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# SECURITIES AND
EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

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FORM 20-F ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d) OF 
THE
SECURITIES EXCHANGE ACT OF 1934 
For the fiscal year ended December 31, 2004

Commission File No.
1-8201

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

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Israel 
(Jurisdiction
of incorporation or organization)

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

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

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

Ordinary
Shares, nominal value 1.00 New Israeli Shekel per share

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

None 
(Title of Class)

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Indicate the number of outstanding
shares of each of the issuers classes of capital or common stock as of the close of
the period covered by the annual report 25,681,743 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:

Yes     x       No o

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

# Item 17 o  Item 18 x

1

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

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

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2

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|                                                                    |                                                         |   
|------------------------------------------------------------------- | ------------------------------------------------------- | --
|
|
|
|
|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                    | 6 
|                                                                    | RISK FACTORS RELATED TO OUR ORDINARY SHARES             | 15
|                                                                    | GENERAL RISKS                                           | 21
|                                                                   
|ITEM 4. INFORMATION ON THE COMPANY                                  | 23                                                     
|                                                                    | HISTORY AND DEVELOPMENT OF THE COMPANY                  | 23
|                                                                    | BUSINESS OVERVIEW                                       | 25
|                                                                    | ORGANIZATIONAL STRUCTURE                                | 45
|                                                                    | PROPERTY, PLANTS AND EQUIPMENT                          | 46
|                                                                   
|ITEM 5.  OPERATING AND FINANCIAL REVIEW AND PROSPECTS               | 46                                                     
|                                                                    | SELECTED FINANCIAL DATA                                 | 46
|                                                                    | OPERATING RESULTS                                       | 50
|                                                                    | LIQUIDITY AND CAPITAL RESOURCES                         | 55
|                                                                    | RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC     | 56
|                                                                    | TREND INFORMATION                                       | 58
|                                                                    | OFF-BALANCE SHEET ARRANGEMENTS                          | 59
|                                                                    | TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS           | 60
|                                                                   
|ITEM 6.  DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                 | 60                                                     
|                                                                    | DIRECTORS AND SENIOR MANAGEMENT                         | 60
|                                                                    | COMPENSATION                                            | 63
|                                                                    | BOARD OF DIRECTORS                                      | 64
|                                                                    | EMPLOYEES                                               | 66
|                                                                    | SHARE OWNERSHIP                                         | 67
|                                                                   
|ITEM 7.  MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS          | 69                                                     
|                                                                    | MAJOR SHAREHOLDERS                                      | 69
|                                                                    | RELATED PARTY TRANSACTIONS                              | 71
|                                                                   
|ITEM 8.  FINANCIAL INFORMATION                                      | 74                                                     
|                                                                    | CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION | 74
|                                                                    | SIGNIFICANT CHANGES                                     | 75
|                                                                   
|ITEM 9.  THE OFFER AND LISTING                                      | 75                                                     
|                                                                    | OFFER AND LISTING DETAILS                               | 75
|                                                                    | MARKETS                                                 | 75
|                                                                   
|ITEM 10. ADDITIONAL INFORMATION                                     | 77                                                     
|                                                                    | MEMORANDUM AND ARTICLES OF ASSOCIATION                  | 77
|                                                                    | MATERIAL CONTRACTS                                      | 83
|                                                                    | EXCHANGE CONTROLS                                       | 86
|                                                                    | TAXATION                                                | 86
|                                                                    | DOCUMENTS ON DISPLAY                                    | 95
|                                                                   
|ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 96                                                     
|                                                                    | INTEREST RATE RISK                                      | 96
|                                                                    | FOREIGN CURRENCY EXCHANGE                               | 97
|                                                                    | EQUITY PRICE RISK                                       | 80
|                                                                   
|ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES     | 97                                                     
|                                                                   
|                                                                   

3

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|                                                                        |                     |   
|----------------------------------------------------------------------- | ------------------- | --
|
|
|
|
|                                                                        |                     |   
|PART II                                                                
|                                                                       
|ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                | 97                 
|                                                                       
|ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS      
|                                                                        | AND USE OF PROCEEDS | 97
|                                                                       
|ITEM 15. CONTROLS AND PROCEDURES                                        | 97                 
|                                                                       
|ITEM 16. [RESERVED]                                                     | 98                 
|                                                                       
|ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT                              | 98                 
|                                                                       
|ITEM 16B. CODE OF ETHICS                                                | 98                 
|                                                                       
|ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES                        | 98                 
|                                                                       
|ITEM 16D. EXEMPTIONS FROM THE LISTING AND STANDARDS OF AUDIT COMMITTEES | 98                 
|                                                                       
|ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILLIATED 
|PURCHASERS                                                              | 98                 
|                                                                       
|                                                                       
|PART III                                                               
|                                                                       
|ITEM 17. FINANCIAL STATEMENTS                                           | 99                 
|                                                                       
|ITEM 18. FINANCIAL STATEMENTS                                           | 99                 
|                                                                       
|ITEM 19. EXHIBITS                                                       | 99                 

4

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# PART I.

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

Not Applicable.

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

Not Applicable.

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

A.
          The selected financial data is incorporated by reference to Item 5of
          this annual report.

B.
          Not Applicable

C.
          Not Applicable

D.
          Risk Factors

This annual report and statements
that we may make from time to time herein may contain forward-looking information. There
can be no assurance that actual results will not differ materially from our expectations,
statements or projections. Factors that could cause actual results to differ from our
expectations, statements or projections include the risks and uncertainties relating to
our business described below.

# RISK FACTORS

An
investment in the securities of Elbit Vision Systems Ltd., or EVS, is
speculative and involves a high degree of risk. Therefore, you should not invest in our
securities unless you are able to bear a loss of your entire investment. You should
carefully consider the following factors as well as the other information contained herein
before deciding to invest in our ordinary shares. Factors that could cause actual results
to differ from our expectations, statements or projections include the risks and
uncertainties relating to our business described below. This annual report and statements
that we may make from time to time herein may contain forward-looking information. There
can be no assurance that actual results will not differ materially from our expectations,
statements or projections. The information in this annual report is complete and accurate
as of this date, but the information may change after the date of this annual report.

The market prices of our
ordinary shares have been and may continue to be volatile.

The
market prices of our ordinary shares are subject to fluctuations. The following factors
may significantly impact on our ability to achieve expected operating results and growth
plan goals and/or affect the market price of our ordinary shares:

# Risks related to our
business:

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

5

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| |  | difficulty
of integrating and operating acquired businesses;
| | - | ------------------------------------------------------------

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

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

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

| |  | necessity
of expansion into new markets;
| | - | ----------------------------------------

| |  | pursuit
of business to acquire;
| | - | -------------------------------

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

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

| |  | dependence
on the worldwide textile industry;
| | - | ---------------------------------------------

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

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

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

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

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

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

| |  | reliance
on international sales;
| | - | --------------------------------

| |  | changes
in domestic and foreign regulation;
| | - | -------------------------------------------

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

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

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

# Risks related to our ordinary
shares:

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

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

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

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

| |  | difficulty
of accessing sufficient funding when needed;
| | - | -------------------------------------------------------

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

| |  | risks
associated with certain loan agreements;
| | - | ----------------------------------------------

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

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

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

# General Risks:

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

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

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

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

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

These
risk factors are discussed in further detail below:

# Risks Related to our
Business

We have a history of losses and may not be profitable in the future.        We
have not generated net income on an annual basis since 1997. We incurred net losses of
$1.68 million, $0.98 million and $ 5.9 million in 2002, 2003 and 2004,
respectively. As of December 31, 2004, we had an accumulated deficit of approximately
$24.4 million.

6

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

We
anticipate operating losses for at least the initial period of integration of Yuravision
and cannot estimate when we will achieve profitability.

ScanMaster
incurred net losses of $1.2 million in 2002, net profits of $0.12 million in 2003 and net
losses of $0.23 million in 2004.

We
believe that our current assets, together with anticipated cash generated from operations
and available credit lines, will be sufficient to meet our cash requirements for working
capital and capital expenditures for at least twelve months from June 30, 2005.
Thereafter, if cash generated from operations is insufficient to satisfy our liquidity
requirements, we may have to sell additional equity or debt securities or seek to obtain
additional credit facilities. Since we anticipate that the majority of our revenues will
be derived from the operations of ScanMaster, should ScanMaster fail to achieve
profitability, there is no certainty that we will have the financial resources to continue
our operations.

We
may not successfully integrate recently acquired businesses Yuravision and ScanMaster.

On
September 8th 2004, we completed the acquisition of ScanMaster. ScanMaster is a
company that develops, manufactures and markets ultrasonic inspection equipment for the
automotive, transportation and metal industries.

In
June 2004 we completed the second phase of acquisition of Yuravision, a South Korean
company, pursuant to which we increased our shareholding in Yuravision to 51.2% of its
issued share capital. We currently have legal obligation to purchase an additional 18.8%
from former shareholders of Yuravision. Yuravision specializes in the development of
automated vision inspection equipment for the microelectronics industry as well as flat
panel display and other industrial applications.

The
parallel process of integrating both the businesses of ScanMaster and Yuravision is risky
and may create unforeseen operating difficulties and expenses resulting from the diversion
of management time (both ours and those of our businesses) from the ongoing development of
our business in order to ensure the successful integration of new businesses in which we
have little previous experience. In addition, the integration of ScanMaster and Yuravision
requires implementation of controls, procedures and policies appropriate for a public
company.

In 2004 we began operation of two
further distinct divisions in addition to our Web Inspection Division: (a) Non-Destructive
Automated Inspection Systems Division consisting of ScanMasters non-destructive
inspection business; and (b) the Microelectronics Division consisting of our Bare Wafer
inspection activities and Yuravisions LCD inspection business. While we have
developed and commenced implementation of a comprehensive integration plan to integrate
Yuravision and ScanMaster, we have limited experience in managing this dual integration
process. Failure to integrate the operations of ScanMaster and Yuravision into our
business will have a material adverse affect on our financial condition and the
anticipated benefits of these acquisitions may not be realized. For further information,
see Item 4, Information on the Company  History and Development of the
Company and Item 10, Additional Information  Material
Contracts.

7

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We
may not successfully operate the business of ScanMaster.

ScanMaster
manufactures instruments, transducers and turnkey non-destructive inspection systems for a
wide range of industrial applications using ultrasonic technologies. ScanMaster has an installed base of more five hundred
field-proven systems and instruments, including equipment for such inspection applications
as composite material-based aircraft and aerospace structural elements, aircraft engine
turbine rings, automotive spot welds, train wheels and rails, as well as plates, bars,
tubes and pipes manufactured from steel, aluminum and titanium alloys.

Our
acquisition of ScanMaster presents the challenge of operating a business in a field in
which we have no previous experience. We also anticipate that a majority of our revenues
in the short-term will be derived from ScanMasters non-destructive inspection
business. Should we fail to operate the business in the manner required to sustain and
increase profitability, or should ScanMaster fail to continue developing or
commercializing its inspection systems as expected, we may not succeed in maintaining or
expanding ScanMasters current customer base or penetrating new industries requiring
non-destructive inspection applications that we currently believe are necessary for our
future profitability. Such a failure would have a material adverse effect on our future
operations and business.

ScanMaster
is heavily dependent upon certain worldwide industries.

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

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

8

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We
may not successfully complete the acquisition of Yuravision.

We
presently own a 51.2% of the issued shares of Yuravision which we acquired through direct
investment in Yuravision and a series of purchase agreements with Yuravisions
shareholders; we also have a legal obligation to purchase an additional 18.8% from former
shareholders of Yuravision. Our total investment in Yuravision, including advances, is
approximately $1.1 million. We will need to invest approximately an additional $0.3 million
in order to complete the purchase of the additional 18.8% of Yuravisions issued
share capital.

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 and display industry that we currently believe are necessary for our
future profitability.

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

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

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.

9

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

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

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

More
specifically, should we 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
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 2002, 2003 and 2004 one of our customers accounted for 9.5%, 17% and 18% of our net
sales respectively. In 2002, 2003 and 2004 one of its customers accounted for 15%, 14% and
11.5% of ScanMasters net sales respectively. While no other customer in any area of
business accounted for more than 10% of our net sales in any of 2002, 2003 and 2004, 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.

10

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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
still maintain a certain dependence on the worldwide textile industry.

While
we have implemented our strategic decision to diversify our product lines, a material
portion of our revenue will still be generated by our sales of automated visual inspection
devices and quality monitoring systems to textile manufacturers. 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.

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

The
marketing and sales cycle for our machine vision systems in all of the industries in which
our various products are sold, especially in recently penetrated markets and in new
applications, is lengthy, and can last as long as three years. Even in existing markets,
due to the $8,000 to $1,500,000 price range for our systems and possibly significant
ancillary costs required for a customer to install the system, the purchase of a machine
vision system can constitute a substantial capital investment for a customer (which may
need more than one machine for its particular proposed application), requiring lengthy
consideration and evaluation. In particular, the product must provide a potential customer
with a high degree of assurance that it will meet the customers needs, successfully
interface with the customers own manufacturing, production or processing system, and
have minimal warranty, safety and service problems. Accordingly, the time lag from
initiation of marketing efforts to final sales can be lengthy and expensive, and there is
no guaranty that the expenditure of significant time and resources will result in sales.

Competition
in the automated inspection industry is intense.

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

11

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

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

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

12

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

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

We
cannot guarantee market acceptance of our products.

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

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

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

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

Our
systems have been sold primarily in the United States, Europe and the FarEast . 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.

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

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

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

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

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

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

14

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We
may become involved in litigation.

From
time to time, we may be subject to various claims and lawsuits by competitors, customers,
or other parties arising in the ordinary course of business. Such matters can be
time-consuming, divert managements attention and resources, and cause us to incur
significant expenses. Furthermore, 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.

# Risks Related to Our
Ordinary Shares

We
may require additional financing.

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

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

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In addition, in March 2004, we
entered into a Standby Equity Distribution Agreement, or the Standby Equity Distribution
Agreement, with Cornell Capital Partners L.P., or Cornell, pursuant to which we are
entitled to issue Cornell with advance notices requiring it to purchase, six days
following each advance notice, a number of our ordinary shares as per our advance notice.
We registered a total of 5,555,555 of our ordinary shares for future issuance to Cornell
under the Standby Equity Distribution Agreement. Following a decrease in the price of our
shares, we are currently registering an additional 14,444,445 of our ordinary shares for
future issuances to Cornell under the Standby Equity Distribution Agreement. 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, including the
$4,000,000 advanced to us by Cornell to fund ScanMaster. In order to fund the acquisition
of ScanMaster, we signed a short-term promissory note with Cornell, where Cornell agreed
to advance us the sum of $4,000,000. In an agreement signed in February 2005 where we
amended the original terms of the promissory note, we agreed to repay the advance by 2006
in weekly cash installments, derived out of (1) our working capital; or (2) advances made
under the Standby Equity Distribution Agreement; (for more information on both
transactions with Cornell, see Item 10, Additional Information  Material
Contracts).

We
believe that our current assets, together with anticipated cash generated from operations
and available credit lines, will be sufficient to meet our cash requirements for working
capital and capital expenditures for at least twelve months from June 30, 2005.
Thereafter, if cash generated from operations is insufficient to satisfy our liquidity
requirements, we may sell additional equity or debt securities or seek to obtain
additional financing. We may not, however, be able to obtain additional financing on terms
satisfactory to us, if at all. In addition, given the existing potential for significant
dilution in light of the large number of outstanding convertible securities as well as the
large number of our ordinary shares we have recently registered or are currently
registering, our ability to complete additional debt or equity financing may be very
limited.

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

As
of June 2005, 26,648,953 of our shares were outstanding. In addition, 3,953,459 of our
shares are issuable upon the exercise of the warrants distributed to our shareholders
pursuant to the Warrant Distribution. Additionally, pursuant to the Private Placement
Investments, we issued the Investors warrants to purchase an aggregate of 1,844,094 of our
ordinary shares, of which warrants to purchase 1,602,380 shares remain outstanding as
follows:

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

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

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

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

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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. In 2004, we issued Mr. Nir Alon, our chairman of the board, options to purchase
600,000 ordinary shares, at an exercise price of $1.25 per share, vesting quarterly over a
period of two years. In addition, 4,347,788 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, as of June 15, 2005
have issued Cornell 1,018,385 ordinary shares under the Standby Equity Distribution
Agreement, and may issue Cornell a further currently unknown number of our ordinary
shares. We initially estimated issuing Cornell 5,555,555 of our ordinary shares pursuant
to the Standby Equity Distribution Agreement, but due to the fact that our share price has
decreased since we registered this amount, we are currently registering an additional
14,444,445 of our ordinary shares for future issuance to Cornell under the Standby Equity
Distribution Agreement. The re-sale of a large number of shares by Cornell may create
additional downward pressure on the price of our shares. Furthermore, as our share price
falls, we may need to issue an additional amount of our ordinary shares to Cornell. While
we estimate this amount of our shares to be sufficient in order to receive the remaining
$5,500,000available to us under the Standby Equity Distribution Agreement, we may
issue a lesser or greater number depending on the lowest volume weighted average per share
price of our shares over the five day period following each advance notice. In addition,
in consideration for the acquisition of ScanMaster we paid ScanMasters former
shareholders $3 million in cash and agreed to issue them 7,414,213 of our ordinary shares,
of which 3,707,106 were placed in escrow and will be released by 2007, upon the attainment
of certain milestones. Assuming the release of all of our ordinary shares from escrow,
ScanMasters former shareholders will own approximately 27.9% of our share capital.
In May 2005, ScanMasters former shareholders requested that we register these shares
and pursuant to our obligations to the shareholders we anticipate filing a registration
statement to cover these shares before the end of 2005. For more information on the
ScanMaster acquisition, see Item 10, Additional Information  Material
Contracts.

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

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

| | (b) | 3,953,459
ordinary shares underlying Warrant Distribution;
| | --- | ----------------------------------------------------------

| | (c) | 1,627,843
ordinary shares issuable to employees under 1996 , 2000 employee                option
plans;
| | --- | -------------------------------------------------------------------------------------------------------

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

| | (e) | 5,555,555
ordinary shares issued or to be issued to Cornell under Standby Equity
               Distribution Agreement.
| | --- | -----------------------------------------------------------------------------------------------------------------------

In
addition, we reserved to register or are currently registering the following securities for
resale:

| | (a) | 7,414,213
ordinary shares for ScanMasters former shareholders;
| | --- | ---------------------------------------------------------------

| | (b) | 14,444,445
ordinary shares for future issuance to Cornell under the Standby                Equity
Distribution Agreement; and
| | --- | -----------------------------------------------------------------------------------------------------------------------------

| | (c) | 2,422,837
ordinary shares issuable to employees under 2003 employee option plan.
| | --- | --------------------------------------------------------------------------------

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

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

As
of June 15, 2005, we have issued 1,018,385 ordinary shares to Cornell pursuant to the
Standby Equity Distribution Agreement (of which 148,438 ordinary shares were issued in
consideration for providing the Standby Equity Distribution Agreement and 869,947 ordinary
shares were issued pursuant to advance notices delivered under the Standby Equity
Distribution Agreement). We do not know how many additional ordinary shares will be issued
to Cornell over the next year pursuant to the Standby Equity Distribution Agreement. We
anticipate 20,000,000 shares to represent the maximum number of ordinary shares that we
may issue to Cornell. At our recent share price of $0.6, we would only need to issue to
Cornell 9,166,666 of our ordinary shares in order to draw down the remaining $5,500,000
available to us under the Standby Equity Distribution Agreement, which would represent
approximately 30.5% of our outstanding ordinary shares upon issuance (assuming the
exercise of all of our currently convertible securities into our ordinary shares).
However, our ability to cause Cornell to advance funds under the Standard Equity
Distribution Agreement is not subject to any minimum volume weighted average price of our
ordinary shares. The lower the price of our ordinary shares on the market at the time of
an advance, the more shares will be issued to Cornell and the greater dilution will be
caused to the interests of our shareholders.

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

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

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We
may not be able to access sufficient funds when needed under the Standby Equity
Distribution Agreement and the price of our ordinary shares will affect our ability to
draw down on the Standby Equity
Distribution Agreement.

Currently,
we are dependent upon external financing to fund our operations. Our financing needs are
provided, in large part, by our Standby Equity Distribution Agreement. The amount of each
advance under the Standby Equity Distribution Agreement is subject to a maximum amount
equal to $300,000 per week. Because of this maximum advance restriction, we may not be
able to access sufficient funds when needed.

In
addition, there is an inverse relationship between the price of our ordinary shares and
the number of ordinary shares which will be issued under the Standby Equity Distribution
Agreement. Based on our recent share price of $0.6, we would have to issue to Cornell
9,166,666 of our ordinary shares in order to draw down the remaining $5,500,000 available
to us under the Standby Equity Distribution Agreement. Our Articles of Association
currently authorize us to issue 60,000,000 shares and, as of June 15, 2005 we had
26,648,953shares issued and outstanding (assuming the exercise of all currently
convertible securities). In the event we desire to draw down any available amounts
remaining under the Standby Equity Distribution Agreement after we have issued all
14,444,445 shares being registered for resale by Cornell and all 5,555,555 ordinary shares
registered for resale, we will have to file a new registration statement to cover such
additional shares that we would issue for additional draw downs on the Standby Equity
Distribution Agreement, and we may have to call a meeting of our shareholders in order to
approve an increase in our authorized share capital. In the event we are unable to
generate a profit, it may be difficult for us to secure additional financing from external
sources other than our Standby Equity Distribution Agreement. Therefore, if we are unable
to draw down on our Standby Equity Distribution Agreement, we may be forced to curtail or
cease our business operations.

