---

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

# FORM 20-F

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

# OR

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

# For the fiscal year
ended December 31, 2008

# OR

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

# For the transition
period from __________ to __________

# OR

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

Date of event requiring this shell company report _________

# For the transition period
from __________ to __________

Commission file number000-1021604



# 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)

Galit Mendelson, VP
of Corporate RelationsTel: (201) 944-5200 (#111)E-mail:
galit@otiglobal.com2 Executive Drive, Suite 740, Fort Lee, New Jersey 07024, USA(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

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

|                                              |                                          
|--------------------------------------------- | -----------------------------------------
|
|
|
|
|Title of each class                           | Name of each exchange on which registered
|                                              |                                          
|Ordinary Shares, par value NIS 0.10 per share | NASDAQ Global Market                     

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

# 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: 21,495,409 Ordinary
Shares, par value NIS 0.10 per share.

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

oYes    xNo

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

oYes    xNo

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.

xYes    oNo

Indicate
by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and
posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)
during the preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files).

oYes  oNo

Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated filer and large
accelerated filer in Rule 12b-2 of the Exchange Act.

|                          |                     |                        
|------------------------- | ------------------- | -----------------------
|
|
|
|
|Large Accelerated Filer o | Accelerated Filer o | Non-Accelerated Filer x

Indicate
by check mark which basis of accounting the registrant has used to prepare the financial
statements included in this filing:

|            |                                                 |        
|----------- | ----------------------------------------------- | -------
|
|
|
|
|U.S. GAAP x | International Financial Reporting Standards o   | Other o
|            | as issued by the International Accounting Board

If
Other has been checked in response to the previous question, indicate by check
mark which financial statement item the registrant has elected to follow:

Item 17 o       Item 18 o

If
this is an annual report, indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b-2 of the Exchange Act).

oYes    xNo

2

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# INTRODUCTION

Unless
indicated otherwise by the context, all references in this annual report to:

| |  | "we",
"us", "our", "OTI", or the "Company" are to On Track Innovations Ltd. and its
subsidiaries;
| | - | -------------------------------------------------------------------------------------------------

| |  | "dollars"
or "$" are to United States dollars;
| | - | ----------------------------------------------

| |  | "NIS"
or "shekels" are to New Israeli Shekels;
| | - | ----------------------------------------------

| |  | the
"Companies Law" or the "Israeli Companies Law" are to the Israeli Companies Law,
5759-1999; and
| | - | ---------------------------------------------------------------------------------------------------

| |  | the
"SEC" is to the United States Securities and Exchange Commission.
| | - | ---------------------------------------------------------------------

# CAUTIONARY STATEMENT
REGARDING FORWARD-LOOKING STATEMENTS

Except
for the historical information contained in this annual report, the statements contained
in this annual report are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities
Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of
1995, as amended, and other federal securities laws with respect to our business,
financial condition and results of operations. Such forward-looking statements reflect our
current view with respect to future events and financial results.

We
urge you to consider that statements which use the terms anticipate,
believe, expect, plan, intend,
estimate, anticipate and similar expressions are intended to
identify forward-looking statements. We remind readers that forward-looking statements are
merely predictions and therefore inherently subject to uncertainties and other factors and
involve known and unknown risks that could cause the actual results, performance, levels
of activity, or our achievements, or industry results, to be materially different from any
future results, performance, levels of activity, or our achievements, or industry results,
expressed or implied by such forward-looking statements. Such forward-looking statements
appear in Item 4  Information on the Company regarding, among other
things, our belief as to increased acceptance of smart-card technology, expansions of the
use of our technology, acquisitions, the impact of our relationship with technology
partners and business partners as well as to our revenue and the development of future
products, and 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, as well as elsewhere in this annual report.Readers
are cautioned not to place undue reliance on these forward-looking statements, which speak
only as of the date hereof. Except as required by applicable law, including the securities
laws of the United States, we undertake no obligation to publicly release any update or
revision to any forward-looking statements to reflect new information, future events or
circumstances, or otherwise after the date hereof. We have attempted to identify
significant uncertainties and other factors affecting forward-looking statements in the
Risk Factors section that appears in Item 3.D., Key Information- Risk Factors,
and elsewhere in this annual report.

