---

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# UNITED STATES 
SECURITIES AND
EXCHANGE COMMISSION 
WASHINGTON, D.C. 20549

# FORM 20-F

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

# OR

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

For the fiscal year
ended December 31, 2004

# OR

|x |  | TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------

# For the transition
period from __________ to __________

# Commission file number
0-49877



# On Track Innovations
Ltd. (Exact Name of
Registrant as Specified in Its Charter)

# ISRAEL 
(Jurisdiction of
Incorporation or Organization)

# Z.H.R Industrial Zone,
Rosh-Pina 12000, Israel

# (Address of Principal
Executive Offices)

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

|                    |                                          
|------------------- | -----------------------------------------
|
|
|
|
|Title of Each Class | Name of Each Exchange On Which Registered
|None                | None                                     

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

# Ordinary Shares, NIS
0.1 nominal value 
(Title of Class)

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

# None 
(Title of Class)

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

# 8,422,175 Ordinary
Shares, NIS 0.1 nominal value.

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.

x  Yes                           o  No

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

Item 17 o      Item 18 x



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# TABLE OF CONTENTS

|                                                                     | Page
|-------------------------------------------------------------------- | ----
|
|
|
|
|ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS        | 1   
|ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE                      | 1   
|ITEM 3. KEY INFORMATION                                              | 1   
|A. SELECTED FINANCIAL DATA                                           | 1   
|B. CAPITALIZATION AND INDEBTEDNESS                                   | 2   
|C. REASONS FOR THE OFFER AND USE OF PROCEEDS                         | 2   
|D. RISK FACTORS                                                      | 2   
|ITEM 4. INFORMATION ON THE COMPANY                                   | 13  
|A. HISTORY AND DEVELOPMENT OF THE COMPANY                            | 13  
|B. BUSINESS OVERVIEW                                                 | 13  
|C. ORGANIZATIONAL STRUCTURE                                          | 29  
|D. PROPERTY, PLANTS AND EQUIPMENT                                    | 31  
|ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS                 | 32  
|A. OPERATING RESULTS                                                 | 32  
|B. LIQUIDITY AND CAPITAL RESOURCES                                   | 37  
|C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC               | 39  
|D. TREND INFORMATION                                                 | 39  
|E. OFF BALANCE SHEET ARRANGEMENTS                                    | 39  
|F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS                     | 39  
|ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                   | 39  
|A. DIRECTORS AND SENIOR MANAGEMENT                                   | 39  
|B. COMPENSATION                                                      | 41  
|C. BOARD PRACTICES                                                   | 43  
|D. EMPLOYEES                                                         | 47  
|E. SHARE OWNERSHIP                                                   | 48  
|ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS            | 50  
|A. MAJOR SHAREHOLDERS                                                | 50  
|B. RELATED PARTY TRANSACTIONS                                        | 51  
|C. INTERESTS OF EXPERTS AND COUNSEL                                  | 52  
|ITEM 8. FINANCIAL INFORMATION                                        | 52  
|A. CONSOLIDATED FINANCIAL STATEMENTS AND OTHER FINANCIAL INFORMATION | 52  
|B. SIGNIFICANT CHANGES                                               | 53  

i

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# TABLE OF CONTENTS 
(continued)

|                                                                                      | Page
|------------------------------------------------------------------------------------- | ----
|
|
|
|
|ITEM 9. THE OFFER AND LISTING                                                         | 53  
|A. OFFER AND LISTING DETAILS                                                          | 53  
|B. PLAN OF DISTRIBUTION                                                               | 54  
|C. MARKETS                                                                            | 54  
|D. SELLING SHAREHOLDERS                                                               | 54  
|E. DILUTION                                                                           | 54  
|F. EXPENSES OF THE ISSUE                                                              | 55  
|ITEM 10. ADDITIONAL INFORMATION                                                       | 55  
|A. SHARE CAPITAL                                                                      | 55  
|B. MEMORANDUM AND ARTICLES OF ASSOCIATION                                             | 55  
|C. MATERIAL CONTRACTS                                                                 | 60  
|D. EXCHANGE CONTROLS                                                                  | 60  
|E. TAXATION                                                                           | 61  
|F. DIVIDENDS AND PAYING AGENTS                                                        | 62  
|G. STATEMENT BY EXPERTS                                                               | 62  
|H. DOCUMENTS ON DISPLAY                                                               | 62  
|I. SUBSIDIARY INFORMATION                                                             | 62  
|ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                   | 62  
|ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                       | 62  
|ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                              | 71  
|ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS | 71  
|ITEM 15. CONTROLS AND PROCEDURES                                                      | 71  
|ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT                                            | 71  
|ITEM 16B. CODE OF ETHICS                                                              | 71  
|ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES                                      | 71  
|ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES                  | 72  
|ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS      | 72  
|ITEM 17. FINANCIAL STATEMENTS                                                         | 73  
|ITEM 18. FINANCIAL STATEMENTS                                                         | 73  
|ITEM 19. EXHIBITS                                                                     | 73  

ii

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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. | SELECTED
FINANCIAL DATA
|-- | -----------------------

The
following selected consolidated statements of operations data for the years ended December
31, 2002, 2003 and 2004, and the selected consolidated balance sheet data as of December
31, 2003 and 2004, have been derived from the audited consolidated financial statements of
On Track Innovations Ltd. (together with its subsidiaries, the Company or
OTI) set forth elsewhere in this annual report. These financial statements
have been prepared in accordance with generally accepted accounting principles in the
United States (U.S. GAAP). The selected consolidated statements of operations
data for the years ended December 31, 2000 and 2001 and the selected consolidated balance
sheet data as of December 31, 2000, 2001 and 2002 have been derived from our audited
consolidated financial statements not included in this annual report, which have also been
prepared in accordance with U.S. GAAP. The selected consolidated financial statements set
forth below should be read in conjunction with and are qualified by reference to our
consolidated financial statements and the related notes, as well as Item
5.  Operating and Financial Review and Prospects, included elsewhere in
this annual report.

Effective
as of June 17, 2002, we consummated a one to ten reverse split of our ordinary shares,
such that each ten ordinary shares of NIS 0.01 par value became one ordinary share of NIS
0.1 par value. All shares, per share, warrants and options amounts in the consolidated
financial statements have been adjusted to give retroactive effect to this reverse share
split for all periods presented.

|                            | Year ended December 31
|--------------------------- | ----------------------
|
|
|
|
|REVENUES                    |                       
|Products                    |                       
|Non-recurring engineering   |                       
|Licensing and transaction   |                       
|fees                        |                       
|Customer service and        |                       
|technical support           |                       
|                            |                       
|Total revenues              |                       
|                            |                       
|COST OF REVENUES            |                       
|Products                    |                       
|Non-recurring engineering   |                       
|Customer service and        |                       
|technical support           |                       
|                            |                       
|Total cost of               |                       
|revenues                    |                       
|                            |                       
|Gross profit                |                       
|                            |                       
|OPERATING EXPENSES          |                       
|Research and development    |                       
|Less  participation by the |                       
|Office of the Chief         |                       
|Scientist                   |                       
|                            |                       
|Research and development,   |                       
|net                         |                       
|Selling and marketing       |                       
|General and administrative  |                       
|Amortization of goodwill    |                       
|and intangible assets       |                       
|Other expenses              |                       



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|                                    | Year ended December 31
|----------------------------------- | ----------------------
|
|
|
|
|
|
|
|Expenses relating to                |                       
|raising of capital                  |                       
|and exchange of                     |                       
|subsidiary's employees              |                       
|equity interest of the              |                       
|Company                             |                       
|                                    |                       
|Total operating                     |                       
|expenses                            |                       
|                                    |                       
|                                    |                       
|Operating loss                      |                       
|                                    |                       
|Financial income (expenses), net    |                       
|Other income (expenses), net        |                       
|                                    |                       
|Loss before taxes                   |                       
|on income                           |                       
|Tax benefit (expenses)              |                       
|                                    |                       
|                                    |                       
|                                    |                       
|Minority interests                  |                       
|                                    |                       
|Net loss                            |                       
|                                    |                       
|Basic and diluted net loss per      |                       
|ordinary share                      |                       
|                                    |                       
|Weighted average number of ordinary |                       
|shares used in computing net loss   |                       
|per ordinary share - basic and      |                       
|diluted                             |                       

|                                           | As of December 31
|------------------------------------------ | -----------------
|
|
|
|
|Balance Sheet Data:                        |                  
|Cash and cash equivalents                  |                  
|Total current assets                       |                  
|Total assets                               |                  
|Total liabilities                          |                  
|Long term loans, net of current maturities |                  
|Total shareholders' equity                 |                  

|B. | CAPITALIZATION
AND INDEBTEDNESS
|-- | -------------------------------

Not
applicable.

|C. | REASONS
FOR THE OFFER AND USE OF PROCEEDS
|-- | -----------------------------------------

Not
applicable.

|D. | RISK
FACTORS
|-- | ------------

This
annual report contains forward-looking statements that involve risks and uncertainties.
The statements contained in this annual report that are not purely historical are
forward-looking statements within the meaning of Section 21E of the Securities Exchange
Act of 1934, as amended (the Exchange Act), including, without limitation,
statements regarding our expectations, beliefs, intentions, goals, plans, investments or
strategies regarding the future and any assumptions underlying any of the foregoing.
Forward-looking statements include statements in (i) Item 4.  Information
on the Company regarding our belief as to increased acceptance of smart-card
technology, expansion of the use of our technology, the impact of our relationship with
technology partners and business partners as well as to our future revenue and the
development of future products and (ii) Item 5.  Operating and Financial
Review and Prospects regarding, among other things, future sources of revenue,
ongoing relationships with current and future end-user customers and resellers, future
costs and expenses, and adequacy of capital resources. Forward-looking statements involve
risks and uncertainties, as well as assumptions that, if they never materialize or prove
incorrect, could cause our actual results to differ materially from such results
discussed in these statements. Many of these risks and uncertainties are described in the
risk factors set forth below in this section and elsewhere in this annual report. All
forward-looking statements included in this document are based on information available
to us on the date hereof, and we assume no obligation to update any such forward-looking
statements.

2

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# RISKS RELATED TO OUR
BUSINESS

WE HAVE A HISTORY OF LOSSES AND
EXPECT TO CONTINUE TO INCUR FULL YEAR LOSSES AT LEAST THROUGH 2005.

We
have incurred losses in each year since we commenced operations in 1990. We reported net
losses of $8.3 million in 2000, $11.7 million in 2001, $6.2 million in 2002, $3.6 million
in 2003 and $9.3 million in 2004. We expect to incur full year losses at least through
2005 as we invest in the expansion of our global marketing network, reduce our product
prices in return for transaction fees based on the volume of transactions effected in
systems that contain our products, enhance our research and development capabilities and
expand our internal manufacturing capabilities.

IF THE MARKET FOR SMART CARDS IN
GENERAL, AND FOR CONTACTLESS MICROPROCESSOR-BASED SMART CARDS IN PARTICULAR, DOES NOT
GROW, SALES OF OUR PRODUCTS MAY NOT GROW AND MAY EVEN DECLINE.

The
success of our products depends on commercial enterprises, governmental authorities and
other potential card issuers adopting contactless microprocessor-based smart card
technologies. Other card technologies, such as magnetic strips or bar codes, are widely
used and could be viewed by potential customers as more cost effective alternatives to our
products. Additionally, potential customers in developed countries such as the United
States may already have installed systems that are based on technologies different from
ours and may therefore be less willing to incur the capital expenditures required to
install or upgrade to a contactless microprocessor-based smart card system. As a result,
we cannot assure you that there will be significant market opportunities for contactless
microprocessor-based smart card products. If demand for contactless microprocessor-based
smart card products such as ours does not develop or develops more slowly than we
anticipate, we may have fewer opportunities for growth than we expect.

IF WE FAIL TO DEVELOP NEW PRODUCTS OR
ADAPT OUR EXISTING PRODUCTS FOR USE IN NEW MARKETS, OUR REVENUE GROWTH MAY BE IMPEDED AND
WE MAY INCUR SIGNIFICANT LOSSES.

To
date, we have sold products incorporating our technology within a limited number of
markets. We are currently developing and marketing products such as medical cards for use
in hospitals and identity cards for use by governmental authorities. We have yet to
recognize revenues from sales of these products. We are devoting significant resources to
developing and marketing these and other products and adapting our existing products for
use in new markets. If we fail to develop new products or adapt our existing products for
new markets, we may not recoup the expenses incurred in our efforts to do so, our revenue
growth may be impeded and we may incur significant losses.

WE HAVE HISTORICALLY DERIVED A
SIGNIFICANT PORTION OF OUR REVENUES FROM SALES TO SYSTEMS INTEGRATORS WHO ARE NOT THE
END-USERS OF OUR PRODUCTS. WE ARE TO A CERTAIN EXTENT DEPENDENT ON THE ABILITY OF THESE
INTEGRATORS TO MAINTAIN THEIR EXISTING BUSINESS AND SECURE NEW BUSINESS.

In
2002, 2003 and 2004, 22%, 28% and 16%, respectively, of our revenues were derived from
sales to systems integrators, who incorporate our products into systems which they supply
and install for use in a specific project. To the extent our revenues depend on the
ability of systems integrators to successfully market, sell, install and provide technical
support for systems in which our products are integrated or to sell our products on a
stand-alone basis, our revenues may decline if the efforts of these systems integrators
fail. Further, the faulty or negligent implementation and installation of our products by
systems integrators may harm our reputation and dilute our brand name. Because we are one
step removed from the end-users of our products, it may be more difficult for us to
rectify damage to our reputation caused by systems integrators who have direct contact
with end-users. In addition, termination of agreements with systems integrators or
revocation of exclusive distribution rights within a certain area can be difficult. If we
are unable to maintain our current relationships with systems integrators or develop
relationships with new systems integrators, we may not be able to sell our products and
our results of operations could be impaired.

Unless
we continue to expand our direct sales, our future success will depend upon the timing and
size of future purchases by systems integrators and the success of the projects and
services for which they use our products.

3

---

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OUR REVENUE GROWTH MAY BE IMPAIRED IF
WE ARE UNABLE TO MAINTAIN OUR CURRENT, AND ESTABLISH NEW, STRATEGIC RELATIONSHIPS.

The
markets for our products are usually highly specialized and require us to enter into
strategic relationships in order to facilitate or accelerate our penetration into new
markets. We consider a relationship to be strategic when we integrate our technology into
some of the product offerings of a manufacturer or systems integrator that has a
significant position in a specified market, and then we cooperate in marketing the
resulting product. The termination of any of our strategic relationships or our failure to
develop additional relationships in the future may limit our ability to expand the markets
in which our products are deployed or to sell particular products.

SOME OF OUR AGREEMENTS MAY IN THE
FUTURE RESTRICT OUR ABILITY TO TAKE ACTIONS THAT WE THEN BELIEVE TO BE DESIRABLE.

In
some of our agreements with suppliers, distributors and joint venture partners, we have
agreed to restrict ourselves in some areas of business for different time periods ranging
from several months to several years. For example, our agreement with Samsung concerning
the development and manufacture of a particular type of microprocessor chip that we refer
to as a monochip requires us not to sell that microprocessor chip to the
existing customers of Samsung. In addition, in some markets we sell our products through
distributors who, in general, have exclusive distribution rights in that market if sales
quotas are met.

WE FACE INTENSE COMPETITION. IF WE
ARE UNABLE TO COMPETE SUCCESSFULLY, OUR BUSINESS PROSPECTS WILL BE IMPAIRED.

We
face intense competition from developers of contact and contactless microprocessor-based
technologies and products, developers of contactless products that use other types of
technologies that are not microprocessor-based, and non-smart card technologies. We
compete on the basis of a range of competitive factors including price, compatibility with
the products of other manufacturers, and the ability to support new industry standards and
introduce new reliable technologies. Many of our competitors, including Philips
Semiconductors, a division of Philips Electronics N.V., and Infineon Technologies AG, have
greater market recognition, larger customer bases, and substantially greater financial,
technical, marketing, distribution, and other resources than we possess. As a result, they
may be able to introduce new products, respond to customer requirements and adapt to
evolving industry standards more quickly than we can. In addition, we may not be able to
differentiate our products sufficiently from those of our competitors.

From
time to time, we or one or more of our present or future competitors may announce new or
enhanced products or technologies that have the potential to replace or shorten the life
cycles of our existing products. The announcement of new or enhanced products may cause
customers to delay or alter their purchasing decisions in anticipation of such products,
and new products developed by our competitors may render our products obsolete or achieve
greater market acceptance than our products.

If
we cannot compete successfully with our existing and future competitors, we could
experience lower sales, price reductions, loss of revenues, reduced gross margins and
reduced market share.

IF THERE IS A SUSTAINED INCREASE IN
DEMAND FOR MICROPROCESSORS, AVAILABILITY MIGHT BE LIMITED AND PRICES MIGHT INCREASE.

Our
products require microprocessors. The microprocessor industry periodically experiences
increased demand and limited availability due to production capacity constraints.
Increased demand for, or limited availability of, microprocessors could substantially
increase the cost of producing our products. Because some of our customer contracts have
fixed prices, we may not be able to pass on any increases in costs to these customers, and
consequently our profit margin could be reduced.

In
addition, as a result of a shortage, we may be compelled to delay shipments of our
products, or devote additional resources to maintaining higher levels of microprocessor
inventory. Consequently, we may experience substantial period-to-period fluctuations in
our cost of revenues and, therefore, in our future results of operations.

4

---

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OUR PRODUCTS HAVE LONG DEVELOPMENT
CYCLES AND WE MAY EXPEND SIGNIFICANT RESOURCES IN RELATION TO A SPECIFIC PROJECT WITHOUT
REALIZING ANY REVENUES.

The
development cycle for our products varies from project to project. Typically, the projects
in which we are involved are complex and require that we customize our products to our
customers needs and specifications in return for payment of a fixed amount. We then
conduct evaluation, testing, implementation and acceptance procedures of the customized
products with the customer. Only after successful completion of these procedures will
customers place orders for our products in commercial quantities. In addition, our
contracts do not typically include minimum purchase requirements. We, therefore, cannot
assure you that contracts into which we enter will result in commercial sales. Our average
development cycle is typically between 12 and 18 months from initial contact with a
potential customer until we deliver commercial quantities to the customer and recognize
significant revenues. As a result, we may expend financial, management and other resources
to develop customer relationships before we recognize any revenues.

FLUCTUATIONS IN OUR QUARTERLY
FINANCIAL PERFORMANCE MAY CREATE VOLATILITY IN THE MARKET PRICE OF OUR SHARES AND MAY MAKE
IT DIFFICULT TO PREDICT OUR FUTURE PERFORMANCE.

Our
quarterly revenues and operating results have varied in the past and are likely to do so
in the future. These fluctuations may be driven by various factors which are beyond our
control, are difficult to predict and may not meet the expectations of analysts and
investors. These factors include:

| |  | the
size and timing of orders placed by our customers, particularly in government projects.
Government projects typically involve a protracted competitive procurement process and in
some circumstances litigation following the award of a contract. As a result, it is
difficult to predict the timing and size of orders under such contracts. For example, we
started to prepare our offer for the Israeli national electronic parking system project
in 1992, we were awarded the contract in May 1998 and deployment began in January 2000.
We started recognizing revenues in the second half of 2000.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
fact that our rental and financing expenses are fixed and we may not be able to reduce
them in the event of a reduction in revenues in a particular quarter. In addition, our
payroll expenses are relatively fixed and we would not expect to reduce our workforce due
to a reduction in revenues in any particular quarter.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
tendency of our clients to place orders for products toward the last quarter of their
financial year.
| | - | ---------------------------------------------------------------------------------------------------------

Because
of these factors, our revenues and operating results in any quarter may not be indicative
of our future performance, and it may be difficult for you to evaluate our prospects.

DELAYS OR DISCONTINUANCE OF THE
SUPPLY OF COMPONENTS MAY HAMPER OUR ABILITY TO PRODUCE OUR PRODUCTS ON A TIMELY BASIS AND
CAUSE SHORT-TERM ADVERSE EFFECTS.

The
components we use in our products, including microprocessors and cards, are supplied by
third party suppliers and manufacturers. Except for Samsung, currently the sole supplier
of the chip that integrates our antenna interface into Samsungs microprocessor, none
of these suppliers is a sole supplier. Nevertheless, we sometimes experience short-term
adverse effects due to delayed shipments that have in the past interrupted and delayed,
and could in the future interrupt and delay, the supply of our products to our customers,
and may result in cancellation of orders for our products. In addition, we do not
generally have long term supply contracts under which our suppliers are committed to
supply us with components at a fixed price. Suppliers could increase component prices
significantly without warning or could discontinue the manufacture or supply of components
used in our products. We may not be able to develop alternative sources for product
components if and as required in the future. Even if we are able to identify alternative
sources of supply, we may need to modify our products to render them compatible with other
components. This may cause delays in product shipments, increase manufacturing costs and
increase product prices.

Because
some of our suppliers are located in Europe and the Far East, we may experience logistical
problems in our supply chain, including long lead times for receipt of products or
components and shipping delays. In addition, our subcontractors located in Israel and the
Far East may, on occasion, feel the impact of potential economic or political instability
in their regions, which could affect their ability to supply us with components for our
products in a timely manner.

5

---

---



IF WE FAIL TO HIRE, TRAIN AND RETAIN
QUALIFIED RESEARCH AND DEVELOPMENT PERSONNEL, OUR ABILITY TO ENHANCE OUR EXISTING
PRODUCTS, DEVELOP NEW PRODUCTS AND COMPETE SUCCESSFULLY MAY BE MATERIALLY AND ADVERSELY
AFFECTED.

Our
success depends in part on our ability to hire, train and retain qualified research and
development personnel. Individuals who have expertise in research and development in our
industry are scarce. Competition for such personnel in the electronics industry is
intense, particularly in Israel. Consequently, hiring, training and retaining such
personnel is both time consuming and expensive. In addition, it may be difficult to
attract qualified personnel to Rosh Pina, which is in the North of Israel. If we fail to
hire, train and retain employees with skills in research and development, we may not be
able to enhance our existing products or develop new products.

OUR ABILITY TO COMPETE DEPENDS ON OUR
CONTINUING RIGHT TO USE, AND OUR ABILITY TO PROTECT, OUR INTELLECTUAL PROPERTY RIGHTS.

Our
success and ability to compete depend in large part on using our intellectual property and
proprietary rights to protect our technology and products. We rely on a combination of
patent, trademark, copyright and trade secret law, as well as confidentiality agreements
and other contractual relationships with our employees, customers, affiliates,
distributors and others. While substantially all of our employees are subject to
non-compete agreements, these agreements may be difficult to enforce as a result of
Israeli law limiting the scope of employee non-competition undertakings.

We
currently have patents in the United States, Israel and other countries covering some of
our technology and have pending applications in the United States, Europe, Israel and
elsewhere which have not yet resulted in granted patents. We cannot be certain that
patents will be issued with respect to any of our pending or future patent applications or
that the scope of our existing patents, or any future patents that are issued to us, will
provide us with adequate protection for our technology and products. Others may challenge
our patents or registered trademarks. We do not know whether any of them will be upheld as
valid or will be enforceable against alleged infringers. Thus we do not know whether they
will enable us to prevent or hinder the development of competing products or technologies.
Moreover, patents provide legal protection only in the countries where they are registered
and the extent of the protection granted by patents varies from country to country.

The
measures we have taken to protect our technology and products may not be sufficient to
prevent their misappropriation by third parties or independent development by others of
similar technologies or products. Competitors may also develop competing technology by
designing around our patents and thereafter manufacturing and selling products that
compete directly with ours.

In
order to protect our technology and products and enforce our patents and other proprietary
rights, we may need to initiate, prosecute or defend litigation and other proceedings
before courts and patent and trademark offices in numerous countries. These legal and
administrative proceedings could be expensive and could occupy significant management time
and resources.

OUR PRODUCTS MAY INFRINGE THE
INTELLECTUAL PROPERTY RIGHTS OF OTHERS.

It
is not always possible to know with certainty whether or not the manufacture and sale of
our products does or will infringe patents or other intellectual property rights owned by
third parties. For example, patent applications may be pending at any time which, if
granted, cover products that we developed or are developing. In certain jurisdictions, the
subject matter of patents is not published until the patents are issued. Third parties may
from time to time claim that our products infringe their patent or other intellectual
property rights. In addition, if third parties claim that our customers are violating
their intellectual property rights, our customers may seek indemnification from us (which
could be costly), or may terminate their relationships with us. Our products depend on
operating systems licensed to us and we may also be subject to claims by third parties
that our use of these operating systems infringes their intellectual property rights. Any
intellectual property claim could involve time-consuming and disruptive litigation that,
if determined adversely to us, could prevent us from making or selling our products,
subject us to substantial monetary damages or require us to seek licenses.

Intellectual
property rights litigation is complex and costly, and we cannot be sure of the outcome of
any litigation. Even if we prevail, the cost of litigation could harm our results of
operations. In addition, litigation is time consuming and could divert our
managements attention and resources away from our business. If we do not prevail in
any litigation, in addition to any damages we might have to pay, we might be required to
discontinue the use of certain processes, cease the manufacture, use and sale of
infringing products and solutions, expend significant resources to develop non-infringing
technology or obtain licenses on unfavorable terms. Licenses may not be available to us on
acceptable terms or at all. In addition, some licenses are non-exclusive and, therefore,
our competitors may have access to the same technology licensed to us. If we fail to
obtain a required license or cannot design around any third party patents or otherwise
avoid infringements, we may be unable to sell some of our products.

6

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---



THE LOSS OF THE SERVICES OF OUR
CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER, ODED BASHAN, COULD SERIOUSLY HARM OUR
BUSINESS.

Our
success depends, in part, on the continued service of Oded Bashan, our Chairman, President
and Chief Executive Officer. Mr. Bashan is one of our founders and has developed our
business and technology strategy since our inception. The loss of services of Mr. Bashan
could disrupt our operations and harm our business.

IN THE PAST FIVE YEARS WE HAVE
ACQUIRED SEVERAL COMPANIES OR GROUPS OF COMPANIES AND WE INTEND TO CONTINUE TO PURSUE
STRATEGIC ACQUISITIONS IN THE FUTURE. THE FAILURE TO SUCCESSFULLY INTEGRATE ACQUIRED
COMPANIES AND BUSINESSES OR TO ACQUIRE NEW COMPANIES AND BUSINESSES MAY HARM OUR FINANCIAL
PERFORMANCE AND GROWTH.

In
the past five years we have acquired the SoftChip group, an Israeli designer of
microprocessors and operating systems for smart cards, InterCard Systemelectronic GmbH
(InterCard Systemelectronic), a German company that provides OEM and
electronics manufacturing services, and, most recently, ASEC Spolka Akcyjna
(ASEC), a Polish company that develops, manufactures and markets card readers
and reader modules based on radio frequency identification technologies. We paid for all
four of these acquisitions through the issuance of our ordinary shares. These and future
acquisitions could result in:

| |  | difficulties
in integrating our operations, technologies, products and services with those of the
acquired               companies;
| | - | -----------------------------------------------------------------------------------------------------------------------------------

| |  | difficulty
in integrating operations that are spread across significant geographic distances;
| | - | ---------------------------------------------------------------------------------------------

| |  | diversion
of our capital and our management's attention away from other business issues;
| | - | ----------------------------------------------------------------------------------------

| |  | potential
loss of key employees and customers of companies we acquire;
| | - | ----------------------------------------------------------------------

| |  | increased
liabilities as a result of liabilities of the companies we acquire; and
| | - | ---------------------------------------------------------------------------------

| |  | dilution
of shareholdings in the event we acquire companies in exchange for our shares.
| | - | ---------------------------------------------------------------------------------------

We
may not successfully integrate any technologies, manufacturing facilities or distribution
channels that we have or may acquire and we cannot assure you that any of our recent
acquisitions will be successful. In addition, if we do not acquire new companies and
businesses in the future, our business may not grow as expected. If any of our recent or
future acquisitions are not successful, our financial performance and business may be
adversely affected.

WE ARE SUSCEPTIBLE TO CHANGES IN
INTERNATIONAL MARKETS AND DIFFICULTIES WITH INTERNATIONAL OPERATIONS COULD HARM OUR
BUSINESS.

Over
the last five years, we have derived revenues from different geographical areas. The
following table sets forth our sales in different geographical areas as a percentage of
revenues:

|     | Africa | Europe | Far East | North America | South America | Israel
|---- | ------ | ------ | -------- | ------------- | ------------- | ------
|
|
|
|
|2000 |        |        |          | 8             |               |       
|2001 |        |        |          | 6             |               |       
|2002 |        |        |          | 13            |               |       
|2003 |        |        |          | 15            |               |       
|2004 |        |        |          | 11            |               |       

* Less than 1%

7

---

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Our
ability to maintain our position in existing markets and to penetrate new, regional and
local markets, is dependent, in part, on the stability of regional and local economies.
Our regional sales may continue to fluctuate widely and may be adversely impacted by
future political or economic instability in these or other foreign countries or regions.

In
addition, there are inherent risks in these international operations which include:

| |  | changes
in regulatory requirements and communications standards;
| | - | ----------------------------------------------------------------

| |  | required
licenses, tariffs and other trade barriers;
| | - | ----------------------------------------------------

| |  | difficulties
in enforcing intellectual property rights across, or having to litigate disputes in,
various               jurisdictions;
| | - | --------------------------------------------------------------------------------------------------------------------------------------

| |  | difficulties
in staffing and managing international operations;
| | - | ---------------------------------------------------------------

| |  | potentially
adverse tax consequences; and
| | - | -----------------------------------------

| |  | the
burden of complying with a wide variety of complex laws and treaties in various
jurisdictions.
| | - | --------------------------------------------------------------------------------------------------

If
we are unable to manage the risks associated with our focus on international sales, our
business may be harmed.

BECAUSE WE REPORT IN DOLLARS WHILE A
PORTION OF OUR REVENUES AND EXPENSES ARE INCURRED IN OTHER CURRENCIES, CURRENCY
FLUCTUATIONS COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.

Our
functional and reporting currency is the U.S. dollar. We generate a significant portion of
our revenues in U.S. dollars but we incur a large portion of our expenses in other
currencies, principally some employees salaries in NIS and the majority of the
expenses of our German InterCard Systemelectronic subsidiary in Euros. To the extent that
we and our subsidiaries based in Israel and Germany conduct our business in different
currencies, our revenues and expenses and, as a result, our assets and liabilities are not
necessarily in the same currency. We are, therefore, exposed to foreign exchange rate
fluctuations. These fluctuations may negatively affect our results of operations. Our
operations also could be adversely affected if we are unable to limit our exposure to
currency fluctuations in the future. Accordingly, we may enter into currency hedging
transactions to decrease the risk of financial exposure to fluctuations in the exchange
rate of the U.S. dollar against the NIS.

However,
these measures may not adequately protect us from material adverse effects resulting from
currency fluctuations. In addition, if we wish to maintain the dollar-denominated value of
sales made in other currencies, any devaluation of the other currencies relative to the
U.S. dollar would require us to increase our other currency denominated sales price. That
could cause our customers to cancel or decrease orders.

WE MAY HAVE TO ADAPT OUR PRODUCTS IN
ORDER TO INTEGRATE THEM INTO OUR CUSTOMERS SYSTEMS OR IF NEW GOVERNMENT REGULATIONS
OR INDUSTRY STANDARDS ARE ADOPTED OR CURRENT REGULATIONS OR STANDARDS ARE CHANGED.

Some
of our products are subject to government regulation in the countries in which they are
used. For example, card readers that are used in the United States and in Europe require
certification of compliance with regulations of the Federal Communications Commission and
the European Telecommunications Standards Institute, respectively, regarding emission
limits of radio frequency devices. In addition, governmental certification for the systems
into which our products are integrated may be required. The International Standards
Organization is in the process of approving industry standards regulating the transfer of
data between contactless smart cards and a reader. If there is a change in government
regulations or industry standards, we may have to make significant modifications to our
products and, as a result, could incur significant costs and may be unable to deploy our
products in a timely manner.

In
addition, prior to purchasing our products, some customers may require us to receive or
obtain a third party certification, or occasionally certify ourselves, that our products
can be integrated successfully into their systems or comply with applicable regulations.
Receipt of third party certifications may not occur in a timely manner or at all. In some
cases, in order for our products, or for the system into which they are integrated, to be
certified, we may have to make significant product modifications. Failure to receive third
party certifications could render us unable to deploy our products in a timely manner or
at all.

8

---

---



OUR PRODUCTS MAY CONTAIN DEFECTS THAT
ARE ONLY DISCOVERED AFTER THE PRODUCTS HAVE BEEN DEPLOYED. THIS COULD HARM OUR REPUTATION,
RESULT IN LOSS OF CUSTOMERS AND REVENUES AND SUBJECT US TO PRODUCT LIABILITY CLAIMS.

Our
products are highly technical and deployed as part of large and complex projects. Because
of the nature of our products, they can only be fully tested when fully deployed. For
example, the testing of our parking payment product required the distribution of sample
parking payment cards to drivers, installation of electronic kiosks at which a card holder
can increase the balance on his or her card, linking of kiosks to financial and parking
databases, collection of data through handheld terminals, processing of data that is
collected by the system, compilation of reports and clearing of parking transactions. Any
defects in our products could result in:

| |  | harm
to our reputation;
| | - | -----------------------

| |  | loss
of, or delay in, revenues;
| | - | -------------------------------

| |  | loss
of customers and market share;
| | - | -----------------------------------

| |  | failure
to attract new customers or achieve market acceptance for our products; and
| | - | -----------------------------------------------------------------------------------

| |  | unexpected
expenses to remedy errors.
| | - | -------------------------------------

In
addition, we could be exposed to potential product liability claims. While we currently
maintain product liability insurance, we cannot assure you that this insurance will be
sufficient to cover any successful product liability claim. Any product liability claim
could result in changes to our insurance policies, including premium increases or the
imposition of a large deductible or co-insurance requirements. Any product liability claim
in excess of our insurance coverage would have to be paid out of our cash reserves.
Furthermore, the assertion of product liability claims, regardless of the merits
underlying the claim, could result in substantial costs to us, divert managements
attention away from our operations and damage our reputation.

TERRORIST ATTACKS MAY HAVE A MATERIAL
ADVERSE EFFECT ON OUR OPERATING RESULTS.

Terrorist
attacks and other acts of violence or war may affect the financial markets on which our
ordinary shares trade, the markets in which we operate, our operations and profitability
and your investment. These attacks or subsequent armed conflicts resulting from or
connected to them may directly impact our physical facilities or those of our suppliers or
customers. Furthermore, these terrorist attacks may make travel and the transportation of
our supplies and products more difficult and/or expensive and ultimately affect the sales
of our products.

# RISKS RELATED TO OUR
ORDINARY SHARES

OUR SHARE PRICE HAS FLUCTUATED IN THE
PAST AND MAY CONTINUE TO FLUCTUATE IN THE FUTURE.

The
market price of our ordinary shares has experienced significant fluctuations and may
continue to fluctuate significantly. The market price of our ordinary shares may be
significantly affected by factors such as the announcements of new products or product
enhancements by us or our competitors, technological innovations by us or our competitors
or quarterly variations in our results of operations. In addition, any statements or
changes in estimates by analysts covering our shares or relating to the smart card
industry could result in an immediate effect, that may be adverse on the market price of
our shares.

Trading
in shares of companies listed on the Nasdaq National Market and the Prime Standard Segment
of the Frankfurt Stock Exchange in general and trading in shares of technology companies
in particular has been subject to extreme price and volume fluctuations that have been
unrelated or disproportionate to operating performance. These factors may depress the
market price of our ordinary shares, regardless of our actual operating performance.

Securities
litigation has also often been brought against companies following periods of volatility
in the market price of its securities. In the future, we may be the target of similar
litigation that could result in substantial costs and diversion of our managements
attention and resources.

9

---

---



OUR SHARE PRICE COULD BE ADVERSELY
AFFECTED BY FUTURE SALES OF OUR ORDINARY SHARES.

As
of April 30, 2005, we have outstanding 8,854,980 ordinary shares, warrants to purchase
1,065,748 additional ordinary shares at a weighted average exercise price of $13.20 per
share and options to purchase 3,297,057 additional ordinary shares at a weighted average
exercise price of $7.74 per share. During 2004, we filed several registration statements
registering the resale of a total of 6,479,016 ordinary shares, including ordinary shares
issuable upon exercise of options and warrants and shares that may be issuable pursuant to
the earn-out provisions of the share purchase agreement that we entered into with Nextel
in connection with the ASEC acquisition. We may in the future sell or issue additional
ordinary shares. The market price of our ordinary shares could drop as a result of sales
of substantial amounts of our ordinary shares in the public market or the perception that
such sales may occur, including sales or perceived sales by our directors, officers or
principal shareholders. These factors could also make it more difficult to raise
additional funds through future offerings of our ordinary shares or other securities.

WE CANNOT PREDICT THE FURTHER IMPACT
ON THE PRICE OF OUR ORDINARY SHARES FOLLOWING OUR RESTATEMENT IN AUGUST 2002 OF CERTAIN OF
OUR FINANCIAL STATEMENTS OR THE EXTENT OF THE POTENTIAL CLAIMS THAT MAY BE ASSERTED
AGAINST US.

We
reevaluated our accounting treatment of certain past transactions and restated our
financial statements for the fiscal years ended December 31, 1999, December 31, 2000 and
December 31, 2001. We filed our restated financial statements in accordance with
requirements in Germany where our ordinary shares were listed at that time. The market for
our ordinary shares in Germany was adversely affected by our restatement and the adverse
effect in Germany may have an adverse impact on the value of our ordinary shares listed on
the Nasdaq National Market. Our share price may be adversely affected by the threat of
litigation based upon our restatement and the recovery by plaintiffs in any litigation
actually commenced against us.

IF OUR ORDINARY SHARES ARE EVER
CONSIDERED A PENNY STOCK, ANY INVESTMENT IN OUR ORDINARY SHARES WILL BE CONSIDERED A
HIGH-RISK INVESTMENT AND BECOME SUBJECT TO RESTRICTIONS ON MARKETABILITY.

If
the bid price of our ordinary shares falls below $5.00 and we fail to maintain our Nasdaq
listing, our ordinary shares may be deemed a penny stock for the purposes of
the Exchange Act. The bid price of our ordinary shares as of April 30, 2005 was $11.75 but
was less than $5.00 from February 26, 2003 until October 22, 2003. We continue to maintain
our Nasdaq listing. Brokers effecting transactions in a penny stock are subject to
additional customer disclosure and record keeping obligations. The additional obligations
include disclosure of the risks associated with low price stocks, stock quote information
and broker compensation. In addition, brokers making transactions in penny stocks are
subject to additional sales practice requirements under the Exchange Act. These additional
requirements include making inquiries into the suitability of penny stock investments for
each customer or obtaining the prior written agreement of the customer for the penny stock
purchase. Because of these additional obligations, some brokers will not effect
transactions in penny stocks. If our shares are deemed a penny stock in the
future, this designation could have an adverse effect on the liquidity of our ordinary
shares and your ability to sell our ordinary shares.

OUR SHAREHOLDERS COULD EXPERIENCE
DILUTION OF THEIR OWNERSHIP INTEREST BY REASON OF OUR ISSUING MORE SHARES THAT ARE
PURCHASED BY THIRD PARTIES.

Under
Israeli law, shareholders in public companies do not have preemptive rights. This means
that our shareholders do not have the legal right to purchase shares in a new issue before
they are offered to third parties. In addition, our board of directors may approve the
issuance of shares in many instances without shareholders approval. As a result, our
shareholders could experience dilution of their ownership interest by reason of our
raising additional funds through the issuance of more shares that are purchased by third
parties. The weighted average price per share at which we sold shares during 2003 and
during 2004 was $4.40 and $11.64, respectively. In addition, we may continue to acquire
companies or businesses in exchange for our shares, resulting in dilution of your
shareholding.

10

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---



WE DO NOT ANTICIPATE PAYING CASH
DIVIDENDS IN THE FORESEEABLE FUTURE.

We
have never declared or paid cash dividends and we do not anticipate paying cash dividends
in the foreseeable future. We intend to retain all future earnings to fund the development
of our business. In addition, because we have received benefits under Israeli law for our
Approved Enterprises, payment of a cash dividend may create additional tax
liabilities for us.

OUR CONCENTRATION OF VOTING POWER
WILL LIMIT YOUR ABILITY TO INFLUENCE OR CONTROL CORPORATE ACTIONS.

Oded
Bashan currently has the right to vote approximately 12.74% of our outstanding shares by
reason of his ownership of 934,925 of our outstanding shares and his holding proxies to
vote 287,388 additional ordinary shares that are owned by others. He therefore has
substantial voting power in comparison to our other shareholders and, accordingly, his
vote in the shareholders meetings may influence the outcome of such meetings.

OUR UNITED STATES INVESTORS COULD
SUFFER ADVERSE TAX CONSEQUENCES IF WE ARE CHARACTERIZED AS A PASSIVE FOREIGN INVESTMENT
COMPANY.

We
cannot assure you that we will not be treated as a passive foreign investment company for
2004 or future years. We could be a passive foreign investment company if 75% or more of
our gross income in a taxable year is passive income. We would also be a passive foreign
investment company if at least 50% of the average value, or possibly the adjusted bases of
our assets in particular circumstances, of our assets in a taxable year produce, or are
held for the production of, passive income. Passive income includes interest, dividends,
royalties, rents and annuities. If we are or become a passive foreign investment company,
many of our U.S. shareholders may be subject to adverse tax consequences.

# RISKS RELATED TO ISRAEL

CONDITIONS IN ISRAEL MAY HARM OUR
ABILITY TO PRODUCE AND SELL OUR PRODUCTS AND SERVICES AND MAY ADVERSELY AFFECT OUR SHARE
PRICE.

Our
principal executive offices and research and development facilities, as well as some of
our suppliers, are located in Israel. Political, economic and military conditions in
Israel directly affect our operations. Since the establishment of the State of Israel in
1948, a number of armed conflicts have taken place between Israel and its Arab neighbors.
A state of hostility, varying in degree and intensity, has led to security and economic
problems for Israel. Despite the progress towards peace between Israel and its Arab
neighbors, the future of these peace efforts remains uncertain. Since October 2000, there
has been a substantial deterioration in the relationship between Israel and the
Palestinian Authority and a significant increase in violence, primarily in the West Bank
and Gaza Strip. The ongoing violence between Israel and the Palestinians or any future
armed conflicts, political instability or continued violence in the region would likely
have a negative effect on our business condition, harm our results of operations and
adversely affect the share price of publicly traded Israeli companies such as us. In
addition, Israels economy has been subject to numerous destabilizing factors,
including a period of rampant inflation in the early to mid-1980s, low foreign exchange
reserves, fluctuations in world commodity prices, military conflicts and civil unrest.
Furthermore, several countries still restrict business with Israel and Israeli companies,
which may limit our ability to make sales in those countries. These restrictions may have
an adverse impact on our operating results, financial condition or the expansion of our
business.

