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

NOTE 6  LOAN FROM SHAREHOLDER:

| | 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.                                                                                                                                                                                                                    
| |                                                                                                                                                                                                                       
| | b.                                                                                                                                                                                                                    
| |                                                                                                                                                                                                                       

15

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 7  COMMITMENTS AND CONTINGENT LIABILITIES:

| | a. | Commitments:
| | -- | ------------
| |    |             
| |    | 1)          
| |    |             
| |    |             
| |    |             
| |    |             
| |    |             
| |    |             
| |    |             
| |    |             
| |    |             
| |    |             
| |    |             
| |    |             
| |    |             
| |    |             
| |    |             
| |    |             
| |    |             
| |    |             

16

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 7  COMMITMENTS AND CONTINGENT LIABILITIES (continued):

| |  | 2) | Lease commitments:
| |  | -- | ------------------
| |  |    |                   
| |  |    | (a)               
| |  |    |                   
| |  |    |                   

|                         |  | $ in
  thousands |    
|------------------------ |  | ---------------- | ---
|                         |  |                  |    
|Year ending December 31: |  |                  |    
|2004                     |  |                  | 175
|2005                     |  |                  | 169
|2006                     |  |                  | 29 
|                         |  |                  |    
|                         |  |                  | 373
|                         |  |                  |    

| |  |  |     | 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
  $ 150,000, $ 247,000 and $ 248,000 in the years ended
  December 31, 2003, 2002 and 2001, respectively.                                                                 
| |  |  |     |                                                                                                                                                                                                   
| |  |  | (b) | The Company leases motor
  vehicles under long-term operating lease agreements.  The lease agreements expire on various
  dates ending in 2004  2006 (with prior notice of cancellation clauses).
| |  |  |     | Minimum lease commitments
  of the Company under the above leases, at rates in effect on December
  31, 2003, are as follows:                                                                     

|     |  | $ in
  thousands |    
|---- |  | ---------------- | ---
|     |  |                  |    
|2004 |  |                  | 202
|2005 |  |                  | 152
|2006 |  |                  | 49 
|     |  |                  |    
|     |  |                  | 403
|     |  |                  |    

| |    |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | To secure the amounts due
  to the lessor, the Company has deposited a total of
  U.S. $ 38,000.  Equal to
  three-month lease payments.  The
  deposits are unlinked and presented among other receivables and long-term
  receivables.
| | -- | ------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | Lease expenses in 2003,
  2002 and 2001, amounted to $ 154,000, $ 204,000 and $ 221,000.                                                                                                                                                
| |    |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                         
| | b. | Contingent
  liabilities:
| |    |                           |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |                                                                                                                                                                                                                                         
| |    | 1)                        | The
  Company guarantees  its employees
  bank loans. The loans are repayable through 2005.  In case of failure in repayment by the employee, the Company is
  liable to the bank for the loan.  The
  Company requires collateral to secure these guarantees.  The Companys maximum exposure under these
  guarantees is $ 40 thousands. 
  This exposure is not indicative of the likelihood of the expected loss
  under the guarantee. As of December 31, 2003, the fair value of these
  guarantees was insignificant.

17

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 7  COMMITMENTS AND CONTINGENT LIABILITIES (continued):