3

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|          |                                                                              |   
|--------- | ---------------------------------------------------------------------------- | --
|
|
|
|
|ITEM 1.   | IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS                        | 6 
|ITEM 2.   | OFFER STATISTICS AND EXPECTED TIMETABLE                                      | 6 
|ITEM 3.   | KEY INFORMATION                                                              | 6 
|          | A.  SELECTED FINANCIAL DATA                                                  | 6 
|          | B.  CAPITALIZATION AND INDEBTEDNESS                                          | 7 
|          | C.  REASONS FOR THE OFFER AND USE OF PROCEEDS                                | 7 
|          | D.  RISK FACTORS                                                             | 7 
|ITEM 4.   | INFORMATION ON THE COMPANY                                                   | 19
|          | A.  HISTORY AND DEVELOPMENT OF THE COMPANY                                   | 19
|          | B.  BUSINESS OVERVIEW                                                        | 20
|          | C.  ORGANIZATIONAL STRUCTURE                                                 | 35
|          | D.  PROPERTY, PLANT AND EQUIPMENT                                            | 38
|ITEM 4A.  | UNRESOLVED STAFF COMMENTS                                                    | 38
|ITEM 5.   | OPERATING AND FINANCIAL REVIEW AND PROSPECTS                                 | 39
|          | A.  OPERATING RESULTS                                                        | 39
|          | B.  LIQUIDITY AND CAPITAL RESOURCES                                          | 47
|          | C.  RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC                      | 49
|          | D.  TREND INFORMATION                                                        | 49
|          | E.  OFF BALANCE SHEET ARRANGEMENTS                                           | 49
|          | F.  TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS                            | 49
|ITEM 6.   | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                                   | 50
|          | A.  DIRECTORS AND SENIOR MANAGEMENT                                          | 50
|          | B.  COMPENSATION                                                             | 52
|          | C.  BOARD PRACTICES                                                          | 54
|          | D.  EMPLOYEES                                                                | 58
|          | E.  SHARE OWNERSHIP                                                          | 58
|ITEM 7.   | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                            | 62
|          | A.  MAJOR SHAREHOLDERS                                                       | 62
|          | B.  RELATED PARTY TRANSACTIONS                                               | 63
|          | C.  INTERESTS OF EXPERTS AND COUNSEL                                         | 64
|ITEM 8.   | FINANCIAL INFORMATION                                                        | 64
|          | A.  CONSOLIDATED FINANCIAL STATEMENTS AND OTHER FINANCIAL INFORMATION        | 64
|          | B.  SIGNIFICANT CHANGES                                                      | 65
|ITEM 9.   | THE OFFER AND LISTING                                                        | 65
|          | A.  OFFER AND LISTING DETAILS                                                | 65
|          | B.  PLAN OF DISTRIBUTION                                                     | 66
|          | C.  MARKETS                                                                  | 66
|          | D.  SELLING SHAREHOLDERS                                                     | 66
|          | E.  DILUTION                                                                 | 66
|          | F.  EXPENSES OF THE ISSUE                                                    | 67
|ITEM 10.  | ADDITIONAL INFORMATION                                                       | 67
|          | A.  SHARE CAPITAL                                                            | 67
|          | B.  MEMORANDUM AND ARTICLES OF ASSOCIATION                                   | 67
|          | C.  MATERIAL CONTRACTS                                                       | 71
|          | D.  EXCHANGE CONTROLS                                                        | 72
|          | E.  TAXATION                                                                 | 72
|          | F.  DIVIDENDS AND PAYING AGENTS                                              | 83
|          | G.  STATEMENT BY EXPERTS                                                     | 83
|          | H.  DOCUMENTS ON DISPLAY                                                     | 84
|          | I.  SUBSIDIARY INFORMATION                                                   | 84
|ITEM 11.  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                   | 84
|ITEM 12.  | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES                       | 84
|ITEM 13.  | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                              | 84
|ITEM 14.  | MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS | 84
|ITEM 15T. | CONTROLS AND PROCEDURES                                                      | 85

4

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|          |                                                                        |   
|--------- | ---------------------------------------------------------------------- | --
|
|
|
|          |                                                                        |   
|ITEM 16A. | AUDIT COMMITTEE FINANCIAL EXPERT                                       | 86
|ITEM 16B. | CODE OF ETHICS                                                         | 86
|ITEM 16C. | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                 | 86
|ITEM 16D. | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES             | 87
|ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS | 87
|ITEM 16F. | CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT                          | 87
|ITEM 16G. | CORPORATE GOVERNANCE                                                   | 87
|ITEM 17.  | FINANCIAL STATEMENTS                                                   | 88
|ITEM 18.  | FINANCIAL STATEMENTS                                                   | 88
|ITEM 19.  | EXHIBITS                                                               | 88

5

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# PART I

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

Not applicable.