OUR OPERATIONS COULD BE DISRUPTED AS
A RESULT OF THE OBLIGATION OF KEY PERSONNEL TO PERFORM ISRAELI MILITARY SERVICE.

Some
of our executive officers and employees must perform annual military reserve duty in
Israel and may be called to active duty at any time under emergency circumstances. Our
operations could be disrupted by the absence for a significant period of one or more of
our executive officers or other key employees due to military service. Any disruption to
our operations would harm our business.

11

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THE ISRAELI GOVERNMENT PROGRAMS AND TAX BENEFITS IN WHICH WE CURRENTLY
PARTICIPATE OR WHICH WE CURRENTLY
RECEIVE REQUIRE US TO MEET SEVERAL CONDITIONS AND MAY BE TERMINATED OR REDUCED IN THE
FUTURE. THIS COULD INCREASE OUR COSTS OR TAXES.

We
are entitled to tax benefits under Israeli government programs, largely as a result of the
Approved Enterprise status granted to some of our capital investment programs
by the Israeli Ministry of Industry and Trade. Taxable income derived from each program is
tax exempt for a period of ten years beginning in the year in which the program first
generates taxable income, up to 14 years from the date of approval or 12 years from the
date of the beginning of production. Without such benefits our taxable income from such
programs would be taxed at the regular corporate tax rate (34% in 2005, 32% in 2006 and
30% in 2007 and thereafter). To maintain our eligibility for these tax benefits, we must
continue to meet conditions, including making specified investments in property, plants
and equipment, 30% of which must be from paid-in capital. We cannot assure you that we
will continue to receive these tax benefits at the same rate or at all. From time to time,
we submit requests for expansion of our approved enterprise programs. These requests might
not be approved. The termination or reduction of these programs and tax benefits could
increase our taxes and could have a material adverse effect on our business. The authority
of the Investment Center Administration under the Law for Encouragement of Capital
Investments, 1959, to approve new programs will expire on December 31, 2007. Accordingly,
requests for new programs or expansions that are not approved by December 31, 2007 will
not confer any tax benefits, unless the term of the law is extended. The termination or
reduction of these tax benefits could harm our results of operations.

IT MAY BE DIFFICULT TO ENFORCE A
UNITED STATES JUDGMENT AGAINST US, OUR OFFICERS AND DIRECTORS OR TO ASSERT UNITED STATES
SECURITIES LAW CLAIMS IN ISRAEL.

We
are incorporated in Israel. Most of our executive officers and directors and the Israeli
experts named in this prospectus are non residents of the United States and a substantial
portion of our assets and the assets of these persons are located outside of the United
States. Therefore, it may be difficult for an investor, or any other person or entity, to
enforce a United States court judgment based upon the civil liability provisions of the
United States federal securities laws in an Israeli court against us or any of these
persons or to effect service of process upon these persons in the United States.
Additionally, it may be difficult for an investor, or any other person or entity, to
enforce civil liabilities under United States federal securities laws in original actions
instituted in Israel.

PROVISIONS OF ISRAELI LAW MAY DELAY,
PREVENT OR MAKE UNDESIRABLE AN ACQUISITION OF ALL OR A SIGNIFICANT PORTION OF OUR SHARES
OR ASSETS.

Israeli
corporate law regulates acquisitions of shares through tender offers, requires special
approvals for transactions involving significant shareholders and regulates other matters
that may be relevant to these types of transactions. These provisions of Israeli law could
have the effect of delaying or preventing a change in control and may make it more
difficult for a third party to acquire us, even if doing so would be beneficial to our
shareholders. These provisions may limit the price that investors may be willing to pay in
the future for our ordinary shares. Furthermore, Israeli tax considerations may make
potential transactions undesirable to us or to some of our shareholders.

# SPECIAL NOTE REGARDING
FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA

This
annual report includes forward-looking statements. We have based these forward-looking
statements on our current expectations and projections about future events.

Words
such as believe, anticipate, expect,
intend, seek, will, plan,
could, may, project, goal,
target and similar expressions often identify forward-looking statements but
are not the only way we identify these statements.

These
forward-looking statements involve risks, uncertainties, assumptions and other factors
that could cause our actual results to differ materially from future results expressed or
implied by the forward-looking statements. Important factors that could cause actual
results to differ materially from the information set forth in any forward-looking
statements include the risk factors described in Risk Factors above and other
factors discussed elsewhere in this annual report.

Many
of these factors are beyond our ability to control or predict. You should not assume that
forecasts and anticipated events will occur, or that our expectations and plans will not
change. We do not have any intention to update forward-looking statements after we
distribute this annual report unless we are required to do so under U.S. federal
securities laws or other applicable laws.

12

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

|A. | HISTORY
AND DEVELOPMENT OF THE COMPANY
|-- | --------------------------------------

We
were incorporated under the laws of the State of Israel on February 15, 1990, under the
name of De-Bug Innovations Ltd. Our name was changed to On Track Innovations Ltd. on July
8, 1991.

Our
address is Z.H.R Industrial Zone, Rosh-Pina 12000, Israel. Our telephone number is
011-972-4-686-8000. In 1998 we established a wholly-owned subsidiary in the United States,
OTI America, Inc., a New Jersey corporation. OTI America, Inc. is located at 2 Executive
Drive Suite 740, Fort Lee, New Jersey 07024, and its telephone number is 1 (201) 944-3233.
Copies of this annual report and other documents incorporated herein by reference can be
obtained on our website, www.otiglobal.com, or upon request from our Director of Corporate
Communication, Ms. Galit Mendelson, at the following telephone number: 1 (201) 944-5200
(#111).

On
December 30, 1999, we acquired all of the outstanding shares of City Smart Ltd., a
Hong-Kong based systems integrator in exchange for 6,686 of our ordinary shares (which, as
of that date, had an aggregate market value of approximately $451,300). On January 28,
2000, we acquired all of the outstanding shares of SoftChip Israel Ltd. and SoftChip
Technologies (3000) Ltd., each an Israel-based developer and designer of microprocessors
and operating systems for smart cards, in exchange for 12,119 of our ordinary shares
(which, as of that date, had an aggregate market value of approximately $1.3 million). On
February 2, 2000, we entered into an agreement with an indirect wholly-owned subsidiary of
Cheung Kong Infrastructure Ltd., a Hong Kong-based infrastructure company, to establish
the e-Smart System joint venture in Hong Kong to, among other things, be the exclusive
distributor for our products in Greater China. In connection therewith, we contributed
$3.1 million to the joint venture. On June 15, 2000 and in January 2001, we acquired 51%
and the remaining 49%, respectively, of the nominal share capital of two related German
companies, Intercard Kartensysteme GmbH and InterCard Systemelectronic GmbH, the former of
which is a systems integrator for smart card systems and the latter of which is a
manufacturer of electronic devices, for an aggregate purchase price of $5.8 million. In
June 2004, we sold our 50% stake in our e-Smart System joint venture to our partner. On
October 1, 2004 we completed the acquisition of ASEC, a Polish company that develops,
manufactures and markets card readers and reader modules , for a purchase price of
approximately $1.6 million, which was paid through the issuance of 186,264 of our ordinary
shares. In addition, the ASEC share purchase agreement provides for the payment of up to
an additional $350,000 to Nextel in the event that specified performance criteria are met
by ASEC for the years ended December 31, 2004 and 2005. In October 2004, we sold our
InterCard Kartensysteme subsidiary for approximately $2.5 million. For additional
information concerning these transactions, see C.  Organizational
Structure below, and note 7 to our consolidated financial statements included
elsewhere in this annual report.

|B. | BUSINESS
OVERVIEW
|-- | -----------------

# General

Since
our incorporation in 1990, we have designed, developed and sold contactless
microprocessor-based smart card products. Because our cards contain a microprocessor, they
can store and process information and run multiple applications. Our cards are referred to
as contactless because they do not require physical contact with a card
reader, as power and data are transferred to a card through a magnetic field generated by
a card reader. Our products combine the benefits of both microprocessors and contactless
cards. We believe that we are one of the first companies to deploy contactless
microprocessor-based smart card products for commercial use. In addition to contactless
microprocessor-based smart cards, we also sell products that are based on other card
technologies.

Since
our incorporation in 1990, we have focused on the development of our core technologies and
our OTI Platform-based products. We currently offer four lines of products, each of which
constitutes a complete system, as well as components (such as smart cards and readers)
that we sell to original equipment manufacturers, or OEMs, for incorporation into their
own products. Our four complete system product lines include:

| |  | Micropayments
Solutions, including the PayPass system that we are installing for
MasterCard, our EasyPark system and our mass transit payment system;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Petroleum
Systems,including both our gasoline management system, or GMS, and our EasyFuel systems;
| | - | --------------------------------------------------------------------------------------------------

| |  | Smart
ID Solutions,for both personal identification and credentialing purposes; and
| | - | -----------------------------------------------------------------------------------

| |  | Campus
Systems.
| | - | ---------------

13

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Substantially
all of our contactless microprocessor-based products are based on a common platform which
we refer to as the OTI Platform. The OTI Platform combines our patented technologies and
consists of our smart cards, our smart card readers, software that enables the development
of applications for the smart card and a communications technology that ensures that the
transmission of data to and from the card is secure and reliable. The OTI Platform can be
customized to support a large number of applications, such as credit and debit card
functions, identification and loyalty programs. The OTI Platform has been deployed in
different markets, such as petroleum, mass transit and e-passport/national ID, and is
being developed for other markers, such as medical services. For some markets, we have
developed extensively customized hardware and software systems based on our OTI Platform,
such as a gasoline management system for fleet managers and an electronic parking payment
system..

Our
products offer the following benefits:

| |  | The
information stored on a card and transferred between the card and the reader is secure.
| | - | -------------------------------------------------------------------------------------------

| |  | Our
products provide for a reliable transfer of information to and from a card.
| | - | -------------------------------------------------------------------------------

| |  | Our
cards are durable, easy to use and take a variety of forms, including key chains, tags,
stickers and wristwatches.
| | - | ----------------------------------------------------------------------------------------------------------------------

| |  | Our
products are easy to install and maintain.
| | - | ----------------------------------------------

| |  | Our
products enable the transition from other card technologies to our contactless
microprocessor-based technology.
| | - | -------------------------------------------------------------------------------------------------------------------

| |  | Our
products support multiple, independent applications on the same card.
| | - | -------------------------------------------------------------------------

We
intend to enhance our position in the design and development of contactless
microprocessor-based smart card products by developing new applications for our
technology. We also intend to enter new markets, either alone or through relationships
with other parties, such as Mastercard International and Beyond Petroleum (formerly known
as British Petroleum), and we aim to generate additional revenues from transaction fees
and ongoing payments for customer support.

We
market our technologically advanced products through our global network of subsidiaries
and strategic relationships. Our sales and marketing efforts are directed from our U.S.
subsidiary, OTI America, Inc., located in Fort Lee, New Jersey, and carried out through
our subsidiaries in Israel, America, Europe and Africa.

# Industry Background

# What is a smart card?

Plastic
cards that contain a semiconductor chip are generally referred to as smart
cards. Smart card technologies were first developed in response to the limitations
of the magnetic strip commonly used in most credit and debit cards, telephone cards and
hotel room access cards. Smart cards store larger amounts of information than magnetic
strip cards. They can also update this information and store it more securely than a
magnetic strip card can. Depending on the complexity of the chip that a smart card
contains, some smart cards can process the stored information and support more than one
application. For example, smart cards can act as a substitute for cash by storing a cash
balance on the card that may later be reduced or increased. The same card can also store
information identifying its holder.

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# What is a smart card
system?



A
smart card system is comprised of a smart card, a reader that transmits and receives data
from the smart card, and a computer that processes data received from the reader. A reader
housed in a protective casing is known as a terminal. Most terminals today are designed
for contact smart cards. These terminals rely on physical contact between the
card and the reader and contain a slot into which the smart cards are inserted or through
which they are swiped. Most smart cards today are credit card-sized plastic cards.
However, with the introduction of contactless smart cards that do not need any
physical contact with a reader, the form which smart cards and readers take can vary
widely.

# Types of smart card chips

The
type of semiconductor chip on a smart card determines the amount of information and the
number and complexity of applications that can be provided by the card, or how
smart the card is. In todays market, there are three primary types of
chips. From the least technologically advanced to the most technologically advanced, they
are as follows:

Memory
chip. The most basic type of chip used in smart cards is the memory chip. Smart cards
containing memory chips are more advanced than magnetic strip cards because they can store
larger amounts of data. Like magnetic strip cards, however, memory chips are not capable
of processing the stored information. An external reader extracts the data stored on a
memory chip card which is then transferred to an external computer system where it is
processed. Updated information is then transferred back to the reader and then to the
card. The most common memory card application is a disposable prepaid telephone card.

Application
Specific Integrated Circuit, or ASIC, chip. An ASIC chip can store data and perform
limited pre-determined data processing tasks. It cannot be reprogrammed once created.
ASIC-based chips are primarily used for applications that require limited processing
capabilities and lower levels of security, such as premises access control and mass
transit.

Microprocessor
chip. Unlike ASIC chips, microprocessor chips can be reprogrammed after being
manufactured. New software applications can be added, replaced or updated at any time.
Microprocessor chips can also run more applications and perform more complex calculations
than ASIC chips. The difference between an ASIC-based smart card and a
microprocessor-based smart card can be analogized to the difference between a calculator
and a personal computer. A calculator is typically programmed at the time of manufacture
to perform only a limited number of functions, and like an ASIC-based smart card, these
functions cannot subsequently be changed. A personal computer has an operating system that
can run many different applications, and like a microprocessor-based smart card, these
applications can be modified and added to a personal computer.

Microprocessors
can process information using a formula, or algorithm, with a great number of variables,
whereas ASIC chips can only repeat a fixed algorithm with a limited number of variables.
Therefore, data stored on a microprocessor chip can be encrypted using a random code that
is difficult to break. As a result, data stored on a microprocessor chip benefits from a
higher level of security than data stored on an ASIC chip. At the same time,
microprocessors require more power than ASIC chips for their operations and are typically
more expensive.

# Contact vs. Contactless

Another
primary distinction between types of smart cards is whether they are contact
or contactless, that is, whether physical contact between the card and the
reader is required in order to transfer data and power between them. When using a contact
card, the cardholder swipes or inserts the card into a slot in the card reader. When
inserted properly, a metallic pad, or contact plate, on the smart card aligns with the
electronic contacts inside the reader, and data and power are transferred across this
connection. By contrast, in contactless smart card systems, power and data are transmitted
through antennas located on the smart card and the reader without making physical contact.

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The
developers of contactless microprocessor-based smart cards face the following significant
challenges:

| |  | Support
of ISO standards. The International Standard Organization, or ISO, is in the process
of approving standards regulating the transfer of data between a contactless smart card
and its reader, under the name ISO 14443. Currently, two separate types of standards
 Type A and Type B  are undergoing approval by ISO. Because both standards
are currently being used, only readers that can support both standards offer users the
flexibility to use smart cards based on either standard.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Transfer
of power to the card. Most providers of contactless smart card systems use a
technology called resonant circuitry to create a magnetic field between the card and
reader through which power is transferred to the card. Current limitations of resonant
circuitry technology make this technology impractical for providing sufficient power to a
microprocessor-based smart card in a contactless system.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Support
of existing card-based infrastructure. Because of the large existing base of
contact-based systems, there is demand for technologies that can support both contact and
contactless applications with the same equipment. However, combined contact and
contactless cards have traditionally contained two chips, one for use by contact-based
systems and one for use by contactless-based systems. The use of two chips increases the
cost of the card and the likelihood of discrepancies between the information stored on
each chip by different applications. The use of two chips also limits the level of
security to the level offered by the ASIC chip. We believe that the shortcomings of these
dual contact/contactless cards create a need for a single chip that can work with both
contact and contactless systems. There have been attempts, principally by some of the
larger chip manufacturers, to develop a technology that uses a single chip, but we are
unaware of any successful commercial implementation of this technology by anyone other
than us.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Despite
the challenges discussed above, contactless smart cards offer considerable advantages over
traditional contact-based smart cards including:

| |  | Speed. Transaction
time in contactless systems is shorter than in contact systems because it is not
necessary to insert the card in, or swipe it through, a reader or otherwise position it
in any specific direction. As a result, for systems that need to handle a large number of
users over a short period of time, such as mass transit systems, contactless systems
provide considerable time savings when aggregated over a large number of users while
users save time on each of their transactions.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Convenience. Contactless
systems simplify the way transactions are executed. For example, a shopper can pay for
goods in a retail outlet simply by positioning a wallet containing a contactless smart
card in close proximity to a reader positioned at the check-out, without the need to
withdraw the card from the wallet.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Variety
of forms. Because contactless smart cards do not need to fit into a slot in a reader,
they can take a wider array of forms desired by smart card users and providers, such as
key chains, tags, wristwatches and other forms.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Maintenance
costs of contactless smart card systems are lower than maintenance costs for contact
systems since the components can be shielded in a protective casing, and the readers and
the cards are not subject to friction caused by inserting the card into, or swiping it
through, a reader. Moreover, contactless smart card readers do not contain moving parts
such as the contact plates in contact-based systems that are subject to wear and tear. As
a result, contactless systems can operate under harsher conditions and have longer lives
than contact systems. However, because contactless smart card systems require additional
components, such as antennas in the reader and on the card and other transmission
components at the level of the reader, the up-front costs associated with a contactless
system are higher than the costs associated with a contact-based system.

16

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# The OTI Solution

Our
technology enables microprocessor-based smart card systems to operate in a contactless
environment. This technology is not only available for new systems, but can be integrated
with and upgrade existing contact systems and other contactless systems. Our products have
the benefits discussed below.

| |  | Combining
the advantages of contactless systems and microprocessor-based systems.Our technology
successfully combines the features of microprocessor-based cards and contactless cards
and provides the following benefits to card users and card issuers:
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|Features                                  | Advantages to card users        | Advantages to card issuers        
|----------------------------------------- | ------------------------------- | ----------------------------------
|
|
|
|
|Benefits of contactless cards compared to |                                 |                                   
|contact cards                            
|Faster transaction time                   | Shorter time to complete a      | More transactions per minute      
|                                          | transaction                    
|Cards do not need to be inserted or put   | Easier to use and come in a     | Lower maintenance costs           
|into readers                              | variety of forms               
|Durability                                | The card lasts longer           | Reduce card replacement cost      
|Benefits of microprocessors compared to  
|ASIC or memory chips                     
|Multiple applications                     | The card has multiple uses      | Generates revenues from           
|                                          |                                 | additional applications           
|Enhanced security                         | Information on the card is more | System is less vulnerable to fraud
|                                          | secure                         

| |  | Ease
of transition from other card systems to contactless microprocessor-based systems. We
provide our customers with an easy upgrade of their existing systems by allowing card
issuers who currently utilize magnetic strip card systems or other contact-based systems
to switch to a contactless system without forcing them to replace their existing
infrastructure. For example, as part of a project for SmartStop, we upgraded standard
point-of-sales and gaming machines that supported only magnetic strip and coins to
support contactless microprocessor-based smart cards.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Ease
of transition from contact-based microprocessors to contactless microprocessors. Chip
manufacturers and operating system providers can use our technology to upgrade their off
the- shelf products to support both contact and contactless operations. This can be done
by combining our technology with our customers microprocessor, enabling the
microprocessor to support contact and contactless operations. By applying our patented
hardware, customers can save months of development time and reduce the time to market for
their products.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Support
of multiple standards. Our readers are capable of supporting ISO 14443 Type A and
Type B standards. Because both of these standards are currently being used, we offer
users the flexibility to adopt either standard.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Strategy

Our
goal is to be the leading provider of contactless microprocessor-based smart card
products. Key elements of our strategy for achieving this goal include:

| |  | Enhance
technological position. We intend to continue to invest in research and development
in order to enhance our technological position, develop new technologies, extend the
functionality of our products and services, and offer innovative products to our
customers. In the future, we intend to achieve an in-house capability to design
microprocessors and operating systems for smart cards.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Expand
global market presence. Our sales and marketing effort is currently directed from our
U.S. subsidiary, OTI America, located in Fort Lee, New Jersey. We market our product
through a global network of marketing subsidiaries in Israel, America, Europe and Africa.
We intend to use these entities to strengthen our presence in existing markets, penetrate
new markets, provide local customer service and technical support, and adapt our products
to our local customers specific needs.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Increase
focus on generating high-margin, recurring revenues. We currently derive most of our
revenues from one-time payments for our products and technologies. We intend to generate
additional revenues by receiving service fees for ongoing customer services and technical
support and transaction fees from our customers based on the volume of transactions
effected in systems that contain our products. For example, we have entered into such fee
arrangements with respect to our parking systems in Israel and our gasoline management
systems in South Africa. By reducing customers up-front payments or deferring
payment for our products in return for receiving on-going participation in the revenue
they generate for the customer, we are able to build and maintain long-term relationships
with our customers and generate a constant stream of high-margin, recurring revenues and,
at the same time, provide cost-effective turnkey solutions to our customers.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Leverage
existing relationships and seek new relationships. We have entered into relationships
with Xerox to cover the U.S. public library and higher education markets, and Beyond
Petroleum, or BP (formerly known as British Petroleum), to cover the South African
petroleum market. We have entered into these relationships in order to facilitate or
accelerate our penetration into new markets, as well as assist us in defining and
pursuing new applications for our products. We are continuously seeking additional
relationships to complement our marketing strategy and promote our brand worldwide.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Leverage
presence in existing industries to enter into new industries. We offer our customers
the ability to add new applications to their smart cards, thereby expanding the number of
industries in which our products are used. For example, users of the gasoline management
system we have sold to BP in South Africa will have in the future the option to add a
payment application to their card. The application will allow them to pay with the card
at convenience stores that install the system and to earn loyalty points every time they
do so. We plan to generate additional revenues through the sale of products required to
add and operate these applications.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Pursue
strategic acquisitions. We plan to pursue acquisitions of companies that enhance our
manufacturing, sales, marketing and research and development capabilities. In this way,
we plan to expand our product offerings and provide more comprehensive service to our
customers. Since our initial public offering in 1999, we have acquired the SoftChip
Group, an Israeli based developer and designer of microprocessors and operating systems
for smart cards, InterCard Systemelectronic, a German company that provides OEM and
electronics manufacturing services, and ASEC, a Polish company that develops,
manufactures and markets card readers and reader modules based on radio frequency
identification technologies.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Core technologies

Since
our inception in 1990, we have developed technologies that facilitate the transmission of
data and power between a contactless microprocessor-based smart card and a reader. Our
products are based on a number of core technologies, which are discussed below.

Power and data
transmission technology

We
refer to our power and data transmission technology as matched antenna
technology. The power, as well as the data, is transmitted to the microprocessor installed
on the smart card through an electro-magnetic field generated by the reader. Our
technology offers a number of key advantages:

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| |  | Contactless
smart cards can be based on microprocessors. In contrast to resonant circuitry
technology, which is the predominant technology used for ASIC-based contactless smart
cards, our matched antenna technology enables a reader to power a standard microprocessor
embedded in the contactless card.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Replacing
one of the components of the smart card system does not require re-tuning the system. In
smart card systems based on resonant circuitry, once a component of the system is
replaced the whole system needs to be re-tuned in order to function properly. This
increases maintenance time and costs. Our technology allows components of the system to
be replaced without any need for re-tuning, providing for easy, cost effective
installation and maintenance of our products.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The
reader does not need to be installed in close proximity to its antenna. The reader
can be installed at a distance of up to 33 meters, or 100 feet, from the antenna,
providing the ability to install smart card systems in harsh conditions, including
potentially explosive environments such as gasoline stations. In addition, the customer
can install the reader where there is easy access, facilitating installation and
maintenance of the reader.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Antenna interface



Our
antenna interface technology enables a single microprocessor to connect, or interface,
with both contact and contactless readers. We refer to this as a dual
interface feature. This enables customers with existing contact systems to gradually
transition to contactless cards, rather than incurring up-front all the costs of replacing
the contact system with a contactless system. We have developed the following two methods
of implementing our dual interface feature:

| |  | Adding
our antenna interface chip. The chip can be added to standard microprocessor-based
contact cards, allowing the card to operate as a contactless smart card, in addition to
being a contact card. This can be implemented within a relatively short period of up to
three months, which reduces our customers time to market.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Integrating
an antenna interface into the microprocessor. The antenna interface can be integrated
into a microprocessor, which reduces the cost of manufacturing dual interface cards once
manufacturing levels reach significant volumes of chips. At that point, the additional
upfront cost of engineering work required in order to successfully integrate the two
components  the microprocessor and the antenna interface into one chip, is
offset by the fact that only a single component is required. This is referred to as a
monochip.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In
1998, our antenna interface, which enables any contact-based microprocessor with any
operating system to work in a contactless environment, was awarded the annual prize of the
European Smart Card Applications and Technology organization for the most innovative
achievement for smart cards in 1997.

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Antenna module

Contactless
smart cards require an antenna as a conduit for ingoing and outgoing transmissions of
power and data. Traditional contactless smart cards contain an antenna coil that is
embedded around the edge of the card. The technology for embedding the antenna coil into
the card is complex, creating a barrier for contact smart card manufacturers to transition
to manufacturing contactless smart cards. Our technology eliminates the need to embed the
antenna coil around the edge of the smart card by mounting the antenna on a standard size
platform, or module, into which the microprocessor is embedded. Our technology allows
contactless cards to be produced using existing contact card production processes without
the need for new machinery. This significantly reduces manufacturing costs. In addition,
when a manufacturing infrastructure exists in the local market, shipping costs to the
local market and possibly duties can be reduced.

In
2000, our antenna module was awarded the annual prize of the European Smart Card
Applications and Technology organization for the most innovative achievement for smart
cards in 1999.

Communications technology

We
have developed a unique communications technology that includes:

| |  | a
set of rules, or a protocol, that is designed to ensure that information is properly
transmitted from the               reader to the card, and vice versa;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | an
additional layer of coding that makes the transmission of information more difficult to
intercept and               read; and
| | - | --------------------------------------------------------------------------------------------------------------------------------

| |  | a
technique that reduces the effect of background interference on the quality of the
transmission.
| | - | --------------------------------------------------------------------------------------------------

Microprocessor chip and
operating system design know-how

Through
our acquisition of the SoftChip Group, we have employed personnel skilled in the design of
microprocessors and development of operating systems for smart cards. SoftChip acquired
its know-how through its involvement in the design of microprocessors for smart cards on
behalf of leading microprocessor manufacturers.

# Products

The OTI Platform

Substantially
all of our products are based on a common platform, which we refer to as the OTI Platform.
The OTI Platform combines our patented technologies and consists of:

| |  | smart
cards, which can take a variety of forms including tags, stickers, wristwatches, key
chains and               plastic credit card-sized cards;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------

| |  | smart
card readers;
| | - | -------------------

| |  | software
that enables the development of applications on contactless microprocessor-based smart
cards; and
| | - | ----------------------------------------------------------------------------------------------------------

| |  | a
method of communications that regulates the transmission of data between a contactless
smart card and a               reader.
| | - | -------------------------------------------------------------------------------------------------------------------------------

The
following is a graphical representation of a contactless microprocessor-based smart card
based on the OTI Platform:

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All
of these elements work together to provide a foundation, upon which we or our customers
build applications. The transmission of information between the card and the reader in an
OTI Platform -based product is secure and reliable. For example, if communications are
interrupted in the course of a transmission, the information transferred is incomplete,
and the OTI Platform will reject the impaired transmission and require that the
information be re-transmitted. In addition, our OTI Platform ensures that information is
transmitted from the card in an encrypted form only to readers that are authorized to
receive and able to decipher the transmission.

The
OTI Platform supports several types of payment methods including debit and credit
applications, loyalty points and an electronic cash substitute that increases or reduces
the balance on the users card. We refer to these as e-purse applications.

Customized products.

We
sell customized equipment based on our OTI Platform, including smart cards, readers and
related equipment, to support applications in particular markets. Examples of these
applications are described below. We typically receive payments for nonrecurring
engineering for this customization and then sell the customized product to the customer.

Complete systems.

We
sell complete systems based on our OTI Platform. In addition to the equipment included in
our customized products, complete systems include application software and specifically
designed hardware. Our complete systems currently consist of our gasoline management
system, our campus system and our parking payment system.

Our Products

Our products consist of:

Micropayments Solutions.

We
typically design our micropayments solutions while teaming up with financial institutions
and back office providers. These solutions offer a cashless system and loyalty program for
small purchases, such as fast food, gasoline and movie tickets. Our micropayments
solutions include the following:

| |  | PayPass. An
OTI micropayments solution is supplying key components of the technology behind
MasterCard Internationals PayPass, a new contactless card payment program
that can be utilized at any of MasterCards more than 29 million acceptance
locations around the world. We commenced sales of micropayments solutions in 1998. Sales
of micropayments accounted for $5.3 million (or 23%) of our revenues in 2004, $2.0
million (or 10%) of our revenues in 2003 and $2.3 million (or 13%) of our revenues in
2002.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | E-purse
(Stored Value Cards). We have developed a product that enables a person to load
pre-paid value on a card, which provides float for issuers, while enabling cardholders to
pay for small purchases in environments such as phone booths, vending machines and fast
food restaurants, without the need for exact change.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | As
of the date of this annual report, we have not derived revenues from sales of our E-purse
product.
| | -----------------------------------------------------------------------------------------------------

| |  | Parking
payment system. Our electronic parking payment system, which we refer to as EasyPark,
enables drivers to be charged for the exact period of time they are parked and simplifies
the monitoring and collection of parking fees. Drivers are issued contactless
microprocessor-based smart cards, or EasyPark cards, to replace existing parking payment
methods, including parking meters. The EasyPark card stores the amount of money, or the
balance that is available for payment of parking fees. A driver can increase the balance
at special self-service kiosks placed at convenient locations. Compliance with parking
regulations is monitored by inspectors using specially designed hand-held terminals.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
May 1999, the EasyPark system was selected as the national parking system for Israel.
During 2000, the system was widely implemented throughout Israel. We are currently
marketing the EasyPark system through our global network of subsidiaries.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Mass
transit. We have designed a product that enables efficient fare collection from a
large volume of passengers in various types of mass transportation systems, such as buses
and trains. The smart card serves as the passengers ticket. The chip in the smart
card stores the passengers fare balance and is debited with the fare when the
passenger boards or disembarks. The balance on the smart card can be increased
repeatedly. Our former joint venture in Hong-Kong, e-Smart Systems, received the first
commercial order for this product for installation in a mass transit system in China.
Installation of the system commenced in the first quarter of 2001. In 2002 less than 2%,
and in 2003 and 2004 less than 1%, of our revenues were derived from this system.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Petroleum Systems.

Our
petroleum systems include our gasoline management system, or GMS, and EasyFuel. Sales of
our petroleum systems accounted for $2.9 million (or 13%) of our revenues in 2004, $4.6
million (or 23%) of our revenues in 2003, $2.5 million (or 14%) of our revenues in 2002,
$1.2 million (or 6%) of our revenues in 2001 and $1.6 million (or 12%) of our revenues in
2000.

| |  | GMS.
GMS records and monitors the identity of the driver and the vehicle, the drivers or
fleets credit status, the vehicles fuel consumption and other information
determined by the customer, such as periodic vehicle maintenance. By processing and
managing this information, GMS allows oil companies and fleet managers to receive billing
information automatically, simplify payment processes, track the use of each vehicle and
reduce the risk of theft or fraud. GMS also enhances the loyalty of fleet drivers and
managers to oil companies operating participating gas stations.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
information is communicated via an antenna in the vehicles gas tank to an antenna
mounted on the fuel nozzle when the fuel nozzle is inserted into the vehicles gas
tank, and is then transferred to the gas station computer. Disengaging the nozzle from
the gas tank will immediately turn off the pump.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| | The
following diagram illustrates a typical GMS system:
| | -------------------------------------------------------



| | We
commenced sales of GMS in 1995. GMS is being used by a number of petroleum companies,
such as BP South Africa in Africa, Turcas in Turkey and Mobil in Ecuador. As of December
31, 2004, a total of approximately 900 gas stations have been equipped with GMS,
including in South Africa, Turkey and Ecuador, and we have delivered GMS equipment for
approximately 105,000 vehicles.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | EasyFuel.
Our wireless petroleum solutions are named EasyFuel. Similar to GMS, EasyFuel
incorporates options for retail and private fleets as well as a pay-at-the-pump solution.
The system monitors and expedites the fueling and payment process through a completely
wireless detection and authorization system. This system is also ideally positioned for
the retail petroleum market by enabling drivers to pay for gasoline at the pump, pay for
other services and products at the gas station and earn loyalty points for these
purchases.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Smart ID Solutions.

Our
smart identification products combine the portability of smart cards with the capability
to support advanced identification and authentication technology and manage significant
amounts of information. Our smart identification products include the following:

| |  | e-passport/National
ID. We have developed a product that supports advanced authentication methods
developed by other companies. Authentication methods are required by governments for
identification documentation. Biometric identification involves inputting data regarding
the physical characteristics of the smart card holder, such as his fingerprints or facial
impression, into the smart card. This data is stored in the smart card and compared with
the actual characteristics of the smart card holder when the card is presented for
identity validation. This enables governments to transition from paper-based national
documentation systems to a more cost-effective paperless identification system,
encompassing multiple forms of government identification such as passports, national
identification cards, drivers licenses and national health cards. In addition, we
have incorporated our antenna module into a sticker. The sticker can be attached to
existing paper documentation, thus converting it into a contactless smart card.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Israeli government selected our technology and products for use in a system controlling
passage between Israel and areas governed by the Palestinian Authority which will be
supplied by Electronic Data Systems.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Sales
of our national documentation product commenced in 2003, and accounted for $1.3 million
(or 6%) of our revenues in 2004 and 1% of our revenues in 2003.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | MediSmart. Our
MediSmart product is designed to secure, process and manage medical information by
providing doctors and hospital administrators with information regarding the patients
identity, medical history, insurance coverage and payment history. This information can
be automatically updated after each treatment. Treatment information can be automatically
transferred to the insurance providers computer system. This product reduces costs
to medical providers, provides increased security for a patients medical history
and improve the quality and speed of service to patients. We began field tests of the
product in South Africa in 2003 and the product was successfully deployed in June 2004 by
CareCross Health, the leading primary heathcare provider in South Africa, and in October
2004 by HARMONIX®  Outpatient Mental health Services in the U.S.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Campus Systems.

Our
campus system provides applications such as access control, pre-paid value cards for small
purchases, cafeteria access and copy machine payments on a single card. We designed our
OTI campus system for use in self-contained or campus environments, including closed
communities, senior citizen homes, universities, schools and corporate facilities. Each
campus user is provided with a contactless smart card that provides secured access to
different areas of the campus, and can include various types of e-purse applications,
monitoring of time and attendance at work, vending machine functions, gasoline management
and cafeteria operations.

Our
OTI campus system has been in full commercial operation in over 40 kibbutzim in Israel
since 1993, more than 20 residential complexes in Hong Kong since 1997, two senior citizen
homes in Israel since 1998 and a country club in Israel since 2000. We also have installed
a campus system operation at a university in Germany. In January, 2001, we established a
relationship with Xerox to market our campus system in the United States. Sales of our
campus system accounted for $4.7 million (or 20%) of our revenues in 2004, $6.4 million
(or 33%) of our revenues in 2003 and $6.8 million (or 38%) of our revenues in 2002.

Our
previously wholly-owned German subsidiary, InterCard Kartensysteme, also sells and manages
campus systems, operated by cards based on a wide array of technologies, including
magnetic strips, ASIC-based systems and contact microprocessor-based systems, provided by
a number of companies, such as GemPlus and Cards & More GmbH. During 2004, InterCard
Kartensystemes campus system was used in over 80 universities in Germany under the
name UniCard. The primary difference between the OTI campus system and InterCard
Kartensystemes campus system is that InterCard Kartensystemes campus system
includes management and clearing software for closed campus environments and is based
solely on contact cards.

# Technology licensing

In
December 2003, we entered into an agreement with Atmel Corporation for the purpose of
collaborating on the development of Mastercards PayPass contactless payment
program. Atmel was selected by Mastercard to supply the secure contactless
microcontroller. Under the agreement, Atmel has partnered with us to provide contactless
solution expertise for PayPass, including the operating system, application support
and inlay technology. The agreement may be terminated by either party in the event of a
breach of the agreement by, or the commencement of a bankruptcy, receivership or
liquidation proceeding involving, the other party.

In
1998, we licensed our contactless technology on a non-exclusive basis to Samsung for the
purpose of developing a microprocessor that integrates our antenna interface into
Samsungs microprocessor, which we refer to as a monochip. The duration of the
license is ten years and is extended automatically for one-year periods for so long as
Samsung continues to commercially manufacture monochips. We received a one-time technology
licensing fee from Samsung and will receive royalties from sales of monochips by Samsung.
We may purchase monochips from Samsung at a preferential price and we have agreed to sell
components for card readers to Samsung at preferential prices. Both we and Samsung are
permitted to sell monochips worldwide other than to customers who are known to be a client
of the other party. We may license our technology to other microprocessor manufacturers in
the future.

# Customer service and
technical support

We
provide our customers with training and installation support and ongoing customer service
and technical support through our global network of subsidiaries. We have a support team
of nine employees consisting of seven employees located in our corporate headquarters in
Rosh Pina, Israel and two in Africa. Our customer service team in Rosh Pina, Israel
provides central services to our network of local subsidiaries. The subsidiaries, in turn,
provide 24-hour customer support to our customers, through telephone and email for an
ongoing fee. On-site technical support is provided to customers for a fee. During each of
the five years in the period ended December 31, 2004, revenues derived from customer
service and technical support constituted no more than 6% of our total revenue.

# Customers

We
sell our products to systems integrators and service providers. Our customers can be
divided into the following groups:

24

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---



| |  | Systems
integrators. Systems integrators incorporate our products into their systems, which
they then sell to service providers and install for use in a specific project. Some of
these systems integrators also market and distribute our products. We derived $6.0
million (or 46%) of our revenues in 2000, $3.6 million (or 18%) of our revenues in 2001,
$3.9 million (or 22%) of our revenues in 2002, $5.5 million (or 28%) of our revenues in
2003 and $3.7 million (or 16%) of our revenues in 2004 from sales to systems integrators.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Service
providers. Service providers include companies and government agencies that offer
smart card services to end-users who are their customers. We derived $7.1 million (or
54%) of our revenues in 2000, $16.3 million (or 82%) of our revenues in 2001, $14.1
million (or 78%) of our revenues in 2002, $14.1 million (or 72%) of our revenues in 2003
and $19.4 million (or 84%) of our revenues in 2004 from sales to service providers.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Sales and marketing

We
have built a global network of subsidiaries through which we sell and market our products.
As of December 31, 2004, we had a total sales and marketing staff of 25 employees in four
locations. We market our products in the Americas through OTI America, which employs four
people in sales and marketing. In Africa we sell and market through OTI Africa, which
employs eight people in sales and marketing. In Europe, we sell and market through
InterCard Systemelectronic and ASEC, which together employ nine people in sales and
marketing. In Israel, we sell and market through our headquarters in Rosh Pina, which
employs two people in sales and marketing. Our sales and marketing staff implements
marketing programs to promote our products and services and enhance our global brand
recognition. Our current marketing efforts include participation in trade shows and
conferences, press releases, updating our web site, conducting speaking engagements and
advertising in industry publications. We also conduct technical seminars to inform
customers, distributors and other industry participants of the benefits of our products
and technologies.

Some
of the independent systems integrators to which, for their own use, we sell our products
also act as distributors for our products. We have granted some of our systems integrators
exclusive distribution rights within a particular country or region. We generally
guarantee exclusivity only if certain sales targets are met.

# Seasonality

Our
revenues are subject to seasonal fluctuations related to the slowdown in spending
activities and the increased activity related to the year-end purchasing cycles of many
end-users of our products. Hence, our sales and profits in the fourth quarter of every
year tend to be higher than in other quarters, particularly the first and second quarters
of each year. We anticipate that we will continue to experience quarter-to-quarter
seasonal fluctuations.

# Manufacturing

External
manufacturers and suppliers

We
currently purchase substantially all of the hardware and software components of our
products from third-party suppliers and outsource substantially all of the manufacturing
and assembling of our products to manufacturing subcontractors. This allows us to focus
our resources on the design, development and marketing of our products. We have not
entered into long-term supply contracts. Instead, we purchase components on a purchase
order basis. Our policy is to use more than one supplier and manufacturing subcontractor
for each part of our production process in order to limit over-dependence on any one
supplier or manufacturer.

Smart
cards.

| |  | Microprocessors. The
current suppliers of microprocessors for our smart cards are STM, Atmel, and Samsung. In
addition, we have jointly developed with Samsung a monochip that integrates
our antenna interface with Samsungs microprocessor. Samsung has begun production of
the monochip. In addition, through SoftChip, we are currently developing a microprocessor
design for smart cards.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Modules. A
module is a silicon plate into which the components of a microprocessor are embedded. The
microprocessor module and the antenna module on which the microprocessor and antenna
interface are mounted are manufactured in Europe and South East Asia.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

25

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| |  | Packaging. We
package the components for our smart cards in a variety of forms, including key chains,
tags, stickers and cards. The key chains, tags and stickers containing our microprocessor
and antenna modules are manufactured in China and in Europe. Our credit card-sized smart
cards are manufactured in Korea, China, Thailand and the United States.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Readers. We
purchase off-the-shelf components for our readers from various suppliers including
Infineon, Motorola, AMD and National Semiconductor. The readers are assembled for us in
Israel, mainly by USR Electronics Ltd.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Operating
systems.

We
have developed DVK, a smart card operating system for contact-based microprocessors, that
we intend to upgrade to contactless operation and incorporate into some of our products
over the next 12 months.

Quality
control

We
maintain strict internal and external quality control processes. We require that the
facilities of our suppliers and manufacturing subcontractors be ISO 9001:2000 certified.
ISO 9001:2000 refers to a quality assurance model established by ISO for companies that
design, produce, install, inspect and test products.

Internal
manufacturing capabilities

We
currently package, test and encode our readers at our production facility in Rosh Pina,
Israel. Our packaging and testing facilities are ISO 9001:2000 certified. In Rosh Pina, we
also incorporate modules into credit card-sized contactless smart cards.

InterCard
Systemelectronic, our wholly-owned German subsidiary, owns a manufacturing facility in
Germany for electronic devices primarily for the transportation industry and card
terminals. We also manufacture card readers at the facilities of InterCard
Systemelectronic.

We
have granted our former joint venture, e-Smart, an option to manufacture smart cards using
our technology for sale in Greater China. We will retain exclusive rights to our
technology and any smart cards manufactured by e-Smart will be required to contain modules
manufactured by us. We are entitled to receive royalties at rates to be agreed upon for
smart cards manufactured by e-Smart.