|                               |    | 2)                                         | Panoptes
  claim                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|------------------------------ | -- | ------------------------------------------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                               |    |                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                               |    |                                            | In
  November 2002, the Company filed in the Haifa District Court an application
  for a permanent injunction against Panoptes Ltd. (Panoptes) to cease all
  production and marketing of its current products. The Company also claimed
  damages from Panoptes in the amount of at least NIS 2.6 million ($600,000).
  The claim was also brought against the CEO of Panoptes and former founder of
  the Company.  The claim states that
  Panoptes, which was established by the CEO of Panoptes and former founder of
  the Company, recruited several former company employees, and currently
  markets products which are unlawfully based on Companys technology.                                                                                                                                                                              
|                               |    |                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                               |    |                                            | Panoptes
  filed a counter claim in December 2002, alleging that the Company had
  conducted negotiations with Panoptes in bad-faith and had failed to execute
  an agreement regarding Panoptes products as a result of bad faith. The claim
  was for a minimum of NIS 3 million ($700,000). Panoptes also filed a defense
  to the statement of claim of the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|                               |    |                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                               |    |                                            | On February 2, 2004,
  Panoptes filed an application with the Haifa District Court to have the part
  of the Companys claim relating to intellectual property infringement
  summarily dismissed.  The pre-trial
  hearing which had been scheduled for February 3, 2004 was
  abandoned.  Currently the parties are
  negotiating a compromise whereby all of the claims with respect to one
  another will be dropped, with the exception of the NIS 2.6 million
  damages claim filed by the Company and the NIS 3 million
  damages claim filed by Panoptes.  Should the compromise be executed by the parties, they will
  remit the claims for financial damages to the District Court for a summary
  ruling.                                                                                                                                     
|                               |    |                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                               |    |                                            | Management
  is presently unable to predict the ultimate outcome of the above legal
  proceedings, including whether they will eventually result in a lawsuit
  against the Company. Accordingly, no provision in respect thereof has been
  recorded in the financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                               |    |                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|NOTE 8 - SHAREHOLDERS 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                               |    |                                            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|                               |    | 2)                                         | In March 2001, Mr. Alon,
  the Companys chairman, as from March 2001, purchased 1,500,000 of its ordinary
  shares at a price per share of $1.00. 
  At that time, Mr. Alon also agreed to complete a second investment in
  which he would purchase by no later than March 15, 2002, an additional
  1,500,000 shares at a price per share of $1.00; provided that the Companys
  financial results for 2001 met certain minimum thresholds.  In March 2002, the Company agreed to
  permit Altro Warenhandelsgesmbh (hereafter  Altro), an Austrian company
  controlled by Mr. Alon, to complete the second investment in nine equal
  monthly installments commencing March 2002. 
  In May 2002, the Company deferred payment of the first four of these
  installments until no later than June 30, 2002.  This investment was not done by Altro.

18

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 8 - SHAREHOLDERS EQUITY (continued):

| |  |    | 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.  To date, Altro has paid the first two
  installments in the aggregate amount of $385,000 (through December 31,
  2003, the Company received $140,000 [net of issuance costs amounting to
  $30,000] and additional $245,000 in 2004).                                                            
| |  | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |    | The shares are to be held
  by a trustee and will be released, pro rata (after Altro completes an
  investment in the amount of $460,000), as the payments are received by the
  Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |    | Also, pursuant to the
  arrangement, the Company will distribute, without consideration, warrants to
  purchase approximately 4 million of its ordinary shares to all of its
  shareholders (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) below and note 14a), as of a record
  date to be set, on a pro rata basis. 
  Each warrant will be exercisable for a period of four years following
  the grant date, at a price of $0.35 per share.  The fair value of the said warrants granted was $0.1.  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.
Completion of the transaction, including issuance of warrants and allotment of shares will take
  place in 2004.
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  | 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
  892,325 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.                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |    | Through December 31, 2003,
  the Company received $1,765,000 (net of issuance costs amounting to
  $118,000), in respect of 2,769,299 shares and 692,325 warrants, issued as
  above.  The amount received was
  recorded in Companys shareholders equity as of December 31, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  |    | In January 2004, the
  Company received $511,360 (net of issuance costs amounting to $32,640), in
  respect of 800,000 shares and 200,000 warrants issued as above.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |  |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |  |    | The said private investors
  participating in the issuance of shares and warrants as above, do not
  participate in the warrant distribution Arrangement mentioned in 2) above.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

19

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

NOTE 8 - SHAREHOLDERS EQUITY
(continued):

| |    |                     | As part of
  the issuance as above, the Company issued 293,300 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.  Through December 31, 2003, the Company issued 245,300
  warrants:  51,500 warrants have the
  same terms as the warrants issued to the investors as above, and 193,800
  warrants are exercisable at a price of $0.68 per share, for a period of 24
  months from date of issuance (In January 2004, the Company issued additional
  48,000 warrants at the same terms).                                                                                                                                
| | -- | ------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                     | 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 $0.28.  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.
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | 4)                  | As to
  raising of additional capital in January 2004, see note 14a.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| | b. | Share option plans:
| |    |                    
| |    | 1)                  | The plans:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                     | (a)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                     | (b)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    |                     | (c)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

