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SECURITIES AND EXCHANGE COMMISSIONWashington,
D.C. 20549

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FORM 20-F

(Mark One)

|o                                           | REGISTRATION STATEMENT PURSUANT TO
  SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
|------------------------------------------- | ------------------------------------------------------------------------------------------------
|                                            |                                                                                                 
|OR                                         
|                                            |                                                                                                 
|x                                           | ANNUAL REPORT PURSUANT TO SECTION
  13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934          
|FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
|                                            |                                                                                                 
|OR                                         
|                                            |                                                                                                 
|o                                           | TRANSITION REPORT PURSUANT TO
  SECTION 13 OR 15(d) OF THE SECURITIES 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:                    None

Securities registered or to be registered pursuant to Section 12(g) of
the Act: ordinary shares, NIS 0. 1 nominal value

Securities for which there is a reporting obligation pursuant to
Section 15(d) of the Act:     None.

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:
1,817,156 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.

Yes
X
          No

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

Item 17 __ Item 18X

1

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TABLE OF CONTENTS

|PART I    
|----------
|          
|ITEM 1.   
|          
|ITEM 2.   
|          
|ITEM 3.   
|          
|ITEM 4.   
|          
|ITEM 5.   
|          
|ITEM 6.   
|          
|ITEM 7.   
|          
|ITEM 8.   
|          
|ITEM 9.   
|          
|ITEM 10.  
|          
|ITEM 11.  
|          
|ITEM 12.  
|          
|PART II   
|          
|ITEM 13.  
|          
|ITEM 14.  
|          
|ITEM 15.  
|          
|ITEM 16.  
|          
|PART III  
|          
|ITEM 17.  
|          
|ITEM 18.  
|          
|ITEM 19.  
|          
|SIGNATURES
|          

2

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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.

3

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ITEM
3.          KEY INFORMATION

The
following selected consolidated statements of operations data for the years
ended December 31, 2000, 2001 and 2002, and the selected consolidated balance
sheet data as of December 31, 2001 and 2002, 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 Form
20-F.  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, 1998 and 1999 and the selected
consolidated balance sheet data as of December 31, 1998, 1999 and 2000 have
been derived from the Companys audited consolidated financial statements not
included in this Form 20-F and 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 the Companys consolidated financial statements and
the related notes as well as Item 5 - Operating and Financial Review and
Prospects included elsewhere in this Form 20-F.

On
May 14, 2002, the Board of Directors of the Company approved a ten to one
reverse split of the Companys ordinary shares, such that each ten ordinary
shares of NIS 0.01 par value became one ordinary share of NIS 0.1 par value.
The above reverse share split was approved by the shareholders on June 14,
2002. The reverse share split was effective as of June 17, 2002. All shares,
per share, warrants and options amounts in the financial statements have been
adjusted to give retroactive effect to this reverse share split for all periods
presented.

|                                                                                                              |  | Year ended December 31
|------------------------------------------------------------------------------------------------------------- |  | ----------------------
|                                                                                                              |  |                       
|                                                                                                              |  | 1998                  
|                                                                                                              |  |                       
|                                                                                                              |  |                       
|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                                                                                              |  |                       
|                                                                                                              |  |                       
|Total
  operating expenses                                                                                    |  |                       
|                                                                                                              |  |                       
|                                                                                                              |  |                       
|Operating
  loss                                                                                              |  |                       
|Amortization of beneficial
  conversion feature on
  convertible loan                                         |  |                       
|Financial income, net                                                                                         |  |                       
|Other expenses, net                                                                                           |  |                       
|Loss
  before income taxes                                                                                    |  |                       
|Tax benefit (taxes on
  income)                                                                               |  |                       
|                                                                                                              |  |                       
|                                                                                                              |  |                       
|Minority interest in losses
  (earnings)
       Of subsidiaries                                               |  |                       
|Equity in losses of an
  affiliated company                                                                   |  |                       
|                                                                                                              |  |                       
|Net loss                                                                                                      |  |                       
|                                                                                                              |  |                       
|                                                                                                              |  |                       
|Basic and diluted net loss
  per share                                                                        |  |                       
|                                                                                                              |  |                       
|                                                                                                              |  |                       
|Weighted average number of shares
       used in computing net loss per
           shares - basic and diluted |  |                       
|                                                                                                              |  |                       

4

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|                                            |  | As of December 31 |      
|------------------------------------------- |  | ----------------- | -----
|                                            |  |                   |      
|                                            |  | 1998              |      
|                                            |  |                   |      
|Balance Sheet Data:                         |  |                   |      
|Cash
  and cash equivalents                 |  | $                 | 2,035
|Total
  currentassets                       |  |                   | 6,108
|Total
  assets                              |  |                   | 7,976
|Total
  liabilities                         |  |                   | 5,974
|Long
  term loans, net of currentmaturities |  |                   | 1,938
|Total
  shareholders equity                |  |                   | 2,002

RISK FACTORS

This
Form 20-F contains forward-looking statements that involve risks and
uncertainties. The statements contained in this Form 20-F 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 the
Companys 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 the Companys belief
as to increased acceptance of smart-card technology, expansion of the use of
our technology, the impact of the Companys relationship with technology
partners and business partners as well as to the Companys 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 the
Companys 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 Form 20-F.  All
forward-looking statements included in this document are based on information
available to the Company on the date hereof, and the Company assumes no
obligation to update any such forward-looking statements.

Risks
Related to Our Business

We have a history of
losses and may not achieve profitability in the foreseeable future.

We
have incurred losses in each year since we commenced operations in 1990. We
reported net losses of $2.9 million in 1998, $3.1 million in 1999, $8.3 million
in 2000, $11.7 million in 2001 and $6.2 million in 2002. Our losses resulted
primarily from expenses we incurred in marketing and selling, as well as in
research and development and general and administrative expenses, which have
offset any increases in revenues, if any, over these periods. We expect to
continue to incur operating losses in future periods 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. Although we anticipate
becoming profitable in our operations in the second half of 2003, there can be
no assurance that we will accomplish that goal.

If the market for
smart cards in general, and for contactless microprocessor-based smart cards in
particular, does not grow as we expect, we may not succeed in selling our products.

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 than
ours and may therefore be less willing to incur the capital expenditure
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 expected.

5

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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 sold products incorporating our technology within a limited number of
markets. In 1999, our gasoline management system, or GMS, accounted for 40% of
our product sales and sales of other products for use in the petroleum industry
accounted for 13%. 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. From the beginning
of 1999 through 2002, we spent $18.3 million on research and development and
$19.5 million on sales and marketing. If we fail to develop new products or
adapt our existing products for new markets, 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. Although the percentage of our
revenues attributable to such sales is declining, we are to a certain extent
dependent on the ability of these integrators to maintain their existing
business and secure new business.

In
2000, 46%, in 2001, 18% and in 2002, 22% of our revenues were derived from
sales to systems integrators, some of which are distributors of our products,
who incorporate our products into systems which they supply and install for use
in a specific project. To the extent our revenues depend on systems
integrators ability 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 such systems
integrators efforts 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.
For example, we terminated our agreement with our systems integrator in South
Africa because we believed it had materially breached its agreement with us. As
a result, we were subject to a costly arbitration proceeding which resulted in
expenses of $630,000 incurred in 2000. Even in the case of successful
arbitration such as this in which we were awarded $400,000, we may not be able
to collect in full or at all such award. In addition, 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.

Our inability to
maintain our current, and establish new, strategic relationships could impair
our revenue growth.

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, and
thereby impair our revenue growth.

Some of our
agreements restrict our ability to conduct business. Although the types of
restrictions are customary in a commercial setting, the result may be that in
the future we may not be able to take actions that we may believe are
desirable.

Under
some of our agreements with suppliers, distributors and joint venture partners,
we have agreed to restrict ourselves in some areas of business. For example, we
have granted our joint venture with Cheung Kong, e-Smart, exclusive rights to
distribute our products in Greater China and we granted our joint venture
partner veto rights over key business decisions relating to the distribution of
our products in that region. In addition, in the event that our products are
sold in Greater China by third parties other than through e-Smart, we have
agreed to pay to e-Smart 7.5% of the net revenues we receive from such sales.
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, if sales quota are met, have exclusive distribution rights in
that market.

6

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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 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, such as 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. 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.

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 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. For example, there has been a shortage in the
availability of microprocessors since the middle of 1999. Increased demand for,
or limited availability of, microprocessors could substantially increase the
cost of producing our products. Because some of our 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 the shortages, we
may be forced 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.

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 which we enter into 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 based on
our results in any quarter.

| |  | 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, 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.

7

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Although the extent of our dependence on a
small number of suppliers is decreasing, delays or discontinuance of the supply
of components may still 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, which
is currently the sole supplier of the chip that integrates our antenna
interface into Samsungs microprocessor, none of these suppliers are sole suppliers.
Nevertheless, and although we continue to seek additional sources of supply, we
sometimes experience short-term adverse effects due to delayed shipments which
have in the past, and could in the future, interrupt and delay the supply of
our products to our customers, or which 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 any alternative source of supply, we may need to modify our products
to be compatible with other components, which 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.

We currently rely on
a third party for licensing and updating the primary operating system we use in
our products.

We
are currently required to license operating system software for the operation
of our products. Since 1995, the principal licensor of this software has been
Personal Cipher Card Corporation, or PC3, pursuant to a license agreement that
terminates on July 5, 2005. If PC3 terminates the license it granted us, we may
face some delays in providing our products to our customers and we expect that
it may take several months to provide an adequate alternative. Even in the case
of any such delay, we would anticipate no material disruption to our business.

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 is
intense in the electronics industry, particularly in Israel, and therefore
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. While substantially all of our
employees are subject to non-compete agreements, these agreements may be
difficult to enforce as the result of new Israeli case law which limits the
scope of employee non-competition undertakings and may make them unenforceable
in Israeli courts. 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, affiliates, distributors and others.

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 and 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.

8

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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 will then be able to
manufacture and sell products which compete directly with ours. In that case,
our business and operating results would be harmed.

In
order to protect our technology and products and enforce our patents and other
proprietary rights, we may need to initiate litigation against third parties or
defend opposition proceedings before the European Patent Office or prosecute
interference proceedings before the U.S. Patent and Trademark Office. These
legal and administrative proceedings could be expensive and occupy significant
management time and resources. Our European patent covering contactless
transmission of power and data between a microprocessor and a reader was revoked
as the result of a third party opposing our patent. Currently, this patent is
the subject of an appeal proceeding before the European Patent Office. If our
appeal is not successful, we will lose our European patent and therefore the
right to prevent others in Europe from using the technology covered by the
patent.Furthermore,
a successful opposition to our patent could provide a basis for our competitors
to claim that our patents in other jurisdictions covering this technology are
invalid. See BusinessProprietary Technologies.

Our products may
infringe the intellectual property rights of others.

It
is not possible to know with certainty that the manufacture and sale of our
products do not or will not infringe patents or other intellectual property
rights owned by third parties. There may, for example, be patent applications
pending at the moment, which when granted, may cover products that we have just
developed or are developing. In certain other jurisdictions there is no
publication of the subject matter of patents until the patents are issued.
Third parties may from time to time claim that our current or future 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 and, 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 such litigation. Even if we prevail, the cost of such litigation
could harm our results of operations. In addition, such 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.

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 three and
a half years we have acquired three 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.

| |  | Difficulties in integrating our operations,
  technologies, products and services with those of the acquired companies. For
  example, we cannot be sure if the InterCard groups current customer base
  will upgrade their systems to incorporate our products.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Difficulty in integrating operations spread
  across significant geographic distances as our three acquisitions were made
  in two continents.                                                                                                                   
| |  | 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.                                                                                                                                                                                  
| |  | Dilution of your shareholding in the event
  we acquire companies in exchange for our shares.                                                                                                                                                                    

9

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All
three of our recent acquisitions were made through the issuance of our ordinary
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, we may not be able to grow
our business 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 |    | FarEast |  | North 
  America |   | South 
  America |    | Israel
|---- |  |  | ------ | - | ------ | -- | ------- |  | ---------------- | - | ---------------- | -- | ------
|     |  |  |        |   |        |    |         |  |                  |   |                  |    |       
|     |  |  |        |   |        |    |         |  |                  |   |                  |    |       
|1998 |  |  | 25     | % |        | 21 | %       |  | 45               | % |                  | 4  | %     
|1999 |  |  | 16     |   |        | 16 |         |  | 33               |   |                  | 30 |       
|2000 |  |  | 8      |   |        | 56 |         |  | 13               |   |                  | 19 |       
|2001 |  |  | 6      |   |        | 71 |         |  | 10               |   |                  | 9  |       
|2002 |  |  | 13     |   |        | 67 |         |  | 3                |   |                  | 11 |       

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 certain 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, principally in Euros and Shekels, currency fluctuations
could adversely affect our results of operations.

The functional and reporting
currency of the company is the U.S. dollar. We generate a significant portion
of our revenues in dollars and incur a large portion of our expenses in other
currencies, principally some of our employees salaries in Shekels and the
majority of the expenses of the InterCard group in Euros. To the extent that OTI and our
subsidiaries based in Israel and Germany conduct their business in different
currencies, their revenues and expenses, and as a result, their assets and
liabilities, are not necessarily in the same currency and therefore they are
exposed to foreign exchange rate fluctuations. These fluctuations may
negatively affect their results of operations. 
Our operations also could be adversely affected if we are unable
to limit our exposure against currency fluctuations in the future. Accordingly,
we may enter into currency hedging transactions to decrease the risk of
financial exposure from fluctuations in the exchange rate of the dollar against
the Shekel.However, these measures may not adequately
protect us from material adverse effects due to the impact of currency
fluctuations. In addition, if we wish to maintain the dollar-denominated value
of our products in non-U.S. markets, such as Europe, devaluation in the local
currencies of our customers relative to the dollar could cause our customers to
cancel or decrease orders or default on payment.

10

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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 mandatory 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 in Europe of compliance with regulations of
European Telecommunications Standards Institute 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 to 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 certification that our products can be integrated successfully into
their systems or comply with applicable regulations. Receipt of these
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
become so certified could render us unable to deploy our products in a timely
manner or at all.

Our products may
contain defects that we find only after deployment, which 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 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 the kiosks to financial and parking databases, collecting
data through handheld terminals, processing of data that is collected by the
system, compilation of reports and clearing the 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,
such as 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, which would
harm our business. 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.

Current terrorist
attacks may have a material adverse effect on our operating results.

Terrorist
attacks, such as the attacks that occurred in New York and Washington, D.C. on
September 11, 2001, and other acts of violence or war may affect the markets on
which our ordinary shares trade, the markets in which we operate, our
operations and profitability and your investment. There can be no assurance
that there will not be further terrorist attacks against the United States or
Israel, or against American or Israeli businesses. 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. Also, as a result of terrorism, the United States and other countries
may enter into an armed conflict that could have a further impact on our sales,
profitability, supply chain, production capability and ability to deliver
product and services to customers.

11

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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. In addition, 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. During 2002, violence has intensified between
Palestinians and Israelis and Israel has undertaken military actions in the
West Bank and the Gaza Strip. The future effect of the substantial
deterioration and the ongoing violence between Israel and the Palestinians is
unknown. 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. 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.

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, which would 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 $3.5 million 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 would be
taxed at a rate of 36%. To maintain our eligibility for these tax benefits, we
must continue to meet conditions, including making specified investments in
fixed assets, 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 have a material
adverse effect on our business.

It may be difficult to enforce a United
States judgment against us, our officers and directors and some of the experts
named in this Form 20-F and other documents incorporated hereinor 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 Form 20-F and other documents
incorporated herein
reside 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 person 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. See Enforcement of Civil Liabilities.

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. See Description of Ordinary
SharesAnti-Takeover Provisions under Israeli Law.

12

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTSAND INDUSTRY DATA

This
20-F 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 20-F.

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 20-F unless we are required
to do so under U.S. federal securities laws or other applicable laws.

ITEM 4.          INFORMATION
ON THE COMPANY

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, through the
InterCard group, products that are based on other card technologies.

Substantially
all of our contactless microprocessor-based products are based on a common
platform which we currently refer to as OTI Platform. (We have previously
referred to it as the EYECON platform). OTI Platform is based on our patents
and technologies and consists of our smart cards, readers, software that
enables the development of applications for smart cards and a communication technology
that ensures that the transmission of data to and from the card is secure and
reliable. OTI Platform can be customized to support a large number of
applications in a multitude of markets. Some of the markets for which we have
customized OTI Platform include petroleum, parking, mass transit, border
crossing and medical services.Our products offer the following benefits:     The information stored on our 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 such as key chains, tags, tickers 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; and     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
strategic relationships. Additionally, 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 Cupertino, California, and carried out through our subsidiaries
in North America, Africa and Europe and our joint venture in Asia.

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 Ltd. 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.

12

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Our address is Z.H.R
Industrial Zone, Rosh-Pina 12000, Israel.   The telephone number is 972-4-6868-000. Copies of this Form 20-F
and other documents incorporated herein by reference can be obtained on the
Companys website, www.otiglobal.com or upon request from the Companys
Director of Corporate Communication, Ms. Galit Mendelson 212-531-3247.

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.

What is a smart card
system?

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.The 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.

13

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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. In 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.

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 contactbased 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
  the contact-based system and one for the contactless-based systems. The use
  of two chips increases the cost of the card, as well as the likelihood of
  discrepancies between the information stored on each chip by different
  applications and 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
  based on a device that would switch between contact and the contactless
  operations. We are unaware of any successful commercial implementation of
  this technology other than by 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.

15

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Conclusion

Given
the benefits of contactless smart cards and microprocessor-based smart cards,
we believe that there is strong demand within the smart card industry for cards
that combine the benefits of both technologies. A number of companies such as
Infineon and ST Microelectronics have already indicated their intention to
offer contactless microprocessor-based smart cards. However, we believe that we
are one of the first companies to deploy contactless microprocessor-based smart
card products for commercial use.

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

| |  | 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, 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 include:

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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. For example, currently the microprocessors in our products
are designed and supplied by STM, Atmel and Samsung, and the smart card
operating systems by Personal Cipher Card Corporation and ZhongChao TongFang
Smart Card Ltd. In the future, we intend to achieve an in-house capability to
design microprocessors and operating systems for smart cards.

Expand
global market presence.Our sales and marketing effort is directed from Cupertino,
California. We market our product through a global network of marketing
subsidiaries in North America, Europe and Africa, and in Asia through our joint
venture, e-Smart. 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.

Generate
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 services 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, our
gasoline management systems in South Africa.Leverage
existing 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 (f/k/a 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 British Petroleum 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 CitySmart, a systems integrator in Hong Kong, the
SoftChip Group, an Israeli based developer and designer of microprocessors and
operating systems for smart cards, and the InterCard group, a German systems
integrator for card systems and manufacturer of electronic devices.

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:

| |  | 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                              

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Antenna interface

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.

Antenna moduleContactless
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.

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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
the acquisition of the SoftChip Group we have acquired 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

TheOTI Platform

Substantially
all of our products are based on a common platform, which we refer to as the
OTI Platform, formerly known as the EYECON 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:

Contactless Microprocessor-based Smart Card based on the OTI Platform

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.

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.

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Our products

Our
products consist of:

| |  | 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.                          
| |  | OEM: We sell components including smart
  cards and readers, with development tools for integration into other
  products.                                                                                                                                                                                                                                                            

Customized products

Trucking.We
have designed a product for use in truck stops. The product enables truck
drivers to use contactless smart cards for local and long distance telephone
services, electronic identification, fuel management, truck scale services,
gaming machine payment, web access and e-purse, including loyalty programs. In
2001, we installed in two additional truck stop chains.Sales
of our trucking product, including associated nonrecurring engineering,
accounted for 1% of our revenues in 2000, 16% in 1999 and insignificant amounts
in 1998 and 1997. In the first half of 2000, our product was installed as part
of a pilot program at one truck stop in a truck stop chain. We have begun to
install it in additional truck stops in the same chain.

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. We have not derived significant revenues from sales of
our mass transit product. e-Smart 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. We started the installation of
the system from which we derived revenues which accounted for 9% of our
revenues in 2001 and less than 2% in 2002.

Medical
services.We
currently are testing a product that will be designed to secure, process and
manage medical information. The product will provide doctors and hospital
administrators with information regarding the patients identity, medical
history, insurance coverage and payment history. This information could be
automatically updated after each treatment. Treatment information could be
automatically transferred to the insurance providers computer system. This
product would reduce costs to medical providers, provide increased security for
a patients medical history and improve the quality and speed of service to
patients. We have not derived revenues from sales of our medical services
product. We began a pilot program for the product in South Africa during the
second quarter of 2001.