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

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

Failure
to Repay the Promissory Note could cause Cornell to Exercise its Guarantees

Should
we fail to repay all or any part of the promissory note and the accrued interest on it, by
December 31, 2006 Cornell may be entitled to foreclose on a significant part of our assets
and those of our subsidiaries EVS Inc and ScanMaster Ltd. A foreclosure on such assets, or
even part of them, would have a material adverse affect on our business and we may not be
able to continue our business as a going concern.

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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
2005 was 30,253 shares. The high and low bid price of our ordinary shares for the last two
years has been $2.05and $0.19, 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 are currently traded on the OTC Bulletin Board and may be difficult to
buy and sell.

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

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Our
results are affected by volatility in the securities markets.

Due
to the downturn in the world economy over recent years, the securities markets in
general have recently experienced increased volatility, which has particularly affected
the market prices of equity securities of many hi-tech companies, including companies that
have a significant presence in Israel. Although the volatility of these companies
securities has often been unrelated to their operating performance, they, and particularly
those in the fields of communications, software and internet, may experience difficulties
in raising additional financing required to effectively operate and grow their businesses.
Such failure and the volatility of the securities market in general, and in relation to
our shares in particular, may affect our ability to raise additional financing in the
future.

# General Risks

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

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

Conditions
in Israel may affect our operations.

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

A
significant increase in violence began in September 2000 and has continued with varying
levels of severity into 2005 and negotiations between Israel and Palestinian
representatives ceased for some time. Beginning in late September 2000 and until the first
months of 2005, there was a significant increase in hostilities and unrest as between
Israel, the Palestinian Authority and certain terrorist groups operating within the
Palestinian Authority. Since the beginning of 2005, negotiations between Israel and the
Palestinian Authority have been renewed and hostilities have diminished. While such
development has calmed the region and while previous hostilities did not have a material
adverse impact on our business, we cannot guarantee that hostilities will not be renewed
and have such an effect in the future. The political and security situation in Israel may
result in parties with whom we have contracts claiming that they are not obligated to
perform their commitments under those agreements pursuant to force majeure provisions. Any
hostilities involving Israel or the interruption or curtailment of trade between Israel
and its present trading partners could adversely affect our operations and could make it
more difficult for us to raise capital. Furthermore, many of our facilities are located in
Israel. Since we do not have a detailed disaster recovery plan that would allow us to
quickly resume business activity, we could experience serious disruptions if acts
associated with this conflict result in any serious damage to our facilities. Our business
interruption insurance may not adequately compensate us for losses that may occur and any
losses or damages incurred by us could have a material adverse effect on our business. Any
future armed conflicts or political instability in the region would likely negatively
affect business conditions and harm our results of operations.

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

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

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

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

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

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Israeli
courts might not enforce judgments rendered outside of Israel.

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

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

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

A.
          History and Development of the Company

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

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

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

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

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

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

23

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

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

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

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

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

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

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

In
June 2004, we completed an investment in Yuravision Co. Ltd. and a series of purchase
agreements with certain of its shareholders, increasing our holdings in Yuravision to
approximately 51.2%. We also have a legal obligation to purchase an additional 18.8% from
former shareholders of Yuravision. Yuravision is a South Korean developer of visual
inspection systems for the microelectronics and display industries. The acquisition of a
controlling stake in Yuravision is intended to facilitate our efforts to penetrate the
Flat Panel Display (FPD) and display technology markets. Though we anticipated we would be
increasing our interest in Yuravision to 100% during 2004, we are currently renegotiating
the terms of this transaction. See the discussion regarding the Yuravision Acquisition in
Item 3, Key Information  Risk Factors  Risk Factors Related to Our
Business and Item 10, Additional Information  Material
Contracts.

Our
legal and commercial name is Elbit Vision Systems Ltd. We were established in Israel on
September 2, 1992 and organized pursuant to the Israel Companies Ordinance, 1983, which
was replaced by the 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.

# Recent Developments

On December 26, 2004 Mr. Zami Aberman
ceased serving as our CEO and was replaced by Mr. Menashe Shohat. The terms of his
termination were in accordance with his Employment Agreement.

For other recent developments, the
discussions on the investments by Mr. Nir Alon and/or Altro, the Standby Equity
Distribution Agreement, the promissory note, the Private Placement Investments and the
acquisitions of Yuravision and ScanMaster 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.

24

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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

Having completed both acquisitions of
ScanMaster and Yuravision, in September 2004 we began operating as three distinct
divisions: (a) the NonDestructive Automated Inspection Systems Division consisting of
ScanMasters non-destructive inspection business; (b) the Web Inspection Industry
Division; and (c) the Microelectronics Division consisting of our Bare Wafer inspection
activities and Yuravisions LCD inspection business.

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

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

ScanMaster Systems (IRT) has made
more than 450 equipment installations in 25 countries, for a total 10-year sales volume
exceeding $55 million. Typical uses of ScanMaster equipment include the imaging and
assessment of defects in forged discs used in jet engines, detection of flaws in welded
pipe, periodic inspection of the integrity of train rail, evaluation of the integrity of
spot weld bonds in automobiles and detection of bonding defects in composite aerospace
structures.

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

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

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

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

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

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

25

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

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

# Applications

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

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

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

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

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

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

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

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

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

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

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

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

26

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# Product Overview

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

Instrumentation

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

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

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

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

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

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

Transducers

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

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

27

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C-Scan
Imaging Systems

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

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

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

| | DS-200i-
The DS-200i immersion ultrasonic inspection system is designed for the scanning of
oversize parts. It is a rugged, reliable system for multi shift operation in an
industrial environment. The high accuracy scanning mechanics have exceptional resolution
and repeatability on all the linear and angular axes allowing for scanning of complex
parts. The average net transfer price is $450,000.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | LS-500 The
LS-500 immersion ultrasonic inspection system is a modular design allowing for stretching
of the tank and scanner to fit the application. The average net transfer price is
$90,000.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

Pipe
and plate Inspection

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

28

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

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

Product
Inspection Systems

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

Train
Inspection Systems

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

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

| | SFB-100 High-Speed
Rail Inspection System. A fully integrated ultrasonic inspection car fitted with complete
mechanical hardware such as transducer sled and a sophisticated couplant provision
system. The system includes high volume digital data acquisition, imaging, process and
evaluation. Powerful software features include prediction of the inspected parts
degradation and defect propagation, generation of custom & standard reporting and
analysis. The average net transfer price is $1,200,000.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

Software

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

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

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

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

29

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

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

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

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

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

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

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

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

Low
end  transducers, gages, portable instruments

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

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

30

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

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

Instruments

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

Immersion and
squirter-based C-scan imaging systems

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

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

Production-line GO/NOGO
inspection systems

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

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

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

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

Ultrasonic inspection
equipment for steel mills

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

31

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

Train wheel and train
rail inspection

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

Two main companies provide rail
service inspection as well as equipment. Sperry of USA, Speno of Switzerland, Tokimec of
Japan acts in Japan only.

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

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

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

# II. Web Inspection
Industry Division

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

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

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

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

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

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

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

32

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

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

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

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

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

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

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

The EVS Solution for the
Web 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.

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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.

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.

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

Models

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 $250,000,
depending on the configuration.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Modules

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

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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 rollof web into
smaller rolls while optimizing the fabrics yield per class (A; B; C )
according to the users specifications. Our Cut Optimization software offers the
following benefits:

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

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

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

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

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

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

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

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

Accessories

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

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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.

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

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

Broken
Filaments Analyzer

The Broken Filaments Analyzer (or the
BFA) is a visual inspection system designed for the detection of broken filaments in glass
fabrics used for the electronic printed circuit board (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.

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The BFA utilizes proprietary
processing and software technology, cameras and lighting systems to inspect glass web in
real-time at speeds exceeding 120 meters per minute. The broken filaments detected by the
BFA are displayed on a monitor that shows the running map of the fabric in real time, and
are recorded for further analysis. The BFA produces a detailed report of each web roll,
showing the broken filaments distribution in the roll, its statistics and the
fabrics grading. The BFA is integrated with the I-TEX 100 system, which can be used
for the detection of other defects in glass fabrics, and with the Video Album to provide a
more comprehensive solution to the visual inspection and quality monitoring of glass
fabrics. The BFA can also be used for the detection of surface defects in other fabrics or
webs including airbags and technical fabrics. The list price for the BFA system is ranges
between $200,000 and $300,000.

Shade
Variation Analyzer

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

# The LOOM-TEX

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

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|b. | Sales
and Markets for Web Industry
|-- | ----------------------------------

Sales Network

We market our products through
in-house sales personnel in conjunction with independent sales representatives. As of
May 31, 2005, 5 in-house sales personnel and 19 independent sales representatives
marketed our products Our independent sales representatives provide essential pre-and-post
sales support for our products in their territories and account for a substantial
percentage of our sales worldwide. We believe that our sales representatives network will
enable us to introduce new products and to penetrate additional web manufacturers around
the world. We intend to further expand our international sales representatives network by
entering into relationships with additional sales representatives and forming joint
ventures in target markets.

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

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

I-TEX
Inspected Standard

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

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Relationships with
Leading Equipment Manufacturers

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

Sales by Principal
Markets and Activities

In 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.In 2004, approximately 26.3% of our consolidated sales were in the United States,
approximately 44.5% were in Europe, and approximately 29.2% were in the Far East.One customer accounted for 9.5%, 17% and 18% in each of the years 2002, 2003, and 2004
respectively. No other customers accounted for more than 10% of our net sales in any of
the years 2002, 2003, or 2004. Historically, our highest level of net sales has been in
the fourth quarter of each year. Nevertheless, we have experienced and may in the future
experience significant fluctuations in revenues and operating results from quarter to
quarter as a result of a number of factors, many of which are outside our control. For
more information, see Item 3, Key Information  Risk Factors  Risk
Factors Relating to Our Business  Fluctuations in the Market.

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

The principal manufacturing and
assembly of our basic systems are conducted by subcontractors. We perform logistics and
purchasing activities, integration and final testing in-house. In addition, we perform the
software installation and configuration, final hardware configuration, quality control and
any special system customization needed for a particular customer. Production is based
upon firm customer commitments and anticipated orders and is generally planned three to
six months in advance. We contract with third party subcontractors to perform the
manufacturing of our systems so that we can focus on design and product development
strengths and minimize fixed costs and capital expenditures. Our engineers work closely
with subcontractors to increase manufacturing yields, lower manufacturing costs and assure
quality. The spectrophotometer included in our products are manufactured by a single
source supplier. Some of the electronic components included in our product are
manufactured especially for us by exclusive suppliers. If any of these exclusive suppliers
stop manufacturing these components we will need to find alternative suppliers. Our
reliance on sole suppliers involves several risks, including a potential inability to
obtain adequate supplies of these components and reduced control over pricing and timely
delivery of these components. We believe that we maintain a sufficient inventory of these
components to meet our foreseeable needs. However, if our single source supplier ceases to
produce these components, we would have to transfer the manufacture of the components to
another supplier or suppliers. We estimate that such a transfer would take approximately
up to six months and could delay the production and supply of our products, which could
harm our results of operations.

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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.

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

Over the past few years there have
been several academic and commercial attempts to develop systems that will be competitive
with our I-TEX family of products. Most of those projects did not reach a commercial
stage. 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 technical fabric
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 technical fabric 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.

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

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

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

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

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|III. | The
Microelectronics Division
|---- | -----------------------------

# Bare Wafer Inspection
Acitvities

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

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.

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.

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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.

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

In 2003, we did not sell any of our
products designed for the microelectronics industry,. In 2004, we sold 2 systems to one of
our customers to be evaluated. As soon as we receive feedback from this evaluation, we
will consider future steps to be taken in this area.

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.

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

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.

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

We are not aware of any competition
in the field of wafer inspection for the microelectronic 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, Camtek Ltd 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.

44

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

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.

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

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

In addition, we receive certain tax
benefits and reduced tax rates from the government of Israel. See Item 10,
Additional Information  Effective Corporate Tax Rate. The
entitlement to these benefits is conditional upon our fulfillment of the conditions
stipulated by the law, regulations 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.

# 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, as well as acquired the business of ScanMaster (IRT) Ltd and IRT
ScanMaster Systems Inc.. For more information on both transactions, see Item 4,
Information on the Company  History and Development of the Companyand Item 10, Additional Information  Material Contracts.

45

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# 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 5,000 square feet at our facilities in Israel, at an annual rent of
approximately $100,000. Our lease expires on January 31, 2006. EVS US leases approximately
1,500 square feet office space in Greenville, South Carolina, at an annual rent of
approximately $30,000.

ScanMaster Ltd.s facilities are
located in Hod Hasharon, Israel. ScanMaster Ltd. leases approximately 6,000 square feet,
at an annual rent of $250,000. ScanMaster Ltd.s lease expires on March 2006.
ScanMaster Inc.s facilities are located in Nashua, New Hampshire. ScanMaster
Inc.s leases approximately 1,780 square feet, at an annual rent of $21,000.
ScanMaster Inc.s lease expires on January 2008.

Yuravisions facilities are
located in Suwon-si, Kyeonggi-do, South Korea. Yuravision leases approximately 4,120
square feet, at an annual rent of $50,000. Yuravisions lease expires on April, 2006.

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 Consolidated selected
financial data for the years ended December 31, 2002, 2001 and 2000, 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 the years
2000 and 2001, was a member of the firm Arthur Andersen, independent public accountants.
In 2002, Luboshitz Kasierer became a member firm of Ernst & Young International,
independent public accountants. The selected financial data for the year ended December
31, 2003 and 2004 is derived from the 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.

46

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|                                                  | 2004 | 2003 | 2002 | 2001   | 2000
|------------------------------------------------- | ---- | ---- | ---- | ------ | ----
|
|
|
|
|(in U.S. thousand Dollars )                       |      |      |      |        |     
|Statement of Operations Data:                     |      |     
|Net sales (1)                                     |      |      |      | 10,960 |     
|Cost of sales                                     |      |      |      | 8,542  |     
|Gross profit (loss)                               |      |      |      | 2,418  |     
|Research and development expenses, net            |      |      |      | 2,456  |     
|Marketing and selling expenses, net               |      |      |      | 3,527  |     
|General and administrative expenses               |      |      |      | 2,153  |     
|Total operating expenses                          |      |      |      | 8,136  |     
|Operating loss                                    |      |      |      | (5,718 | )   
|Other income                                      |      |      |      | 116    |     
|Financing income (expenses), net                  |      |      |      | (297   | )   
|loss before taxes                                 |      |      |      | (5,899 | )   
|Taxes on income                                   |      |      |      | 6      |     
|Net loss from continuing operations               |      |      |      | (5,905 | )   
|Cumulative effect of change in accounting         |      |     
|principle, net (1)                                |      |      |      |       |     
|Net loss                                          |      |      |      | (5,905 | )   
|Basic earnings per share, net loss                |      |      |      | (0.32  | )   
|Cumulative effect of change in accounting         |      |     
|principle, net                                    |      |      |      |       |     
|Net Income (loss) per share (2)                   |      |      |      | (0.32  | )   
|Weighted average number of shares outstanding (2) |      |      |      | 18,724 |     

|                     | 2004 | 2003 | 2002 | 2001    | 2000
|-------------------- | ---- | ---- | ---- | ------- | ----
|
|
|
|
|Balance Sheet Data:  |      |      |      |         |     
|Working capital      |      |      | $    | (4,819  | )   
|Total assets         |      |      |      | 19,453  |     
|                     |      |     
|Total liabilities    |      |      |      | 17,307  |     
|Accumulated deficit  |      |      |      | (24,454 | )   
|Shareholders' equity |      |      |      | 2,146   |     

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

# 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.

47

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

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

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

# Critical Accounting
Policies

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

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

a. Revenue recognition

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

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

48

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b.
          Acceptance clause, customers support service and warranty

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

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

The Company

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

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

ScanMaster

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

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

ScanMaster distinguishes between
sales of new products, in respect of which it has no past installation experience and
sales of products, the installation of which it is highly experienced. In respect of sales
of new products ScanMaster recognizes revenues only after the company receives the ATP
from the customer. In respect of sales of other products, the installation of which the
company is well experienced, the ATP is only a formal procedure, and therefore, the
installation of products is a sufficient requirement to recognize revenues.

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

49

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c.
          Right of return

Neither we, nor our subsidiaries,
provide, in the normal course of business, a right of return to our customers. If
uncertainties exist, such as the granting of a right of cancellation to the customer,
revenue is recognized when the uncertainties are resolved.

d. Emerging Issues Task
Force (EITF) Issue 00-21, Revenue Arrangements with MultipleDeliverables

EITF 00-21 addresses the
accounting, by a vendor, for contractual arrangements in which multiple revenue-generating
activities will be performed by the vendor. It is effective prospectively for all
arrangements entered into in fiscal periods beginning after June 15, 2003. EITF Issue
00-21 addresses when and, if so, how an arrangement involving multiple deliverables should
be divided into separate units of accounting. Our adoption of EITF Issue 00-21 in the year
ended December 31, 2003 has had no significant impact on its financial position or results
of operations to date.

e.
          EITF 99-19  Recording Revenue Gross as Principal
          versus Net as an Agent

Revenue from third-party sales is
recorded according to the criteria established in EITF 99-19, and Staff Accounting
Bulletin (SAB) 104. Revenue is recorded at gross amount for transactions in which we and
our subsidiaries are the primary obligor under the arrangement and/or possess other
attributes such as pricing and supplier selection latitude. In specific circumstances
where we do not meet the above criteria, particularly when the contract stipulates that we
are not the primary obligor, we recognize revenue on a net basis.

# Services Rendered

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

# A. Operating Results

# I. Financial Data

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

|                                       | 2004 | 2003 | 2002 | 2001  | 2000
|-------------------------------------- | ---- | ---- | ---- | ----- | ----
|
|
|
|
|Net sales                              |      |      |      | 100.0 |     
|Cost of sales                          |      |      |      | 77.9  |     
|Gross profit                           |      |      |      | 22.1  |     
|                                       |      |     
|                                       |      |     
|Research and development expenses, net |      |      |      | 22.4  |     
|Marketing and selling expenses, net    |      |      |      | 32.2  |     
|General and administrative expenses    |      |      |      | 19.6  |     
|Total operating expenses               |      |      |      | 74.2  |     
|Operating loss                         |      |      |      | (52.2 | )   
|Other expenses                         |      |      |      | 1.1   |     
|Financing income(expenses), net        |      |      |      | (2.7  | )   
|Loss before taxes                      |      |      |      | (53.8 | )   
|Income taxes                           |      |      |      | 0.05  |     
|Net (loss)                             |      |      |      | (53.9 | )   

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

# Sales

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

# Cost of Revenues

Cost of revenues consists of
component costs, hardware costs, technical support costs, royalty payments, compensation
costs and overheads related to the production and assembly of our products. Cost of sales
as a percentage of net sales was 77.9% in 2004 compared with 59.2% in 2003.The increase in
cost of revenues in 2004 is mainly due to provision in respect of slow inventory and costs
incurred in year 2004, relating to an efficiency program; in addition, profitability
percentage in 2004 was affected by the sale of ScanMasters and Yuravisions
inventories, for which the accounting principles applied through the acquisition
of these subsidiaries recorded the cost of revenues when realized at the fair market value
of those inventories.

# Gross Profit

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

# Research and Development
Costs

Our research and development expenses
consist of our total costs less grants from the Government of Israel. Gross research and
development expenditures consist primarily of salaries and related costs of employees
engaged in ongoing research and development, and, to a lesser extent, costs of materials,
depreciation and other expenditures. Gross research and development expenditures increased
to $2.6 million in 2004 from $1.8 million in 2003, and were offset by Israeli government
grants of $0.16 million in 2004 and $0.4 million in 2003. Net research and development
expenses in 2004 were $2.4 million compared with $1.4 million in 2003. The increase in the
gross research and development expenses was mainly for consolidating the expenses of our
two subsidiaries we acquired during 2004.

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# Sales and Marketing
Expenses

Gross marketing and sales
expenditures consist primarily of costs relating to promotion, advertising and trade
shows, payroll and related expenses, sales commissions, travel expenses. Marketing and
selling expenses amounted to $3.5 million in 2004, compared to $1.6 million in 2003. The
increase in the marketing and sales expenses was primarily due to expenses we had
penetrating the new markets, NDT and microelectronics and for consolidating our
subsidiaries expenses.

# General and
Administrative Expenses

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

# Financial Income

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

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

# Loss

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

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.

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# 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.

# 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.

53

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# 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.