# Government regulation

Some
of our products are subject to government regulation in the countries in which they are
used. For example, card readers that are used in the United States require certification
of compliance with regulations of the Federal Communications Commission and those used in
Europe require certification of compliance with regulations of the European
Telecommunications Standards Institute regarding emission limits of radio frequency
devices. In the United States, our GMS and retail petroleum products are subject to
compliance with regulations of Underwriters Laboratories Inc., a public safety and testing
certification organization, and in Europe to regulations of the European Union. Our
products are currently compliant with these regulations.

# Research and development

We
believe that our future success depends on our ability to maintain our technological
leadership, enhance our existing products and develop new products and technologies.
Accordingly, we intend to continue devoting substantial resources to research and
development. We are paying royalties to the Government of Israel at a rate of 3%-5% of
sales of the products in which the Government of Israel has participated in financing
through grants, up to the amounts granted, linked to the U.S. dollar with annual interest
at LIBOR as of the date of the approval. The following table describes our research and
development activities during each of the past five years:

26

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|                                            | 2000 | 2001 | 2002 | 2003 | 2004
|------------------------------------------- | ---- | ---- | ---- | ---- | ----
|
|
|
|
|Our expenditures net of grants from the OCS |      |      | $    | 3.9  |     
|Our net expenditures of annual revenues     |      |      |      | 30   | %   
|OCS grants                                  |      |      | $    | 1.0  |     

Our
research and development activities focus on three areas:

| |  | implementing
our core technologies in microprocessors and readers;
| | - | ------------------------------------------------------------------

| |  | enhancing
the functionality of our components and expanding the range of our  products to serve new
              markets; and
| | - | ------------------------------------------------------------------------------------------------------------------------------

| |  | developing
new innovative technologies related to the operation of contactless  microprocessor based
smart               cards.
| | - | -------------------------------------------------------------------------------------------------------------------------------

At
December 31, 2004, we employed 59 persons in our research and development department. Our
research and development facilities are located at our headquarters in Rosh Pina, Israel.
We believe that our success is based on our experienced team of senior engineers and
technicians who have on average 12 years of experience in their respective fields. Our
research and development facilities are ISO 9001:2000 certified.

# Proprietary technologies

Our
success and ability to compete depend in large part upon protecting our proprietary
technology. We rely on a combination of patent, trademark, copyright and trade secret law,
as well as know-how, confidentiality agreements and other contractual relationships with
our employees, affiliates, distributors and others. We have a number of issued patents in
various jurisdictions with respect to our technologies, as well as a number of pending
patent applications. The more significant of these are as follows:

|Technology                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 | Status                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Contactless transmission of power and data     
between a smart card and a reader.             
                                               
Dual interface technology for contact/         
contactless operation using a single           
microprocessor on the same card.               
                                               
                                               
System that uses contactless smart card for    
parking systems.                               
Dual interface technology for contact/         
contactless operating in a single card         
conforming to ISO 14443 Type A and B standards.
                                               
Long range transmission of data.               
                                               
                                               
                                               
                                               
Vehicle tag incorporated into a capless fuel   
inlet cap. | Patents granted in the United States, Israel, Canada, Singapore,
Australia, South Africa and Hong Kong.  The U.S. patent expires
in 2010 and the other patents expire in 2011.
Patent granted in the United States, Israel and Australia.  These
patents expire in 2017.  European, Canadian and Hong Kong patent
applications pending.  Patent Cooperation Treaty ("PCT")
application in the national phase for Germany, France, Italy,
Spain, United Kingdom and The Netherlands.
Patents granted to Easy Park in Israel, the United States,
Europe, Hong Kong and South Africa.  These patents expire in 2012.
Patent granted in the United States, Europe and Hong Kong.  PCT 
application in the national phase for Germany, Belgium, France, 
Ireland, Italy, United Kingdom and The Netherlands.  Application
pending in Israel, Canada and Australia.                        
                                                                
Patent granted in the United States, Europe, Hong Kong and in   
Israel.  PCT application in the national phase for Germany,     
France, Italy, Spain and the United Kingdom.  Applications      
pending in Canada and Australia.                                
                                                                
Patent granted in the United States, Europe and in Australia.   
Accepted in Israel and Hong Kong.  Application pending in       
Canada.  PCT application in the national phase for Germany,     
France, Italy, Spain and the United Kingdom.

We
cannot be certain that patents will be issued with respect to any of our pending or future
patent applications. In addition, we do not know whether any issued patents will be
enforceable against alleged infringers or will be upheld if their validity is challenged.

27

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We
have registered trademarks in the United States, the European Community and Israel for OTI
and OTI INSIGHT. EYECON is a registered European Community Trade Mark and is also
registered in Israel. As the result of an opposition action by Eicon Networks Corporation,
we reached an agreement with Eicon on January 2, 2002 regarding the future use of the
EYECON trademark described in our US Trademark Application Serial No. 75/313,746 and
Israeli Trademark Application No. 110844. According to the agreement, we: (i) withdrew our
US trademark application and all other applications associated with the EYECON trademark
worldwide and notify all trademark offices of our intention to withdraw such applications
within 30 days of the effective date of the agreement; (ii) cancelled and will cancel
existing registrations of the EYECON trademark by providing notice of such cancellation to
the relevant trademark offices in the US and Canada and by no later than December 18, 2004
in all other countries worldwide, except several countries including Israel, where the
applicable date will be December 18, 2005; and (iii) have begun phasing out our use of the
EYECON trademark worldwide. SCIENCE-NON FICTION is a registered European Community Trade
Mark and registered in Israel and is a pending trademark application in the United States.
EASY PARK is a registered trademark in the United States, Canada, Singapore and Israel. We
are also using other less important registered trademarks and unregistered trademarks and
trade names.

# Competition

Contactless
microprocessor-based products and technologies. We anticipate competition in sales of
our products, systems and technologies from other providers of contactless
microprocessor-based smart card technologies. We expect competition to intensify as our
competitors commit greater resources to the development of contactless
microprocessor-based smart cards. Some of the larger chip manufacturers that operate in
the smart card market, including Atmel, STM, Infineon and Philips Semiconductors, have
announced that they are developing contactless microprocessor-based smart cards. However,
we are not aware of any other company that has deployed contactless microprocessor-based
smart card products for commercial use.

Contactless
ASIC-based products and technologies. We compete with contactless ASIC-based
technologies developed primarily by Philips Semiconductors, which comply with ISO 14443
and which are used by some of the largest manufacturers of smart cards, including Gemplus,
Schlumburger and Giesecke & Devrient, and Sonys contactless ASIC-based
technology, that is not ISO compliant. Other companies offer contactless ASIC-based
systems for specific applications. For example, TIRIS, a subsidiary of Texas Instruments,
provides ASIC-based keyring tags for gasoline management systems, which compete with the
VeriPass system which we have developed with and for VeriFone. In addition, Orpak
Industries, Ltd. and Roisman Engineering Ltd., both based in Israel, also offer gasoline
management systems, which use simple ASIC-based devices powered by batteries and that do
not comply with the standards set by ISO.

Other
contact-based technologies. We compete with contact-based products such as
microprocessor-based contact cards, ASIC-based contact cards, memory chip cards and
magnetic strip cards. We believe that these cards offer inferior functionality compared to
contactless microprocessor-based smart cards. Nevertheless, some of our potential
customers have in the past, and may in the future, consider these alternatives sufficient
for their needs.

28

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|C. | ORGANIZATIONAL
STRUCTURE
|-- | ------------------------

The
chart below describes the corporate structure of our principal subsidiaries and major
affiliates.

Easy Park Ltd. Soft Chip Technologies (3000) Ltd. InterCard GmbH Systemelectronic ASEC Spolka Akcyjna OTI Africa Ltd. (*) Easy Park Israel Ltd. On Track Innovations Ltd. OTI America, Inc. 91.8%(1) 100% 100% 100% 100%(4) 100%(3) 100%(2)


| | (1) | The
remaining shares of Easy Park Ltd. are held by two investors.
| | --- | -----------------------------------------------------------------

| | (2) | Including
10% of the shares of Easy Park Israel Ltd. that we hold directly.
| | --- | ---------------------------------------------------------------------------

| | (3) | We
acquired a 51% interest in our existing InterCard Systemelectronic and our
          former InterCard Kartensysteme subsidiaries in June 2000. We acquired the
          remaining 49% interest in these subsidiaries in January 2001. We sold InterCard
          Kartensysteme in October 2004.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (4) | We
acquired ASEC in October 2004.
| | --- | ---------------------------------

Easy Park Ltd.

Easy
Park Ltd. developed our EasyPark system. Easy Park is incorporated under the laws of the
State of Israel, uses office space in our headquarters in Rosh Pina, Israel and rents
additional office space in Tel Aviv. Each holder or holders, individually or in the
aggregate, of 10.5% of Easy Parks issued share capital may appoint one member to
Easy Parks board of directors. By reason of our ownership of 91.8% of Easy
Parks outstanding shares, we currently we have the right to appoint all of the
members of its board of directors.

Our
Easy Park system was selected for a national parking system for Israel.

The SoftChip Group

On
January 28, 2000, we acquired from Michael and Yael Cohen all of the shares of SoftChip
Israel Ltd. and SoftChip Technologies (3000) Ltd., which we refer to collectively as the
SoftChip group, in exchange for 12,119 of our ordinary shares. The closing price of our
ordinary shares on this date was EUR103.30 per share (equivalent to $100.90 per share). It
was agreed that Michael Cohen would continue as chief executive officer of SoftChip
Technologies (3000) Ltd. pursuant to an employment agreement with a six year term. Michael
Cohens employment agreement was terminated on March 31, 2003 and instead we have
hired Michael Cohen to provide services as a consultant. We also granted Michael Cohen
options to purchase 10,000 of our ordinary shares at an exercise price of $30.00 per
share. These options vest in five equal installments commencing on February 1, 2001.

The
SoftChip group designs microprocessors and operating systems for smart cards. Under the
share purchase agreement, Michael and Yael Cohen agreed not to develop, promote or sell
competing or similar products to our products or the SoftChip groups products for a
period of two years after the termination of his employment with Softchip, without our or
the SoftChip companies prior approval.

29

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OTI America, Inc.

OTI
America, Inc., our U.S. subsidiary, is headquartered in Fort Lee and incorporated in New
Jersey, and provides marketing and customer support services for our products in North and
South America. In addition, our global marketing and strategy development is headed from
OTI America.

OTI Africa Ltd.

OTI
Africa Ltd. is headquartered and incorporated in South Africa and provides marketing,
distribution and customer support services for our products in Africa.

The InterCard group

On
June 15, 2000 and in January 2001, we acquired 51% and the remaining 49%, respectively, of
the nominal share capital of two related German companies, one of which, InterCard
Kartensysteme GmbH, is a systems integrator for smart card systems and the other of which,
InterCard Systemelectronic GmbH, is a manufacturer of electronic devices, for an aggregate
purchase price of $5.8 million. InterCard Kartensysteme primarily supplied smart card
systems for over 80 university campuses in Germany. InterCard Kartensysteme also sold copy
machine payment systems to universities, libraries and corporations.

Following
an agreement signed on September 14, 2004, in October 2004, we sold our InterCard
Kartensysteme subsidiary. The purchase price for our shares in InterCard Kartensysteme is
$ 2.5 million, to be paid in two installments. The first installment in the amount of
$1.25 million, which was paid in January 2005, consisted of $685,000 in cash, a Euro
325,000 interest-free promissory note ($432,000), payable in 32 monthly installments of
Euro 10,000 and a final installment of Euro 5,000, beginning on February 1, 2005, and a
Euro 100,000 promissory note ($133,000), payable in 12 monthly installments of Euro 9,000,
beginning on February 1, 2005. The second installment in the amount of $1.25 million will
be paid in 25 quarterly payments beginning on April 1, 2005.

e-Smart System Inc.

On
February 2, 2000, we entered into a shareholders agreement to establish e-Smart System
Inc., a joint venture in Hong Kong owned 50% by us and 50% by Ocean Wonder Limited, an
indirect wholly-owned subsidiary of Cheung Kong Infrastructure Ltd., or CKI, a Hong
Kong-based infrastructure company, which in turn is a subsidiary of Cheung Kong (Holdings)
Ltd. Cheung Kong (Holdings) has significant stakes in Hutchison Wampoa, a Hong Kong based
telecommunications company, and Hong Kong Electric. As part of the joint venture, we
appointed e-Smart as exclusive distributor for our products in Greater China (the
Peoples Republic of China, Taiwan, Hong Kong and Macau). The joint venture is using
the established distribution network of Cheung Kong (Holdings) and will also undertake
marketing activities in Greater China.

In
exchange for its interest in the venture, CKI contributed $3.6 million in cash. We
contributed $3.1 million in cash and undertook to contribute an additional $500,000 on
February 2, 2001. In January 2001, e-Smart exercised an option that we had granted to it
to acquire the assets of our subsidiary, City Smart Ltd., a Hong Kong based systems
integrator, in lieu of the additional $500,000 we had undertaken to contribute to e-Smart.
City Smart supplied smart card systems to residential housing complexes in Hong Kong using
identification cards for security. City Smart ceased all operations following the
acquisition of its assets by e-Smart. We have agreed to indemnify e-Smart and CKI against
any losses they incur in connection with City Smart as a result of any event occurring
prior to February 2, 2000 or arising out of any City Smart customer contract entered into
prior to the exercise of the option, provided we are notified of the claim prior to
February 2, 2002. We have received no notice of any claim under the indemnification.

In
June 2004, we signed an agreement with CKI for the sale of our 50% interest in the issued
share capital of e-Smart and the transfer of e-Smarts exclusive distribution rights
in China. Under the agreement, we received $10,000 in consideration for the acquisition of
the shares by CKI and paid $40,000 and $20,000 for the transfer of e-Smarts
exclusive distribution rights and for management services provided by CKI to e-Smart,
respectively. In addition, we agreed to pay e-Smart royalties equivalent to a certain
percentage of our net revenues generating from e-Smarts activities in China up to
$300,000.

30

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ASEC Spolka Akcyjna

On
October 22, 2004, we completed the acquisition of ASEC, which is headquartered in Krakow,
Poland, from Nextel Spolka Akcyjna (Nextel). ASEC develops, manufactures and
markets card readers and reader modules based on radio frequency identification
technologies, including high-end programmable smart card as well as economically priced
readers. Pursuant to the Preliminary Share Purchase Agreement, dated as of September 14,
2004, as amended by Annex No.1 to the Preliminary Share Purchase Agreement, dated as of
October 22, 2004, between us and Nextel (the Agreement), the aggregate
purchase price for the acquisition was $1.6 million, which was paid to Nextel through the
issuance of 186,264 of our ordinary shares, calculated by dividing the purchase price by
the average price of our ordinary shares during the ten trading days prior to, but
excluding, the closing date of the acquisition ($8.59 per share). In addition, the
Agreement provides for additional consideration of up to $350,000 to be paid to Nextel in
the form of our ordinary shares, subject to ASEC meeting specified performance criteria
for the years ended December 31, 2004 and 2005 (the earn-out formula). ASEC
met the performance criteria for the year ended December 31, 2004. The results of
operations of ASEC have been included in the consolidated financial statements as from
October 1, 2004.

On
January 14, 2005, we received from Nextel all of ASECs share capital (2,200 shares)
in exchange for 186,264 of our ordinary shares. The shares of both parties were initially
deposited with a trustee on the day that management control passed to us in October 2004.
The shares were released by the trustee on December 20, 2004.

|D. | PROPERTY,
PLANT AND EQUIPMENT
|-- | -----------------------------

We
lease an aggregate of 10,639 square meters of land in Rosh Pina, Israel from the Israel
Lands Authority. Of the 10,639 square meters, 2,377 meters are leased under a 49 year
lease which expires on November 16, 2041, with an option to extend for a further period of
49 years. Our principal management, administration and marketing activities occupy a 1,188
square meter facility on the site. The remaining 8,262 square meters of land are leased
under a 49 year lease with the Israel Lands Authority which expires on September 14, 2047,
with an option to extend for a further period of 49 years. Our principal engineering,
research and development and part of our manufacturing activities occupy a 4,000 square
meter facility on this site. The rent for the initial 49-year term of each of these leases
was prepaid in its entirety at the beginning of the lease terms as is customary in Israel
for leases of property for industrial purposes from the Israel Lands Authority.

Our
rights under these leases, including the facilities built on the site, are pledged for the
benefit of Bank Hapoalim. Our majority owned subsidiary, Easy Park Ltd., leases office
space in this complex from us. Easy Park also leases an aggregate of 90 square meters in
Tel Aviv pursuant to a lease that expires on December 31, 2004. Easy Park Ltd. still uses
these offices and it signed an agreement to lease an aggregate of 137 meters in Tel Aviv
pursuant to a lease that expires on April 14, 2008.

OTI
America, Inc. leases an aggregate of 4,375 square feet of office space in Fort Lee, New
Jersey pursuant to a lease that expires on August 31, 2009. OTI Africa Ltd. leases an
aggregate of 2,500 square meters of office space in Cape Town, South Africa, pursuant to a
lease that expires on December 31, 2008. ASEC leases an aggregate of 495 square meters of
office space in Krakow, Poland pursuant to a lease that expires on Juy 31, 2005 with an
option to extend the lease for an additional two years..

InterCard
Systemelectronic owns an aggregate of 5,201 square meters of land in Bad Durrheim,
Germany. Of this land, 3,000 square meters can be used commercially and the remainder is
currently designated as farmland. The commercially usable land is currently being used by
InterCard Systemelectronic for its manufacturing facility.

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

|A. | OPERATING
RESULTS
|-- | -----------------

The
following discussion and analysis is based on and should be read in conjunction with our
consolidated financial statements, including the related notes, contained in Item
18.  Financial Statements.

# Overview

We
design, develop and sell contactless microprocessor-based smart card products. Our
headquarters and research and development activities are in Israel. Our sales and
marketing efforts are directed from our U.S. subsidiary, OTI America, located in Fort Lee,
New Jersey, with additional sales and support offices located in Israel, Europe and South
Africa. Our packaging, assembly and manufacturing facilities are located in Israel and
Germany.

31

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Since
our incorporation in 1990, we have focused on the development of our core technologies and
our OTI Platform-based products. We currently offer four lines of products, each of which
constitutes a complete system, as well as components (such as smart cards and readers)
that we sell to original equipment manufacturers, or OEMs, for incorporation into their
own products. Our four complete system product lines include:

| |  | Micropayments
Solutions, including the PayPass system that we are installing for
MasterCard International, our EasyPark system and our mass transit payment system;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Petroleum
Systems, including both our gasoline management system, or GMS, and our
EasyFuel systems;
| | - | ---------------------------------------------------------------------------------------------------

| |  | Smart
ID Solutions,for both personal identification and credentialing purposes; and
| | - | -----------------------------------------------------------------------------------

| |  | Campus
Systems.
| | - | ---------------

We
began selling campus systems, our first product line, in 1993. Over time, our customer
base for campus systems increased and, in 1995, we began selling our second product line,
GMS. In 2003, we introduced and began to realize revenues from EasyFuel, our contactless
petroleum system, which we expect to account for an increasing proportion of our petroleum
system sales. In 1998, we were awarded a contract for the first of our micropayments
systems, an electronic parking payment system which we refer to as EasyPark. We began to
deploy EasyPark in 2000 and completed deployment of the first system in June 2001. We
deployed our first mass transit micropayments system in China during 2000 and in the
United States in 2003. In 2002, we began to realize nonrecurring engineering revenues from
the PayPass micropayments system that we are installing for MasterCard International
and we began to recognize product sale revenues from that system in 2004.

We
began to market components for incorporation into the products of OEMs with our
acquisition of InterCard Systemelectronic in June 2000. During 2002, 2003 and 2004,
product sales to OEMs accounted for $6.1 million (34%), $6.3 million (32%) and $8.9
million (38%), respectively, of our total revenues.

We
have reported net losses for each year that we have been in business. For the unaudited
fourth and third quarters of 2004 and for the third quarter of 2003 we reported net losses
of $2.2 million, $1.2 million and $1.8 million, respectively. We reported net income of
$102,000 for the fourth quarter of 2003. Because our business tends to be seasonal, with
greater sales in the third and, particularly, the fourth quarters of every year, we do not
anticipate having net earnings for either of the first two quarters of 2005 and we also
cannot assure you that we will be profitable in either of the last two quarters of 2005.
Furthermore, we expect to incur full year losses at least through 2005.

# Sources of Revenue

We
have historically derived a substantial majority of our revenues from the sale of our
products, including both complete systems and OEM components. Asubstantial
majority of our product revenues has been, and is likely to continue to be, from the sale
of complete systems. We anticipate that revenues from product sales will continue to
represent the substantial majority of our revenues in the future. We also generate
revenues from nonrecurring engineering, customer services and technical support, and
licensing and transaction fees. We anticipate that revenues from services and support and
licensing and transaction fees will make a proportional greater contribution to our total
sales and that revenues from product sales will make a proportionally smaller contribution
to our sales in the future.

During
the past three years, the revenues that we have derived from product sales, non-recurring
engineering, customer services and technical support, and licensing and transaction fees
have been as follows (dollar amounts in thousands):

|                      | 2002 | 2003 | 2004
|--------------------- | ---- | ---- | ----
|
|
|
|
|Product sales         |      |      | $   
|Non-recurring         |      |     
|engineering           |      |      |     
|Customer services and |      |     
|technical support     |      |      |     
|Licensing and         |      |     
|transaction           |      |      |     
|                      |      |      |     
|                      |      |      | $   
|                      |      |      |     

32

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Product
sales increased by $1.8 million and $1.9 million in 2003 and 2004, respectively, due
to an increase in sales of products that we had begun to market in prior years, as well as
initial sales of new products that we began to market in 2003 and 2004. We expect that,
over time, our newer products will make a proportionately greater contribution to our
total sales than our older products. We also anticipate that our revenues from products
will make a proportionally smaller contribution to our sales in the future.

Non-recurring
engineering revenues consist of payments for the adaptation of our products to the
requirements of a specific customer. We receive payments for non-recurring engineering
regardless of whether our customers ultimately purchase the customized product. Revenues
from non-recurring engineering vary widely from period to period because not all projects
that we undertake require customization of our products and those that do require varying
degrees of customization.

Customer
services and technical support consist of fees paid by purchasers of our products for
ongoing customer services and technical support. These fees tend to vary widely from
period to period, as customers requirements tend to be ad hoc, rather than subject
to any fixed schedule, but we anticipate that these fees will make a proportionally
greater contribution to our sales in the future.

Licensing
and transaction fees include one-time and periodic payments for manufacturing or
distribution rights for our products. Transaction fees are paid by customers based on the
volume of transactions processed by systems that contain our products. We expect to
generate additional revenues from transaction fees in the future as the installation and
usage of systems that contain our products become more widespread, and accordingly
anticipate that these fees will make a proportionally greater contribution to our sales in
the future.

Our
business plan anticipates that revenues from customer services and technical support and
from licensing and transaction fees will account for a growing portion of our overall
revenues in future periods. However, our product sales may be adversely affected in the
near term by our offering customers a reduction in up-front product and system prices as
an inducement to accept transaction fee-based pricing.

Although
we sell our products primarily in Europe, we have historically derived revenues from
different geographical areas. The following table sets forth our sales, by dollar amount
(in thousands) and as a percentage of revenues in different geographical areas, during the
past three years:

|     | Africa | Europe | Far East
|---- | ------ | ------ | --------
|
|
|
|
|2002 |        |        | $       
|2003 |        |        | $       
|2004 |        |        | $       
|     |        |       
|
|     |        |       
|2002 |        |        | $       
|2003 |        |        | $       
|2004 |        |        | $       

* Less than 1%

We anticipate that, over time, the
revenues that we derive from North America will grow both in absolute amounts and as a
percentage of our total revenues. Our revenues from Europe, which are primarily received
in Euros, will have a varying impact upon our total revenues, as a result of fluctuations
in the Euro/dollar exchange rate. In addition, and regardless of these fluctuations, as
the proportionate contribution of North America to our total revenues grows, the
proportionate contribution of Europe is likely to decline.

# Cost of revenues and
gross margin

Our
costs of revenues, by revenue source, and gross profit, for each of the past three years
were as follows (in thousands):

|                          | Year ended December 31
|------------------------- | ----------------------
|
|
|
|
|Cost of revenues*         |                       
|Products                  |                       
|Non-recurring engineering |                       

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|                                        | Year ended December 31
|--------------------------------------- | ----------------------
|
|
|
|
|
|
|                                        |                       
|Customer services and technical support |                       
|                                        |                       
|Total cost of revenues                  |                       
|                                        |                       
|Gross profit                            |                       

---

* Licensing and transaction fees do
not have directly attributable cost of revenues. See below.

Products.          Products
cost of revenues consists primarily of materials, as well as the           salary,
subcontractors and related costs for our technical staff who assemble           our
products and related overhead expenses. The increase in 2004 is primarily           the
result of increased revenues from product sales during the years covered by           the
table, and due to execution of the initial stages of new projects which are
          characterized by lower margins in their early stages.

Nonrecurring
engineering. Nonrecurring engineering cost of revenues consists of the salary and
related costs for our technical staff who customize our products and related overhead
expenses.

Customer
services and technical support. Customer services and technical support cost of
revenues consist of the salary and related costs for our technical staff that provide
those services and support and related overhead expenses.

Licensing
and transaction fees. Licensing and transaction fees revenues do not have directly
attributable cost of revenues. The only costs incurred to initiate the project include
selling and marketing and are classified as such in the consolidated statement of
operations.

For
any given period, our total gross margin will depend on, and vary to reflect, the mix of
product sale revenues, non-recurring engineering revenues, customer services and technical
support fees and licensing and transaction fees in that period. The gross margin for each
of our sources of revenue during the past three years was as follows:

|                         | 2002 | 2003 | 2004
|------------------------ | ---- | ---- | ----
|
|
|
|
|Product sales            |      |      |     
|Nonrecurring engineering |      |      |     
|Services and support     |      |      |     
|                         |      |     
|Total gross margin       |      |      |     

Operating expenses

Our
operating expenses and operating loss for each of the past three years were as follows (in
thousands):

|                                          | Year ended December 31
|----------------------------------------- | ----------------------
|
|
|
|
|Operating expenses                        |                       
|Research and development                  |                       
|Less  participation by the Office of the |                       
|Chief Scientist                           |                       
|                                          |                       
|                                          |                       
|Research and development, net             |                       
|Selling and marketing                     |                       
|General and administrative                |                       
|Amortization of intangible assets         |                       
|Expenses relating to raising of capital   |                       
|and exchange of subsidary's employees     |                       
|equity interest in equity interest of     |                       
|the Company                               |                       
|                                          |                       
|                                          |                       
|Total operating expenses                  |                       
|                                          |                       
|                                          |                       
|Operating loss                            |                       

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Research
and development. Our research and development expenses consist primarily of salaries
and related expenses of our research and development staff, as well as subcontracting
expenses. All research and development costs are expensed as incurred. Our research and
development expenses decreased in 2003 due to cost-cutting measures that we undertook and
our increased focus on developing solutions for our customers specific order
requirements, and increased in 2004 primarily due to a decrease in the participation of
the Office of the Chief Scientist which is likely to continue to decrease in the future
and also due to costs associcated with our working various compliance and standard
institutions. We expect that our research and development expenses will increase in the
future as we continue to develop new products and new applications for our existing
products and as a result of designing our own microprocessors and smart card operating
system.

Selling
and marketing. Our selling and marketing expenses consist primarily of salaries and
substantially all of the expenses of our sales and marketing subsidiaries and offices in
the United States, South Africa, the Far East and Europe, as well as expenses related to
advertising, professional expenses, participation in exhibitions and tradeshows. The
increase in 2003 was the result of both increased sales and an increase in our European
selling and marketing costs, as reported in dollars, by reason of the appreciation of the
value of the Euro against the dollar. The increase in 2004 is primarily the result of
increased marketing expenses as opposed to increased sales, due to an increase in
marketing and advertising efforts associated with (i) our successful bid to participate in
the first phase of the U.S. Governments e-passport project, (ii) our various
micropayments solutions projects, (iii) increasing our presence in the petroleum systems
market, specifically in China and in another country in Asia and (iv) our continuing
efforts to promote a number of significant projects in the U.S.

We
expect that our selling and marketing expenses will increase in the future as we continue
to expand our local sales and marketing subsidiaries, open new offices and hire additional
personnel.

General
and administrative. Our general and administrative expenses consist primarily of
salaries and related expenses of our executive management, such as management fees and
business trips, as well as financial and administrative staff. These expenses also include
costs of our professional advisors such as legal and accounting experts, office expenses,
insurance and vehicle expenses, which have collectively grown with the scope, magnitude
and complexity of our business. We expect that general corporate and administrative
expenses will increase in the future as we continue to expand our operations.

Expenses
relating to raising of capital and exchange of subsidiarys employees equity interest
in equity interest of the Company. These expenses consist primarily of $1.1 million of
options granted to employees of our South African subsidiary in exchange for their
existing shares and options in that subsidiary, $661,000 of options granted and $550,000
of bonuses paid to our employees in 2004 and $904,000 of expenses related to the repricing
of employee options during 2004.

# Financing income
(expenses), net

Financing
income consists primarily of interest earned on our cash equivalents balances and other
financial investments and foreign exchange gains. Financing expenses consist primarily of
interest payable on bank loans and foreign exchange losses.

Our
financing income (expenses), net for each of the past three years, has been as follows (in
thousands):

|                                | Year ended December 31
|------------------------------- | ----------------------
|
|
|
|
|Financing income                |                       
|Financing expenses              |                       
|                                |                       
|Financing income (expense), net |                       
|                                |                       

# Critical Accounting
Policies and Estimates

We
prepare our consolidated financial statements in conformity with accounting principles
generally accepted in the U.S. In so doing, we are required to make certain estimates,
judgments and assumptions that we believe are reasonable based upon the information
available. These estimates and assumptions affect the reported amounts of assets and
liabilities at the date of the financial statements and results of operations. To fully
understand and evaluate our reported financial results, we believe it is important to
understand our revenue recognition policy, our policy with respect to the impairment of
goodwill and other intangible assets and our policy with respect to stock compensation.

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Revenue
recognition. We recognize product revenues upon delivery, provided there is persuasive
evidence of an agreement, delivery has occurred, the fee is fixed or determinable and
collection is probable. In the case of nonrecurring engineering, delivery is deemed to
occur on completion of testing and approval of the customization of the product by the
customer and no further obligation exists.

Technology
license revenues are recognized at the time the technology and license is delivered to the
customer, collection is probable, the fee is fixed and determinable, persuasive evidence
of an arrangement exists, no significant obligation remains under the sale or licensing
agreement and no significant customer acceptance requirements exist after delivery of the
technology.

We
recognize revenues from customer services and technical support as the services are
rendered over the period of the contract.

We
recognize transaction fees as they are earned based on usage.

Our
revenue recognition policies are consistently applied for all revenues recognized.

Impairment
of Goodwill and Other Intangible Assets. We periodically assess the impairment of
goodwill and other intangible assets whenever events or changes in circumstances indicate
that the carrying value may not be recoverable. In 2002, Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets became effective, and
as a result, commencing on January 1, 2002, goodwill is no longer being amortized. In lieu
of amortization, we have performed an initial impairment review of goodwill as of January
1, 2002 and will perform an annual impairment review thereafter at the level of each
reporting unit. We have estimated the fair value of each reporting unit and compared it to
its reported carrying amount. To determine fair value, we have used a number of valuation
methods including quoted market prices, discounted cash flows and revenue multiples,
taking into consideration factors such as control premiums and synergies. In certain cases
we have obtained an opinion from an independent appraiser. Based on this comparison for
each reporting unit, no goodwill impairment losses were recorded. As we operate in an
industry which is rapidly evolving and extremely competitive, it is possible that our
estimates could change in the near term and there can be no assurance that future goodwill
impairment tests will not result in a charge to our results of operation. Net goodwill and
other intangible assets amounted to approximately $5.6 million as of December 31, 2004.

Significant
management judgments and estimates must be made when establishing criteria for future cash
flows, estimating reporting unit fair value and assessing impairment. If our judgments and
estimates relating to goodwill and other intangible assets prove to be inadequate, an
asset may be determined to be impaired and our financial results could be materially
adversely impacted. Likewise, if a future event or circumstance indicates that an
impairment assessment is required and, through the performance of that assessment, an
asset is determined to be impaired, our financial results could be materially and
adversely impacted in future periods.

Stock
option plans. We continue to apply the provisions of APB No. 25, including FASB
Interpretation No. 44 Accounting for Certain Transactions Involving Stock
Compensation  and Interpretation of APB No.25 and provide pro forma
disclosures required by SFAS No. 123, as amended by SFAS 148, Accounting for
Stock-Based Compensation  Transition and Disclosure, an amendment of Statement
123". SFAS 123 Accounting for Stock-based Compensation establishes
financial accounting and reporting standards for stock-based compensation plans. The
statement defines a fair value based method of accounting for an employee stock option. As
required by SFAS 123, the Company has determined the weighted average fair value of
stock-based arrangement grants. The fair values of stock-based compensation awards granted
were estimated using the Black  Scholes option pricing model with
certain assumptions that are significant inputs.

The
critical assumptions relate to determining the expected life of the option, considering
the outcome of service-related conditions (i.e., vesting requirements and forfeitures),
expected volatility of the underlying stock, an estimate of the future price fluctuation
of the underlying stock for a term commensurate with the expected life of the option,
expected dividend yield on the underlying stock, reflecting a reasonable expectation of
dividend yield commensurate with the expected life of the option, and risk-free interest
rate during the expected term of the option.

SFAS
123 requires that the option pricing model used consider managements expectations
about the life of the option, future dividends, and stock price volatility. Both the
volatility and dividend yield components should reflect reasonable expectations
commensurate with the expected life of the option. To determine the expected volatility,
we generally begin with calculating historical volatility over the most recent period
equal to the expected life of the options. The expected dividend yield on the underlying
stock for all relevant periods is zero since there is no history of paying dividends. The
expected life of an employee stock option award was estimated based on reasonable facts
and assumptions on the grant date.

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These
estimates introduce significant judgment into determining the fair value of stock-based
compensation awards.

# Recently issued
accounting guidance

In
November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment to ARB 43,
Chapter 4. The amendment made by SFAS No. 151 clarifies that abnormal amounts of idle
facility expense, freight, handling costs, and wasted material (spoilage) should be
recognized as current-period charges, and also require the allocation of fixed production
overhead to inventory based on the normal capacity of the production facilities. The
guidance is effective for inventory costs incurred during fiscal years beginning after
June 15, 2005. Earlier application is permitted for inventory costs incurred during fiscal
years beginning after November 23, 2004. The provision of SFAS No. 151 should be applied
prospectively.

Adoption
of this statement is not expected to have a material impact on our financial position or
results of operations.

In
March 2004, the Emerging Issues Task Force (EITF) reached a consensus on EITF
Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application
to Certain Investments (EITF 03-1) regarding disclosures for certain
SFAS No. 115 investment securities and investments accounted for under SFAS No. 124. The
objective of EITF 03-1 is to provide guidance on determining when an investment is
considered impaired, whether that impairment is other-than-temporary, and the measurement
of an impairment loss. The guidance also includes accounting considerations subsequent to
the recognition of an other-than-temporary impairment and requires certain disclosures
about unrealized losses that have not been recognized as other-than-temporary impairments.
In September 2004, the FASB issued FASB Staff Position (FSP) EITF Issue 03-1-1
that delays the effective date for the measurement and recognition guidance included in
EITF 03-1. The FASB recently announced that it intends on reconsidering in its entirety
EITF 03-1 and all other guidance on disclosing, measuring, and recognizing
other-than-temporary impairments of debt and equity securities. Until new guidance is
issued, companies must continue to comply with the disclosure requirements of EITF 03-1
and all relevant measurement and recognition requirements in other accounting literature.
Quantitative and qualitative disclosures for investments accounted for under SFAS No. 115
are included in Note 2E of our consolidated financial statements.

In
December 2004, the FASB issued SFAS No. 123 (Revision 2004), Share-Based
Payment, (SFAS No. 123R), that addresses the accounting for share-based payment
transactions in which employee services are received in exchange for either equity
instruments of our, liabilities that are based on the fair value of our equity instruments
or that may be settled by the issuance of such equity instruments. SFAS No. 123R
eliminates the ability to account for share-based compensation transactions using the
intrinsic value method as prescribed in APB Opinion No. 25, Accounting for Stock
Issued to Employees. Instead, SFAS No. 123R requires that such transactions be
accounted for using a fair-value-based method and that compensation expense be recognized
in the statement of operations rather than disclosing the pro forma impact of the stock
based compensation as we currently disclose in Note 2Q and 14C of our consolidated
financial statements.

SFAS
No. 123R provides two alternative adoption methods. The first method is a modified
prospective transition method whereby a company would recognize share-based employee costs
from the beginning of the fiscal period in which the recognition provisions are first
applied as if the fair-value-based accounting method had been used to account for all
employee awards granted, modified, or settled after the effective date and to any awards
that were not fully vested as of the effective date. Measurement and attribution of
compensation cost for awards that are unvested as of the effective date of SFAS No. 123R
would be based on the same estimate of the grant-date fair value and the same attribution
method used previously under SFAS No. 123, Accounting for Stock-Based
Compensation (SFAS No. 123). The second adoption method is a modified
retrospective transition method whereby a company would recognize employee compensation
cost for periods presented prior to the adoption of SFAS No. 123R in accordance with the
original provisions of SFAS No. 123; that is, an entity would recognize employee
compensation costs in the amounts reported in the pro forma disclosures provided in
accordance with SFAS No. 123. A company would not be permitted to make any changes to
those amounts upon adoption of SFAS No. 123R unless those changes represent a correction
of an error. The provisions of SFAS No. 123R are effective for annual periods beginning
after June 15, 2005. This standard will be effective for us as of January 1, 2006. We
expect the adoption of this standard will reduce our 2006 net income by approximately
$954,000. This estimate is based on the number of options currently outstanding and
exercisable and could change based on the number of options granted or forfeited in fiscal
2005 and 2006.

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In
December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets 
an amendment to APB No. 29. This Statement amends Opinion No. 29 to eliminate the
exception for nonmonetary exchanges of similar productive assets and replaces it with a
general exception for exchanges of nonmonetary assets that do not have commercial
substance. A nonmonetary exchange has commercial substance if the future cash flows of the
entity expected to change significantly as a result of the exchange. Adoption of this
statement is not expected to have a material impact on our consolidated financial position
or results of operations.

|B. | LIQUIDITY
AND CAPITAL RESOURCES
|-- | -------------------------------

Our
principal sources of liquidity since our inception have been sales of equity securities,
borrowings from banks, convertible loans, cash from the exercise of options and grants
from the Office of the Chief Scientist. We had cash and cash equivalents of $23.9 million
as of December 31, 2004 and $9.7 million as of December 31, 2003. In addition, we had
short-term investments of $4.6 million as of December 31, 2004 and $1.0 million as of
December 31, 2003. We believe that our working capital is sufficient to meet our present
requirements.

Operating
activities. For the year ended December 31, 2004 we used $330,000 of cash in operating
activities primarily due to our net loss of $9.3 million, an increase of $1.2 million in
inventories resulting from anticipated higher sales in the coming quarters, a $1.1 million
increase in trade receivables resulting from increased product sales during 2004, and a
$792,000 increase in other receivables and prepaid expenses mainly due to Israeli value
added tax (VAT) returns, partially offset by the amortization of $4.9 million
of deferred stock compensation in respect of stock options granted to employees, a $2.1
million increase in trade payables resulting from increased supplier payables, a $1.9
million expense related to the grant of stock options to consultants, a $999,000 decrease
in short-term investments as a result of the maturity of certain Company investments in
Israeli government bonds and $596,000 in accrued severance pay, net. For the year ended
December 31, 2003, our operating activities generated $267,000 of cash despite our net
loss of $3.6 million, primarily due to a $1.1 million increase in trade receivables
resulting from increased product sales and a $716,000 decrease in long-term deferred
revenues. The principal non-expense items that resulted in our operations being cash
positive were the amortication of $1.9 million of deferred stock compensation, a
$1.5 million depreciation expense for property and equipment and a $674,000 expense
related to the grant of stock options to consultants.

Investing
and financing activities. For the year ended December 31, 2004, net cash used in
investing activities was $5.1 million, consisting mainly of a $4.5 million investment in
available for-sale securities and a $449,000 investment in equipment purchases. For the
year ended December 31, 2003, net cash used in investing activities was $502,000.
Substantially all of our investments in both years were in property, plants and equipment,
primarily in a building, computers, software, manufacturing equipment and office
equipment.

For
the year ended December 31, 2004, net cash provided by financing activities was $19.5
million, consisting mainly of $12.8 million of net proceeds from the issuance in April
2004 of ordinary shares and detachable warrants, net of issuance expenses, $6.8 million
received in connection with the exercise of options and warrants and a $437,000 increase
in our short-term bank debt, net, partially offset by the $475,000 repayment of long-term
bank debt. For the year ended December 31, 2003, net cash provided by financing activities
was $7.8 million consisting mainly of $8.9 million of net proceeds from the issuance in
December 2003 of ordinary shares, partially offset by the $2.1 million repayment of long
term bank debt.

Market Risk

Market
risks relating to our operations result primarily from changes in interest rates and
currency fluctuations. In order to limit our exposure, we may enter, from time to time,
into various derivative transactions. Our objective is to reduce exposure and fluctuations
in earnings and cash flows associated with changes in interest rates and foreign currency
rates. We do not use financial instruments for trading purposes. It is our policy and
practice from time to time to use derivative financial instruments only to limit exposure.

As
of December 31, 2004, we held $4.6 million in marketable bonds, all with high credit
quality U.S. issuers and with a limited amount of credit exposure to any one issuer.

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Interest Rate Risks.

We
are exposed to market risks resulting from changes in interest rates, relating primarily
to our loan obligations to banks. We do not currently use derivative financial instruments
to limit exposure to interest rate risk. As of December 31, 2004, we had fixed interest
rate loan obligations of $217,000. Of this amount, $90,000 was denominated in Euros and
$127,000 was denominated in NIS. These loans will be repaid during the next 2 years. At
the same time, we had variable interest rate loan obligations of $1.8 million in dollars.
These loans will also be repaid during the next 7 years. We believe that the potential
loss that would result from an increase or decrease in the interest rate is immaterial to
our business and consolidated net assets.

The
carrying value of the loans are equivalent to or approximate their value as they bear
interest at approximate market rates.

Impact of Inflation and
Currency Fluctuations.

Our
functional and reporting currency is the U.S. dollar. We generate a significant portion of
our revenues and we incur some of our expenses in other currencies. As a result, we are
exposed to the risk that the rate of inflation in Israel will exceed the rate of
devaluation of the NIS in relation to the dollar or that the timing of this devaluation
will lag behind inflation in Israel. In addition, we are exposed to the risk that the
dollar will be devalued against the NIS. To date, we have not been materially affected by
changes in the Israeli rate of inflation or the exchange rates of the Shekel compared to
the dollar, but we cannot assure you that we will not be adversely affected in the future.