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

Not applicable.

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

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

The
following selected consolidated statements of operations data for the years ended December
31, 2006, 2007 and 2008, and the selected consolidated balance sheet data as of December
31, 2007 and 2008, have been derived from our audited consolidated financial statements
set forth elsewhere in this annual report. These financial statements have been prepared
in accordance with generally accepted accounting principles in the United States, or U.S.
GAAP. The selected consolidated statements of operations data for the years ended December
31, 2004 and 2005 and the selected consolidated balance sheet data as of December 31,
2004, 2005 and 2006 have been derived from our audited consolidated financial statements
not included in this annual report, which have also been prepared in accordance with U.S.
GAAP. The selected consolidated financial data set forth below should be read in
conjunction with and are qualified by reference to our consolidated financial statements
and the related notes, as well as Item 5.  Operating and Financial Review
and Prospects included elsewhere in this annual report. Effective as of June 17,
2002, we consummated a one for ten reverse share split of our ordinary shares, such that
every ten ordinary shares of NIS 0.01 par value became one ordinary share of NIS 0.1 par
value. All shares, per share, warrants and options amounts in the consolidated financial
statements have been adjusted to give retroactive effect to this reverse share split for
all periods presented.

|                                  | Year ended December 31
|--------------------------------- | ----------------------
|
|
|
|
|REVENUES                          |                       
|Sales                             |                       
|Licensing and transaction         |                       
|fees                              |                       
|                                  |                       
|Total revenues                    |                       
|                                  |                       
|                                  |                       
|COST OF REVENUES                  |                       
|Sales                             |                       
|                                  |                       
|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 and impairment       |                       
|of intangible assets              |                       
|Impairment of goodwill            |                       
|Expenses relating to raising of   |                       
|capital, exchange of subsidiary's |                       
|employees equity interest         |                       
|in equity interests of the        |                       
|Company and new acquisitions      |                       
|in the Far East                   |                       
|Gain from sale of                 |                       
|subsidiary                        |                       
|                                  |                       
|Total operating                   |                       
|expenses                          |                       
|                                  |                       

6

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|                                      | Year ended December 31
|------------------------------------- | ----------------------
|
|
|
|Operating loss                        |                       
|                                      |                       
|Financial income (expense), net       |                       
|Other income (expense), net           |                       
|                                      |                       
|Loss before taxes on income           |                       
|Taxes on income                       |                       
|Equity in net losses of affiliated    |                       
|company                               |                       
|Minority share in income (loss) of    |                       
|subsidiaries                          |                       
|                                      |                       
|Loss before extraordinary             |                       
|item                                  |                       
|Extraordinary item                    |                       
|                                      |                       
|Net loss                              |                       
|                                      |                       
|                                      |                       
|Basic and diluted net loss per        |                       
|ordinary share from:                  |                       
|Loss before extraordinary item        |                       
|Extraordinary item                    |                       
|                                      |                       
|Net loss                              |                       
|                                      |                       
|                                      |                       
|Weighted average number of ordinary   |                       
|shares used in computing net loss per |                       
|ordinary share - basic and diluted    |                       

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

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

Not applicable.

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

Not applicable.

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

The
following risk factors, among others, could in the future affect our actual results of
operations and could cause our actual results to differ materially from those expressed in
forward-looking statements made by us. These forward-looking statements are based on
current expectations and we assume no obligation to update this information. Before you
decide to buy, hold, or sell our ordinary shares, you should carefully consider the risks
described below, in addition to the other information contained elsewhere in this annual
report. The following risk factors are not the only risk factors facing our company.
Additional risks and uncertainties not presently known to us or that we currently deem
immaterial may also affect our business. Our business, financial condition and results of
operations could be seriously harmed if any of the events underlying any of these risks or
uncertainties actually occurs. In that event, the market price for our ordinary shares
could decline, and you may lose all or part of your investment.