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

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

The exchange rate between NIS and the
U.S. Dollar has fluctuated during the past twelve months from a high of NIS 4.634 to the
Dollar to a low of NIS 4.299 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:

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|LOW 1 U.S. Dollar = | HIGH 1 U.S. Dollar = | MONTH        
|------------------- | -------------------- | -------------
|4.308               | 4.374                | December 2004
|4.308               | 4.414                | January 2005 
|4.357               | 4.392                | February 2005
|4.299               | 4.379                | March 2005   
|4.360               | 4.395                | April 2005   
|4.348               | 4.416                | May 2005     

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

|Exchange Rate | Period                             
|------------- | -----------------------------------
|4.067 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
|4.4823 NIS/$1 | January 1, 2004 - December 31, 2004

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 of inflation was
approximately 6.5% and the rate of devaluation was 7.26%. In 2003, the rate on inflation
was approximately -1.9% and the Dollar devalued against the NIS by 7.55%. In 2004, the
rate of inflation of approximately 1.21% and the Dollar revalued against the NIS by
approximately 1.61%. 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 2004, 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 2001 to 2000, see page 32 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, 2004,
we had negative working capital of $4.8 million.

55

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We anticipate that we will continue
to incur significant operating expenses in connection with the development and marketing
of our products. We believe that our current assets, together with anticipated cash
generated from operations and available credit lines, will be sufficient to meet our cash
requirements for working capital and capital expenditures for at least twelve months from
June 30, 2005. Thereafter, if cash generated from operations is insufficient to satisfy
our liquidity requirements, we may sell additional equity or debt securities or seek to
obtain additional credit facilities.

Investments

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, , Standby Equity Distribution Agreement and promissory note 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 and ScanMaster acquisitions are hereby incorporated by reference to Item 4,
Information on the Company  History and Development of the Companyand Item 10, Additional Information  Material Contracts.

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

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

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| | For
our developments in the Web Inspection Industry Division we have devised 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
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
our developments in the Microelectronics Industry Division we have already applied for
patents for hazing and wax inspection technologies. 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
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
our developments in the NonDestructive Automated Inspection Systems Division we are
expanding our capabilities by developing multi transducers of automatic calibration,
different process algorithms and a scanner capable of inspecting in 2.5 dimensions.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As of May, 2005, our research and
development staff working on products for the web 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 web industry, especially for the development of the
technical fabrics product, engages in hardware and electro-optics development, real-time
software development, PC software development, manufacturing engineering, system
engineering and customer support engineering. In 2002 our gross research and development
expenditures for the web industry were approximately1.2 million, in 2003 they were $1.1
million and in 2004 they were $1.9 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 $150,000, $396,000 and $45,000in each of 2002, 2003,
and 2004 respectively.

As of May 31, 2005, 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 2004, our gross research and
development expenditures for the microelectronic industry were approximately $0.4 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 in the amount of
approximately $115,000. We expect to continue to commit substantial resources to research
and development in the future.

In 2004, our gross research and
development expenditures for the ultrasonic testing industry were approximately $0.25
million

# Research and Development
Grants

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.

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

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

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

|(in thousands)                              | 2004 | 2003 | 2002 | 2001  | 2000
|------------------------------------------- | ---- | ---- | ---- | ----- | ----
|
|
|
|
|Research and development expenses, net      |      |      | $    | 2,456 |     
|OCS grants                                  |      |      |      | 160   |     
|Gross research and development expenditures |      |      |      | 2,616 |     

ScanMaster has not received any OCS
grants for over six years. ScanMaster has put in a request for 2005 and will in all
likelihood receive approximately $200,000 for its research and development in the rail
inspection.

# D. Trend Information

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

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

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

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In addition, 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, out of which we will continue to market only the
Mounting Wax 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.

# E. Off-Balance Sheet
Arrangements

The Standby Equity
Distribution Agreement

On March 30, 2004, we entered into
the Standby Equity Distribution Agreement with Cornell. Upon execution of the Standby
Equity Distribution Agreement, we issued Cornell with 148,438 of our ordinary shares.
Pursuant to this agreement we will be entitled to issue Cornell with advance notices
requiring it to purchase, six days following each advance notice, a number of our ordinary
shares with a value of up to $300,000 per advance put notice and up to an aggregate value
of $10 million over two years. The price per share payable by Cornell will be determined
by the minimum volume weighted average price of our ordinary shares during the five day
period following our advance notice to Cornell to purchase our ordinary shares. Cornell
will deduct 5% from the price payable for our ordinary shares as a fee for this service.
In addition to the 148,438 ordinary shares, we also transferred Cornell, out of the
5,555,555 ordinary shares held in escrow pursuant to the promissory note, a further
869,947 ordinary shares, for which we received proceeds in the amount of $433,000 which we
used to repay part of the promissory note . We initially registered 5,555,555 of our
ordinary shares for future issuance to Cornell, based upon a good faith estimate that this
would represent the maximum number of shares that we would be required to issue pursuant
to advances under the Equity Distribution Agreement. However, due to the fact that our
share price on the Nasdaq over-the-counter bulletin board decreased following our
registration of these shares, we are currently registering an additional 14,444,445 of our
ordinary shares for future issuance to Cornell, which together with the 5,555,555 ordinary
shares registered, represents the maximum number of our ordinary shares that we currently
anticipate issuing to Cornell pursuant to advances under the Standby Equity Distribution
Agreement. We may issue all, part or a greater number of our ordinary shares to Cornell,
depending on the minimum volume weighted average price of our ordinary shares over the
five day period following each advance notice. We will also issue Cornell a number of our
ordinary shares with a value of $150,000, upon the first to occur of (i) our receipt of an
aggregate of $5,000,000 pursuant to the equity line and (ii) the first advance notice to
be made following the first anniversary of the Standby Equity Distribution Agreement. The
number of our ordinary shares which we will issue to Cornell in this event will be based
on the closing price of our ordinary shares on the public market on the date on which
Cornell purchases our shares under (i) or (ii), whichever is applicable. Pursuant to the
Standby Equity Distribution Agreement, Cornell will never be entitled to hold more than
9.9% of our outstanding share capital, and consequently, Cornell has agreed that in the
event that a future purchase pursuant to an advance notice to Cornell would take it above
this threshold percentage, it will sell, prior to the purchase, as many of our ordinary
shares as is required to ensure that at the time of the purchase of our ordinary shares,
its holdings in our company remain below the threshold percentage.

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

Our significant financial and
contractual obligations as of December 31, 2004, and the periods in which such
obligations are due are as follows:

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

G.  Safe Harbor.   Not Applicable

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

# A. Directors and Senior
Management

As of May 31, 2005, our directors,
senior managers and key employees are as follows:

|Name           | Age | Position                                             
|-------------- | --- | -----------------------------------------------------
|
|
|
|
|Nir Alon       | 42  | Chairman of the Board                                
|Menashe Shohat | 46  | Chief Executive Officer                              
|Yaky Yanay*    | 34  | Vice president, Chief Financial Officer and Secretary
|Yoav Kahane*   | 32  | Vice President of Sales & Marketing                  
|Ilan Laver*    | 61  | Vice President of Electronic Inspection Division     
|Jossef Barath  | 54  | Director                                             
|Yuval Berman*  | 37  | External Director                                    
|Zahi Dekel*    | 42  | External Director                                    
|Shlomo Alon    | 66  | Director                                             
|Naomi Livne*   | 59  | Director                                             
|Michel Haviv   | 38  | Director                                             
|Avner Shacham  | 52  | Director                                             
|Robert Dalfen  | 44  | Director and CFO of ScanMaster                       

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

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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.

Menashe Shohatwas appointed our chief executive officer on December 27, 2004, following the
successful completion of the acquisition of ScanMaster. Mr. Shohat has spent over ten
years with ScanMaster, serving first as ScanMasters chief operating officer and as
ScanMasters chief executive officer from 2002 to 2004.

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.

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Jossef (Yossi)
Barathis 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.

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

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

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.

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Michel Haviv was
elected director by our board of directors on March 27, 2005. Michel Haviv has served as
Elrons Business Development Manager since 2003. Prior to Elron, he founded Matar
Capital Advisors, a financial advisory firm. In 2001 Mr. Haviv established and managed the
investment banking activity of ING Barings in Israel. Mr. Haviv is a former partner of MBI
Partners investment bank, and served as Vice President of Investment Banking at Cukierman
& Co. Investment House. During the 90s Mr. Haviv was a diplomat in Israels
foreign service, where he served as Economic Consul in Boston, and earlier as the first
Commercial Attache in Korea. As Captain (Res.) in the IDF Navy, Mr. Haviv was involved in
the development of advanced Naval systems for the Navys elite unit. Mr. Haviv holds
an Aeronautical Engineering degree from the Technion-Israel Institute of Technology.

Avner Shachambegan serving as a consultant to ScanMaster in January 2002. Mr. Shacham
was elected director by our board of directors in 2004. Since 1992, Mr. Shacham has held
the position of president and chief executive officer of Bet Shemesh Engines. Mr. Shacham
holds a Bachelor of Science degree, a Masters of Science degree as well as a degree
in Industrial Management from the Technion-Israel Institute of Technology.

Robert Dalfen
has served as chief financial officer of ScanMaster since August 1998. Mr. Dalfen has over
20 years of business experience having previously held the positions of controller and
special projects supervisor. Mr. Dalfen holds a Bachelor of Commerce and a Chartered
Accountant degree from Canada. Prior to Mr. Dalfens joining ScanMaster, Mr. Dalfen
provided accounting and management consulting services as an independent advisor.

Board of Directors Our chairman of the board of
directors, Mr. Nir Alon, is the son of one of our directors Mr. Shlomo Alon. Our
directors, who are not external directors, commence their term when they are elected at
the annual general meeting of our shareholders until the following annual general meeting.
In 2004, Mr. Tzvi Piran resigned as External Director and was replaced by Mr. Yuval
Berman, who was appointed for a period of three years at the annual general meeting of our
shareholders in August 2004.Mr. Zahi Dekel replaced Mr. Israel Gal as director in
March 2004.

# B. Compensation

During 2004, we paid to all our
directors and officers a total of $82 thousands in salaries, fees and bonuses. This does
not include money spent on automobiles made available to our officers, expenses (including
business travel, professional and business association dues and expenses) reimbursed to
officers and other fringe benefits commonly reimbursed or paid by companies in Israel.

Our directors Messrs. Shlomo Alon and
Michel Haviv and Mrs. Naomi Livne received no compensation in 2004. Mr. Meir Amit resigned
as an external director in December 2003 and was replaced by Mr. Zahi 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. Mr. Tzvi Piran resigned as an external
director in August 2004 and was replaced by Mr. Yuval Berman at our Annual General Meeting
of Shareholders in August 2004. At this meeting, it was decided Mr. Nir Alon, the chairman
of the board, shall be issued options to purchase 600,000 ordinary shares, at an exercise
price of $1.25 per share vesting quarterly over a period of two years. We paid
approximately $4,400 in aggregate to Mr. Barath in 2004. We paid an aggregate of $14,400
to our serving external directors in 2004.

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Pension and Retirement
BenefitsWe offered no pension or retirement
benefits to our directors and key personnel in 2004.

# 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. The Israeli
Companies Law-1999 which entered into effect on February 1, 2000 and was amended most
recently in March 2005, requires the board of directors of a public company to determine
the number of directors who shall possess accounting and financial expertise. This
requirement is subject to, and will only enter into effect upon, the promulgation of
regulations by the Israeli Minister of Justice which have not yet been published. The
board of directors must make such determination by no later than 90 days following
publication of such regulations. 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. For further information on
the appointment of directors, please see Item 7, Major Shareholders and Related
Party Transactions  Voting and Right of First Refusal Agreements.


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

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

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

| | an
employment relationship;
|- | ---------------------------

| | a
business or professional relationship maintained on a regular basis;
|- | ----------------------------------------------------------------------

| | control;
and
|- | ------------

| | service
as an office holder.
|- | ----------------------------

A person shall be qualified to serve
as an outside director only if he or she possesses accounting and financial expertise or
professional qualifications. At least one outside director must posses accounting and
financial expertise. The conditions and criteria for possessing accounting and financial
expertise or professional qualifications are to be determined by the Israeli Minister of
Justice in consultation with the Israeli Securities Authority and have not yet been
published. No person may serve as an external director if the persons position or
other business activities create, or may create, a conflict of interest with the
persons responsibilities as an external director or may otherwise interfere with the
persons ability to serve as an external director. If, at the time external directors
are to be appointed, all current members of the board of directors are of the same gender,
then at least one external director must be of the other gender.

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

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

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

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

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

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

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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 Berman serve on the audit committee of the board of directors.

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

# D. Employees

# 2004

As of May, 31, 2005 we employed a total of 132 full time persons
in all three of our divisions , as
follows:

# NonDestructive
Automated Inspection Systems Division

As of May 31, 2005, we employed 71
full-time persons, out of which 66 were employed in Israel of whom 19 were in research and
development, 8 were in marketing and sales, 6 were in customer support, 33 were in
operations and 5 were in administration and management.

# Web Inspection Industry
Division

As of May 31, 2005, we employed 47
full-time persons, out of which 38 were employed in Israel of whom 13 were in research and
development, 7 were in marketing and sales, 9 were in customer support, 10 were in
operations and 8 were in administration and management.

# Microelectronics Division

As of May 31, 2005, we employed 14
full-time persons. All 14 were employed in Korea, of whom 8 were in research and
development, 2 were in marketing and sales, 1 were in customer support and 3 were in
administration and management.

# 2003

In 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).

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We believe that our success will
depend, in large part, on our ability to attract and retain highly-skilled engineering,
managerial and sales and marketing personnel. Competition for such personnel is intense.

Certain provisions of the collective
bargaining agreements between the Histadrut (General Federation of Labor in Israel) and
the Coordination Bureau of Economic Organizations (including the Industrialists
Associations) are applicable to our employees by order of the Israeli Ministry of Labor.
These provisions concern principally the length of the workday, minimum daily wages for
professional workers, insurance for work-related accidents, procedures for dismissing
employees, determination of severance pay, and other conditions of employment. We
generally provide our employees with benefits and working conditions beyond the required
minimums.

Israeli law generally requires
severance pay, which may be funded by Managers Insurance described below, upon the
retirement or death of an employee or termination of employment without cause (as defined
in the law). These payments amount to approximately 8.33% of wages. Furthermore, Israeli
employees and employers are required to pay predetermined sums to the National Insurance
Institute, which is similar to the United States Social Security Administration. Such
amounts also include payments for national health insurance. The payments to the National
Insurances Institute are equal to approximately 14.5% of the wages (up to a specified
amount), of which the employee contributes approximately 66% and the employer contributes
approximately 34%.

Although not legally required, we
contribute funds on behalf of most of our employees to a fund known as
Managers Insurance. This fund provides a combination of savings plan,
insurance and severance pay benefits to the employee, giving the employee a lump sum
payment upon retirement and securing the severance pay, if legally entitled, upon
termination of employment. We decide whether each employee is entitled to participate in
the plan, and each employee who agrees to participate contributes an amount equal to 5% of
a salary and the employer contributes between 13.3% and 15.8% of a salary.

# E. Share Ownership

Of the persons listed above under the
caption Directors, Senior Management and Employees, Messrs. Nir Alon, Shlomo
Alon and Menashe Shohat beneficially own shares and options exceeding 1% of our
outstanding ordinary shares since Mr. Nir Alon is the controlling shareholder of Altro,
our majority shareholder, Mr. Shlomo Alon is his father and Mr. Shohat serves as our CEO.
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 currently represented by Mr.
Michel Haviv on our board of directors.

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Employee Share Option
Plans

We maintain the following share
option plans for our employees and the employees of our subsidiaries. In addition to the
discussion below, see Note 10 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, 2005,
options to purchase187,280 of such ordinary shares were outstanding and options to
purchase 322,690 ordinary shares were available for future grants. Of the outstanding
options, options to purchase 82,780, 102,500 and 2,000 ordinary shares are fully vested
and are exercisable at an exercise price of $3.00, $1.68 and $0.2 per share, respectively.
All of the outstanding options terminate ten years following the date of grant if not
exercised earlier or terminated by reason of termination of employment.

The 1996 Share Option Plan is
administered by a committee of the board of directors, which designates the optionees and
dates of grant. The option exercise price is determined by our board of directors. All
recent grants have been made at an exercise price equal or above to the fair market value
of our shares. The options are non-assignable except by the laws of succession. The last
date on which the options may be granted 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.

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, 2005, options to purchase 1,428,370 of such ordinary shares
were outstanding and options to purchase 2,655,582 ordinary shares were available for
future grants. 523,639 of the outstanding options have an exercise price of $1.169 per
share. All of the options referred to above vested equally on the anniversary of May 24
from 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. 281,750 of the options referred to above vested equally on January 21, 2002,
January 21, 2003 and January 21, 2004, assuming continuous employment with us through such
periods.312,600 of the outstanding options have an exercise price of $0.48 per
share. 227,000 of the options referred to above vested equally on the anniversary of March
18 from 2003 until 2005 and the remaining 54,750 will vest on 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 or
above the fair market value of our shares. The options are non-assignable except by the
laws of descent. The last date on which the options may be granted is April 2010. The
remaining options will be exercisable for a period up to ten years from the date of grant
and will generally vest as to 25-33% commencing the beginning of the second year after the
grant and as to an additional 25-33% in each of the remaining years thereafter, assuming
continuous employment with us through such periods.

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In November 2003, the board of
directors adopted a share option plan pursuant to which 2,000,000 ordinary shares were
reserved for issuance upon the exercise of options to be granted to our directors,
officers, employees and consultants. The number of ordinary shares issuable under the
share option plan is annually increased by 1,500,000 ordinary shares. As of May 31, 2005,
options to purchase 2,652,000 of such ordinary shares were outstanding and options to
purchase 2,338,000 ordinary shares were available for future grants. 757,500 of the
outstanding options have an exercise price of $1.25 per share. 44,000 of the outstanding
options have an exercise price of $1 per share. 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. 477,000 of the outstanding options have an exercise price of
$0.8 per share. 595,000 of the outstanding options have an exercise price of $0.75 per
share. 266,000 of the outstanding options have an exercise price of $0.68 per share and an
additional 258,500 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 or above the
fair market value of our shares. The options are non-assignable except by the laws of
descent. The last date on which the options may be granted is November 2013. The
remaining options will be exercisable for a period up to ten years from the date of grant
and will generally vest as to 25-33% commencing the beginning of the second year after the
grant and as to an additional 25-33% in each of the remaining years thereafter, assuming
continuous employment with us through such periods.

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

# A. Major Shareholders

The following table and notes set
forth information, as of May 31, 2005, concerning the beneficial ownership (as defined in
Rule 13d-3 under the Securities Exchange Act of 1934) of ordinary shares by (i) any person
who is known to own at least 5% of our outstanding ordinary shares and (ii) our directors
and officers as a group. The voting rights of our major shareholders do not differ from
the voting rights of holders of all of our ordinary shares.

|Identity of Person or Group                                       | Amount Beneficially Owned | Percent of Class
|----------------------------------------------------------------- | ------------------------- | ----------------
|Altro Warenhandels GmbH (1)(2)(3)(4)(5)(6)                        | 3,500,000                 | 12.1%           
|Nir Alon Holdings GmbH(7)                                         | 2,375,000                 | 8.2%            
|Elbit Ltd.(8)Advanced Technology Center
P.O. Box 539Haifa, Israel | 4,160,438                 | 14.4%           
|ScanMaster Former Shareholders (3)                                | 5,695,464                 | 19.7%           
|All directors and officers as a group (9)                         | 16,041,520                | 55.6%           

The percentages in this table are
based on 28,847,434 of ordinary shares currently issued and outstanding and options
exercisable within 60 days.

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|(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,                controlled by Mr. Nir Alon and a company controlled by members of
the Alon                family.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | In
an agreement signed among Nir Alon Holding GmbH, Altro, Nir Alon, Elbit Ltd.,
               and ScanMasters former shareholders, dated September 8, 2004, or the
               Amendment, which amended the original terms of the Shareholders Agreement
               entered into among Elbit Ltd., Altro and Nir Alon, dated March 21, 2001,
the                parties to the Amendment agreed to vote their shares, at meetings of
our                shareholders at which members of the board are to be elected, as
follows: (a)                elect to our board three directors nominated by Nir Alon
Holding GmbH or Altro                (including the appointment of Nir Alon as chairman
of the board); (b) elect to                our board one director designated by Elbit
(for as long as Elbit holds 5% of our                outstanding share capital); (c)
elect to our board two directors designated by                ScanMasters former
shareholders; and (d) Elbit and Nir Alon Holding GmbH                agreed to vote their
shares so as to elect Yossi Barath as a member of the board                for as long as
he is entitled to be appointed director pursuant to our 1993                Formation
Agreement.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|(7) | Since
Mr. Nir Alon controls Altro, Mr. Nir Alon may be deemed the beneficial
               owner of all of the shares held by Altro and Nir Alon Holdings GmbH. In
2004, we                issued Mr. Nir Alon, our chairman of the board, options to
purchase 600,000                ordinary shares, at an exercise price of $1.25 per share,
vesting quarterly over                a period of two years.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|(9) | Includes
all of the shares deemed as beneficially owned by Mr. Nir Alon and                options
currently exercisable by directors and officers within 60 days.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

As of May 31, 2005, there were a
total of 66 holders of record of our ordinary shares, of which 24 were registered in the
United States. Such United States shareholders were, as of such date, the holders of
record of approximately 23.5% of our outstanding ordinary shares.