The
annual rate of inflation in Israel was 1.21% in 2004, (1.89)% in 2003 and 6.5% in 2002.
The NIS increased in value by approximately 1.62% and 7.6% in 2004 and 2003, respectively
and devalued against the dollar by approximately 7.3% in 2002.

The
functional currency of InterCard Systemelectronic is the Euro. Significantly, all of
Intercard Systemelectronics revenues are earned, and significantly all of its
expenses are incurred, in Euros. To the extent that there are fluctuations between the
Euro and the U.S. dollar, the translation adjustment will be included in our consolidated
changes in shareholders equity and will not impact the consolidated statement of
operations. We do not expect our exposure to these fluctuations to be material.

Corporate Tax Rate

On June 29, 2004, the Israeli Knesset
passed Income Tax Ordinance (No. 140 and Temporary Order), 2004 (hereinafter, the
Amendment). The Amendment provides for gradual reduction of the tax rates for
companies, from the rate of 36% to the rate of 30%, in the following manner: in the 2004
tax year the tax rate will be 35%, in the 2005 tax year the tax rate will be 34%, in the
2006 tax year the tax rate will be 32%, and in the 2007 tax year and thereafter the tax
rate will be 30%. As of December 31, 2004, our net operating loss carry-forwards for
Israeli tax purposes amounted to approximately $37.5 million. Under Israeli law, net
operating losses can be carried forward indefinitely and offset against certain future
taxable income. Since we have incurred tax losses through December 31, 2004, we have not
yet utilized the tax benefits for which we are eligible under the Approved
Enterprise status. $4.5 million of our investment programs in buildings, equipment
and production facilities have been granted Approved Enterprise status and we
are, therefore, eligible for a tax exemption under the Law for the Encouragement of
Capital Investments, 1959. All of our operating income and the operating income of
EasyPark generated in Israel is derived from Approved Enterprise programs.
Subject to compliance with applicable requirements, the portion of our income derived from
the Approved Enterprise programs is tax-exempt for a period of the earliest of
(1) ten years commencing in the first year in which it generates taxable income, (2) 14
years from the date of approval or (3) 12 years from the date of beginning of production.
If we do not comply with these requirements, the tax benefits may be cancelled and we may
be required to refund the amount of benefits received, in whole or in part, with the
addition of linkage differences to the Israeli consumer price index and interest. As of
the date of this annual report,we believe that we are in compliance with these conditions.
The authorization of the Investment Center Administration under the Encouragement of
Capital Investments Law, 1959 to approve such Approved Enterprise programs
shall terminate in December 31, 2007 and therefore there is a doubt regarding obtaining
new benefits after December 31, 2007. There can be no assurance that such tax benefits
will be continued in the future at their current levels or otherwise.

Government of Israel
Support Programs

We
participate in programs offered by the Office of the Chief Scientist of the Ministry of
Industry and Trade that support research and development activities. We received and
obtained grants of $1.1 million in 2002, $853,000 million in 2003 and $394,000 in 2004
from the Office of the Chief Scientist with respect to our e-purse application. Under the
terms of these grants, a royalty of 3% to 5% of the sales of this product must be paid to
the Office of the Chief Scientist, beginning with the commencement of sales of products
developed with grant funds and ending when the dollar value of the grant is repaid.

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Royalties
payable with respect to grants received under programs approved after January 1, 1999,
however, will be subject to interest on the dollar-linked value of the total grants
received at an annual rate of LIBOR applicable to dollar deposits. As of December 31,
2004, we have received a total of $5.2 million from the Office of the Chief Scientist net
of royalties paid to it (or accrued for). The terms of Israeli government participation
also require that the manufacturing of products developed with government grants be
performed in Israel, unless the Office of the Chief Scientist has granted special
approval. If the Office of the Chief Scientist consents to the manufacture of the products
outside Israel, we may be required to pay increased royalties, ranging from 120% to 300%
of the amount of the Office of the Chief Scientist grant, depending on the percentage of
foreign manufacture. These restrictions continue to apply even after we have paid the full
amount of royalties payable in respect of the grants. Based upon the aggregate grants
received to date, we expect that we will continue to pay royalties to the Office of the
Chief Scientist to the extent of our sales of our products and related services for the
foreseeable future. Separate Office of the Chief Scientist consent is required to transfer
to third parties technologies developed through projects in which the government
participates. These restrictions do not apply to exports from Israel of products developed
with these technologies.

|C. | RESEARCH
AND DEVELOPMENT, PATENTS AND LICENSES, ETC.
|-- | ----------------------------------------------------

Discussed
above in "Item 5.  A.  Overview."

|D. | TREND
INFORMATION
|-- | -----------------

Discussed
above in "Item 5.  A.  Overview."

|E. | OFF
BALANCE SHEET ARRANGEMENTS
|-- | ------------------------------

In
1999, the Company entered into an interest rate swap (IRS) agreement on the
amount of Euro 1.0 million. Under the terms of the IRS, the Company received variable
interest payments on the Eurobor rate, and made fixed rate payments at an annual rate of
4.55%. The IRS expired in January 2004.

|F. | TABULAR
DISCLOSURE OF CONTRACTUAL OBLIGATIONS
|-- | ---------------------------------------------

At
December 31, 2004, we and our subsidiaries have contractual obligations which are expected
to affect our consolidated cash flow in future periods as follows:

|                            | 2005 | 2006 | 2007 | 2008  | 2009 and
thereafter | Total
|--------------------------- | ---- | ---- | ---- | ----- | ------------------- | -----
|
|
|
|
|Operating lease obligations |      |      | $    | 309   |                     | $    
|Loans                       |      |      | $    | 752   |                     | $    
|Total                       |      |      | $    | 1,061 |                     | $    

We
shall also pay royalties to the Office of the Chief Scientist as discussed above in "Item
5B.  Liquidity and Capital Resources."

For
an additional information on our contractual obligations as of December 31, 2004, under
long-term bank loans and operating leases, see Notes 10 and 13 to our consolidated
financial statements. For a description of liens on our assets see Note 13C to our
consolidated financial statements.

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

|A. | DIRECTORS
AND SENIOR MANAGEMENT
|-- | -------------------------------

# Management

The
following table sets forth certain information concerning our current directors and
executive officers, including officers of certain of our subsidiaries:

40

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|Name                     | Age | Position                                                 
|------------------------ | --- | ---------------------------------------------------------
|
|
|
|
|Oded Bashan (1)          | 58  | President, Chief Executive Officer, Chairman and Director
|Ronnie Gilboa            | 48  | Vice President  Projects and Director                   
|Guy Shafran              | 32  | Chief Financial Officer                                  
|Moshe Aduk               | 48  | Vice President  Gasoline Management System              
|Nehemya Itay             | 55  | Vice President  Hardware Engineering                    
|Ohad Bashan              | 33  | Head of Global Marketing and Strategy Development;       
|                         |     | President and Chief Executive Officer, OTI America, Inc. 
|Raanan Ellran (1)(2)(3)  | 55  | Director                                                 
|Eliezr Manor (1)(2)(3)   | 57  | Director                                                 
|Liora Katzenstein (2)(3) | 49  | Director                                                 
|Eli Akavya (1)(2)        | 57  | Director                                                 

---

(1)
          Compensation committee member 
(2)
          Audit committee member 
(3)
          External director

Oded
Bashanco-founded the Company in 1990 and has continued to serve as our President,
Chief Executive Officer and Chairman since that time. Prior to founding us, he served as
the president of Electo-Galil, an Israeli manufacturer of radio frequency identification
cards, from 1984 to 1990. Mr. Bashan is Chairman of OTI America, Inc., OTI Africa Ltd.,
SoftChip Technologies (3000) Ltd., Easy Park Ltd. and Easy Park Israel Ltd. and a director
of ASEC and Z.H.R. Industrial Park Company Ltd. In 1997, Mr. Bashan was awarded the
Leading Businessman Award in Management, Business and Economics by the Israeli Institute
of Public Opinion. He is currently a member of the trustee committee of the Tel-Chai
College and a member of the consulting committee for the Executive MBA program at Bar Ilan
University. Mr. Bashan holds both a B.A. and an M.A. in economics and business management
from the Hebrew University of Jerusalem.

Ronnie
Gilboaco-founded the Company in 1990 and has continued to serve as a director since
that time. From 1990 to the end of 2001 he served as Vice President R&D and since that
date serves as our Vice President-Projects. He serves on the board of directors of OTI
America, Inc., ASEC S.A, OTI Africa Ltd., Easy Park Ltd., Easy Park Israel Ltd. and
Softchip Technologies (3000) Ltd. Prior to founding us, Mr. Gilboa was the manager of
research and development at Electo-Galil, an Israeli manufacturer of radio frequency-based
identification cards, from 1984 to 1990. Mr. Gilboa holds a B.Sc. in electrical
engineering from The Technion (Israeli Institute of Technology).

Guy
Shafranserves as our Chief Financial Officer and has served as a director of Easy
Park Ltd. since June 2000 and as a director of Easy Park (Israel) Ltd. since March, 2002.
Prior to joining us, Mr. Shafran was chief financial officer at the Israel Cold Storage
and Supply Company Ltd., an Israeli public company engaged in the distribution of soft
drinks and cold storage, from June 1996 to March 2000. From July 1995 to February 1996,
Mr. Shafran was assistant to the chairman of the Baran Group Ltd., an Israeli engineering
company. Mr. Shafran holds a B.A. in economics with a specialization in business
administration from Ben Gurion University, Beer Sheba.

Moshe
Adukserves as our Vice President  Gasoline Management System having served in
that position since July 1995. From 1990 to July 1995, he was employed by us as a research
and development engineer. He served as a director from 1995 to July 1999. Prior to joining
us, Mr. Aduk was a hardware and software development engineer at Electo-Galil, an Israeli
manufacturer of radio frequency-based identification cards, from 1985 to 1990. From 1984
to 1985, he was employed as a technical support engineer at Motorola Israel. Mr. Aduk
holds a B.Sc. in electrical engineering from The Technion (Israeli Institute of
Technology).

Nehemya
Itayserves as our Vice President  Hardware Engineering, having served in that
position since July 1995. From 1990 to July 1995, he was employed by us as a research and
development engineer. He served as a director from 1991 to July 1999. Mr. Itay is a member
of the Joint Task Committee of the International Standards Organisation on standards for
contactless smart cards. Prior to joining us, Mr. Itay was a hardware development engineer
at Electo-Galil, an Israeli manufacturer of radio frequency-based identification cards,
from 1986 to 1990. From 1982 to 1985, he was an hardware electronic engineer at Elscint,
an Israeli technology company. Mr. Itay holds a B.Sc. in electrical engineering from The
Technion (Israeli Institute of Technology) and an M.A. in electronics from Drexel
University, Philadelphia.

41

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Ohad
Bashanserves as our Head of Global Marketing and Strategy Development, having served
in that position since June 2000 and as President, Chief Executive Officer and a director
of OTI America, Inc., since August 1998. From 1996 to August 1998, he was our business
development manager. Mr. Bashan holds a B.A. in business from the College of Business
Management, Tel Aviv, with specializations in marketing and finance, and an M.B.A. from
Pepperdine University, California.  Ohad Bashan is the son of Oded Bashan.

Raanan
Ellranserves as a director, having served in that position since July 1999. He serves
as a director and the Chairman of the Investments Committee of Dikla Mutual Funds
Management Company (sister company to the First International Bank), F.I.B.I Holding
Company Ltd., and as a director of AAI Ltd., an Israeli internet software designer. From
1993 to 1998, he was a director of First International Bank of Israel, Provident and
Pension Funds. He served as the General Manager of Assuta Medical Centers from March 1997
until September 2002. From 1995 to February 1997, he served as the General Manager of
Raton Import Ltd. From 1994 to 1995, he was the General Manager of Ace Hardware (Israel)
Ltd. Mr. Elran holds a B.A. in economic and business administration and a M.A. in finance
from Bar llan University.

Eliezer
Manor serves as a director, having served in that position since July 2003. He serves
as a managing partner and co-founder of Global Catalyst Partners (GCP) VC Fund, a managing
partner and co-founder of Global Catalyst Partners II VC Fund, as a director of Trans
Balkan Fund (a private equity fund active in Romania, Bulgaria and Croatia), a director on
several portfolio companies of GCP, a member of the Executive Steering Committee of China
VC Research Institute and as a lecturer and consultant in Israel and abroad on Hi-Tech and
Venture Capital. Mr. Manor holds a B.Sc. Physics from the Tel Aviv University and a M.Sc.
Applied Physics from the Weizmann Institute of Science, Israel.

Prof.
          Liora Katzenstein serves as a director, having served in that position
since           July 2003. Prof. Katzenstein serves as the President of ISEMI  the
          Institute for the Study of Entrepreneurship Management and Innovation, Managing
          Director of the Consulta Associates, an international business development
          consulting firm, a partner and Joint Managing Director of Palafric Investment,
a           real estate investment company, an owner and President of Forum
International,           an Israeli business development consulting firm, and a program
manager of MIL            Israel Management Center. Prof. Katzenstein serves as a
director in           Amanet Ltd., Palafric Investment Ltd. and in several companies of
the RAD group           which are traded on Nasdaq. Prof. Katzenstein holds a License es
Sciences           Politiques from the Graduate Institute of International Studies,
University of           Geneva, Switzerland, a MALD in Law and Diplomacy from the
Fletcher School of Law           and Diplomacy, Tufts University, Boston, MA and a Ph.D.
in International           Economics from the Graduate Institute of International
Studies, University of           Geneva, Switzerland.

Eli
Akavya,serves as a director since December 2003. Mr. Akavya is an independent
consultant. Until recently, Mr. Akavya worked for Luoboshitz Kasierer, an Israeli auditing
firm (formerly a member firm of Arthur Andersen and currently merged with Ernst &
Young, Israel) for 30 years, first as an employee and later as a senior partner. Mr.
Akavyas roles at Luboshitz Kasierer included: Head of Audit Department, Head of Hi
Tech Division and Partner in charge of the Firm Professional Standards Group. He
specialized in hi-tech companies and accumulated invaluable experience in US GAAP and SEC
Rules. Mr. Akavya has participated in a large number of companies initial public
offerings in the United States.

|B. | COMPENSATION
|-- | ------------

# Executive Compensation

The
aggregate compensation paid by us and our subsidiaries to our executive directors and
executive officers listed above under Management, in the year ended December
31, 2004 was $804,183. This amount includes approximately $13,978 set aside or accrued to
provide pension, severance, retirement or similar benefits or expenses, but does not
include business travel, relocation, professional and business association dues and
expenses reimbursed to officers, and other benefits commonly reimbursed or paid by
companies in Israel.

Non-executive
directors are reimbursed for their expenses for each board meeting attended and in
addition receive compensation for their service on the board. Our executive directors do
not receive compensation for their service on the board of directors or any committee of
the board of directors. The aggregate amount paid by us and our subsidiaries to our
non-executive directors listed above under Management, in the year ended
December 31, 2004 was $34,000.

See
Item 6.  E.  Share Ownership for information on beneficial
ownership of our shares by our directors and executive officers. We have no outstanding
loans to any of our directors or executive officers.

42

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# Employment Agreements

We
maintain written employment and related agreements with all of our office holders. These
agreements provide for monthly salaries and contributions by us to executive insurance and
vocational studies funds. The employment agreements of certain of our office holders
further provide that we may give the employee an annual bonus in accordance with targets
to be determined by the compensation committee by December 31 of each calendar year in
respect of the following year. In determining the amount of the bonus, the compensation
committee must relate it to our revenues or profits, as applicable to the employee. We
approved bonus plan principles for our senior management on a shareholders general
meeting held on January 31, 2003. If justifiable in light of our quarterly financial
results, we may make advances on bonus payments pursuant to a resolution of our board of
directors. All of our office holders employment and related agreements contain
provisions regarding noncompetition, confidentiality of information and assignment of
inventions. The enforceability of covenants not to compete in Israel is unclear.

Agreement
with Oded Bashan. The employment agreement of Oded Bashan, dated July 1, 2004,
provides for a five-year term ending on June 30, 2009. Mr. Bashan may terminate his
employment, and we may terminate his employment for reasonable and justifiable cause, in
either case on six months notice. In the event of termination, Mr. Bashan is
entitled to receive severance pay equal to twice the rate of one months current
salary multiplied by the number of years of employment. In the event we terminate his
employment prior to June 30, 2009, unless the termination occurred as a result of
circumstances depriving him of the right to severance pay at law or as a result of a
breach of fiduciary duty or a material breach of confidentiality or noncompetition
undertakings, we are required to continue paying Mr. Bashan a monthly salary, including
benefits but excluding bonuses, until June 30, 2009, and in any event, for a period that
shall not be less than six months following the notice period described above. In addition
to the salary, contributions and bonus described above, Mr. Bashan is entitled under his
contract of employment to an additional bonus of $15,000 for every one percent increase in
our average share price quoted for the last two months of any year over the average share
price quoted for the last two months of the preceding year.

Agreement
with Ronnie Gilboa. The employment agreement of Ronnie Gilboa, dated July 1, 1999,
provides for a five-year term ended on June 30, 2004, and was extended automatically. Mr.
Gilboa may terminate his employment, and we may terminate his employment for reasonable
and justifiable cause, in either case on six months notice. In the event of
termination, Mr. Gilboa is entitled to receive severance pay equal to twice the statutory
rate of one months current salary multiplied by the number of years of employment.

Agreement
with Guy Shafran. The employment agreement of Guy Shafran, dated March 25, 2005,
provides for a five-year term ended on March 24 , 2010, and is automatically extended
unless terminated as described below. In the event of termination, Mr. Shafran is entitled
to receive severance pay equal to twice the rate of one months current salary
multiplied by the number of years of employment. Mr. Shafran may terminate his employment
on six months notice, and we may terminate his employment for reasonable or justifiable
cause on one years notice. In the event of termination of employment, unless the
termination occurred as a result of circumstances depriving Mr. Shafran of the right to
severance pay at law or as a result of a breach of fiduciary duty or a material breach of
his confidentiality or noncompetition undertakings, Mr. Shafran shall be entitled to six
months adjustment with full terms and benefits.

Agreements
with Moshe Aduk and Nehemya Itay. The employment agreements of Moshe Aduk and Nehemya
Itay, each dated July 1, 1999, provide for a five-year term ending on June 30, 2004, and
were extended automatically. These individuals may terminate their employment, and we may
terminate their employment for reasonable and justifiable cause, in either case on six
months notice. In the event of termination, these individuals are entitled to
receive severance pay equal to twice the rate of one months current salary
multiplied by the number of years of employment. In the event we terminate the employment
of either Mr. Aduk or Mr. Itay, unless the termination occurred as a result of
circumstances depriving them of the right to severance pay at law or as a result of a
breach of fiduciary duty or a material breach of his confidentiality or noncompetition
undertakings, we are required to continue paying each of them a monthly salary for three
months following the notice period described above.

Agreement
with Ohad Bashan. The employment agreement of Ohad Bashan with OTI America, Inc.,
dated August 23, 1998, provides for a two-year term which was extended until August 22,
2002 and then further extended for three years commencing on August 24, 2002. On March 1,
2003, we signed a supplemental agreement with Ohad Bashan, which was approved at our
General Meeting on January 31, 2003, which further amended his employment agreement. Mr.
Bashan may terminate his employment on six months notice and we may terminate his
employment only for cause. In the event we terminate his employment, Mr. Bashan shall be
entitled to four months adjustment with full terms and benefits. In the event that we
terminate Mr. Bashans employment during school year of his children, Mr. Bashan
shall be entitled to full compensation until the end of the school year, provided,
however, that the school year started on or before the termination date. In addition to
his monthly salary, as long as Mr. Bashan serves in the U.S., he shall be entitled to
receive a special annual bonus of 0.25% of the annual sales amount of OTI America. In
addition, OTI America has the right to assign Mr. Bashans employment agreement to
us, and require Mr. Bashan to relocate to Israel.

43

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|C. | BOARD
PRACTICES
|-- | ---------------

# Election of Directors;
Appointment of Officers

Our
current board of directors consists of six directors. Under our articles of association,
our board of directors may not consist at any time of more than nine members. A majority
of these directors must be non-executive directors, who are directors that are neither
office holders nor our employees. Directors are appointed, removed or replaced, by a
majority vote of our shareholders present in person or by proxy at a general meeting of
shareholders. Each group of shareholders holding in aggregate 20% or more of our
outstanding share capital is entitled to submit a written list of candidates for
appointment as directors at a general meeting. Shareholders may only vote for a list in
its entirety unless shareholders present at the meeting holding at least 20% of our
outstanding share capital require that the vote be for individual directors.

Once
elected at a shareholders meeting, our directors, except our external directors,
hold office until the first general meeting of shareholders held at least twenty-four
months after their election. Incumbent directors may be reelected at that meeting. Unless
contrary to the law, a director may be elected for consecutive terms.

Under
the new Israeli Companies Law, which took effect on February 1, 2000 (the Companies
Law), the chief executive officer of a public company may not serve as a chairman of
the board of directors unless authorized by a general meeting of the shareholders and then
only for a period of time that does not exceed three years. On July 11, 2003, our
shareholders authorized our chairman, Oded Bashan, to act as our CEO for an additional
three-year period ending May 25, 2006.

Our
board of directors appoints our chief executive officer. Each of our executive officers
serves at the discretion of the board of directors, subject to the terms of any employment
agreement, and holds office until his or her successor is elected or until his or her
earlier resignation or removal. Except for Ohad Bashan, our Head of Global Marketing and
Strategy Development, and President and Chief Executive Officer of OTI America, Inc., who
is the son of Oded Bashan, our co-founder and chairman of our board of directors, none of
our directors or executive officers has any family relationship with any other director or
executive officer.

# External Directors

The
Israeli Companies Law requires Israeli companies with shares that have been offered to the
public in or outside of Israel to appoint two external directors. No person may be
appointed as an external director of a company if the person, or the persons
relative, partner, employer or any entity under the persons control, has, or had
within the two years preceding the persons appointment as an external director, any
affiliation with the company or with any entity controlling, controlled by or under common
control with the company. The term affiliation includes control, an employment
relationship, a business or professional relationship maintained on a regular basis, or
service as an office holder, excluding service as a director appointed to serve as an
external director in a company that intends to make an initial offering of its shares to
the public. The term office holder is defined as a director, general manager,
chief business manager, deputy general manager, vice general manager, executive vice
president, vice president, other manager directly subordinate to the general manager or
any other person assuming the responsibilities of any of the foregoing positions, without
regard to such persons title. Each person listed in the table above is an office
holder. The external directors were not office holders until elected.

In
addition, no person may serve as an external director if that persons other
positions or business activities create, or may create, a conflict of interest with the
persons service as an external director or may otherwise interfere with the
persons ability to serve as an external director. If, at the time an external
director is appointed, all current members of the board of directors are of the same
gender, then that external director must be of the other gender. Regulations promulgated
under the Companies Law provide that the requirement of Israeli residency does not apply
to the external directors of companies whose shares are listed for trading outside of
Israel.

44

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External
directors are elected by a majority vote at a shareholders meeting at which 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 the election
of the external director, or the total number of shares held by non-controlling
shareholders voted against the election of the external 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 one additional
three year period. External directors may only be removed 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. If an external directorship becomes
vacant, our board of directors is required under the Companies Law to call a
shareholders meeting immediately to appoint a new external director.

A
company may not appoint an external director as an office holder and may not employ or
receive services from an external director, directly or indirectly, including through a
corporation controlled by that person, for two years following the termination of his or
her service as an external director of that company.

Each
committee of our board of directors must include at least one external director and the
audit committee must include all of the external directors. An external director is
entitled to compensation as provided in regulations adopted under the Companies Law and is
otherwise prohibited from receiving any other compensation, directly or indirectly, in
connection with services provided as an external director.

In
addition, the audit committee of our board of directors must include at least three
independent directors within the meaning of the Nasdaq National Market listing
requirements. Our directors Raanan Ellran, Eliezer Manor and Prof. Liora Katenstein,
qualify as external directors under the Companies Law and independent directors under the
Nasdaq National Market listing requirements. In addition, our director Eli Akavya, CPA,
qualifies as an independent director under the Nasdaq National Market listing
requirements.

# Alternate Directors

Under
our articles of association, each of our directors, other than our external directors, may
appoint, by written notice to us, any person to serve as an alternate director. Under the
Companies Law, a current director cannot be appointed as an alternate director nor can a
currently-serving alternate director be appointed as an alternate director. An alternate
director has all the rights and duties of the director appointing him, unless the
appointment of the alternate provides otherwise, and the right to remuneration. The
alternate director may not act at any meeting at which the appointing director is present.
Unless the time period or scope of the appointment is limited by the appointing director,
the appointment is effective for all purposes, but expires upon the expiration of the
appointing directors term. Currently, none of our directors has appointed any
alternate directors.

# Exculpation,
Indemnification and Insurance of Office Holders

Under
the Companies Law, an Israeli company may only exculpate an office holder in advance, in
whole or in part, for breach of duty of care and only if a provision authorizing such
exculpation is included in its articles of association. Our articles of association
include such a provision. A company may not exculpate an office holder in advance from his
liability towards the company which is caused by a breach of duty of care in case of
distribution (as defined in the Companies Law). A company may not exculpate an office
holder for breach of duty of loyalty. However, the company may approve an act performed in
breach of the duty of loyalty of an office holder provided that the office holder acted in
good faith, the act or its approval does not harm the company, and the office holder
discloses the nature of his or her personal interest in the act and all material facts and
documents a reasonable time before discussion of the approval.

A
company may indemnify an office holder in respect of certain liabilities either in advance
of an event or following an event provided a provision authorizing such indemnification is
inserted in its articles of association. Advance indemnification of an office holder must
be limited to the following:

| | a
financial liability imposed on him in favor of another person pursuant to a judgment,
settlement or arbitrators award approved by court provided that the indemnification
shall be limited to events which are determined by the board of directors, are
foreseeable in light of the companys activities at the time when the obligation for
indemnification is granted, and to amounts and standards which are determined by the
board of directors as reasonable in such event, and provided that the obligation for
indemnification will specify the said events and amounts or standards; and
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

45

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| | reasonable
litigation expenses, including attorneys fees, incurred by the office holder or
imposed by a court in proceedings instituted against him by the company, on its behalf or
by a third party, in connection with criminal proceedings in which the officer holder was
acquitted or as a result of a conviction for a crime that does not require proof of
criminal intent.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | reasonable
litigation expenses, including attorneys fees, incurred by the office holder due to
investigation or proceedings instituted against the office holder by an authority
authorized to conduct such investigation or proceedings and ended without filing an
indictment against him and without imposing monetary liability as an alternative to
criminal proceedings or ended without filing an indictment against him but in imposing
monetary liability as an alternative to criminal proceedings for a crime that does not
require proof of criminal intent.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

A
company may insure an office holder against the following liabilities incurred for acts
performed as an office holder:

| | a
breach of duty of loyalty to the company, to the extent that the office holder acted in
good faith and had a reasonable basis to believe that the act would not prejudice the
company;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a
breach of duty of care to the company or to a third party; and
|- | ----------------------------------------------------------------

| | a
financial liability imposed on the office holder in favor of a third party.
|- | -----------------------------------------------------------------------------

An Israeli company may not indemnify
or insure an office holder against any of the following:

| | a
breach of duty of loyalty, except tothe extent that the office holder acted in good faith
and had a reasonable basis to believe that the act would not prejudice the company;
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a
breach of duty of care committed intentionally or recklessly except that such
recklessness is made solely negligently;
|- | ------------------------------------------------------------------------------------------------------------------------

| | an
act or omission committed with intent to derive illegal personal benefit; or
|- | -------------------------------------------------------------------------------

| | a
fine levied against the office holder.
|- | ----------------------------------------

Under
the Companies Law, indemnification and insurance of office holders must be approved by our
audit committee and our board of directors and, in specified circumstances, by our
shareholders.

Our
articles of association allow us to indemnify and insure our office holders to the fullest
extent permitted by the Companies Law. Our office holders are currently covered by a
directors and officers liability insurance policy with an aggregate claim limit of
$5 million. As of the date of this annual report, no claims for directors and
officers liability insurance have been filed under this policy.

Our
U.S. subsidiary has also entered into indemnification agreements with certain of its key
employees. These agreements provide, independent of the indemnification these individuals
are entitled to by law and under the provisions of the subsidiarys charter,
indemnification for certain acts while employed by the subsidiary. These indemnification
agreements contain exclusions, such as limiting indemnification that would be unlawful or
that is covered by other liability insurance. Moreover, employees are not indemnified
against liability to the extent that the employee gained a personal profit to which he or
she is not legally entitled, including proceeds obtained from the illegal trading of our
equity securities. The performance of these agreements is guaranteed by us as parent of
the U.S. subsidiary, to the extent permitted by Israeli law.

# Compensation Committee

Our
board of directors established our compensation committee in July 1999. The duties of the
compensation committee are to review the terms of employment of our senior management, to
review and recommend to our board of directors the issuance and the allocation of options
under our share option plans and to perform any other task delegated by our board of
directors.

The
current members of our compensation committee are Oded Bashan, Eliezer Manor, Raanan
Ellran and Eli Akavya, .

# Steering Committee

Our
board of directors established our Steering committee in November 2004. The duties of the
Steering Committee are to review the deployment of our company towards the implementation
of the Sarbanes Oxley Act.

46

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The
current members of our Steering Committee are our CFO, Controller, General Counsel and in
addition Oded Bashan, and Eli Akavya.

# Audit Committee

Our
board of directors established our audit committee in July 1999. The Companies Law
requires public companies to appoint an audit committee consisting of at least three
directors, including all the external directors. The audit committees
responsibilities are governed by a written charter. The responsibilities of the audit
committee include identifying irregularities in the management of our business in
consultation with our independent accountants and the internal auditor and suggesting
appropriate responses. The audit committees responsibilities also include approving
related party transactions as required by the Companies Law. Neither the chairman of the
board of directors, nor any director employed by or otherwise providing services on a
regular basis to us, a controlling shareholder, or relative of a controlling shareholder
may be a member of the audit committee. The audit committee may not approve an action or a
transaction with a controlling shareholder, or with an office holder, unless at least two
external directors are serving on the audit committee at the time of the approval, one of
whom is present at the meeting at which the approval is granted. In addition, pursuant to
the listing requirements of the Nasdaq National Market, we are required to maintain an
audit committee including at least three independent directors. In accordance with the
provisions of the Sarbanes-Oxley Act, our Audit Committee is required to pre-approve all
audit and permitted non-audit services provided by our external auditors.

The
current members of our audit committee are Raanan Ellran, Liora Katzenstein Eliezer Manor
and Eli Akavya, all of which are independent directors. Raanan Ellran is the
Audit Committees Chairman and financial expert.

# Internal Auditor

Under
the Companies Law, the board of directors must appoint an internal auditor that is
recommended by the audit committee. The role of the internal auditor is to examine, among
other things, whether the companys actions comply with the law and orderly business
procedure. Under the Companies Law, the internal auditor may not be an office holder or an
interested party, as defined below, or a relative of an office holder or an interested
party, and he or she may not be the companys independent accountant or the
independent accountants representative. The Companies Law defines an
interested party as a holder of 5% or more of the issued shares or voting
rights of a company, a person or entity who has the right to designate at least one
director or the general manager of the company, and a person who serves as a director or
general manager. In August 2000, our audit committee recommended and our board of
directors appointed Brightman Almagor & Co., the Israeli practice of Deloitte &
Touche LLP, as our internal auditors.

# Fiduciary Duties;
Approval of Certain Transactions

The
Companies Law codifies the fiduciary duties that office holders owe to a company. An
office holders fiduciary duties consist of a duty of care and a duty of loyalty. The
duty of care requires an office holder to act with the degree of care with which a
reasonable office holder in the same position would act under the same circumstances. The
duty of care includes using reasonable means to obtain information as to the advisability
of a given action submitted for his or her approval or performed by virtue of his or her
position, as well as all other information pertaining to such actions.

The
duty of loyalty requires an office holder to act in good faith and for the benefit of the
company, and includes avoiding any conflict of interest between the office holders
other positions or personal affairs and the performance of his or her position in the
company, avoiding any competition with the company, avoiding exploiting any business
opportunity of the company in order to receive a personal benefit for himself or herself
or others, and revealing to the company any information or documents relating to the
companys affairs which come into the office holders possession as a result of
his or her position as an office holder.

47

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---



The
Companies Law further requires that an office holder disclose to the company 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. The disclosure
must be made promptly and in no event later than the board of directors meeting at which
the transaction is first discussed. In addition, if the transaction is an extraordinary
transaction, as defined below, 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 and by any corporation
in which the office holder is a 5% or greater shareholder, director or general manager or
in which he or she has the right to appoint the general manager or at least one director.
The Companies Law defines an extraordinary transaction as a transaction that
is not in the ordinary course of business, that is not on market terms, or that is likely
to have a material impact on a companys profitability, assets or liabilities. In the
case of a transaction between the company and an office holder, or a third party in which
an office holder has a personal interest, but that is not an extraordinary transaction and
is not adverse to the companys interest, once the office holder complies with the
above disclosure requirements only board approval is required unless the articles of
association of the company provide otherwise. In the case of an extraordinary transaction
between the company and an office holder, or a third party in which an office holder has a
personal interest, in addition to any approval required by the articles of association,
the transaction must be approved first by the audit committee, then by the board of
directors and, in certain cases, by the shareholders. A director who has a personal
interest in a matter that is considered at a meeting of the board of directors or the
audit committee may in general not be present at this meeting or vote on this matter. If a
majority of the directors have a personal interest in an extraordinary transaction, these
directors are permitted to be present and vote on the transaction, but shareholder
approval is also required.

Under
the Companies Law, all arrangements as to compensation of office holders who are not
directors require approval by the board of directors, and undertakings to indemnify or
insure an office holder who is not a director require both board and audit committee
approval. In general, arrangements regarding the compensation, indemnification and
insurance of directors require audit committee and shareholder approval in addition to
board approval.

The
Companies Law applies the same disclosure requirements to a controlling party of a public
company that it applies, as described above, to an office holder. For these purposes a
controlling party is any person possessing the ability to direct the
activities of the company, including a shareholder which holds 25% or more of the voting
rights of the company if no other shareholder owns more than 50% of the voting rights in
the company, but excluding a person whose power is derived solely from his or her position
on the board of directors or from another position with the company. Two or more
shareholders with a personal interest in the approval of the same transaction are deemed
to be joint shareholders. Extraordinary transactions with a controlling party or in which
a controlling party has a personal interest, and the engagement and terms of compensation
of a controlling party as an office holder, require the approval of the audit committee,
the board of directors and the shareholders. Shareholder approval must be by a majority of
shares voted at the meeting, including at least one-third of the shares of the
disinterested shareholders who are present, in person or by proxy, at the meeting, or,
alternatively, the total shareholdings of the disinterested shareholders who vote against
the transaction must not represent more than 1% of the aggregate voting rights in the
company.

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

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

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

| | a
merger; and
|- | -------------

| | approval
of a related-party transaction requiring shareholder approval.
|- | -----------------------------------------------------------------------

In
addition, any controlling shareholder, any shareholder who knows that its vote can
determine the outcome of a shareholder vote and any shareholder who, under a
companys articles of association, can appoint or prevent the appointment of an
office holder, is under a duty to act with fairness towards the company. The Companies Law
does not describe the substance of this duty.

# Compensation Committee
Interlocks and Insider Participation

Other
than Oded Bashan, who serves as a member of our compensation committee, none of the
members of our compensation committee or audit committee is currently, or has ever been at
any time since our formation, an officer or employee of our company. None of our executive
officers serves as a member of the board of directors or compensation committee of any
entity that has one or more executive officers serving on our compensation committee.

|D. | EMPLOYEES
|-- | ---------

The breakdown of our employees,
including employees in our subsidiaries, by department, is as follows:

48

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|                                         | Number of employees as of December 31
|---------------------------------------- | -------------------------------------
|
|
|
|
|Sales and marketing                      |                                      
|Research and development and engineering |                                      
|Manufacturing and operations             |                                      
|Customer support                         |                                      
|Management and administration            |                                      
|                                         |                                      
|                                         |                                      
|Total                                    |                                      

Of
these employees, on December 31, 2004, 89 were based in Israel, 8 in the United States, 93
in Europe and 28 in South Africa.

Under
applicable law and by order of the Israeli Ministry of Labor and Welfare, we and our
Israeli employees are subject to certain provisions of the collective bargaining
agreements between the Histadrut, the General Federation of Labor in Israel and the
Coordination Bureau of Economic Organizations, including the Industrialists Association.
These provisions principally concern cost of living increases, length of the working day,
minimum daily wages for professional employees, contributions to pension funds, insurance
for work-related accidents, procedures for dismissing employees, determination of
severance pay, annual and other vacation, sick pay and other conditions of employment. We
provide our employees with benefits and working conditions above the required minimum and
which we believe are competitive with benefits and working conditions provided by similar
companies in Israel. Our employees are not represented by a labor union. We have written
employment agreements with substantially all of our employees. Competition for qualified
personnel in our industry is intense and it may be difficult to attract qualified
personnel to our offices. We dedicate significant resources to employee retention and have
never experienced work stoppages and believe that our relations with our employees are
good.

|E. | SHARE
OWNERSHIP
|-- | ---------------

Except
for Messrs. Oded Bashan, Ronnie Gilboa, Nehemya Itay, Moshe Aduk and Ohad Bashan, as of
December 31, 2004, none of our directors or executive officers owned more than one percent
of the outstanding ordinary shares. For information as to the share ownership of Messrs.
Oded Bashan, Ronnie Gilboa, Nehemya Itay, Moshe Aduk and Ohad Bashan, see Item
7.  Major Shareholders and Related Party Transactions.

# Share Option Plans

The
following is a description of the share option plans that we and our subsidiaries
maintain. In addition to the discussion below, please see Notes 14B and 14C to our
consolidated financial statements. Under Israeli law, except for issuances of options to
directors, or their families, share option plans and revisions to these plans are not
subject to shareholder approval.

2001 Share Option Plan

We
established our 2001 Share Option Plan in February 2001. The plan provides for the grant
of options to our employees, directors and consultants, and those of our subsidiaries and
affiliates. Upon establishment of the plan, we reserved 75,000 ordinary shares for
issuance. On February 26, 2002, on July 12, 2002, on March 28, 2003, on July 16, 2003, on
September 2, 2003, on November 17, 2003, on April 20, 2004 and on March 25, 2005 our board
of directors adopted certain resolutions with regard to the 2001 Share Option Plan that
increased the number of available options under the plan by a total of 7,675,000 so that
the aggregate number of options available under the plan is now 7,750,000, 500,000 options
of which are subject to shareholders approval or Nasdaq exemption as set forth below. The
increase of the number of available options under the plan pursuant to the Board of
Directors resolutions dated March 28, 2003, July 16, 2003 and September 2, 2003 were
subject to either our shareholders approval or an exemption granted pursuant to
Nasdaq Market Place Rules that such approval is not required. We applied for an exemption
in connection with such increases approved by the board of directors and such exemption
has been obtained from Nasdaq due to differences between the Israeli law and Nasdaq rules.
On November 17, 2003, our board of directors approved a further increase of 500,000
options subject to either shareholders approval or additional exemption from Nasdaq.
On April 20, 2004, our board of directors approved a further increase of 2,500,000 options
subject to either shareholders approval or additional exemption from Nasdaq. On
March 25, 2005, our board of directors approved a further increase of 2,500,000 options
subject to either shareholders approval or additional exemption from Nasdaq. We have
applied for a Nasdaq exemption on the same grounds as its previous exemption. Under this
plan, as of April 30, 2005, 2,329,674 options had been exercised and 3,289,672 are
outstanding (of which 2,595,736 are vested and exercisable). Of the options that are
outstanding, as of April 30, 2005, 1,755,497 are held by our directors and officers listed
above under Item 6.  A.  Directors and Senior Management,
and have a weighted average exercise price of $0.84.

49

---

---



On
February 26, 2002, our board of directors resolved to approve a grant by which, inter
alia, we may pay, during a 12-month period, the salaries of certain of its employees who
agree to participate in the grant, by way of grant of options. All such options are to be
held by a trustee, for the benefit of each such employee. At the direction of and in
accordance with instructions given by an employee who has received options, the trustee
shall exercise such options and sell the shares issued upon such exercise. The proceeds
mentioned above will be released on a monthly basis by the trustee (net of deductions
required by law) to the maximum extent necessary for payment of such monthly salary to
such employee. We undertook to pay from our own sources any and all differences between
the relevant monthly salary and such proceeds. On March 28, 2003, our board of directors
approved the extension of the arrangement for an additional period of six months
commencing May 2003 and on October 28, 2003 our board of directors approved the extension
of the arrangement for the employees of InterCard Systemelectronic for the period
commencing November 2003 and ending July 2004. On August 26, 2004, our board of directors
approved the extension of the arrangement for an additional period of six months
commencing July 2004 and on November 26, 2004 our board of directors approved the
extension of the arrangement for an additional period of twelve months commencing January
2005. The principal purpose of this arrangement is to enable us to use our available cash
for other proper corporate purposes, including payment of sales expenses and research and
development costs.

Our
2001 Share Option Plan is administered by our compensation committee which makes
recommendations to our board of directors regarding the grantees of options and the terms
of the grant, including exercise prices, grant dates, vesting schedules, acceleration of
vesting and forfeiture. Under the Companies Law the allocation of options is solely within
the authority of our board of directors. Under the plan, the terms and conditions of
options are set forth in individual option agreements with the grantee.

Under
the plan, if the employment of a grantee is terminated for cause, all of his or her
options expire immediately. A grantee whose employment is terminated without cause may
exercise his or her vested options within three months of termination. If the termination
is due to the death or disability of the grantee, the options may be exercised within 18
months of the date of termination in the case of death and 12 months in the case of
disability.

In
accordance with the terms and conditions imposed by Section 102 of the Israel Income
Tax Ordinance, grantees that receive options under the 2001 Share Option Plan
(excluding grantees who previously received options that were incorporated upon the
commencement of Amendment No. 132 of the Income Tax ordinance (the Tax Reform)
that was approved on July 24, 2002 and became effective on January 1, 2003, and those who
are not employees or office holders and those who are our controlling shareholders) are
afforded certain tax benefits. We elected the benefits available under the capital
gains alternative. There are various conditions that must be met in order to qualify
for these benefits, including registration of the options in the name of a trustee (the
Trustee) for each of the employees who is granted options. Each option, and
any ordinary shares acquired upon the exercise of the option, must be held by the Trustee
for a period commencing on the date of grant and ending no earlier than 24 months after
the end of the tax year in which the option was granted and deposited in trust with the
Trustee. In the capital gains track a company may not recognize expenses pertaining to the
options for tax purposes. We also granted our employees options pursuant to Section 102(c)
of the Ordinance that are not held in trust by a trustee, which while enabling the
immediate exercising and selling of options granted under the 2001 Share Option Plan, will
be subject to the marginal tax rate up to 50% plus payments to the National Insurance
Institute and health tax on the date of the sale of the shares or options. As of January
1, 2003, Section 3(i) of the Ordinance was partially replaced by Section 102(c) and no
longer applies to allocations of options to employees (including directors and office
holders). Section 3(i) still applies and imposes taxes on those who are not employees
(such as consultants and service providers) and to employees who are considered
controlling shareholders.