7

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# Risks Related to Our
Business

We have a history of
losses and expect to continue to incur full-year losses at least through 2009.

We
have incurred losses in each year since we commenced operations in 1990. We reported net
losses of $9.3 million in 2004, $9.1 million in 2005, $6.6 million in 2006, $20.6 million
in 2007 and $50.0 million in 2008 (including a goodwill impairment charge of $24.2
million). We expect to incur full year losses at least through 2009, 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 in systems that contain our products,
enhance our research and development capabilities and expand our internal manufacturing
capabilities.

If the market for smart
cards in general, and for contactless microprocessor-based smart cards in particular,
does not grow, sales of our products may not grow and may even decline.

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

If we fail to develop new
products or adapt our existing products for use in new markets, our revenue growth may
be impeded and we may incur significant losses.

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

We have acquired several
companies or groups of companies and we intend to continue to pursue strategic acquisitions
in the future. The failure to successfully integrate acquired companies and businesses or to
acquire new companies and businesses may harm our financial performance and growth.

During
the last few years we acquired several companies around the world.

We
paid for all of these acquisitions through the issuance of our ordinary shares (and in
certain cases, warrants to purchase ordinary shares and cash consideration). These and
future acquisitions could result in:

| |  | difficulties
in integrating our operations, technologies, products and services with those of
         the acquired companies; o        difficulty in integrating operations that
are spread across significant geographic distances;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

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

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

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

We derive a portion of our
revenues from sales to systems integrators that are not the end-users of our products. We
are to a certain extent dependent on the ability of these integrators to maintain their
existing business and secure new business.

In
2006, 2007 and 2008, 8%, 8% and 9%, respectively, of our revenues were derived from sales
to systems integrators that incorporate our products into systems which they supply and
install for use in a specific project. To the extent our revenues depend on the ability of
systems integrators to successfully market, sell, install and provide technical support
for systems in which our products are integrated or to sell our products on a stand-alone
basis, our revenues may decline if the efforts of these systems integrators fail. Further,
the faulty or negligent implementation and installation of our products by systems
integrators may harm our reputation and dilute our brand name. Because we are one step
removed from the end-users of our products, it may be more difficult for us to rectify
damage to our reputation caused by systems integrators that have direct contact with
end-users. In addition, termination of agreements with systems integrators or revocation
of exclusive distribution rights within certain countries can be difficult. If we are
unable to maintain our current relationships with systems integrators or develop
relationships with new systems integrators, we may not be able to sell our products and
our results of operations could be impaired.

8

---

---

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 dependence on third
party distributors, sales agents, and value-added resellers could result in marketing
and distribution delays which would prevent us from generating sales revenues.

We
market and sell some of our products using a network of distributors covering several
major world regions, including the United States. We establish relationships with
distributors and resellers through written agreements that provide prices, discounts and
other material terms and conditions under which the reseller is eligible to purchase our
systems and products for resale. These agreements generally do not grant exclusivity to
the distributors and resellers and, as a general matter, are fixed-term contracts, do not
always have commitments for minimum sales and can be terminated by the distributor. We are
currently engaged in discussions with other potential distributors, sales agents, and
value-added resellers. Such arrangements may never be finalized and, if finalized, such
arrangements may not increase our revenues or enable us to achieve profitability.

Our
ability to terminate our relationship with a distributor that is not performing
satisfactorily may be limited. Inadequate performance by a distributor may affect our
ability to develop markets in the regions for which the distributor is responsible and
could result in substantially greater expenditures by us in order to develop such markets.
Our operating results will be highly dependent upon: (i) our ability to maintain our
existing distributor arrangements; (ii) our ability to establish and maintain coverage of
major geographic areas and establish access to customers and markets; and (iii) the
ability of our distributors, sales agents, and value-added resellers to successfully
market our products. A failure to achieve these objectives could result in lower revenues.

Our revenue growth may be
impaired if we are unable to maintain our current, and establish new, strategic
relationships.