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# 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 an agreement signed among Nir Alon
Holding GmbH, Altro, Nir Alon, Elbit Ltd., and ScanMasters former shareholders,
dated September 8, 2004, or the Amendment, which amended the original terms of the
Shareholders Agreement entered into among Elbit Ltd., Altro and Nir Alon, dated March 21,
2001, the parties to the Amendment agreed to vote their shares, at meetings of our
shareholders at which members of the board are to be elected, as follows:

| | (a) | elect
to our board three directors nominated by Nir Alon Holding GmbH or Altro
               (including the appointment of Nir Alon as chairman of the board);
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | elect
to our board one director designated by Elbit (for as long as Elbit holds
               5% of our outstanding share capital);
| | --- | ------------------------------------------------------------------------------------------------------------------------------------

| | (c) | elect
to our board two directors designated by ScanMasters former
               shareholders; and
| | --- | ---------------------------------------------------------------------------------------------------

| | (d) | Elbit
and Nir Alon Holding GmbH agreed to vote their shares so as to elect Yossi
               Barath as a member of the board for as long as he is entitled to be
appointed                director pursuant to the Formation Agreement.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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.

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

Plan of Arrangement and
Warrant Distribution

Our audit committee and board of
directors approved the Plan of Arrangement with Altro that was approved by a special
majority of out shareholders in October 2003, and subsequently by the Haifa District Court
in November 2003, whereby Altros prior commitments to invest were cancelled subject
to Altros fulfillment of new investment terms and a warrant distribution to our
shareholders. According to the Plan of Arrangement, Altro was required to invest $700,000
in EVS for the purchase of 2 million of our ordinary shares, payable in up to five
quarterly installments. Altro assigned its rights and obligations under the Plan of
Arrangement to Nir Alon Holding GmbH, a company wholly owned by Nir Alon. Nir Alon
Holdings GmbH completed payment of all the installments and was issued with 2,000,000 of
our ordinary shares, which amounts to approximately 7.5% of our share capital. Pursuant to
the Plan of Arrangement, on May 14, 2004, or the Record Date, we distributed to most of
our shareholders warrants to purchase 4,183,950 of our ordinary shares on a pro rata basis
(or the Warrant Distribution). Each warrant is exercisable at a price of $0.35 per share
and exercisable for four years from the date of registration thereof. The warrants were
distributed to all persons who are the registered holders of our ordinary shares on the
Record Date (Record Holders), with the exception of certain shareholders. The shareholders
which agreed to be excluded from the Warrant Distribution are as follows: Altro, our
controlling shareholder, Cornell, Newbridge and those investors which participated in our
December 2003 and January 2004 Private Placement Investments (other than Meitav Capital
(2002) Ltd., with respect to 241,714 of our ordinary shares which it holds having
exercised, prior to the Record Date, a warrant that it received for its financial services
in connection with such investments). As of June 15, 2005, of the warrants distributed
under the Plan of Arrangement, 185,061 warrants have been exercised.

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As of June 15, 2005,
through the companies he controls, Nir Alon owned 20.6% of our outstanding ordinary shares
and Elbit owned 9.9 % of our outstanding ordinary shares. However, in the event that all
the warrants distributed to our shareholders are exercised pursuant to the Plan of
Arrangement, Altro and Nir Alon will beneficially hold 17.9% of our outstanding ordinary
shares.

Relationships with Elbit

We maintain a number of material
relationships with Elbit.

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

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

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.

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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 2004, 95.8% of our sales,
amounting to $10,497,000 were exported outside of Israel.

# Litigation

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

Lemelson
Patent Infringement Claim

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

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

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.

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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.

# Dividend Distributions

We have never paid any cash dividends
on our ordinary shares and we do not intend to pay cash dividends on our ordinary shares
in the foreseeable future. Our current policy is to retain earnings for reinvestment in
our business.

In the event that we decide to pay a
cash dividend from income that is tax exempt under our approved enterprise status, we
would be liable for corporate tax on the amount distributed at the rate of up to 25%.
Income not derived from an approved enterprise in 2004 is taxable at regular rates of 35%.
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, the promissory note and the
ScanMaster acquisition, 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

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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:

|Period                  | High ($) | Low ($)
|----------------------- | -------- | -------
|May 2005                | 0.70     | 0.60   
|April 2005              | 0.71     | 0.47   
|March 2005              | 0.61     | 0.42   
|February 2005           | 0.58     | 0.44   
|January 2005            | 0.64     | 0.46   
|December 2004           | 0.68     | 0.37   
|First quarter 2005      | 0.64     | 0.42   
|Fourth quarter 2004     | 0.68     | 0.37   
|Third quarter 2004      | 1.01     | 0.56   
|Second quarter 2004     | 1.40     | 0.69   
|First quarter 2004 (5)  | 1.65     | 0.86   
|Fourth quarter 2003 (4) | 1.86     | 0.28   
|Third quarter 2003 (3)  | 0.47     | 0.2    
|Second quarter 2003 (3) | 0.29     | 0.2    
|First quarter 2003 (3)  | 0.23     | 0.08   
|Year ended 2004 (5)     | 1.65     | .0.37  
|Year ended 2003 (4)     | 1.86     | 0.11   
|Year ended 2002 (3)     | 0.77     | 0.10   
|Year ended 2001 (2)     | 0.88     | 0.23   
|Year ended 2000 (1)     | 3.56     | 0.12   

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

B.
          Plan of Distribution.  Not Applicable

D.
          Selling Shareholders.  Not Applicable

E.
          Dilution.   Not Applicable

F.
          Expenses of the Issue.  Not Applicable

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

# Memorandum and Articles
of Association

A.
          Share Capital.  Not Applicable

# B. Memorandum Articles
of Association

In February 2000, the Companys
Ordinance (New Version)-1983 was replaced by the new Companies Law 1999 and was
amended most recently in March 2005. 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.

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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.

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

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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.

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:

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| | 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 actively
participate in the voting process, or, alternatively, the total shareholdings of the
disinterested shareholders who vote against the transaction must not represent more than
one percent of the voting rights in the company.

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

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

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

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

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

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

In addition, under the Companies Law
 1999, certain transactions or a series of transactions are considered to be one
private placement. Any placement of securities that does not fit the above description may
be issued at the discretion of the board of directors.

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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.

Provisions Restricting
Change in Control of Our Company

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

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

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Merger.
          The Companies Law permits merger transactions if approved by each partys
          board of directors and the majority of each partys shares voted on the
          proposed merger at a shareholders meeting called on at least 21 days
          prior notice. Under the Companies Law, merger transactions may be approved by
          holders of a simple majority of our shares present, in person or by proxy, at a
          general meeting and voting on the transaction. In determining whether the
          required majority has approved the merger, if shares of a company are held by
          the other party to the merger, or by any person holding at least 25% of the
          outstanding voting shares or 25% of the means of appointing directors of the
          other party to the merger, then a vote against the merger by holders of the
          majority of the shares present and voting, excluding shares held by the other
          party or by such person, or anyone acting on behalf of either of them, is
          sufficient to reject the merger transaction. If the transaction would have been
          approved but for the exclusion of the votes of certain shareholders as provided
          above, a court may still approve the merger upon the request of holders of at
          least 25% of the voting rights of a company, if the court holds that the merger
          is fair and reasonable, taking into account the value of the parties to the
          merger and the consideration offered to the shareholders. Upon the request of a
          creditor of either party to the proposed merger, the court may delay or prevent
          the merger if it concludes that there exists a reasonable concern that, as a
          result of the merger, the surviving company will be unable to satisfy the
          obligations of any of the parties to the merger. In addition, a merger may not
          be executed unless at least 30 days have passed from the receipt of the
          shareholders approval and 50 days have passed from the time that a
          proposal for approval of the merger has been filed with the Israeli Registrar of
          Companies. See also Item 6A. Directors, Senior Management And Employees
           Directors And Senior Management  Approval of Related Party
          Transactions Under Israeli Law.

Nasdaq Marketplace Rules
and Home Country Practices

In accordance with Israeli law and
practice and subject to the exemption set forth in Rule 4350(a)(1) of the NASD Marketplace
Rules, we follow the provisions of the Israeli Companies Law  1999, rather than the
requirements of Rule 4350 of the Market Place Rules with respect to the following
requirements:

| |  | Distribution
of annual and quarterly reports to shareholders  Under Israeli law we are not
required to distribute annual and quarterly reports directly to shareholders and the
generally accepted business practice in Israel is not to distribute such reports to
shareholders. We do however make our audited financial statements available to our
shareholders prior to our annual general meeting and file our quarterly and annual
financial results with the Securities Exchange Commission on Form 6-K.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Quorum
 Under Israeli law a company is entitled to determine in its articles of
association the number of shareholders and percentage of holdings required for a quorum
at a shareholders meeting. Our Articles of Association provide that a quorum of two or
more shareholders holding at least 33.3% of the voting rights in person or by proxy is
required for commencement of business at a general meeting. However, the quorum set forth
in our Articles of Association with respect to an adjourned meeting, consists of two or
more shareholders in person or by proxy.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Approval
of Related Party Transactions  All related party transactions are approved in
accordance with the requirements and procedures for approval of interested party acts and
transactions, set forth in sections 268 to 275 of the Israeli Companies Law-1999, and the
Regulations promulgated thereunder.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Shareholder
Approval  We seek shareholder approval for all corporate action requiring such
approval, in accordance with the requirements of the Israeli Companies Law  1999.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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# C. Material Contracts

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

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

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

Yuravision Acquisition. In
June 2004, we completed an investment in Yuravision Co. Ltd. and a series of purchase
agreements with certain of its shareholders, increasing our holdings in Yuravision to
approximately 51.2%. We have a legal obligation to purchase an additional 18.8% from former
share holders of Yuravision. Yuravision is a South Korean developer of visual inspection
systems for the microelectronics and display industries. The acquisition of a controlling
stake in Yuravision is intended to facilitate our efforts to penetrate the Flat Panel
Display (FPD) and display technology markets. Though we initially intended to increase our
interest in Yuravision to 100% we are currently renegotiating the terms of this
transaction. For more information, see Item 3, Key Information  Risk
Factors  Risk Factors Related to Our Business and Item 4,
Information on the Company  History and Development of the Company.

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Standby
Equity Distribution Agreement. On March 30, 2004, we entered into the Standby Equity
Distribution Agreement with Cornell. Upon execution of the Standby Equity Distribution
Agreement, we issued Cornell with 148,438 of our ordinary shares. Pursuant to this
agreement we are entitled to issue Cornell with advance notices requiring it to purchase,
six days following each advance notice, a number of our ordinary shares with a value of up
to $300,000 per advance put notice and up to an aggregate value of $10,000,000 over two
years. The price per share payable by Cornell will be determined by the minimum volume
weighted average price of our ordinary shares during the five day period following our
advance notice to Cornell to purchase our ordinary shares. Cornell will deduct 5% from the
price payable for our ordinary shares as a fee for this service. In addition to the
148,438 ordinary shares, we also transferred Cornell, out of the 5,555,555 ordinary shares
held in escrow pursuant to the promissory note, a further 869,947 ordinary shares, for
which we received proceeds in the amount of $433,000 which were used to repay part of the
promissory note . We initially registered 5,555,555 of our ordinary shares for future
issuance to Cornell (excluding 148,438 ordinary shares which we issued to Cornell as a
commitment fee), based upon a good faith estimate that this would represent the maximum
number of shares that we would be required to issue pursuant to advances under the Equity
Distribution Agreement. However, due to the fact that our share price on the Nasdaq
over-the-counter bulletin board decreased following our registration of these shares, we
are currently registering an additional 14,444,445 of our ordinary shares for future
issuance to Cornell, which together with the 5,555,555 ordinary shares registered,
represents the maximum number of our ordinary shares that we currently anticipate issuing
to Cornell pursuant to advances under the Standby Equity Distribution Agreement.

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

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

Promissory
Note.On August 26, 2004, we signed a short-term promissory note with Cornell Capital
Partners L.P. whereby Cornell agreed to advance us the sum of $4,000,000, which was used
to fund the acquisition of ScanMaster. This amount plus interest thereon is repayable by
no later than December 31, 2006 or immediately following an event of default, as described
below .

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We
paid to Cornell Capital Partners, L.P. a commitment fee of five per cent (5%) of the
principal amount of the promissory note which was set-off against the first $200,000
payable by us to Cornell Capital Partners, L.P. and a further $15,000 and $25,000 to
Butler Gonzalez LLP and Yorkville Advisors Management LLC, respectively. The proceeds of
the advance from Cornell were used in order to acquire ScanMaster and fund other
acquisition-related expenses.

The
promissory note will become immediately due and payable upon the occurrence of any of the
following events of default: (i) failure to pay the amount of any principal or interest
when due under the promissory note; (ii) any proceedings under the United States
Bankruptcy Code or under any insolvency, reorganization, receivership, readjustment of
debt, dissolution, liquidation or any similar law or statute of any jurisdiction is filed
by or against us for all or any part of our property; and (iii) failure to perform any of
our obligations pursuant to the note and any other ancillary agreement with Cornell.

As
security for repayment of the advance, we: (i) granted Cornell a second ranking floating
charge on all of our assets (to the extent permitted under Israeli law) and on the assets
of ScanMaster; (ii) issued to the Trustee 5,555,555 of our registered ordinary shares, out
of which 869,947 ordinary shares have been released to Cornell for resale, pursuant to the
delivery of 9 advance notices under the promissory note; and (iii) issued to the Trustee
an additional 2,500,000 of our restricted ordinary shares, all of which have since been
released to Yigal Arnon & co. Trust Company, as our nominee. We are currently
registering an additional 14,444,445 of our ordinary shares for issuance to Cornell
pursuant to the Standby Equity Distribution Agreement.

According
to an agreement entered into between our company and Cornell in May 2005, pursuant to
which we amended the original terms of the promissory note, we will repay the advance in
monthly installments, out of our working capital. In addition, we may also repay the note
out of the proceeds received under the Standby Equity Distribution Agreement. To date, we
have repaid $233,000 of the promissory note, out of working capital. For further
information, see Item 3, Key Information  Risk Factors  Risk Factors
Relating to our Ordinary Shares.

ScanMaster Acquisition.On
September 8, 2004 we purchased all of the outstanding securities of ScanMaster Systems
(IRT) Ltd., an Israeli company, and IRT ScanMaster Systms Inc., a New Hampshire
corporation, or ScanMaster. In consideration for all the securities of ScanMaster we
agreed to issue ScanMasters shareholders with 7,414,213 of our ordinary shares and
pay them up to $3 million in cash of which $2,700,000 was paid directly to them and an
additional $300,000 was placed in escrow until March 1, 2005 to guarantee projected
revenues of at least $3,686,400 for ScanMaster for the period from September 1, 2004 until
December 31, 2004. The cash consideration was released from escrow on March 27, 2005 to
ScanMasters shareholders. All of the shares which we agreed to issue to
ScanMasters shareholders were placed in escrow as follows: (i) an aggregate of
3,707,107 ordinary shares were placed in escrow until receipt of a tax ruling from the
Israeli tax authorities relating to the deferment of capital gains tax due on our ordinary
shares which were issued to the shareholders of ScanMaster as part of the consideration
for the acquisition, until their sale by the shareholders; (ii) 1,718,749 ordinary shares
were placed in escrow until March 15, 2007 as a guarantee for certain representations and
undertakings of some of ScanMasters former shareholders; and (iii) an aggregate of
1,988,357 ordinary shares was released from escrow on May 9, 2005 upon meeting a projected
revenues of $6,148,000 for ScanMaster for the period from September 1, 2004 until March
31, 2005.

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The funds for the acquisition were
drawn from our equity line with Cornell Capital.

Assuming the release of all of our ordinary
shares from escrow, ScanMasters former shareholders own approximately 27.9% of our
share capital, and our shareholder equity will exceed to $4.7 million.

# 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

Israeli companies are subject to
corporate tax at the rate of 35% of taxable income in the 2004 tax year, 34% in the 2005
tax year, 32% in the 2006 tax year and 30% in the 2007 tax year. However, the effective
tax rate payable by a company which derives income from an Approved Enterprise (as further
discussed below) may be considerably less.

Law for the Encouragement
of Capital Investments, 1959

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

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

Tax Benefits Prior to the
Amendment

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

A company which qualifies as a
Foreign Investors Company is entitled to an extended benefit period and
further reductions in the tax rate normally applicable to Approved Enterprises. Subject to
certain conditions, a Foreign Investors Company is a company 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, as defined in the Investment Law, 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 as detailed below:

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|Level of Foreign Investment   | Company Tax Rate | Benefit period (years)
|----------------------------- | ---------------- | ----------------------
|
|
|
|
|Over 0% but less than 25%     | 25%              | 7                     
|Over 25% but less than 49%    | 25%              | 10                    
|49% or more but less than 74% | 20%              | 10                    
|74% or more but less than 90% | 15%              | 10                    
|90% or more                   | 10%              | 10                    

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

Prior to the Amendment, a company
owning an Approved Enterprise approved after April 1, 1986 (or prior thereto provided no
government grants or loans had previously been granted regarding such enterprise) was
entitled to elect (as we have) to forego certain Government grants extended to Approved
Enterprises in return for an alternative route of tax benefits (the
Alternative Route). Under the Alternative Route, a companys
undistributed income derived from an Approved Enterprise is exempt from corporate tax for
a period of between two and ten years from the first year of taxable income, depending on
the geographic location of the Approved Enterprise within Israel, and such company is
eligible for the reduced tax rates under the Investment Law for the remainder of the
benefit period as mentioned above.

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

Should we derive income from sources
other than the Approved Enterprise during the relevant periods of benefits, such income
will be taxable at regular corporate tax rates (36%).

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

Subject to certain provisions
concerning income subject to the Alternative Route, all dividends are considered to be
attributable to the entire enterprise and the effective tax rate is the result of a
weighted combination of the various applicable tax rates.

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

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

# Tax Benefits under the
Amendment

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

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

The tax benefits available under the
Amendment to qualifying income of a Benefited Enterprise are determined by the geographic
location of the Benefited Enterprise in Israel. The Investment Law divides the country
into three zones  A, B and C, so that a Benefited Enterprise operating in Zone A
(which generally includes areas remote from the center of Israel) will receive the
greatest benefits and Benefited Enterprises in Zone C will receive the least benefits.

The Amendment provides that a company
producing income from a Benefited Enterprise in Zone A may elect either that (i) the
undistributed income derived from the Benefited Enterprise will be fully tax exempt for
the entire benefit period described below (tax exemption), in which case the
ordinary provisions described below concerning the taxation of the company and shareholder
for distribution of dividends will apply; or (ii) that the income from its Benefited
Enterprise will be subject to corporate tax at a rate of a 11.5%, in which case dividends
paid out of such income to a foreign resident will be taxed at a rate of 4% and the
company will not be subject to additional tax upon dividend distribution. Further benefits
are available in the event of certain large investments by multinational companies.
Benefited Enterprises located in Zones B and C will be exempt from tax for six and two
years, respectively, and subject to tax at a rate of 10%-25% for the remainder of the
benefit period, depending on the extent of foreign investment in the Company, as described
above.

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Dividends paid out of income derived
by a Benefited Enterprise, or out of dividends received from a company whose income is
derived from a Benefited Enterprise, are generally subject to withholding tax at the rate
of 15%, such tax being deductible at source. The reduced withholding tax rate of 15% is
limited to dividends and distributions out of income derived during the benefit period and
actually paid at any time up to 12 years thereafter. A company qualifying for tax benefits
under the Amendment which pays a dividend out of income derived by its Benefited
Enterprise during the tax exemption period will be subject to corporate tax in respect of
the gross amount of the dividend. The rate of such corporate tax will be 25%, which is the
rate to which a Benefited Enterprise is generally subject. Such tax rate is lower in the
case of a qualified Foreign Investors Company which is a company at
least 49% of which is owned by non-Israeli residents. The dividend recipient is subject to
tax at the rate of 15% on the amount received which tax is deductible at source.

The period for which tax benefits are
available under the Amendment is also determined by the geographical location of the
Benefited Enterprise in Israel. The benefit period for Benefited Enterprises in Zone A
will end on the earlier of (i) a period of ten years from the tax year in which the
company first derived taxable income from the Benefited Enterprise (the Commencement
Year); or (ii) twelve years (or in certain cases fourteen years) from the first day
of the Year of Election. The benefit period for Benefited Enterprises in Zones B and C
will extend until the earlier of (i) seven years from the Commencement Year or (ii) 12
years from the first day of the Year of Election. This period may be extended for
Benefited Enterprises owned by a Foreign Investors Company during all or
part of the benefit period.

Additionally, the Amendment sets
forth a minimal amount of foreign investment required for a company to be regarded a
Foreign Investors Company.

There can be no assurance that we
will attain approval for additional tax benefits under the Amendment, or receive approval
for Approved Enterprises in the future.

Law for the Encouragement
of Industrial Research and Development, 1984

Under the Law for the Encouragement
of Industrial Research and Development (the Research Law), research and
development programs approved by the Research Committee (the Research
Committee) of the Office of the Chief Scientist (OCS) 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 and subject to other
restrictions. Once a project is approved, the OCS will award grants of up to 50% of the
projects expenditures in return for royalties, usually at the rate of 3% to 5% of
sales of products developed with such grants, up to a dollar-linked amount equal to 100%
or 150% of such grants. For projects approved after January 1, 1999, the amount of
royalties payable is up to a dollar-linked amount equal to 100% of such grants plus
interest at LIBOR. There is no further liability for payment.