1995 Share Option Plan

We
established our 1995 Share Option Plan in December 1995. The plan provides for the grant
of options to our employees. Our 1995 Share Option Plan has been superseded by our 2001
Share Option Plan and we have ceased to grant options under our 1995 Share Option Plan. On
July 12, 2002 our board of directors adopted certain resolutions with regard to the 1995
Share Option Plan that increased the number of available options under the plan by 30,300
so that the aggregate number of options available under this plan is 130,300. Under this
plan, as of April 30, 2005, 79,007 options to purchase shares had been exercised and 7,385
of the options are outstanding of which 6,825 are vested and exercisable.

50

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Generally,
options issued under the plan vest over a period of three to five years in equal annual
installments commencing immediately following the grant date. Under the plan, if the
employment of a grantee is terminated for cause, all of his or her options expire
immediately. Generally, a grantee whose employment is terminated without cause after a
trial period of no less than six months may exercise his or her vested options. If the
termination is due to the death of the grantee, the options may be exercised within twelve
months of the date of termination. In the event of disability or retirement of the
grantee, the compensation committee determines the treatment of options held by the
grantee.

Our
1995 Share Option Plan is subject to the same provisions of the Israeli Income Tax
Ordinance as our 2001 Share Option Plan.

2001 Employee Share
Purchase Plan

In
June 2001, we approved the establishment of an employee share purchase plan. No shares
have been issued under the plan. Under the plan, we have reserved 67,500 ordinary shares
for purchase by our employees and those of our subsidiaries who have been employed for at
least six months. Eligible employees may purchase our ordinary shares at 85% of the lesser
of the fair market value of our ordinary shares of the first day of the applicable
offering period or the first day of the applicable offering period. As of April 30, 2005,
no ordinary shares are available for sale under the 2001 Employee Share Purchase Plan.

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

|A. | MAJOR
SHAREHOLDERS
|-- | ------------------

The
following table provides summary information regarding the beneficial ownership by the
following persons of our outstanding ordinary shares as of April 30, 2005:

| | each
person or entity known to beneficially own more than 5% of our ordinary shares;
|- | ------------------------------------------------------------------------------------
| | each
of our directors individually;                                                 
| | each
of our executive officers individually; and                                    
| | all
of our executive officers and directors as a group.                             

Beneficial
ownership of shares is determined under the rules of the Securities and Exchange
Commission and generally includes any shares over which a person exercises sole or shared
voting or investment power. To our knowledge and except as indicated by footnote, each
person identified in the table below possesses sole voting and investment power with
respect to all ordinary shares held by them.

The
table also includes the number of shares underlying options that are exercisable within 60
days of the date of this prospectus. Ordinary shares subject to these options are deemed
to be outstanding for the purpose of computing the ownership percentage of the person
holding these options, but are not deemed to be outstanding for the purpose of computing
the ownership percentage of any other person. The table reflects 8,838,330 ordinary shares
outstanding as of April 30, 2005. Unless otherwise indicated below, the address of each
director, executive officer or listed shareholder is care of On Track Innovations Ltd.,
Z.H.R. Industrial Zone, P.O. Box 32, Rosh Pina, Israel 12000.

|                                                | Shares beneficially owned
|----------------------------------------------- | -------------------------
|
|
|
|
|Oded Bashan (1)                                 | 1,274,101                
|Ronnie Gilboa (2)                               | 239,212                  
|Guy Shafran (3)                                 | 62,784                   
|Moshe Aduk (4)                                  | 189,971                  
|Nehemya Itay (5)                                | 228,585                  
|Ohad Bashan (6)                                 | 283,696                  
|Raanan Ellran (7)                               | 29,700                   
|Eliezer Manor                                   | 28,500                   
|Liora Katzenstein                               | 28,500                   
|Eli Akavya                                      | 15,000                   
|All executive officers and directors as a group | 2,380,049                
|Herald Investment Trust PLC (8)                 | 272,727                  

---

*** Less than 1%

51

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|(1) | Includes 135,368 ordinary shares held
by Mr. Bashan. Also includes options to purchase 846,109 ordinary shares (of which 80,948
are still subject to our shareholders approval) and options held by Mr.
Bashans wife to purchase 4,288 ordinary shares (of which 288 are still subject to
our shareholders approval). Mr. Bashan disclaims beneficial ownership of the options
held by his wife. Also includes 287,388 shares as to which Mr. Bashan has voting power pursuant
to irrevocable proxy granted in connection with the Private Placements.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Includes 130,060 ordinary shares held
by Mr. Gilboa. Also includes options to purchase 135,576 ordinary shares (of which 576 are
still subject to our shareholders approval).
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Consists
of options held by Mr. Shafran to purchase 62,784 ordinary shares.
|--- | ---------------------------------------------------------------------------

|(4) | Includes
10,000 ordinary shares held by Moshe Aduk Assets Ltd., which is
               wholly-owned by Mr. Aduk, and 14,248 ordinary shares and options to
purchase                165,723 ordinary shares held directly by Mr. Aduk.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Includes 50,455 ordinary shares held by Mr. Itay. Also includes
 options to purchase 178,131 ordinary shares.
|--- | -------------------------------------------------------------------------------------------------------------

|(6) | Consists
of 18,220 ordinary shares and options to purchase 331,125 ordinary                shares
(of which 40,000 are still subject to our shareholders approval).
               Mr. Bashans address is c/o OTI America, Inc., 2 Executive Drive
Suite 740,                Fort Lee, New Jersey.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Consists
of options held by Mr. Ellran to purchase 29,700 ordinary shares.
|--- | --------------------------------------------------------------------------

|(8) | Consists
of 181,818 ordinary shares and warrants to purchase 90,909 ordinary                shares
held by Herald Investment Trust PLC. The address of Herald Investment
               Trust PLC is 12 Charterhouse Square London ECIM 6AX.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|B. | RELATED
PARTY TRANSACTIONS
|-- | --------------------------

Our
policy is to enter into transactions with related parties on terms that are on the whole
no less favorable to us than those that would be available from unaffiliated parties.
Based on our experience in the business sectors in which we operate and the terms of our
transactions with unaffiliated third parties, we believe that all of the transactions
described below met this policy standard at the time they occurred.

# Agreement with HolyTech
Ltd.

In
January 1996, we entered into an agreement with HolyTech Ltd., a company owned by Varda
Bashan, Ora Gilboa and certain other of our shareholders, which formalized an arrangement
that had existed since 1992. Varda Bashan is the spouse of Oded Bashan, our co-founder and
chairman of our board of directors, and Ora Gilboa is the spouse of Ronnie Gilboa, our
co-founder and a director. Under the agreement, HolyTech provides us with management and
engineering services as needed. Mrs. Bashan provides administration services, Mrs. Gilboa
provides sales operation services and a number of other shareholders of HolyTech, who are
also our employees, provide engineering and warehouse services. HolyTech has no activities
other than the provision of these services to us. The cost of these services is intended
to equal the cost of these services if performed by unrelated parties. The aggregate
consideration for the services that HolyTech provided to us was $101,143 in 2002, $76,000
in 2003 and $44,000 in 2004. On August 25, 2000, our audit committee reviewed and
reapproved the terms of this agreement.

52

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# Agreements with
Directors and Officers

We
have entered into employment agreements with all of our officers. In addition, we have
granted options to purchase our ordinary shares to our officers and directors. On January
31, 2003 the shareholders of OTI approved a bonus plan for our senior management and on
July 11, 2003 our general meeting approved a plan to issue options to our non-executive
directors.

# Agreement Relating to
Insurance Services

We
have been receiving insurance agency services from a family member of one of our officers.
On August 22, 2003, our board of directors ratified and approved such engagement in
accordance with the applicable Israeli Companies Law provisions.

|C. | INTERESTS
OF EXPERTS AND COUNSEL
|-- | --------------------------------

Not
applicable.

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

|A. | CONSOLIDATED
FINANCIAL STATEMENTS AND OTHER FINANCIAL INFORMATION
|-- | -----------------------------------------------------------------

The
financial statements required by this item are found at the end of this annual report,
beginning on page F-1.

Legal
Proceedings

We
are currently not a party to any material legal proceedings and are not aware of any
pending or threatened litigation against us that we believe would have a material adverse
effect on our business and the business of our subsidiaries taken as a whole. During the
last two fiscal years, we have not been a party to any legal proceedings that have had a
material adverse effect on our business and the business of our subsidiaries taken as a
whole.

In
November, 2001 we were notified by a contracting party, P-Card, of the termination of our
purchase agreement with them. We continue to review our options to pursue available claims
against P-Card, and we believe that all claims by P-Card that we have breached our
obligation to provide products to them are baseless and otherwise without merit and we
will aggressively defend against any such claims if they are ever asserted. To date no
litigation or other proceeding has been filed by any person relating to this dispute. On
June 4, 2002, we filed with the insolvency receiver our claim for performance in the
amount of $4,220,000 plus interest and expenses under the purchase agreement with P-Card.

On
June 2002, the insolvency receiver informed the creditors that there are not enough assets
to satisfy the obligation of the insolvent estate. On July 2002, we received the report of
the insolvency receiver, in which the insolvency receiver did not reject our claims filed
on its behalf. On February 24, 2003 we received and excerpt of the insolvency schedule
from the insolvency court, pursuant to which the insolvency receiver challenged the
asserted claims as filed. On May 5, 2003, we received a letter form the insolvency
receiver of P-Card wherein he claims that the repayment of three installments of an
aggregate amount of $ 1,000,000 in favor of the receivers account not later than May
23, 2003. We were advised by our German legal counsel that the insolvency receivers
claims are insufficient to claim repayment successfully. On May 12, 2003, we rejected the
receiver claim as groundless.

On
September 3, 2003, Edi Wuhl, once an employee of ours, filed a suit against us to the
District Labor Court in Nazareth in the amount of NIS 3,953,520. The suit is based on Mr.
Wuhls claims that we have breached the employment agreement with him, and that we
owe him commission payments for certain sales. On May 23, 2004, a preliminary hearing was
conducted, which did not lead to any settlement. On January 2005, Mr. Wuhl filed his
testimony in the form of an affidavit with the court. We intend to file our response to
Mr. Wuhls testimony with the court in April 2005. In our opinion, based on our legal
advisors, Mr. Wuhls chances of prevailing against us are remote. No provision in
respect thereof has been included in the financial statements.

53

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Dividend
Policy

We
have never declared or paid any cash dividends on our ordinary shares or other securities.

We currently
expect to retain all future earnings, if any, to finance the development of our business,
and do not anticipate paying any cash dividends in the foreseeable future. Any future
determination relating to dividend policy will be made by our board of directors and will
depend on a number of factors, including future earnings, capital requirements, financial
condition and future prospects and other factors the board of directors may deem relevant.
In the event of a distribution of a cash dividend out of tax exempt income, we will be
liable for corporate tax at a rate of 25% in respect of the amount distributed.

|B. | SIGNIFICANT
CHANGES
|-- | -------------------

Except
as otherwise disclosed in this annual report, no significant change has occurred since
December 31, 2004.

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

|A. | OFFER
AND LISTING DETAILS
|-- | -------------------------

Our
ordinary shares have been quoted on the Neuer Market of the Frankfurt Stock Exchange since
August 31, 1999. Our ordinary shares were traded on the Neuer Market in Germany until
February 3, 2002 after which, the shares were listed on the new Prime Standard Market of
the Frankfurt Stock Exchange. Commencing November 2002, our ordinary shares were also
listed for trading on NASDAQ Small Cap Market and commencing December 2004 is listed on
NASDAQ National Market.

The
following table shows, for the periods indicated, the high and low closing prices of our
ordinary shares in Euros giving effect to the reverse split as reported on the Neuer
Market of the Frankfurt Stock Exchange. The closing prices that are indicated below
commencing February 3, 2003 were as reported in the Prime Standard Market of the Frankfurt
Stock Exchange. It also shows, for the periods indicated, the high and low closing prices
of our ordinary shares expressed in U.S. dollars based on the noon buying rate in New York
City for cable transfers in foreign currencies, as certified for customs purposes by the
Federal Reserve Bank of New York on the relevant dates. See the discussion below for the
exchange rates applicable during the periods set forth below. The following table also
shows, for the periods indicated since November 2002, the high and low closing prices of
our ordinary shares in U.S. dollars as reported on NASDAQ SmallCap.

|               | Frankfurt Stock
Exchange (1)
per
Share  | Frankfurt Stock
Exchange (1)
per
Share $ | Nasdaq National
Market (2)
per
Share $
|-------------- | ---------------------------------------- | ---------------------------------------- | --------------------------------------
|
|
|
|
|2000           |                                          |                                          |                                       
|Annual 2000    | 313.0                                    | 32.5                                     | 301.7                                 
|2001          
|Annual 2001    | 77.5                                     | 8.5                                      | 73.1                                  
|2002          
|Annual 2002    | 14.5                                     | 3.5                                      | 12.8                                  
|2003          
|First quarter  | 5.3                                      | 3.0                                      | 5.7                                   
|Second quarter | 4.7                                      | 3.2                                      | 5.4                                   
|Third quarter  | 4.4                                      | 3.0                                      | 4.9                                   
|Fourth quarter | 9.7                                      | 3.6                                      | 12.1                                  
|Annual 2003    | 9.7                                      | 3.0                                      | 12.1                                  
|2004          
|October 2004   | 7.3                                      | 5.3                                      | 9.1                                   
|November 2004  | 6.5                                      | 5.7                                      | 8.1                                   
|December 2004  | 9.6                                      | 6.3                                      | 13.0                                  
|First quarter  | 11.5                                     | 5.9                                      | 14.5                                  
|Second quarter | 11.0                                     | 7.2                                      | 13.1                                  
|Third quarter  | 7.7                                      | 5.3                                      | 9.3                                   
|Fourth quarter | 9.6                                      | 5.3                                      | 13.0                                  
|Annual 2004    | 11.5                                     | 5.3                                      | 14.5                                  

54

---

---



|              | Frankfurt Stock
Exchange (1)
per
Share  | Frankfurt Stock
Exchange (1)
per
Share $ | Nasdaq National
Market (2)
per
Share $
|------------- | ---------------------------------------- | ---------------------------------------- | --------------------------------------
|
|
|
|
|2005          |                                          |                                          |                                       
|January 2005  | 9.8                                      | 8.0                                      | 13.0                                  
|February 2005 | 9.9                                      | 8.6                                      | 12.7                                  
|March 2005    | 11.0                                     | 9.3                                      | 14.6                                  
|April 2005    | 11.5                                     | 8.56                                     | 14.9                                  
|First quarter | 11.0                                     | 8.0                                      | 14.6                                  
|              |                                          |                                          |                                       

---

|(1) | Our
ordinary shares were quoted on the Neuer Market of the Frankfurt Stock
               Exchange from August 31, 1999 until January 31, 2003. Since January 31,
2003,                the shares have been listed on the new Prime Standard Segment of the
Frankfurt                Stock Exchange.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Our
ordinary shares were quoted on the Nasdaq SmallCap Market from November 12,
               2002 until December 20, 2004. On December 16, 2004, we were approved for
listing                on the Nasdaq National Market, and our ordinary shares commenced
trading on the                National Market on December 20, 2004.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|B. | PLAN OF DISTRIBUTION
|-- | --------------------

Not
applicable.

|C. | MARKETS
|-- | -------

Our
ordinary shares, to the extent they are admitted to the Neuer Market, are represented by
global share certificates registered in the name of Clearstream Banking AG. As a result,
we do not know the number of our outstanding ordinary shares held in the United States or
the number of holders of our ordinary shares who reside in the United States.

The
following table sets forth, for the periods and dates indicated, information concerning
the noon buying rate for the Euro, expresses in Euros per dollar.

|                              | Average
Rate (1) | High | Low | Period-
End Rate
|----------------------------- | ---------------- | ---- | --- | ----------------
|
|
|
|
|1999                          |                  |      |     | .9455           
|2000                          |                  |      |     | 1.0860          
|2001                          |                  |      |     | 1.1173          
|2002                          |                  |      |     | 1.0578          
|2003                          |                  |      |     | 0.8833          
|2004                          |                  |      |     | 0.8040          
|2005 (through April 22, 2005) |                  |      |     | 0.7647          

---

|(1) | The
average daily noon buying rate from the Federal Reserve Bank of New York.
|--- | -----------------------------------------------------------------------------

Our
ordinary shares are traded publicly on the NASDAQ National Market under the symbol
OTIV. Our ordinary shares are traded publicly on the Prime Standard Market of
the Frankfurt Stock Exchange under the symbol OT5.

On
April 30, 2005, the last reported sale price of our ordinary shares on the NASDAQ National
Market was $11.75 per share. According to our transfer agent, as of April 30, 2005, there
were 29 holders of record of our ordinary shares.

|D. | SELLING
SHAREHOLDERS
|-- | --------------------

Not
applicable.

55

---

---



|E. | DILUTION
|-- | --------

Not
applicable.

|F. | EXPENSES
OF THE ISSUE
|-- | ---------------------

Not
applicable.

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

|A. | SHARE
CAPITAL
|-- | -------------

Not
applicable.

|B. | MEMORANDUM
AND ARTICLES OF ASSOCIATION
|-- | --------------------------------------

We
were incorporated under the laws of the State of Israel on February 15, 1990, under the
name of De-Bug Innovations Ltd., with unlimited duration. We are registered with the
Israeli registrar of companies in Jerusalem. Our founders were Oded Bashan and Ronnie
Gilboa and our registration number is 52-004286-2. Our name was changed to On Track
Innovations on July 8, 1991. Our objectives under our memorandum of association are to
engage in any activity related to innovation and inventions in the fields of science and
technology.

The
following is a summary of the material provisions of our Articles of Association and
related provisions of Israeli corporate law. This summary is qualified in its entirety by
reference to the complete text of the Articles of Association; see Item
4.  Information on the Company.  General and Item
19.  Exhibits.

# Description of Shares

Our
authorized share capital consists of 30,000,000 ordinary shares, NIS 0.1 nominal value.

The following table sets out changes
in our authorized share capital occurring during the last three years:

|Date              | Nature of Action               | State of Authorized Share Capital          
|----------------- | ------------------------------ | -------------------------------------------
|
|
|
|
|June 17, 2002     | Consolidation of share capital | NIS 500,000 divided into 5,000,000 ordinary
|                  |                                | shares of nominal value NIS 0.1.           
|                 
|November 14, 2003 | Raise of share capital by      | NIS 1,000,000 divided into 10,000,000      
|                  | additional 5,000,000           | ordinary shares of nominal value NIS 0.1   
|                 
|April 6, 2004     | Increase in share capital      | NIS 10,000,000 increased into 30,000,000   
|                  |                                | ordinary shares of nominal value NIS 0.01. 

Description
of Ordinary Shares

As
of April 30, 2005, our authorized share capital consists of 30,000,000 ordinary shares,
nominal value of NIS 0.1 per share, of which 8,854,980 are issued and outstanding.

The
ownership or voting of ordinary shares by non-residents of Israel is not restricted in any
way by our articles of association or the laws of the State of Israel, except that
nationals of countries which are in a state of war with Israel might not be recognized as
owners of ordinary shares.

# Dividend and Liquidation
Rights

We
are permitted to declare a dividend to be paid to the holders of ordinary shares, but we
have never declared a dividend and we do not anticipate any dividend declaration in the
foreseeable future. Dividends may only be paid out of our profits and other surplus funds,
as defined in the Companies Law, as of the end of the most recent fiscal year or as
accrued over a period of two years, whichever is higher, provided that there is no
reasonable concern that payment of a dividend will prevent us from satisfying our existing
and foreseeable obligations as they become due. In the event of our liquidation, after
satisfaction of liabilities to creditors, our assets will be distributed to the holders of
ordinary shares in proportion to the nominal value of their holdings. This right may be
affected by the grant of preferential dividend or distribution rights to the holders of a
class of shares with preferential rights that may be authorized in the future by our
shareholders. Under the Companies Law, the declaration of a dividend does not require the
approval of the shareholders of a company unless the companys articles of
association require otherwise. Our articles of association provide that our board of
directors may declare and pay dividends without the approval of our shareholders.

56

---

---



# Preemptive Rights

Under
Israeli law, shareholders in public companies such as ours do not have preemptive rights.

This
means that our shareholders do not have the legal right to purchase shares in a new issue
before they are offered to third parties. As a result, our shareholders could experience
dilution of their ownership interest if we decide to raise additional funds by issuing
more shares and these shares are purchased by third parties.

# Voting,
Shareholders Meetings and Resolutions

Holders
of our ordinary shares have, for each ordinary share held, one vote on all matters
submitted to a vote of shareholders. These voting rights may be affected by the grant of
any special voting rights to the holders of a class of shares with preferential rights
that may be authorized in the future by our shareholders. The quorum required for a
general meeting of shareholders consists of at least two shareholders present, in person
or by proxy, who hold or represent together at least 25% of our issued and outstanding
ordinary shares, provided, however that as long as we are listed on NASDAQ, the quorum at
a general meeting shall be two members present in person or by proxy holding at least
33-1/3% of our issued and outstanding ordinary shares or such higher percentage as NASDAQ
may impose on listed companies from time to time so long as such higher percentage is in
effect. A meeting adjourned for lack of a quorum is generally adjourned to the same day in
the following week at the same time and place. If a quorum is not present within half an
hour following the time appointed for the reconvened meeting, the shareholders then
present, in person or by proxy, shall constitute a quorum.

Under
the Companies Law, unless otherwise provided in the articles of association or by
applicable law, shareholders resolutions require the approval of holders of a simple
majority of our ordinary shares voting, in person or by proxy on the matter. A
shareholders resolution to amend our articles requires the approval of a simple
majority of our shareholders present in person or by proxy.

Under
the Companies Law, a shareholder has certain duties of good faith and fairness towards the
company.

# Transfer of Shares and
Notices

Fully
paid ordinary shares are issued in registered form and may be freely transferred under our
articles of association unless the transfer is restricted or prohibited by Israeli law or
the rules of a stock exchange on which the shares are traded. Under the Companies Law,
unless otherwise provided in the articles of association or by applicable law,
shareholders of record are entitled to receive at least 21 days prior notice of meetings
of shareholders. Our articles of association provide that each shareholder of record is
entitled to receive at least 14 days prior notice of any annual or extraordinary
shareholders meeting and at least 21 days prior notice of any shareholders
meeting at which a special resolution is proposed.

# Special Notification
Duties

Our
articles of association provide that any shareholder whose shareholding increases above
1%, 5%, 10%, 15%, 20%, 25%, 30%, and so on, of our then outstanding share capital, is
obliged to notify us in writing of such change within ten days. A shareholder who fails to
comply with this requirement will be denied his or her voting rights, in respect of shares
in excess of the particular threshold the crossing of which was not reported, for a six-
to 24-month period to be determined in light of relevant circumstances by the board of
directors in its sole discretion. Shareholders complying with the filing requirements of
Sections 13(d) and 13(g) of the U.S. Securities Exchange Act of 1934 and the regulations
promulgated thereunder will not be subject to this requirement.

The
German Securities Trading Act (Wertpapierhandelsgesetz  WpHG) provides that any
shareholder whose shareholdings in a listed company reaches, exceeds or falls short of 5%,
10%, 25%, 50% or 75% of the voting rights by purchase, sale of by any other means shall
immediately, and at the latest within seven calendar days, notify the company and the
Federal Agency for Supervision for Financial Services (Bundesanstalt fur
Finanzdienstleistungsaufsicht) in writing of having reached, exceeded or fallen short of
the above-mentioned thresholds and of their percentage of the voting rights, by indicating
his address and the day on which he has reached, exceeded or fallen short of the
respective threshold.

57

---

---



# Anti-Takeover Provisions
under Israeli Law

Tender
Offer. A person wishing to acquire 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
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 refuse to sell their shares hold less than 5% of the issued share
capital of the company, all of the shares held by such shareholders that the acquirer
offered to purchase will be transferred to the acquirer by operation of law. 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. As of the date of this annual report, we are not
aware of any single shareholder which holds 25% or more of our shares. 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 50% or greater shareholder of the
company. Regulations promulgated under the Companies Law provide that the tender offer
requirements described in this paragraph do not apply to companies whose shares are listed
for trading outside of Israel if, according to the law in the country in which the shares
are traded, including the rules and regulations of the stock exchange on which the shares
are traded, either:

| |  | there
is a limitation on the acquisition of any level of control of the company; or
| | - | -----------------------------------------------------------------------------------

| |  | the
acquisition of any level of control must be by means of a tender offer to the public.
| | - | -----------------------------------------------------------------------------------------

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. Our articles of association provide that merger transactions may
be           approved by a simple majority of the shareholders present, in person or by
          proxy, at a general meeting of our shareholders. Under the Companies Law, in
          determining whether the required majority has approved the merger, shares held
          by the other party to the merger, any person holding at least 25% of the
          outstanding voting shares or holding at least 25% of the means of appointing
          directors of the other party to the merger, or anyone acting on their behalf,
          including their relatives or companies controlled by them, are excluded from
the           vote. If a majority of shareholders of one of the parties do not approve
the           transaction because the votes of certain shareholders are excluded from the
          vote, 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 70 days have passed from the time that a proposal
          for approval of the merger has been filed with the Israeli Registrar of
          Companies.

Tax
Law. Israeli tax law treats specified acquisitions, including a share-for-share swap
between an Israeli company and a foreign company, less favorably than does United States
tax law. For example, Israeli tax law may subject a shareholder who exchanges ordinary
shares in an Israeli company for shares in a foreign company to immediate taxation.

# Other Anti-Takeover
Provisions

Under
the German Act relating to Tenders for the Acquisition of Securities and Companies
(Wertpapiererwerbs und Übernahmegesetz  Wp ÜG), anybody who obtains the
control of a target company is obligated to make an offer for the acquisition of the
shares of the outside shareholders for adequate consideration. Control under the Wp
ÜG means the direct or indirect holding of 30% of the voting rights of the target
company. We are also subject to the tender offer provisions of the U.S. Securities
Exchange Act of 1934, as amended.

58

---

---



# Transfer Agent,
Registrar and Paying Agent

The
transfer agent and registrar for our ordinary shares in the United States is Continental
Stock Transfer & Trust Company. Its address is 17 Battery Place, New York, New York
10004, and its telephone number at this location is 212-509-4000. Our paying agent in
Germany is Dresdner Bank AG.

# Election of Directors;
Appointment of Officers

Our
current board of directors consists of six directors. Under our articles of association,
our board of directors may not consist at any time of more than nine members. A majority
of these directors must be non-executive directors, who are directors that are neither
office holders nor our employees. Directors are appointed, removed or replaced, by a
majority vote of our shareholders present in person or by proxy at a general meeting of
shareholders. Each group of shareholders holding in aggregate 20% or more of our
outstanding share capital is entitled to submit a written list of candidates for
appointment as directors at a general meeting. Shareholders may only vote for a list in
its entirety unless shareholders present at the meeting holding at least 20% of our
outstanding share capital require that the vote be for individual directors.

Once
elected at a shareholders meeting, our directors, except our external directors,
hold office until the first general meeting of shareholders held at least twenty-four
months after their election. Incumbent directors may be reelected at that meeting. Under
the new Israeli Companies Law, which took effect on February 1, 2000, the chief executive
officer of a public company may not serve as a chairman of the board of directors unless
authorized by a general meeting of the shareholders and then only for a period of time
that does not exceed three years. As a result, on July 11, 2003, our shareholders
authorized our chairman, Oded Bashan, to act as our CEO for an additional three-year
period ending May 25, 2006.

Our
board of directors appoints our chief executive officer. Each of our executive officers
serves at the discretion of the board of directors, subject to the terms of any employment
agreement, and holds office until his or her successor is elected or until his or her
earlier resignation or removal. Except for Ohad Bashan, our Head of Global Marketing and
Strategy Development, and President and Chief Executive Officer of OTI America, Inc., who
is the son of Oded Bashan, our co-founder and chairman of our board of directors, none of
our directors or executive officers has any family relationship with any other director or
executive officer.

# Fiduciary Duties;
Approval of Certain Transactions

The
Companies Law codifies the fiduciary duties that office holders owe to a company. An
office holders fiduciary duties consist of a duty of care and a duty of loyalty. The
duty of care requires an office holder to act with the degree of care with which a
reasonable office holder in the same position would act under the same circumstances. The
duty of care includes using reasonable means to obtain information as to the advisability
of a given action submitted for his or her approval or performed by virtue of his or her
position, as well as all other information pertaining to such actions. The duty of loyalty
requires an office holder to act in good faith and for the benefit of the company, and
includes avoiding any conflict of interest between the office holders other
positions or personal affairs and the performance of his or her position in the company,
avoiding any competition with the company, avoiding exploiting any business opportunity of
the company in order to receive a personal benefit for himself or herself or others, and
revealing to the company any information or documents relating to the companys
affairs which come into the office holders possession as a result of his or her
position as an office holder.

The
Companies Law further requires that an office holder disclose to the company 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. The disclosure
must be made promptly and in no event later than the board of directors meeting at which
the transaction is first discussed. In addition, if the transaction is an extraordinary
transaction, as defined below, 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 and by any corporation
in which the office holder is a 5% or greater shareholder, director or general manager or
in which he or she has the right to appoint the general manager or at least one director.
The Companies Law defines an extraordinary transaction as a transaction that
is not in the ordinary course of business, that is not on market terms, or that is likely
to have a material impact on a companys profitability, assets or liabilities. In the
case of a transaction between the company and an office holder, or a third party in which
an office holder has a personal interest, but that is not an extraordinary transaction and
is not adverse to the companys interest, once the office holder complies with the
above disclosure requirements only board approval is required unless the articles of
association of the company provide otherwise. In the case of an extraordinary transaction
between the company and an office holder, or a third party in which an office holder has a
personal interest, in addition to any approval required by the articles of association,
the transaction must be approved first by the audit committee, then by the board of
directors and, in certain cases, by the shareholders. A director who has a personal
interest in a matter that is considered at a meeting of the board of directors or the
audit committee may in general not be present at this meeting or vote on this matter. If a
majority of the directors have a personal interest in an extraordinary transaction, these
directors are permitted to be present and vote on the transaction, but shareholder
approval is also required.

59

---

---



Under
the Companies Law, all arrangements as to compensation of office holders who are not
directors require approval by the board of directors, and undertakings to indemnify or
insure an office holder who is not a director require both board and audit committee
approval. In general, arrangements regarding the compensation, indemnification and
insurance of directors require audit committee and shareholder approval in addition to
board approval.

The
Companies Law applies the same disclosure requirements to a controlling party of a public
company that it applies, as described above, to an office holder. For these purposes a
controlling party is any person possessing the ability to direct the
activities of the company, including a shareholder which holds 25% or more of the voting
rights of the company if no other shareholder owns more than 50% of the voting rights in
the company, but excluding a person whose power is derived solely from his or her position
on the board of directors or from another position with the company. Two or more
shareholders with a personal interest in the approval of the same transaction are deemed
to be joint shareholders. Extraordinary transactions with a controlling party or in which
a controlling party has a personal interest, and the engagement and terms of compensation
of a controlling party as an office holder, require the approval of the audit committee,
the board of directors and the shareholders. Shareholder approval must be by a majority of
shares voted at the meeting, including at least one-third of the shares of the
disinterested shareholders who are present, in person or by proxy, at the meeting, or,
alternatively, the total shareholdings of the disinterested shareholders who vote against
the transaction must not represent more than 1% of the aggregate voting rights in the
company.

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

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

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

| |  | a
merger; and
| | - | -------------

| |  | approval
of a related-party transaction requiring shareholder approval.
| | - | -----------------------------------------------------------------------

In
addition, any controlling shareholder, any shareholder who knows that its vote can
determine the outcome of a shareholder vote and any shareholder who, under a
companys articles of association, can appoint or prevent the appointment of an
office holder, is under a duty to act with fairness towards the company. The Companies Law
does not describe the substance of this duty.

# Exculpation,
Indemnification and Insurance of Office Holders

Under
the Companies Law, an Israeli company may only exculpate an office holder in advance, in
whole or in part, for breach of duty of care and only if a provision authorizing such
exculpation is included in its articles of association. Our articles of association
include such a provision. A company may not exculpate an office holder in advance from his
liability towards the company which is caused by a breach of duty of care in case of
distribution (as defined in the Companies Law). A company may not exculpate an office
holder for breach of duty of loyalty. However, the company may approve an act performed in
breach of the duty of loyalty of an office holder provided that the office holder acted in
good faith, the act or its approval does not harm the company, and the office holder
discloses the nature of his or her personal interest in the act and all material facts and
documents a reasonable time before discussion of the approval.

A
company may indemnify an office holder in respect of certain liabilities either in advance
of an event or following an event provided a provision authorizing such indemnification is
inserted in its articles of association. Advance indemnification of an office holder must
be limited to the following:

| | a
financial liability imposed on him in favor of another person pursuant to a judgment,
settlement or arbitrators award approved by court provided that the indemnification
shall be limited to events which are determined by the board of directors, are
foreseeable in light of the companys activities at the time when the obligation for
indemnification is granted, and to amounts and standards which are determined by the
board of directors as reasonable in such event, and provided that the obligation for
indemnification will specify the said events and amounts or standards; and
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

60

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| | reasonable
litigation expenses, including attorneys fees, incurred by the office holder or
imposed by a court in proceedings instituted against him by the company, on its behalf or
by a third party, in connection with criminal proceedings in which the officer holder was
acquitted or as a result of a conviction for a crime that does not require proof of
criminal intent.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | reasonable
litigation expenses, including attorneys fees, incurred by the office holder due to
investigation or proceedings instituted against the office holder by an authority
authorized to conduct such investigation or proceedings and ended without filing an
indictment against him and without imposing monetary liability as an alternative to
criminal proceedings or ended without filing an indictment against him but in imposing
monetary liability as an alternative to criminal proceedings for a crime that does not
require proof of criminal intent.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

A
company may insure an office holder against the following liabilities incurred for acts
performed as an office holder:

| | a
breach of duty of loyalty to the company, to the extent that the office holder acted in
good faith and had a reasonable basis to believe that the act would not prejudice the
company;
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a
breach of duty of care to the company or to a third party; and
|- | ----------------------------------------------------------------

| | a
financial liability imposed on the office holder in favor of a third party.
|- | -----------------------------------------------------------------------------

An Israeli company may not indemnify
or insure an office holder against any of the following:

| | a
breach of duty of loyalty, except to the extent that the office holder acted in good
faith and had a reasonable basis to believe that the act would not prejudice the company;
|- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | a
breach of duty of care committed intentionally or recklessly except that such
recklessness is made solely negligently;
|- | ------------------------------------------------------------------------------------------------------------------------

| | an
act or omission committed with intent to derive illegal personal benefit; or
|- | -------------------------------------------------------------------------------

| | a
fine levied against the office holder.
|- | ----------------------------------------

Under
the Companies Law, indemnification and insurance of office holders must be approved by our
audit committee and our board of directors and, in specified circumstances, by our
shareholders.

Our
articles of association allow us to indemnify and insure our office holders to the fullest
extent permitted by the Companies Law. Our office holders are currently covered by a
directors and officers liability insurance policy with an aggregate claim limit of
$5 million. As of the date of this annual report, no claims for directors and
officers liability insurance have been filed under this policy.

Our
U.S. subsidiary has also entered into indemnification agreements with certain of its key
employees. These agreements provide, independent of the indemnification these individuals
are entitled to by law and under the provisions of the subsidiarys charter,
indemnification for certain acts while employed by the subsidiary. These indemnification
agreements contain exclusions, such as limiting indemnification that would be unlawful or
that is covered by other liability insurance. Moreover, employees are not indemnified
against liability to the extent that the employee gained a personal profit to which he or
she is not legally entitled, including proceeds obtained from the illegal trading of our
equity securities. The performance of these agreements is guaranteed by us as parent of
the U.S. subsidiary, to the extent permitted by Israeli law.

|C. | MATERIAL
CONTRACTS
|-- | ------------------

Other
than in the ordinary course of business, we did not enter into any material contracts in
the past two years.

|D. | EXCHANGE
CONTROLS
|-- | -----------------

There
are currently no Israeli currency control restrictions on payments of dividends or other
distributions with respect to our ordinary shares or the proceeds from sales of the
shares, except for the obligation of Israeli residents to file reports with the Bank of
Israel regarding some transactions. However, legislation remains in effect under which
currency controls can be imposed by administrative action at any time.

61

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The
ownership of voting of our ordinary shares by non-residents of Israel, except with respect
to citizens of countries which are in a state of war with Israel, is not restricted in any
way by our memorandum of association or articles of association or by the laws of the
State of Israel.

|E. | TAXATION
|-- | --------

# Israeli Taxation,
Foreign Exchange Regulation and Investment Programs

The
following is a summary of the material aspects of the current tax structure applicable to
companies in Israel and their effect on us. The summary also contains a discussion of
Israeli tax consequences to persons purchasing our ordinary shares not by way of issuance
of bonus shares and Israel Government programs benefiting us. Portions of this discussion
are based on tax legislation that has not yet been subject to judicial or administrative
interpretation, and we cannot assure you that the views expressed in this discussion will
be accepted by the tax authorities in question. The discussion should not be relied on as
legal or professional tax advice and is not exhaustive of all possible tax considerations.

We
urge investors in our ordinary shares to consult their own tax advisors as to the Israeli
or other tax consequences of the purchase, ownership and disposition of ordinary shares,
including, in particular, the effect of any foreign, state or local taxes.

# Tax Reform

Effective
as of January 1, 2003 a comprehensive tax reform took effect in Israel. Pursuant to the
reform, resident companies are subject to Israeli tax on income accrued or derived in
Israel or abroad. In addition, the concept of controlled foreign corporation
was introduced according to which an Israeli company or an individual may become subject
to Israeli taxes on certain income of a non-Israeli subsidiary if the subsidiarys
primary source of income is passive income (such as interest, dividends, linkage
differences royalties, rental income or capital gains). The tax reform also substantially
changed the system of taxation of capital gains.

# Taxation of companies

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 and thereafter. However, the effective tax rate payable
by a company which derives income from certain approved enterprises may be considerably
lower, as discussed further below.

Tax
Benefits Under the Law for the Encouragement of Capital Investments, 1959. The Law for
the Encouragement of Capital Investment, 1959, commonly referred to as the Investment Law,
provides that a proposed capital investment in eligible facilities may, upon application
to the Investment Center of the Ministry of Industry and Trade of the State of Israel, be
designated as an approved enterprise. Each certificate of approval for an approved
enterprise relates to a specific investment program delineated both by its financial
scope, including its capital sources, and by its physical characteristics, e.g., the
equipment to be purchased and utilized under the program. The tax benefits derived from
any certificate of approval relate only to taxable income attributable to the specific
approved enterprise. If a company has more than one approval or only a portion of its
capital investments is approved, its effective tax rate is the result of a weighted
combination of the applicable rates. Income derived from activity which is not integral to
the activity of the enterprise should not be divided between the different approved
enterprises and should not enjoy tax benefits.

Taxable
income of a company derived from an approved enterprise is subject to a reduced corporate
tax rate of 25%. The tax rate is subject to additional reductions depending on the
percentage of foreign investment in the relevant company until the earlier of:

| |  | Seven
consecutive years, or ten years in the case of a foreign investors company as
defined below, starting in the year in which the approved enterprise first generates
taxable income;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Twelve
years from the start of production; or
| | - | ---------------------------------------------

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| |  | Fourteen
years from the date of approval of the approved enterprise status.
| | - | ---------------------------------------------------------------------------

A
company owning an approved enterprise may elect to forego entitlement to grants otherwise
available as a result of an approved enterprise in return for an alternative package of
benefits. Under the alternative package of benefits, a companys undistributed income
derived from an approved enterprise will be exempt from company 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 the company will be
eligible for a reduced tax rate for the remainder of the benefits period.

We
elected to adopt the Alternative Benefits Program status for our investment
programs. A company that has elected to receive the alternative package of benefits and
that subsequently pays a dividend out of income derived from the approved enterprise
during the tax exemption period will be subject to tax in respect of the amount
distributed, including any company tax on these amounts, at the rate which would have been
applicable had it not elected the alternative package of benefits, generally 10%-25%,
depending on the percentage of the investment in the companys shares held by foreign
shareholders. The dividend recipient is taxed at the reduced rate applicable to dividends
from approved enterprises, which is 15%, if the dividend is distributed during the tax
exemption period or within 12 years after this period. The company must withhold this tax
at source. If classified as a foreign investors company there is no limit on the
period during which a dividend may be distributed from approved enterprise profits and it
should always enjoy the benefits of the law.

Subject
to the provisions of the law concerning income under the alternative package of benefits,
all dividends are considered to be attributable to the entire enterprise and their
effective tax rate is the result of a weighted combination of the various applicable tax
rates. Under the Investment Law, a company that has elected the alternative package of
benefits is not obliged to distribute exempt retained profits, and may generally decide
from which years profits to declare dividends. We currently intend to reinvest any
amount derived from our approved enterprise programs and not to distribute the income as a
dividend.

A
company that has an approved enterprise program is eligible for further tax benefits if it
qualifies as a foreign investors company. A foreign investors company is a
company whose investees, comprising non-Israeli residents, directly or indirectly hold
more than 25% of the companys share capital and combined share and loan capital. A
company that qualifies as a foreign investors company and has an approved enterprise
program is eligible for tax benefits for a ten-year benefit period. The company tax rate
applicable to income earned from approved enterprise programs (currently, for programs on
which an application for an approved enterprise status was submitted before 31, December,
2003) in the benefit period (following the period, if any, of no tax) by a company meeting
these qualifications is as follows:

|For a company with foreign investment of | Tax Rate
|---------------------------------------- | --------
|
|
|
|
|Over 25% but less than 49%               | 25%     
|49% or more but less than 74%            | 20%     
|74% or more but less than 90%            | 15%     
|90% or more                              | 10%     

The
Investment Center bases its decision as to whether or not to approve an application on the
criteria set forth in the Investment Law and regulations, the then prevailing policy of
the Investment Center, and the specific objectives and financial criteria of the
applicant. Accordingly, there can be no assurance that any such applications will be
approved. In addition, the benefits available to an approved enterprise are conditional
upon the fulfillment of conditions stipulated in the Investment Law and its regulations
and upon the criteria in the specific certificate of approval, as described above. In the
event that a company does not meet these conditions, it would be required to refund the
amount of tax benefits, with the addition of consumer price index linkage adjustment and
interest.

The
Investment Center has granted approved enterprise status to three of our investment
programs under the alternative benefits option. Taxable income derived from these programs
is tax exempt for a period of ten years beginning with the year in which we first generate
taxable income. We have derived, and expect to continue to derive, a substantial portion
of our revenues from our approved enterprise programs at our manufacturing facility. 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. There is no certainty that the Israeli government will continue to provide the
same or similar tax benefits in the future.