National
documentation.We
have developed a product that supports various types of user authentification
through advanced authentication methods developed by other companies such as
biometrics, which 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 and 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. The system is
currently being developed.

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Complete systems

Gasoline
management system.Our gasoline management system, or 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.

The
following diagram illustrates a typical GMS system:

GMS system

We
commenced sales of GMS in 1995. Sales of GMS accounted for 14% of our revenues
in 2002, 6% of our revenues in 2001 and 12% in 2000. 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, 2001, a total of approximately
700 gas stations have been equipped with GMS, including in South Africa, Turkey
and Ecuador, and we have delivered GMS equipment for approximately 70,000
vehicles.

Campus
systems.We
designed our campus system for use in self-contained or campus environments,
such as closed communities, kibbutzim, which are self-contained communities
found only in Israel, senior citizen homes, universities, schools and corporate
facilities. Each campus user is provided with a contactless smart card which
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
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 and in January, 2001, we established a relationship with Xerox to
exploit our campus system operation in the United States. Sales of our campus
system accounted for 6% of our revenues in 2002, 6% of our revenues in 2001, 9%
in 2000, 36% in 1999, 40% in 1998 and 37% in 1997.

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.

Other productsThrough
InterCard GmbH Kartensysteme, we offer products that are based on other card
technologies. These products include the following:

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InterCard
campus system.The
InterCard group currently sells and manages campus systems that are operated by
cards based on a wide array of technologies, including magnetic strips,
ASICbased systems and contact microprocessor-based systems, provided by a
number of companies, such as GemPlus and Cards & More GmbH. The InterCard
groups campus system is used in over 80 universities in Germany under the name
UniCard. The primary difference between the InterCard groups campus system and
the campus system that we offer is that the InterCard groups campus system
includes management and clearing software for closed campus environments and is
based solely on contact cards. Within the next 12 months we intend to offer
campus systems integrating our contactless smart card technology with the
InterCard groups management and clearing software. Additionally, we intend to
offer the InterCard groups customers the option to gradually replace or
upgrade their readers and cards to our contactless microprocessor-based
systems. Revenues from the InterCard groups campus systems have accounted for
$3.8 million of the InterCard groups revenues in 2002.

CopyTex.CopyTex
is a type of products that operate copying machines. CopyTex products use a
variety of technologies including paper or plastic magnetic strips and
microprocessor-based smart cards. There are approximately 10,000 customers for
CopyTex which is installed in universities, schools, corporations and
libraries. Revenues from CopyTex have accounted for $3.6 million of the
InterCard groups revenues in 2002.

Transportation.In
addition, InterCard GmbH Systemelectronic manufactures and sells electronic
devices for InterCard GmbH Kartensysteme and for non-smart card applications in
the transportation industry. Revenues from sales by InterCard GmbH
Systemelectronic, excluding sales to InterCard GmbH Kartensysteme, accounted
for $3.8 million or 41% of the InterCard groups revenues in 1999, $3.9 million
or 52% in 2000, $4.7 million or 35% in 2001 and $5.4 million or 42% in 2002.

Technology licensingIn
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 supportWe 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 12 employees
consisting of three employees located in our corporate headquarters in Rosh
Pina, Israel, two in the United States, three in Africa and four in Europe. Our
customer service team in Rosh Pina, Israel provides central services to our
network of local subsidiaries which 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. For 1998, 1999, 2000, 2001 and for
2002 revenues derived from customer service and technical support constituted
up to 5% of our total revenue for each year.

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Subsidiaries and Affiliates

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

Corporate Structure

---

(2) We hold the remaining 10% of the shares
of Easy Park Israel Ltd.

(3) We acquired a 51% interest in InterCard
GmbH Systemelectronic and InterCard GmbH Kartensysteme, or the InterCard group
in June 2000. We acquired the remaining 49% in January 2001. 9% of our shares
in the InterCard group are pledged to the former owner as security for the
payment of a loan granted to us by the former owner. These shares will be
gradually released as the loan is paid. The pledge will terminate upon complete
payment of the loan.

(4) Cheung Kong Infrastructure holds its
interest in e-Smart System Inc. through its subsidiary Ocean Wonder Ltd.

Easy Park Ltd.Our
subsidiary, Easy Park Ltd., developed our EasyPark system. Easy Park is
incorporated under the laws of the State of Israel and uses office space in our
headquarters in Rosh Pina, Israel. 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. Currently, we appoint all of the
members of the board of directors.

Our
Easy Park system was selected for a national parking system for Israel. The
deployment and operation of the Israeli project is managed by a subsidiary of
Easy Park called Easy Park Israel Ltd. Easy Park holds 100% of the issued share
capital of Easy Park Israel.

OTI America, Inc.OTI
America, Inc. is headquartered in Cupertino and incorporated in US, California 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.

e-Smart System Inc.e-Smart
System Inc. is a 50% owned joint venture with Cheung Kong Infrastructure
Holdings Ltd., a Hong Kong-based infrastructure company, and subsidiary of
Cheung Kong (Holdings) Ltd. through its subsidiary Ocean Wonder Limited. 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 venture is using the established distribution network of Cheung Kong
(Holdings) and will also undertake marketing activities in Greater China. The
venture is building a research and development center in Hong Kong that will
conduct ongoing product and technological research to customize our products to
different local needs within Greater China.

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In
January 2001, e-Smart exercised an option that we had granted to it to acquire
the assets of City Smart, our wholly-owned systems integrator located in Hong
Kong.

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 SoftChip GroupThe
SoftChip Group is a designer of microprocessors and operating systems for smart
cards, incorporated in Israel.

The InterCard groupWe
acquired 51% of the InterCard group in June 2000 and the remaining 49% in
January 2001.The InterCard group consists of two main companies:

InterCard
GmbH Kartensystemeis incorporated under the German laws. InterCard GmbH
Kartensysteme is a systems integrator primarily
supplying smart card systems for over 80 university campuses in Germany.
InterCard GmbH Kartensysteme also sells copy machine payment systems to
universities, libraries and corporations. We plan to offer to the InterCard
groups customers the option to upgrade their existing payment systems to
contactless smart card systems using our technologies. In addition, we intend
to market, distribute and support our products through the InterCard groups
marketing, distribution and support network in Europe to their existing
customer base in order to accelerate our penetration into the European market.

InterCard
GmbH Systemelectronicis incorporated under the German laws. InterCard GmbH
Systemelectronic has a
manufacturing facility which currently manufactures electronic devices for
InterCard GmbH Kartensysteme and the transportation industry. We manufactured
some of our readers in this facility commencing in 2001, and we expect to
continue manufacturing products for the transportation industry.

For
more details on these acquisitions see Certain Transactions.

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

| |  | 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 81% of our revenues in 1999,
  46% in 2000, 18% in 2001 and 22% in 2002 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 19% of our revenues in 1999, 54% in 2000,
  82% in 2001 and 78% in 2002 from sales to service providers.                                                                                                      

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Salesand marketing

We
have built a global network of subsidiaries through which we sell and market
our products.

As
of 2002, 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 five employees, in Africa we sell and market through OTI Africa, which
also employs five employees, in Europe we sell and market through the InterCard
group and our Frankfurt office, which together employ six employees, and to
Israel through our headquarters in Rosh Pina, which employs four employees. 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.

We
also sell our products through independent systems integrators, some of which
also act as distributors for our products. We have granted some of our systems
integrators exclusive distribution rights within a particular country or
region. In such cases, we generally guarantee exclusivity only if certain sales
targets are met. In addition, we have appointed our joint venture, e-Smart, as
exclusive distributor of our products in Greater China, not subject to any
minimum sales targets. e-Smart will remain our exclusive distributor in the
Greater China for so long as we and our joint venture partner, Cheung Kong
Infrastructure Holdings, hold any shares of e-Smart, unless we and Cheung Kong
Infrastructure Holdings agree to terminate the appointment. We have also
undertaken not to compete with the activities of e-Smart in Greater China for
so long as we are a shareholder of e-Smart and for a period of one year after
the termination of our distribution agreement if the termination occurs due to
our default. e-Smart has undertaken not to compete with our activities in
Greater China for one year following the termination of our distribution
agreement for any reason.

Cheung
Kong Infrastructure Holdings has agreed to use reasonable efforts to cause its
affiliated companies not to compete with e-Smart. For further details, see
Certain TransactionsEstablishment of Joint Venture with Cheung Kong
Infrastructure.

We
have entered into relationships which we believe will enable us to penetrate
new markets, develop new products and enhance the visibility of our brand name.
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 we then cooperate in
marketing the resulting product. We have established relationships with Xerox,
Beyond Petroleum (f/k/a British Petroleum). Our relationship with Xerox is
intended to exploit U.S. public library and higher education markets and our
relationship with Beyond Petroleum is focussed on the South African petroleum
market.

Manufacturing

External
manufacturers and suppliers

We
currently purchase substantially all of the hardware components and software
for our products from third-party suppliers and outsource substantially all of
the manufacturing and assembling of our products to manufacturing
subcontractors. We have not entered into long-term supply contracts and
purchase these hardware components on a purchase order basis. This allows us to
focus our resources on the design, development and marketing of our products.
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.

| |  | Microprocessors.The current suppliers of
  microprocessors for our smart cards are STM, Atmel, and Samsung. In addition,
  we have jointly developed together with Samsung a monochip that integrates
  our antenna interface with Samsungs microprocessor. Samsung began 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.                                                                                                                                            
| |  | Packaging.We package the components for our
  smart cards in a variety of forms, such as 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 currently use two different
  operating systems in our OTI Platform:                                                                                                                                                                                                                                                                                                                       
| |  | PC3 smart card operating system.We have licensed the PC3 smart
  card operating system from Personal Cipher Card
  Corporation under a royalty-bearing non-exclusive license since July 1995
  which terminates in July 2005.                                                                                                                                                                                   

| | Sales of products containing the PC3 smart
  card operating system accounted for 73% of our revenues from smart cards in
  1999, substantially all of our revenues from smart cards in 2000, it
  accounted for 53% of our revenues from smart cards in 2001, and for 46% of
  our revenues from smart cards in 2002.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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Quality control.We maintain strict
internal and external quality control processes. We require that the facilities
of our suppliers and manufacturing subcontractors are ISO 9002 certified. ISO
9002 refers to a quality assurance model established by ISO for companies that
design, produce, install, inspect and test products.

Internal manufacturing capabilitiesWe
currently package, test and encode our readers at our production facility in
Rosh Pina, Israel. Our packaging and testing facilities are ISO 9002 certified.
We consummated recently the building of a manufacturing facility in Rosh Pina,
which will permit us to incorporate modules into credit card-sized contactless
smart cards. This expansion will enable us to respond more rapidly to customer
demand for smart cards in the initial phase of a project.

InterCard
Systemelectronic, our subsidiary, owns a manufacturing facility in Germany for
electronic devices primarily for the transportation industry and card terminals
for the systems provided by InterCard Kartensysteme, its sister company. Our
acquisition enhances our in-house manufacturing capabilities to manufacture our
terminals and card readers. We started manufacturing small quantities of our
readers at the facilities of InterCard Systemelectronic in 2001. We expect that
InterCard Systemelectronic will also continue to manufacture products for the
transportation industry.

We
have granted our joint venture, e-Smart, an option exercisable after January 1,
2001, to manufacture smart cards using our technology for sale in Greater
China. In such event, we will retain exclusive rights to our technology and any
smart cards manufactured by e-Smart must 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 regulationsSome
of our products are subject to mandatory 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 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 compliant with these regulations.

26

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| |  | 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.

As
December 31, 2002, we employed 51 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 certified. ISO 9001 refers to a quality assurance model
established by ISO for research and development facilities.

Proprietary technologiesOur
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.                                                   |  | 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.                
|Dual interface technology for contact/
  contactless operation using a single
  microprocessor on the same card.                    |  | Patent granted in the United States, Israel
  and Australia.
  These patents expire in 2017. European, Canadian and
  Hong Kong patent applications pending. PCT application in
  the national phase.
|System that uses contactless smart
  card for parking systems.                                                                      |  | Patents granted to Easy Park in Israel, the
  United States,
  Europe, Hong Kong and South Africa. These patents expire
  in 2012.                                                                   
|Dual interface technology for contact/
  contactless operating in a single card
  conforming to ISO 14443 Type A and
  B standards. |  | Patent granted in the United States, Europe
  and Hong
  Kong. PCT in national phase. Application pending in Israel,
  Canada and Australia.                                                         
|Long range transmission of data.                                                                                                    |  | Patent granted in the United States,
  Europe, Hong Kong
  and in Israel. PCT in national phase. Applications pending
  in Canada and Australia.                                                     
|Vehicle tag incorporated into a capless
  fuel inlet cap.                                                                           |  | Patent granted in Europe, United States and
  Australia.
  Accepted in Israel and Hong Kong. Application pending in
  Canada. PCT in the national phase.                                             

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. We are currently appealing the decision of the
European Patent Office revoking our patent relating to contactless transmission
of power and data. Our reader products, but not those of the InterCard group,
are based on the technology covered by this patent. We cannot assure you that
this proceeding will be successful. If our appeal is not successful, we could
lose the right to prevent others in Europe from using the technology covered by
the patent. Our right to manufacture and sell our products in Europe is not
dependent on the outcome of this opposition proceeding. This proceeding does
not have a direct effect on our patents granted in the United States and
elsewhere although a successful opposition to this patent could provide a basis
for our competitors to claim that our patents in other jurisdictions covering
this technology are invalid.

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, the Company and Eicon reached an agreement on January 2,
2002 regarding the future use of the EYECON trademark described in the
Companys US Trademark Application Serial No. 75/313,746 and Israeli Trademark
Application No. 110844. According to the agreement, the Company will: (i)
withdraw its US trademark application and all other applications associated
with the EYECON trademark worldwide and notify all trademark offices of its intention
to withdraw such applications within 30 days of the effective date of the
agreement; (ii) cancel any existing registrations of the EYECON trademark by
providing notice of such cancellation to the relevant trademark offices
worldwide, no later than December 18, 2003 for the US and Canada and no later
than December 18, 2004 for all other countries worldwide, except several
countries including Israel, where the applicable date will be December 18,
2005; and (iii) immediately begin phasing out its 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.

CompetitionContactless
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.

Real propertyWe
lease an aggregate of 10,639 square meters of land in Rosh Pina, Israel from
the Israel Lands Authority. Out 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.The
Companys 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.OTI
America, Inc. leases an aggregate of 1,964 square feet of office space in
Cupertino, California pursuant to a lease that expires on January 31, 2005.
e-Smart leases an aggregate of 427 square meters of office space in Hong Kong
pursuant to a lease that expires on July 9, 2003. 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, 2004, with an option to extend
the lease for an additional three years.Softchip
utilizes an aggregate of 204 square meters in Jerusalem pursuant to a lease
which expired on December 31, 1998. The lease agreement was not extended, but
the parties continue to act according to the provisions of it.

InterCard
GmbH Kartensysteme owns an aggregate of 5,201 square meters of land in Bad D ̈
urrheim, 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 leased by InterCard GmbH Kartensysteme to InterCard GmbH Systemelectronic. This
land is used by InterCard GmbH Systemelectronic for its manufacturing facility.
InterCard GmbH Kartensysteme leases an additional 1,626 square meters of space
which is used for administration, storage and development purposes.
The lease agreement was automatically
extended until December 31, 2003.

28

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ITEM
5.          OPERATING AND
FINANCIAL REVIEW AND PROSPECTS

The
following discussion and analysis is based on and should be read in conjunction
with the Companys 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 Cupertino, California, with
additional sales and support offices in Europe, South Africa and Asia, and our
packaging, assembly and manufacturing facilities are in Israel and Germany.

Since
our incorporation in 1990, we have focused on the development of our core
technologies and our products based on our OTI Platform. In 1993, we began
selling our campus system to kibbutzim, which are self-contained communities
found only in Israel. Over time, our customer base for campus systems increased
from two kibbutzim in 1993 to over 40 kibbutzim in 2000. In 1995, we began
selling our gasoline management system, which we refer to as GMS, which has
since been installed in over 700 gas stations in South Africa, Ecuador and
Turkey. In 1998, we were awarded a contract for an electronic parking payment
system, which we refer to as EasyPark, in Israel. We began to deploy EasyPark
in 2000 and completed deployment of the system in June 2001.

Acquisitions
have been a key component of our growth strategy. On December 30, 1999, we
acquired City Smart Ltd., a Hong Kong systems integrator. On January 28, 2000,
we acquired the SoftChip Group, an Israeli designer of microprocessors and
operating systems for smart cards. In June 2000, we acquired a 51% interest in
InterCard GmbH Kartensysteme and InterCard GmbH Systemelectronic, which we
refer to as the InterCard group, a German systems integrator for card systems
and manufacturer of electronic devices. In January 2001, we acquired the
remaining 49% of the InterCard group. In February 2000, we formed a joint
venture, e-Smart, with a subsidiary of Cheung Kong Infrastructure, for the sale
of our products and systems in the Asia Pacific region. During the first
quarter of 2001, the operations of City Smart were transferred to e-Smart. Our
results of operations for the year ended December 31, 2000 include the
operating results of SoftChip from January 1, 2000 and the InterCard group from
June 1, 2000, both of which were accounted for under the purchase method. For
this reason, it may be difficult to compare our recent operating results with
our operating results from previous years. For example, for the year ended
December 31, 2000, revenues from the InterCard group accounted for 51% of our
total revenues.

In December 2002, the Company issued 10%
Redeemable Convertible Promissory Notes (the notes) in the amount of
$250,000. The notes may be converted into ordinary shares of the Company.  The conversion price shall be the average
closing price of the Companys shares on NASDAQ during the ten (10) consecutive
trading days prior to the conversion which in no event will be less than 75% or
greater than 125% of the closing price on the day of closing ($6.00).  The entire principal balance is due on
December 31, 2004.  The notes are
exercisable 90 days from the date of closing.

As of the date of this 20-F, 2002, none of
the notes has been converted into ordinary shares.

In connection with the issuance of these
notes, the Company also issued detachable warrants to purchase an aggregate of
16,758 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 on December 5,
2002, the Company was required to record a discount in the amount of
approximately $42 representing the fair value of above mentioned warrants,
which is being amortized to financial expenses over a period of two years.

29

---

---

Our
consolidated financial statements included elsewhere in this prospectus are
prepared in U.S. dollars and in accordance with accounting principles generally
accepted in the
United States.

RevenuesWe
have experienced rapid revenue growth during the last years, but we have
experienced a decrease in revenues in 2002. Our revenues grew from $2.1 million
in the year ended December 31, 1997 to $19.9 million in the year ended December
31, 2001. For the year ended December 31, 2002 our revenues decreased 10% to
$18.0 million from $19.9 million for the year ended December 31, 2001.

We
derive revenues from product sales, nonrecurring engineering, customer services
and technical support, and licensing and transaction fees.

Products.To
date, our product sales have consisted primarily of sales of GMS and our campus
system. In 1999, we started to derive revenues from sales of customized
products, including smart cards, readers and related equipment, for use in the
retail petroleum and trucking industries. Additionally, since June 2000, we
have derived revenues of $16.2 million from sales by our subsidiary, InterCard
GmbH Kartensysteme, of card products based on other technologies and $15.0
million from sales by our subsidiary, InterCard GmbH Systemelectronics, of
products for use in the transportation industry.

Nonrecurring
engineering.Nonrecurring
engineering revenues consist of payments for the adaptation of our products to
the requirements of a specific customer. We receive payments for nonrecurring
engineering regardless of whether our customers ultimately purchase the
customized product. Revenues from nonrecurring engineering have varied widely
from period to period. For example, in 1999 nonrecurring engineering accounted
for 9% of our revenues, but accounted for only 1% of our revenues for the year
ended December 31, 2000, 3% of our revenues for the year ended December 31,
2001 and 5% of our revenues for the year ended December 31, 2002. Revenues from
nonrecurring engineering fluctuate 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.Customer services and technical
support consist of fees paid by purchasers of our products for ongoing customer
services and technical support.Customer services and technical support accounted for 3% of our
revenues for the year ended December 31, 2000, 3% of our revenues for the year
ended December 31, 2001, and 5% of our revenues for the year ended December 31,
2002.