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The terms of these grants prohibit
the manufacture outside of Israel without the prior consent of the Research Committee of
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.

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.
Until recently, the Research Law stated that such know-how may not be transferred to
non-Israeli third parties at all. A recent amendment to the Research Law has set forth
certain exceptions to this rule, however, the practical implications of such exceptions
are quite limited. 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 final products developed with such technologies.
Approval of the transfer may be granted only if the transferee undertakes to abide 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 such consent, if requested, will be granted or, if granted, that
such consent will be on reasonable commercial terms.

Tax Benefits and Grants
for Research and Development

Israeli tax law allows, under certain
conditions, a tax deduction in the year incurred for expenditures (including capital
expenditures) in scientific research and development projects, if the expenditures are
approved by the relevant Israeli Government Ministry (determined by the field of research)
and the research and development is for the promotion of the enterprise and is carried out
by or on behalf of the company seeking such deduction. Such expenditures not so approved
are deductible over a three-year period.

Law for the Encouragement
of Industry (Taxes), 1969

Under the Law for the Encouragement
of Industry (Taxes), 1969 (the Industry Encouragement Law), Industrial
Companies (as defined below) are entitled to the following tax benefits:

(a)       
          Amortization of purchases of know-how and patents over eight years for tax
          purposes.

(b)       
          The right to elect, under specified conditions, to file a consolidated tax
          return with other related Israeli Industrial Companies.

(c)       
          Amortization of expenses incurred in connection with certain public securities
          issuances over a three-year period.

(d)       
          Tax exemption for shareholders who held shares before a public offering on
          capital gains derived from the sale (as defined by law) of securities, if
          realized after more than five years from the public issuance of additional
          securities of the company. (As of November 1994, this exemption was repealed,
          however, it applies to some of our shareholders pursuant to a grand-fathering
          clause; the recent tax reform repealed the grandfathered exemption for any gains
          accrued from January 1, 2003.)

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(e)       
          Accelerated depreciation rates on equipment and buildings.

Eligibility for benefits under the
Industry Encouragement Law is not subject to receipt of prior approval from any
governmental authority. Under the Industry Encouragement Law, an Industrial
Company is defined as a company resident in Israel, at least 90% of the income of
which, in any tax year, determined in Israeli currency, exclusive of income from
government loans, capital gains, interest and dividends, is derived from an
Industrial Enterprise owned by it. An Industrial Enterprise is
defined as an enterprise whose major activity in a given tax year is industrial production
activity.

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

Taxation under
Inflationary Conditions

The Income Tax Law (Inflationary
Adjustments), 1985 (the Inflationary Adjustments Law) represents an attempt to
overcome the problems presented to a traditional tax system by an economy undergoing rapid
inflation. The Inflationary Adjustments Law is characterized by a high degree of
complexity and its salient features can be described generally as follows:

(a)A
special tax adjustment for the preservation of equity whereby certain corporate assets are
classified broadly into Fixed (inflation resistant) Assets and Non-Fixed (non-inflation
resistant) Assets. Where a corporations equity, as defined in such law, exceeds the
depreciated cost of Fixed Assets, a tax deduction which takes into account the effect of
the annual inflationary change on such excess is allowed (up to a ceiling of 70% of
taxable income in any single tax year, with the unused portion permitted to be carried
forward on a linked basis). If the depreciated cost of Fixed Assets exceeds a
corporations equity, then such excess multiplied by the annual inflation rate is
added to taxable income.

(b)
          Depreciation deductions on Fixed Assets and losses carried forward are adjusted
          for inflation based on the increase in the Israeli Consumer Price Index.

(c)
          Gains from the sale of certain traded securities are fully taxable
          notwithstanding the exemptions or reduced tax rates which might otherwise apply
          to those securities.

Capital Gains Tax on
Sales of Our Ordinary Shares

Until the end of the year 2002 and
provided we maintained our status as an industrial corporation, capital gains from the
sale of our securities were generally exempt from Israeli Capital Gains Tax. This
exemption did not apply to a shareholder whose taxable income is determined pursuant to
the Israeli Income Tax Law (Inflationary Adjustments) 1985, or to a person whose gains
from selling or otherwise disposing of our securities were deemed to be business income.

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

In
any event, under the US-Israel Tax Treaty, a US treaty resident may in general only be
liable to Israeli capital gains tax on the sale of our ordinary shares (subject to the
provisions of Israeli domestic law as described above) if that US treaty resident holds
10% or more of the voting power in our company.

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.

Effective Corporate Tax
Rate

Our effective tax rate in Israel was
0% in each of the years 2002, 2003 and 2004 (the regular rate of corporate tax being 35%
in 2004).

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

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

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

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

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

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

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

In 2005, we received from the
Investment Center the instrument of approval for its fourth approved enterprise.

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

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

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

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

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

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

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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.

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.

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# 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, 2004,
consisted primarily of demand deposits. A material change in yields of the securities in
which we invest, and in our liquidity requirements before the maturity of our investments,
may have an effect on our financial results and cash flow. However, due to the nature of
our cash and cash equivalents and short-term investments, we have concluded that we do not
have material market risk exposure.

Interest Rate Risk on Liabilities.As of December 31, 2004 we had liabilities in the amount of $5.2 million. Market risk
was estimated as the potential increase in fair value of our liabilities resulting from a
hypothetical 10% increase in the year-end interest rate of our liabilities. Assuming such
increase in the interest rates, the fair value of our cash and cash equivalents would
decrease by approximately $23thousands. The increase in interest rates in
2004 did not result in any material change to our liabilities. As of December 31, 2004 we
had accounts payable in the amount of $9 millions. Our accounts receivable are held in
foreign currencies and are not linked to any interest rates. Consequently, the decrease in
interest rates in 2004 did not result in any change to our accounts payable. As of
December 31, 2004 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.

96

---

---

As of December 31, 2004 we had a
credit facility in NIS, consequently we had no market risk resulting from any increase in
the year-end NIS/Dollar and the Euro/Dollar exchange rate.

As of December 31, 2004, we had
accounts payable in New Israeli Shekels (NIS) or in funds linked thereto in the amount of
$1.9 million. Market risk was estimated as the potential increase in fair value resulting
from a hypothetical 10% decrease in the year-end NIS/Dollar and the Euro/Dollar exchange
rate. Assuming such decrease in the NIS/Dollar and the Euro/Dollar exchange rate, the fair
value of our accounts payable would increase by $211,000.

# Equity Price Risk

As of December 31, 2004, 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]
|-------- |  | ----------

97

---

---

|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 |  | Principal
Accountant Fees and Services
|-------- |  | --------------------------------------

|The
following table presents fees for professional audit services rendered by Price
Waterhouse Coopers and Ernst & Young for the audit of our consolidated annual financial statements for the
year ended December 31, 2003 and 2004.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                   | 2004
$000 | Percentage | 2003
$000 | Percentage
|------------------ | --------- | ---------- | --------- | ----------
|
|
|
|
|Audit Fees(1)      |           |            |           | 119       
|Audit-Related Fees |           |            |           | 28        
|Tax Fees(2)        |           |            |           | -         
|All Other Fees(3)  |           |            |           | 25        
|Total              |           |            |           | 172       

| | (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
|-------- |  | -------------------------------------------------------------

|As
a foreign private issuer we remain exempt, until July 31, 2005, from NASDAQ audit
committee related listing standards that have come into effect following December 13,
1999.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|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 RelatedParty Transactions.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

98

---

---

# PART III

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

| | Not
applicable.
| | ---------------

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

| | See
pages F-1 to F-45.
| | ----------------------

|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 |  | 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 dated 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 |  | Shareholders
Agreement dated March 18, 2001 between Elbit Ltd., Altro          Warenhandels GmbH and
Nir Alon(3)
|--- |  | ----------------------------------------------------------------------------------------------------------------

|4.6 |  | Amendment
to the Shareholders Agreement dated September 8, 2004, among  Elbit Ltd., Altro
         Warenhandels GmbH, Nir Alon, Nir Alon Holding GmbH, M.S. Master Investments
(2002) Ltd.,          S.R. Master Investments (2002) Ltd., RD Master Investments (2002)
Ltd. and Avner Shachman          (*)
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.7 |  | Amendment
to the Share Purchase Agreement of February 7, 2001, among Elbit Vision Systems
         Ltd., Nir Alon and Altro Warenhandels GmbH, dated March 18, 2002(4)
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.8 |  | Share
Purchase Agreement dated March 18, 2002, between Elbit Vision Systems Ltd. and Altro
         Warenhandels GmbH(4)
|--- |  | ------------------------------------------------------------------------------------------------------------------------

|4.9 |  | Form
of Warrant Agreement and Warrant Certificate issued to Shareholders pursuant to the
         Warrant Distribution(6)
|--- |  | -------------------------------------------------------------------------------------------------------------------------

99

---

---

|4.10 |  | Share
Purchase Agreement dated April 2004, between Elbit Vision Systems Ltd. and STIC Angel
         Investment Partnership No. IV(5)
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------

|4.11 |  | Share
Purchase Agreement dated May 18, 2004, between Elbit Vision Systems Ltd. and
         Yuravision Co. Ltd.(5)
|---- |  | ------------------------------------------------------------------------------------------------------------------

|4.12 |  | Share
Purchase Agreement dated April 2004, between Elbit Vision Systems Ltd. and Kuen Yu
         Liu(5)
|---- |  | --------------------------------------------------------------------------------------------------------

|4.13 |  | Share
Purchase Agreement dated May 18, 2004, between Elbit Vision Systems Ltd. and
         Professor Whoi Yul Kim and Hoe Choon Kim(5)
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------

|4.14 |  | Standby
Equity Distribution Agreement, dated March 30, 2004, between Cornell Capital
         Partners LLP and Elbit Vision Systems Ltd.(6)
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------

|4.15 |  | Placement
Agent Agreement, dated March 30, 2004, between Cornell Capital Partners LLP,
         Newbridge Securities Corporation and Elbit Vision Systems Ltd.(6)
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.16 |  | Registration
Rights Agreement, dated March 30, 2004 between Cornell Capital Partners LLP          and
Elbit Vision Systems Ltd. (7)
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------

|4.17 |  | Amendment
to the Standby Equity Distribution Agreement, dated March 30, 2004, between
         Cornell Capital Partners LLP and Elbit Vision Systems Ltd., dated June 24, 2005.
(7)
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.18 |  | Investment
Agreement, dated August 26, between Cornell Capital Partners LLP and Elbit
         Vision Systems Ltd.(7)
|---- |  | ---------------------------------------------------------------------------------------------------------------------

|4.19 |  | Promissory
Note dated August 26, between Cornell Capital Partners LLP and Elbit Vision
         Systems Ltd. (7)
|---- |  | ----------------------------------------------------------------------------------------------------------------

|4.20 |  | Security
Agreement dated August 26, between Cornell Capital Partners LLP and Elbit Vision
         Systems Ltd. (7)
|---- |  | -------------------------------------------------------------------------------------------------------------------

|4.21 |  | Security
Agreement dated August 26, between Cornell Capital Partners LLP and EVS Inc. (7)
|---- |  | -----------------------------------------------------------------------------------------

|4.22 |  | Pledge
and Escrow Agreement dated August 26, between Cornell Capital Partners LLP and
         Elbit Vision Systems Ltd. (7)
|---- |  | ----------------------------------------------------------------------------------------------------------------------------

|4.23 |  | Share
Purchase Agreement dated August 6, 2004, by and among Elbit Vision Systems Ltd.,
         ScanMaster Systems (IRT) Ltd., and IRT ScanMaster Systems Inc.(*)
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.24 |  | Amendment
to Share Purchase Agreement dated September 1, 2004, by and among Elbit Vision
         Systems Ltd., ScanMaster Systems (IRT) Ltd., and IRT ScanMaster Systems Inc. (*)
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.25 |  | Amendment
to Investment Agreement, dated May 2004, between Cornell Capital Partners LLP and
         EVS Inc.(*)
|---- |  | ----------------------------------------------------------------------------------------------------------------

100

---

---

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

|10.1 |  | Consent
of Luboshitz Kasierer, certified public accountants (Israel) (*).
|---- |  | -------------------------------------------------------------------------

|10.2 |  | Consent
of Kesselman & Kesselman, certified public accounts (Israel) (*)
|---- |  | ------------------------------------------------------------------------

|10.3 |  | Consent
of Ernst & Young, Hang Young, certified public accountants      (Republic of
         Korea) (*)
|---- |  | --------------------------------------------------------------------------------------------------------

|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(*)
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------

---

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

|(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.
000-28580, 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
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------

|.(7) | Incorporated
by reference from our Registration Statement on Form F-2, File No.
               333-120034, filed with the Commission on October 28, 2004.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------

101

---

---

# 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 14th day of July 2005.

| |  | ELBIT VISION SYSTEMS LTD.BY: /S/ MENASHE SHOHAT
Menashe Shohat Chief Executive Officer
| |  | ----------------------------------------------------------------------------------------------------

102

---

---

# ELBIT VISION SYSTEMS
LTD.

(An Israeli Corporation)

2004 CONSOLIDATED
FINANCIAL STATEMENTS



---

---



# ELBIT VISION SYSTEMS
LTD.

2004 CONSOLIDATED
FINANCIAL STATEMENTS

TABLE OF CONTENTS

|                                                        | Page      
|------------------------------------------------------- | ----------
|
|
|
|
|REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM | F-2       
|CONSOLIDATED FINANCIAL STATEMENTS:                     
|Balance sheets                                          | F-3 - F-4 
|Statements of operations                                | F-5       
|Statements of changes in shareholders' equity           | F-6       
|Statements of cash flows                                | F-7 - F-8 
|Notes to Financial Statements                           | F-9 - F-45

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



---

---



| |                                                                                                                                                  
| | -------------------------------------------------------------------------------------------------------------------------------------------------
|
| | Kesselman & Kesselman
Certified Public Accountants (Isr.)
1 Nathanson Street
Haifa 33034 Israel
Telephone +972-4-8605000
Facsimile +972-4-8605001

# REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM

To the shareholders of ELBIT
VISION SYSTEMS LTD.

We have audited the accompanying
consolidated balance sheets of Elbit Vision Systems Ltd. (the Company) and
its subsidiaries as of December 31, 2004 and 2003 and the related consolidated
statements of operations, changes in shareholders equity and cash flows for each of
the two years ended December 31, 2004. These financial statements are the responsibility
of the Companys Board of Directors and management. Our responsibility is to express
an opinion on these financial statements based on our audit.

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

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

In our opinion, based on our audits
and the report of the other auditors, the consolidated financial statements referred to
above present fairly, in all material respects, the consolidated financial position of
the Company and its subsidiaries as of December 31, 2004 and 2003 and the
results of operations, changes in shareholders equity and cash flows for each of
the two years ended December 31, 2004, in conformity with accounting principles generally
accepted in the United States of America.

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

F - 2

---

---



| | n | ERNST & YOUNG HAN YOUNGYeoido Post Office Box 428
25-15, Yeoido-dong 
Youngdeungpo-gu, Seoul 150-010 Korea | n | Phone: 3787-6600, 3787-6800
Fax  : 783-5890, 785-6991
           786-6956, 786-6957
           761-5084, 783-4866
| | - | ---------------------------------------------------------------------------------------------------------- | - | -----------------------------------------------------------------------------------------------------------------
| |   |                                                                                                            |   |                                                                                                                  

# Report of Independent
Registered Public Accounting Firm

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

We have audited the balance sheet of
Yuravision Co., Ltd. (the Company) as of December 31, 2004, and the related
statements of operations, changes in stockholders deficiency and cash flows for the
seven-month period ended December 31, 2004 (not presented separately herein). These
financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. We were not engaged to
perform an audit of the Companys internal control over financial reporting. Our
audit included consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not for the
purpose of expressing an opinion on the effectiveness of the Companys internal
control over financial reporting. Accordingly, we express no such opinion. An audit
includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis for our
opinion.

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

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

Seoul, Korea July 8,
2005

F - 2a

---

---



# REPORT OF INDEPENDENT
AUDITORS

To the Shareholders of Elbit Vision Systems Ltd.

We have audited the accompanying
consolidated statements of operations, changes in shareholders equity and cash flows
of Elbit Vision Systems Ltd. (the Company) and its subsidiaries for the year
ended December 31, 2002. These financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these financial
statements based on our audit.

We conducted our audit in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. We were not engaged to
perform an audit of the Companys internal control over financial reporting. An audit
includes consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not for the
purpose of expressing an opinion on the effectiveness of the Companys internal
control over financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and significant
estimates made by management, and 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 results of operations, changes in shareholders equity and cash flows of
the Company and its subsidiaries for the year ended December 31, 2002, in conformity with
accounting principles generally accepted in the United States.

| |                                                   
| | --------------------------------------------------
|
|
|
|
| | /s/ Luboshitz Kasierer                            
| | An affiliate member of Ernst & Young International

Haifa, Israel June 25,
2003

F - 2b

---

---



# ELBIT VISION SYSTEMS
LTD.

CONSOLIDATED BALANCE
SHEETS

|                                                    |  | December 31
|--------------------------------------------------- |  | -----------
|
|
|
|
|A s s e t s                                         |  |            
|CURRENT ASSETS:                                     |  |            
|Cash and cash equivalents                           |  |            
|Restricted deposit                                  |  |            
|Accounts receivable:                                |  |            
|Trade                                               |  |            
|Other                                               |  |            
|Inventories                                         |  |            
|                                                    |  |            
|T o t a l   current assets                          |  |            
|                                                    |  |            
|INVESTMENTS AND LONG-TERM RECEIVABLES:              |  |            
|Funds in respect of employee rights upon retirement |  |            
|Other long-term receivables                         |  |            
|                                                    |  |            
|                                                    |  |            
|                                                    |  |            
|PROPERTY AND EQUIPMENT, net of accumulated          |  |            
|depreciation and amortization                       |  |            
|                                                    |  |            
|OTHER ASSETS AND DEFERRED CHARGES -                 |  |            
|net of accumulated amortization:                    |  |            
|Goodwill                                            |  |            
|Other intangible assets                             |  |            
|Deferred charges                                    |  |            
|                                                    |  |            
|                                                    |  |            
|                                                    |  |            
|T o t a l   assets                                  |  |            
|                                                    |  |            

|               | ) Chairman of the Board
|-------------- | -----------------------
| |                        
|Nir Alon       | ) of Directors         

|               | )  Chief Executive Officer
|-------------- | --------------------------
| |                           
|Menashe Shohut | )                         

F - 3

---

---



|                                                                         |  | December 31
|------------------------------------------------------------------------ |  | -----------
|
|
|
|
|Liabilities and shareholders' equity                                     |  |            
|CURRENT LIABILITIES:                                                     |  |            
|Credit from banks                                                        |  |            
|Current maturities of loan from shareholder                              |  |            
|Credit from Cornell Capital Partners L.P.                                |  |            
|Accounts payable and accruals:                                           |  |            
|Trade                                                                    |  |            
|Deferred income                                                          |  |            
|Other                                                                    |  |            
|                                                                         |  |            
|T o t a l   current liabilities                                          |  |            
|                                                                         |  |            
|LONG-TERM LIABILITIES:                                                   |  |            
|Loans and other liabilities (net of current maturities)                  |  |            
|Liability for employee rights upon retirement                            |  |            
|                                                                         |  |            
|T o t a l   long-term liabilities                                        |  |            
|                                                                         |  |            
|COMMITMENTS AND CONTINGENT LIABILITIES                                   |  |            
|                                                                         |  |            
|T o t a l   liabilities                                                  |  |            
|                                                                         |  |            
|SHAREHOLDERS' EQUITY:                                                    |  |            
|Share capital - ordinary shares of NIS 1 par value ("Ordinary Shares");  |  |            
|Authorized - 60,000,000 Ordinary Shares as of December 31, 2004          |  |            
|20,000,000 ordinary shares as of December 31, 2003                       |  |            
|Issued and outstanding:                                                  |  |            
|December 31, 2004 - 25,681,743 Ordinary shares;                          |  |            
|December 31, 2003 - 13,006,466 Ordinary shares                           |  |            
|Receipts on account of shares to be allotted                             |  |            
|Warrants                                                                 |  |            
|Additional paid-in capital                                               |  |            
|Differences from translation of foreign currency financial statements of |  |            
|subsidiary                                                               |  |            
|Accumulated deficit                                                      |  |            
|                                                                         |  |            
|T o t a l   shareholders' equity                                         |  |            
|                                                                         |  |            
|T o t a l   liabilities and shareholders' equity                         |  |            
|                                                                         |  |            
|                                                                         |  |            