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On March 30, 2005, the Knesset
approved a reform of the Encouragement of Capital Investments Law  1959. The primary
changes are as follows:

|n | Companies
that meet the criteria of the Alternate Path of tax benefits will receive those benefits
without prior approval. In addition there will be no requirement to file reports with the
Investment Center. Audit will take place via the Income Tax Authorities as part of the
tax audits. Request for pre-ruling is possible.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|n | Tax
benefits of the Alternate Path include lower tax rates or no tax depending on area and
the path chosen, lower tax rates on dividends and accelerated depreciation.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

|n | In
order to receive benefits in the Grant Path or the Alternate Path, the Industrial
Enterprise must contribute to the economic independence of the Countrys economy in
one of the following ways:
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Grants under the Law for the
Encouragement of Industrial Research and Development, 1984.

Under
the law for the Encouragement of Industrial Research and Development, 1984, commonly
referred to as the Research Law, research and development programs which meet specified
criteria and are approved by a governmental committee of the Office of the Chief Scientist
are eligible for grants of up to 50% of the projects expenditure, as determined by
the research committee, in exchange for the payment of royalties from the sale of products
developed under the program. Regulations under the Research Law generally provide for the
payment of royalties to the Chief Scientist of 3 to 5% on sales of products and services
derived from our technology developed using these grants until 100% of the dollar-linked
grant is repaid. For programs approved from 1999 and thereafter, the amount of the grant
to be repaid will include annual interest at LIBOR from the date of approval.

The
terms of the Israeli government participation also require that the manufacture of
products developed with government grants be performed in Israel. However, under the
regulations of the Research Law, if any of the manufacturing is performed outside Israel
by any entity other than us, assuming we receive approval from the Chief Scientist for the
foreign manufacturing, we may be required to pay increased royalties. The increase in
royalties depends upon the manufacturing volume that is performed outside of Israel
follows:

|Manufacturing Volume Outside of Israel | Royalties to the Chief Scientist
as a Percentage of Grant
|-------------------------------------- | ---------------------------------------------------------
|
|
|
|
|less than 50%                          | 120%                                                     
|between 50% and less than 90%          | 150%                                                     
|90% and more                           | 300%                                                     

If
the manufacturing is performed outside of Israel by us, the rate of royalties payable by
us on revenues from the sale of products manufactured outside of Israel will increase by
1% over the regular rates. If the manufacturing is performed outside of Israel by a third
party, the rate of royalties payable by us on those revenues will be a percentage equal to
the percentage of our total investment in the given system that was funded by grants. In
addition, in recent years the government of Israel has accelerated the rate of royalty
rates for repayment of Chief Scientist grants, and may further accelerate them in the
future.

The
technology developed with Chief Scientist grants may not be transferred to third parties
without the prior approval of a governmental committee under the Research Law, and may not
be transferred to non-residents of Israel (Beginning April 1, 2005, governmental committee
under the Research Law may approve a transfer of technology to non-residents of Israel
under restricted conditions and in accordance with the Research Law). Approval, however,
is not required for the export of products developed using the grants. Approval of the
transfer of technology to residents of Israel may be granted in specific circumstances,
only if the recipient abides by the provisions of the Research Law and related
Regulations, including the restrictions on transfer of know-how and the obligation to pay
royalties in an amount that may be increased. We cannot provide any assurance that
consent, if requested, will be granted.

The
funds available for grants from the Chief Scientist depend on several criteria and
prevailing government policy and budget, and may be reduced or eliminated in the future.
Even if these grants are maintained, there is no assurance that we will receive Chief
Scientist grants in the future. In addition, each application to the Chief Scientist is
reviewed separately, and grants are based on the program approved by the research
committee. Expenditures supported under other incentive programs of the State of Israel
are not eligible for grants from the Chief Scientist. We cannot provide any assurance that
applications to the Chief Scientist will be approved and, until approved, the amounts of
any grants are not determinable.

64

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Tax
Benefits for Research and Development. Israeli tax law allows, under specific
conditions, a tax deduction in the year incurred for expenditures, including capital
expenditures, relating to 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 the deduction. Expenditures not
so approved are deductible over a three-year period. However, expenditures made out of
proceeds made available to us through government grants are not deductible according to
Israeli law.

Tax
Benefits Under the Law for the Encouragement of Industry (Taxes), 1969. The Law for
the Encouragement of Industry (Taxes), 1969, generally referred to as the Industry
Encouragement Law, provides several tax benefits for industrial companies. An
Industrial Company is defined as a company resident in Israel, at least 90% of
whose income in a given tax year exclusive of income from specified sources, 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.

Under
the Industry Encouragement Law, industrial companies are entitled to the following
preferred corporate tax benefits:

| |  | deduction
of purchase of know-how and patents utilized in the development of the company over an
eight-year               period;
| | - | ---------------------------------------------------------------------------------------------------------------------------------

| |  | deduction
of expenses incurred in connection with a public stock issuance over a three-year period;
and
| | - | -------------------------------------------------------------------------------------------------------

| |  | right
to elect, under certain conditions, to file a consolidated tax return with additional
related Israeli industrial companies operating a common production line.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

Under
some tax laws and regulations, an industrial enterprise may be eligible for special
depreciation rates for machinery, equipment and buildings. These rates differ based on
various factors including the date operations begin and the number of work shifts. An
industrial company owning an approved enterprise may choose between the depreciation rates
for an industrial company provided for in the Income Tax Regulations (Inflationary
Adjustments) (depreciation rates), 1986 or the regular depreciation rates determined in
the above Regulations.

Eligibility
for benefits under the Industry Encouragement Law is not subject to receipt of prior
approval from any governmental authority. We cannot assure you that we will continue to
qualify as an industrial company or that the benefits described above will be available to
us in the future.

Special
Provisions Relating to Taxation under Inflationary Conditions. The Income Tax Law
(Inflationary Adjustments), 1985, referred to as 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 highly complex.
These are some of its important features:

| |  | There
is a special tax adjustment for the preservation of equity whereby certain corporate
assets are classified broadly into fixed (inflation resistant) assets and non-fixed
assets. Where a companys equity, as defined in the law, exceeds the depreciated
cost of fixed assets, a deduction from taxable income that takes into account the effect
of the applicable annual rate of inflation on the 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
companys equity, then the excess multiplied by the applicable annual rate of
inflation is added to taxable income.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Subject
to certain limitations, depreciation deductions on fixed assets and losses carried
forward are adjusted for inflation based on the increase in the Israeli consumer price
index.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Gains
on traded securities, are taxable in certain circumstances determined under the
Inflationary Adjustments Law. However, dealers in securities are subject to the regular
tax rules applicable to business income in Israel.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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One
of the net effects of the Inflationary Adjustments Law is that our taxable income for
Israeli corporate tax purposes will be different from our dollar income reflected in our
financial statements, which are based on changes in the Shekel exchange rate with respect
to the dollar.

# Taxation of our
shareholders

Reform
in Taxation of Capital Market. As mentioned above, on July 24, 2002, the Israeli
parliament, the Knesset, approved an extensive amendment to the Income Tax Ordinance. The
amendment substantially changed the taxation in several areas, including taxation of the
capital market. Generally, the amendment shall become effective regarding taxation of the
capital market on January 1, 2003.

Capital
Gains Tax on Sales of Our Ordinary Shares. Israeli law imposes a capital gains tax on
the sale of capital assets. The law distinguishes between real gain and inflationary
surplus. The inflationary surplus is a portion of the total capital gain that is
equivalent to the increase of the relevant assets purchase price that is
attributable to the increase in the Israeli consumer price index between the date of
purchase and the date of sale. The real gain is the excess of the total capital gain over
the inflationary surplus. The inflationary surplus accumulated from and after December 31,
1993 is exempt from any capital gains tax in Israel. The real gain is added to ordinary
income, which effective until December 31, 2002 was taxed at ordinary rates of up to 50%
for individuals and 36% for corporations.

Effective
January 1, 2003, the capital gains tax rate imposed upon sale of capital assets acquired
after that date has been reduced to 25%; capital gains accrued from assets acquired before
that date are subject to a blended tax rate based on the relative periods of time before
and after that date that the asset was held.

Capital
Gains Tax on Sales of Our Ordinary Shares Effective January 1, 2003. Payers of Israeli
tax who are not subject to the Inflationary Adjustments Law or are not entitle to maintain
books in foreign currency shall be subject to 15% tax on the real capital gain in case the
shares were purchased after December 31, 2002, and in case the shares were purchased
before that date the sale will be subject to a blended tax in which the portion of the
gain accrued until December 31, 2002 will be exempt from Israeli capital gains tax and the
portion of the real gain accrued from January 1, 2003 until the date of sale will be
subject to 15% tax. The taxable real gain will be based on the difference between the
adjusted average value of the shares during the last three trading days before January 1,
2003 (or the adjusted original cost if it is higher than the adjusted average value) and
the value of the shares at the date of sale. In the event the above calculation create a
loss; such loss can only be offset against capital gain from other traded securities
according to the provisions of the Israeli law. The amount of the loss is limited to the
difference between the adjusted average value and the value of the shares at the date of
sale. However, such payers of Israeli tax shall be subject to 25% tax on the real capital
gain in the case that they deduct interest expenses and linkage differences.

Notwithstanding
the foregoing, dealers in securities in Israel and companies taxed under the Inflationary
Adjustment Law or are entitled to maintain books in foreign currency are taxed at regular
tax rates applicable to business income.

Notwithstanding
the above, securities that are defined as foreign securities that are sold prior to
January 1, 2007 shall be subject to 35% tax on the real capital gain. Foreign securities
that are bought prior to January 1, 2007 and sold after January 1, 2007 shall be subject
to 35% capital gains tax on the real gains accrued until January 1, 2007 and 15% capital
gains tax on the real gains accrued thereafter. With regards to individuals and companies,
which are not subject to the Inflationary Adjustments Law and to bookkeeping in foreign
currency provisions, capital gains from sale of foreign securities are subject to 15% tax
beginning January 1, 2005. However, according to new tax legislation our ordinary shares
are not considered foreign traded securities.

Generally
under the amendment losses from tradable shares by payers of Israeli tax who are not
subject to the Inflationary Adjustments Law or have the right to maintain books in foreign
currency can be offset with gains from the same source (e.g., sales of foreign securities,
sales of securities that are not foreign securities). Such losses can be carried forward
indefinitely.

In
addition, since our ordinary shares are traded on a Stock Exchange outside of Israel,
gains on the sale of ordinary shares held by non-Israeli tax resident investors will be
exempt from Israeli capital gains tax, provided, inter alia, that such capital gains are
not by a permanent establishment in Israel, that such shareholders did not acquire their
shares prior to the public offering and that the shareholders are not subject to the
Inflationary Adjustment law or are entitle to maintain books in foreign currency all
subject to the provision of the Israeli tax legislation.

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Under
the convention between the government of the United States of America and the government
of Israel with respect to taxes on income, the sale, exchange or disposition of ordinary
shares by a person who qualifies as a resident of the United States within the meaning of
the U.S.- Israel tax treaty and who is entitled to claim the benefits afforded to the
person by the U.S.-Israel tax treaty generally will not be subject to the Israeli capital
gains tax unless certain exceptions apply, including where the U.S. resident holds,
directly or indirectly, shares representing 10% or more of our voting power during any
part of the 12-month period preceding the sale, exchange or disposition of the shares
subject to certain conditions. A sale, exchange or disposition of ordinary shares by a
treaty U.S. resident who holds, directly or indirectly, shares representing 10% or more of
our voting power at any time during the preceding 12-month period would be subject to
Israeli tax, to the extent applicable unless the aforementioned exemption from capital
gains tax for shares listed on a Stock Exchange outside of Israel applies. However, in any
case, under the U.S.-Israel tax treaty and the Israeli tax law a treaty U.S. resident will
be subject to capital gains tax in Israel, the U.S. resident would be permitted to claim a
credit for the taxes against the U.S. federal income tax imposed with respect to the sale,
exchange or disposition, subject to the limitations in U.S. laws applicable to foreign tax
credits. The U.S.-Israel tax treaty does not relate to U.S. state or local taxes.

Taxation
of Non-Resident Holders of Shares. Non-residents of Israel are subject to income tax
on income accrued or derived from sources in Israel. Under the amendment, capital gain is
deemed to accrue or derive in Israel in the case of sale of shares of an Israeli company
(see above in Section Capital Gains Tax on Sales of Our Ordinary Shares).

Non-residents
of Israel are subject to tax on income accrued or derived from sources in Israel. These
sources of income include passive income such as dividends, royalties and interest, as
well as non-passive income, such as income received for services rendered in Israel. On
distribution of dividends other than bonus shares, income tax is withheld at source, at
the rate of 25%, (or 12.5% for dividends not generated by an approved enterprise if the
non-resident is a U.S. corporation and holds at least 10% of our voting power throughout a
certain period, and 15% for dividends generated by an approved enterprise), unless in each
case a different rate is provided in a treaty between Israel and shareholders
country of residence. Under the U.S.-Israel tax treaty, the maximum tax on dividends paid
to a holder of ordinary shares who is a U.S. resident will be 25%. However, under the
Investment Law, dividends generated by an approved enterprise are taxed at the rate of
15%.

Foreign
Exchange Regulations. We are permitted to pay in Israeli and non-Israeli currency:

| |  | dividends
to holders of our ordinary shares; and
| | - | ------------------------------------------------

| |  | any
amounts payable with respect to our ordinary shares upon our dissolution, liquidation or
winding up.
| | - | --------------------------------------------------------------------------------------------------------

If
we make any payments in Israeli currency, the payments may be converted into freely
repatriable dollars at the rate of exchange prevailing at the time of conversion.

# Material United States
Federal Income Consequences

The
following is a summary of the material United States federal income tax consequences of
the acquisition, ownership and disposition of our ordinary shares by United States holders
(as defined below). This summary is based upon the United States Internal Revenue Code of
1986, as amended, applicable Treasury regulations promulgated and proposed under the
Internal Revenue Code, judicial authority and current administrative rulings and
practices, all of which are subject to change, possibly with retroactive effect or
different interpretations. We have not sought any ruling from the United States Internal
Revenue Service with respect to the matters discussed below, and we cannot provide any
assurance that the IRS or a court will agree with our conclusions. The discussion below
assumes that you will hold the ordinary shares as capital assets.

THE
FOLLOWING SUMMARY IS INCLUDED HEREIN FOR GENERAL INFORMATION AND IS NOT INTENDED TO BE,
AND SHOULD NOT BE CONSTRUED TO BE, LEGAL OR TAX ADVICE. ACCORDINGLY, EACH UNITED STATES
HOLDER IS URGED TO CONSULT A TAX ADVISOR WITH RESPECT TO THE U.S. FEDERAL, STATE, LOCAL OR
NON-U.S. TAX CONSEQUENCES OF HOLDING AND DISPOSING OF ORDINARY SHARES.

This
discussion is not a comprehensive description of all of the tax consequences that may be
relevant to United States holders of ordinary shares, and you should consult your
professional advisor as to the tax consequences of the acquisition, ownership and
disposition of our ordinary shares. In particular, this discussion does not address your
tax treatment if you are subject to special tax rules under United States federal income
tax law, for example, if you are:

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| |  | a
bank, insurance company or other financial institution, or "financial services entity",
| | - | -----------------------------------------------------------------------------------------

| |  | a
regulated investment company, real estate investment trust or grantor trust,
| | - | ------------------------------------------------------------------------------

| |  | a
broker or dealer in securities or foreign currency,
| | - | -----------------------------------------------------

| |  | a
United States holder who has a functional currency other than the United States dollar,
| | - | -----------------------------------------------------------------------------------------

| |  | a
person who acquires ordinary shares in connection with employment or other performance of
services, or who acquires ordinary shares in the form of bonus shares from us,
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
person subject to alternative minimum tax,
| | - | --------------------------------------------

| |  | a
person who owns, or is deemed to own, at least 10% or more, by voting power or value, of
our shares,
| | - | ------------------------------------------------------------------------------------------------------

| |  | a
person who owns ordinary shares as part of a straddle, hedging transaction, conversion
transaction, constructive sale transaction or other risk-reduction transaction for United
States federal income tax purposes,
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | a
tax-exempt entity, or
| | - | -----------------------

| |  | an
expatriate or former long-term resident of the United States.
| | - | ----------------------------------------------------------------

Further,
this description does not address any United States federal estate and gift tax
consequences, nor any state, local or foreign tax consequences relating to the
acquisition, ownership and disposition of our ordinary shares. If a partnership or other
entity taxable as a partnership for U.S. federal income tax purposes holds common stock,
the U.S. federal income tax treatment of a partner will generally depend on the status of
the partner and the activities of the partnership. Such partners are urged to consult
their tax advisors.

For purposes of this discussion, you
are a United States holder if you are:

| | (i)                 a
citizen or resident of the United States, including an alien individual who is
          a lawful permanent resident of the United States or meets the substantial
          presence residency test under United States federal income tax laws,
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (ii)                 a
corporation or other entity treated as a corporation for United States federal
          income tax purposes, which is created or organized in or under the laws of the
          United States, any of its states or the District of Columbia, unless otherwise
          provided by Treasury regulations,
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (iii)                 an
estate the income of which is subject to United States federal income           taxation
regardless of its source,
| | -------------------------------------------------------------------------------------------------------------------------------------------

| | (iv)                 a
trust if a court within the United States is able to exercise primary
          supervision over the administration of the trust and one or more United States
          persons have the authority to control all substantial decisions of the trust,
or           electing trusts in existence on August 20, 1996 to the extent provided in
          Treasury regulations, or
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (v)                 any
person otherwise subject to United States federal income tax on a net income
          basis in respect of ordinary shares, and if your status as a United States
          holder is not overridden pursuant to the provisions of an applicable tax
treaty.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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# Taxation of OTI

In
general, we will be subject to U.S. federal income tax only to the extent we have income
which has its source in the U.S. or is effectively connected with a U.S. trade or
business. We anticipate that we will derive substantially all of our income from foreign
sources and that none of our income will be effectively connected with a U.S. trade or
business, except perhaps for some income from our U.S. subsidiary. In addition, we
anticipate that any U.S. source investment income we derive will come from investments the
interest on which will be exempt from U.S. federal income taxation.

# Distributions

We
do not at this time anticipate paying any dividends. But, if we do distribute property to
you in the future, then subject to the discussion below under Passive Foreign
Investment Company Considerations, the following rules regarding distributions will
generally apply.

Distributions
you receive from us with respect to your ordinary shares, including any related tax
withheld by Israel, will constitute dividends for United States federal income tax
purposes to the extent paid out of our current or accumulated earnings and profits as
determined for United States federal income tax purposes. To the extent that a
distribution exceeds our available earnings and profits, it will be treated as a
nontaxable return of capital to the extent of your adjusted tax basis in the ordinary
shares (reducing such adjusted tax basis dollar for dollar), and thereafter as capital
gain.

Dividends
you receive generally will be treated as foreign source dividend income and will not be
eligible for the dividends-received deduction allowed to corporate shareholders under the
Internal Revenue Code.

For
a temporary period beginning with taxable years beginning in 2003 and ending with taxable
years beginning after December 31, 2008, qualified dividend income will generally be
subject to a maximum U.S. federal income tax rate of 15% for non-corporate United States
holders. Because our shares trade on the NASDAQ National Market, any dividends we pay on
shares traded on the NASDAQ National Market during that period should generally constitute
qualified dividend income to you, unless, in the year we pay a dividend or in the prior
year, we are a foreign investment company, foreign personal holding company, or a passive
foreign investment company, a circumstance described below under Passive Foreign
Investment Company Consideration. Due to the nature of our operations and/or
ownership, we do not believe we are, or are likely to become, a foreign investment company
or foreign personal holding company. If our beliefs concerning our foreign investment
company or foreign personal holding company status are correct, and if we are not a
passive foreign investment company, dividend distributions with respect to our shares
should be treated as qualified dividend income, subject to the United States holder
satisfying holding period and other requirements described below. A United States holder
will not be entitled to the preferential rate: (a) if the U.S. holder has not held the
ordinary shares or ADRs for at least 61 days of the 121-day period beginning on the date
which is 60 days before the ex-dividend date, or (b) to the extent the U.S. holder is
under an obligation to make related payments on substantially similar property. Any days
during which the U.S. holder has diminished its risk of loss on our shares are not counted
towards meeting the 61-day holding period. Finally, U.S. holders who elect to treat the
dividend income as investment income pursuant to section 163(d)(4) of the Code
will not be eligible for the preferential rate of taxation.

The
amount of any distribution we make to you will equal the fair market value in United
States dollars of the Israeli Shekels or other property you receive, including the amount
of any related withheld tax, on the date of distribution, which, in the case of a
distribution paid in Israeli Shekels will be based on the exchange rate on the date of
your receipt. For United States federal income tax purposes, you will have a basis in any
Israeli Shekels you receive equal to the dollar value of the Israeli Shekels on the date
of payment. Any gain or loss that you recognize upon a subsequent disposition of these
Israeli Shekels will generally be ordinary income or loss.

The
Israeli withholding tax will generally be treated for United States federal income tax
purposes as a foreign tax that you may claim as a foreign tax credit against your United
States federal income tax liability, subject to limitations generally applicable to
foreign tax credits. For example, dividends distributed by us will generally be
categorized as passive income or, in the case of some holders, as financial services
income, for purposes of computing allowable foreign tax credits for United States federal
income tax purposes. In general, you may not claim a foreign tax credit with respect to a
category of income in excess of the United States federal income tax otherwise payable
with respect to that category of income. For purposes of this determination, you would be
required to adjust the amount of any qualified dividend income we pay to you, while such
dividends are subject to the 15% maximum tax rate described above, to account for the
difference between the 15% maximum tax rate and ordinary U.S. federal income tax rates.
You may carry back any excess foreign tax credits to the two preceding tax years and then
carry any remaining excess credits forward five subsequent tax years to reduce your United
States federal income tax payable on foreign source income in the same category that is
not otherwise offset by a foreign tax credit. The consequences of the separate limitation
calculation will depend on the nature and sources of your income and the deductions
allocable to that income. You should consult with your tax advisor regarding the use of
foreign tax credits.

69

---

---



In
lieu of claiming a credit, you may claim all foreign tax that you paid during a particular
taxable year as an itemized deduction. Unlike a credit, a deduction does not reduce your
United States federal income tax on a dollar for dollar basis. The deduction, however, is
not subject to the category limitations described above regarding foreign tax credits. You
are urged to consult your own tax advisor concerning whether you are eligible for benefits
under the United States-Israel tax treaty, whether, and to what extent, a foreign tax
credit will be available with respect to dividends received from us, and the treatment of
any foreign currency gain or loss on any Israeli Shekels received with respect to the
shares that are not converted into United States dollars on the date the Israeli Shekels
are actually or constructively received.

# Sale or other Taxable
Disposition Exchange of Our Ordinary Shares

Subject
to the discussion below under Passive Foreign Investment Company
Considerations, the following rules regarding dispositions will generally apply.

In
general, you will recognize gain or loss upon the sale, exchange, redemption or other
taxable disposition of an ordinary share equal to your amount realized in the disposition
less your adjusted income tax basis in the ordinary share. Your initial income tax basis
in any ordinary shares that you acquire will be the U.S. dollar amount that you paid for
the ordinary shares, or the U.S. dollar equivalent of the fair market value of any
property, including foreign currency, you exchanged for the ordinary shares as of the date
of exchange. Your amount realized is the amount of cash and the fair market value of
property received, including or the United States dollar value on the date of the
disposition of the amount realized in Israeli Shekels.

Gain
or loss recognized upon the sale, exchange, redemption or other taxable disposition of an
ordinary share will generally be capital gain or loss, and will generally be long-term
capital gain or loss if your holding period in the disposed of ordinary shares exceeds one
year. Special rates of tax apply to long-term capital gains recognized by non-corporate
United States holders. Under most circumstances, your gain or loss will be treated as
United States source income for United States foreign tax credit purposes.

Passive
Foreign Investment Company Considerations

Special
United States federal income tax rules apply to a United States holder who owns shares of
a corporation that was at any time during the United States holders holding period a
passive foreign investment company, commonly known by its acronym (a
PFIC). A non-United States corporation will be classified as a PFIC for United
States federal income tax purposes in any taxable year in which, after applying
look-through rules for lower tier affiliates, either (1) at least 75% of its gross income
is passive income, or (2) at least 50% of the gross value of its assets is
attributable to assets that produce passive income or are held for the production of
passive income. Passive income for this purpose generally includes dividends, interest,
royalties, rents and gains from commodities and securities transactions.

Based
on our estimated gross income, the average value of our gross assets (assuming that we are
entitled to value our intangible assets using the methods suggested for publicly traded
corporations) and the nature of our business, we believe there is only a small chance that
we will be a PFIC for our current taxable year and in the foreseeable future. Since PFIC
status is a factual determination that must be made annually and is therefore subject to
change, our status in current and future years depends on our assets and activities in
those years. Because the market price of our ordinary shares is likely to fluctuate and
because the market price of the shares of technology companies has been especially
volatile, we cannot assure you whether or not we will be considered a PFIC for any taxable
year. Also, because PFIC status is in part based on facts on and through December 31 of
each year, it is not possible to determine whether we will have become a PFIC for a
calendar year until after the close of the year, when we finalize our financial
information on and through December 31. In addition, we cannot provide any assurance that
the applicable tax law will not change in a manner which adversely affects our PFIC
determination. If we were a PFIC for a taxable year and you are a United States holder of
our ordinary shares at any point during that year, you generally could be subject to
interest charges and higher tax rates with respect to any gain from the sale or exchange
of, and certain distributions with respect to, your ordinary shares.

If
we are or become a PFIC, a United States holder of our ordinary shares could make a
variety of elections that may alleviate the tax consequences referred to above. However,
it is expected that the conditions necessary for making an election to treat us as a
qualified electing fund under the PFIC rules will not be available. You should consult
your tax advisor regarding our potential status as a PFIC and the tax consequences to you
that would arise if we were treated as a PFIC.

70

---

---



Backup
Withholding and Information Reporting

If
you hold ordinary shares, you may be subject to information reporting and backup
withholding of United States federal income tax with respect to cash payments in respect
of dividends or the gross proceeds from dispositions. The backup withholding rate is
currently 28%. However, you will not be subject to backup withholding if you properly
execute, under penalties of perjury, an IRS Form W-9 or a substantially similar form in
which you provide your correct taxpayer identification number, certify that it is correct,
certify that you are a United States person, and certify as to one of the following
conditions: (1) you are not subject to backup withholding because you are a corporation or
come within another enumerated exempt category, (2) you have not been notified by the IRS
that you are subject to backup withholding, or (3) you have been notified by the IRS that
you are no longer subject to backup withholding.

If
you do not provide your correct taxpayer identification number on the IRS Form W-9 or a
substantially similar form, you may be subject to penalties imposed by the IRS. Unless you
have established on a properly executed IRS Form W-9 or a substantially similar form that
you are a corporation or come within another enumerated exempt category, dividends and
other payments paid to you during the taxable year, and the amount of tax withheld, if
any, will be reported to you and to the IRS.

Amounts
withheld under backup withholding are generally not an additional tax and may be refunded
or credited against your United States federal income tax liability, provided you timely
furnish the required information to the IRS. You should consult your tax advisor as to
your qualification for exemption from backup withholding and the procedure for obtaining
that exemption.

The
above description is not intended to constitute a complete analysis of all tax
consequences relating to the ownership or disposition of our ordinary shares by a United
States holder. You should consult your own tax advisor concerning the tax consequences of
your particular situation, as well as any tax consequences that may arise under the laws
of any state, local, foreign, or other taxing jurisdiction.

|F. | DIVIDENDS
AND PAYING AGENTS
|-- | ---------------------------

Not
applicable.

|G. | STATEMENT
BY EXPERTS
|-- | --------------------

Not
applicable.

|H. | DOCUMENTS
ON DISPLAY
|-- | --------------------

We
are subject to the informational requirements of the Securities Exchange Act of 1934, as
amended, applicable to foreign private issuers and fulfill the obligation with respect to
such requirements by filing reports with the Securities and Exchange Commission. As a
foreign private issuer, we are exempt from the rules under the Exchange Act prescribing
the furnishing and content of proxy statements, and our officers, directors and principal
shareholders are exempt from the reporting and short-swing profit recovery
provisions contained in Section 16 of the Exchange Act. In addition, we are not required
under the Exchange Act to file periodic reports and financial statements with the
Securities and Exchange Commission as frequently or as promptly as United States companies
whose securities are registered under the Exchange Act. You may read and copy any document
we file with the Securities and Exchange Commission without charge at the Securities and
Exchange Commissions public reference room at 450 Fifth Street, N.W., Washington
D.C. 20549. Copies of such material may be obtained by mail from the Public Reference
Branch of the Securities and Exchange Commission at such address, at prescribed rates.
Please call the Securities and Exchange Commission at 1-800-SEC-0330 for further
information on the public reference room. A copy of each report submitted in accordance
with applicable United States law is also available for public review at our principal
executive offices.

In
addition, the Securities and Exchange Commission maintains an Internet website at
http://www.sec.govthat contains reports, proxy statements, information statements
and other material that are filed through the Securities and Exchange Commissions
Electronic Data Gathering, Analysis and Retrieval, or EDGAR, system.

71

---

---



|I. | SUBSIDIARY
INFORMATION
|-- | ----------------------

Not
applicable.

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

| | For
disclosure regarding our market risk exposure, see Item 5.  Operating and
Financial Review and Prospects above.
| | ---------------------------------------------------------------------------------------------------------------------

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

Not
applicable.

72

---

---



# PART II

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

There
are no defaults, dividend arrearages or delinquencies that are required to be disclosed.

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

There
are no material modifications to, or qualifications of, the rights of security holders
that are required to be disclosed.

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

Our
management evaluated, with the participation of our principal executive and principal
financial officers, the effectiveness of the design and operations of our disclosure
controls and procedures (as defined in Rules 13a-15(e) under the Securities Exchange Act
of 1934, as amended (the Exchange Act), as of December 31, 2004. Based on
their evaluation, our principal executive and principal financial officers concluded that
our disclosure controls and procedures were effective as of December 31, 2004.

There
has been no change in our internal control over financial reporting (as defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during our fiscal year ended
December 31, 2004, that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.

|ITEM 16A. |  | AUDIT
COMMITTEE FINANCIAL EXPERT
|--------- |  | --------------------------------

Our
board of directors has determined that Raanan Ellran, a member of its audit committee, is
an audit committee financial expert, as defined by applicable SEC regulations.

|ITEM 16B. |  | CODE
OF ETHICS
|--------- |  | --------------

We
have adopted a Code of Business Conduct and Ethics that applies to our executive and
financial officers and all of our employees. The Code of Business Conduct and Ethics is
publicly available on our website at www.otiglobal.com and we will provide
shareholders with a written copy upon request. If we make any substantive amendments to
the Code of Business Conduct and Ethics or grant any waivers, including any implicit
waiver, from a provision of these codes to our chief executive officer, chief financial
officer or corporate controller, we will disclose the nature of such amendment or waiver
on our website.

|ITEM 16C. |  | PRINCIPAL
ACCOUNTANT FEES AND SERVICES
|--------- |  | --------------------------------------

Policy on Pre-Approval of Audit
and Non-Audit Services of Independent Auditors

Our
audit committee is responsible for the oversight of our independent auditors work.
The audit committees policy is to pre-approve all audit and non-audit services
provided by Somekh Chaikin (a member of KPMG International). These services may include
audit services, audit-related services, tax services and other services, as further
described below. The audit committee sets forth the basis for its pre-approval in detail,
listing the particular services or categories of services which are pre-approved, and
setting forth a specific budget for such services. Additional services may be pre-approved
by the audit committee on an individual basis. Once services have been pre-approved,
Somekh Chaikin and our management then report to the audit committee on a periodic basis
regarding the extent of services actually provided in accordance with the applicable
pre-approval, and regarding the fees for the services performed.

73

---

---



# Principal Accountant
Fees and Services

We
paid the following fees for professional services rendered by Somekh Chaikin, a member of
KPMG International for the years ended December 31:

|                   | 2004 | 2003
|------------------ | ---- | ----
|
|
|
|
|Audit fees         |      |     
|                   |      |     
|Audit-related fees |      |     
|                   |      |     
|Tax fees           |      |     
|                   |      |     
|All other fees     |      |     
|                   |      |     
|                   |      |     
|                   |      |     

The
audit fees for the years ended December 31, 2004 and 2003, are the aggregate fees billed
(for the year) for the professional services rendered for the audits of our 2004 and 2003
annual consolidated financial statements, review of consolidated quarterly financial
statements of 2004 and 2003, statutory audits of us and our subsidiaries, consents and
assistance with review of documents filed with the SEC.

The
audit-related fees are the aggregate fees billed (for the year) for assurance and related
services that are reasonably related to the performance of the audit or review of our
financial statements and are not reported under Audit Fees.

Tax
Fees are the aggregate fees billed (in the year) for professional services rendered for
tax compliance, tax advice on actual or contemplated transactions and tax planning.

All
other fees are the aggregate fees billed (in the year) for professional services mainly in
connection with the due diligence concerning the acquisition of Asec S.A. and compliance
with Sarbanes-Oxley Act requirements.

Our
audit committee pre-approved all audit and non-audit services provided to us and to our
subsidiaries during the periods listed above. The committee approves discrete projects on
a case-by-case basis that may have a material effect on our operations and also considers
whether proposed services are compatible with the independence of the public accountants.

|ITEM 16D. |  | EXEMPTIONS
FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
|--------- |  | ----------------------------------------------------------

Not
applicable.

|ITEM 16E. |  | PURCHASES
OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
|--------- |  | ----------------------------------------------------------------------

None.

74

---

---



# PART III

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

| | We
have responded to Item 18.
| | -----------------------------

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

# Index to the Financial
Statements of the Registrant

|                                                                                  |           
|--------------------------------------------------------------------------------- | ----------
|
|
|
|
|Report of Independent Registered Public Accounting Firm                           | F-2       
|Consolidated Balance Sheets                                                       | F-3 - F-4 
|Consolidated Statements of Operations                                             | F-5       
|Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Loss | F-6       
|Consolidated Statements of Cash Flows                                             | F-7 - F-8 
|Notes to the Consolidated Financial Statements                                    | F-9 - F-44

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

|Exhibit No. |  | Description
|----------- |  | -----------

|1 |  | Articles
of Association (incorporated by reference to Exhibit 3.1 to our Registration Statement on
                 Form F-1, no. 333-90496).
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------

|2 |  | Specimen
share certificate (incorporated by reference to Exhibit 4.1 to our Registration Statement
                 on Form F-1, no. 333-90496).
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------

|4 |  | Material
agreements (incorporated by reference to Exhibits 10.1  10.49 to our Amendment No. 1 to
                 Form F-1 Registration Statement, File No. 333-108770).
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|8 |  | List
of subsidiaries (incorporated by reference to Exhibit 21.1 to our Registration Statement
on                  Form F-1, File No. 333-90496).
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------

|10.1 |  | Consent
of Luboshitz Kasierer, an affiliate member of Ernst & Young International
|---- |  | ---------------------------------------------------------------------------------

|10.2 |  | Consent
of Somekh Chaikin, a member of KPMG International
|---- |  | ---------------------------------------------------------

|31.1 |  | Certification
of Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|---- |  | ----------------------------------------------------------------------------------------------------

|31.2 |  | Certification
of Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|---- |  | ----------------------------------------------------------------------------------------------------

|32.1 |  | Certification
of Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|---- |  | ----------------------------------------------------------------------------------------------------

|32.2 |  | Certification
of Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|---- |  | ----------------------------------------------------------------------------------------------------

75

---

---



# On Track Innovations Ltd. and
its Subsidiaries

# Consolidated Financial
Statements As of December 31, 2004



---

---



|On Track Innovations Ltd.and its subsidiaries            
|---------------------------------------------------------
|Consolidated Financial Statements as of December 31, 2004
|                                                         

Contents

|                                                                       | Page      
|---------------------------------------------------------------------- | ----------
|Report of Independent Registered Public Accounting Firm                | F-2       
|Consolidated Balance Sheets                                            | F-3 - F-4 
|Consolidated Statements of Operations                                  | F-5       
|Consolidated Statements of Shareholders' Equity and Comprehensive loss | F-6       
|Consolidated Statements of Cash Flows                                  | F-7 - F-8 
|Notes to the Consolidated Financial Statements                         | F-9 - F-44



---

---



Report of Independent Registered
Public Accounting Firm To the Board of Directors and Shareholders of On Track Innovations
Ltd.

We have audited the accompanying
consolidated balance sheets of On Track Innovations Ltd. and its subsidiaries (the
Company) as of December 31, 2004 and 2003 and the related consolidated statements of
operations, shareholders equity and comprehensive loss and cash flows for the years
then ended. These consolidated financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits. The consolidated financial
statements of the Company for the year ended December 31, 2002 were audited by other
auditors, whose reports thereon dated March 28, 2003 expressed an unqualified opinion.

We conducted our audits in accordance
with the Standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. 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
statements presentation. We believe that our audits provide a reasonable basis for our
opinion.

In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the
consolidated financial position of the Company and its subsidiaries as of December 31,
2004 and 2003 and the results of their operations and their cash flows for the years then
ended, in conformity with generally accepted accounting principles in the United States of
America.