20

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

NOTE 8 - SHAREHOLDERS EQUITY
(continued):

| |  |  |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |  |  |  | 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.                                                                                                                                                                                                                                                                                                                                                                                           
| |  |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  |  |  | The 2000 and
  2003 plans are subject to the terms stipulated by Section 102 of the Israeli
  Income Tax Ordinance.  Inter alia,
  these terms provide that the Company will be allowed to claim, as
  an expense for tax purposes, the amounts credited to the employees as
  a benefit in respect of shares or options granted under the plan, as
  follows:                                                                                                                                                                                                                                                                                                                                                    
| |  |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  |  |  | Through
  December 31, 2002, the amount that the Company will be allowed to claim
  as an expense for tax purposes will be the amount of the benefit chargeable
  to tax in the hands of the employee.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |  |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  |  |  | As from
  January 1, 2003, the amount that the Company will be allowed to claim as
  an expense for tax purposes, will be the amount of the benefit chargeable to
  tax as work income in the hands of the employee, while that part of the
  benefit that is chargeable to capital gains tax in the hands of the employee
  shall not be allowable.  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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  |  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |  |  |  | On March 19,
  2002, the Board of Directors approved an exchange program to give all the
  employees a choice to cancel stock options granted to them from May 7, 1997
  through and including May 24, 2000 in exchange for an equal number of new
  options, in the future.  The new
  options will be granted no sooner than September 20, 2002, and the
  exercise price shall be the market value of the shares on the replacement
  grant date.  All employees who were
  offered the exchange program accepted the offer.  On September 20, 2002, in accordance with the decision of the
  Companys Board of Directors, 88,500 options were granted to employees in
  connection with the exchange program.
| |  |  |  | As to
  options issued in 2004, to employees of acquired company, see note 14b.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

21

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

NOTE 8 - SHAREHOLDERS EQUITY
(continued):

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

|                                                                            |  | Y e a r  e n d e d  D e c e m b e r  3 1 |  
|--------------------------------------------------------------------------- |  | ---------------------------------------- | -
|                                                                            |  |                                          |  
|                                                                            |  | 2 0 0 3                                  |  
|                                                                            |  |                                          |  
|                                                                            |  | Number                                   |  
|                                                                            |  |                                          |  
|Options outstanding at beginning of year                                    |  | 2,413,486                                |  
|Changes during the year:                                                    |  |                                          |  
|Granted
  (1)                                                               |  | 934,000                                  |  
|Exercised                                                                   |  | (70,450                                  | )
|Forfeited                                                                   |  | (119,950                                 | )
|                                                                            |  |                                          |  
|Options outstanding at end
  of year                                        |  | 3,157,086                                |  
|                                                                            |  |                                          |  
|Options exercisable at year
  end                                           |  | 1,388,682                                |  
|                                                                            |  |                                          |  
|Weighted average fair value
  of
       options granted during the year (2) |  | 0.24                                     |  
|                                                                            |  |                                          |  

|(1) | Except for
  500,000 options granted in 2003 (weighted average exercise price of 0.77 and
  fair value of $0.22) and 200,000 options, granted in 2002 (weighted average
  exercise price of $1 and fair value of $0.05), at the above market value
  exercise price.  All other grants were
  made at market value, or near market value exercise price, as follows:
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                          |  | Number    |  | Weighted
  average
  exercise
  price |      | Weighted
  average
  fair value | 
|------------------------- |  | --------- |  | ------------------------------------- | ---- | ------------------------------- | 
|                          |  |           |  |                                       |      |                                 | 
|Year ended
  December 31: |  |           |  |                                       |      |                                 | 
|2003                      |  | 934,000   |  |                                       | 0.57 |                                 | 
|                          |  |           |  |                                       |      |                                 | 
|2002                      |  | 1,291,400 |  |                                       | 0.44 |                                 | 
|                          |  |           |  |                                       |      |                                 | 
|2001                      |  | 708,000   |  |                                       | 0.36 |                                 | 
|                          |  |           |  |                                       |      |                                 | 