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

The terms of certain of
our agreements may restrict our ability to take actions that we believe to be desirable.

Pursuant
to certain agreements we have entered into with our suppliers, distributors and joint
venture partners, we have agreed to restrict ourselves in some areas of business for
different time periods, ranging from several months to several years. In addition, in
certain markets, we sell our products through distributors which, in general, have
exclusive distribution rights in that market if specified sales quotas are met. The
foregoing could have a material adverse effect on our business, operating results and
financial condition if these partners do not perform in a satisfactory manner.

We face intense
competition. If we are unable to compete successfully, our business prospects will be impaired.

We
face intense competition from developers of contact and contactless microprocessor-based
technologies and products, developers of contactless products that use other types of
technologies that are not microprocessor-based, and non-smart card technologies. We
compete on the basis of a range of competitive factors including price, compatibility with
the products of other manufacturers, and the ability to support new industry standards and
introduce new reliable technologies. Many of our competitors, including NXP Semiconductors
(previously Philips Semiconductors), 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.

9

---

---

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

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

If there is a sustained
increase in demand for microprocessors, availability might be limited and prices might
increase.

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

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

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 that future contracts will result in commercial sales. Our average development
cycle is typically between 18 and 24 months from initial contact with a potential customer
until we deliver commercial quantities to the customer and recognize significant revenues.
As a result, we may expend financial, management and other resources to develop customer
relationships before we recognize any revenues.

Fluctuations in our
quarterly financial performance may create volatility in the market price of our shares
and may make it difficult to predict our future performance.

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

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

| |  | The
fact that our rental expenses are fixed and we may not be able to reduce these expenses
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.

10

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Delays or discontinuance
of the supply of components may hamper our ability to produce our products on a timely
basis and cause short-term adverse effects.

The
components we use in our products, including microprocessors and cards, are supplied by
third party suppliers and manufacturers. We sometimes experience short-term adverse
effects due to delayed shipments that have in the past interrupted and delayed, and could
in the future interrupt and delay, the supply of our products to our customers, and may
result in cancellation of orders for our products. In addition, we do not generally have
long term supply contracts under which our suppliers are committed to supply us with
components at a fixed price. Suppliers could increase component prices significantly
without warning or could discontinue the manufacturing or supply of components used in our
products. We may not be able to develop alternative sources for product components if and
as required in the future. Even if we are able to identify alternative sources of supply,
we may need to modify our products to render them compatible with other components. This
may cause delays in product shipments, increase manufacturing costs and increase product
prices.

Because
some of our suppliers are located in Europe and the Far East, we may experience logistical
problems in our supply chain, including long lead times for receipt of products or
components and shipping delays. In addition, our subcontractors 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.

If we fail to hire, train
and retain qualified research and development personnel, our ability to enhance our
existing products, develop new products and compete successfully may be materially and adversely
affected.

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

Our ability to compete
depends on our continuing right to use, and our ability to protect, our intellectual
property rights.

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

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

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

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

11

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Our products may infringe
the intellectual property rights of others.

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

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

The loss of the services
of our Chairman and Chief Executive Officer, Oded Bashan, could seriously harm our
business.

Our
success depends, in part, on the continued services of Oded Bashan, our Chairman 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.

We are susceptible to
changes in international markets and difficulties with international operations could
harm our business.

We
have derived revenues from different geographical areas. The following table sets forth
our sales in different geographical areas as a percentage of revenues:

|     | Africa | Europe | Far East | Americas | Israel
|---- | ------ | ------ | -------- | -------- | ------
|
|
|
|
|2004 | 11     | 64     | 6        | 11       | 8     
|2005 | 11     | 26     | 15       | 39       | 9     
|2006 | 8      | 35     | 29       | 20       | 8     
|2007 | 11     | 41     | 21       | 17       | 10    
|2008 | 13     | 48     | 16       | 13       | 10    

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

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

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

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

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

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

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| |  | 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 is incurred in other currencies,
currency fluctuations could adversely affect our results of operations.