Licensing
and transaction fees.Licensing fees include one-time and periodic payments for
manufacturing or distribution rights for our products. These rights have been
granted to select customers and the terms and fees are negotiated on a case by
case basis. As a result, licensing fees fluctuate. Transaction fees are paid by
customers based on the volume of transactions effected in systems that contain
our products.Licensing
and transaction fees
accounted for 1% of our revenues for the year ended December 31, 2000, 2% of
our revenues for the year ended December 31, 2001, and 4% of our revenues for
the year ended December 31, 2002

We
currently derive our revenues primarily from sales of our products. Revenues
from product sales accounted for 92% of our total revenues for the year ended
December 31, 2001 and 86% for the year ended December 31, 2002.

Revenues
from our customers have fluctuated substantially from period to period in part
because sales of our products sometimes involve a one-time payment for nonrecurring
engineering followed by an initial bulk sale of tangible products, with lower
revenues generated from repeat sales of components and services in following
years.

Geographical
breakdown.We
sell our products primarily in Europe. For the year ended December 31, 2002 we
derived 67% of our revenues from sales in Europe, 3% of our revenues from sales
in the Far East, 13% of our revenues from sales in Africa, 5% of our revenues
from sales in Israel, 11% of our revenues from sales in North America and 1% of
our revenues from sales in South America. For the year ended December 31, 2001,
we derived 71% of our revenues from sales in Europe, 10% of our revenues from
sales in the Far East, 9% of our revenues from sales in North America, 6% of
our revenues from sales in Africa, 3% of our revenues from sales in Israel and
1% of our revenues from sales in South America. For the year ended December 31,
2000, we derived 56% of our revenues from sales in Europe, 13% of our revenues
from sales in the Far East, 19% of our revenues from sales in North America, 8%
of our revenues from sales in Africa, 3% of our revenues from sales in Israel
and 1% of our revenues from sales in South America.

We
believe that changes in regional and local economies, such as the financial
crisis suffered by the Asian countries in 1998, may have affected our sales in
that region. In addition, because the majority of the InterCard groups
customers is located in Europe, the proportion of our revenues derived from
European customers has increased following our acquisition of the InterCard
group.

30

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Cost
of revenues and gross marginProducts.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.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.Licensing
and transaction fees.Licensing and transaction fees revenues do not have associated
cost of revenues because the costs incurred to initiate the project from which
they are derived are included under marketing and selling 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.

For
any given period, our gross margin will depend on the mix of products revenues,
nonrecurring engineering revenues, licensing and transaction fees and customer
and technical support fees in that period. In general, the gross margin related
to products revenues is lower than the gross margin related to nonrecurring
engineering and licensing and transaction fees. The gross margin for products
sales was 44% for the year ended December 31, 2002, 41% for the year ended December
31, 2001, 49% for 2000, 45% for 1999 and 36% for 1998. The gross margin for
nonrecurring engineering was 77% for the year ended December 31, 2002, 96% for
the year ended December 31, 2001, 0% for 2000, 82% for 1999 and 70% for 1998.
Historically, we have had no costs associated with licensing and transaction
fees. The gross margin for customer services and technical support was 37% for
the year ended December 31, 2002, 27% for the year ended December 31, 2001, and
22% for the year ended December 31, 2000. We did not receive fees for customer
services and technical support prior to 2000. Our total gross margin was 47%
for the year ended December 31, 2002, 43% for the year ended December 31, 2001,
48% for 2000, 50% for 1999 and 45% for 1998.

Operating
expensesResearch
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 and intellectual property registration expenses. All
research and development costs are expensed as incurred. Since 1997 until 2001,
we have significantly increased our research and development expenditures. In
2002, the Company research and development expenses have decreased due to the
cost cutting measures which the Company took and the Companys trend to
developing solutions for our customers specific order requirements.

Research
and development expenses, net, are net of payments received from the Government
of Israel, through the Office of the Chief Scientist of the Israeli Ministry of
Industry and Trade. We received grants from the Office of the Chief Scientist
for the development of our products totaling $645,000 in 1999, $1.0 million in
2000, $599,000 in 2001 and $1.1 million in 2002. See Government of Israel
Support Programs.

Marketing
and selling.Our
marketing and selling 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.

General
and administrative.Our general and administrative expenses consist primarily of
salaries and related expenses of our executive, financial and administrative
staff. These expenses also include costs of our professional advisors such as
legal and accounting experts, expenses related to doubtful accounts and depreciation
expenses.

Financing
income and expensesFinancing
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.

Critical
Accounting Policies.

We
prepare our consolidated financial statements in conformity with accounting
principles generally accepted in the U.S. As such, 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 the reported amounts of the periods presented. To fully
understand and evaluate our reported financial results, we believe it is
important to understand our revenue recognition policy, and our policy with
respect to Goodwill and Other Intangible Assets.

31

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Revenue
recognition.We
recognize product revenues upon delivery, provided there is persuasive evidence
of an agreement, 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.

Amounts
billed where the revenue recognition criteria have not been met, and as a
result the revenue is not yet earned, are reflected as deferred revenue, which
is netted off against the related receivable. If amounts billed and classified
as deferred revenues are collected, the amounts are included in liabilities.

Impairment of Goodwill
and Other Intangible AssetsWe
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 (SFAS 142) 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
$5.9 million as of December 31, 2002.

32

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Results of Operations

The
following table presents, for the periods indicated, certain information data
concerning the Companys results of operations:

|                                                                          |  | Year ended December 31
|------------------------------------------------------------------------- |  | ----------------------
|                                                                          |  |                       
|                                                                          |  | 2000                  
|                                                                          |  |                       
|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                                                          |  |                       
|                                                                          |  |                       
|Total
  operating expenses                                                |  |                       
|                                                                          |  |                       
|                                                                          |  |                       
|Operating
  loss                                                          |  |                       
|Financing income                                                          |  |                       
|Financing expenses                                                        |  |                       
|Other expenses, net                                                       |  |                       
|                                                                          |  |                       
|Loss
  before income taxes                                                |  |                       
|Tax benefit (taxes on
  income)                                           |  |                       
|                                                                          |  |                       
|                                                                          |  |                       
|                                                                          |  |                       
|Minority interest in losses
  (earnings)
            Of subsidiaries      |  |                       
|                                                                          |  |                       
|Net
  loss                                                                |  |                       
|                                                                          |  |                       

33

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The
following table sets forth, for the periods indicated, certain operations data
expressed as a percentage of our revenues:

|                                                                          |  | As a Percentage of Total Revenues
|------------------------------------------------------------------------- |  | ---------------------------------
|                                                                          |  |                                  
|                                                                          |  | Year ended December 31           
|                                                                          |  |                                  
|                                                                          |  | 2000                             
|                                                                          |  |                                  
|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                                                          |  |                                  
|                                                                          |  |                                  
|Total
  operating expenses                                                |  |                                  
|                                                                          |  |                                  
|                                                                          |  |                                  
|Operating
  loss                                                          |  |                                  
|Financing income                                                          |  |                                  
|Financing expenses                                                        |  |                                  
|Other expenses, net                                                       |  |                                  
|                                                                          |  |                                  
|Loss
  before income taxes                                                |  |                                  
|Tax benefit (taxes on
  income)                                           |  |                                  
|                                                                          |  |                                  
|                                                                          |  |                                  
|Minority interest in losses
  (earnings)
       Of subsidiaries           |  |                                  
|                                                                          |  |                                  
|Net
  loss                                                                |  |                                  
|                                                                          |  |                                  

34

---

---

Revenues

Products.  Revenues
from products were $12.5 million in 2000, $18.2 million in 2001 and $15.5
million in 2002. The increases in 2001 resulted primarily due to the inclusion of $12.9
million of annual product sales by the InterCard group in 2001, whereas 2000
includes the sales of the InterCard group from June 2000. The decrease in revenues in 2002 was primarily a
result of lower spending by the Companys customers, much of which was
attributable to the global economic slow down, continuous weakness in the
service providers sector and a more competitive market place.

Nonrecurring
engineering.Revenues from
nonrecurring engineering were $89,000 in 2000, $500,000 in 2001 and $952,000 in
2002.

Licensing
and transaction fees.Revenues from licensing and transaction fees were
$62,000 in 2000, $495,000 in 2001 and $651,000 in 2002.The increase in 2001 in licensing
and transaction fees was due to license fees received from OTI Africa and the
InterCard group.
The increase in revenues from licensing and transaction fees in 2002 was also mainly
due to license fees received from the InterCard group.

Customer
services and technical support.Revenues from customer services and technical
support were $428,000 in 2000, $676,000 in 2001 and $868,000 in 2002. The increase in
2001 is mainly due to the increase in revenues from customer service and
technical support and due to relatively lower margin sales of customer services
and technical support. The increase in revenues from customer services and
technical support in 2002 is primarily consisted of revenues from OTI Africa.

Cost of revenues and
gross margin

Products.Cost of products
revenues was $6.4 million in 2000, $10.7 million in 2001 and $8.7 million in
2002. The increase in cost of sales of products revenues in 2001 was primarily due to the increase in product
sales. The
decrease in cost of sales of products in 2002 was due to relatively lower
margin sales made by the InterCard group.

Nonrecurring
engineering.Cost
of nonrecurring engineering revenues was $89,000 in 2000, $20,000 in 2001and
$216,000 in 2002. The increase in cost of sales of nonrecurring engineering in
2002 is a result of higher sales of nonrecurring engineering.

Licensing
and transaction fees.Cost of licensing and
transaction revenues was zero for 2000, 2001 and 2002.

Customer
services and technical support.Cost of customer
services and technical support was $332,000 in 2000, $491,000 in 2001and
$546,000 in 2002. Cost of customer services and technical support increased in
2002 primarily due to the increase in revenues from customer service and
technical support and due to relatively lower margin sales of customer services
and technical support.

Gross margin was 48% in 2000, 43% in 2001 and
47% in 2002. The
decrease in our overall gross margin in 2001 was primarily due to the change in
our revenue mix as compared with the same period in 2000. During 2001, as
compared with the same period in 2000 we sold a higher percentage of OEM
products as compared to system products. The gross margin of OEM products is
lower than that of system products. The increase in our overall gross margin in 2002
is a result of sales with relatively lower margins, which is a result of market
conditions.

Operating expenses

Research
and development.Research and
development expenses, net of participation from the Office of the Chief
Scientist (OCS), was $3.9 million in 2000, $6.2 million in 2001and $3.4
million in 2002, representing 30% of
revenues in 2000, 31% in 2001 and 19% in 2002.The
increase in 2001 was primarily due to an increase of $750,000 relating to the
hiring of additional research and development staff, an increase of $529,000 in
material expenses and an increase of $340,000 in subcontracting expenses. The
hiring of additional staff and increased contracting expenses were incurred
partly in connection with the development of the companys future line of
products and partly in connection with the adaptation of our products to
proposed standards of the International Standards Organization for contactless
smart cards. The
decrease in 2002 was primarily due to $790,000 related to the decrease in
subcontractors, a reduction of $619,000 in salaries and from a decrease of
$584,000 in materials. The decrease in subcontractor and materials, reflects
the Companys trend of developing solutions for our customers specific order
requirements.

35

---

---

The
participation received from the OCS totaled $1.0 million in 2000, $599,000 in
2001 and $1.1
million in 2002. Research and development expenses, net increased in 2001 as a
result of a change in policy of the OCS, which decreased the OCSs
participation in research and development expenses.

Marketing
and selling.Marketing
and selling was $7.0 million in 2000, $6.6 million in 2001 and $3.9 million in
2002, representing 54% of revenues in 2000, 33% in 2001 and 22% in 2002. The decrease in marketing and
selling in 2001 was primarily due to the reduction in salaries and the
reduction in the amount of staffing. The decrease in marketing and selling expenses in
2002 was primarily due to $1.3 million related to salary reductions, a decrease
of $977,000 related to marketing and advertising and due to $352,000 decrease in
exhibition and traveling exepnses.

General
and administrative.General and
administrative expense was $3.7 million in 2000, $4.7 million in 2001 and $5.2
million in 2002, representing, 28% of revenues in 2000, 23% in 2001 and 29% in
2002. This increase in
general and administrative expense in 2001 was primarily due to an increase of
$855,000 related to the hiring of additional general and administrative staff. The increase in
general and administrative expenses in 2002 was primarily due to an expense of
$379,000 related to salaries and $105,000 related to doubtful accounts.

Amortization
of intangible assets.Amortization of
intangible assets was $472,000 in 2000, $1.1 million in 2001 and $161,000 in
2002. The increase in
2001 is primarily due to the purchase of 49% of the InterCard group in January
2001. The
decrease in 2002 was due to the adoption of SFAS 142, in which the Company
reclassified certain intangible assets as goodwill, which it ceased to
amortize. The Company continues to amortize its intangibles assets acquired
during the purchase of the SoftChip group, the InterCard group and Easy Park
Israel. Intangible
assets are currently being amortized over five years for the SoftChip Group, seven
years for the InterCard group and three years for EasyPark Israel Ltd.

Other
expenses.Other
expenses were $599,000 in 2000, $340,000 in 2001 and zero in 2002. In 2000, we
incurred $599,000 due to legal and related expenses in connection with an
arbitration proceeding with one of our distributors. We received a favorable
award in this arbitration proceeding. In 2001, we recorded a non-cash provision
of $340,000 in respect of the dissolution of our subsidiary InterCard Inc,
which enabled us to further reduce our operating expenses without effecting our
normal course of business.

Financing income and
expenses.

Financing
income.Our
financing income was $1.3 million in 2000, $520,000 in 2001, $990,000 in 2002.  Financing income in 2001 was due to interest earned on the
proceeds from our 1999 initial public offering. Financing income in 2002 was due to foreign
currency gains and due to the interest earned on the proceeds from our 1999
initial public offering in Germany.

Financing
expenses.Our
financing expenses were $481,000 in 2000, $471,000 in 2001 and $949,000 in
2002. Financing
expenses in 2001 were primarily due to $330,000 due to our loan balance and
$119,000 in foreign currency losses. Financing expenses in 2002 were primarily
due to $576,000 foreign
currency losses and $370,000 due to interest on our loan balance.

Other
expenses, net.Other expenses, net, were
zero in 2000, $1.6 million in 2001 and $2.0 million in 2002. Other expenses for
2001 were in connection with an aborted public offering in which we incurred
expenses of $1.6 million. Other expenses during 2002 were primarily due to
$935,000 related to the registration costs, $769,000 in connection to options
and warrants to consultants and a $271,000 cancellation of a debt of a former
shareholder of our subsidiary CitySmart and due to capital loss from the sale
of unused assets.

36

---

---

Quarterly Results of Operations

The
tables below set forth consolidated statements of operations data for each of
the eight consecutive quarters ended December 31, 2002, both in U.S. dollar
amounts and as a percentage of revenues. This information has been derived from
our unaudited consolidated financial statements. In managements opinion, the
unaudited consolidated financial statements have been prepared on the same
basis as our audited consolidated financial statements contained elsewhere in
this prospectus and include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of such financial
information. You should read this information together with our consolidated
financial statements and the related notes appearing elsewhere in this
prospectus. The operating results for any quarter are not necessarily
indicative of our results for a full year or any future period and we cannot
assure you that any trend reflected in such results will continue in the
future. The reason for the increase in products sales between the first and
second quarters of 2002 is the cyclical nature of our sales, which are
characterized by lower sales in the first quarter and increases during
subsequent quarters.

|                                                         |  | 2001           |        | 2002 |  
|-------------------------------------------------------- |  | -------------- | ------ | ---- | -
|                                                         |  |                |        |      |  
|                                                         |  | Q1             |        | Q2   |  
|                                                         |  |                |        |      |  
|                                                         |  | (in thousands) |       
|Revenues:                                                |  |                |        |      |  
|Products                                                 |  | $              | 3,719  |      | $
|                                                         |  |                |        |      |  
|Nonrecurring
  engineering                               |  |                | 0      |      |  
|License
  and transaction fees                           |  |                | 44     |      |  
|Customer
  services and technical support                |  |                | 49     |      |  
|                                                         |  |                |        |      |  
|Total
  revenues                                         |  |                | 3,812  |      |  
|                                                         |  |                |        |      |  
|Cost
  of Revenues:                                      |  |                |        |      |  
|Products                                                 |  |                | 2,097  |      |  
|                                                         |  |                |        |      |  
|Nonrecurring
  engineering                               |  |                | 0      |      |  
|License
  and transaction
  fees                         |  |                | 0      |      |  
|Customer
  services and technical support                |  |                | 33     |      |  
|                                                         |  |                |        |      |  
|Total
  cost of revenues                                 |  |                | 2,130  |      |  
|                                                         |  |                |        |      |  
|Gross
  profit                                           |  |                | 1,682  |      |  
|                                                         |  |                |        |      |  
|Operating
  expenses:                                    |  |                |        |      |  
|Research
  and
  development                             |  |                | 1,935  |      |  
|Less  participation by the Office of theChief Scientist |  |                | 0      |      |  
|                                                         |  |                |        |      |  
|Research
  and development,
  net                        |  |                | 1,935  |      |  
|Marketing
  and
  selling                                |  |                | 1,778  |      |  
|General
  and
  administrative                           |  |                | 1,116  |      |  
|Amortization
  of intangible assets                      |  |                | 281    |      |  
|Other
  expenses                                         |  |                | 0      |      |  
|                                                         |  |                |        |      |  
|Total
  operating
  expenses                             |  |                | 5,110  |      |  
|                                                         |  |                |        |      |  
|Operating
  loss                                         |  |                | (3,428 | )    |  
|Financing
  income
  (expenses)                          |  |                | 130    |      |  
|Other
  income
  (expenses)                              |  |                | 0      |      |  
|                                                         |  |                |        |      |  
|Loss
  before taxes on income                            |  |                | (3,298 | )    |  
|Tax
  benefit (taxes on
  income)                        |  |                | (25    | )    |  
|Minority
  interest                                      |  |                | (11    | )    |  
|                                                         |  |                |        |      |  
|Net
  loss                                               |  | $              | (3,334 | )    | $
|                                                         |  |                |        |      |  



37

---

---

As a Percentage of Total Revenues

|                                                                        |  | 2001 |     |    | 2002 |    
|----------------------------------------------------------------------- |  | ---- | --- | -- | ---- | ---
|                                                                        |  |      |     |    |      |    
|                                                                        |  | Q1   |     |    | Q2   |    
|                                                                        |  |      |     |    |      |    
|Revenues                                                                |  |      |     |    |      |    
|Products                                                                |  |      | 98  | %  |      | 83 
|Nonrecurring
  engineering                                              |  |      | 0   |    |      | 10 
|License
  and transaction fees                                          |  |      | 1   |    |      | 3  
|Customer
  services and technical                                       |  |      |     |    |      |    
|Support                                                                 |  |      | 1   |    |      | 4  
|                                                                        |  |      |     |    |      |    
|Total
  revenues                                                        |  |      | 100 |    |      | 100
|Cost
  of revenues                                                      |  |      |     |    |      |    
|Products                                                                |  |      | 55  |    |      | 43 
|Nonrecurring
  engineering                                              |  |      | 0   |    |      | 1  
|License
  and transaction
  fees                                        |  |      | 0   |    |      | 0  
|Customer
  services and technical                                       |  |      |     |    |      |    
|Support                                                                 |  |      | 1   |    |      | 1  
|                                                                        |  |      |     |    |      |    
|Total
  cost of revenues                                                |  |      | 56  |    |      | 45 
|                                                                        |  |      |     |    |      |    
|Gross
  profit                                                          |  |      | 44  |    |      | 55 
|                                                                        |  |      |     |    |      |    
|Operating
  expenses                                                    |  |      |     |    |      |    
|Research
  and
  development                                            |  |      | 51  |    |      | 38 
|Less
   participation by the                                           |  |      |     |    |      |    
|Office
  of the Chief
  Scientist                                       |  |      | 0   |    |      | 3  
|                                                                        |  |      |     |    |      |    
|Research
  and development, net                                         |  |      | 51  |    |      | 35 
|Marketing
  and selling                                                 |  |      | 47  |    |      | 35 
|General
  and administrative                                            |  |      | 29  |    |      | 20 
|Amortization
  of intangible
  assets                                   |  |      | 7   |    |      | 5  
|Other
  expenses
  (income)                                             |  |      | 0   |    |      | 0  
|                                                                        |  |      |     |    |      |    
|Total
  operating
  expenses                                            |  |      | 134 |    |      | 95 
|                                                                        |  |      |     |    |      |    
|Operating
  loss                                                        |  |      | (90 | )  |      | (40
|Amortization
  of beneficial
  conversion feature on convertible
  Loan |  |      | 0   |    |      | 0  
|Financing
  income
  (expenses)                                         |  |      | 3   |    |      | 1  
|Other
  income
  (expenses)                                             |  |      | 0   |    |      | 0  
|                                                                        |  |      |     |    |      |    
|Loss
  before taxes on
  income                                         |  |      | (87 | )  |      | (39
|Tax
  benefit (taxes on
  income)                                       |  |      | 0   |    |      | 1  
|Minority
  interest                                                     |  |      | 0   |    |      | 0  
|                                                                        |  |      |     |    |      |    
|Net
  loss                                                              |  |      | (87 | )% |      | (38
|                                                                        |  |      |     |    |      |    

The
Companys future revenues and operating results are uncertain and may fluctuate
from quarter to quarter and from year to year due to a combination of factors,
including the timing of new product releases and acceptance of new products,
the demand for the Companys products, the volume and timing of orders and the
ability to fulfill orders, the level of product and price competition, the
expansion of the Companys sales and marketing ­organizations, the Companys
ability to develop new and enhanced products and control costs, the Companys
ability to attract and retain key technical, sales and managerial employees,
the mix of distribution channels through which products are sold, the mix of
products and services sold, the growth in the acceptance of smart-card
technology, seasonal trends in customer purchasing, customer capital spending
budgets, foreign currency exchange rates and general economic factors. The
Companys 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 the Companys products. The Company
believes that it will continue to encounter quarter-to-quarter seasonality that
could result in proportionately lower sales in the first quarters of each
physical year.