|(2) | The fair
  value of each option granted is estimated on the date of grant using the
  Black-Scholes option-pricing model with the following weighted average
  assumptions:
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                            |  | Year ended December 31 |  
| | -------------------------- |  | ---------------------- | -
| |                            |  |                        |  
| |                            |  | 2003                   |  
| |                            |  |                        |  
| | Dividend
  yield           |  | 0                      | %
| |                            |  |                        |  
| | Expected
  volatility      |  | 137                    | %
| |                            |  |                        |  
| | Risk-free
  interest rate  |  | 1.9                    | %
| |                            |  |                        |  
| | Expected
  life - in years |  | 3.3                    |  
| |                            |  |                        |  

22

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

NOTE 8 - SHAREHOLDERS EQUITY (continued):

| |  |  | (b) | The
  following table summarizes certain information about options granted to
  employees which were outstanding and exercisable under the above plans as of
  December 31, 2003:
| |  |  | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Options outstanding |  | Options exercisable                            | 
| |  | ------------------- |  | ---------------------------------------------- | 
| |  |                     |  |                                                | 
| |  | Exercise
  prices   |  | Number
  outstanding at 
  December 31,
  2003 | 
| |  |                     |  |                                                | 
| |  | $                   |  |                                                | 
| |  |                     |  |                                                | 
| |  | 3.00                |  | 99,447                                         | 
| |  | 1.68                |  | 110,000                                        | 
| |  | 1.17                |  | 533,639                                        | 
| |  | 1.00                |  | 200,000                                        | 
| |  | 0.48                |  | 444,700                                        | 
| |  | 0.36                |  | 373,500                                        | 
| |  | 0.20                |  | 375,800                                        | 
| |  | 0.68                |  | 266,000                                        | 
| |  | 0.85                |  | 234,000                                        | 
| |  | 0.83                |  | 20,000                                         | 
| |  | 0.15                |  | 400,000                                        | 
| |  | 0.75                |  | 100,000                                        | 
| |  |                     |  |                                                | 
| |  |                     |  | 3,157,086                                      | 
| |  |                     |  |                                                | 

|                          | 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.
|                          |    |                                                                                                                                                                                                                                                                                                                                                                                                                 
|NOTE 9 - TAXES ON INCOME:
|                         
|                          | a. | 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 is entitled to various tax benefits.                                                                                                                                                                                                                                                      
|                          |    |                                                                                                                                                                                                                                                                                                                                                                                                                 
|                          |    | The main tax
  benefits available to the Company are:                                                                                                                                                                                                                                                                                                                                                           
|                          |    |                                                                                                                                                                                                                                                                                                                                                                                                                 
|                          |    | 1)                                                                                                                                                                                                                                                                                                                                                                                                              
|                          |    |                                                                                                                                                                                                                                                                                                                                                                                                                 
|                          |    |                                                                                                                                                                                                                                                                                                                                                                                                                 

23

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

NOTE 9 - TAXES ON INCOME
(continued):

| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | The Company
  has three approved enterprises; the benefit period in respect of the first,
  second and third enterprises commenced in 1994, 1995, and 1997, respectively.                                                                                                                             
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | The period
  of benefits for the first approved enterprise expired in 2003.                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | The periods
  of benefits for the second and third approved enterprises will expire in 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.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                       
| |    | 2)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           | Accelerated
  depreciation                                                                                                                                                                                                                                                                            
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |                                                                                                                                                                                                                                                                                                       
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              | The Company
  is entitled to claim accelerated depreciation in respect of equipment used by
  the approved enterprises during five tax years.                                                                                                                                                         
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    | The
  entitlement to the above benefits is conditional upon the Company fulfilling
  the conditions stipulated by the above law, regulations published thereunder
  and the certificate of approval for the specific investments in approved
  enterprises.  In the event of failure
  to comply with these conditions the benefits may be canceled, and 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.               
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | b. | 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 Israel CPI.  The Company is taxed under this law.                                                                                                                                                                                                                                                                                                                                                      
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    | As explained
  in note 1a(4), 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.
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | c. | Tax benefits under the Law for the Encouragement of Industry
  (Taxes), 1969                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    | The Company
  is an industrial company as defined by this law and as such is 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.                                                                                                                                                                       