We
generate a significant portion of our revenues in U.S. dollars but we incur a large
portion of our expenses in other currencies, principally some employees salaries in
New Israeli Shekels, and the majority of the expenses of our German, French and Polish
subsidiaries, InterCard, InSeal, PARX France and ASEC, in euros and of our subsidiary in
the Far East, MCT, in Yuan Renminbi. To the extent that we and our subsidiaries based in
Israel, Europe and the Far East conduct our business in different currencies, our revenues
and expenses and, as a result, our assets and liabilities, are not necessarily accounted
for in the same currency. We are, therefore, exposed to foreign currency exchange rate
fluctuations. These fluctuations may negatively affect our results of operations. Our
operations could also be adversely affected if we are unable to limit our exposure to
currency fluctuations in the future. Accordingly, we may enter into currency hedging
transactions to decrease the risk of financial exposure to fluctuations in the exchange
rate of the U.S. dollar against the New Israeli Shekel or other currencies.

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

We may have to adapt our
products in order to integrate them into our customers systems if new government
regulations or industry standards are adopted or current regulations or standards are
changed.

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

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

Our products may contain
defects that are only discovered after the products have been deployed. This could harm
our reputation, result in loss of customers and revenues and subject us to product
liability claims.

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

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

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

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

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

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

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

We have sought government
contracts in the past and may seek additional government contracts in the future,
which subjects us to certain risks associated with such types of contracts.

Most
government contracts are awarded through a competitive bidding process, and some of the
business that we expect to seek in the future likely will be subject to a competitive
bidding process. Competitive bidding presents a number of risks, including:

| |  | the
frequent need to compete against companies or teams of companies with more financial and
marketing resources and more experience than we have in bidding on and performing major
contracts;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
need to compete against companies or teams of companies that may be long-term, entrenched
incumbents for a particular contract we are competing for and which have, as a result,
greater domain expertise and established customer relations;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
need to compete on occasion to retain existing contracts that have in the past been
awarded to us on a sole-source basis;
| | - | -----------------------------------------------------------------------------------------------------------------------------

| |  | the
substantial cost and managerial time and effort necessary to prepare bids and proposals
for contracts that may not be awarded to us;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------

| |  | the
need to accurately estimate the resources and cost structure that will be required to
                 service any fixed-price contract that we are awarded; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
expense and delay that may arise if our competitors protest or challenge new contract
awards made to us pursuant to competitive bidding or subsequent contract modifications,
and the risk that any of these protests or challenges could result in the resubmission of
bids on modified specifications, or in termination, reduction or modification of the
awarded contract.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We
may not be afforded the opportunity in the future to bid on contracts that are held by
other companies and are scheduled to expire if the government determines to extend the
existing contract. If we are unable to win particular contracts that are awarded through
the competitive bidding process, we may not be able to operate in the market for products
and services that are provided under those contracts for a number of years. If we are
unable to win new contract awards or retain those contracts, if any, that we are awarded
over any extended period, our business, prospects, financial condition and results of
operations will be adversely affected.

In
addition, government contracts subject us to risks associated with public budgetary
restrictions and uncertainties, actual contracts that are less than awarded contract
amounts, and cancellation at any time at the option of the government. Any failure to
comply with the terms of any government contracts could result in substantial civil and
criminal fines and penalties, as well as suspension from future contracts for a
significant period of time, any of which could adversely affect our business by requiring
us to pay significant fines and penalties or prevent us from earning revenues from
government contracts during the suspension period. Cancellation of any one of our major
government contracts, however, could have a material adverse effect on our financial
condition.

The
government may be in a position to obtain greater rights with respect to our intellectual
property than we would grant to other entities. Government agencies also have the power,
based on financial difficulties or investigations of their contractors, to deem
contractors unsuitable for new contract awards. Because we will engage in the government
contracting business, we will be subject to audits and may be subject to investigation by
governmental entities. Failure to comply with the terms of any government contracts could
result in substantial civil and criminal fines and penalties, as well as suspension from
future government contracts for a significant period of time, any of which could adversely
affect our business by requiring us to spend money to pay the fines and penalties and
prohibiting us from earning revenues from government contracts during the suspension
period.

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

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

Delays in the
implementation stage in some of the projects we are involved with may prevent us from generating
sales revenues as expected in the year.