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

F - 4

---

---



# ELBIT VISION SYSTEMS
LTD.

CONSOLIDATED STATEMENTS
OF OPERATIONS

|                                              | Note | 2004 | 2003 | 2002
|--------------------------------------------- | ---- | ---- | ---- | ----
|
|
|
|
|REVENUES:                                     |      |      |      |     
|Sale of products                              |      |      |      |     
|Services rendered                             |      |      |      |     
|                                              |      |      |      |     
|                                              |      |      |      |     
|                                              |      |      |      |     
|COST OF REVENUES:                             |      |      |      | 14e 
|Cost of products sold                         |      |      |      |     
|Cost of services rendered                     |      |      |      |     
|                                              |      |      |      |     
|                                              |      |      |      |     
|                                              |      |      |      |     
|GROSS PROFIT                                  |      |      |      |     
|RESEARCH AND DEVELOPMENT COSTS - net          |      |      |      | 14f 
|SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: |      |     
|Marketing and selling                         |      |      |      |     
|General and administrative                    |      |      |      |     
|                                              |      |      |      |     
|OPERATING LOSS                                |      |      |      |     
|FINANCIAL INCOME (EXPENSES) - net             |      |      |      | 14g 
|OTHER INCOME                                  |      |      |      |     
|                                              |      |      |      |     
|LOSS BEFORE TAXES ON INCOME                   |      |      |      |     
|TAXES ON INCOME                               |      |      |      | 11d 
|                                              |      |      |      |     
|LOSS FOR THE YEAR                             |      |      |      |     
|                                              |      |      |      |     
|                                              |      |     
|LOSS PER SHARE - BASIC AND DILUTED            |      |      |      | 1q  
|                                              |      |      |      |     
|WEIGHTED AVERAGE NUMBER OF SHARES USED IN     |      |     
|COMPUTATION OF LOSS PER SHARE - BASIC AND     |      |     
|DILUTED (IN THOUSANDS)                        |      |     
|                                              |      |      |      |     
|                                              |      |      |      |     

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

F - 5

---

---



# ELBIT VISION SYSTEMS
LTD.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

|                                                          | Share capital | Receipts on account of shares to be allotted | Warrants (see notes 2a,10a)) | Additional paid-in capital | Differences from  translation of foreign currency financial statements of subsidiary | Accumulated deficit | Total shareholders' equity
|--------------------------------------------------------- | ------------- | -------------------------------------------- | ---------------------------- | -------------------------- | ------------------------------------------------------------------------------------ | ------------------- | --------------------------
|
|
|
|
|BALANCE AT DECEMBER 31, 2001                              |               |                                              |                              | 10,167                     |                                                                                      |                     | 1,208                     
|CHANGES DURING 2002 -                                     |               |                                             
|loss                                                      |               |                                              |                              |                            |                                                                                      |                     |                           
|                                                          |               |                                              |                              |                            |                                                                                      |                     |                           
|BALANCE AT DECEMBER 31, 2002                              |               |                                              |                              | 10,167                     |                                                                                      |                     | 1,208                     
|CHANGES DURING 2003:                                      |               |                                             
|Loss                                                      |               |                                              |                              |                            |                                                                                      |                     |                           
|Issuance of share capital and warrants (note 10a)         |               |                                              |                              | 2,769                      |                                                                                      |                     | 633                       
|Employee stock options exercised and paid                 |               |                                              |                              | 70                         |                                                                                      |                     | 15                        
|Receipts on account of shares to be allotted (note 10a)   |               |                                              |                              |                            |                                                                                      |                     |                           
|                                                          |               |                                              |                              |                            |                                                                                      |                     |                           
|BALANCE AT DECEMBER 31, 2003                              |               |                                              |                              | 13,006                     |                                                                                      |                     | 1,856                     
|                                                          |               |                                              |                              |                            |                                                                                      |                     |                           
|CHANGES DURING 2004:                                      |               |                                             
|Loss                                                      |               |                                              |                              |                            |                                                                                      |                     |                           
|Currency translation differences                          |               |                                              |                              |                            |                                                                                      |                     |                           
|                                                          |               |                                              |                              |                            |                                                                                      |                     |                           
|Total comprehensive loss                                  |               |                                              |                              |                            |                                                                                      |                     |                           
|Employee stock options exercised and paid                 |               |                                              |                              | 393                        |                                                                                      |                     | 85                        
|Receipts on account of shares to be allotted (note 10a)   |               |                                              |                              |                            |                                                                                      |                     |                           
|Issuance of share capital and warrants (notes 2a,2b, 10a) |               |                                              |                              | 11,957                     |                                                                                      |                     | 1,848                     
|Warrant exercised and paid (note 10a)                     |               |                                              |                              | 326                        |                                                                                      |                     | 74                        
|                                                          |               |                                              |                              |                            |                                                                                      |                     |                           
|BALANCE AT DECEMBER 31, 2004                              |               |                                              |                              | 25,682                     |                                                                                      |                     | 3,863                     
|                                                          |               |                                              |                              |                            |                                                                                      |                     |                           

| | * Net
of share issuance costs.
| | ------------------------------

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

F - 6

---

---



(Continued) - 1

# ELBIT VISION SYSTEMS
LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                    | 2004 | 2003 | 2002
|------------------------------------------------------------------- | ---- | ---- | ----
|
|
|
|
|CASH FLOWS FROM OPERATING ACTIVITIES:                               |      |      |     
|Loss                                                                |      |      |     
|Adjustments to reconcile loss to net                                |      |     
|cash provided by or used in operating activities:                   |      |     
|Depreciation and amortization                                       |      |      |     
|Trading marketable securities - net                                 |      |      |     
|Liability for employee rights upon retirement                       |      |      |     
|Changes in operating assets and liabilities:                        |      |     
|Decrease (increase) in accounts receivable:                         |      |     
|Trade (including non-current portion)                               |      |      |     
|Other                                                               |      |      |     
|Increase (decrease) in accounts payable and accruals:               |      |     
|Trade                                                               |      |      |     
|Deferred revenues                                                   |      |      |     
|Other                                                               |      |      |     
|Decrease in inventories                                             |      |      |     
|                                                                    |      |      |     
|Net cash used in operating activities                               |      |      |     
|                                                                    |      |      |     
|CASH FLOWS FROM INVESTING ACTIVITIES:                               |      |     
|Acquisition of subsidiaries consolidated for the first time(a)      |      |      |     
|Purchase of property and equipment                                  |      |      |     
|Collection of long-term receivables                                 |      |      |     
|Investment in long-term deposits                                    |      |      |     
|Redemption of (investment in) restricted deposit                    |      |      |     
|Proceeds from disposal of property and equipment                    |      |      |     
|Long-term loan granted                                              |      |      |     
|Amounts carried to other assets and deferred charges                |      |      |     
|Funds in respect of employee rights upon retirement                 |      |      |     
|                                                                    |      |      |     
|Net cash used in investing activities                               |      |      |     
|                                                                    |      |      |     
|CASH FLOWS FROM FINANCING ACTIVITIES:                               |      |     
|Issuance of share capital and warrants -net of issuance costs       |      |      |     
|Short-term credit from bank - net                                   |      |      |     
|Proceeds from exercise of options and warrants                      |      |      |     
|Receipts on account of shares to be allotted                        |      |      |     
|Discharge of long-term loan from shareholder                        |      |      |     
|Discharge of long-term loans from bank                              |      |      |     
|Short-term credit received from Cornell Capital Partners L.P. - net |      |      |     
|                                                                    |      |      |     
|Net cash provided by financing activities                           |      |      |     
|                                                                    |      |      |     
|TRANSLATION DIFFERENCES ON CASH BALANCES OF                         |      |     
|CONSOLIDATED SUBSIDIARY                                             |      |      |     
|                                                                    |      |      |     
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                |      |      |     
|BALANCE OF CASH AND CASH EQUIVALENTS AT                             |      |     
|BEGINNING OF YEAR                                                   |      |      |     
|                                                                    |      |      |     
|BALANCE OF CASH AND CASH EQUIVALENTS AT END OF YEAR                 |      |      |     
|                                                                    |      |      |     
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW                                |      |     
|INFORMATION - cash paid during the year for:                        |      |     
|Interest paid                                                       |      |      |     
|                                                                    |      |      |     
|Income taxes paid - net                                             |      |      |     
|                                                                    |      |      |     

(Concluded) - 2

ELBIT VISION SYSTEMS LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

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

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

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

| | 2) | In
2004, the Company issued Cornell Capital Partners L.P. and Newbridge           Securities
Coporation 156,250 of its ordinary shares in an amount equivalent to           $ 200,000
as part of the Standby Equity Distribution Agreement (see note           10a5)). .The
said amount is not reflected in the statement of cash flows for the           year ended
December 31, 2004.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

F - 8

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# NOTE 1 
SIGNIFICANT ACCOUNTING POLICIES:

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

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

| | 1) | Nature
of operations
| | -- | --------------------

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

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

| | In
June 2004, the Company expanded its activities and entered into new fields of operations
through the acquisition of 70% of Yuravision Co. Ltd.s (Yuravision)
shares, a South Korean developer of visual inspection software and systems for the
microelectronics industry and display industries. In September 2004, the Company also
completed its acquisition of entire shareholding of ScanMaster Systems (IRT) Ltd. (ScanMaster
Ltd.), an Israeli company and IRT ScanMaster System Inc. (ScanMaster Inc.),
a new Hampshire corporation (collectively ScanMaster). ScanMaster is
engaged in the development, manufacturing and marketing of equipment for the ultrasonic
inspection of industrial parts and components for the automotive and transportation
industries, the metal industry as well as applications for aircraft and jet engine
inspection (see note 2).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Group relies on a small number of customers for a significant portion of its revenues
(see also note 16d). As to Business and Geographical segments  see note 16c.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Accounting
principles
| | -- | ---------------------

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

| | 3) | Use
of estimates in the preparation of financial statements
| | -- | -----------------------------------------------------------

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

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

F - 9

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

| | 4) | Functional
currency:
| | -- | --------------------

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

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

| | Transactions
and balances originally denominated in dollars are presented at their original amounts.
Balances in non-dollar currencies are remeasured into dollars using historical and
current exchange rates for non-monetary and monetary balances, respectively. For
non-dollar transactions and other items (stated below) reflected in the statements of
operations, the following exchange rates are used: (i) for transactions  exchange
rates at transaction dates or average rates; and (ii) for other items (derived from
non-monetary balance sheet items such as depreciation and amortization, changes in
inventories, etc.)  historical exchange rates. The resulting currency transaction
gains or losses are carried to financial income or expenses, as appropriate.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | The
exchange rate of the U.S. dollar at December 31, 2004 was NIS 4.308
          (December 31, 2003  NIS 4.379, December 31, 2002           NIS 4.737).
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Principles
of consolidation:
| | -- | ----------------------------

| | 1) | The
consolidated financial statements include the accounts of the Company and           its
subsidiaries. As to companies consolidated for the first time, see note 2.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | The
cost of the assets and liabilities of consolidated subsidiaries is based on           the
fair value attributed to them at date of investment in those companies.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3) | 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. | Translation
of financial statements of Yuravision drawn up in Korean currency
| | -- | -----------------------------------------------------------------------------

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

| | The
operating results and cash flows of Yuravision are translated into U.S. dollars at the
exchange rates existing on the dates of the transactions (or at the average exchange
rates for the
period, where these approximate the actual exchange rates). Balance sheet items, including
the balances of fair value adjustments made, and goodwill recognized, on the acquisition
of Yuravision, are translated at the exchange rate at the end of the year.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 10

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

| | Exchange
differences arising from the translation of the net investment in Yuravision are carried
as a separate item within shareholders equity (differences from translation
of foreign currency financial statements of a subsidiary). Upon disposal of the
investment in the Yuravision, these exchange differences will be carried to the income
statement, as part of the gain or loss recognized on the disposal.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Cash
equivalents
| | -- | ----------------

| | The
Group 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | Concentration
of credit risks and allowance for doubtful accounts
| | -- | -----------------------------------------------------------------

| | As
of December 31, 2004 and 2003, the Group held cash and cash equivalents and
short-term bank deposits, most of which were deposited with major Israeli, European, Far
East, and U.S. banks. The Company is of the opinion that the credit risk in respect of
these balances is insignificant.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
allowance for doubtful accounts is determined for specific debts doubtful of collection.
| | --------------------------------------------------------------------------------------------

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

| | g. | 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 | 6-20              
|Vehicles                       | 15-20             
|Building                       | 2.5-5             
|                               |                   

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

F - 11

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

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

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

| | In
accordance with FAS No. 142: Goodwill and Other Intangible Assets, goodwill
is not amortized, but rather tested for impairment at least annually. The Companys
reporting units consist of reportable segments; goodwill is allocated to the ultrasonic
inspection segment and the microelectronics and inspection display segment (see also note
16).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has designated December 31 of each year as the date on which it will perform its
annual goodwill impairment test. No impairment resulted from the annual review performed
in the year 2004.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

|                     | %                 
|-------------------- | ------------------
|
|
|
|
|Technology           | 10;33 (mainly 10%)
|Customer relations   | 8.33              
|Distribution network | 10;16.6           
|Brand name           | 8.33              

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

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

| | Relating
to Standby Equity Distribution Agreement and Promissory Note Agreement, which have been
signed between the company and Cornell Capital Partners L.P. (hereafter  Cornell).
The deferred charges include prepaid issuance costs, which are carried to shareholders equity
as issuance costs upon the issuance of company shares to Cornell, and commitment fees,
which are carried to companys results of operations over the period of the
Promissory Note Agreement signed with Cornell (see also note 10a5).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

F - 12

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

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

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

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

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

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

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

| | The
Group distinguishes between revenue recognition in respect of revenue derived from
automatic vision inspection products (sold by the Company) and ultrasonic inspection
products (sold by ScanMaster).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

| | In
some cases, the Company grants its customers support services, including warranty in
respect of products sold; these services are usually provided for a period of six to
twelve months. In those cases, upon revenue recognition, the Company defers a portion of
the sale price and recognizes it as service revenue ratably over the abovementioned
period.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 13

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

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

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

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

| | ScanMaster
distinguishes between sales of new products, in respect of which ScanMaster has not past
installation experience and sales of products, in installation of which the company is
well experienced. In respect of sales of new products ScanMaster recognizes revenues only
after the company receives the ATP from the customer. In respect of sales of other
products, in the installation of which the company is well experienced, the ATP is only a
formal procedure, and therefore, the installation of products is a sufficient requirement
to recognize revenues.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

| | d. | Emerging
Issues Task Force (EITF) Issue 00-21, Revenue           Arrangements
with Multiple Deliverables
| | -- | ------------------------------------------------------------------------------------------------------------

| | EITF00-21
addresses the accounting, by a vendor, for contractual arrangements in which multiple
revenue-generating activities will be performed by the vendor. It is effective
prospectively for all arrangements entered into in fiscal periods beginning after June
15, 2003. EITF Issue 00-21 addresses when and, if so, how an arrangement involving
multiple deliverables should be divided into separate units of accounting. The Companys
adoption of EITF Issue 00-21 in the year ended December 31, 2003 has had no significant
impact on its financial position or results of operations to date.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | e. | EITF 99-19
 Recording Revenue Gross as Principal versus           Net as an Agent
| | -- | --------------------------------------------------------------------------------------

| | Revenue
from third-party sales is recorded according to the criteria established in EITF 99-19,
and Staff Accounting Bulletin (SAB) 104. Revenue is recorded at gross amount for
transactions in which the Group is the primary obligor under the arrangement and/or
possesses other attributes such as pricing and supplier selection latitude. In specific
circumstances where the Company does not meet the above criteria, particularly when the
contract stipulates that the Company is not the primary obligor, the Company recognizes
revenue on a net basis.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 14

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

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

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

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

| | The
deferred income balance as of December 31, 2004 and 2003 include amounts of revenues
that were invoiced and due on delivery, but deferred less applicable product and warranty
costs.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | k. | Research
and development
| | -- | ------------------------

| | Research
and development expenses are charged to income as incurred. Government funding for
development of approved projects, the success of which is uncertain when received, is
recognized as a reduction of expenses as the related cost is incurred.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | m. | Advertising
expenses
| | -- | --------------------

| | Advertising
expenses are charged to income as incurred. Advertising expenses for the years ended
December 31, 2004, 2003 and 2002 were $ 132,000, $ 45,000, and $ 18,000,
respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | n. | Deferred
income taxes:
| | -- | ----------------------

| | 1) | Deferred
taxes are determined utilizing the asset and liability method based on           the
estimated future tax effects of differences between the financial accounting
          and tax bases of assets and liabilities under the applicable tax laws. Deferred
          income tax provisions and benefits are based on the changes in the deferred tax
          asset or tax liability from period to period. Valuation allowances are provided
          if, based upon the weight of available evidence, it is more likely than not
that           some or all the deferred tax assets will not be realized.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Taxes,
which would apply in the event of disposal of investments in           subsidiaries, have
not been taken into account in the computation of deferred           taxes, as it is the
Companys intention to hold these investments, not to           realize them.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | 1) | The
Company accounts for employee stock based compensation in accordance with
          Accounting Principles Board Opinion No. 25 Accounting for Stock Issued to
          Employees (APB 25) and related interpretations. In accordance
          with FAS 123  Accounting for Stock-Based Compensation          (FAS
123), the Company discloses pro forma data assuming the Company           had
accounted for employee stock option grants using the fair value-based method
          defined in FAS 123.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 15

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

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

|                                           | Year ended December 31
|------------------------------------------ | ----------------------
|
|
|
|
|Loss, as reported                          |                       
|Add - stock-based employee compensation    |                       
|expense determined under fair value method |                       
|                                           |                       
|Pro forma loss                             |                       
|                                           |                       
|Loss per share:                            |                       
|Basic and diluted - as reported            |                       
|                                           |                       
|Basic and diluted - pro forma              |                       
|                                           |                       

| | As
to information about the stock option plans and assumptions used in calculating the pro
forma information, see note 10b.
| | ---------------------------------------------------------------------------------------------------------------------------

| | p. | Comprehensive
loss
| | -- | ------------------

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

| | q. | Loss
per share (LPS)
| | -- | ----------------------

| | Basic
LPS is computed based on the weighted average number of shares outstanding during each
year. 3,707,000 ordinary shares, which were issued and were placed in escrow (see note
2b) were reflected in basic and diluted LPS shares. All 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, is 6,262,882, 2,592,000, and 2,000,000 shares for the years 2004, 2003 and
2002, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | r. | Reclassification
| | -- | ----------------

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

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

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

F - 16

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

| | In
December 2004, the Financial Accounting Standards Board (FASB) issued the
revised Statement of Financial Accounting Standards (FAS) No. 123,
Share-Based Payment (FAS 123R), which addresses the accounting for share-based
payment transactions in which the Company obtains employee services in exchange for (a)
equity instruments of the Company or (b) liabilities that are based on the fair value of
the Companys equity instruments or that may be settled by the issuance of such
equity instruments. This Statement eliminates the ability to account for employee
share-based payment transactions using APB Opinion No. 25, Accounting for Stock Issued to
Employees, and requires instead that such transactions be accounted for using the
grant-date fair value based method. This Statement will be effective as of the beginning
of the first interim or annual reporting period that begins after January 1, 2006. Early
adoption of FAS 123R is encouraged. This Statement applies to all awards granted or
modified after the Statements effective date. In addition, compensation cost for
the unvested portion of previously granted awards that remain outstanding on the Statements
effective date shall be recognized on or after the effective date, as the related
services are rendered, based on the awards grant-date fair value as previously
calculated for the pro-forma disclosure under FAS 123. The Company estimates that the
cumulative effect of adopting FAS 123R as of its adoption date by the Company (July 1,
2006), based on the awards outstanding as of December 31, 2004, will not have a material
effect on the Companys financial statements.. This estimate does not include the
impact of additional awards, which may be granted, or forfeitures, which may occur
subsequent to December 31, 2004 and prior to our adoption of FAS 123R. The Company
expects that upon the adoption of FAS 123R, the Company will apply the modified
prospective application transition method, as permitted by the Statement. Under such
transition method, upon the adoption of FAS 123R, the Companys financial statements
for periods prior to the effective date of the Statement will not be restated.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | In
November 2004, the FASB issued FAS No. 151, Inventory Costs  an amendment of
ARB 43, Chapter 4 (FAS 151). This Statement amends the guidance in ARB No. 43,
Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts
of idle facility expense, freight, handling costs, and wasted material. This Statement
requires that those items be recognized as current-period charges. In addition, this
Statement requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. This Statement
will be effective for inventory costs incurred during fiscal years beginning after June
15, 2005 (January 1, 2006 for the Company). Earlier application of FAS 151 is permitted.
The provisions of this Statement shall be applied prospectively. The Company does not
expect this Statement to have a material effect on the Companys financial
statements or its results of operations.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 17