24

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

NOTE 9 - TAXES ON INCOME
(continued):

| | d. | Other applicable tax rates:
| | -- | ---------------------------
| |    |                            
| |    | 1)                         
| |    |                            
| |    |                            
| |    |                            
| |    | 2)                         
| |    |                            
| |    |                            
| |    |                            
| | e. | Taxes on income            
| |    |                            
| |    | 1)                         

| |                       |  | 2003 |  | 2002  |   | 2001  |  
| | --------------------- |  | ---- |  | ----- | - | ----- | -
| |                       |  |      |  |       |   |       |  
| |                       |  |      |  |       |   |       |  
| | Domestic              |  | 763  |  | 1,763 |   | 1,534 |  
| | Subsidiaries
  abroad |  | 216  |  | (85   | ) | (227  | )
| |                       |  |      |  |       |   |       |  
| |                       |  | 979  |  | 1,678 |   | 1,307 |  
| |                       |  |      |  |       |   |       |  

| |  | 2) | 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 |  
| | ------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------- | -
| |                                                                                                                                                   |  |                        |  
| |                                                                                                                                                   |  | 2003                   |  
| |                                                                                                                                                   |  |                        |  
| | Loss before
  taxes on income                                                                                                                     |  | (979                   | )
| |                                                                                                                                                   |  |                        |  
| | Theoretical
  tax benefit on the above amount                                                                                                     |  | (352                   | )
| | Increase in
  taxes in respect of tax losses
       incurred in the reported year for which
       deferred taxes were not created (see f. below) |  | 352                    |  
| | Other                                                                                                                                             |  | 3                      |  
| |                                                                                                                                                   |  |                        |  
| | Actual tax
  expense                                                                                                                              |  | 3                      |  
| |                                                                                                                                                   |  |                        |  

| |    | Taxes on
  income included in the statement of operations relate to Companys
  subsidiaries.                                                                                                                                                                                                                                                                                                   
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                 
| | f. | Deferred income taxes                                                                                                                                                                                                                                                                                                                                                                           
| |    |                                                                                                                                                                                                                                                                                                                                                                                                 
| |    | The Company
  has unutilized carryforward tax losses from prior years.  Therefore, no current tax liability has
  been provided in 2003, 2002, and 2001.                                                                                                                                                                                                                                        
| |    | 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 a1) above. 
  Accordingly, no deferred tax assets have been included in these
  financial statements in respect of the Companys carryforward tax losses.

25

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

NOTE 9 - TAXES ON INCOME
(continued):

|                                                    | g. | Carryforward tax losses                                                                                                                                                                                                                                                                
|--------------------------------------------------- | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                    |    |                                                                                                                                                                                                                                                                                        
|                                                    |    | Carryforward
  tax losses aggregate approximately $16.5 million at December 31, 2003.                                                                                                                                                                                                  
|                                                    |    |                                                                                                                                                                                                                                                                                        
|                                                    | h. | Tax assessments                                                                                                                                                                                                                                                                        
|                                                    |    |                                                                                                                                                                                                                                                                                        
|                                                    |    | Final tax
  assessments have been received by the Company through the tax year 1999.                                                                                                                                                                                                   
|                                                    |    |                                                                                                                                                                                                                                                                                        
|NOTE 10 - 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
11  LIABILITIES SECURED BY PLEDGES AND RESTRICTION PLACED IN RESPECT OF
LIABILITIES:

| | a. | The Company has registered fixed charge on a bank deposits in favor
  of a certain banks.  The bank deposits
  are used to secure a credit line granted to the Company by the banks.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | The bank deposits  amounting to $537 thousands 
   are linked to the dollar, and bear no
  interest.  The bank deposits are for a
  period of one month.                          
| |    |                                                                                                                                                                                     
| | b. | The Company has registered floating charges on all of its assets if
  favor of banks and lease companies.                                                                           