In
2007 and 2008 we experienced delays in some of the projects we are involved with 
for example in our joint venture selling electronic travel document inlays for the Chinese
government we have experienced delays in the project implementation. Delays in other
projects might occur as a result of factors that are beyond our control such as customer
readiness or shortage in purchased components needed for project implementation as well as
our readiness to implement the projects. If such delays occur in the future it might
affect our revenues, profitability and our share price. Global economic conditions
may adversely affect our business and financial results.

Unfavorable
economic conditions, including the impact of recessions throughout the world, may
negatively affect our business and financial results. These economic conditions could
negatively impact (i) consumer demand for our products, including shifting consumer
purchasing patterns to lower-cost options, (ii) the mix of our products sales, and
(iii) our ability to collect accounts receivable on a timely basis from certain customers.
A prolonged recession could result in decreased revenue, margins and earnings.

# Risks Related to Our
Ordinary Shares

Our share price has
fluctuated in the past and may continue to fluctuate in the future.

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

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

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

Our share price could be
adversely affected by future sales of our ordinary shares.

As
of June 23, 2009, we had 22,860,102 outstanding ordinary shares, 2,426,431 warrants to
purchase additional ordinary shares at a weighted average exercise price of $5.56 per
share and 2,834,412 options to purchase additional ordinary shares at a weighted average
exercise price of $1.89 per share. We may, in the future, sell or issue additional
ordinary shares. The market price of our ordinary shares could drop as a result of sales
of substantial amounts of our ordinary shares in the public market or the perception that
such sales may occur, including sales or perceived sales by our directors, officers or
principal shareholders. These factors could also make it more difficult to raise
additional funds through future offerings of our ordinary shares or other securities.

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If our ordinary shares
are ever considered a penny stock, any investment in our ordinary shares will be considered
a high-risk investment and become subject to restrictions on marketability.

If
the bid price of our ordinary shares falls below $1.00 our ordinary shares may be deemed
to be penny stock for purposes of the Securities Exchange Act of 1934, as
amended, or the Exchange Act. The closing price of our ordinary shares on June
23, 2009 was $1.49. Brokers effecting transactions in a penny stock are subject to
additional customer disclosure and record keeping obligations. The additional obligations
include disclosure of the risks associated with low price stocks, stock quote information
and broker compensation. In addition, brokers making transactions in penny stocks are
subject to additional sales practice requirements under the Exchange Act. These additional
requirements include making inquiries into the suitability of penny stock investments for
each customer or obtaining the prior written agreement of the customer for the penny stock
purchase. Because of these additional obligations, some brokers will not effect
transactions in penny stocks. If our shares are deemed a penny stock in the
future, this designation could have an adverse effect on the liquidity of our ordinary
shares and your ability to sell our ordinary shares.

If the bid price of our
ordinary shares is less than $1.00 we may not be able to meet NASDAQ Global Market
continued listing requirements and our shares may be delisted.

On
June 23, 2009, the closing price of our ordinary share was $1.49. If the bid price of our
ordinary shares is less than $1.00, we may not be able to meet NASDAQ Global Market
continued listing requirements and our ordinary shares may be delisted. After the bid
price of a company goes below $1.00, NASDAQ provides it a grace period before shares are
being delisted. Due to market condition, NASDAQ announced a temporary suspension of the
enforcement of the rules requiring a minimum bid price and market value of publicly held
shares, which would remain in effect until July 19, 2009. We cannot predict whether NASDAQ
will further extend the suspension.

Our shareholders could
experience dilution of their ownership interest by reason of our issuing more shares.

Under
Israeli law, shareholders in public companies do not have preemptive rights. This means
that our shareholders do not have the legal right to purchase shares in a new issue before
they are offered to third parties. In addition, our board of directors may approve the
issuance of shares in many instances without shareholder approval. As a result, our
shareholders could experience dilution of their ownership interest by reason of our
raising additional funds through the issuance of ordinary shares. In addition, we may
continue to acquire companies or businesses in exchange for our shares, resulting in
further dilution.

We do not anticipate
paying cash dividends in the foreseeable future.

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

We have adopted a share
repurchase plan which may adversely affect our financial position.