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 1  SIGNIFICANT
ACCOUNTING POLICIES(continued):

| | 3) | FAS
153 Exchanges of Nonmonetary Assets  An Amendment of APB Opinion No.           29
| | -- | --------------------------------------------------------------------------------------

| | In
December 2004, the FASB issued FAS No. 153, Exchanges of Nonmonetary Assets  An
Amendment of APB Opinion No. 29 (FAS 153).  FAS 153 amends APB Opinion No. 29,
Accounting for Nonmonetary Transactions (Opinion 29). The amendments made by FAS 153 are
based on the principle that exchanges of nonmonetary assets should be measured based on
the fair value of the assets exchanged. Further, the amendments eliminate the exception
for nonmonetary exchanges of similar productive assets and replace it with a general
exception for exchanges of nonmonetary assets that do not have commercial substance. The
provisions in FAS 153 are effective for nonmonetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005 (July
1, 2005 for the Company).  Early application of the FAS 153 is permitted. The
provisions of this Statement shall be applied prospectively. The Company does not
expect the adoption of FAS 153 to have a material effect on the Companys financial
statements or its results of operations.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4) | EITF
Issue 02-14, Whether an Investor Should Apply the Equity Method of
          Accounting to Investments Other Than Common Stock
| | -- | -----------------------------------------------------------------------------------------------------------------------------------

| | In
July 2004, the FASB issued EITF Issue No. 02-14, Whether an Investor
Should Apply the Equity Method of Accounting to Investments Other Than Common Stock.EITF
Issue No. 02-14 addresses whether the equity method of accounting applies when an
investor does not have an investment in voting common stock of an investee but exercises
significant influence through other means. EITF Issue No. 02-14 states that an
investor should only apply the equity method of accounting when it has investments in
either common stock or in-substance common stock of the investee, provided that the
investor has the ability to exercise significant influence over the operating and
financial policies of the investee. The provisions in EITF Issue No. 02-14 are
effective for reporting periods beginning after September 15, 2004 (October 1, 2004 for
the Company). The adoption of EITF 02-14 by the Company did not have any effect on the
Companys financial statements or its results of operations.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5) | FAS
154  Accounting Changes and Error Corrections
| | -- | --------------------------------------------------

| | In
May 2005, the FASB issued FAS No. 154, Accounting Changes and Error Corrections.
FAS No. 154 is a replacement of Accounting Principles Board Opinion (APB) No.
20 and FASB Statement No. 3. FAS No. 154 provides guidance on the accounting for and
reporting of accounting changes and error corrections. It establishes retrospective
application as the required method for reporting a change in accounting principle. FAS
No. 154also requires that a change in depreciation, amortization, or depletion method for
long-lived, nonfinancial assets be accounted for as a change in accounting estimate
effected by a change in accounting principle. The Statement carries forward the guidance
contained in APB No. 20 for reporting the correction of an error in previously issued
financial statements and a change in accounting estimate. FAS No. 154 is effective for
accounting changes and corrections of errors made in fiscal years beginning after
December 15, 2005 (January 1, 2006 for the Company). The Company does not expect this
standard to have a material effect on the Companys financial statements or results
of operations.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 18

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 2  CONSOLIDATED SUBSIDIARIES:

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

| | On
December 2, 2003, the Company signed a term sheet (the validity of which was extended on
February 16, 2004) to acquire 100% of the shares of Yuravision (as to the nature of
operation of Yuravision, see note 1a1)).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| | Under
the swap transaction, the company is to purchase these shares in consideration for the
issuance of 320,547 company shares (at a conversion rate of 0.955455). As of December 31, 2004,
the company recorded in its books of accounts an investment representing the holding of
app. 70% in Yuravision and recorded the said liability to purchase the shares as a
short-term liability.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
manner in which the purchase will be made (cash or swap transaction) is to be determined
by the sellers.
| | ------------------------------------------------------------------------------------------------------------

| | In
addition to the cash payment, the Company issued to one of Yuravisions shareholders
warrants to purchase 50,000 of the Companys shares, at an exercise price of $ 0.75;
the warrants are exercisable for a period of two years from the date of issuance. The
weighted fair value of the warrants granted was $ 0.6. The said fair value was determined
in accordance with the Black&Scholes model, based on the following assumptions:
dividend yield  0%; expected volatility  146%; risk free interest  2.1%;
expected life  1 year.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
results of Yuravisions operations have been included in the consolidated financial
statements as from June 1, 2004.
| | ------------------------------------------------------------------------------------------------------------------------

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

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

F - 19

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE
2  CONSOLIDATED SUBSIDIARIES (continued):

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

| | As
of December 31, 2004, the sellers did not exercise their option relating the selling of
their holding in Yuravision.
| | -----------------------------------------------------------------------------------------------------------------------

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

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

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

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

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

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

| | In
September 2004, the Company acquired 100% of the shares of ScanMaster (as to the nature
of operations of ScanMaster  see note 1a1)).
| | ----------------------------------------------------------------------------------------------------------------------------------------

| | The
Company acquired ScanMaster for total consideration in the amount of $ 8,201,000
(including estimated direct transaction costs amounting to $ 159,000). The consideration
for the acquisition of ScanMaster consisted of $ 3,000,000 in cash and 7,414,213 ordinary
shares of the Company, which represented approximately 27.9% of the issued and
outstanding share capital of the Company after giving effect to the issuance. The value
of the shares issued was calculated based upon the average of the closing prices per
Companys shares for the period of two days before through two days after the
announcement of the agreement. For the purposes of the financial statements as of
December 31, 2004, the acquisition cost was recorded at the amount of $ 5,680,000,
after eliminating a consideration of $ 2,521,000 in shares,
which are considered as contingent consideration, and are placed in escrow as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 20

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE
2  CONSOLIDATED SUBSIDIARIES (continued):

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

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

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

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

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

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

| | c. | Hereafter
are the unaudited pro forma combined condensed income statements for           the years
ended December 31, 2004 and 2003, assuming that the acquisition           of
ScanMaster and Yuravision occurred at the beginning of the respective           periods,
after giving effect to certain adjustments, including amortization of
          identifiable intangible assets of $ 905,000, and decreasing financial expenses
          in respect of the Companys receiving a credit of $ 4,000,000 from
          Cornell Capital Partners L.P.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 21

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 2  CONSOLIDATED SUBSIDIARIES (continued):

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

|                                   | 2004 | 2003
|---------------------------------- | ---- | ----
|
|
|
|
|Revenues                           |      |     
|                                   |      |     
|Loss                               |      |     
|                                   |      |     
|Loss per share - basic and diluted |      |     
|                                   |      |     
|                                   |      |     

| | d. | As
to deferred income taxes in respect of the assets acquired and liabilities
          assumed at the date of the above acquisition, see note 11e.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 3 
INVENTORIES:

|                   | December 31
|------------------ | -----------
|
|
|
|
|Raw materials      |            
|Spare parts        |            
|Work in process    |            
|Finished products* |            
|                   |            
|                   |            
|                   |            
|                   |            

| | * Mainly
systems in trial by customers (see note 1j)).
| | ------------------------------------------------------

# NOTE 4  OTHER
LONG-TERM RECEIVABLES

|                                                  | December 31
|------------------------------------------------- | -----------
|
|
|
|
|Deposits on leased vehicle (see also note 9a2)(b) |            
|Loan to employees(1) (see also note 9b1))         |            
|Loan to other(2)                                  |            
|Prepaid expenses                                  |            
|                                                  |            
|                                                  |            
|                                                  |            
|                                                  |            

| | (1) | The
loans are mainly denominated in NIS and linked to the Israeli CPI.
| | --- | ----------------------------------------------------------------------

| | (2) | Representing
a loan to a company, convertible into 8% of this companys           share capital.
The loan is denominated in dollars, with no interest. The Company           can convert
the loan into share capital after December 31, 2003. On July           22, 2004, the
Company requested, pursuant to the loan agreement, to convert the           loan to
197,217 shares of the Company. To date, the conversion of the loan has           not yet
been executed. The Company assures that the said conversion will be           completed
by the end of 2005.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

# NOTE 5  PROPERTY
AND EQUIPMENT:

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

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

| | b. | Depreciation
and amortization expenses totaled $ 269,000, $ 238,000,           and $
256,000, in the years ended December 31, 2004, 2003 and 2002,
          respectively.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 6  OTHER
ASSETS AND DEFERRED CHARGES:

| | a. | Intangible
assets:
| | -- | ------------------

|                     | December 31, 2004
|-------------------- | -----------------
|
|
|
|
|Technology           |                  
|Customer relations   |                  
|Distribution network |                  
|Brand name           |                  
|Backlog              |                  
|                     |                  
|                     |                  
|                     |                  
|                     |                  

| | Aggregate
amortization expense for the year ended December 31, 2004 is U.S. $ 611,000.
| | --------------------------------------------------------------------------------------

| | Estimated
amortization expense for the following years, subsequent to December 31, 2004:
| | ----------------------------------------------------------------------------------------

|                        | U.S. dollars
in thousands
|----------------------- | -------------------------
|
|
|
|
|Year ended December 31: |                          
|2005                    |                          
|2006                    |                          
|2007                    |                          
|2008                    |                          
|2009                    |                          

F - 23

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 6  OTHER ASSETS AND
DEFERRED CHARGES(continued):

| | b. | Deferred
charges*
| | -- | -----------------

|                              | December 31, 2004
|----------------------------- | -----------------
|
|
|
|
|Share issuance costs(1)       |                  
|Commitment fees - related to  |                  
|credit provided by Cornell(2) |                  
|                              |                  
|                              |                  
|                              |                  
|                              |                  

| | * | Relating
to Standby Equity Distribution Agreement and Promissory Note Agreement signed between the
Company and Cornell  see also notes 1h3) and 10a5).
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | (1) | Prepaid
share issuance costs
| | --- | ----------------------------

| | These
include direct issuance costs and part of the commitment fees paid to Cornell, allocated
to future issuances (see note 10a5)). The said costs will be carried to companys
shareholders equity as issuance costs upon the issuance of shares to Cornell, under
the Standby Equity Distribution Agreement.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | Commitment
fees
| | --- | ---------------

| | The
said costs are amortized over the period of the Promissory Note, in proportion to the
balance outstanding and are carried to financial expenses. The said costs are composed as
follows: (i) an amount of $ 230,000, which have been deducted from the amount of the
Promissory Note that was granted to the company, as of August 26, 2004. (ii) an
allocation of 40% of the commitment fees paid to Cornell, under the above agreement.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 7  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 Group 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 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 and its Israeli subsidiary 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 Korean, Dutch, and Israeli subsidiaries 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.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 24

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 7  LIABILITY FOR
EMPLOYEE RIGHTS UPON RETIREMENT(continued):

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

| | c. | Severance
pay and defined contribution plan expenses were $ 255,000,           $ 160,000,
and $ 176,000 in the years ended December 31, 2004, 2003,           and 2002,
respectively. Theearnings on the amounts funded were $ 80,000,           $ 54,000,
and $ 41,000. forthe years ended           December 31, 2004, 2003, and
2002, respectively.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | d. | Cash
flows information regarding the companys liability for employee           rights
upon retirement:
| | -- | -------------------------------------------------------------------------------------------------------

| | 1) | The
company expects to contribute in 2005, $369,000 to the insurance companies           and
provident fund in respect of its severance pay obligation and its defined
          contribution plan.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | The
Company expects that the amount, which will be paid in the following five           years
in respect of future benefits to its employees upon their normal           retirement age
will not be material.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 8  LONG-TERM
LIABILITIES  LOANS AND OTHER:

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

|                                     | December 31
|------------------------------------ | -----------
|
|
|
|
|Loans from banks(1)                  |            
|Other liabilities:                   |            
|Loan from shareholder(2)             |            
|Income received in advance           |            
|                                     |            
|                                     |            
|Less - current maturities:           |            
|From banks                           |            
|From shareholder (see also note 14c) |            
|                                     |            
|                                     |            
|                                     |            
|                                     |            
|                                     |            
|                                     |            

| | (1) | The
loans are linked to the Korean Won and bear weighted average annual interest rates of
4.7%. The Korea Technology Credit Guarantee Fund has provided a guarantee amounting to $ 144
thousands in respect of the said loans.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | During 2003,
the Company and Elbit Ltd. (a shareholder), reached an agreement, whereby the Companys
debt to Elbit of $ 400,000 and accrued interest thereon that was due in 2003, will have
the following terms:
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a. | The
loan will bear annual interest of Libor+2% (formerly Libor+0.5%) payable
          quarterly.
| | -- | -------------------------------------------------------------------------------------------------

| | b. | The
loan is repayable in quarterly installments of $ 40,000 each, commencing in           the
third quarter of 2003, but only if the cash flows provided by Companys
          operating activities in the quarter preceding the payment exceeds $ 50,000. In
          2004, $ 80,000 were repaid in respect of the said loan.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 25

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 8  LONG-TERM
LIABILITIES  LOANS AND OTHER(continued):

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

|                          | December 31
|------------------------- | -----------
|
|
|
|
|Second year               |            
|Third year                |            
|Fourth year               |            
|Fifth year and thereafter |            
|                          |            
|                          |            
|                          |            
|                          |            

NOTE 9  COMMITMENTS AND
CONTINGENT LIABILITIES:

| | a. | Commitments:
| | -- | ------------

| | 1) | Royalty
commitments:
| | -- | --------------------

| | (a) | The
Company is committed to pay royalties to the Government of Israel on           proceeds
from sales of products in the research and development of which the           Government
participates by way of grants. At the time the grants were received,           successful
development of the related projects was not assured.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
the case of failure of a project that was partly financed as above, the Company is not
obligated to pay any such royalties.
| | ------------------------------------------------------------------------------------------------------------------------------

| | Under
the terms of Companys funding from the Israeli Government, royalties of 3%-5% are
payable on sales of products developed from a project so funded, up to 100% of the amount
of the grant received by the Company (dollar linked); as from January 1, 2001 with
the addition of an annual interest rate based on Libor.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Royalty
expenses to the Government of Israel totaled $ 583,000, $ 213,000, and $ 108,000
in the years ended December 31, 2004, 2003 and 2002, respectively, and are included in
the statements of operations among cost of revenues.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) | The
Company and ScanMaster Ltd. are committed to pay royalties to the           Government of
Israel in respect of marketing expenses in which the government           participated by
way of grants. At the time the grants were received, successful           development of
the related projects was not assured. In the case of failure of a           project that
was partly financed as above, the Company is not obligated to pay           any such
royalties. The royalties are payable at the rate of 4% of the increase           in
export sales, up to the amount of the dollar-linked grant received. No
          royalties were paid in the reported years to the Government of Israel.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
maximum royalty amount payable by the Company to the Government of Israel at December 31, 2004
is approximately 3,800,000 (see (a) and (b) above).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------

F - 26

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 9  COMMITMENTS AND
CONTINGENT LIABILITIES(continued):

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

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

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

| | As
a result of the amendment of the agreement, the Company recorded net royalty income of
$64,000 in the year ended December 31, 2002. The royalty expenses totaled $ 27,000
and $ 32,000 in the years ended December 31, 2004 and 2003, respectively,
and are included in the statements of operations among cost of revenues.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (d) | ScanMaster
Ltd. signed an agreement with a supplier, whereunder the supplier           assisted
Scanmaster Ltd. to complete a development of one of the Companys
          products. The supplier is also entitled to receive royalties from the
          products sales. The royalty expenses in respect of royalties paid to the
          said supplier amounted to $ 14,000 in the period starting
          September 8, 2004 through December 31, 2004, and are
          included in the statements of operations among cost of revenues.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | Lease
commitments:
| | -- | ------------------

| | (a) | The
premises occupied by the Company and certain subsidiaries are rented under
          various operating lease agreements. The lease agreements for the premises
expire           in 2006-2007.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Minimum
lease commitments of the Company and the subsidiary under the above leases, at rates in
effect on December 31, 2004, are as follows:
| | --------------------------------------------------------------------------------------------------------------------------------------------

|                         | $ in thousands
|------------------------ | --------------
|
|
|
|
|Year ending December 31: |               
|2005                     |               
|2006                     |               
|2007                     |               
|                         |               
|                         |               
|                         |               
|                         |               

| | 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 $ 240,000, $ 150,000, and $ 247,000 in the years ended
December 31, 2004, 2003 and 2002, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------

| | (b) | The
Company leases motor vehicles under long-term operating lease agreements.           The
lease agreements expire on various dates ending in 2005  2006 (with           prior
notice of cancellation clauses).
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 9  COMMITMENTS AND
CONTINGENT LIABILITIES(continued):

| | Minimum
lease commitments of the Company under the above leases, at rates in effect on December
31, 2004, are as follows:
| | -------------------------------------------------------------------------------------------------------------------------

|     | $ in thousands
|---- | --------------
|
|
|
|
|2005 |               
|2006 |               
|2007 |               
|     |               
|     |               
|     |               
|     |               

| | 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 2004, 2003 and 2002, amounted to
$ 194,000, $ 154,000, and $ 204,000.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Contingent
liabilities:
| | -- | -----------------------

| | 1) | The
Company guarantees its employees bank loans. The Company requires
          collateral to secure these guarantees. The Companys maximum exposure
under           these guarantees is $ 11 thousands.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | To
secure the Companys commitment under its sales agreements, the Company
          provided guarantees to its customers. The guarantees are usually secured by
cash           advances received from the said customers.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 10 
SHAREHOLDER EQUITY:

| | a. | Authorized,
issued and outstanding shares:
| | -- | ------------------------------------------

| | 1) | The
Companys Ordinary Shares are traded in the United States on the OTC
               Bulletin Board over the counter market under the symbol EVSNF.OB.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2) | In
March 2001, Mr. Alon, the Companys chairman, as from March 2001,
               purchased 1,500,000 of its ordinary shares at a price per share of $1.00.
At                that time, Mr. Alon also agreed to complete a second investment in
which he                would purchase by no later than March 15, 2002, an additional
1,500,000 shares                at a price per share of $1.00; provided that the Companys
financial                results for 2001 met certain minimum thresholds. In March 2002,
the Company                agreed to permit Altro Warenhandelsgesmbh (hereafter  Altro),
an Austrian                company controlled by Mr. Alon, to complete the second
investment in nine equal                monthly installments commencing March 2002. In
May 2002, the Company deferred                payment of the first four of these
installments until no later than                June 30, 2002. This investment was
not done by Altro.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
a plan of arrangement (hereafter  the arrangement) between the Company, its
shareholders and Altro, approved by the Companys shareholders in October 2003 and
the District Court of Haifa in November 2003, the Company agreed to cancel Altros
prior commitment to invest in the Company and replace it with new investment terms, and
at the same time grant warrant to purchase shares to the other shareholders. According to
the plan of arrangement, Altro will purchase 2,000,000 of the Companys ordinary
shares for a purchase price of $0.35 per share, payable in up to five quarterly
installments to be completed by November 2004.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 28

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 10  SHAREHOLDERS
EQUITY(continued):

| | Through
December 31, 2004, the Company received from Altro an amount of $564,000 (net of issuance
costs amounting to $ 30,000) in respect of 1,500,000 shares issued to Altro.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
April 2005, the Company received $ 106,000 in respect of the completion of the
transaction.
| | ----------------------------------------------------------------------------------------------

| | Also,
pursuant to the arrangement, in 2004, the Company distributed, without consideration,
warrants to purchase 4,183,950 of its ordinary shares to all of its shareholders on a pro
rata basis (other than Altro, Mr. Alon and a group of investors which purchased the
Companys shares in private placements which occurred in December 2003 and January
2004 (see 3) and 4) below. Each warrant is exercisable for a period of four years
following the grant date 14 May , 2004, at a price of $0.35 per share.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of the said warrants granted was $ 0.1. The fair value was determined in
accordance with the Black & Scholes model, based on the following assumptions:
dividend yield  0%, expected volatility  137%, risk free interest 1.91%,
expected life  2 years.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Through
December 31, 2004, warrants to purchase 84,851 shares were exercised by one of the said
shareholders.
| | -------------------------------------------------------------------------------------------------------------

| | 3) | In
December 2003 and in January 2004, the Company entered into shares and           warrants
purchase agreements with several private investors. Under these           agreements, the
Company issued to the said investors 3,569,299 shares of           NIS 1 par value
at a price of $0.68 per share and 1,067,325 warrants. Each           warrant entitles its
holder to purchase one ordinary share of NIS 1 par value at           the exercise price,
payable in cash, of $ 0.85; the warrants are exercisable for           a period of 24
months from date of issuance.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
this agreement, the Company received $ 2,276,360 (net of issuance costs amounting to $
150,640), in respect of the shares and warrants, issued as above (of which $ 1,765,000
 net of issuance costs of $ 150,640  were received through December 31, 2003).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
said private investors participating in the issuance of shares and warrants as above, do
not participate in the warrant distribution Arrangement mentioned in 2) above.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
part of the issuance as above, the Company issued 293,300 warrants to consultants and
providers of financial services (245,300 warrants were issued in December 2003 and 48,000
warrants were issued in January 2004). The said warrants were issued to consultants and
service providers in respect of their assistance in the said capital raising. 51,500
warrants have the same terms as the warrants issued to the investors as above, and
241,800 warrants are exercisable at a price of $ 0.68 per share, for a period of 24
months from date of issuance.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 29