NOTE 12 - SUPPLEMENTARY BALANCE SHEET INFORMATION:

| |                                                  |  | December 31     |  
| | ------------------------------------------------ |  | --------------- | -
| |                                                  |  |                 |  
| |                                                  |  | 2003            |  
| |                                                  |  |                 |  
| |                                                  |  | $  in thousands |  
| |                                                  |  |                 |  
| | a.       Accounts receivable                     |  |                 |  
| |                                                  |  |                 |  
| | 1)    Trade
   allowance for doubtful accounts: |  |                 |  
| | Balance
  at beginning of year                   |  | 1,527           |  
| | Charged
  to general and administrative expenses |  | (310            | )
| |                                                  |  |                 |  
| | Balance
  at end of year                         |  | 1,217           |  
| |                                                  |  |                 |  

26

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

NOTE 12 - SUPPLEMENTARY BALANCE SHEET INFORMATION
(continued):

| |                                                  |  | December 31     | 
| | ------------------------------------------------ |  | --------------- | 
| |                                                  |  |                 | 
| |                                                  |  | 2003            | 
| |                                                  |  |                 | 
| |                                                  |  | $  in thousands | 
| |                                                  |  |                 | 
| | 2)   Other:                                      |  |                 | 
| | Employees                                        |  | 57              | 
| | Prepaid
  expenses                               |  | 100             | 
| | Israeli
  Government departments and agencies    |  | 346             | 
| | Sundry                                           |  | 117             | 
| |                                                  |  |                 | 
| |                                                  |  | 620             | 
| |                                                  |  |                 | 
| | b.      Accounts
  payable and accruals - other: |  |                 | 
| |                                                  |  |                 | 
| | Employees
  and employee institutions            |  | 241             | 
| | Israeli
  Government departments and agencies    |  | 1,388           | 
| | Provision
  for vacation and recreation pay      |  | 336             | 
| | Commissions
  to agents                          |  | 195             | 
| | Accrued
  expenses and sundry                    |  | 267             | 
| |                                                  |  |                 | 
| |                                                  |  | 2,427           | 
| |                                                  |  |                 | 

| | c. | Credit from banks     
| | -- | ----------------------
| |    |                       
| |    | Composed as
  follows:

|               |                                |  |                                           |  | December 31 | 
|-------------- | ------------------------------ |  | ----------------------------------------- |  | ----------- | 
|              
|               |                                |  |                                           |  | 2003        | 
|               |                                |  | % interest rate as of
  December 31, 2003 |  |             | 
|$ in thousands
|               |                                |  |                                           |  |             | 
|               | Unlinked
  credit from bank*   |  | 8.2                                       |  |             | 
|               | Short-term
  loans from banks* |  |                                           |  |             | 
|               | Unlinked                       |  | 8.2                                       |  |             | 
|               | Linked
  to the Euro           |  | 4.25                                      |  |             | 
|               |                                |  |                                           |  |             | 
|               |                                |  |                                           |  |             | 
|               |                                |  |                                           |  |             | 

| | * | 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
  $537,000; to secure the credit facilities, the Company registered a fixed
  charge on certain bank deposits in favor of the said banks (see note
  11a).  As of
  December 31, 2003, the Company fully utilized its credit
  facilities.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

27

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

NOTE 12 - SUPPLEMENTARY BALANCE SHEET INFORMATION
(continued):

| | d. | Revenues
| | -- | --------
| |    |         
| |    | 1)      

| |                                  |  | 2003             |  | 2002  |  | 2001  | 
| | -------------------------------- |  | ---------------- |  | ----- |  | ----- | 
| |                                  |  |                  |  |       |  |       | 
| |                                  |  | $
  in thousands | 
| |                                  |  |                  | 
| | U.S.A.                           |  | 2,531            |  | 3,278 |  | 5,267 | 
| | Europe                           |  | 2,893            |  | 3,253 |  | 2,894 | 
| | Other
  (mainly Japan and China) |  | 904              |  | 697   |  | 1,142 | 
| |                                  |  |                  |  |       |  |       | 
| |                                  |  | 6,328            |  | 7,228 |  | 9,303 | 
| |                                  |  |                  |  |       |  |       | 