38

---

---

The
Companys expense levels are based, in part, on expectations as to future
revenues. If revenue levels are below expectations, operating results are
likely to be adversely affected. Net
income may be disproportionately affected by a reduction in revenues due to the
relatively small amount of the Companys expenses, which vary with its
revenues. As a result, the Company believes that period-to-period comparisons
of its results of operations are not necessarily meaningful and should not be
relied upon as indications of future performance. Due to all of the foregoing
factors, it is likely that in some future quarter the Companys operating
results may be below the expectations of public market analysts and investors.
In such event, the price of the Companys ordinary shares would likely be
materially adversely affected.

Liquidity and Capital
Resources

Our
principal sources of liquidity since our inception have been private and public
sales of equity securities, borrowings from banks, convertible loans, cash from
the exercise of options and grants from the Office of the Chief Scientist and
to a lesser extent, cash from operations. We had cash and cash equivalents of
$2.1 million as of December 31, 2002, and $6.0 million as of December 31, 2001.
In addition, we had short-term investments of $1.7 million as of December 31,
2002, and $1.9 million as of December 31, 2001. We expect that our working
capital is sufficient to meet our present requirements.

Operating
activities.For
the year ended December 31, 2002 we used $1.1 million of cash in operating
activities primarily due to our net loss of $6.2 million and from a $1.3
million decrease in trade payables, which mainly reflects the cost measures
which we took and from a $497,000 decrease in other current liabilities, which
mainly reflects the cancellation of the debt of a former shareholder of our
subsidiary CitySmart, partially offset by $1.6 million amortization of deferred
stock compensation, a $1.4 million decrease in trade receivables, due to
improved collections, a $1.1 million decrease in inventories which is due to a
continuous effort to reduce the inventory level and from a $1.1 million stock compensation
in respect of stock options granted to consultants. For the year ended December 31,
2001, we used $7.8 million of cash in operating activities primarily due to our
net loss of $11.7 million and from a $270,000 decrease in other current
liabilities, partially offset by a $744,000 decrease in trade receivables due
to improved collections offset by the decrease in our allowance for doubtful
accounts and a $1.2 million decrease in other receivables and prepaid expenses
as a result of a write off of expenses. In the same period in 2000, net cash
used in operating activities totaled $10.7 million primarily due to our net
loss of $8.3 million and a $1.5 million increase in inventories as a result of
increased revenues and anticipated growth in revenues.

For
the year ended December 31, 2002, net cash used in investing activities was $779,000
primarily due to a $793,000 investment in equipment purchases. For the year ended December 31,
2001, net cash used in investing activities was $2.9 million primarily due to a
$2.6 million investment in plant and equipment purchases. For the same period
in 2000, net cash provided by investing activities was $7.4 million primarily
due to a $10.2 million decrease in bank deposits, partially offset by a $2.5
million investment in plant and equipment purchases.

For
the year ended December 31, 2002, net cash used in financing activities was $2.1 million due
to $1.6 million repayment of long-term loans and from a $1.1 decrease in
short-term bank credit, partially offset by $372,000 long term loans received. For the year ended December 31,
2001, net cash provided by financing activities was $1.1 million due to a $4.0
million long-term loans received, partially offset by a $2.3 million repayment
of long-term loans and a decrease of $582,000 in short-term bank credit. For
the same period in 2000, net cash provided by financing activities totaled $2.6
million primarily due to a $2.5 million long-term loans received and an
increase of $1.6 million in short-term bank credit partially offset by a $1.7
million repayment of long-term loans.

Capital Expenditure

In
2000, we invested $2..5 million in capital expenditure, primarily the building
of a new manufacturing facility in Rosh Pina, Israel, which was completed in
2001. The new facility supports the research and development, testing and
manufacturing of the Companys contactless microprocessor-based smart card
products. The completion of the new facility cost $3.7 million, approximately $2.8
million of which was financed by a loan from Bank Hapoalim, and the remainder
from the Companys cash balances. The Companys rights in the facility and the
real estate on which the facilty is built are pledged for the benefit of Bank
Hapoalim as security, inter alia, for the loan. See BusinessReal Property.
The new facility is built on a 4,000 square meters area located next to the
Companys old facility, which now houses the Companys global management
offices. The land for the new facility was leased from the Israeli Lands
Authority for a period of 49 years, expiring on September 14, 2047 with an
option to extend the lease for an additional 49 years.

39

---

---

In
2001, we invested $2.6 million in capital expenditures, which related primarily to the construction of our new
manufacturing facility and in 2002, we invested $793,000 in capital expenditures which, related primarily to
additional computers, software and manufacturing equipment.In
connection with our joint venture, e-Smart, we have agreed to guarantee up to
$2.0 million of borrowings under a line of credit that Cheung Kong
Infrastructure has undertaken to provide, or cause to be provided, to the joint
venture. As of December 31, 2002, this line of credit has not been utilized.
See Certain TransactionsEstablishment of Joint Venture with Cheung Kong
Infrastructure.On
February 26, 2002, our Board approved a plan by which the Company may pay,
during a 12 month period, the salaries of certain of our employees who agree to
participate in the plan, by way of grant of options. An employee who
participates in the plan and who receives options may direct the trustee of the
plan to exercise such options and sell the shares issued upon such exercise. On
March 28, 2003, our Board approved the extension of the plan for an additional
period of six months commencing May 2003. See Share Option Plans  2001 Share
Option Plan. 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. In the event we or our employees
determined to terminate this arrangement, we would have sufficient cash to
cover our salary and other current obligations.

At December 31, 2002, we and our
subsidiaries have contractual obligations which are expected to affect our
consolidated cash flow in future periods as follows:

|                          |  |   | 2003      |  |   | 2004      |  |   | 2005    |  |   | 2006    |  |   | 2007 and
  thereafter |  |   | Total     | 
|------------------------- |  | - | --------- |  | - | --------- |  | - | ------- |  | - | ------- |  | - | --------------------- |  | - | --------- | 
|                          |  |   |           |  |   |           |  |   |         |  |   |         |  |   |                       |  |   |           | 
|Capital lease obligations |  | $ | 225,000   |  | $ | 222,000   |  | $ | 170,000 |  | $ | -       |  | $ | -                     |  | $ | 617,000   | 
|Loans                     |  | $ | 1,301,000 |  | $ | 984,000   |  | $ | 575,000 |  | $ | 442,000 |  | $ | 1,613,000             |  | $ | 4,915,000 | 
|Total                     |  | $ | 1,526,000 |  | $ | 1,206,000 |  | $ | 745,000 |  | $ | 442,000 |  | $ | 1,613,000             |  | $ | 5,532,000 | 

Research and Development, Patents and
Licenses

For disclosures regarding our research and development, patents and
licenses, see Item 4. Information on the Company above.

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, 2002, we held $1.7
million in marketable bonds of the State of Israel, all with high credit
quality issuers and with a limited amount of credit exposure to any one issuer.

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, 2002, we had fixed interest rate loan obligations of $4.7
million. $2.6 were denominated in US dollars, $1.6 million were denominated in
Euros and $512,000 were denominated in NIS. These loans will be repaid during
the next 9 years. At the same time, we had variable interest rate loan
obligations of $1.0 million in dollars. 
These loans will also be repaid during the next 9 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.

40

---

---

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 Shekel 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 Shekel. 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 6.5% in 2002, 1.4% in 2001 and 0% in
2000. The Shekel devalued against the dollar by approximately 7.3% in 2002 and 9.4% in 2001 and
the Shekel appreciated against the dollar by approximately 2.7% in 2000.

The
functional currency of the InterCard group is the Euro. Significantly, all of
the Intercard group 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.

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Corporate Tax Rate

Israeli
companies are generally subject to income tax at the corporate tax rate of 36%.
As of December 31, 2002, our net operating loss carry-forwards for Israeli tax
purposes amounted to approximately $27.6 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,
2002, we have not yet utilized the tax benefits for which we are eligible. In
addition, $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. A total of $260,000 of the investment programs of
our subsidiary, EasyPark, has also been granted approved enterprise status. We
have derived approximately 24% of our consolidated income from our approved
enterprise programs. 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 the benefits, 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
filing, we believe that we comply with these conditions. The law prescribing
the benefits will be terminated in December 2003 and therefore there is a doubt
regarding obtaining new benefits. There can be no assurance that such tax
benefits will be continued in the future at their current levels or otherwise.

In July 2002, the Israeli Parliament approved a law enacting extensive
changes to Israels tax law generally effective January 1, 2003,  which could adversely affect the Companys
effective tax rate.  See Israeli
Taxation, Foreign Exchange Regulation and Investment Programs in Item 10 -
Additional Information.

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 grants of $1.0 million in 2000, $599,000 in 2001 and
$1.1 million in 2002 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.

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, 2002, we have received a total of $4.3 million from the
Office of the Chief Scientist net of royalties paid to it. 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.

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ITEM
6.          DIRECTORS, SENIOR
MANAGEMENT AND EMPLOYEES

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

|Name                        |  | Age |  | Position                                                                                                       
|--------------------------- |  | --- |  | ---------------------------------------------------------------------------------------------------------------
|                            |  |     |  |                                                                                                                
|Oded Bashan (1)             |  | 56  |  | President, Chief Executive Officer,
  Chairman and Director                                                    
|Ronnie Gilboa               |  | 47  |  | Vice PresidentProjects and Director                                                                           
|Guy Shafran                 |  | 31  |  | Chief Financial Officer                                                                                        
|Moshe Aduk                  |  | 46  |  | Vice PresidentGasoline Management System                                                                      
|Nehemya Itay                |  | 54  |  | Vice PresidentHardware Engineering                                                                            
|Ohad Bashan                 |  | 32  |  | Head of Global Marketing and Strategy
  Development;
  President and Chief Executive Officer, OTI America, Inc.
|Shulamith Shiffer (1)(2)(3) |  | 57  |  | Director                                                                                                       
|Felix Goedhart (2)(3)       |  | 39  |  | Director                                                                                                       
|Raanan Ellran (1)(2)(3)     |  | 53  |  | 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 e-Smart System Inc. 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 Vice President Projects of the Issuer. He serves on the board of
directors of OTI America, Inc., e-Smart System Inc., 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.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.

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Shulamith
Shifferserves
as a director, having served in that position since May 2000. Ms. Shiffer is a
Judge  Vice President of the disciplinary court of the Israeli Bar Association
in the district of Jerusalem and serves as Vice Chairman of the Israeli Bar
Association tax committee. Ms. Shiffer has been a practicing lawyer and member
of the Israel Bar Association since 1968 and has headed a private law office
with offices in Jerusalem, Tel Aviv and Zichron Yaakov, since that time. From
1970 to 1985, Ms. Shiffer was legal adviser to the district of Jerusalem and
the Department of Customs and V.A.T. Ms. Shiffer holds an LL.B. and an LL.M.,
both from the Hebrew University of Jerusalem.Felix
Goedhartserves
as a director, having served in that position since August 1999. He has served
as chief executive officer of Equitrust AG, formerly Pre IPO AG of Hamburg,
Germany since June 1999. Prior to this position he served as a member of the
Management Board of Premiere Medien GmbH & Co. KG, the German Pay-TV
station. From 1995 to 1996, he was head of digital projects at Kirch Group,
Munich. From 1991 to 1995, he was a senior associate at Booz-Allen &
Hamilton, management consultants. Mr. Goedhart holds a Lic.Dec.HSG from
Hochschule St. Gallen, Switzerland, and an M.B.A. from the University of
Chicago.Raanan
Ellranserves
as a director, having served in that position since July 1999. He serves as a
director and as the Chairman of the Finance Committee of Rafael Ltd, 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 has served as the General
Manager of Assuta Medical Centers since March 1997 and 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.

Except
for Messrs. Oded Bashan, Ronnie Gilboa, Nehemya Itay, Moshe Aduk and Ohad
Bashan, as of June ­­­­24, 2003, none of the directors or executive officers of
the Company 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.

Board Composition

Our
current board of directors consists of five directors. Under our articles of
association, our board of directors may not consist at any time of more than
seven 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.

On
July 19, 1999, some of our shareholders, including Oded Bashan, Ronnie Gilboa,
Moshe Aduk and Ohad Bashan, who hold in the aggregate approximately 15% of our
outstanding share capital, entered into a voting agreement together with a
number of our former directors and officers. The voting agreement had applied
solely to the election of directors. The parties terminated that voting
agreement, effective October 31, 2002.

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. Prior to December 31, 2004, however, our founders,
Oded Bashan and Ronnie Gilboa, may not be replaced or removed without the
affirmative vote of 75% of our shareholders entitled to vote and voting, in
person or by proxy, at a general shareholders meeting. Unless contrary to the
law, a director may be elected for consecutive terms.

External Directors

The
new Israeli Companies Law, which took effect on February 1, 2000, requires
Israeli companies with shares that have been offered to the public in or
outside of Israel to appoint two external directors. No person may be appointed
as an external director 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 for a period of not more than three-months during which the company
first offered 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, chief business 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.

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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.

| |  | 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, our board of directors must include at least three independent
directors within the meaning of the Nasdaq National Market listing
requirements. Our directors, Shulamith Shiffer and Raanan Ellran, qualify both
as external directors under the Companies Law and independent directors under
the Nasdaq national Market listing requirements. Our director, Felix Goedhart,
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.

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, Shulamith
Shiffer and Raanan Ellran.

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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
responsibilities of the audit committee include identifying irregularities in
the management of the companys business in consultation with the companys
independent accountants and the internal auditor and suggesting appropriate
responses. The audit committees responsibilities also include approving related
party transactions as required by law.

Neither the chairman of the board of
directors, a director employed by or otherwise providing services on a regular
basis to the company, a controlling shareholder, nor any 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.

The
current members of our audit committee are Shulamith Shiffer, Raanan Ellran and
Felix Goedhart.

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.

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.

Executive
Compensation

The
aggregate compensation paid by us and our subsidiaries to our executive
directors and executive officers listed in at the beginning of this item (Item
6), in year ended December 31, 2002 was $759,000. This amount includes
approximately $265,000 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 in the beginning of this
item (item 6), in the year ended December 31, 2002 was $31,400.

See
Principal Shareholders 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.

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Stock
Options

The
following is a description of the share option plans that we and our
subsidiaries maintain. In addition to the discussion below, please see Note 13B
to our consolidated financial statements included elsewhere in this 20-F. 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 and
on March 28, 2003, the Companys 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 1,125,000 so that the aggregate
number of options available under the plan is now 1,200,000. Under this plan as
of the date of this 20-F we have granted 1,633,757 options, of which 295,129
were granted to non-employees and directors 473,429 options had been exercised
and 1,150,286 are outstanding of which 758,047 were vested and exercisable. Of
the options that are outstanding 474,825 are held by our directors and officers
listed under Management. The weighted average exercise price of these share
options is $0.75.

On
February 26, 2002, our Board resolved to approve 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 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. The Company undertook to pay from its own sources any and all
differences between the relevant monthly salary and such proceeds. On March 28,
2003, our Board approved the extension of the arrangement for an additional
period of six months commencing May 2003.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 the Amendment No. 132 of the
Income Tax ordinance (the Tax Reform) that was approved on July 24, 2002 and
entered into force on January 1 ,2003, and those who are not employees or
office holders and those who are controlling shareholders of the Company) are
afforded certain tax benefits. The Company has 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 the company may not recognize expenses pertaining to
the options for tax purposes.  The
Company also granted its employees 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 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/options. . As of January 1, 2003 Section 3(i) of the Ordinance no longer
applies to allocations of options to employees (including directors and office
holders). Section 3(i) will only apply to those who are not employees (such as
consultants and service providers) and to employees who are considered
controlling shareholders.

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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 the Companys 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 the date of this 20-F, options to purchase 49,006 shares had
been exercised and 69,423 were outstanding of which 54,353 were vested and
exercisable. Of the options that are outstanding, 30,000 are held by our
directors and officers listed under Management. The weighted average exercise
price of these share options is $6.62.

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 PlanWe
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. The purchase price of our ordinary
shares will be 85% of their trading price on the date of purchase.

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Employees

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

|                                           |  | Number of employees as of December 31 | 
|------------------------------------------ |  | ------------------------------------- | 
|Department                                 |  | 2000                                  | 
|                                           |  |                                       | 
|                                           |  |                                       | 
|Sales
  and marketing                      |  | 30                                    | 
|Research
  and development and engineering |  | 58                                    | 
|Manufacturing
  and operations             |  | 98                                    | 
|Customer
  support                         |  | 26                                    | 
|Management
  and administration            |  | 22                                    | 
|                                           |  |                                       | 
|Total                                      |  | 234                                   | 

Of
these employees, on December 31, 2002, 78 were based in Israel, 10 in the
United States, 101 in Europe and 19 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.

49

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ITEM
7.          MAJOR
SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

MAJOR SHAREHOLDERS

The
following table provides summary information regarding the beneficial ownership
by the following persons of our outstanding ordinary shares as of June 26,
2003:

     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 20-F. 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 2,089,340 ordinary shares outstanding as of
June 26, 2003.  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.

|                                                  |  | Shares beneficially owned
|------------------------------------------------- |  | -------------------------
|Name of beneficial owner                          |  | Number                   
|                                                  |  |                          
|Oded Bashan (1)                                   |  | 276,243                  
|Ronnie Gilboa (2)                                 |  | 132,060                  
|Guy Shafran (3)                                   |  | 35,600                   
|Moshe Aduk (4)                                    |  | 55,526                   
|Nehemya Itay (5)                                  |  | 85,762                   
|Ohad Bashan (6)                                   |  | 59,345                   
|Shulamith Shiffer (7)                             |  | 1,200                    
|Felix Goedhart (8)                                |  | 11,200                   
|Raanan Ellran (9)                                 |  | 1,200                    
|All executive officers and directors as a
  group |  | 658,136                  

---

|(1) | Includes 23,000 ordinary shares held by
  Oded Bashan Shares Ltd., 23,000 ordinary shares held by Oded Bashan
  Securities Ltd. and 24,000 ordinary shares held by Oded Bashan Assets Ltd.,
  all of which are wholly-owned by Mr. Bashan. Also includes 4,000 ordinary
  shares held by Oded Bashan Holdings Ltd., which is wholly-owned by Mr.
  Bashans wife. Mr. Bashan disclaims beneficial ownership of the shares held by
  Oded Bashan Holdings Ltd. The remaining 21,368 ordinary shares are held
  directly by Mr. Bashan. Also includes options to purchase 176,875 ordinary
  shares and options held by Mr. Bashans wife to purchase 4,000 ordinary
  shares. Mr.Bashan disclaims beneficial ownership of the options held by his
  wife.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(2) | Includes 25,000 ordinary shares held by
  Ronnie Gilboa Securities Ltd., 20,000 ordinary shares held by Ronnie Gilboa
  Shares Ltd. and 25,000 ordinary shares held by Ronnie Gilboa Assets Ltd., all
  of which are wholly-owned by Mr. Gilboa. The remaining 33,600 ordinary shares
  are held directly by Mr. Gilboa. Also includes options to purchase 25,000
  ordinary shares and options held by Mr. Gilboas wife to purchase 4,000
  ordinary shares. Mr. Gilboa disclaims beneficial ownership of the options
  held by his wife.                                                                                                                                                                                                             
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(3) | Consists of options held by Mr. Shafran to
  purchase 35,600 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 31,278
  ordinary shares held directly by Mr. Aduk.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(5) | Consists of 20,000 ordinary shares held by
  Likuy Meorot Ltd., 15,000 ordinary shares held by Josphid Ltd., 15,000
  ordinary shares held by Likuy Chama Ltd., and 255 ordinary shares held by
  Toussia-Cohen Company for Trust Holding Ltd. These companies are owned by
  Adv. Toussia- Cohen in trust for Mr. Itay. An additional 4,000 ordinary
  shares are held by j.o.g.o.f Ltd., which is wholly owned by Mr. Itay and
  options to purchase 30,766 ordinary shares are held directly by Mr. Itay and
  options held by Mr. Itays wife to purchase 741 ordinary shares. Mr.Itay
  disclaims beneficial ownership of the options held by his wife.                                                                                            
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(6) | Consists of 18,220 ordinary shares and options
  to purchase 41,125 ordinary shares. Mr. Bashans address is c/o OTI America,
  Inc., 1601 South De Anza Blvd., Suite 201, Cupertino, California.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(7) | Consists of options held by Ms. Shiffer to
  purchase 1,200 ordinary shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(8) | Mr. Goedhart holds options to purchase
  11,200 ordinary shares. Mr. Goedharts address is c/o pre-IPO AG, Am
  Sandtorkai 75, Hamburg 20457.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|(9) | Consists of options held by Mr. Ellran to
  purchase 1,200 ordinary shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

50

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RELATED PARTY TRANSACTIONS

Our
policy is to enter into transactions with related parties on terms that are on
the whole no less favorable 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 $191,714 in 2000, $157,401 in 2001
and $101,143 in 2002. On August 25, 2000, our audit committee reviewed and
reapproved the terms of this agreement.