Somekh ChaikinCertified Public Accountants (Isr.)A Member of KPMG International

March 25, 2005



---

---



|On Track Innovations Ltd.and its subsidiaries          
|-------------------------------------------------------
|Consolidated Balance Sheets                            
|                                                       
|US dollars in thousands except share and per share data

|                                                    |  | December 31
|--------------------------------------------------- |  | -----------
|
|
|Assets                                              |  |            
|Current assets                                      |  |            
|Cash and cash equivalents                           |  |            
|Short-term investments                              |  |            
|Trade receivables (net of allowance for doubtful    |  |            
|accounts of $ 282 and $ 329 as of December 31, 2003 |  |            
|and 2004, respectively)                             |  |            
|Other receivables and prepaid expenses              |  |            
|Inventories                                         |  |            
|                                                    |  |            
|                                                    |  |            
|Total current assets                                |  |            
|                                                    |  |            
|                                                    |  |            
|Severance pay deposits fund                         |  |            
|                                                    |  |            
|Long-term receivables                               |  |            
|                                                    |  |            
|Property, plant and equipment, net                  |  |            
|                                                    |  |            
|Other intangible assets, net                        |  |            
|                                                    |  |            
|Goodwill                                            |  |            
|                                                    |  |            
|                                                    |  |            
|Total assets                                        |  |            
|                                                    |  |            

F - 3

---

---



|On Track Innovations Ltd.and its subsidiaries          
|-------------------------------------------------------
|Consolidated Balance Sheets                            
|                                                       
|US dollars in thousands except share and per share data

|                                                        |  | December 31
|------------------------------------------------------- |  | -----------
|
|
|
|
|Liabilities and Shareholders' Equity                    |  |            
|Current Liabilities                                     |  |            
|Short-term bank credit and current maturities           |  |            
|of long-term bank loans                                 |  |            
|Trade payables                                          |  |            
|Other current liabilities                               |  |            
|                                                        |  |            
|Total current liabilities                               |  |            
|                                                        |  |            
|Long-Term Liabilities                                   |  |            
|Long-term loans, net of current maturities              |  |            
|Accrued severance pay                                   |  |            
|Deferred tax liabilities                                |  |            
|                                                        |  |            
|Total long-term liabilities                             |  |            
|                                                        |  |            
|                                                        |  |            
|Total liabilities                                       |  |            
|                                                        |  |            
|Commitments and Contingencies                           |  |            
|                                                        |  |            
|Shareholders' Equity                                    |  |            
|Ordinary shares of NIS 0.1 par value: Authorized -      |  |            
|10,000,000 and 30,000,000 shares as                     |  |            
|of December 31, 2003 and 2004, respectively;            |  |            
|issued and outstanding - 4,778,715 and 8,422,175 shares |  |            
|as of December 31, 2003 and 2004, respectively          |  |            
|Additional paid-in capital                              |  |            
|Deferred stock compensation                             |  |            
|Accumulated other comprehensive income                  |  |            
|Accumulated deficit                                     |  |            
|                                                        |  |            
|                                                        |  |            
|Total shareholder's equity                              |  |            
|                                                        |  |            
|Total liabilities and shareholders' equity              |  |            
|                                                        |  |            

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

F - 4

---

---



|On Track Innovations Ltd.and its subsidiaries          
|-------------------------------------------------------
|Statements of Operations                               
|                                                       
|US dollars in thousands except share and per share data

|                                              |  | Year ended December 31
|--------------------------------------------- |  | ----------------------
|
|
|
|
|Revenues                                      |  |                       
|Products                                      |  |                       
|Non-recurring engineering                     |  |                       
|Licensing and transaction fees                |  |                       
|Customer service and technical support        |  |                       
|                                              |  |                       
|Total revenues                                |  |                       
|                                              |  |                       
|Cost of Revenues                              |  |                       
|Products                                      |  |                       
|Non-recurring engineering                     |  |                       
|Customer service and technical support        |  |                       
|                                              |  |                       
|Total cost of revenues                        |  |                       
|                                              |  |                       
|                                              |  |                       
|Gross profit                                  |  |                       
|                                              |  |                       
|                                              |  |                       
|Operating Expenses                            |  |                       
|Research and development                      |  |                       
|Less - participation by the Office of the     |  |                       
|Chief Scientist                               |  |                       
|                                              |  |                       
|Research and development, net                 |  |                       
|Selling and marketing                         |  |                       
|General and administrative                    |  |                       
|Amortization of intangible assets             |  |                       
|Expenses relating to raising of capital       |  |                       
|and exchange of subsidiary's employees equity |  |                       
|interest in equity interest of the Company    |  |                       
|                                              |  |                       
|Total operating expenses                      |  |                       
|                                              |  |                       
|                                              |  |                       
|Operating loss                                |  |                       
|                                              |  |                       
|Financial income                              |  |                       
|Financial expenses                            |  |                       
|                                              |  |                       
|Financial income (expenses), net              |  |                       
|Other income (expenses), net                  |  |                       
|                                              |  |                       
|Loss before taxes on income                   |  |                       
|Taxes on income                               |  |                       
|                                              |  |                       
|                                              |  |                       
|Minority interest                             |  |                       
|                                              |  |                       
|                                              |  |                       
|Net loss                                      |  |                       
|                                              |  |                       
|Basic and diluted net loss per ordinary share |  |                       
|                                              |  |                       
|Weighted average number of ordinary           |  |                       
|shares used in computing basic and            |  |                       
|diluted net loss per ordinary share           |  |                       
|                                              |  |                       

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

F - 5

---

---



|On Track Innovations Ltd.and its subsidiaries            
|---------------------------------------------------------
|Statements of Shareholders' Equity and Comprehensive Loss
|                                                         
|US dollars in thousands except share and per share data  

|                                            | Number of
Shares | Share
capital | Additional
paid-in
capital | Deferred
stock
Compensation | Accumulated
other
comprehensive
income | Accumulated
deficit | Total
shareholders'
equity
|------------------------------------------- | ---------------- | ------------- | -------------------------- | --------------------------- | -------------------------------------- | ------------------- | --------------------------
|
|
|
|
|Balance as of January 1, 2002               |                  |               |                            | 1,589,311                   |                                        | $                   | 47                        
|                                            |                  |               |                            |                             |                                        |                     |                           
|Deferred stock compensation, net            |                  |               |                            | -                           |                                        |                     | -                         
|Exercise of options                         |                  |               |                            | 227,845                     |                                        |                     | 5                         
|Amortization of deferred stock              |                  |              
|compensation                                |                  |               |                            | -                           |                                        |                     | -                         
|Stock options granted to consultants        |                  |               |                            | -                           |                                        |                     | -                         
|Beneficial conversion feature on            |                  |              
|convertible notes                           |                  |               |                            | -                           |                                        |                     | -                         
|Warrants issued in connection with the      |                  |              
|issuance of convertible notes               |                  |               |                            | -                           |                                        |                     | -                         
|Foreign currency translation adjustments    |                  |               |                            | -                           |                                        |                     | -                         
|Net loss                                    |                  |               |                            | -                           |                                        |                     | -                         
|                                            |                  |               |                            |                             |                                        |                     |                           
|                                            |                  |               |                            |                             |                                        |                     |                           
|Balance as of December 31, 2002             |                  |               |                            | 1,817,156                   |                                        | $                   | 52                        
|                                            |                  |               |                            |                             |                                        |                     |                           
|Deferred stock compensation, net            |                  |               |                            | -                           |                                        |                     | -                         
|Amortization of deferred stock              |                  |              
|compensation                                |                  |               |                            | -                           |                                        |                     | -                         
|Stock options granted to consultants        |                  |               |                            | -                           |                                        |                     | -                         
|Exercise of options and warrants            |                  |               |                            | 864,856                     |                                        |                     | 19                        
|Conversion of a loan to options             |                  |               |                            | -                           |                                        |                     | -                         
|Conversion of convertible promissory note   |                  |               |                            | 52,000                      |                                        |                     | 1                         
|Issuance of shares and detachable warrants, |                  |              
|net of issuance expenses of $1,204          |                  |               |                            | 2,044,703                   |                                        |                     | 47                        
|Foreign currency translation adjustments    |                  |               |                            | -                           |                                        |                     | -                         
|Net loss                                    |                  |               |                            | -                           |                                        |                     | -                         
|                                            |                  |               |                            |                             |                                        |                     |                           
|                                            |                  |               |                            |                             |                                        |                     |                           
|Balance as of December 31, 2003             |                  |               |                            | 4,778,715                   |                                        | $                   | 119                       
|                                            |                  |               |                            |                             |                                        |                     |                           
|Deferred stock compensation, net            |                  |               |                            | -                           |                                        |                     | -                         
|Amortization of deferred stock              |                  |              
|compensation                                |                  |               |                            | -                           |                                        |                     | -                         
|Stock options granted to consultants        |                  |               |                            | -                           |                                        |                     | -                         
|Exercise of options and warrants            |                  |               |                            | 2,057,196                   |                                        |                     | 45                        
|Issuance of shares and detachable warrants, |                  |              
|net of issuance expenses of $ 2,260         |                  |               |                            | 1,400,000                   |                                        |                     | 31                        
|Shares issued in connection with the        |                  |              
|purchase of a subsidiary                    |                  |               |                            | 186,264                     |                                        |                     | 4                         
|Foreign currency translation adjustments    |                  |               |                            | -                           |                                        |                     | -                         
|Net unrealized loss on available-for-sale   |                  |              
|securities                                  |                  |               |                            | -                           |                                        |                     | -                         
|Net loss                                    |                  |               |                            | -                           |                                        |                     | -                         
|                                            |                  |               |                            |                             |                                        |                     |                           
|Balance as of December 31, 2004             |                  |               |                            | 8,422,175                   |                                        | $                   | 199                       
|                                            |                  |               |                            |                             |                                        |                     |                           

|                                          | Year ended December 31
|----------------------------------------- | ----------------------
|
|
|
|
|Total comprehensive loss:                 |                       
|Net loss                                  |                       
|Foreign currency translation adjustments  |                       
|Net unrealized loss on available-for-sale |                       
|securities                                |                       
|                                          |                       
|Total comprehensive loss                  |                       
|                                          |                       

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

F - 6

---

---



|On Track Innovations Ltd.
and its subsidiaries         
|-------------------------------------------------------
|Statements of Cash Flows                               
|                                                       
|US dollars in thousands except share and per share data

|                                                                   | Year ended December 31
|------------------------------------------------------------------ | ----------------------
|
|
|
|
|Cash flows from operating activities                               |                       
|Net loss                                                           |                       
|Adjustments required to reconcile net loss to                      |                       
|net cash provided by (used in) operating activities:               |                       
|Amortization of deferred stock compensation                        |                       
|Stock options granted to consultants                               |                       
|Loss on sale of property and equipment                             |                       
|Amortization of intangible assets                                  |                       
|Depreciation                                                       |                       
|Amortization of beneficial conversion feature on convertible notes |                       
|Accrued severance pay, net                                         |                       
|Minority interest in losses of subsidiaries                        |                       
|Accrued interest and linkage differences on long-term loans        |                       
|Decrease in deferred tax liabilities                               |                       
|Decrease (increase) in short-term investments                      |                       
|Decrease (increase) in trade receivables                           |                       
|Decrease (increase) in other receivables and prepaid expenses      |                       
|Decrease (increase) in inventories                                 |                       
|Increase (decrease) in trade payables                              |                       
|Increase (decrease) in other current liabilities                   |                       
|Decrease in long-term deferred revenues                            |                       
|                                                                   |                       
|Net cash provided by (used in) operating activities                |                       
|                                                                   |                       
|Cash flows from investing activities                               |                       
|Sale of a consolidated subsidiary, net of cash disposed of         |                       
|(Supplement C)                                                     |                       
|Acquisition of a consolidated subsidiary, net of cash acquired     |                       
|(Supplement D)                                                     |                       
|Proceeds from sale of property and equipment                       |                       
|Purchase of property and equipment                                 |                       
|Purchase of available-for-sale securities                          |                       
|Increase in short-term deposit                                     |                       
|                                                                   |                       
|Net cash used in investing activities                              |                       
|                                                                   |                       
|Cash flows from financing activities                               |                       
|Increase (decrease) in short-term bank credit, net                 |                       
|Proceeds from issuance of shares and detachable warrants,          |                       
|net of issuance expenses                                           |                       
|Proceeds from long-term bank loans                                 |                       
|Repayment of long-term bank loans                                  |                       
|Exercise of options and warrants                                   |                       
|Proceeds from issuance of convertible notes                        |                       
|Proceeds from issuance of warrants in connection with the          |                       
|issuance of convertible notes                                      |                       
|Proceeds allocated to beneficial conversion feature on convertible |                       
|notes                                                              |                       
|                                                                   |                       
|Net cash provided by (used in) financing activities                |                       
|                                                                   |                       
|Effect of exchange rate changes on cash                            |                       
|                                                                   |                       
|Increase (decrease) in cash and cash equivalents                   |                       
|Cash and cash equivalents at the beginning of the year             |                       
|                                                                   |                       
|Cash and cash equivalents at the end of the year                   |                       
|                                                                   |                       

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

F - 7

---

---



|On Track Innovations Ltd.
and its subsidiaries         
|-------------------------------------------------------
|Consolidated Statements of Cash Flows (cont'd)         
|                                                       
|US dollars in thousands except share and per share data

|                                     |  | Year ended December 31
|------------------------------------ |  | ----------------------
|
|
|
|
|Supplementary cash flows activities: |  |                       
|                                     |  |                       
|A.                                   |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|B.                                   |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|C.                                   |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|D.                                   |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       
|                                     |  |                       

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

F - 8

---

---



|On Track Innovations Ltd.
and its subsidiaries         
|-------------------------------------------------------
|Notes to the Consolidated Financial Statements         
|                                                       
|US dollars in thousands except share and per share data

# Note 1  General

| | On
Track Innovations Ltd. (the Company) was founded in 1990, in Israel. The
Company and its subsidiaries (together the Group) are principally engaged in
the field of design and development of contactless microprocessor-based smart card
systems. The Companys ordinary shares were traded on the Neuer Markt in Germany
until February 3, 2002 after which, the shares were listed on the new Prime Standard
Market of the Frankfurt Stock Exchange. Commencing November 2002, the Companys
shares were also listed for trading on NASDAQ.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 2 
Significant Accounting Policies

| | The
financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America (US GAAP). The significant
accounting policies followed in the preparation of the financial statements, applied on a
consistent basis, are as follows:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | A. | Principles
of consolidation
| | -- | ---------------------------

| | The
consolidated financial statements include the financial statements of the Company and its
subsidiaries. The Companys principal subsidiaries are InterCard GmbH Kartensysteme
(Germany  disposed in October 2004), InterCard GmbH Systemelectronic (Germany), OTI
Africa Ltd. (South Africa), SoftChip Technologies (3000) Ltd. (Israel), ASEC Spolka
Akcyjna (Poland) SoftChip Israel Ltd. (Israel), OTI America, Inc. (U.S.A.), Easy Park
Ltd. (Israel) and Easy Park Israel Ltd. (Israel). All intercompany transactions and
balances have been eliminated upon consolidation.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Estimates
| | -- | ---------

| | The
preparation of the consolidated financial statements requires management of the Company
to make a number of estimates and assumptions relating to the reported amounts of assets
and liabilities and the disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and expenses
during the period. Actual results could differ from those estimates.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Substantially
all of the Companys and certain of its subsidiaries sales are in U.S.
dollars. A significant portion of purchases of materials and components and most
marketing costs are denominated in U.S. dollars. Therefore, the functional and reporting
currency of the Company and certain of its subsidiaries is the U.S. dollar.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Transactions
and balances denominated in dollars are presented at their original amounts.
| | -----------------------------------------------------------------------------------------

| | Transactions
and balances in other currencies are remeasured into U.S. dollars in accordance with the
principles set forth in Statement of Financial Accounting Standards (SFAS)
No. 52, Foreign Currency Translation. All exchange gains and losses from
remeasurement of balance sheet items denominated in non-dollar currencies are reflected
in the consolidated statements of operations.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 9

---

---



# Note 2 
Significant Accounting Policies (contd)

| | C. | Financial
statements in U.S. dollars (contd)
| | -- | ---------------------------------------------

| | The
functional currency of InterCard GmbH Kartensysteme (disposed in October 2004) and
InterCard GmbH Systemelectronic is the Euro and the functional currency of ASEC Spolka
Akcyjna is the Polish currency, the Zloty. The financial statements of these companies
are translated into US dollars in accordance with SFAS No. 52, using the exchange rate at
the balance sheet date for assets and liabilities, and weighted average exchange rates
for revenues and expenses. Translation adjustments resulting from the process of the
aforesaid translation included as a separate component of shareholders equity
(accumulated other comprehensive income).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Cash
equivalents
| | -- | ----------------

| | Cash
equivalents are short-term highly liquid investments and debt instrument that are readily
convertible to cash with original maturities of three months or less from the date of
deposit.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | E. | Marketable
securities
| | -- | ---------------------

| | In
accordance with SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities, the Company has classified its marketable debt securities into trading
or available-for-sale. Trading securities are held for resale in anticipation of
short-term market movements.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Marketable
securities classified as trading securities are stated at the quoted market prices at
each balance sheet date. Gains and losses (realized and unrealized) related to trading
securities as well as interest on such securities are included as financial income or
expenses, as appropriate.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Marketable
securities classified into available-for-sale are stated at market value. Unrealized
gains and losses are reported as a separate component of shareholders equity
(accumulated other comprehensive income). Interest income is included in financing
income. Realized gains and losses are included in financial income or expenses.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following table shows the gross unrealized losses and fair value of the Companys
investments with unrealized losses that are not deemed to be other-than-temporarily
impaired, aggregated by investment category and length of time that individual securities
have been in a continuous unrealized loss position, at December 31, 2004:
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                    | Less than 12 months | 12 months or greater |   | Total
unrealized
losses
|------------------- | ------------------- | -------------------- | - | -----------------------
|
|
|
|
|Available-for-sale: |                     |                      |   |                        
|                    |                     |                     
|U.S. treasury       |                     |                     
|securities          |                     |                      | $ | 4,514                  
|                    |                     |                      |   |                        
|Total               |                     |                      | $ | 4,514                  
|                    |                     |                      |   |                        

| | The
unrealized losses on the Companys investments in fixed rate bonds were caused by
interest rate increases. Because the Company has the ability to hold these investments
until a recovery of fair value, which may be maturity, the Company does not consider
these investments to be other-than-temporarily impaired at December 31, 2004.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 10

---

---



# Note 2 
Significant Accounting Policies (contd)

| | F. | Long-term
investments
| | -- | ---------------------

| | In
these financial statements, affiliated companies are companies held to the extent of 20%
or more (which are not subsidiaries). The investment in affiliated companies is accounted
for by the equity method. The Company discontinues applying the equity method when its
investment is at or reduced to zero and it has not guaranteed obligations of the
affiliate or otherwise committed to provide further financial support to the affiliate.
Profits on intercompany sales, not realized outside the Group, were eliminated.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | G. | Allowance
for doubtful accounts
| | -- | -------------------------------

| | The
allowance for doubtful accounts is calculated on the basis of specific identification of
balances, the collection of which, in managements opinion, is doubtful. In
determining the adequacy of the provision, management bases its opinion, inter alia, on
the estimated risk, in reliance on available information with respect to the debtors
financial position and an evaluation of the collateral received.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
activity in the allowance for doubtful accounts for the years ended December 31, 2002,
2003 and 2004 follows:
| | -----------------------------------------------------------------------------------------------------------------

|                                                | 2002 | 2003 | 2004
|----------------------------------------------- | ---- | ---- | ----
|
|
|
|
|Allowance for doubtful accounts at beginning of |      |      |     
|year                                            |      |      | $   
|Additions charged to bad debt expense           |      |      |     
|Write-downs charged against the allowance       |      |      |     
|Decrease from disposal of a subsidiary          |      |      |     
|                                                |      |      |     
|Allowance for doubtful accounts at end of year  |      |      | $   
|                                                |      |      |     

| | H. | Inventories
| | -- | -----------

| | Inventories
are stated at the lower of cost or net realizable value. Inventory write-offs are
provided to cover risks arising from slow moving items or technological obsolescence.
Such write-offs, which were not material for 2002, 2003 and 2004, have been included in
cost of revenues.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Cost
is determined by calculating raw materials, work in process and finished products on a
moving average basis.
| | -------------------------------------------------------------------------------------------------------------------

| | I. | Property
and equipment, net
| | -- | ---------------------------

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

|                                                | Years
|----------------------------------------------- | -----
|
|
|
|
|Leasehold land                                  |      
|Buildings                                       |      
|Computers, software and manufacturing equipment |      
|Office furniture and equipment                  |      
|Motor vehicles                                  |      

F - 11

---

---



# Note 2 
Significant Accounting Policies (contd)

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

| | The
Companys long-lived assets (including intangible assets) are reviewed for
impairment in accordance with SFAS No. 144 Accounting for the Impairment or
Disposal of Long- Lived Assets, whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. Recoverability of
an asset to be held and used is measured by a comparison of the carrying amount of the
asset to the future undiscounted cash flows expected to be generated by the asset. If
such asset is considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amount of the asset exceeds its fair value. As of
December 31, 2004, no impairment losses have been identified.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | K. | Business
combinations
| | -- | ---------------------

| | The
Company adopted SFAS No. 141 Business Combinations, issued in July
2001 which requires that the purchase method be used for all business combinations
initiated after June 30, 2001. Separate recognition of intangible assets is required if
they meet one of two criteria  the contractual-legal right criterion or the
separability criterion. In addition to the disclosure requirements of APB Opinion No. 16,
this Statement requires disclosure of the primary reason for the business combination and
the allocation of the purchase price paid to the assets acquired and liabilities assumed
by major balance sheet caption.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | L. | Goodwill
| | -- | --------

| | In
July 2001, the Financial Accounting Standards Board issued SFAS No. 142, Goodwill
and Other Intangible Assets. Under SFAS No. 142, goodwill and intangible assets
with indefinite lives are no longer amortized but are reviewed annually (or more
frequently if impairment indicators arise) for impairment. All other intangible assets
will continue to be amortized over their estimated useful lives. The provisions of SFAS
No. 142 apply to goodwill and intangible assets acquired after June 30, 2001. With
respect to goodwill and intangible assets acquired prior to June 1, 2001, the Company
adopted SFAS No. 142 effective January 1, 2002.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
accordance with the provisions of SFAS No. 142, the Company evaluated its existing
intangible assets as of January 1, 2002 and concluded that the purchase cost assigned to
assembled workforce as part of the SoftChip Group acquisition in January 2000 and the
purchase cost assigned to the assembled workforce as part of the InterCard Group
acquisition in 2000 and 2001 did not meet the criteria for separate recognition as an
intangible asset, and have therefore been reclassified as goodwill as of January 1, 2002.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---



# Note 2 
Significant Accounting Policies (contd)

| | L. | Goodwill
(contd)
| | -- | -----------------

| | As
of January 1, 2002, the Company therefore had unamortized goodwill in the amount of
$5,383.
| | ----------------------------------------------------------------------------------------------

| | In
accordance with SFAS No. 142, goodwill is required to be tested for impairment at the
reporting unit level, which is generally defined as an operating segment or a component
of an operating segment in certain circumstances. For the purposes of applying SFAS No.
142, the Company has identified five reporting units  the InterCard Group, the
SoftChip Group, EasyPark, OTI Africa and OTI Israel. The goodwill has been assigned to
two of these reporting units, being the Softchip Group and the InterCard Group.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Goodwill
impairment is a two-step process: Step 1 is to determine the fair value of each reporting
unit and step 2 is to compare the fair value of the reporting unit to its carrying value.
For the InterCard Group reporting unit, the fair value is determined by the income
approach as the reporting unit functions as a profit based business which generates both
revenues and expenditures. This approach included two steps: (1) establishing an estimate
of future cash flows and (2) discounting these cash flows to present value. For the
SoftChip Group reporting unit, the fair value is determined by the cost approach, as this
reporting unit is involved in research and development, and does not generate revenues.
The cost approach involved estimating the total cost that the reporting unit would be
required to incur in order to gain the knowledge of the current work force.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company completed the transitional goodwill impairment test in the second quarter of
fiscal 2002 and completed the annual goodwill impairment test in the first quarter of
fiscal 2003, 2004 and 2005 in respect of goodwill balances as of December 31, 2002, 2003
and 2004, respectively.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of each reporting unit exceeded the respective carrying amount, and therefore,
the goodwill allocated to each reporting unit was not considered impaired. However, there
can be no assurance that goodwill will not be impaired at any time in the future.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
October 2004, the Company completed the acquisition of ASEC (see Note 7E). In connection
with the acquisition, the Company recognized goodwill in the amount of US$ 167.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | M. | Other
intangible assets
| | -- | -----------------------

| | Intangible
assets acquired in a business combination should be amortized over their useful life
using a method of amortization that reflects the pattern in which the economic benefits
of the intangible assets are consumed or otherwise used up, in accordance with SFAS No.
142 Goodwill and Other Intangible Assets. Acquired technology, brand,
know-how and contracts with customers are amortized on the straight-line basis between
one and seven years.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 13

---

---



# Note 2 
Significant Accounting Policies (contd)

| | N. | Revenue
recognition
| | -- | -------------------

| | The
Company and its subsidiaries generate revenues from product sales, non-recurring
engineering, licensing and transaction fees, and customer services and technical support.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenues
from products sales and non-recurring engineering are recognized in accordance with Staff
Accounting Bulletin (SAB) No. 101 Revenue Recognition in Financial
Statements, that was amended by SAB No. 104, when delivery has occurred provided
there is persuasive evidence of an agreement, the fee is fixed or determinable and
collection of the related receivable is probable and no further obligations exist. In the
case of non-recurring engineering, delivery is deemed to occur on completion of testing
and approval of the customization of the product by the customer and provided that no
further obligation exits.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Technology
license revenues are recognized in accordance with SAB No. 101, that was amended by SAB
104, at the time the technology and license is delivered to the customer, collection is
probable, the fee is fixed and determinable, a persuasive evidence of an agreement
exists, no significant obligation remains under the sale or licensing agreement and no
significant customer acceptance requirements exist after delivery of the technology.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Transaction
fees are recognized as earned based on usage. Usage is determined by receiving
confirmation from the users.
| | -----------------------------------------------------------------------------------------------------------------------

| | Revenues
relating to customer services and technical support are recognized as the services are
rendered ratably over the term of the related contract.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | O. | Research
and development costs
| | -- | ------------------------------

| | Research
and development costs are charged to operations as incurred. The Company has evaluated
the establishment of technological feasibility of its products in accordance with SFAS
No. 86, Accounting for the Costs of Computer Software to Be Sold, Leased or
Otherwise Marketed. Based on the Companys product development process,
technological feasibility is established upon completion of a working model. Costs
incurred by the Company between completion of the working models and the point at which
the products are ready for general release have been insignificant. Therefore, all
research and development costs have been expensed.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | P. | Government
grants
| | -- | -----------------

| | The
Company and one of its subsidiaries receive royalty-bearing participation, which
represents participation of the Government of Israel (Office of the Chief Scientist  OCS)
in approved programs for research and development. These amounts are recognized on the
accrual basis as a reduction of research and development costs as such costs are
incurred. Royalties to the OCS are recorded in cost of sales.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 14

---

---



# Note 2 
Significant Accounting Policies (contd)

| | Q. | Stock-based
compensation
| | -- | ------------------------

| | Employees
| | ---------

| | The
Company has adopted SFAS No. 123, Accounting for Stock-Based Compensationwhich
permits entities to recognize as an expense over the vesting period, the fair value on
the date of grant of all stock-based awards. Alternatively, SFAS No. 123 allows entities
to continue to apply the provisions of Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees and related interpretations(APB No. 25)
and provide pro forma net loss and pro forma net loss per share disclosures for employee
stock option grants as if the fair-value based method defined in SFAS No. 123 had
been applied. The Company has elected to continue to apply the provisions of APB No. 25,
including FASB interpretation No. 44 Accounting for Certain Transactions Involving
Stock Compensation  an Interpretation of APB No. 25 and provide the pro forma
disclosures required by SFAS No. 123, as amended by SFAS No. 148, Accounting for
Stock-Based Compensation  Transition and Disclosure, an amendment of Statement No.
123".
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company applies the intrinsic value-based method prescribed in APB No. 25 for its stock
compensation to employees and directors. As such, the Company computes and records
compensation expense for grants whose terms are fixed with respect to the number of
shares and option price only if the market price on the date of grant exceeds the
exercise price of the stock option. The compensation cost for the fixed plans is recorded
over the period the employee performs the service to which the stock compensation
relates.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Non-Employees
| | -------------

| | The
Company applies SFAS No. 123 and EITF 96-18 Accounting for Equity Instruments that
are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods
or Services with respect to options issued to non-employees. SFAS No. 123 requires
use of an option valuation model to measure the fair value of these options at the grant
date.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | If
compensation cost had been determined under the alternative fair value accounting method
provided under SFAS No. 123, the Companys and subsidiaries stock-based employee
compensation cost, consolidated net loss and basic and diluted net loss per share would
have changed to the following consolidated pro forma amounts:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                          | Year ended December 31
|----------------------------------------- | ----------------------
|
|
|
|
|Net loss as reported                      |                       
|Deduct: Compensation expense according to |                       
|APB 25 included in reported net loss      |                       
|Add:      Application of compensation    
|according to SFAS No. 123                 |                       
|                                          |                       
|Pro forma net loss                        |                       
|                                          |                       
|Basic and diluted net loss per share:     |                       
|As reported                               |                       
|                                          |                       
|Pro forma                                 |                       
|                                          |                       

F - 15

---

---



# Note 2 
Significant Accounting Policies (contd)

| | R. | Basic
and diluted net loss per share
| | -- | ------------------------------------

| | Basic
and diluted net loss per share is computed based on the weighted average number of
ordinary shares outstanding during each year in accordance with SFAS No. 128, Earnings
Per Share.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | All
outstanding stock options and convertible notes have been excluded from the calculation
of the diluted net loss per ordinary share because all such securities are anti-dilutive
for all periods presented.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | S. | Fair
value of financial instruments
| | -- | -----------------------------------

| | The
Company in estimating fair value disclosures for financial instruments used the following
methods and assumptions:
| | ----------------------------------------------------------------------------------------------------------------------

| | The
carrying amount of cash and cash equivalents, trade receivables, short-term bank credit,
trade payables and convertible notes are equivalent to, or approximate their fair value
due to the short-term maturity of these instruments.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of marketable securities are based on quoted market prices.
| | --------------------------------------------------------------------------

| | Long-term
receivables are presented at the present value of expected future cash flows discounted
at the interest rate of 10%.
| | ------------------------------------------------------------------------------------------------------------------------------

| | The
carrying amount of long-term loans are equivalent to or approximate their fair value as
they bear interest at approximate market rates.
| | -------------------------------------------------------------------------------------------------------------------------------------------

| | T. | Income
taxes
| | -- | ------------

| | The
Company accounts for income taxes in accordance with SFAS No. 109, Accounting for
Income Taxes. Deferred tax asset and liability account balances are recognized for
the future tax consequences attributable to differences between the financial statements
carrying amounts of existing assets and liabilities and their respective tax bases and
operating loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is recognized in the
consolidated statement of operations in the period that includes the enactment date. The
Company provides a valuation allowance to reduce deferred tax assets to their estimated
realizable value.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 16

---

---



# Note 2 
Significant Accounting Policies (contd)

| | U. | Severance
pay
| | -- | -------------

| | The
Companys liability for severance pay is calculated pursuant to Israeli severance
pay law based on the most recent salary of the employees multiplied by the number of
years of employment, as of the balance sheet date. Employees are entitled to one months
salary for each year of employment or a portion thereof. Certain senior executives are
entitled to receive additional severance pay. The Companys liability for all of its
Israeli employees is partly provided by monthly deposits for insurance policies and by an
accrual. The value of these policies is recorded as an asset in the Companys
balance sheet.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Severance
pay deposits fund represent contributions to severance pay funds and cash surrender value
of life insurance policies that are recorded at their current redemption value, which
also represent their fair value.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | V. | Advertising
expenses
| | -- | --------------------

| | Advertising
expenses are charged to the statements of operations as incurred.
| | -----------------------------------------------------------------------------

| | W. | Concentrations
of credit risk
| | -- | -----------------------------

| | Financial
instruments that potentially subject the Company to concentrations of credit risk consist
principally of cash and cash equivalents, short-term bank investments, U.S. treasury
securities, long-term receivables and trade receivables.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Cash
and cash equivalents are invested mainly in U.S. dollars with major banks in Israel and
the United States. Management believes that the financial institutions that hold the Groups
investments are financially sound and, accordingly, minimal credit risk exists with
respect to these investments.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | U.S.
treasury securities are denominated in U.S. dollars. Management believes that
                    minimal credit risk exists with respect to these securities.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Long-term
receivables represent amounts to be received in consideration of the sale of KS (see note
7B). Management believes that the Company received satisfactory guarantees and pledge
which may assure the receipts of the aforesaid amounts.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys trade receivables are derived from sales to large and financially secure
organizations located mainly in the United States, Far East, Africa and Europe. The
Company performs ongoing credit evaluations of its customers and to date has not
experienced any material losses. An allowance for doubtful accounts is determined with
respect to those amounts that the Company has determined to be doubtful of collection. In
certain circumstances, the Company may require letters of credit, other collateral or
additional guarantees.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 17

---

---



# Note 2 
Significant Accounting Policies (contd)

| | X. | Recently
issued accounting standards
| | -- | ------------------------------------

| | 1. | In
November 2004, the FASB issued SFAS No. 151, Inventory Costs, an amendment to
          ARB 43, Chapter 4. The amendment made by SFAS No. 151 clarifies that abnormal
          amounts of idle facility expense, freight, handling costs, and wasted material
          (spoilage) should be recognized as current-period charges, and also require the
          allocation of fixed production overhead to inventory based on the normal
          capacity of the production facilities. The guidance is effective for inventory
          costs incurred during fiscal years beginning after June 15, 2005. Earlier
          application is permitted for inventory costs incurred during fiscal years
          beginning after November 23, 2004. The provision of SFAS No. 151 should be
          applied prospectively.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Adoption
of this statement is not expected to have a material impact on the Companys
financial position or results of operations.
| | ----------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
March 2004, the Emerging Issues Task Force (EITF) reached a
          consensus on EITF Issue No. 03-1, The Meaning of Other-Than-Temporary
          Impairment and Its Application to Certain Investments (EITF
          03-1) regarding disclosures for certain SFAS No. 115 investment
securities           and investments accounted for under SFAS No. 124. The objective of
EITF 03-1 is           to provide guidance on determining when an investment is
considered impaired,           whether that impairment is other-than-temporary, and the
measurement of an           impairment loss. The guidance also includes accounting
considerations subsequent           to the recognition of an other-than-temporary
impairment and requires certain           disclosures about unrealized losses that have
not been recognized as           other-than-temporary impairments. In September 2004, the
FASB issued FASB Staff           Position (FSP) EITF Issue 03-1-1 that delays
the effective date for           the measurement and recognition guidance included in
EITF 03-1. The FASB           recently announced that it intends on reconsidering in its
entirety EITF 03-1           and all other guidance on disclosing, measuring, and
recognizing           other-than-temporary impairments of debt and equity securities.
Until new           guidance is issued, companies must continue to comply with the
disclosure           requirements of EITF 03-1 and all relevant measurement and
recognition           requirements in other accounting literature. Quantitative and
qualitative           disclosures for investments accounted for under SFAS No. 115 are
included in           Note 2E.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | In
December 2004, the FASB issued SFAS No. 123 (Revision 2004),           Share-Based
Payment, (SFAS No. 123R), that addresses the accounting           for share-based
payment transactions in which employee services are received in           exchange for
either equity instruments of the Company, 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. SFAS No. 123R eliminates the           ability
to account for share-based compensation transactions using the intrinsic           value
method as prescribed in APB Opinion No. 25, Accounting for Stock           Issued
to Employees. Instead, SFAS No. 123R requires that such           transactions be
accounted for using a fair-value-based method and that           compensation expense be
recognized in the statement of operations rather than           disclosing the pro forma
impact of the stock based compensation as the Company           currently discloses in
Note 2Q and 14C. SFAS No. 123R provides two alternative           adoption methods. The
first method is a modified prospective transition method           whereby a company
would recognize share-based employee costs from the beginning           of the fiscal
period in which the recognition provisions are first applied as if           the
fair-value-based accounting method had been used to account
for all employee awards granted, modified, or settled after the effective date and to any
awards that were not fully vested as of the effective date. Measurement and attribution
of compensation cost for awards that are unvested as of the effective date of SFAS No.
123R would be based on the same estimate of the grant-date fair value and the same
attribution method used previously under SFAS No. 123, Accounting for Stock-Based
Compensation (SFAS No. 123). The second adoption method is a modified
retrospective transition method whereby a company would recognize employee compensation
cost for periods presented prior to the adoption of SFAS No. 123R in accordance with the
original provisions of SFAS No. 123; that is, an entity would recognize employee
compensation costs in the amounts reported in the pro forma disclosures provided in
accordance with SFAS No. 123. A company would not be permitted to make any changes to
those amounts upon adoption of SFAS No. 123R unless those changes represent a correction
of an error. The provisions of SFAS No. 123R are effective for periods beginning after
June 15, 2005, which will be the Companys third quarter beginning July 1, 2005. The
Company expects the adoption of this standard will reduce the third and fourth quarters
of 2005 net income by approximately US$ 986 thousand and US$ 881 thousand, respectively.
This estimate is based on the number of options currently outstanding and exercisable and
could change based on the number of options granted or forfeited in fiscal 2005.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 18

---

---



# Note 2 
Significant Accounting Policies (contd)

| | X. | Recently
issued accounting standards (contd)
| | -- | ---------------------------------------------

| | See
Note 18 regarding event after the date of the report of Independent Registered Accounting
Firm.
| | ---------------------------------------------------------------------------------------------------

| | 4. | In
December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary
          Assets  an amendment to APB No. 29. This Statement amends Opinion
          No. 29 to eliminate the exception for nonmonetary exchanges of similar
          productive assets and replaces it with a general exception for exchanges of
          nonmonetary assets that do not have commercial substance. A nonmonetary
exchange           has commercial substance if the future cash flows of the entity
expected to           change significantly as a result of the exchange. Adoption of this
statement is           not expected to have a material impact on the consolidated
financial position or           results of operations of the Company.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 3  Cash and
Cash Equivalents

|                                                | December 31
|----------------------------------------------- | -----------
|
|
|
|
|Cash in banks                                   |            
|Bank deposits in U.S. dollars and U.S. treasury |            
|securities                                      |            
|Bank deposits in Euro                           |            
|Bank deposits in NIS                            |            
|Other                                           |            
|                                                |            
|                                                |            
|                                                |            

F - 19

---

---



# Note 4  Short-Term
Investments

| | Short-term
investments as of December 31, 2003 consist of marketable bonds of the State of Israel
(bearing annual interest rate of 1.38%).
| | ------------------------------------------------------------------------------------------------------------------------------------------

| | Short-term
investments as of December 31, 2004, consist of primarily U.S. treasury securities
(bearing annual interest rate of 1.489%  3.188%).
| | ------------------------------------------------------------------------------------------------------------------------------------------------

# Note 5  Other
Receivables and Prepaid Expenses

|                                                  | December 31
|------------------------------------------------- | -----------
|
|
|
|
|Government institutions                           |            
|Prepaid expenses                                  |            
|Receivable in respect of the sale of a subsidiary |            
|(see Note 7B)                                     |            
|Other receivables                                 |            
|                                                  |            
|                                                  |            
|                                                  |            

Note 6  Inventories

|                  | December 31
|----------------- | -----------
|
|
|
|
|                  |            
|Raw materials     |            
|Work in progress  |            
|Finished products |            
|                  |            
|                  |            
|                  |            

# Note 7  Investments

| | A. | Softchip
Technologies (3000) Ltd. / Softchip Israel Ltd.
| | -- | --------------------------------------------------------

| | On
January 28, 2000, the Company acquired two Israeli companies; SoftChip Israel Ltd. and
SoftChip Technologies (3000) Ltd. (the SoftChip Group), after which the
SoftChip Group entities became wholly owned subsidiaries of the Company. The Company
exchanged 12,119 of its publicly traded ordinary shares valued at approximately $1,259
according to the market price of the Companys share on the date of the transaction
(being the purchase price), for all the outstanding shares of the SoftChip Group. The
SoftChip Group is a designer of microprocessors and operating systems for smart cards.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 20

---

---



# Note 7 
Investments (contd)

| | A. | Softchip
Technologies (3000) Ltd. / Softchip Israel Ltd. (contd)
| | -- | -----------------------------------------------------------------

| | The
acquisition was accounted for as a purchase and the Company allocated the purchase price
according to the fair value of assets acquired and liabilities assumed. The excess of the
purchase price over the fair value of net tangible assets acquired and liabilities
assumed of approximately $1,171 was recorded as intangibles being mainly assembled
workforce ($991) and technology ($180), which up to December 31, 2001 were amortized over
a period of five years on a straight-line basis. As of January 1, 2002, the Company
adopted the provisions of SFAS No. 142  see Note 2L.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
part of the acquisition of the SoftChip Group, the Company granted the chief executive
officer of the SoftChip Group, options to purchase 10,000 shares of the Company at a
price of $30.00 per share. The options vest in five equal annual installments commencing
February 2001. In accordance with EITF 95-8 Accounting for Contingent Consideration
Paid to the Shareholders of an Acquired Enterprise in a Purchase, these options are
not considered as part of the purchase price, and the Company has accordingly recorded a
deferred stock compensation in the amount of $730 to be amortized over the vesting period
which is five years. As of December 31, 2004, none of these options were exercised.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Intercard
Gmbh Kartensysteme/Intercard Gmbh Systemelectronic
| | -- | ------------------------------------------------------------

| | On
June 15, 2000, the Company acquired a 51% equity interest in InterCard GmbH Kartensysteme
(KS) and InterCard GmbH Systemelectronic (SE) (the InterCard
Group) in consideration for ordinary shares of the Company having a fair value of
DM5 million (approximately $2.4 million) (being the purchase price). The DM 5 million
consideration was paid in five equal monthly installments of the Companys ordinary
shares valued at DM 1 million each at the time of transfer followed by a sixth
installment such that the total number of shares transferred in each installment
multiplied by the average closing price of the Companys shares on the Neuer Markt
of the Frankfurt Stock Exchange for the twenty days immediately following each
installment, equals DM 5 million. Pursuant to this transaction, in June 2000, the Company
issued an aggregate of 39,317 ordinary shares which were held in escrow for the purpose
of these transfers.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 15, 2000, the Company transferred an aggregate of 29,742 ordinary shares to
the sellers. The InterCard Group is a systems integrator and manufacturer of electronic
devices. The acquisition was accounted for as a purchase, and the Company has allocated
the purchase price according to the fair value of assets acquired and liabilities
assumed. The excess of the purchase price over the fair value of net tangible assets
acquired and liabilities assumed of approximately $2,778 has been recorded as intangibles
being mainly assembled workforce ($2,638) and technology ($140), which up to December 31,
2001 were amortized over seven years on a straight-line basis. As of January 1, 2002, the
Company adopted the provisions of SFAS No. 142  see Note 2L.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
results of operations of the InterCard Group have been included in the consolidated
financial statements as from June 1, 2000.
| | ----------------------------------------------------------------------------------------------------------------------------------

| | On
June 15, 2000, as part of the acquisition the Company received a call option to buy, and
the minority shareholders of the InterCard Group had a put option to sell, the remaining
49% interest in the InterCard Group in consideration for shares of the Company having a
market value of DM7 million (approximately $3,400) to be issued in seven monthly
installments.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 21

---

---



# Note 7 
Investments (contd)

| | B. | Intercard
Gmbh Kartensysteme/Intercard Gmbh Systemelectronic (contd)
| | -- | ---------------------------------------------------------------------

| | In
January 2001, the minority shareholders of the InterCard Group exercised their put option
to sell the remaining 49% interest in the InterCard Group to the Company in consideration
for a long-term loan in the amount of $595 and 78,500 ordinary shares of the Company
having in total aggregate fair value of DM 7 million (being the purchase price). The DM 7
million (approximately $3,400) consideration was to be paid in seven monthly installments
of the Companys ordinary shares valued at DM 1 million each at the time of
transfer. The number of shares transferred in these installments was determined by the
average closing price of the Companys shares on the Neuer Markt of the Frankfurt
Stock Exchange on the three trading days prior to the date of the particular installment.
The number of shares transferred in the seventh installment were determined by
subtracting from DM 7 million the aggregate value of the previous six installments based
on the average closing price on the twenty days immediately following the date of the
particular installment.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
total number of shares transferred was subject to adjustment by a eighth installment such
that the total number of shares transferred in each installment multiplied by the average
closing price for the twenty days immediately following each installment, equals DM 7
million. Pursuant to this transaction, the Company issued 88,075 ordinary shares and
instead of issuing additional shares to compensate the seller for the reduction in value
of the Companys shares at the installment dates, OTI restructured its payment
obligations to the sellers. A payment of approximately $198 was paid on October 4, 2001.
The balance of approximately $595 was granted to the Company as a loan from the sellers
and was payable in 36 monthly installments of Euro 19,724 which included interest on the
outstanding principal at the rate of 6% per annum. As security for payment of the loan
the Company pledged 18% of OTIs shares in the InterCard Group to the sellers. In
June 2003, the Company converted the balance of the loan in the amount of $ 465 to
135,485 options to purchase ordinary shares of the Company at an exercise price equal to
par value. The fair value of the options approximates the amount of the loan. The options
vest immediately and expire in May 2008.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
acquisition was accounted for as a purchase, and the Company has allocated the purchase
price according to the fair value of assets acquired and liabilities assumed. The excess
of the purchase price over the fair value of net tangible assets acquired and liabilities
assumed of approximately $3,377 recorded as intangibles being mainly assembled workforce
($3,207) and technology ($170), which up to December 31, 2001 were amortized over seven
years on a straight line basis. As of January 1, 2002, the Company adopted the provisions
of SFAS No. 142  see Note 2L.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Following
an agreement signed on September 14, 2004, in October 2004, the Company sold its
wholly-owned German subsidiary, KS. In exchange for the Companys shares in KS, the
Company shall receive $ 2,500 (the Purchase price). The Purchase price shall
be paid in two installments. The first installment in the amount of $1,250 shall be paid
by receiving $ 685 in cash (received in January 2005), offsetting an amount of Euro 325
thousand ($432) against a loan granted to the buyer, which is repayable in 32 monthly
installments of Euro 10 thousand and a final installment of Euro 5 thousand, beginning on
February 1, 2005 and that is interest-free and offsetting an amount of Euro 100 ($ 133)
against a loan granted to the buyer, which is repayable in 12 monthly installments of
Euro 9,167, beginning on February 1, 2005. The second installment in the amount of $
1,250 shall be paid in 25 quarterly payments beginning on April 1, 2005.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---