| |  | 2) | The
  following customers accounted for 10% or more of the Companys sales:
| |  | -- | ---------------------------------------------------------------------------

| |            |  | 2003 |  | 2001 | 
| | ---------- |  | ---- |  | ---- | 
| |            |  |      |  |      | 
| | Customer A |  |      |  | 21%  | 
| | Customer B |  | 17%  |  |      | 

| |  | 3) | The Companys long-lived assets
  by geographic areas are as follows:
| |  | -- | ---------------------------------------------------------------------

| |        |  | 2003            |  | 2002 | 
| | ------ |  | --------------- |  | ---- | 
| |        |  |                 |  |      | 
| |        |  | $  in thousands | 
| |        |  |                 | 
| | Israel |  | 340             |  | 514  | 
| | U.S.A. |  | 74              |  | 19   | 
| |        |  |                 |  |      | 
| |        |  | 414             |  | 533  | 
| |        |  |                 |  |      | 

| | e. | Cost of revenues:
| | -- | -----------------

| |                                |  | 2003            |   | 2002  |  | 2001  | 
| | ------------------------------ |  | --------------- | - | ----- |  | ----- | 
| |                                |  |                 |   |       |  |       | 
| |                                |  | $  in thousands |  
| |                                |  |                 |  
| | Industrial
  operations:       |  |                 |   |       |  |       | 
| | Materials
  consumed           |  | 1,002           |   | 1,025 |  | 913   | 
| | Payroll
  and related expenses |  | 1,452           |   | 1,427 |  | 1,727 | 
| | Subcontracted
  work           |  | 132             |   | 70    |  | 90    | 
| | Depreciation                   |  | 65              |   | 99    |  | 118   | 
| | Other
  production expenses    |  | 582             |   | 1,153 |  | 1,528 | 
| | Royalties                      |  | 245             |   | 44    |  | 564   | 
| | Decrease
  in inventories:     |  |                 |   |       |  |       | 
| | Finished
  products            |  | (39             | ) | 462   |  | 1,297 | 
| | Products
  in process          |  | 309             |   | 380   |  | 566   | 
| |                                |  |                 |   |       |  |       | 
| |                                |  | 3,748           |   | 4,660 |  | 6,803 | 
| |                                |  |                 |   |       |  |       | 

| | f. | Research and development expenses  net:
| | -- | ----------------------------------------

| | Total
  expenses                                         |  | 1,827 |   | 1,490 |   | 1,531 |  
| | -------------------------------------------------------- |  | ----- | - | ----- | - | ----- | -
| | L
  e s s   grants and participations,
  see note 7a1). |  | (396  | ) | (150  | ) | (126  | )
| |                                                          |  |       |   |       |   |       |  
| |                                                          |  | 1,431 |   | 1,340 |   | 1,405 |  
| |                                                          |  |       |   |       |   |       |  

28

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

NOTE 12 - SUPPLEMENTARY BALANCE SHEET INFORMATION
(continued):