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 the Companys senior management.

51

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ITEM
8.          FINANCIAL
INFORMATION

Consolidated
Financial Statements

The
Companys Consolidated Financial Statements included in this Annual Report on
Form 20-F beginning on page F-1 are hereby incorporated into this Annual Report
by reference.

Dividend
Policy

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.

52

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ITEM
9.          THE OFFER AND
LISTING

Our
shares have been quoted on the Neuer Markt of the Frankfurt Stock Exchange
since August 31, 1999. 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 Small Cap 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 Markt 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.

|                                         |  | Frankfurt Stock
  Exchange (1)
  per
  Share |       | Frankfurt Stock
  Exchange (1)
  Per
  Share$ |  | NASDAQ Small Cap
  Per
  Share$ | 
|---------------------------------------- |  | --------------------------------------------- | ----- | --------------------------------------------- |  | ------------------------------- | 
|                                         |  |                                               |       |                                               |  |                                 | 
|                                         |  | High                                          |       | Low                                           |  | High                            | 
|                                         |  |                                               |       |                                               |  |                                 | 
|1999                                     |  |                                               |       |                                               |  |                                 | 
|Third quarter (from August 31, 999)      |  |                                               | 77.8  |                                               |  | 51.0                            | 
|Fourth quarter                           |  |                                               | 71.0  |                                               |  | 49.5                            | 
|Annual 1999                              |  |                                               | 77.8  |                                               |  | 49.5                            | 
|2000                                     |  |                                               |       |                                               |  |                                 | 
|First quarter                            |  |                                               | 334.0 |                                               |  | 64.7                            | 
|Second quarter                           |  |                                               | 220.0 |                                               |  | 149.5                           | 
|Third 
  quarter                         |  |                                               | 193.5 |                                               |  | 86.0                            | 
|Fourth quarter                           |  |                                               | 102.5 |                                               |  | 32.5                            | 
|Annual 2000                              |  |                                               | 313.0 |                                               |  | 32.5                            | 
|2001                                     |  |                                               |       |                                               |  |                                 | 
|First
  quarter                          |  |                                               | 77.5  |                                               |  | 31.4                            | 
|Second quarter                           |  |                                               | 40.4  |                                               |  | 24.0                            | 
|Third 
  quarter                         |  |                                               | 25.7  |                                               |  | 8.5                             | 
|Fourth quarter                           |  |                                               | 23.1  |                                               |  | 12.2                            | 
|Annual 2001                              |  |                                               | 77.5  |                                               |  | 8.5                             | 
|2002                                     |  |                                               |       |                                               |  |                                 | 
|First 
  quarter                         |  |                                               | 14.5  |                                               |  | 10.4                            | 
|Second quarter                           |  |                                               | 11.4  |                                               |  | 7.0                             | 
|Third 
  quarter                         |  |                                               | 9.6   |                                               |  | 3.9                             | 
|Fourth quarter                           |  |                                               | 8.4   |                                               |  | 3.5                             | 
|Annual 2002                              |  |                                               | 14.5  |                                               |  | 3.5                             | 
|2003                                     |  |                                               |       |                                               |  |                                 | 
|First 
  quarter                         |  |                                               | 5.3   |                                               |  | 3.0                             | 
|Second quarter (through June 24,
  2003) |  |                                               | 4.7   |                                               |  | 3.3                             | 
|December 2002                            |  |                                               | 6.7   |                                               |  | 4.2                             | 
|January 2003                             |  |                                               | 5.2   |                                               |  | 3.9                             | 
|February 2003                            |  |                                               | 5.3   |                                               |  | 3.8                             | 
|March 2003                               |  |                                               | 4.2   |                                               |  | 3.0                             | 
|April 2003                               |  |                                               | 4.2   |                                               |  | 3.3                             | 
|May 2003                                 |  |                                               | 4.7   |                                               |  | 3.6                             | 

53

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Our
ordinary shares, to the extent they are admitted to the Neuer Markt, 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  |      |  | .9984  |  |                    | .8466 
|2000                          |  |                    | 1.0860 |      |  | 1.2090 |  |                    | .9675 
|2001                          |  |                    | 1.1173 |      |  | 1.2346 |  |                    | 1.0488
|2002                          |  |                    | 0.9454 |      |  | 1.1636 |  |                    | 0.9537
|2003 (through June 20, 2003). |  |                    | 1.1030 |      |  | 0.9652 |  |                    | 0.8425

The Companys ordinary shares are traded publicly on the NASDAQ Small
Cap Market under the symbol OTIV.  The
Companys ordinary shares are traded publicly on the Prime Standard Market of the
Frankfurt Stock Exchange under the symbol OT5.

On
June 24, 2003, the last reported sale price of the Companys Ordinary shares on
the NASDAQ Small Cap Market was $3.49 per share.  According to the Companys transfer agent, as of June 25, 2003,
there was 1 holder of record of the Companys ordinary Shares.

ITEM
10.          ADDITIONAL
INFORMATION

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 the Companys 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

| | Date             |  | Nature of Action                 |  | State of Authorized Share Capital                                                 
| | ---------------- |  | -------------------------------- |  | ----------------------------------------------------------------------------------
| |                  |  |                                  |  |                                                                                   
| | March
  11, 2001 |  | Increase
  in share capital      |  | NIS
  500,000 divided into 50,000,000
  ordinary shares of nominal value NIS 0.01.
| | June
  17, 2002  |  | Consolidation
  of share capital |  | NIS
  500,000 divided into 5,000,000 ordinary
  shares of nominal value NIS 0.1.  

Description
of Ordinary Shares

As
of June 25, 2003 , our authorized share capital consists of 5,000,000 ordinary
shares, nominal value of NIS 0.1 per share, of which 2,089,340, are issued and
outstanding.

54

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---

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.

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 the Company is listed on NASDAQ, the
quorum at a general meeting shall be two members present in person or by proxy
holding at least 331/3% of
the issued and outstanding ordinary shares of the Company 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. See ManagementFiduciary Duties; Approval of Certain
Transactions.

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.

55

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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
für 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.

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 offering, 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. Please see Taxation and Foreign Exchange Regulation.

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Other Anti-Takeover Provisions

Under
the German Act relating to Tenders for the Acquisition of Securities and
Companies (Wertpapiererwerbs- und  ̈ UbernahmegesetzWp  ̈ UG), 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  ̈ UG 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.
               Prior
to December 31, 2004, our co-founders, Oded Bashan and Ronnie Gilboa, may not
be removed from our board without the affirmative vote of 75% of our
shareholders entitled to vote and voting, in person or by proxy, at a general
shareholders meeting.

Transfer Agent,
Registrar and Paying AgentThe 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 five directors. Under our articles of
association, our board of directors may not consist at any time of more than
seven 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.

On
July 19, 1999, some of our shareholders, including Oded Bashan, Ronnie Gilboa,
Moshe Aduk and Ohad Bashan, who hold in the aggregate approximately 15% of our
outstanding share capital, entered into a voting agreement together with a
number of our former directors and officers. The voting agreement had applied
solely to the election of directors. The parties terminated that voting
agreement, effective October 31, 2002.

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. Prior to December 31, 2004, however, our founders,
Oded Bashan and Ronnie Gilboa, may not be replaced or removed without the
affirmative vote of 75% of our shareholders entitled to vote and voting, in
person or by proxy, at a general shareholders 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
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 May 25, 2003 our Board approved to include a resolution that will
extend Oded Bashans appointment (who has served as our President and Chief
Executive Officer since 1990), in our upcoming Annual General Meeting scheduled
to July 4, 2003, for an additional period of three years.

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.

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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.
               For
information concerning the direct and indirect personal interests of some of
our office holders and principal shareholders in transactions with us, see
Related Party Transactions.

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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 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 foreseeable liabilities
and reasonable amounts determined by the board of directors. A company may
indemnify an office holder against the following liabilities incurred for acts
performed as an office holder:

| |  | a financial liability imposed on him in
  favor of another person pursuant to a judgment, settlement or arbitrators
  award approved by court; and                                                                                                                                                                                                                                           
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | 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.

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;                                                                                                                   
| |  | 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 offering, no claims for directors and officers
liability insurance have been filed under this policy.
      Our board of directors has resolved to
indemnify and insure our office holders with respect to liabilities resulting
from this offering to the extent that these liabilities are not covered by
insurance.
In the opinion of the U.S. Securities and Exchange Commission, however,
indemnification of directors and office holders for liabilities arising under
the Securities Act is against public policy and therefore unenforceable.

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.

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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 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, 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
36% of taxable income. 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
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                                                                                                                                              
| |  | 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.

A
foreign investors company as described in the law of encouragement of capital
investment may enjoy benefits for a period of up to 10 years. A foreign
investors company is a company of which more than 25% of its shareholders are
foreign residents.

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. See
Dividend Policy.

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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, 2002) 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.

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,
research and development programs which meet certain 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 return for the payment of royalties from the sale of the
product developed in accordance with the program and subject to other
conditions. Regulations promulgated under the Research Law provide for the
payment of royalties to the Chief Scientist ranging from 3% to approximately
5%, on revenues from products developed using such grants until 100-300% 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. Following the full repayment of the grant, there is no
further liability for payment. See Managements Discussion and Analysis of
Financial Condition and Results of Operations.

The
terms of the Israeli government participation also require details regarding
the place of where  the manufacture of
products developed with government grants be performed (in Israel or outside of
Israel) and the resons for the manufacture being performed outside of Israel.
Under the regulations promulgated under the Research Law, in the event that any
of the manufacturing is performed outside Israel by any entity other than us,
if approval is received from the Office of the Chief Scientist for such foreign
manufacturing and the identity of the foreign manufacturers, we may be required
to pay increased royalties. If the manufacturing volume that is performed
outside of Israel is less than 50%, the total amount to be repaid to the Office
of the Chief Scientist may be adjusted to 120% of the grant. If the
manufacturing volume that is performed outside of Israel is between 50% and 90%
of the total amount may be adjusted to 150% of the grant and if it is more than
90%, the total amount may be adjusted to 300% of the grant. Since our
manufacturing activities are performed by subcontractors outside of Israel, the
consent of the Office of the Chief Scientist is required for these activities
and additional consents will be required in connection with the manufacturing
of products developed in the future with Office of the Chief Scientist grants.
The Office of the Chief Scientist has given its ongoing consent in writing to
the manufacturing of chips made for us by Samsung, with no increase in
royalties. There can be no assurance that this ongoing consent will not be
reversed or modified in any way or that we will obtain consents for such
activities at all from the Office of the Chief Scientist in the future. Based
on full disclosure made by us to the Office of the Chief Scientist regarding
our manufacturing activities, the fact that there is no Israeli manufacturer
for our modules and the fact that, except for the manufacturing conducted by Samsung,
our other non-Israeli manufacturing activities are not based on the intellectual property for
which we received grants from the Office of the Chief Scientist, we believe
that other consents of the Office of the Chief Scientist are not required.
Failure to comply with the requirements for consents for manufacturing outside
of Israel could result in penalties, cancellation of grants and denial of any
future applications for grants or for these consents. If the consents obtained
from the Office of the Chief Scientist to manufacture our chip sets outside of
Israel are terminated or if we are unable to obtain similar consents in the
future, our business could be harmed.

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The
technology developed pursuant to the terms of these grants may not be
transferred to third parties without the prior approval of a governmental
committee under the Research Law. Such approval is not required for the export
of any products resulting from such research or development. Approval of the
transfer of technology may be granted in certain circumstances only if the
recipient abides by all the provisions of the Research Law and regulations
promulgated there under, including the restrictions on the transfer of know-how
and the obligation to pay royalties in an amount that may be increased. It is
difficult to quantify the consequences of a change in the royalties payable to
the OCS upon transfer of the technology and there can be no assurance that such
consent, if requested, will be granted. In addition, there is an obligation to
inform the Research Committee of changes in the control in the recipient of the
approval and on changes in the holder of the control measures that deem a
person who is not an Israeli citizen or an Israeli resident or a corporation
established in Israel to a direct related party in the recipient of the
approval.

The
funds available for grants from the Office of the Chief Scientist were reduced
for 1998, and the Israeli authorities have indicated that the government may
further reduce or abolish grants from the Office of the Chief Scientist in the
future. Even if these grants are maintained, there is no assurance we will
receive Office of the Chief Scientist grants in the future. In addition, each
application to the Office of the Chief Scientist is reviewed separately, and
grants are based on the program approved by the Research Committee. Generally,
expenditures supported under other incentive programs of the State of Israel
are not eligible for grants from the Office of the Chief Scientist. There is no
assurance that applications to the Office of the Chief Scientist will be
approved and, until approved, the amounts of any such grants is not
determinable.

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 (Taxation), 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:

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| |  | 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

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 thereafterHowever, according to
new tax legislation our
ordinary shares are not considered foreign traded securities.

63

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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.

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.

| |  | 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. Our counsels legal opinion 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 counsels legal
opinion. The discussion below assumes that you will hold the ordinary shares as
capital assets.

64

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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:

| |  | a bank, insurance company or other
  financial institution,                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | a regulated investment company, real estate
  investment trust or grantor trust,                                                                                                        
| |  | a broker or dealer in securities or foreign
  currency,                                                                                                                                 
| |  | a person 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 or constructive
  sale transaction for United States federal income tax purposes,
| |  | a tax-exempt entity, or                                                                                                                                                                 
| |  | an expatriate 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.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                      

and if your status as a United States holder
is not overridden pursuant to the provisions of an applicable tax treaty.

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.

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%.
Because our shares trade on the NASDAQ Small Cap Market, any dividends we pay
to you during that period should generally constitute qualified dividend income
to you , unless we are or become a passive foreign investment company, a
circumstance described below under Passive Foreign Investment Company
Consideration.

65

---

---

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.

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
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. Your adjusted income tax
basis in an ordinary share is discussed above.

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.

66

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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.

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 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.

ITEM
11.          QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For disclosure regarding our market risk
exposure, see Item 5 Operating and Financial review and Prospectus above.

67

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ITEM
12.          DESCRIPTION OF
SECURITIES OTHER THAN EQUITY SECURITIES

Not
applicable.

68

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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

Evaluation
of Disclosure Controls and Procedures

The term disclosure controls and procedures is defined in Rules
13a-14(c) and 15d-14(c) of the Exchange Act. These rules refer to the controls
and other procedures of a Company that are designed to ensure that information
required to be disclosed by a Company in the reports that it files under the
Exchange Act is recorded, processed, summarized and reported within required
time periods. Within 90 days prior to the filing date of this Form 20-F (the
Evaluation Date), we carried out an evaluation, under the supervision and
with the participation of our management, including our chief executive officer
and chief financial officer, of the effectiveness of the design and operation
of our disclosure controls and procedures. Based upon that evaluation, the
chief executive officer and chief financial officer have concluded that, as of
the Evaluation Date, such disclosure controls and procedures were effective in
ensuring that required information will be disclosed on a timely basis in our
reports filed under the Exchange Act.

Changes
in Internal Controls

We
maintain a system of internal accounting controls that are designed to provide
reasonable assurance that our transactions are properly recorded and reported
and that our assets are safeguarded against unauthorized or improper use. As
part of the evaluation of our disclosure controls and procedures, we evaluated
our internal controls. There were no significant changes to our internal
controls or other factors that could significantly affect the controls
subsequent to the Evaluation Date, nor were any corrective actions taken with
regard to any significant deficiencies or material weaknesses.

ITEM 16.          Reserved.

69

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PART III

ITEM 17.          FINANCIAL
STATEMENTS

The
Company has responded to Item 18.

ITEM 18.          FINANCIAL
STATEMENTS

Index to the financial statement of the
registrant

|                                                                | Page     
|--------------------------------------------------------------- | ---------
|                                                                |          
|Report of Independent Auditors                                  | F-2      
|                                                                |          
|Consolidated Balance Sheets                                     | F-3      
|                                                                |          
|Consolidated Statements of Operations                           | F-4      
|                                                                |          
|Statements of Changes in Shareholders Equity                   | F-5      
|                                                                |          
|Consolidated Statements of Cash Flows                           | F-6 - F-8
|                                                                |          
|Notes to the Consolidated Financial Statements                  | F-9 - F52
|                                                                |          
|Index to the Financial Statements Schedules
  of the Registrant
|                                                                | Page     
|                                                                |          
|Schedule II - Valuation and Qualifying Accounts                 | S-1      
|                                                                |          
|                                                                |          

70

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ITEM 19.          EXHIBITS

| | 1    | Articles of
  Association (incorporated by reference to Exhibit 3.1 to the Companys
  Registration Statement on Form F-1, no. 333-90496).       
| | ---- | -------------------------------------------------------------------------------------------------------------------------------------------------
| |      |                                                                                                                                                  
| | 2    | Specimen
  share certificate (incorporated by reference to Exhibit 4.1 to the Companys
  Registration Statement on Form F-1, no. 333-90496).    
| |      |                                                                                                                                                  
| | 4    | Material
  agreements (incorporated by reference to Exhibits 10.15 - 10.28 to the
  Companys Registration Statement on Form F-1, no. 333-90496).
| |      |                                                                                                                                                  
| | 8    | List of
  subsidiaries - Incorporated by reference to Exhibit 21.1 to the Companys
  Registration Statement on Form F-1, no. 333-90496.         
| |      |                                                                                                                                                  
| | 10   | Consent of
  Luboshitz Kasierer, an affiliate member of Ernst & Young International                                                              
| |      |                                                                                                                                                  
| | 12.1 | Certification
  pursuant to section 906 of the Sarbanes-Oxley Act of 2002                                                                        



71

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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 Bashan                                        
|    |  | Chief Executive
  Officer and Chairman of the Board
|    |  |                                                    
|    |  |                                                    
|By: |  | /s/ Guy
  Shafran                                  
|    |  |                                                    
|    |  | Guy Shafran                                        
|    |  | Chief
  Financial Officer                          



Date: June 27, 2003

72

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CERTIFICATION

I, Oded Bashan, certify that:

|1. | I have reviewed this annual report on Form 20-F of On Track
  Innovations Ltd.;                                                                                                                                                                                                                                                                                                                 
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|2. | Based on my knowledge, this annual report does not contain any untrue
  statement of a material fact or omit to state a material fact necessary to
  make the statements made, in light of the circumstances under which such
  statements were made, not misleading with respect to the period covered by
  this annual report;                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|3. | Based on my knowledge, the financial statements, and other financial
  information included in this annual report, fairly present in all material
  respects the financial condition, results of operations and cash flows of the
  registrant as of, and for, the periods presented in this annual report;                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|4. | The registrants other certifying officers and I are responsible for
  establishing and maintaining disclosure controls and procedures (as defined
  in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|   | a)                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|   | b)                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|   | c)                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|5. | The registrants other certifying officers and I have disclosed,
  based on our most recent evaluation, to the registrants auditors and the
  audit committee of registrants board of directors (or persons performing the
  equivalent functions):                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|   | a)                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|   | b)                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|6. | The registrants other certifying officers and I have indicated in
  this annual report whether or not there were significant changes in internal
  controls or in other factors that could significantly affect internal
  controls subsequent to the date of our most recent evaluation, including any
  corrective actions with regard to significant deficiencies and material
  weaknesses.

|Dated: June
  27, 2003 | By: | /s/Oded
  Bashan                                   
|---------------------- | --- | ---------------------------------------------------
|                       |     |                                                    
|                       |     | Oded Bashan                                        
|                       |     | Chief
  Executive Officer and Chairman of the Board

73

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---

CERTIFICATION

I, Guy Shafran, certify that:

|1. | I have reviewed this annual report on Form 20-F of On Track
  Innovations Ltd.;                                                                                                                                                                                                                                                                                                                 
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|2. | Based on my knowledge, this annual report does not contain any untrue
  statement of a material fact or omit to state a material fact necessary to
  make the statements made, in light of the circumstances under which such
  statements were made, not misleading with respect to the period covered by
  this annual report;                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|3. | Based on my knowledge, the financial statements, and other financial
  information included in this annual report, fairly present in all material
  respects the financial condition, results of operations and cash flows of the
  registrant as of, and for, the periods presented in this annual report;                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|4. | The registrants other certifying officers and I are responsible for
  establishing and maintaining disclosure controls and procedures (as defined in
  Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:                                                                                                                                                                   
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|   | a)                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|   | b)                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|   | c)                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|5. | The registrants other certifying officers and I have disclosed,
  based on our most recent evaluation, to the registrants auditors and the
  audit committee of registrants board of directors (or persons performing the
  equivalent functions):                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|   | a)                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|   | b)                                                                                                                                                                                                                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                                                 
|6. | The registrants other certifying officers and I have indicated in
  this annual report whether or not there were significant changes in internal
  controls or in other factors that could significantly affect internal
  controls subsequent to the date of our most recent evaluation, including any
  corrective actions with regard to significant deficiencies and material
  weaknesses.

|Dated: June
  27, 2003 | By: | /s/ Guy
  Shafran        
|---------------------- | --- | -------------------------
|                       |     |                          
|                       |     | Guy Shafran              
|                       |     | Chief
  Financial Officer

74

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EXHIBIT 4

Material agreements (incorporated by reference to Exhibits 10.15 -
10.28 to the Companys Registration Statement on Form F-1, no. 333-90496).