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 10  SHAREHOLDERS
EQUITY(continued):

| | The
Company has divided the amount raised from issuance, as above, between shareholdersequity
components: share capital, additional paid-in capital and warrants. The warrants granted
to the said private investors were recorded in shareholders equity at their fair
value. Also, the value of the warrants issued to consultants and providers of financial
services was offset from the premium component. The weighted average fair value of
warrants granted was $ 0.25. The said weighted average fair value of all warrants
was determined in accordance with the Black & Scholes model, based on the following
assumptions: dividend yield  0%, expected volatility  137%, risk free
interest rate 1.31%, expected life  1 year.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
May 2004, warrants to purchase 156,000 shares at an exercise price of $0.68 were
exercised by one of the said consultants.
| | -----------------------------------------------------------------------------------------------------------------------------

| | 4) | In
January and February 2004, the Company issued to several private investors
          1,530,612 shares at a price of $0.98 per share and 382,653 warrants for a total
          consideration of $ 1,330,000 (net of issuance costs amounting to
          $ 170,000).
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Each
warrant is exercisable to one ordinary share of NIS 1 par value, at an exercise
price of $ 1.40 per share. The warrants are exercisable for a period of 24 months,
commencing in the date of issuance.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | The
Company has divided the amount raised from issuance, as above, between shareholdersequity
components: share capital, additional paid-in capital and warrants. The warrants granted
to the said private investors were recorded in shareholders equity at their fair
value. Also, the value of the warrants issued to consultants and providers of financial
services was offset from the premium component. The weighted average fair value of
warrants granted was $ 0.42. The said weighted average fair value of all warrants
was determined in accordance with the Black & Scholes model, based on the following
assumptions: dividend yield  0%, expected volatility  137%, risk free
interest rate 1.31%, expected life  1 year.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
May 2004, warrants to purchase 85,714 shares at an exercise price of $ 0.98 were
exercised by one of the said consultants.
| | -----------------------------------------------------------------------------------------------------------------------------

| | 5) | In
March 2004, the Company entered into a Standby Equity Distribution Agreement
          with Cornell. Pursuant to this agreement, the Company will be entitled to issue
          Cornell with put notices requiring it to purchase, six days following each put
          notice, a number of Companys ordinary shares with a value of up to
          $ 300,000 per put notice and up to an aggregate value of $ 10,000,000
          over two years. The price per share payable by Cornell will be determined based
          on the minimum price of Companys shares during the five days period
          following Companys put notice to Cornell to purchase Companys
          shares. Under the said agreement, the Company agrees to pay Cornell commitment
          fees, which were defined as follows:
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

F - 30

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 10  SHAREHOLDERS
EQUITY(continued):

| | b) | Upon
execution of the Agreement, the Company issued Cornell with 148,438 of its
               ordinary shares in an amount equal to $ 190,000. As to the accounting
               treatment applied to the said costs, see note 6b.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

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

| | The
Company paid Cornell a commitment fee of five per cent (5%) of the principal amount of
the Promissory Note, and a further $ 30,000 to an affiliate of Cornell and other
party. When used for the repayment of the note, proceeds received under the Standby
Equity Distribution Agreement, will not be subject to the 5% commitment fee. The Company
records in its books of accounts the commitment fees over the period of the Promissory
Note (see also note 6b).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
securities for repayment of the advance and the Promissory Note, the Company has: (i)
granted Cornell a second ranking floating charge on all of Companys assets (to the
extent permitted under Israeli law) and on the assets of ScanMaster; (ii) issued to a
trustee, 5,555,555 of its ordinary shares which are registered (see above), and (iii)
Issued to Trustee an additional 2,500,000 of Companys restricted ordinary shares.
It has also been agreed to reserve an additional 14,444,445 of Companys ordinary
shares for issuance to Cornell pursuant to the Standby Equity Distribution Agreement, and
have agreed to file the registration statement covering these shares. In October 2005,
the Company filed an additional registration statement concerning the said 14,444,445
shares. The said filing is still not declared effective.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 31

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 10  SHAREHOLDERS
EQUITY(continued):

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

| | The
fair value of the said shares is app. $ 10,000. The said costs are included in companys
accounts as deferred share issuance costs, see note 6b.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------

| | Through
December 31, 2004, the Company repaid $ 394,000 of the Note in cash and $ 273,000
by the issuance of 555,089 shares to Cornell, as stipulated in the said agreement.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
to amendment made to the Promissory Note in 2005, see note 17.
| | -----------------------------------------------------------------

| | 6) | As
to shares issued in consideration, and as contingent consideration, for the
               purchase of the shareholding in ScanMaster, see note 2b.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | Share
option plans:
| | -- | -------------------

| | 1) | The
plans:
| | -- | ----------

| | (a) | In
February 1996, the Companys board of directors adopted the           Companys
Employee Share Option Plan (1996) (hereafter  The 1996           Plan). Under the
1996 plan, 565,720 options can be granted to directors,           employees and
consultants of the Company and its subsidiaries. Each option can           be exercised
into one ordinary share of the Company.
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
1996 plans is valid for ten years and will expire February 2006, except for option awards
outstanding on that date.
| | -----------------------------------------------------------------------------------------------------------------------

| | Under
the 1996 Plan, options usually vest as follows: 50%  two years after the effective
date of grant; 75%  after three years; and 100%  after four years.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

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

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

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

F - 32

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 10  SHAREHOLDERS
EQUITY(continued):

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

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

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

| | Through
December 31, 2004, options to purchase 392,598 shares were exercised. The proceeds from
the exercise amounted to $ 85 thousands.
| | ----------------------------------------------------------------------------------------------------------------------------------------

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

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

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

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

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

F - 33

---

---



# ELBIT VISION SYSTEMS
LTD.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

NOTE 10  SHAREHOLDERS
EQUITY(continued):

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

| | (a) | A
summary of the status of the above plans in respect of options granted to
          employees and directors of the Company and its subsidiaries as of
          December 31, 2004, 2003 and 2002, and changes during the years ended on
          those dates, is presented below:
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                         | Y e a r    e n d e d    D e c e m b e r    3 1
|---------------------------------------- | ----------------------------------------------
|
|
|
|
|Options outstanding at beginning of year |                                               
|Changes during the year:                 |                                               
|Granted (1)                              |                                               
|Exercised                                |                                               
|Forfeited                                |                                               
|                                         |                                               
|Options outstanding at end of year       |                                               
|                                         |                                               
|Options exercisable at year end          |                                               
|                                         |                                               
|Weighted average fair value of           |                                               
|options granted during the year (2)      |                                               
|                                         |                                               

| | (1) | 521,000
options granted in 2004 (weighted average exercise price of $0.83 and           fair
value of $ 0.38), 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), were granted with exercise price that was above market value. All other
          grants were made at market value, or near market value exercise price.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

F - 34

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 10  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, 2004:
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Options outstanding | Options exercisable
|------------------- | -------------------
|
|
|
|
|3.00                |                    
|1.68                |                    
|1.169               |                    
|0.36                |                    
|0.48                |                    
|0.15                |                    
|1.00                |                    
|0.2                 |                    
|0.68                |                    
|0.85                |                    
|0.83                |                    
|1.25                |                    
|0.75                |                    
|0.8                 |                    
|1.2                 |                    
|                    |                    
|                    |                    
|                    |                    

| | 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 11  TAXES ON
INCOME:

| | a. | Corporate
taxation in Israel
| | -- | ----------------------------

| | 1) | Measurement
of results for tax purposes under the Income Tax (Inflationary           Adjustments)
Law, 1985 (the Inflationary Adjustments Law)
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the Inflationary Adjustments Law, results for tax purposes are measured in real terms,
having regard to the changes in the Israeli Consumer Price Index (hereafter  CPI).
The Company and ScanMaster Ltd. are taxed under this law.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 35

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 11  TAXES ON INCOME(continued):

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

| | 2) | Tax
rates
| | -- | ---------

| | a) | The
income of the Company and ScanMaster Ltd. (other than income from                approved
enterprises, see b. below) are taxed at the regular rate.                Through to
December 31, 2004, the corporate tax was 36%. In July 2004, an
               amendment to the Income Tax Ordinance was enacted. One of the provisions
of this                amendment is that the corporate tax rate is to be gradually
reduced from 36% to                30%, in the following manner: the rate for 2004 will
be 35%, in 2005  34%,                in 2006  32%, and in 2007 and thereafter
 30%.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Pursuant
to another amendment to the Income Tax Ordinance, which became effective in 2003, capital
gains are taxed at a reduced rate of 25% from January 1, 2003, instead of the
regular corporate tax rate at which such gains were taxed until the aforementioned date.
The aforesaid amendment stipulates that with regard to the sale of assets acquired prior
to January 1, 2003, the reduced tax rate will be applicable only for the gain
allocated to capital gains earned after the implementation of the amendment, which will
be calculated, as prescribed by said amendment.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b) | Subsidiaries
outside Israel
| | -- | ---------------------------

| | Subsidiaries
that are incorporated outside of Israel are assessed for tax under the tax laws in their
countries of residence. The principal tax rates applicable to subsidiaries outside Israel
are as follows:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Company
incorporated in the USA - tax rate of 39%.                             Company
incorporated in tne Netherlands - tax rate of 29 %.                             Company
incorporated in Republic of Korea - tax rate of 29.7% on taxable income
                            in excess of 100,000 Korean Won (tax rate of 16.5% apply
below 100,000 Korean                             Won).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

F - 36

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 11  TAXES ON INCOME(continued):

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

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

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

| | The
Company has three approved enterprises; the benefit period in respect of the first, second
and third enterprises commenced in 1994, 1995, and 1997, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | In
the event of distribution of cash dividends from income, which was tax exempt as above,
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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
2005, the Company received from the Investment Center the instrument of approval for its
fourth approved enterprise.
| | -----------------------------------------------------------------------------------------------------------------------

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

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

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

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

| | On
March,2004 ScanMaster Ltd. received a warning from the Investment Center that the
instrument of approval of the second approved enterprise might be cancelled. ScanMaster
Ltd. plans to appeal the Investment Centers decision in the near future. ScanMaster
Ltd. has not utilized its tax benefits in respect of this enterprise. In case that the
said approved enterprise will be cancelled, the Company estimates that it will not be
required to be subject to penalties.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 37

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 11  TAXES ON INCOME(continued):

| | (b) | Accelerated
depreciation
| | --- | ------------------------

| | The
Company is entitled to claim accelerated depreciation in respect of equipment used by the
approved enterprises during five tax years.
| | -----------------------------------------------------------------------------------------------------------------------------------------

| | (c) | Conditions
for entitlement of the benefits
| | --- | ------------------------------------------

| | The
entitlement to the above benefits is conditional upon the Company fulfilling the
conditions stipulated by the above law, regulations published thereunder and the
certificate of approval for the specific investments in approved enterprises. In the
event of failure to comply with these conditions, the benefits may be canceled, and
ScanMaster Ltd. and the Company may be required to refund the amount of the benefits, in
whole or in part, with the addition of linkage differences to the Israeli CPI and
interest.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

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

| | 1) | Loss
before taxes on income is composed as follows:
| | -- | ---------------------------------------------------

|                    | 2004 | 2003 | 2002
|------------------- | ---- | ---- | ----
|
|
|
|
|Domestic            |      |      |     
|Subsidiaries abroad |      |      |     
|                    |      |      |     
|                    |      |      |     
|                    |      |      |     
|                    |      |      |     

F - 38

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 11  TAXES ON INCOME(continued):

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

| | Taxes
on income included in the statement of operations relate to Companys subsidiaries.
| | -----------------------------------------------------------------------------------------

| | e. | Deferred
income taxes
| | -- | ---------------------

| | 1) | The
Company has unutilized carryforward tax losses from prior years. Therefore,           no
current tax liability has been provided in 2004, 2003, and 2002.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Virtually
all the Companys temporary differences are in respect of carryforward tax losses.
The Company expects that during the period in which its tax losses are utilized, its
income would be tax exempt, as described in b(a)1) above. Accordingly, no deferred tax
assets have been included in these financial statements in respect of the Companys
carryforward tax losses.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|                               | December 31, 2004
|------------------------------ | -----------------
|
|
|
|
|Provision for vacation pay     |                  
|Accrued severance pay          |                  
|Carryforward tax losses        |                  
|Research and development costs |                  
|Other                          |                  
|Less - valuation allowance     |                  
|                               |                  
|                               |                  
|                               |                  

The
deferred taxes are computed at the average tax rate of 27%  35%.

F - 39

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 11  TAXES ON INCOME(continued):

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

| | Carryforward
tax losses of the Company and its subsidiaries aggregate approximately $ 22 million
at December 31, 2004, of which approximately $2 million will expire in 2009. A
valuation allowance in the amount of approximately $ 2,080,000 is recorded in respect of
deferred tax assets resulting from ScanMaster and Yuravisions losses (see e above).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Final
tax assessments have been received by the Company through the tax year 2000. ScanMaster
Ltd. and Yuravision received final tax assessments through the tax year 2001 and 1999,
respectively.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# NOTE 12  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 13  LIABILITIES SECURED
BY PLEDGES AND RESTRICTION PLACED IN RESPECT OF LIABILITIES:

| | a. | The
Group 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, and as collateral for guarantees provided to its
customers (see           note 9b2).
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2004, the bank deposits amount to $ 768 thousands, out of which $ 528 thousands
are linked to the dollar and $ 240 thousands are linked to the Euro; the deposits
bear no interest. The deposits are for a period of one Month.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | b. | The
Company has registered floating charges on all of its assets in favor of
               banks, lease companies and Cornell (see notes 8, 9a2), 10a5) and 14c).
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 40

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

# NOTE 14 
SUPPLEMENTARY BALANCE SHEET INFORMATION:

|                                                 | December 31
|------------------------------------------------ | -----------
|
|
|
|
|a. Accounts receivable                           |            
|1) Trade - allowance for doubtful accounts:      |            
|Balance at beginning of year                     |            
|Charged to general and administrative expenses   |            
|Add - allowance for doubtful accounts in         |            
|respect of the acquired subsidiaries (note 2)    |            
|                                                 |            
|Balance at end of year                           |            
|                                                 |            
|2) Other:                                        |            
|Employees                                        |            
|Prepaid expenses                                 |            
|Israeli Government departments and agencies      |            
|Advance to suppliers                             |            
|Sundry                                           |            
|                                                 |            
|                                                 |            
|                                                 |            
|b. Accounts payable and accruals - other:        |            
|Employees and employee institutions              |            
|Israeli Government departments and agencies      |            
|Provision for vacation and recreation pay        |            
|Provision for product warranty                   |            
|Liability for commissions to agents              |            
|Customer advances                                |            
|Commitment to acquire 19% of Yuravision's shares |            
|(see note 2a))                                   |            
|Accrued expenses and sundry                      |            
|                                                 |            
|                                                 |            
|                                                 |            

|                                                                     | 2004
|-------------------------------------------------------------------- | ----
|
|
|
|
|The changes in the balance during the year:                          |     
|Balance at beginning of year                                         |     
|Add - allowance for warranty in respect of the acquired subsidiaries |     
|Product warranties issued for new sales                              |     
|Changes in accrual in respect of pre-existing Warranties             |     
|                                                                     |     
|Balance at end of year                                               |     
|                                                                     |     
|                                                                     |     

F - 41

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 14  SUPPLEMENTARY
BALANCE SHEET INFORMATION(continued):

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

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

|                                                | % interest rateas ofDecember 31, 2004 | December 31
|----------------------------------------------- | ------------------------------------- | -----------
|
|
|
|
|Unlinked credit from bank*                      |                                       |            
|Short-term loans from banks:                    |                                       |            
|Linked to the dollar                            |                                       |            
|Linked to the Euro                              |                                       |            
|Unlinked                                        |                                       |            
|Current maturities of long-term loan from banks |                                       |            
|                                                |                                       |            
|                                                |                                       |            
|                                                |                                       |            

| | In
2003, the Company entered into agreements for bank credit facilities, pursuant to which
the Company may, from time to time, borrow an aggregate amount of up to $ 1,750,000;
to secure the credit facilities, the Company registered a floating fixed charge on
certain bank deposits in favor of the said banks (see note 13a).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                            | December 31
|------------------------------------------- | -----------
|
|
|
|
|d.   Deferred income                        |            
|Revenues to be recognized in future periods |            
|Applicable product costs                    |            
|Warranty and other costs                    |            
|Deferred customer support services          |            
|                                            |            
|                                            |            
|                                            |            

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

|                              | 2004 | 2003 | 2002
|----------------------------- | ---- | ---- | ----
|
|
|
|
|Industrial operations:        |      |      |     
|Materials consumed            |      |      |     
|Payroll and related expenses  |      |      |     
|Subcontracted work            |      |      |     
|Depreciation and amortization |      |      |     
|Other production expenses     |      |      |     
|Royalties                     |      |      |     
|Decrease in inventories:      |      |     
|Finished products             |      |      |     
|Products in process           |      |      |     
|                              |      |      |     
|                              |      |      |     
|                              |      |      |     

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

|Total expenses                                       |  |  |  | 2,616 |   |  | 1,827 |   |  | 1,490 |  
|---------------------------------------------------- |  |  |  | ----- | - |  | ----- | - |  | ----- | -
|L e s s  - grants and participations, see note 9a1). |  |  |  | (160  | ) |  | (396  | ) |  | (150  | )
|                                                     |  |  |  |       |   | 
|                                                     |  |  |  | 2,456 |   |  | 1,431 |   |  | 1,340 |  
|                                                     |  |  |  |       |   | 

F - 42

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 14  SUPPLEMENTARY
BALANCE SHEET INFORMATION(continued):

| | g. | Financial
income (expenses) - net:
| | -- | ----------------------------------

|                                           | 2004 | 2003 | 2002
|------------------------------------------ | ---- | ---- | ----
|
|
|
|
|Income:                                    |      |      |     
|Interest:                                  |      |     
|In respect of bank deposits and securities |      |      |     
|In respect of marketable securities        |      |      |     
|Exchange differences                       |      |      |     
|Other                                      |      |      |     
|                                           |      |      |     
|                                           |      |      |     
|                                           |      |      |     
|Expenses:                                  |      |     
|Interest:                                  |      |     
|In respect of liability to related party   |      |      |     
|In respect of credit from banks            |      |      |     
|In respect of credit from Cornell          |      |      |     
|Exchange differences                       |      |      |     
|Other                                      |      |      |     
|                                           |      |      |     
|                                           |      |      |     
|                                           |      |      |     
|                                           |      |      |     
|                                           |      |      |     

NOTE 15  RELATED PARTIES:

|                                     | 2004 | 2003 | 2002
|------------------------------------ | ---- | ---- | ----
|
|
|
|
|Financing expenses on long-term loan |      |      |     
|granted by shareholder - see note 8a |      |      |     
|                                     |      |      |     

# NOTE 16  BUSINESS
AND GEOGRAPHICAL SEGMENTS

| | a. | General
information:
| | -- | --------------------

| | 1) | Factors
management used to identify the enterprises reportable segments
| | -- | ------------------------------------------------------------------------

| | The
Companys reportable segments are strategic business units that offer different
products and services. They are managed separately because each business requires
different technology and marketing strategies. Most of the businesses were acquired as a
unit, and the management at the time of the acquisition was retained.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Due
to a recent acquisition, the internal organizational structure changed; consequently,
commencing September 2004, the company has three reportable segments:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 43

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 16  BUSINESS AND
GEOGRAPHICAL SEGMENTS(continued):

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

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

| | (c) | Microelectronics
and Display Inspection segment  develop visual           inspection software and
systems for the microelectronics industry and display           industries.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

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

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

|                                     | AutomaticVisionInspection | Non-DestructiveAutomatedInspection | Microelectronicsand DisplayInspection | Total 
|------------------------------------ | ------------------------- | ---------------------------------- | ------------------------------------- | ------
|
|
|
|
|Year ended December 31, 2004:        |                           |                                    |                                       |       
|Revenues from unaffiliated customers |                           |                                    |                                       | 6,322 
|Inter-segment revenues               |                           |                                    |                                       | (70   
|                                     |                           |                                    |                                       |       
|Total Consolidated revenues          |                           |                                    |                                       |       
|                                     |                           |                                    |                                       |       
|Segment Operating income (loss)      |                           |                                    |                                       | (5,603
|Unallocated corporate expenses       |                           |                                    |                                       |       
|                                     |                           |                                    |                                       |       
|Operating loss                       |                           |                                    |                                       |       
|                                     |                           |                                    |                                       |       
|Segment assets                       |                           |                                    |                                       | 5,568 
|Other unallocated amounts            |                           |                                    |                                       |       
|                                     |                           |                                    |                                       |       
|Consolidated assets at the year end  |                           |                                    |                                       |       
|                                     |                           |                                    |                                       |       
|Expenditures for segment assets      |                           |                                    |                                       | 141   
|                                     |                           |                                    |                                       |       
|Depreciation and                     |                           |                                   
|amortization                         |                           |                                    |                                       | 203   
|Other unallocated amounts            |                           |                                    |                                       |       
|                                     |                           |                                    |                                       |       
|Total depreciation and amortization  |                           |                                    |                                       |       
|                                     |                           |                                    |                                       |       
|                                     |                           |                                    |                                       |       

F - 44

---

---



# ELBIT VISION SYSTEMS
LTD.

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (continued)

NOTE 16  BUSINESS AND
GEOGRAPHICAL SEGMENTS(continued):

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

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

|                               | 2004 | 2003 | 2002
|------------------------------ | ---- | ---- | ----
|
|
|
|
|U.S.A                          |      |      |     
|Europe                         |      |      |     
|Other (mainly Japan and China) |      |      |     
|                               |      |      |     
|                               |      |      |     
|                               |      |      |     

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

|                  | 2004 | 2003
|----------------- | ---- | ----
|
|
|
|
|Israel            |      |     
|U.S.A             |      |     
|Republic of Korea |      |     
|                  |      |     
|                  |      |     
|                  |      |     
|                  |      |     

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

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

|           | 2004 | 2003
|---------- | ---- | ----
|
|
|
|
|Customer A |      |     
|Customer B |      |     

NOTE 17  SUBSEQUENT
EVENTS

| | In
May 2005, the Company and Cornell signed an amendment to the Promissory Note that was
signed on August 26, 2004 (see also note 10a5)); ;the agreement will be in effect
commencing that date.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the terms of the amendment, the remainder of the loan will be paid in monthly
installments through December 2006, and will bear an annual interest of Prime + 2% (5.75%
as of May 31, 2005).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 45

---

---