# Note 7 
Investments (contd)

| | B. | Intercard
Gmbh Kartensysteme/Intercard Gmbh Systemelectronic (contd)
| | -- | ---------------------------------------------------------------------

| | The
total present value of the purchase price amounted to $ 2,178. The gain from the sale of
the subsidiary in the amount of $ 510, was deferred and will be recognized in the first
quarter of 2005.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys control over KS ceased on the closing date, which was October 1, 2004, and
therefore the Company ceased to consolidate the financial statements of KS on October 1,
2004.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | E-Smart
Systems Inc. (formerly Oti Asia Pacific Ltd.)
| | -- | -----------------------------------------------------

| | In
February 2000, the Company and Cheung Kong Holdings Ltd. (CK) established a
cooperative joint venture, e-Smart Systems Inc. (e-Smart), which will
purchase and distribute the Companys products to Greater China (the Peoples
Republic of China, Taiwan, Hong Kong and Macao). The Company and CK each invested $3,600
in e-Smart. The Companys $3,600 contribution comprised $3,100 in cash and a
deferred payment of $500. In addition, the Company granted the joint venture an option to
buy the operations of CitySmart (the Companys representative and systems integrator
in Hong Kong prior to the acquisition of 49% of e-Smart) from the Company in
consideration for $500 being the fair value of the operations. During the first quarter
of 2001, e-Smart exercised its option to transfer the operations of CitySmart from the
Company to e-Smart. The consideration of $500 to be paid by e-Smart in respect of the
CitySmart option was offset against the $500 deferred investment by the Company.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company does not have control over the joint venture, and accordingly, the investment in
e-Smart is accounted for under the equity method.
| | ----------------------------------------------------------------------------------------------------------------------------------------------

| | As
part of the abovementioned agreement, the Company granted e-Smart exclusive distribution
rights for the Companys products in 18 states in Greater China in consideration for
$3,600 pursuant to a distribution agreement, which has an unspecified term. This amount
is receivable in installments, of which $3,100 was received during the year ended
December 31, 2001 and a deferred payment of $500 due in 2003 and 2002. In the event that
the Companys products are sold by a third party in Greater China, the Company is
required to pay e-Smart 7.5% of such net revenues. As of December 31, 2003, no such
revenues have been concluded.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company has agreed to provide a guarantee of up to $2,000 of borrowings under a line of
credit that CK has undertaken to provide to e-Smart. As of December 31, 2003 the Company
has not been required to perform under the guarantee. In addition, the Company agreed to
indemnify e-Smart and CK against any losses they incur in connection with CitySmart as a
result of any event occurring prior to February 2, 2000 or arising out of any CitySmart
customer contract entered into prior to the exercise of the option, provided OTI is
notified of the claim prior to February 2, 2002. The Company did not receive any
notification of any claims prior to February 2, 2002.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company recorded the abovementioned transactions as a transfer of exclusive distribution
rights in exchange for a 50% non-controlling stake in e-Smart. Consequently, the Company
did not record a gain on the sale of the exclusive distribution rights, and the
investment in e-Smart has been recorded at zero in accordance with EITF 89-7 Exchange
of Assets or Interest in a Subsidiary for a noncontrolling Equity Interest in a New Entity.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 23

---

---



# Note 7 
Investments (contd)

| | C. | E-Smart
Systems Inc. (formerly Oti Asia Pacific Ltd.) (contd)
| | -- | --------------------------------------------------------------

| | Effective
June 22, 2002, the Agreement between the shareholders of e-Smart was amended, to give
effect, among other things, to the following provisions: Termination by e-Smart of all
contacts outside the territories of China, Hong Kong, Macao and Taiwan (Greater
China); transfer of all business contracts outside Greater China by e-Smart to the
Company, so that the territory in which e-Smart will act as the Companys exclusive
agent will be restricted to Greater China; restricting e-Smart for a period of 12 months
from engaging in any business with these terminated or transferred contracts. In
addition, the parties agreed that as of the date of the amendment, the president and the
CEO of e-Smart will be appointed by Ocean Wonder Limited (the other shareholder of
e-Smart) and not by the Company, and that the amount owed by e-Smart to the Company will
be reduced from $330 to $165. This amount was received by the Company during the third
quarter of 2002 and is included as income in other expenses, net, in the consolidated
statement of operations.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2003 the Companys investment in e-Smart was zero.
| | ---------------------------------------------------------------------

| | In
June 2004, the Company signed an agreement with CK for the sale of the Companys 50%
interest in the issued share capital of e-Smart and the transfer of the e-Smart exclusive
distribution rights in the Great China. According to the agreement, the Company received
$ 10 in consideration for the acquisition of the shares by CK and paid $ 40 and $ 20 for
the transfer of e-Smart exclusive distribution rights and for management services
provided by CK to e-Smart, respectively. In addition, the Company agreed to pay e-Smart
royalties equivalent to a certain percentage of the Companys net revenues
generating from its activities in the Great China up to $ 300.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Easy
Park Israel Ltd.
| | -- | ---------------------

| | During
the first half of 2002 a Share Purchase Agreement was signed between EasyPark Ltd. (EasyPark)
a subsidiary of the Company, and Bonus Credit Cards Ltd. (Bonus) according to
which EasyPark purchased all of Bonuss shares (39%) in EasyPark Israel Ltd. (EasyPark
Israel) a subsidiary of EasyPark, in consideration for $327. As a result of the
acquisition, EasyParks holdings in EasyPark Israel reached 90%.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
acquisition was accounted for as a purchase and the Company allocated the purchase price
according to the fair value of the assets acquired and the liabilities assumed. The
excess of the purchase price over the fair value of net tangible assets acquired and
liabilities assumed of approximately $327 was recorded as intangible assets being
technology, which is being amortized over three years.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 24

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---



# Note 7 
Investments (contd)

| | E. | ASEC
Spolka Akcyjna
| | -- | -------------------

| | In
October 2004, the Company completed the acquisition of ASEC Spolka Akcyjna (ASEC)
from Nextel Spolka Akcyjna (Nextel S.A.), headquartered in Karkow, Poland.
ASEC develops, manufactures and markets card readers and reader modules based on radio
frequency identification technologies, including high-end programmable smart card as well
as economically priced readers. Pursuant to the Preliminary Share Purchase Agreement,
dated September 2004, as amended by Annex No.1 to the Preliminary Share Purchase
Agreement, dated October 2004, between Nextel and the Company (the Agreement),
the aggregate purchase price for the acquisition was $ 1,600, which was paid to Nextel
through the issuance of 186,264 of the companys ordinary shares, based on a market
price of US $ 8.59 per share, which was the average closing price of the Companys
ordinary shares for the last ten trading days prior to September 14, 2004. In addition,
the Agreement provides for an additional consideration of up to $ 350 to be paid to
Nextel (the earn-out right) in the form of the Companys ordinary shares
pursuant to the earn-out formula.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
results of operations of ASEC have been included in the consolidated financial statements
as from October 1, 2004.
| | ----------------------------------------------------------------------------------------------------------------------

| | The
acquisition was accounted for as a purchase and the Company allocated the purchase price
according to the fair value of the tangible assets and intangible assets acquired and
liabilities assumed. As of October 2004, the purchase price was re-calculated in
accordance with EITF No. 99-12, Determination of the measurement date for the
market price of acquirer securities issued in purchase business combination, based
on the date the business combination was consummated, and was in the amount of $ 1,245.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2004, the Company also recorded $ 175 from the earn-out right against a
liability in accordance with SFAS No. 150.
| | -------------------------------------------------------------------------------------------------------------------------------------

| | In
connection with the acquisition, the Company recognized goodwill of $ 167. Out of $ 1,437
of acquired intangible assets, $ 579 was assigned to a brand, which is not amortized
since it has an indefinite useful life, $ 406 was assigned to contracts with customers
which is being amortized over up to five years and $ 452 was assigned to know how, which
is being amortized over one-and-a-half years. The amortization of the intangible asset
assigned to contracts with customers is included in cost of revenues.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
January 14, 2005, the Company received from Nextel S.A. 2,200 shares constituting 100% of
ASECs share capital in exchange for 186,264 of the Companys shares. The
shares of both parties were deposited with a trustee since the day of management control
taking by the Company in October 2004, and were released by the trustee when the Companys
shares were registered for trading on the NASDAQ.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 25

---

---



# Note 7 
Investments (contd)

| | F. | Other
intangible assets, net
| | -- | ----------------------------

|                         | December 31
|------------------------ | -----------
|
|
|
|
|Cost                     |            
|Technology               |            
|Brand                    |            
|Know-How                 |            
|Contracts with customers |            
|                         |            
|                         |            
|                         |            
|                         |            
|                         |            
|Accumulated amortization |            
|Technology               |            
|Brand                    |            
|Know-How                 |            
|Contracts with customers |            
|                         |            
|                         |            
|                         |            
|                         |            
|                         |            
|                         |            
|                         |            

| | a. | Amortization
expenses amounted to $ 161, $ 188 and $ 290 for the years ended           December 31,
2002, 2003 and 2004, respectively.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------

| | b. | Estimated
amortization expenses for the years ending:
| | -- | -----------------------------------------------------

|            | 
|----------- | 
|
|
|
|
|December 31 | 
|2005        | 
|2006        | 
|2007        | 
|2008        | 
|2009        | 

F - 26

---

---



# Note 8  Property,
Plant and Equipment, Net

|                                                | December 31
|----------------------------------------------- | -----------
|
|
|
|
|Cost                                            |            
|Land                                            |            
|Leasehold land (1)                              |            
|Buildings on leasehold land (1)                 |            
|Buildings                                       |            
|Computers, software and manufacturing equipment |            
|Office furniture and equipment                  |            
|Motor vehicles                                  |            
|                                                |            
|Total cost                                      |            
|                                                |            
|                                                |            
|                                                |            
|Accumulated depreciation                        |            
|Buildings on leasehold land                     |            
|Computers, software and manufacturing equipment |            
|Office furniture and equipment                  |            
|Motor vehicles                                  |            
|                                                |            
|Total accumulated depreciation                  |            
|                                                |            
|Depreciated cost                                |            
|                                                |            

| | Depreciation
expense for the years ended December 31, 2002, 2003 and 2004 were $ 897, $ 1,453 and $ 571,
respectively.
| | ----------------------------------------------------------------------------------------------------------------------

| | (1) | The
leasehold land consists of two plots owned by the Israel Lands           Administration.
Rights to leasehold land on the first plot extend over the           original period of
49 years ending in the year 2041 with an option to extend for           an additional 49
years, and on the second plot for a period of 49 years, which           will end in the
year 2047 with an option to extend for a further 49 years. The           Company
commenced the construction of the building on this plot of land in 2000           and
completed construction in 2002. The amount includes payments on account of           land
development and payments of the capitalization of leasing payments. The           rent
for the initial 49-year term of each of these leases was prepaid in its
          entirety at the beginning of the lease terms as is customary in Israel for
          leases of property for industrial purposes from the Israel Lands Authority.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | As
to liens  See Note 13C.
| | --- | ---------------------------

F - 27

---

---



# Note 9  Other
Current Liabilities

|                                                       | December 31
|------------------------------------------------------ | -----------
|
|
|
|
|Employees and related expenses                         |            
|Accrued expenses                                       |            
|Customers' advances                                    |            
|Liability with respect to the purchase of a subsidiary |            
|(see Note 7E)                                          |            
|Deferred gain from the sale of KS (see Note 7B)        |            
|Other current liabilities                              |            
|                                                       |            
|                                                       |            
|                                                       |            

# Note 10  Loans

| | A. | Composition
of Long-Term Loans:
| | -- | -------------------------------

|                          | December 31
|------------------------- | -----------
|
|
|
|
|Long-term loans           |            
|Less - current maturities |            
|                          |            
|                          |            
|                          |            

| | As
of December 31, 2004, the loans are primarily from banks and are denominated in US
dollars ($ 2,553),  ($ 90), and NIS ($ 127) and bear interest of approximately
3.75%-6.3% per annum.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Repayments
of Long-Term Loans Dates Subsequent to Balance Sheet Date:
| | -- | ---------------------------------------------------------------------

|                                |  | 
|------------------------------- |  | 
|
|
|
|
|First year (current maturities) |  | 
|Second year                     |  | 
|Third year                      |  | 
|Fourth year                     |  | 
|Fifth year and thereafter       |  | 
|                                |  | 
|                                |  | 
|                                |  | 

F - 28

---

---



# Note 10  Loans
(contd)

| | C. | Composition
of Short-Term Bank Credit and Current Maturities of Long-Term           Loans:
| | -- | ------------------------------------------------------------------------------------------

|                       | December 31 | December 31
|---------------------- | ----------- | -----------
|
|
|
|
|In U.S. dollars        |             |            
|In New Israeli shekels |             |            
|In Euro                |             |            
|                       |             |            
|                       |             |            
|Current maturities of  |             |            
|long-term loans        |             |            
|                       |             |            
|                       |             |            
|                       |             |            

| | Thepercentage
weighted average interest rate for the years ended December 31, 2003 and 2004 were 10.1%
and 6.2%, respectively.
| | ------------------------------------------------------------------------------------------------------------------------------

| | D. | Liens
for short-term and long-term borrowings  see Note 13C.
| | -- | -------------------------------------------------------------

| | E. | The
Company has an authorized credit line of approximately $1,800.
| | -- | ------------------------------------------------------------------

# Note 11 
Convertible Notes

| | On
December 5, 2002, the Company issued $250 10% Redeemable Convertible Promissory Notes (the
Notes) which may be converted into ordinary shares of the Company. The entire
principal balance was due on December 31, 2004 if not earlier converted.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
connection with the issuance of these Notes, the Company also issued detachable warrants
to purchase an aggregate of 16,757 ordinary shares, at an exercise price of 120% of the
average per share price for the ordinary shares for the ten (10) consecutive day trading
period prior to the closing. The warrants will expire on December 31, 2007.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Upon
the issuance of the Notes, the Company was required according to EITF No. 00-27
Application of Issue No. 98-5 to Certain Convertible Instruments (EITF
00-27) to record a discount in the amount of approximately $42 which was to be
amortized to financial expenses over a period of two years.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 29

---

---



# Note 11 
Convertible Notes (contd)

| | According
to EITF No. 98-5 Accounting for Convertible Securities with Beneficial Conversion
Features or Contingently Adjustable Conversion Ratios (EITF 98-5), the
warrants issued in connection with this note were accounted for under APB 14, Accounting
for Convertible Debt and Debt Issued with Stock Purchase Warrants. Under APB 14,
the fair value of the warrants was calculated using the Black-Scholes options pricing
model with the following assumptions: a risk-free interest rate of 2.5%, a dividend yield
of 0%, a volatility of the expected market price of the Companys ordinary shares of
75% and a contractual life of 5 years. The fair value of the warrants of $42 are offset
from the convertible notes and presented as a component of additional paid in capital in
the shareholders equity. This discount represents the theoretical most beneficial
conversion feature to the holder of the note measured at the issuance date of the note
that is also the commitment date.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
November 2003, pursuant to the receipt of a conversion notice, the Notes were converted
into 52,000 ordinary shares.
| | -----------------------------------------------------------------------------------------------------------------------

| | Upon
the conversion of the Notes, the unamortized discount was fully amortized.
| | -------------------------------------------------------------------------------

# Note 12  Severance
Pay

| | Severance
pay expenses for the periods ended December 31, 2002, 2003 and 2004 amounted to
approximately $ 65, $ 246 and $ 596, respectively.
| | --------------------------------------------------------------------------------------------------------------------------------------------

# Note 13 
Commitments and Contingencies

| | A. | Commitments
and Contingencies:
| | -- | ------------------------------

| | The
Company and its Israeli subsidiary, EasyPark, have entered into several research and
development agreements, pursuant to which the Company and EasyPark are obligated to pay
royalties to the Government of Israel at a rate of 3% and 3.5% of sales of products in
which the Government of Israel has participated in financing the research and
development, up to the amounts granted (linked to the US dollar with annual interest at
LIBOR as of the date of approval, for programs approved from January 1, 1999 and
thereafter). Repayment of such grants is not required in the event that there are no
sales of products developed within the framework of such funded programs. As at December
31, 2004, the total amount of grants received, net of royalties paid, was approximately $
5,221.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Royalties
paid or accrued amounted to $ 188, $ 199 and $ 187 for the years ended December 31, 2002,
2003 and 2004, respectively.
| | --------------------------------------------------------------------------------------------------------------------------------

F - 30

---

---



# Note 13 
Commitments and Contingencies (contd)

| | B. | Leases
| | -- | ------

| | The
Group operates from leased facilities in the United States, Israel, Poland, Germany and
South Africa, leased for periods expiring in years 2005 through 2009.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Minimum
lease commitments of certain subsidiaries under operating lease agreements under
non-cancelable leases in respect of premises occupied by them, at rates in effect as of
December 31, 2004 are as follows:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|     | 
|---- | 
|
|
|
|
|2005 | 
|2006 | 
|2007 | 
|2008 | 
|2009 | 
|     | 
|     | 
|     | 

| | Rent
expense amounted to $ 218, $ 201 and $ 475 for the years ended December 31, 2002, 2003
and 2004, respectively.
| | -------------------------------------------------------------------------------------------------------------------

| | C. | Liens
| | -- | -----

| | There
is a floating charge over the Companys motor vehicles, in favor of a bank and
leasing companies to secure loans received.
| | --------------------------------------------------------------------------------------------------------------------------------

| | Leasehold
land are pledged in favor of a bank in relation to both long-term and short-term
borrowings, and the Company has recorded a floating charge on all of its tangible assets.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
manufacturing facility has been pledged as security in respect of a loan received from a
bank.
| | --------------------------------------------------------------------------------------------------

| | D. | Legal
claims
| | -- | ------------

| | On
September 3, 2003, Edi Wuhl (the Plaintiff), once an employee of the Company,
filed a suit against the Company to the District Labor Court in Nazareth in the amount of
NIS 3,953,520. The suit is based on the Plaintiffs claims that the Company has
breached the employment agreement with him, and that the Company owes him commission
payments for certain sales. On December 17, 2003, the Company filed a statement of
defense. On May 23, 2004, a preliminary hearing was conducted, which did not lead to any
settlement. On January 2005, the Plaintiff filed his testimony in the form of an
affidavit with the court. The Company is required to file its answers in April 2005. In
the opinion of the Company, based on its legal advisor, the plaintiffs chances of
prevailing against the Company are remote. No provision in respect thereof has been
included in the financial statements.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 31

---

---



# Note 14 
Shareholders Equity

| | A. | Share
capital
| | -- | -------------

| | 1. | In
July 2003, pursuant to stock purchase agreements, the Company issued to two
          investors 231,818 ordinary shares in consideration for $637 and received a firm
          commitment from one of the investors to purchase an additional 100,000 ordinary
          shares in consideration for an additional $275, when the Company notifies the
          investor that the effectiveness of a registration statement covering shares for
          resale in the U.S. is imminent. Additional warrants to purchase 50,000 ordinary
          shares at an exercise price of $5.75 per share will also be issued upon the
          completion of such registration. Concurrently with the above share issuance,
the           Company issued to the two investors warrants to purchase 50,000 and 90,909
          ordinary shares at a per share exercise price of $5.75 and $3.85, respectively.
          The warrants are fully exercisable and expire in July 2008.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company paid, in respect of the above, a finders fee in cash equivalent to 10% of the
amount raised by the Company and in addition warrants to purchase 18,182 ordinary shares
with an exercise price of $3.85 per share and warrants to purchase 10,000 ordinary shares
with an exercise price of $5.75 per share.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | On
November 2003, convertible promissory notes in the amount of $250 were
          converted into 52,000 ordinary shares (see also Note 11).
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | On
November 14, 2003, upon the shareholders approval for the transaction,
          the Company issued to investors 228,044 ordinary shares in consideration for
          $624. Concurrently with the above share issuance, the Company issued to the
          investors warrants to purchase 112,305 ordinary shares, with a per share
          exercise price of $5.75. The warrants are fully exercisable and expire on July
          2008.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | On
November 14, 2003, the Companys shareholders approved the increase in           the
Companys authorized share capital of NIS 500,000 comprising of           5,000,000
ordinary shares of NIS 0.1 par value each. Following the aforesaid           Companys
shareholders approval, the Companys authorized share           capital is comprised
of 10,000,000 ordinary shares of NIS 0.1 par value each.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | In
November 2003, pursuant to a stock and warrant purchase agreements, the           Company
issued to investors 113,235 ordinary shares in consideration for $385.
          Concurrently with the above share issuance, the Company issued to the investors
          warrants to purchase 56,617 ordinary shares at a per share exercise price of
$5.           The warrants are exercisable upon the occurrence of certain events as set
forth           in the agreements and expire in November 2008.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 6. | In
December 2003, pursuant to a stock and warrant purchase agreements, the           Company
issued to investors 288,889 ordinary shares in consideration for $1,300.
          Concurrently with the above share issuance, the Company issued to the investors
          warrants to purchase 144,447 ordinary shares at a per share exercise price of
          $6.5. The warrants are fully exercisable and expire in December 2008.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company incurred, in respect of the above finders fee, expenses equivalent to 7% of
the amount raised by the Company.
| | --------------------------------------------------------------------------------------------------------------------------

F - 32

---

---



# Note 14 
Shareholders Equity (contd)

| | A. | Share
capital (contd)
| | -- | ----------------------

| | 7. | In
December 2003, pursuant to a stock and warrant purchase agreements, the           Company
issued to an investor 650,000 ordinary shares in consideration for           $3,413.
Concurrently with the above share issuance, the Company issued to the           investor
warrants to purchase 325,000 ordinary shares at a per share exercise           price of
$6.5. The warrants are fully exercisable and expire in December 2008.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company incurred, in respect of the above, finders fee expenses equivalent to 4% of the
amount raised by the Company and, in addition, issued warrants to purchase 45,500
ordinary shares at a per share exercise price of $6.5.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 8. | In
December 2003, pursuant to stock and warrant purchase agreements, the Company
          issued to investors 450,476 ordinary shares in consideration for $2,365.
          Concurrently with the above share issuance, the Company issued to the investors
          warrants to purchase 166,667 and 58,571 ordinary shares at a per share exercise
          price of $6.5 and $7.5, respectively. The warrants are fully exercisable and
          expire in December 2008.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company incurred, in respect of the above, finders fee expenses in the amount of $148
and, in addition, issued warrants to purchase 26,667 and 8,200 ordinary shares at a per
share exercise price of $6.5 and $7.5, respectively.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 9. | In
December 2003, pursuant to stock and warrant purchase agreements, the Company
          issued to two investors 82,241 ordinary shares in consideration for $400.
          Concurrently with the above share issuance, the Company issued to the investors
          warrants to purchase 41,120 ordinary shares at a per share exercise price of
          $6.5. The warrants are fully exercisable and expire in December 2008.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 10. | Following
a private placement agreement signed on October 23, 2003, the Company           signed on
January 7, 2004, a stock purchase agreement pursuant to which the           Company
issued to investors 100,000 Ordinary Shares in consideration for $ 315.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 11. | On
April 6, 2004, the Companys shareholders approved the increase of the
          Companys authorized share capital by NIS 2,000,000 comprising of
          20,000,000 ordinary shares of NIS 0.1 par value each. Following the increase,
          the Companys authorized share capital is comprised of 30,000,000 ordinary
          shares of NIS 0.1 par value each.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 12. | On
April 29, 2004, pursuant to a Securities Purchase Agreement, the Company           issued
to investors 1,300,000 ordinary shares in consideration for $ 15,132.
          Concurrently, with the above share issuance, the Company issued to the
investors           warrants to purchase 780,000 ordinary shares ordinary shares at a per
share           exercise price of $ 13.97. The warrants are fully exercisable and expire
in           April 2009.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company incurred, in respect of the above, finders fee expenses equivalent to
approximately 6% of the amount raised by the Company and, in addition, issued warrants to
purchase 124,800 ordinary shares at a per share exercise price of $13.97. The warrants
are fully exercisable and expire in April 2009.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 33

---

---



# Note 14 
Shareholders Equity (contd)

| | A. | Share
capital (contd)
| | -- | ----------------------

| | 13. | During
2004, warrants to purchase 1,051,224 ordinary shares were converted into
          ordinary shares in consideration of $6,092. Additional warrants to purchase
          140,764 ordinary shares were converted into 53,975 ordinary shares through
          cashless exercise.
| | --- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 14. | Pursuant
to the agreement, dated as of September 2004, between Nextel and the           Company,
the aggregate purchase price for the acquisition of the new subsidiary,           ASEC,
was $ 1,245, which was paid to Nextel through the issuance of 186,264 of           the
Companys ordinary shares (see Note 7E).
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Options to non-employees
| | -- | ------------------------

| | The
Company issued options to non-employees, which are accounted for in accordance with SFAS
No. 123 and EITF No. 96-18 Accounting For Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods and Services:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | In
2002, the Company issued 259,539 options to non-employee in respect of           services
rendered. The aggregate fair value of the options was $1,058 based on           the
Black-Scholes option model with the following assumptions: (1) contractual           life
of 3-10 years, (2) no dividend yield, (3) expected volatility of 75%           93%
and (4) risk free interest rate of 2.5%.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
2003, the Company issued 261,203 options to non-employee in respect of           services
rendered. The aggregate fair value of the options was $ 927 based on           the
Black-Scholes option model with the following assumptions: (1) contractual           life
of 5 years, (2) no dividend yield, (3) expected volatility of 82%            86%
and (4) risk free interest rate of 2.5%.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | In
2004, the Company issued 326,888 options to non-employee in respect of           services
rendered. The aggregate fair value of the options was $ 2,537 based on           the
Black-Scholes option model with the following assumptions: (1) contractual           life
of 5 years, (2) no dividend yield, (3) expected volatility of 78%            85%
and (4) risk free interest rate of 2.5%  3.29%.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | Stock option plans
| | -- | ------------------

| | 1. | In
1995, the Companys Board of Directors approved a stock option plan,           under
which up to 45,000 share options are to be granted to the Groups
          employees, directors and consultants. The vesting period for the options ranges
          from immediate vesting to ratable vesting over a ten-year period. The exercise
          price of options under the plan is at varying prices ranging from $0 to market
          value at the date of grant. Those options will expire up to ten years after the
          date of the grant. Any options which are forfeited or cancelled before
          expiration become available for future grants. In July 1998, the Board of
          Directors expanded the plan for an additional 20,000 share options to be
          granted. In November 1999, the Board of Directors resolved to expand the plan
          with an additional 35,000 share options to be granted. In July 2002, the Board
          of Directors expanded number of options available by 30,300.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 34

---

---



# Note 14 
Shareholders Equity (contd)

| | C. | Stock
option plans (contd)
| | -- | ---------------------------

| | 2. | In
February 2001, the Companys Board of Directors approved an additional
          option plan, under which up to 75,000 share options are to be granted to the
          Companys employees, directors and consultants and those of the
          Companys subsidiaries and affiliates.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
February 2002, the Companys Board of Directors approved an increase of the number
of available options by 150,000 and in July 2002 by a further 600,000.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
March, July and September 2003, the Companys Board of Directors approved an
increase of 375,000, 550,000 and 500,000 shares, respectively, to be reserved under the
Companys share option plan.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
November 17, 2003, the Companys Board of Directors approved an increase of 500,000
shares to be reserved under the Companys share option plan. This increase is
subject to shareholders approval if an exemption from Nasdaq is not obtained.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
vesting period for the options ranges from immediate vesting to ratable vesting over a
ten- year period. The exercise price of options under the plan is at varying prices
ranging from $0 to market value at the date of the grant. Those options will expire up to
ten years after the date of the grant. Any options which are forfeited or cancelled
before expiration become available for future grants.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | On
February 26, 2002, the Board of Directors approved a grant by which, inter
          alia, the Company may pay, during a 12-month period, the salaries of certain of
          its employees who agree to participate, by way of grant of options at an
          exercise price of par value. All such options are to be held by a trustee, for
          the benefit of each such employee. At the direction of and in accordance with
          instructions given by an employee who has received options, the trustee shall
          exercise such options and sell the shares issued upon such exercise. The
          proceeds mentioned above will be released on a monthly basis by the trustee
(net           of deductions required by law) to the maximum extent necessary for payment
of           such monthly salary to such employee. The Company undertook to pay from its
own           sources any and all differences between the relevant monthly salary and
such           proceeds. The arrangement was subject to the Company, the employees and
the           trustees signature on a detailed agreement and necessary ancillary
          documents.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
March 28, 2003, the Board of Directors approved to extend the arrangement of the plan
approved by the Board of Directors on February 26, 2002 to pay salaries of certain of its
employees who agree to participate in the plan, by way of grant of options for an
additional period of 6 months starting May 2003.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
October 28, 2003, the Companys Board of Directors approved the extension of the
arrangement of the plan approved by the Board of Directors on February 26, 2002 to pay
salaries of certain of its employees who agree to participate in the plan, by way of
grant of options, only for the employees of Inter-Card group, for the period commencing
November 2003 and ending July 2004.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 35

---

---



# Note 14 
Shareholders Equity (contd)

| | C. | Stock
option plans (contd)
| | -- | ---------------------------

| | 3. | (contd)
| | -- | --------

| | On
August 26, 2004, the Companys Board of Directors approved the extension of the
arrangement of the plan approved by the Board of Directors on February 26, 2002 to pay
salaries of certain of its employees who agree to participate in the plan, by way of
grant of options, for the period commencing July 2004 and ending December 2004.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
November 26, 2004, the Companys Board of Directors approved the extension of the
arrangement of the plan approved by the Board of Directors on February 26, 2002 to pay
salaries of certain of its employees who agree to participate in the plan, by way of
grant of options, for a 12-month period commencing January 2005 and ending December 2005.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2002, 2003 and 2004, 225,346, 621,768 and 1,055,439 options respectively,
have been granted in respect of the above-mentioned grant. The exercise price per share
for such options is equal to the par value of the ordinary shares of the Company.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | On
November 26, 2004, the Companys Board of Directors approved the
          conversion grant of 130,230 fully vested options with an exercise price of NIS
          0.1 per share to OTI Africa Ltd. employees in exchange to each OTI Africa Ltd.
          employee waiving his rights to receive options and/or shares, he is entitled.
          The transaction resulted in a new measurement date and expenses in the amount
of           $ 1,112 were recorded.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | The
Company applies APB Opinion No. 25 and related interpretations in accounting
          for its stock compensation programs benefiting employees and directors and
          recorded compensation expenses of $1,608, $1,897 and $ 4,872 in the years ended
          December 31, 2002, 2003 and 2004, respectively, according to the intrinsic
value           of the above options.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company applies SFAS No. 123 in respect of options granted to consultants and recorded
compensation expense of $1,058, $927 and $ 2,537 in the years ended December 31, 2002,
2003 and 2004, respectively, related to the above options according to the Black-Scholes
model.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 36

---

---



# Note 14 
Shareholders Equity (contd)

| | C. | Stock
option plans (contd)
| | -- | ---------------------------

| | If
compensation cost had been determined under the alternative fair value accounting method
provided under SFAS No. 123, the Companys and subsidiaries stock-based employee
compensation cost, consolidated net loss and basic and diluted net loss per share would
have changed to the following consolidated pro forma amounts:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                          | Year ended December 31
|----------------------------------------- | ----------------------
|
|
|
|
|Net loss as reported                      |                       
|Deduct: Compensation expense according to |                       
|APB 25 included in the reported net loss  |                       
|Add:      Application of compensation     |                       
|expenses according to SFAS No. 123        |                       
|                                          |                       
|Pro forma net loss                        |                       
|                                          |                       
|Basic and diluted net loss per share:     |                       
|As reported                               |                       
|                                          |                       
|Pro forma                                 |                       
|                                          |                       

| | The fair
value of each option granted is estimated on the date of grant, using the Black-Scholes
model using the following assumptions:
| | ---------------------------------------------------------------------------------------------------------------------------------------

| | 1. | Dividend
yield of zero percent for all periods.
| | -- | -----------------------------------------------

| | 2. | Risk-free
interest rate of 2.5%, 2.5% and 3.29% for December 31, 2002, 2003 and
               2004, respectively.
| | -- | ------------------------------------------------------------------------------------------------------------------

| | 3. | Estimated
expected lives of 3.37 years for all periods.
| | -- | -------------------------------------------------------

| | 4. | Expected
average volatility of 82%, 86% and 78.14% for December 31, 2002, 2003                and
2004, respectively which represents a weighted average standard deviation
               rate for the price of the Companys Ordinary Shares in the Nasdaq
National                Market.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 37

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---



# Note 14 
Shareholders Equity (contd)

| | C. | Stock
option plans (contd)
| | -- | ---------------------------

| | The
Companys options activity (including options to non-employees) and options
outstanding as of December 31, 2002, 2003 and 2004 are summarized in the following table:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                | Number of
options
outstanding | Weighted
average exercise
price per share
|------------------------------- | ----------------------------- | -----------------------------------------
|
|
|
|
|Outstanding - January 1, 2002   |                               |                                          
|Options granted                 |                               |                                          
|Options cancelled or forfeited  |                               |                                          
|Options exercised               |                               |                                          
|                                |                               |                                          
|Outstanding - December 31, 2002 |                               |                                          
|Options granted                 |                               |                                          
|Options cancelled or forfeited  |                               |                                          
|Options exercised               |                               |                                          
|                                |                               |                                          
|Outstanding - December 31, 2003 |                               |                                          
|Options granted                 |                               |                                          
|Options cancelled or forfeited  |                               |                                          
|Options exercised               |                               |                                          
|                                |                               |                                          
|Outstanding - December 31, 2004 |                               |                                          
|                                |                               |                                          
|                                |                               |                                          
|Exercisable as of:              |                               |                                          
|December 31, 2002               |                               |                                          
|                                |                               |                                          
|December 31, 2003               |                               |                                          
|                                |                               |                                          
|December 31, 2004               |                               |                                          
|                                |                               |                                          

F - 38

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# Note 14 
Shareholders Equity (contd)

| | C. | Stock
option plans (contd)
| | -- | ---------------------------

| | The
following table summarizes information about options outstanding and exercisable
(including options to non-employees) as of December 31, 2004:
| | --------------------------------------------------------------------------------------------------------------------------------------------------

|  |  | Options outstanding | Options Exercisable
|- |  | ------------------- | -------------------
|
|
|
|
|$ |  |                     | 0-0.02             
|  |  |                     | 2.75               
|  |  |                     | 3.25-5.16          
|  |  |                     | 6.10-8.17          
|  |  |                     | 8.21-9.89          
|  |  |                     | 10.00-14.00        
|  |  |                     | 16.03-34.00        
|  |  |                     | 42.50-123.60       
|  |  |                     |                    
|  |  |                     |                    
|  |  |                     |                    

| | The
amounts of deferred stock compensation recognized arising from the difference between the
exercise price and the fair market value on the date of the grant of $ 2,182, $ 2,039 and
$ 7,168 for options granted in the years ended December 31, 2002, 2003 and 2004,
respectively, are included in shareholders equity and are being amortized over the
vesting periods of the respective options in accordance with APB 25.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of December 31, 2004, the number of options available for grant was 195,288.
| | -------------------------------------------------------------------------------

F - 39

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# Note 14 
Shareholders Equity (contd)

| | C. | Stock
option plans (contd)
| | -- | ---------------------------

| | The
weighted average fair values of options (including non-employees) granted during the
years ended December 31, 2002, 2003 and 2004 were:
| | -------------------------------------------------------------------------------------------------------------------------------------------

|                 | For exercise price on the grant date that:
|---------------- | ------------------------------------------
|
|
|
|
|
|Weighted average |                                           
|exercise prices  |                                           
|Weighted average |                                           
|fair values on   |                                           
|grant date       |                                           

| | D. | Warrants
| | -- | --------

| | The
Company issued warrants in respect with investments made in the Company. The number of
warrants issued by the Company during the years ended December 31, 2003 and 2004 were
1,553,957 and 904,800 respectively, with a per share weighted average exercise price of
$5.95 and $13.97 respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following table summarizes information about warrants outstanding and exercisable as of
December 31, 2004:
| | --------------------------------------------------------------------------------------------------------------

|  |  | Warrants outstanding
|- |  | --------------------
|
|
|
|
|$ |  |                     
|  |  |                     
|  |  |                     
|  |  |                     
|  |  |                     
|  |  |                     
|  |  |                     
|  |  |                     

| | E. | Employee
Share Purchase Plan
| | -- | ----------------------------

| | In
2001, the Company established an Employee Share Purchase Plan pursuant to which 67,500
shares have been reserved for employees including the Companys subsidiaries who
have been employed for at least six months. The purchase price of the shares will be 85%
of the trading price on the date of purchase. As of the date of these financial
statements, no shares have been issued to any employees under this plan.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 40

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# Note 15  Income
Taxes

| | A. | Measurement
of taxable income under the Income Tax (Inflationary Adjustments)           Law, 1985
| | -- | -------------------------------------------------------------------------------------------------

| | Results
for tax purposes are measured and adjusted in accordance with the change in the Israeli
Consumer Price Index (CPI). As explained in Note 2C the consolidated
financial statements are presented in U.S. dollars. The differences between the change in
the Israeli CPI and in the NIS/U.S. dollar exchange rate causes a difference between
taxable income or loss and the income or loss before taxes reflected in the consolidated
financial statements. In accordance with paragraph 9(f) of SFAS No. 109, the Company and
its Israeli subsidiaries has not provided deferred income taxes on this difference
between the financial reporting basis and the tax basis of assets and liabilities.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Tax
benefits under the Law for the Encouragement of Capital Investments, 1959
| | -- | -----------------------------------------------------------------------------

| | The
Company maintains three investment programs in buildings, equipment and production
facilities which have been granted the status of Approved Enterprise under
the Law for the Encouragement of Capital Investments, 1959. The Company elected to adopt
the Alternative Benefits Program status. This status entitles the Company to
an exemption from taxes on income derived therefrom for a period of 10 years starting in
the year in which the Company first generates taxable income, but not later than 14 years
from the date of approval (the last of which was received in February 2000) or 12 years
from commencement of operations. The tax-exempt profits that will be earned by the Companys
Approved Enterprises can be distributed to shareholders, without imposing tax
liability on the Company only upon its complete liquidation. If these retained tax-exempt
profits are distributed in a manner other than in the complete liquidation of the Company
they would be taxed at the corporate tax rate applicable to such profits as if the
Company had not elected the alternative system of benefits (depending on the level of
foreign investment in the Company) currently between 10% to 25% for an Approved
Enterprise. As the Company has not yet reported any taxable income, the benefit
period has not yet commenced.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Final
approvals in respect of certain investment programs have not yet been received by the
Company.
| | ----------------------------------------------------------------------------------------------------

| | The
Companys subsidiary, EasyPark, has also been granted the status of an Approved
Enterprise for its program plan establishment of a production facility. EasyPark
also elected to adopt the Alternative Benefits Program status for its
investment programs. This status entitles EasyPark to an exemption from tax on income
derived therefrom for a period of 10 years starting in the year in which EasyPark first
generates taxable income, but not later than 14 years from the date of approval (the last
of which was received in February 2000) or 12 years from commencement of operations. In
the event of a distribution of a cash dividend out of tax-exempt income, EasyPark will be
liable to corporate tax at a rate of 25% in respect of the amount distributed. As
EasyPark has not yet reported any taxable income, the benefit period has not yet
commenced.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Income
from sources other than the Approved Enterprise during the benefit period
will be subject to tax at the regular corporate tax rate of (see 15D below).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
entitlement to the above mentioned benefits is conditional upon the Companys
fulfilling the conditions stipulated by the above mentioned law, regulations published
thereunder and the certificates of approval for the specific investments in approved
enterprises. In the event of failure to comply with these conditions, the benefits may be
canceled and the Company may be required to refund the amount of the benefits, in whole
or in part, with the addition of linkage differences, to the CPI and interest. Management
believes that the Company is in compliance with the above-mentioned conditions as of
December 31, 2004.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 41

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---



# Note 15  Income
Taxes (contd)

| | C. | The
Law for the Encouragement of Industry (taxes), 1969
| | -- | -------------------------------------------------------

| | At
the Companys management estimation, the Company is also an Industrial Company under
the Law for the Encouragement of Industry. The principal benefits for the Company is the
deductibility of expenses in connection with a public offering and accelerated
depreciation.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | On June 29, 2004, the Israeli Knesset passed Income Tax Ordinance (No. 140 and
          Temporary Order), 2004 (hereinafter  the Amendment). The
          Amendment provides for gradual reduction of the tax rates for companies, from
          the rate of 36% to the rate of 30%, in the following manner: In the 2004 tax
          year the tax rate will be 35%, in the 2005 tax year the tax rate will be 34%, in
          the 2006 tax year the tax rate will be 32%, and in the 2007 tax year and
          thereafter the tax rate will be 30%.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | This
change had no effect on the financial statements of the Company.
| | ---------------------------------------------------------------------

| | E. | As of December 31, 2004, the net operating loss carryforwards for tax purposes
          relating to Israeli companies amounted to approximately $ 37,500. Carryforward
          losses in Israel may be carried forward indefinitely and may be offset against
          future taxable income. The Company expects that during the period in which these
          tax losses are utilized its income would be substantially tax exempt, and
          accordingly, no deferred tax asset has been recorded. Carryforward losses
          relating to non-Israeli companies, Poland and Germany, approximate $96 and $154,
          respectively. Carryforward losses in Germany may be carried forward indefinitely
          and may be offset against future taxable income. Carryforward losses in Poland
          may be carried forward and may be offset against future taxable income and will
          expire in 2007.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | F. | Deferred taxes in respect of temporary differences between carrying amounts of
          assets and liabilities for financial reporting and amounts used for tax
          reporting purposes are immaterial.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | G. | Income tax expense presented in the consolidated statements of operations is
          derived from taxable income in the German, Poland and American subsidiaries and
          is for current and deferred taxes.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | H. | Non-Israeli subsidiaries are taxed based on tax laws in their countries of
          residence.
| | -- | -----------------------------------------------------------------------------------------------

F - 42

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# Note 16  Related
Party Balances and Transactions

| | A. | Balances
| | -- | --------

|                  | December 31
|----------------- | -----------
|
|
|
|
|Assets            |            
|Trade receivables |            
|                  |            
|Liabilities       |            
|Trade payables    |            

| | B. | Transactions
| | -- | ------------

|                   | Year ended December 31
|------------------ | ----------------------
|
|
|
|
|Revenues           |                       
|Costs and expenses |                       
|Other income       |                       

F - 43

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# Note 17 
Geographic Information and Major Customers

| | In
accordance with SFAS No. 131 Disclosures About Segments of an Enterprise and
Related Information, the Company is organized and operates as one business segment,
the design and development of contactless microprocessor-based smart card systems.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                        | Year ended December 31
|--------------------------------------- | ----------------------
|
|
|
|
|Revenues by geographical areas of       |                       
|end customers                           |                       
|North America                           |                       
|Far East                                |                       
|Africa                                  |                       
|Europe                                  |                       
|South America                           |                       
|                                        |                       
|Total export                            |                       
|Domestic (Israel)                       |                       
|                                        |                       
|                                        |                       
|                                        |                       
|                                        |                       
|
|
|Long lived assets by geographical areas |                       
|Israel                                  |                       
|Germany                                 |                       
|Poland                                  |                       
|Other                                   |                       
|                                        |                       
|                                        |                       
|                                        |                       

Note 18  Event After the Date of the Report of Independent Registered Accounting Firm (Unaudited)

| | On
April 14, 2005, the Securities and Exchange Commission issued a new rule which defers the
effective date of SFAS No. 123R. According to the new rule, registrants must adopt SFAS
No. 123R as of the beginning of their first annual period beginning after June 15, 2005
and not as of beginning of their first interim period beginning after June 15, 2005.
Accordingly, the effective date of the adoption of SFAS No.123R for the Company is
deferred from July 1, 2005 to January 1, 2006. The Company expects the adoption of this
standard will reduce its 2006 net income by approximately US$ 954 thousand. This estimate
is based on the number of options currently outstanding and exercisable and could change
based on the number of options granted or forfeited in fiscal 2005 and 2006.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 44

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---

# SIGNATURES

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

| |  | ON TRACK INNOVATIONS LTD.BY: /S/ Oded Bashan
Oded BashanPresident, Chief Executive Officerand Chairman of the Board
| |  | ---------------------------------------------------------------------------------------------------------------------------------

| |  | BY: /S/ Guy Shafran
Guy ShafranChief Financial Officer
| |  | --------------------------------------------------------------------

Date:  May 1,
2005

76

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