10.15  Software Escrow Agreement, dated as
of March 16, 1999, by and among Personal
               Cipher
Card Corporation, Fort Knox Escrow Services, Inc. and OTI America, Inc.
10.16  License and Cooperation Agreement, dated as of May 18, 1998, between
Samsung
               Electronics
Co. Ltd. and the Registrant.
10.17  Acquisition Agreement, dated as of December 29, 1999, by and among City
Smart Ltd.,
               Wong
Ching Shan, City Smart (Australia) PTY Ltd. and the Registrant.
10.18  Shareholders Agreement, dated as of February 2, 2000, by and among
Ocean Wonder
               Ltd.,
Sailor Group Ltd., Cheung Kong Infrastructure Holdings Ltd. and the Registrant.
10.19  Acquisition Agreement, dated as of January 28, 2000, by and among
Softchip Israel Ltd.,
               Softchip
Technologies (3000) Ltd., Yael Cohen, Michael Cohen and the Registrant.
10.20  Acquisition Agreement, dated as of June 15, 2000, by and among Manfred
Weise,
               Dennis
Robert Weise, Patrick Norbert Weise, a civil partnership and the Registrant.
10.21  Put Option Agreement, dated as of June 15, 2000, by and among Manfred
Weise,
               Dennis
Robert Weise, Patrick Norbert Weise, a civil partnership and the Registrant.
10.22  Call Option Agreement, dated as of June 15, 2000, by and among Manfred
Weise,
               Dennis
Robert Weise, Patrick Norbert Weise, a civil partnership and the Registrant.
10.23  Share Pledge Agreement, dated as of June 15, 2000, by and among Manfred
Weise,
               Dennis
Robert Weise, Patrick Norbert Weise, a civil partnership and the Registrant.
10.24  Escrow Agreement with Respect to the Share Purchase Agreement, dated as
of June 15,
               2000,
by and among Manfred Weise, Dennis Robert Weise, Patrick Norbert Weise, a
               civil
partnership and the Registrant.
10.25  Escrow Agreement with Respect to the Option Agreements, dated as of
June 15, 2000,
               Weise,
Dennis Robert Weise, Patrick Norbert Weise, a civil
               partnership
and the Registrant.
10.26  General Term and Conditions of Sale of OTI.
10.27  Lease, dated as of June 27, 1995, by and between the Israel Lands
Authority and the
               Registrant.
10.28  Development Agreement, dated as of December 7, 1998, by and between the
Israel
               Lands
Authority and the Registrant.

75

---

---

EXHIBIT 10

CONSENT OF INDEPENDENT AUDITORS

We consent to the incorporation by reference
in the Registration Statements (Form S-8 and Form F-1), pertaining to the On
Track Innovations Ltd. 2001 Share Option Plan, 2001 Employee Share Purchase
Plan and 1995 Share Option Plan and pertaining to the Prospectus of On Track
Innovations Ltd. for the registration of 698,027 shares of its Ordinary shares
of our report dated March 28, 2003 with respect to the consolidated financial
statements of On Track Innovations Ltd. and its subsidiaries included in the
Annual Report on Form 20-F for the year ended December 31, 2002 of On Track
Innovations Ltd.

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



Tel Aviv, June 27, 2003

76

---

---

EXHIBIT 12.1

CERTIFICATION

PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY
ACT OF 2002
(SUBSECTIONS (a) AND (b) OF SECTION 1350, CHAPTER 63 OF
TITLE 18, UNITED STATES CODE)

Pursuant
to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of
section 1350, chapter 63 of title 18, United States Code), each of the
undersigned officers of OTI Software Systems Ltd., an Israeli corporation (the
Company), does hereby certify, to the best of such officers knowledge,
information and belief, that

The
Annual Report on Form 20-F for the year ended December 31, 2002 (the Form
20-F) of the Company fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934 and information contained in the
Form 20-F fairly presents, in all material respects, the financial condition
and results of operations of the Company.

|Dated: June
  27, 2003 | By: | /s/Oded Bashan                                        
|---------------------- | --- | ------------------------------------------------------
|                       |     |                                                       
|                       |     | Oded Bashan                                           
|                       |     | Chief
  Executive Officer  and Chairman of the
  Board
|                       |     |                                                       
|                       |     |                                                       
|                       | By: | /s/ Guy
  Shafran                                     
|                       |     |                                                       
|                       |     | Guy Shafran                                           
|                       |     | Chief
  Financial Officer                             



A
signed original of this written statement required by Section 906, or other
document authenticating, acknowledging, or otherwise adopting the signature
that appears in typed form within the electronic version of this written
statement required by Section 906, has been provided to On Track Innovations
Ltd. and will be retained by On Track Innovations Ltd. and furnished to the
Securities and Exchange Commission or its staff upon request.

77

---

---

| | ON
TRACK INNOVATIONS LTD. AND ITS SUBSIDIARIES | 
| | ---------------------------------------------- | 

CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 2002
U.S. Dollars in thousands

INDEX

|                                               | Page     
|---------------------------------------------- | ---------
|                                               |          
|                                               |          
|Report of Independent Auditors                 | F-2      
|                                               |          
|Consolidated Balance Sheets                    | F-3      
|                                               |          
|Consolidated Statements of Operations          | F-4      
|                                               |          
|Statements of Changes in Shareholders Equity  | F-5      
|                                               |          
|Consolidated Statements of Cash Flows          | F-6 - F-8
|                                               |          
|Notes to the Consolidated Financial Statements | F-9 - F52

#  #  #  #  #  #  #

F-1

---

---

ERNST
&YOUNG

REPORT
OF INDEPENDENT AUDITORS

To the Shareholders ofOn Track Innovations Ltd.

We have audited the accompanying consolidated balance sheets of On
Track Innovations Ltd. (the Company) and its subsidiaries as of December 31,
2001 and 2002 and the related consolidated statements of operations, changes in
shareholders equity and cash flows for each of the three years in the period
ended December 31, 2002. Our audits also included the financial statement schedule
listed at item 8. These financial statements are the responsibility of the
Companys management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the 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 statement 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 2001 and 2002 and the
consolidated results of their operations and cash flows for each of the three
years in the period ended December 31, 2002 in conformity with accounting
principles generally accepted in the United States.

As discussed in Note 2K to the consolidated financial statements, the
Company changed its method of accounting for goodwill and other intangible
assets, effective January 1, 2002, in accordance with the provisions of
Statement of Financial Accounting Standards No. 142 (SFAS 142) Goodwill and
Other Intangible Assets.

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

Tel-Aviv, Israel
March 28, 2003

F-2

---

---

ON TRACK INNOVATIONS LTD.

CONSOLIDATED STATEMENTS OF OPERATIONSUS dollars in thousands, except share and per share
data

|                                     |                                                                                                                                                                                                                          |      |       | December 31 |  
|------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ---- | ----- | ----------- | -
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|                                     |                                                                                                                                                                                                                          | Note |       | 2001        |  
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|ASSETS                               |                                                                                                                                                                                                                          |      |       |             |  
|                                     | CURRENT ASSETS                                                                                                                                                                                                           |      |       |             |  
|                                     | Cash and cash equivalents                                                                                                                                                                                                |      | (3)   |             | $
|                                     | Short-term investments                                                                                                                                                                                                   |      | (4)   |             |  
|                                     | Trade receivables (net of
  allowance for doubtful accounts of
  $64 and $244 as of December 31, 2001 and 2002,
  respectively)                                                                                          |      |       |             |  
|                                     | Other receivables and
  prepaid expenses                                                                                                                                                                                 |      | (5)   |             |  
|                                     | Inventories                                                                                                                                                                                                              |      | (6)   |             |  
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|                                     | Total current assets                                                                                                                                                                                                     |      |       |             |  
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|                                     | SEVERANCE PAY DEPOSITS
  FUND                                                                                                                                                                                            |      | (12)  |             |  
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|                                     | PROPERTY, PLANT AND
  EQUIPMENT, NET                                                                                                                                                                                     |      | (8)   |             |  
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|                                     | OTHER INTANGIBLE ASSETS,
  NET                                                                                                                                                                                           |      | (7E)  |             |  
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|                                     | GOODWILL                                                                                                                                                                                                                 |      | (7F)  |             |  
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|                                     | Total assets                                                                                                                                                                                                             |      |       |             | $
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|LIABILITIES AND SHAREHOLDERS EQUITY |                                                                                                                                                                                                                          |      |       |             |  
|                                     | CURRENT LIABILITIES                                                                                                                                                                                                      |      |       |             |  
|                                     | Short-term bank credit and
  current maturities of long-term
  bank loans                                                                                                                                                |      | (10C) |             | $
|                                     | Trade payables                                                                                                                                                                                                           |      |       |             |  
|                                     | Other current liabilities                                                                                                                                                                                                |      | (9)   |             |  
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|                                     | Total current liabilities                                                                                                                                                                                                |      |       |             |  
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|                                     | LONG-TERM LIABILITIES                                                                                                                                                                                                    |      |       |             |  
|                                     | Long-term loans, net of
  current maturities                                                                                                                                                                             |      | (10A) |             |  
|                                     | Convertible notes                                                                                                                                                                                                        |      | (11)  |             |  
|                                     | Deferred revenues                                                                                                                                                                                                        |      |       |             |  
|                                     | Accrued severance pay                                                                                                                                                                                                    |      | (12)  |             |  
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|                                     | Total long-term
  liabilities                                                                                                                                                                                            |      |       |             |  
|                                     |                                                                                                                                                                                                                          |      |       |             |  
|                                     | COMMITMENTS AND
  CONTINGENCIES                                                                                                                                                                                          |      | (13)  |             |  
|                                    
|                                     | SHAREHOLDERS EQUITY                                                                                                                                                                                                     |      | (14)  |             |  
|                                     | Ordinary shares of NIS 0.1
  par value:
  Authorized  5,000,000 shares as of 
  December 31, 2001 and 2002;
  Issued and outstanding - 1,589,311 and 1,817,156 shares as 
  of December 31, 2001 and 2002, 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 to the consolidated
financial statements form an integral part thereof.F-3

---

---

ON TRACK INNOVATIONS LTD.

CONSOLIDATED STATEMENTS OF OPERATIONSUS dollars in thousands, except share and per share
data

|                                                                                                     |                                                               |  |       |       | Year ended December 31 |          
|---------------------------------------------------------------------------------------------------- | ------------------------------------------------------------- |  | ----- | ----- | ---------------------- | ---------
|                                                                                                     |                                                               |  |       |       |                        |          
|                                                                                                     |                                                               |  | Note  |       | 2000                   |          
|                                                                                                     |                                                               |  |       |       |                        |          
|REVENUES                                                                                             |                                                               |  | (19)  |       |                        |          
|                                                                                                     | 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                                                |  |       | (15A) |                        |          
|                                                                                                     |                                                               |  |       |       |                        |          
|                                                                                                     | Total
  operating expenses                                    |  |       |       |                        |          
|                                                                                                     |                                                               |  |       |       |                        |          
|                                                                                                     |                                                               |  |       |       |                        |          
|                                                                                                     | Operating
  loss                                              |  |       |       |                        |          
|Financial
  income, net                                                                              |                                                               |  | (17)  |       |                        | 819      
|Other expenses,
  net                                                                                |                                                               |  | (15B) |       |                        | -        
|                                                                                                     |                                                               |  |       |       |                        |          
|                                                                                                     | Loss before
  income taxes                                    |  |       |       |                        |          
|Tax benefit
  (taxes on income)                                                                      |                                                               |  | (16)  |       |                        | 58       
|                                                                                                     |                                                               |  |       |       |                        |          
|                                                                                                     |                                                               |  |       |       |                        | (8,545   
|Minority interest
  in losses (earnings)
  Of subsidiaries                                           |                                                               |  |       |       |                        | 250      
|                                                                                                     |                                                               |  |       |       |                        |          
|                                                                                                     | Net loss                                                      |  |       |       |                        | $        
|                                                                                                     |                                                               |  |       |       |                        |          
|Basic and
  diluted net loss per share                                                               |                                                               |  |       |       | $                      | (5.60    
|                                                                                                     |                                                               |  |       |       |                        |          
|Weighted
  average number of shares  
  used in computing net loss per 
  shares - basic and diluted |                                                               |  |       |       |                        | 1,480,494
|                                                                                                     |                                                               |  |       |       |                        |          
|                                                                                                     |                                                               |  |       |       |                        |          

The accompanying notes to the consolidated
financial statements form an integral part thereof.F-4

---

---

ON TRACK INNOVATIONS LTD.

STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITYUS dollars in thousands, except share data

|                                                                                                   |  | Number
  of shares |           | Share
  capital |  | Additionalpaid-in 
  capital |    | Deferred 
  stock
  compensation |  | Accumulated
  other
  comprehensive
  income |        | Accumulated
  deficit |  | Total 
  shareholders 
  equity |       
|-------------------------------------------------------------------------------------------------- |  | ------------------ | --------- | --------------- |  | ---------------------------- | -- | -------------------------------- |  | -------------------------------------------- | ------ | --------------------- |  | -------------------------------- | ------
|                                                                                                   |  |                    |           |                 |  |                              |    |                                  |  |                                              |        |                       |  |                                  |       
|                                                                                                   |  |                    |           |                 |  |                              |    |                                  |  |                                              |        |                       |  |                                  |       
|Balance as of January 1, 2000                                                                      |  |                    | 1,445,895 |                 |  | $                            | 44 |                                  |  | $                                            | 37,645 |                       |  | $                                | (306  
|Issuance of shares for the
  acquisitionof 100% of the SoftChip Group, netof issuance costs of $20 |  |                    | 12,119    |                 |  |                              | *  |                                  |  |                                              | 1,239  |                       |  |                                  | -     
|Issuance of shares for the
  acquisitionof 51% of the InterCard Group, net ofissuance costs of $40 |  |                    | 29,742    |                 |  |                              | 1  |                                  |  |                                              | 2,323  |                       |  |                                  | -     
|Exercise of options                                                                                |  |                    | 12,013    |                 |  |                              | *  |                                  |  |                                              | 145    |                       |  |                                  | -     
|Deferred stock compensation                                                                        |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | 230    |                       |  |                                  | (230  
|Deferred stock compensation
  inrespect of options granted to asubsidiarys CEO (Note 7A)          |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | 730    |                       |  |                                  | (730  
|Amortization of deferred
  stockcompensation                                                       |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | -      |                       |  |                                  | 416   
|Other comprehensive income
   foreign currency translation adjustments                            |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | -      |                       |  |                                  | -     
|Net loss                                                                                           |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | -      |                       |  |                                  | -     
|                                                                                                   |  |                    |           |                 |  |                              |    |                                  |  |                                              |        |                       |  |                                  |       
|Balance as of December 31, 2000                                                                    |  |                    | 1,499,769 |                 |  |                              | 45 |                                  |  |                                              | 42,312 |                       |  |                                  | (850  
|Issuance of shares for the
  acquisition of49% of the InterCard Group, net ofissuance costs of $84 |  |                    | 88,075    |                 |  |                              | 2  |                                  |  |                                              | 2,511  |                       |  |                                  | -     
|Exercise of options                                                                                |  |                    | 1,467     |                 |  |                              | *  |                                  |  |                                              | -      |                       |  |                                  | -     
|Amortization of deferred
  stock compensation                                                      |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | -      |                       |  |                                  | 309   
|Other comprehensive income-
  foreigncurrency translation adjustments                              |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | -      |                       |  |                                  | -     
|Net loss                                                                                           |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | -      |                       |  |                                  | -     
|                                                                                                   |  |                    |           |                 |  |                              |    |                                  |  |                                              |        |                       |  |                                  |       
|Balance as of December 31, 2001                                                                    |  |                    | 1,589,311 |                 |  |                              | 47 |                                  |  |                                              | 44,823 |                       |  |                                  | (541  
|Deferred stock compensation                                                                        |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | 2,182  |                       |  |                                  | (2,182
|Exercise of options                                                                                |  |                    | 227,845   |                 |  |                              | 5  |                                  |  |                                              | -      |                       |  |                                  | -     
|Amortization of deferred
  stock compensation                                                      |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | -      |                       |  |                                  | 1,608 
|Stock options granted to
  consultants                                                             |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | 1,058  |                       |  |                                  | -     
|Beneficial conversion
  feature onconvertible notes                                                |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | 42     |                       |  |                                  | -     
|Warrants issued in
  connection with the issuance of convertible notes                             |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | 42     |                       |  |                                  | -     
|Other comprehensive income
   foreign currency translation adjustments                            |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | -      |                       |  |                                  | -     
|Net loss                                                                                           |  |                    | -         |                 |  |                              | -  |                                  |  |                                              | -      |                       |  |                                  | -     
|                                                                                                   |  |                    |           |                 |  |                              |    |                                  |  |                                              |        |                       |  |                                  |       
|Balance as of December 31, 2002                                                                    |  |                    | 1,817,156 |                 |  | $                            | 52 |                                  |  | $                                            | 48,147 |                       |  | $                                | (1,115
|                                                                                                   |  |                    |           |                 |  |                              |    |                                  |  |                                              |        |                       |  |                                  |       

(*)     Represents
an amount lower than $1.

|                          |                                            | Year ended December 31 |  
|------------------------- | ------------------------------------------ | ---------------------- | -
|                          |                                            |                        |  
|                          |                                            | 2000                   |  
|                          |                                            |                        |  
|Total comprehensive loss: |                                            |                        |  
|                          | Net loss                                   |                        | $
|                          | Foreign
  currency translation adjustments |                        |  
|                          |                                            |                        |  
|                          | Total
  comprehensive loss                 |                        | $
|                          |                                            |                        |  

The accompanying notes to the consolidated
financial statements form an integral part thereof.F-5