| | g. | Financial income  net:
| | -- | -----------------------

|                           |                                                                               |  | 2003            |  | 2002 |  | 2001 | 
|-------------------------- | ----------------------------------------------------------------------------- |  | --------------- |  | ---- |  | ---- | 
|                           |                                                                               |  |                 |  |      |  |      | 
|                           |                                                                               |  | $  in thousands | 
|                           |                                                                               |  |                 | 
|                           | Income:                                                                       |  |                 |  |      |  |      | 
|                           | Interest:                                                                     |  |                 |  |      |  |      | 
|                           | In
  respect of bank deposits and securities                                  |  | 6               |  | 59   |  | 50   | 
|                           | In
  respect of marketable securities                                         |  |                 |  | 44   |  | 10   | 
|                           | Exchange
  differences                                                        |  | 19              |  |      |  | 5    | 
|                           | Other                                                                         |  | 67              |  | 2    |  | 37   | 
|                           |                                                                               |  |                 |  |      |  |      | 
|                           |                                                                               |  | 92              |  | 105  |  | 102  | 
|                           |                                                                               |  |                 |  |      |  |      | 
|                           | Expenses:                                                                     |  |                 |  |      |  |      | 
|                           | Interest
  -
            in respect of
  liability to related party           |  | 9               |  | 12   |  | 13   | 
|                           | Exchange
  differences                                                        |  |                 |  | 46   |  |      | 
|                           | Other                                                                         |  | 23              |  | 13   |  |      | 
|                           |                                                                               |  |                 |  |      |  |      | 
|                           |                                                                               |  | 32              |  | 71   |  | 13   | 
|                           |                                                                               |  |                 |  |      |  |      | 
|                           |                                                                               |  | 60              |  | 34   |  | 89   | 
|                           |                                                                               |  |                 |  |      |  |      | 
|                           |                                                                               |  |                 |  |      |  |      | 
|NOTE 13  RELATED PARTIES: |                                                                               |  |                 |  |      |  |     
|                           |                                                                               |  |                 |  |      |  |      | 
|                           | Income
  (expenses):                                                          |  |                 |  |      |  |      | 
|                           | Royalties*                                                                    |  |                 |  |      |  | 300  | 
|                           |                                                                               |  |                 |  |      |  |      | 
|                           | Financing
  expenses on long-term loan
            granted by
  shareholder** |  | 9               |  | 12   |  | 13   | 
|                           |                                                                               |  |                 |  |      |  |      | 

| | * See
  note 7a1)(c).
| | ---------------------
| | **
  See note 6.     

NOTE
14  SUBSEQUENT EVENTS:

| | a. | In January
  2004, the Company issued 1,530,612 shares at a price of $0.98 per share and
  382,653 warrants for a total consideration of $1,500,000.                                                                                                             
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    | 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.                                              
| |    |                                                                                                                                                                                                                                                                  
| |    | 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.                                                                                                                                         

29

---

---

ELBIT VISION SYSTEMS LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)

NOTE 14  SUBSEQUENT EVENTS
(continued):

| | b. | As part of
  its strategy to expand into additional fields of visual
  inspection systems, 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 Co. Ltd. (hereafter  Yuravision), a
  Korea-based company, which develops visual inspection software and systems
  for the microelectronics industry as well as flat panel display
  industries.  Under the term sheet all
  shares of Yuravision will be acquired in exchange for ordinary shares of the
  Company, in aggregate value of $1.5 million to be calculated using the
  average closing price of the Companys ordinary shares for the whole of
  December 2003 ($0.96), and options to purchase an aggregate of 500,000 shares
  of the Company, at an exercise price of $0.75, which shall be vesting within
  two years following the closing of the agreement.  Consummation of the transaction is subject to completion of due
  diligence by the Company, execution of definitive documentation and other
  customary closing conditions.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | c. | In March
  2004, the Company entered into a standby equity distribution agreement with
  Cornell Capital Partnership (hereafter  Cornell).  Pursuant to this agreement the Company will be entitled to
  issue Cornell with put notices requiring it to purchase, six days following
  each put notice, a number of Companys ordinary shares with a value of up to
  $300,000 per put notice and up to an aggregate value of $10,000,000 over two
  years.  The price per share payable by
  Cornell will be determined based on the minimum price of Companys shares
  during the five days period following Companys put notice to Cornell to
  purchase Companys shares.  Cornell
  will deduct 5% from the price payable for Companys ordinary shares as a
  commitment fee.                                                                                                                                                                                                                                                                                                                                 

30



---

---

# CONSENT OF INDEPENDENT
AUDITORS

We hereby consent to the
incorporation by reference in the registration statement on Form 20-F for the year ended
December 31, 2003, of Elbit Vision Systems Ltd. (the Company) of our report
dated June 25, 2003, with respect to the consolidated financial statements of the Company
and subsidiaries as of December 31, 2002, and for the year then ended (the
Report), which report is included in the Companys Report on Form 6-K for
the month of April 2004, filed with the Securities and Exchange Commission on April 2,
2004. We further consent to the incorporation by reference of our Report in the
registration statements of the Company, (on Form F-3 No. 333-114153 and on Form S-8
No.333-12456), and related prospectuses.

/s/ LUBOSHITZ KASIERER
An Affiliate Member of Ernst & Young International
Tel-Aviv, Israel
June 28, 2004



---

---