---

---

ON TRACK INNOVATIONS LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWSUS Dollars in thousands, except share data

|                                                         |                                                                                              | Year ended December 31 |       
|-------------------------------------------------------- | -------------------------------------------------------------------------------------------- | ---------------------- | ------
|                                                         |                                                                                              |                        |       
|                                                         |                                                                                              | 2000                   |       
|                                                         |                                                                                              |                        |       
|CASH FLOWS FROM OPERATING ACTIVITIES                     |                                                                                              |                        |       
|                                                         | Net loss                                                                                     |                        | $     
|                                                         | Adjustments
  required to reconcile net loss to 
  net cash used in operating activities:    |                        |       
|                                                         | Amortization of deferred
  stock compensation                                                |                        |       
|                                                         | Stock options granted to
  consultants                                                       |                        |       
|                                                         | Loss (gain) on sale of
  property and equipment                                              |                        |       
|                                                         | Amortization of goodwill
  and intangible assets                                             |                        |       
|                                                         | Dissolution of a
  subsidiary of the InterCard Group                                         |                        |       
|                                                         | Depreciation                                                                                 |                        |       
|                                                         | Amortization of beneficial
  conversion feature 
  on convertible notes                      |                        |       
|                                                         | Accrued severance pay, net                                                                   |                        |       
|                                                         | Minority interest in
  losses (earnings) of subsidiaries                                     |                        |       
|                                                         | Other                                                                                        |                        |       
|                                                         | Decrease
  (increase) in marketable bonds held for
     trading, net                         |                        |       
|                                                         | Decrease
  (increase) in trade receivables                                                   |                        |       
|                                                         | Decrease
  (increase) in other receivables and 
     prepaid expenses                        |                        |       
|                                                         | Decrease
  (increase) in inventories                                                         |                        |       
|                                                         | Increase
  (decrease) in trade payables                                                      |                        |       
|                                                         | Decrease in
  other current liabilities                                                      |                        |       
|                                                         | Decrease in
  long-term deferred revenues                                                    |                        |       
|                                                         |                                                                                              |                        |       
|                                                         | Net cash
  used in operating activities                                                      |                        |       
|                                                         |                                                                                              |                        |       
|CASH FLOWS FROM INVESTING ACTIVITIES                     |                                                                                              |                        |       
|                                                         | Proceeds
  from short-term bank deposits                                                     |                        |       
|                                                         | Acquisition
  of the InterCard Group                                                         |                        |       
|                                                         | Acquisition
  of the SoftChip Group                                                          |                        |       
|                                                         | Proceeds
  from sale of property and equipment                                               |                        |       
|                                                         | Purchase of
  property and equipment                                                         |                        |       
|                                                         |                                                                                              |                        |       
|                                                         | Net cash
  provided by (used in) investing activities                                        |                        |       
|                                                         |                                                                                              |                        |       
|CASH FLOWS FROM FINANCING ACTIVITIES                     |                                                                                              |                        |       
|                                                         | Increase
  (decrease) in short-term bank credit, net                                         |                        |       
|                                                         | Proceeds
  from long-term bank loans                                                         |                        |       
|                                                         | Repayment of
  long-term bank loans                                                          |                        |       
|                                                         | Exercise of
  options                                                                        |                        |       
|                                                         | 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                                                    |                        |       
|                                                         |                                                                                              |                        |       
|DECREASE IN CASH AND CASH EQUIVALENTS                    |                                                                                              | $                      | (717  
|CASH AND CASH EQUIVALENTS AT THE
  BEGINNING OF THE YEAR |                                                                                              |                        | 16,315
|                                                         |                                                                                              |                        |       
|CASH AND CASH EQUIVALENTS AT THE END 
  OF THE YEAR      |                                                                                              | $                      | 15,598
|                                                         |                                                                                              |                        |       
|                                                         |                                                                                              |                        |       

The accompanying notes to the consolidated
financial statements form an integral part thereof.F-6

---

---

ON TRACK INNOVATIONS LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Cont.)US Dollars in thousands, except share data

|                                    |    | Year ended December 31                                                                 |                             
|----------------------------------- | -- | -------------------------------------------------------------------------------------- | ----------------------------
|                                    |    |                                                                                        |                             
|                                    |    | 2000                                                                                   |                             
|                                    |    |                                                                                        |                             
|                                    |    |                                                                                        |                             
|SUPPLEMENTARY CASH FLOW ACTIVITIES: |    |                                                                                        |                             
|                                    | A. | Cash paid during the period for:                                                       |                             
|                                    |    |                                                                                        | Interest                    
|                                    |    |                                                                                        | Income taxes                
|                                    | B. | Non-cash transactions:                                                                 |                             
|                                    |    | Issuance of
  shares in consideration for
     acquisition of:                         |                             
|                                    |    |                                                                                        | 51% of the
  InterCard Group
|                                    |    |                                                                                        | 100% of the
  SoftChip Group
|                                    |    |                                                                                        | 49% of the
  InterCard Group
|                                    |    | Acquisition
  of 39% of EasyPark Israel shares 
     through assumption of liabilities |                             
|                                    |    | Long-term loan received in
  consideration for 
     equity interest in subsidiaries   |                             
|                                    |    |                                                                                        |                             

The accompanying notes to the consolidated
financial statements form an integral part thereof.F-7

---

---

ON TRACK INNOVATIONS LTD.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Cont.)US Dollars in thousands, except share data

|    |                                    | Year ended
  December 31,
  2000                                                                                 |                                          
|--- | ---------------------------------- | ---------------------------------------------------------------------------------------------------------------- | -----------------------------------------
|    |                                    |                                                                                                                  |                                          
|(a) | Acquisition of the Intercard group |                                                                                                                  |                                          
|    |                                    | Estimated
  fair value of assets acquired and liabilities assumed of subsidiaries 
  at the date of acquisition: |                                          
|    |                                    | Working
  capital deficiency (excluding cash and cash equivalents)                                               |                                          
|    |                                    | Property and
  equipment                                                                                         |                                          
|    |                                    | Intangible
  Assets (primarily assembled workforce and software)                                                 |                                          
|    |                                    | Long-term
  liabilities                                                                                          |                                          
|    |                                    | Minority
  interests in investee companies upon acquisition                                                      |                                          
|    |                                    | Less                                                                                                             | - amount
  acquired by issuance of shares
|    |                                    |                                                                                                                  | - share
  issuance expenses              
|    |                                    |                                                                                                                  |                                          
|    |                                    |                                                                                                                  | $                                        
|    |                                    |                                                                                                                  |                                          
|    |                                    |                                                                                                                  |                                          
|    |                                    |                                                                                                                  | Year ended 
  December 31,
  2000        
|    |                                    |                                                                                                                  |                                          
|(b) | Acquisition of the Softchip group  |                                                                                                                  |                                          
|    |                                    | Estimated
  fair value of assets acquired and liabilities assumed of subsidiariesat the
  date of acquisition:   |                                          
|    |                                    | Working
  capital (excluding cash and cash equivalents)                                                          |                                          
|    |                                    | Property and
  equipment                                                                                         |                                          
|    |                                    | Intangible
  Assets (primarily assembled workforce and software                                                  |                                          
|    |                                    | Long-term
  liabilities                                                                                          |                                          
|    |                                    | Less                                                                                                             | - amount
  acquired by issuance of shares
|    |                                    |                                                                                                                  | - share
  issuance expenses              
|    |                                    |                                                                                                                  |                                          
|    |                                    |                                                                                                                  | $                                        
|    |                                    |                                                                                                                  |                                          

The accompanying notes to the consolidated
financial statements form an integral part thereof.F-8

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTSU.S.
Dollars in thousands

|Note 1  - | GENERAL                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|          | On Track Innovations Ltd. (the Company or
  OTI) 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 (US GAAP). The significant accounting policies followed in the
  preparation of the financial statements, applied on a consistent basis,
  except as described in K below, are:                                                                                                                                                                                                                                                         
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|          | A.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|          | B.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|          |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

F-9

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

|Note 2  - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|--------- | ---------------------------------------
|          |                                        
|          | B.                                     
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          | C.                                     
|          |                                        
|          |                                        
|          |                                        
|          | D.                                     
|          |                                        
|          |                                        

F-10

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

|Note 2  - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|--------- | ---------------------------------------
|          |                                        
|          | E.                                     
|          |                                        
|          |                                        
|          |                                        
|          | F.                                     
|          |                                        
|          |                                        
|          |                                        
|          | G.                                     
|          |                                        
|          |                                        

F-11

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

|Note 2  - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|--------- | ---------------------------------------
|          |                                        
|          | H.                                     
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          | I.                                     
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          | J.                                     
|          |                                        
|          |                                        
|          |                                        

F-12

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

|Note 2  - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|--------- | ---------------------------------------
|          |                                        
|          | K.                                     
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        

F-13

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

|Note 2  - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|--------- | ---------------------------------------
|          |                                        
|          | K.                                     
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        

F-14

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

|Note 2  - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|--------- | ---------------------------------------
|          |                                        
|          | K.                                     
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        

F-15

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

|Note 2  - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|--------- | ---------------------------------------
|          |                                        
|          | L.                                     
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          | M.                                     
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        

F-16

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

|Note 2  - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|--------- | ---------------------------------------
|          |                                        
|          | M.                                     
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          | N.                                     
|          |                                        
|          |                                        
|          |                                        
|          | O.                                     
|          |                                        
|          |                                        

F-17

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

|Note 2  - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|--------- | ---------------------------------------
|          |                                        
|          | P.                                     
|          |                                        
|          |                                        
|          |                                        
|          |                                        

F-18

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

|Note 2  - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|--------- | ---------------------------------------
|          |                                        
|          | P.                                     
|          |                                        
|          |                                        

| |                                                                                                                                                   |                    | Year ended December 31 |       
| | ------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------ | ---------------------- | ------
| |                                                                                                                                                   |                    |                        |       
| |                                                                                                                                                   |                    | 2000                   |       
| |                                                                                                                                                   |                    |                        |       
| |                                                                                                                                                   |                    |                        |       
| | Net loss as reported                                                                                                                              |                    | $                      | (8,295
| | Add: Stock- based employee 
  compensation expense 
  included  in reported net loss                                                              |                    |                        | 416   
| | Deduct: 
  Stock-based 
     compensation expense 
     determined under fair value 
     method for all awards, net of 
     related tax effects |                    |                        | (743  
| |                                                                                                                                                   |                    |                        |       
| |                                                                                                                                                   |                    |                        |       
| |                                                                                                                                                   | Pro forma net loss |                        | $     
| |                                                                                                                                                   |                    |                        |       
| |                                                                                                                                                   |                    |                        |       
| | Basic and diluted net loss per 
     share:                                                                                                       |                    |                        |       
| |                                                                                                                                                   | As reported        |                        |       
| |                                                                                                                                                   | Pro forma          |                        |       

| |  | 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.
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-19

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

| | Q. | BASIC AND DILUTED NET LOSS PER SHARE                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
| |    | Basic net earnings (loss) per share is
  computed based on the weighted average number of shares of ordinary shares
  outstanding during each year. Diluted net earnings (loss) per share is
  computed based on the weighted average number of shares of ordinary shares
  outstanding during each year, plus dilutive potential shares of ordinary
  shares considered outstanding during the year, in accordance with Statement
  of Financial Standard No. 128, Earnings Per Share. (SFAS No. 128).

F-20

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

|Note 2  - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|--------- | ---------------------------------------
|          |                                        
|          | Q.                                     
|          |                                        
|          |                                        
|          |                                        
|          | R.                                     
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          | S.                                     
|          |                                        
|          |                                        

F-21

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

|Note 2  - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|--------- | ---------------------------------------
|          |                                        
|          | T.                                     
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          | U.                                     
|          |                                        
|          |                                        
|          |                                        
|          | V.                                     
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        

F-22

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

|Note 2  - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|--------- | ---------------------------------------
|          |                                        
|          | V.                                     
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          |                                        
|          | W.                                     
|          |                                        
|          |                                        

F-23

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands

|Note 2  - | SIGNIFICANT ACCOUNTING POLICIES (Cont.)
|--------- | ---------------------------------------
|          |                                        
|          | W.                                     
|          |                                        
|          |                                        

F-24

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
Dollars in thousands

|Note 3  - | CASH AND CASH EQUIVALENTS
|--------- | -------------------------

| |                                                                               |  | December 31 |      
| | ----------------------------------------------------------------------------- |  | ----------- | -----
| |                                                                               |  |             |      
| |                                                                               |  | 2001        |      
| |                                                                               |  |             |      
| |                                                                               |  |             |      
| | Cash in banks                                                                 |  | $           | 192  
| | Bank deposits in U.S. dollars (2002 -
  bearing annual interest rate
  of 2%) |  |             | 5,749
| | Bank deposits in Euro (2002 -
  bearing annual interest rate of 2%)           |  |             | 49   
| | Bank deposits in NIS (2002 - bearing
  annual interest rate of 3%)            |  |             | 40   
| |                                                                               |  |             |      
| |                                                                               |  | $           | 6,030
| |                                                                               |  |             |      

|Note 4 
  - | SHORT-TERM INVESTMENTS                                                                                                
|----------- | ----------------------------------------------------------------------------------------------------------------------
|            |                                                                                                                       
|            | Short-term investments comprise marketable bonds of the State of
  Israel (2002  bearing annual interest rate of 2%).
|            |                                                                                                                       
|            | As for liens, see Note 13C.                                                                                           
|            |                                                                                                                       
|Note 5  -   | OTHER RECEIVABLES AND PREPAID EXPENSES                                                                                

| |                         |  | December 31 |      
| | ----------------------- |  | ----------- | -----
| |                         |  |             |      
| |                         |  | 2001        |      
| |                         |  |             |      
| | Government institutions |  | $           | 279  
| | Prepaid expenses        |  |             | 163  
| | Other receivables       |  |             | 649  
| |                         |  |             |      
| |                         |  | $           | 1,091
| |                         |  |             |      

|Note 6 - | INVENTORIES
|-------- | -----------

| |                   |  | December 31 |      
| | ----------------- |  | ----------- | -----
| |                   |  |             |      
| |                   |  | 2001        |      
| |                   |  |             |      
| |                   |  |             |      
| | Raw materials     |  | $           | 2,165
| | Work in progress  |  |             | 1,433
| | Finished products |  |             | 1,400
| |                   |  |             |      
| |                   |  | $           | 4,998
| |                   |  |             |      

F-25

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note 7  - | ACQUISITIONS AND INVESTMENTS
|--------- | ----------------------------
|          |                             
|          | A.                          
|          |                             
|          |                             
|          |                             
|          |                             
|          |                             
|          |                             
|          |                             
|          |                             

F-26

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note 7  - | ACQUISITIONS AND INVESTMENTS (Cont.)
|--------- | ------------------------------------
|          |                                     
|          | B.                                  
|          |                                     
|          |                                     
|          |                                     
|          |                                     
|          |                                     
|          |                                     
|          |                                     
|          |                                     

F-27

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note 7  - | ACQUISITIONS AND INVESTMENTS
  (Cont.)
|--------- | --------------------------------------
|          |                                       
|          | B.                                    
|          |                                       
|          |                                       
|          |                                       
|          |                                       

F-28

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note 7  - | ACQUISITIONS AND INVESTMENTS
  (Cont.)
|--------- | --------------------------------------
|          |                                       
|          | B.                                    
|          |                                       
|          |                                       
|          |                                       
|          |                                       
|          |                                       
|          |                                       

| |                                                 |  | Year endedDecember 31,
  2000 |       
| | ----------------------------------------------- |  | ----------------------------- | ------
| |                                                 |  |                               |       
| |                                                 |  |                               |       
| | Revenues                                        |  | $                             | 15,981
| | Net loss                                        |  |                               | (8,327
| | Net loss per ordinary share-  basic and diluted |  |                               | (5.62 

| | 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 Macau). 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 off set
  against the $500 deferred investment by the Company.

F-29

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note 7  - | ACQUISITIONS AND INVESTMENTS (Cont.)
|--------- | ------------------------------------
|          |                                     
|          | C.                                  
|          |                                     
|          |                                     
|          |                                     
|          |                                     
|          |                                     
|          |                                     
|          |                                     
|          |                                     

F-30

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note 7  - | ACQUISITIONS AND INVESTMENTS
  (Cont.)
|--------- | --------------------------------------
|          |                                       
|          | C.                                    
|          |                                       
|          |                                       
|          |                                       
|          | D.                                    
|          |                                       
|          |                                       
|          |                                       
|          |                                       

F-31

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note 7  - | ACQUISITIONS AND INVESTMENTS (Cont.)
|--------- | ------------------------------------
|          |                                     
|          | E.                                  

| |                            |                       | December 31, |      
| | -------------------------- | --------------------- | ------------ | -----
| |                            |                       |              |      
| |                            |                       | 2001         |      
| |                            |                       |              |      
| |                            |                       |              |      
| | Cost                       |                       |              |      
| |                            | Technology            |              | $    
| |                            | Assembled
  workforce |              |      
| |                            |                       |              |      
| |                            |                       |              | 7,326
| |                            |                       |              |      
| | Accumulated
  amortization |                       |              |      
| |                            | Technology            |              |      
| |                            | Assembled
  workforce |              |      
| |                            |                       |              |      
| |                            |                       |              | 1,596
| |                            |                       |              |      
| |                            |                       | $            | 5,730
| |                            |                       |              |      

| | (*)                                                         | See Note 2K.                                                                                                                                                                                                                   
| | ----------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                             |                                                                                                                                                                                                                                
| | a.                                                          | Amortization expenses amounted to $45, $98
  and $161 for the years ended December 31, 2000, 2001 and 2002 , respectively.                                                                                                     
| |                                                             |                                                                                                                                                                                                                                
| | b.                                                          | During 2002, the Company purchased
  technology as part of its acquisition of EasyPark Israel (see Note 7D
  above).  The purchase has been
  recorded as acquired technology and will be amortized over a three year
  period.
| |                                                             |                                                                                                                                                                                                                                
| | c.   Estimated amortization expenses
  for the years ended:

| | December 31 |  |   |     | 
| | ----------- |  | - | --- | 
| |             |  |   |     | 
| | 2003        |  | $ | 189 | 
| | 2004        |  |   | 189 | 
| | 2005        |  |   | 75  | 
| | 2006        |  |   | 44  | 
| | 2007        |  |   | 16  | 

F-32

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note 7  - | ACQUISITIONS AND INVESTMENTS
  (Cont.)
|--------- | --------------------------------------
|          |                                       
|          | F.                                    
|          |                                       
|          |                                       

| |                         |                               | Year ended
  December 31 |       
| | ----------------------- | ----------------------------- | ------------------------ | ------
| |                         |                               |                          |       
| |                         |                               | 2000                     |       
| |                         |                               |                          |       
| |                         |                               |                          |       
| | Reported
  net loss     |                               | $                        | (8,295
| | Goodwill
  amortization |                               |                          | 409   
| |                         |                               |                          |       
| | Adjusted
  net loss     |                               | $                        | (7,886
| |                         |                               |                          |       
| |                         |                               |                          |       
| | Net
  loss per share    |                               |                          |       
| |                         | Reported
  net loss per share |                          | $     
| |                         | Goodwill
  amortization       |                          |       
| |                         |                               |                          |       
| |                         | Adjusted
  net loss per share |                          | $     
| |                         |                               |                          |       

F-33

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  8  - | PROPERTY
  AND EQUIPMENT, NET
|----------- | -----------------------------

| |                            |                                                     | December 31 |  
| | -------------------------- | --------------------------------------------------- | ----------- | -
| |                            |                                                     |             |  
| |                            |                                                     | 2001        |  
| |                            |                                                     |             |  
| | Cost                       |                                                     |             |  
| |                            | Land                                                |             | $
| |                            | Leasehold land (1)                                  |             |  
| |                            | Buildings on leasehold
  land (1)                   |             |  
| |                            | Buildings                                           |             |  
| |                            | Building under
  construction (1)                   |             |  
| |                            | Computers, software and 
   manufacturing equipment |             |  
| |                            | Office furniture and
  equipment                    |             |  
| |                            | Motor vehicles                                      |             |  
| |                            |                                                     |             |  
| |                            |                                                     |             |  
| |                            | Total cost                                          |             |  
| |                            |                                                     |             |  
| |                            |                                                     |             |  
| | Accumulated
  depreciation |                                                     |             |  
| |                            | Buildings on leasehold
  land                       |             |  
| |                            | Buildings                                           |             |  
| |                            | Computers, software and 
   manufacturing equipment |             |  
| |                            | Office furniture and
  equipment                    |             |  
| |                            | Motor vehicles                                      |             |  
| |                            |                                                     |             |  
| |                            |                                                     |             |  
| |                            | Total accumulated
  depreciation                    |             |  
| |                            |                                                     |             |  
| |                            |                                                     |             |  
| |                            | Depreciated cost                                    |             | $
| |                            |                                                     |             |  
| |                            |                                                     |             |  

| | Depreciation
  expense for the years ended December 31, 2000, 2001 and 2002 was $569, $988,
  and $897, respectively.
| | ---------------------------------------------------------------------------------------------------------------------
| |                                                                                                                      
| | (2)                                                                                                                  
| |                                                                                                                      
| | (2)                                                                                                                  
| |                                                                                                                      

F-34

---

---

ON TRACK INNOVATIONS LTD.

NOTES TO THE
CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  9  - | OTHER
  CURRENT LIABILITIES
|----------- | ---------------------------

| |                                |  | December 31 |      
| | ------------------------------ |  | ----------- | -----
| |                                |  |             |      
| |                                |  | 2001        |      
| |                                |  |             |      
| |                                |  |             |      
| | Employees and related expenses |  | $           | 1,309
| | Accrued expenses               |  |             | 639  
| | Customers advances            |  |             | 334  
| | Other current liabilities      |  |             | 181  
| |                                |  |             |      
| |                                |  | $           | 2,463
| |                                |  |             |      

|Note 10 - | LOANS
|--------- | -----
|          |      
|          | A.   

| |                           |  | December 31 |      
| | ------------------------- |  | ----------- | -----
| |                           |  |             |      
| |                           |  | 2001        |      
| |                           |  |             |      
| |                           |  |             |      
| | Long-term loans           |  | $           | 6,264
| | Less - current maturities |  |             | 1,513
| |                           |  |             |      
| |                           |  | $           | 4,751
| |                           |  |             |      

| |    | As of
  December 31, 2001, the loans are primarily from banks and are denominated in
  US dollars ($4,150), DM ($1,617), and NIS ($497) and bear interest of
  approximately 4.9% - 10.8% per annum.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                     
| |    | As of
  December 31, 2002, the loans are primarily from banks and are denominated in
  US dollars ($3,442),  ($1,578), and NIS ($512) and bear interest of
  approximately 4.3% - 10.8% per annum. 
| |    |                                                                                                                                                                                                     
| | B. | REPAYMENTS OF LONG-TERM LOANS DATES SUBSEQUENT TO BALANCE SHEET DATE:                                                                                                                               

| |                                 |  | December 31
  2002 |      
| | ------------------------------- |  | ------------------ | -----
| |                                 |  |                    |      
| |                                 |  |                    |      
| | First year (current maturities) |  | $                  | 1,526
| | Second year                     |  |                    | 1,206
| | Third year                      |  |                    | 745  
| | Fourth year                     |  |                    | 442  
| | Fifth year and thereafter       |  |                    | 1,613
| |                                 |  |                    |      
| |                                 |  | $                  | 5,532
| |                                 |  |                    |      

F-35

---

---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note 10 - | LOANS (Cont.)
|--------- | -------------
|          |              
|          | C.           

| |                                         |  | December 31       |      | December 31 | 
| | --------------------------------------- |  | ----------------- | ---- | ----------- | 
| |                                         |  |                   |      |             | 
| |                                         |  | 2001              |      | 2002        | 
| |                                         |  |                   |      |             | 
| |                                         |  | %
  interest rate |      |             | 
| |                                         |  |                   |      |             | 
| |                                         |  |                   |      |             | 
| | In U.S. dollars                         |  |                   | -    |             | 
| | In New Israeli shekels                  |  |                   | 10.3 |             | 
| | In DM                                   |  |                   | 8.2  |             | 
| | In Euros                               |  |                   | -    |             | 
| |                                         |  |                   |      |             | 
| |                                         |  |                   |      |             | 
| | Current maturities
  of long-term loans |  |                   |      |             | 
| |                                         |  |                   |      |             | 
| |                                         |  |                   |      |             | 
| |                                         |  |                   |      |             | 

|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            | The
  percentage weighted average interest rate for the years ended December 31,
  2001, and 2002 were 8.7% and 9.8% respectively.
|----------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |                                                                                                                                   
|            | D.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         | Liens for
  short-term and long-term borrowings - see Note 13C.                                                                   
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |                                                                                                                                   
|            | E.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         | The Company
  has an authorized credit line of approximately $1.2 million which was fully
  utilized.                             
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |                                                                                                                                   
|Note
  11 - | CONVERTIBLE
  NOTES                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|            | The Company issued $250,000 10% Redeemable
  Convertible Promissory Notes (the notes) which may be converted into
  ordinary shares of the Company.  The
  conversion price shall be the average closing price of the Companys shares on
  NASDAQ during the ten (10) consecutive trading days prior to the conversion
  which in no event will be less than 75% or greater than 125% of the closing
  price on the day of closing ($6.00). 
  The entire principal balance is due on December 31, 2004.  The notes are exercisable 90 days from the
  date of closing.
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |                                                                                                                                   
|            | As of December 31, 2002, none of the notes
  has been converted into ordinary shares.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

F-36

---

---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  11 - | CONVERTIBLE
  NOTES (Cont.)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|----------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            | In connection with the issuance of these
  notes, the Company also issued detachable warrants to purchase an aggregate
  of 16,758 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 on December
  5, 2002, the Company was required according to EITF No. 00-27 Application of
  Issue No. 98-5 to Certain Convertible Instruments to record a discount in
  the amount of approximately $42 which is being amortized to financial
  expenses over a period of two years.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            | According to EITF 98-5 Accounting for
  Convertible Securities with Beneficial Conversion Features or Contingently
  Adjustable Conversion Ratios, 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.
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|Note
  12 - | SEVERANCE
  PAY                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|            | Severance
  pay expenses for the periods ended December 31, 2000, 2001 and 2002 amounted
  to approximately $267, $262 and $65, respectively.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

F-37

---

---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  13 - | COMMITMENTS
  AND CONTINGENCIES
|----------- | -------------------------------
|            |                                
|            | A.                             
|            |                                
|            |                                
|            |                                
|            |                                
|            |                                
|            | B.                             
|            |                                
|            |                                
|            |                                
|            |                                

| | 2003 |  | $ | 234 |  | 
| | ---- |  | - | --- |  | 
| | 2004 |  |   | 234 |  | 
| | 2005 |  |   | 234 |  | 
| |      |  |   |    
| |      |  | $ | 702 |  | 
| |      |  |   |    

| |    | Rent expense
  amounted to $98, $163, $218 for the years ended December 31, 2000, 2001, and
  2002 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.                                                                                 
| |    |                                                                                                                                                                                                                      
| |    | Short-term
  investments and 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.                                                                                                               

F-38

---

---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  14 - | SHAREHOLDERS
  EQUITY
|----------- | ----------------------
|            |                       
|            | A.                    
|            |                       
|            |                       
|            |                       
|            |                       
|            |                       
|            |                       
|            |                       
|            | B.                    
|            |                       
|            |                       
|            |                       
|            |                       

F-39

---

---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  14 - | SHAREHOLDERS
  EQUITY (Cont.)
|----------- | ------------------------------
|            |                               
|            | B.                            
|            |                               
|            |                               
|            |                               
|            |                               
|            |                               
|            |                               

F-40

---

---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  14 - | SHAREHOLDERS
  EQUITY (Cont.)
|----------- | ------------------------------
|            |                               
|            | B.                            
|            |                               
|            |                               
|            |                               
|            |                               
|            |                               
|            |                               

F-41

---

---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  14 - | SHAREHOLDERS
  EQUITY (Cont.)
|----------- | ------------------------------
|            |                               
|            | B.                            
|            |                               
|            |                               
|            |                               
|            | C.                            
|            |                               
|            |                               
|            |                               
|            |                               
|            |                               
|            |                               

F-42

---

---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  14 - | SHAREHOLDERS
  EQUITY (Cont.)
|----------- | ------------------------------
|            |                               
|            | C.                            
|            |                               
|            |                               
|            |                               
|            |                               

F-43

---

---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  14 - | SHAREHOLDERS
  EQUITY (Cont.)
|----------- | ------------------------------
|            |                               
|            | C.                            
|            |                               
|            |                               

| |                                 |                                | Number of
  optionsoutstanding |         | Weighted
  average
  exercise
  priceper share |  
| | ------------------------------- | ------------------------------ | ------------------------------ | ------- | ---------------------------------------------- | -
| |                                 |                                |                                |         |                                                |  
| |                                 |                                |                                |         |                                                |  
| | Outstanding  January 1,  2000  |                                |                                | 20,080  |                                                |  
| |                                 | Options granted                |                                |         | 76,290                                         |  
| |                                 | Options cancelled or forfeited |                                |         | (1,910                                         | )
| |                                 | Options exercised              |                                |         | (12,013                                        | )
| |                                 |                                |                                |         |                                                |  
| | Outstanding  December 31, 2000 |                                |                                | 82,447  |                                                |  
| |                                 | Options granted                |                                |         | 87,935                                         |  
| |                                 | Options cancelled or forfeited |                                |         | (7,512                                         | )
| |                                 | Options exercised              |                                |         | (1,467                                         | )
| |                                 |                                |                                |         |                                                |  
| | Outstanding  December 31, 2001 |                                |                                | 161,403 |                                                |  
| |                                 | Options granted                |                                |         | 838,971                                        |  
| |                                 | Options cancelled or forfeited |                                |         | (6,885                                         | )
| |                                 | Options exercised              |                                |         | (227,845                                       | )
| |                                 |                                |                                |         |                                                |  
| | Outstanding  December 31, 2002 |                                |                                | 765,644 |                                                |  
| |                                 |                                |                                |         |                                                |  
| |                                 |                                |                                |         |                                                |  
| | Exercisable as of:              |                                |                                |         |                                                |  
| |                                 | December 31, 2000              |                                |         | 7,017                                          |  
| |                                 |                                |                                |         |                                                |  
| |                                 | December 31, 2001              |                                |         | 64,963                                         |  
| |                                 |                                |                                |         |                                                |  
| |                                 | December 31, 2002              |                                |         | 549,560                                        |  
| |                                 |                                |                                |         |                                                |  

F-44

---

---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  14 - | SHAREHOLDERS
  EQUITY (Cont.)
|----------- | ------------------------------
|            |                               
|            | C.                            
|            |                               
|            |                               

|                          |             |                                                    |  | Options Outstanding                                         |         | Options Exercisable                 | 
|------------------------- | ----------- | -------------------------------------------------- |  | ----------------------------------------------------------- | ------- | ----------------------------------- | 
|                          |             |                                                    |  |                                                             |         |                                     | 
|Range of
  ExercisePrices |             | Number
  Outstanding
  as of
  December 31,
  2002 |  | Weighted-
  Average
  Remaining
  Contractual
  Life(Years) |         | Weighted-
  Average
  ExercisePrice | 
|                          |             |                                                    |  |                                                             |         |                                     | 
|                          |             |                                                    |  |                                                             |         |                                     | 
|$                         | 0.10        |                                                    |  |                                                             | 139,646 |                                     | 
|                          | 4.76        |                                                    |  |                                                             | 1,200   |                                     | 
|                          | 6.36        |                                                    |  |                                                             | 128,940 |                                     | 
|                          | 8.21        |                                                    |  |                                                             | 320,650 |                                     | 
|                          | 9.20-9.9    |                                                    |  |                                                             | 18,990  |                                     | 
|                          | 16.2-17.99  |                                                    |  |                                                             | 15,000  |                                     | 
|                          | 25.92       |                                                    |  |                                                             | 2,500   |                                     | 
|                          | 29.70-30.50 |                                                    |  |                                                             | 72,793  |                                     | 
|                          | 39.13       |                                                    |  |                                                             | 3,600   |                                     | 
|                          | 45.00       |                                                    |  |                                                             | 2,000   |                                     | 
|                          | 60.00-62.10 |                                                    |  |                                                             | 27,000  |                                     | 
|                          | 68.80-72.10 |                                                    |  |                                                             | 11,538  |                                     | 
|                          | 102.71      |                                                    |  |                                                             | 21,787  |                                     | 
|                          |             |                                                    |  |                                                             |         |                                     | 
|                          |             |                                                    |  |                                                             | 765,644 |                                     | 
|                          |             |                                                    |  |                                                             |         |                                     | 

| | 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
  $960, $0 and $2,182 for options granted in the years ended December 31, 2000,
  2001 and 2002, respectively, are included in shareholders equity and are
  being amortized over the vesting periods of the respective options in
  accordance with APB 25.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F-45

---

---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  14 - | SHAREHOLDERS
  EQUITY (Cont.)                                                                                                                 
|----------- | -----------------------------------------------------------------------------------------------------------------------------------------------
|            |                                                                                                                                                
|            | C.                                                                                                                                             
|            |                                                                                                                                                
|            | The weighted
  average fair values of options (including non-employees) granted during the
  years ended December 31, 2000, 2001 and 2002 were:

|                                                 |  | For exercise price on the grant date that:    |      
|------------------------------------------------ |  | --------------------------------------------- | -----
|                                                 |  |                                               |      
|                                                 |  | Equals market price
  Year ended December 31, |      
|                                                 |  |                                               |      
|                                                 |  | 2000                                          |      
|                                                 |  |                                               |      
|                                                 |  |                                               |      
|Weighted
  average exercise prices               |  | $                                             | 102.4
|Weighted
  average fair values on
    grant date |  | $                                             | 60.5 

| | D. | 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.                                                                                                                    
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | E. | DIVIDENDS                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |    | The Company
  has never paid cash dividends to shareholders. The Company intends to retain
  future earnings for use in its business and does not anticipate paying cash
  dividends on its ordinary shares in the foreseeable future. Any future
  dividend policy will be determined by the Board of Directors and will be
  based upon conditions then existing, including results of operations, financial
  condition, current and anticipated cash needs, contractual restrictions and
  other conditions as the Board of Directors may deem relevant.

F-46

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---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  15 - | OTHER
  EXPENSES
|----------- | ----------------
|            |                 
|            | A.              
|            |                 
|            | B.              
|            |                 
|            |                 
|            |                 
|Note
  16 - | INCOME
  TAXES  
|            |                 
|            | A.              
|            |                 
|            |                 

F-47

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---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  16 - | INCOME
  TAXES (Cont.)
|----------- | ----------------------
|            |                       
|            | B.                    
|            |                       
|            |                       
|            |                       
|            |                       
|            |                       
|            |                       

F-48

---

---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  16 - | INCOME
  TAXES (Cont.)
|----------- | ----------------------
|            |                       
|            | B.                    
|            |                       
|            |                       
|            |                       
|            |                       
|            |                       
|            | C.                    
|            |                       
|            |                       
|            |                       
|            | D.                    

F-49

---

---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  16 - | INCOME
  TAXES (Cont.)
|----------- | ----------------------
|            |                       
|            | E.                    
|            |                       
|            | F.                    
|            |                       
|            | G.                    
|            |                       
|            | H.                    

| |                     |  | Year ended
  December 31 |      
| | ------------------- |  | ------------------------ | -----
| |                     |  |                          |      
| |                     |  | 2000                     |      
| |                     |  |                          |      
| |                     |  |                          |      
| | Domestic
  (Israel) |  | $                        | 5,788
| | Foreign             |  |                          | 2,815
| |                     |  |                          |      
| |                     |  | $                        | 8,603
| |                     |  |                          |      

| | I. | Non-Israeli
  subsidiaries are taxed based on tax laws in their countries of residence.                                                                                                                                                                              
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |                                                                                                                                                                                                                                                                      
| | J. | The main
  reconciling item between the statutory tax rate of the Company and the
  effective tax rate are the non-recognition of tax benefits from accumulated
  net operating carryforward losses due to the uncertainty of the realization
  of such tax benefits.

F-50

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---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  17 - | FINANCIAL
  INCOME, NET
|----------- | -----------------------

| |          |                                                                        | Year ended
  December 31 |      
| | -------- | ---------------------------------------------------------------------- | ------------------------ | -----
| |          |                                                                        |                          |      
| |          |                                                                        | 2000                     |      
| |          |                                                                        |                          |      
| |          |                                                                        |                          |      
| | Income   |                                                                        |                          |      
| |          | Interest on
  cash equivalents and 
   marketable bonds                |                          | $    
| |          | Foreign currency gains                                                 |                          |      
| |          |                                                                        |                          |      
| |          |                                                                        |                          | 1,300
| |          |                                                                        |                          |      
| |          |                                                                        |                          |      
| | Expenses |                                                                        |                          |      
| |          | Interest on short-term credit and 
   long-term loans                  |                          |      
| |          | Foreign currency losses                                                |                          |      
| |          | Amortization of beneficial conversion 
   feature on convertible notes |                          |      
| |          |                                                                        |                          |      
| |          |                                                                        |                          | 481  
| |          |                                                                        |                          |      
| |          |                                                                        | $                        | 819  
| |          |                                                                        |                          |      

|Note
  18 - | RELATED
  PARTY BALANCES AND TRANSACTIONS
|----------- | -----------------------------------------
|            |                                          
|            | A.                                       

| |              |                                            | December 31 |  
| | ------------ | ------------------------------------------ | ----------- | -
| |              |                                            |             |  
| |              |                                            | 2001        |  
| |              |                                            |             |  
| |              |                                            |             |  
| | Assets:      |                                            |             |  
| |              | Trade
  receivables                        |             | $
| |              |                                            |             |  
| | Liabilities: |                                            |             |  
| |              | Trade payables                             |             |  
| |              | Other current liabilities                  |             |  
| |              | Long-term loan (including current portion) |             |  

| | B. | TRANSACTIONS
| | -- | ------------

| |                      |  | Year ended
  December 31 |    
| | -------------------- |  | ------------------------ | ---
| |                      |  |                          |    
| |                      |  | 2000                     |    
| |                      |  |                          |    
| |                      |  |                          |    
| | Revenues             |  | $                        | 673
| | Costs and
  expenses |  |                          | 575
| | Other income         |  |                          | -  

F-51

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---

ON TRACK INNOVATIONS LTD.

NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS (Cont.)U.S.
dollars in thousands, except per share data

|Note
  19 - | 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 |       
| | ---------------------------------------------- | ------------ | ---------------------- | ------
| |                                                |              |                        |       
| |                                                |              | 2000                   |       
| |                                                |              |                        |       
| |                                                |              |                        |       
| | Revenues by geographical areasof end customers |              |                        |       
| | North America                                  |              | $                      | 2,479 
| | Far East                                       |              |                        | 1,739 
| | Africa                                         |              |                        | 1,047 
| | Europe                                         |              |                        | 7,390 
| | South America                                  |              |                        | 53    
| |                                                |              |                        |       
| |                                                |              |                        |       
| |                                                | Total export |                        |       
| | Domestic (Israel)                              |              |                        | 369   
| |                                                |              |                        |       
| |                                                |              | $                      | 13,077
| |                                                |              |                        |       
| |                                                |              |                        |       

| |                                         |  | December 31 |       
| | --------------------------------------- |  | ----------- | ------
| |                                         |  |             |       
| |                                         |  | 2001        |       
| |                                         |  |             |       
| | Long lived assets by geographical areas |  |             |       
| |                                         |  |             |       
| | Israel                                  |  | $           | 5,896 
| | Germany                                 |  |             | 6,130 
| | Other                                   |  |             | 206   
| |                                         |  |             |       
| |                                         |  | $           | 12,232
| |                                         |  |             |       

| |                                                  |  | Year ended December 31 |   
| | ------------------------------------------------ |  | ---------------------- | --
| |                                                  |  |                        |   
| |                                                  |  | 2000                   |   
| |                                                  |  |                        |   
| |                                                  |  |                        |   
| | Revenues from single customers
    exceeding 10% |  |                        |   
| | Customer
  A                                     |  |                        | 17
| |                                                  |  |                        |   
| | (*) Less
  than 10%                              |  |                        |   

********

F-52

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---

SCHEDULE II - VALUATION AND QUALIFYING
ACCOUNTSThree years ended December 31, 2002
US Dollars in thousands

|Column A                                                               |  | Column B                                   |     | Column C                                        |  | Column D                  |     | Column E                   | 
|---------------------------------------------------------------------- |  | ------------------------------------------ | --- | ----------------------------------------------- |  | ------------------------- | --- | -------------------------- | 
|                                                                       |  |                                            |     |                                                 |  |                           |     |                            | 
|Description                                                            |  | Balance at the
  beginning of
  the period |     | Additions
  charged
  statement of
  operations |  | Deductions
  from reserve |     | Balance at
  end of period | 
|                                                                       |  |                                            |     |                                                 |  |                           |     |                            | 
|Allowance for
  doubtful
  accounts:
  Year ended
  December
  31,2002 |  |                                            | 64  |                                                 |  |                           | 258 |                            | 
|                                                                       |  |                                            |     |                                                 |  |                           |     |                            | 
|Year ended
  December
  31,2001                                        |  |                                            | 240 |                                                 |  |                           | 566 |                            | 
|                                                                       |  |                                            |     |                                                 |  |                           |     |                            | 
|Year ended
  December
  31,2000                                        |  |                                            | 151 |                                                 |  |                           | 98  |                            | 

S-1

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