Although
we have never declared or paid cash dividend, in November 2008, our board of directors
authorized the repurchase of our shares in a total aggregate amount not to exceed $5
million conditioned on courts approval, as required under Israeli law. In May 2009
the court approved repurchase program in a total amount of up to $2 million. The specific
terms of the repurchase program, including the timing and the amount purchased, will be
determined by our board of directors, and we are not obligated to acquire any specific
amount of shares. However, if we pursue the repurchase plan, the acquisition of our
ordinary shares may adversely affect our cash balance and may adversely affect our ability
to keep our business development efforts as planned due to decrease in cash in the
short-run. Moreover, in the long-run, the repurchase of our own shares may also cause us
loss.

Our concentration of
voting power will limit your ability to influence or control corporate actions.

As
of June 23, 2009, Oded Bashan, our Chairman and CEO, has the right to vote approximately
10.6% of our outstanding shares by reason of his ownership (together with his wife) of
869,125 of our outstanding shares, and his holding of proxies to vote 1,548,384 additional
ordinary shares that are owned by other shareholders (where he holds proxies to vote most
of these ordinary shares as chairman of our board; however, our board of directors may
designate someone else to hold these proxies). Mr. Bashan therefore has substantial voting
power in comparison to our other shareholders and, accordingly, his vote in our
shareholders meetings may influence the outcome of such meetings.

16

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We adopted a Shareholders
Rights Plan that may dilute the shares of an Acquiring Person.

On
January 12, 2009, our board of directors approved the adoption of a Shareholders Rights
Plan, according to which each ordinary share of the Company shall give its holder one
right. Each such right will become exercisable only after a person or a group becomes an
Acquiring Person, by obtaining beneficial ownership of, or by commencing a
tender or exchange offer for, 15% or more of our ordinary shares (our board of directors
may reduce this percentage, but to not less than 10%), unless our board of directors
approves such Acquiring Person or redeems the rights. Each right, once it
becomes exercisable, will generally entitle its holder, other than the Acquiring
Person, to purchase from the Company either one or three ordinary shares (depending
on the Companys registered capital on the date of exercising the rights), at par
value. Therefore this Shareholders Rights Plan may dilute the shares of shareholders who
are deemed Acquiring Person under the Plan. In addition, certain institutions
may be discouraged from purchasing or holding our ordinary shares due to the plans
presumed anti-takeover effect. Furthermore, the existence of the plan may discourage bids
to acquire our company at a price that may be attractive to our shareholders.

We may fail to maintain
effective internal control in accordance with Section 404 of the Sarbanes-Oxley Act of 2002.

The
Sarbanes-Oxley Act of 2002 imposes certain duties on us and our executives and directors.
Our efforts to comply with the requirements of the Sarbanes-Oxley Act, and in particular
with Section 404, a portion of which commenced in connection with this annual report on
Form 20-F, have resulted in increased general and administrative expenses and a diversion
of management time and attention, and we expect these efforts to require the continued
commitment of resources. If we fail to maintain the adequacy of our internal controls, we
may not be able to ensure that we can conclude on an ongoing basis that we have effective
internal control over financial reporting. Although our management has determined that we
had effective internal control over financial reporting in 2008, we may identify material
weaknesses or significant deficiencies in our future internal control over financial
reporting. Failure to maintain effective internal control over financial reporting could
result in investigation or sanctions by regulatory authorities, and could have a material
adverse effect on our operating results, investor confidence in our reported financial
information, and the market price of our ordinary shares.

# Risks Related to Israel

Conditions in Israel may
harm our ability to produce and sell our products and services and mayadversely
affect our share price.

We
are incorporated under the laws of the State of Israel, and our principal executive
offices and research and development facilities, as well as some of our suppliers, are
located in Israel. Political, economic and military conditions in Israel directly affect
our operations. Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors. A state of hostility,
varying in degree and intensity, has led to security and economic problems for Israel.
Despite the progress towards peace between Israel and its Arab neighbors, the future of
these peace efforts remains uncertain. Since October 2000, there has been a substantial
deterioration in the relationship between Israel and the Palestinian Authority and a
significant increase in violence, primarily in the West Bank and Gaza Strip. During July
2006, an armed conflict between Israel and the Lebanese terror organization, Hezbollah,
took place in northern Israel and Lebanon. In December 2008 Israel launched a military
operation against armed forces of the Hamas terror organization in the Gaza strip, in
order to stop the firing of missiles and rockets from the Gaza strip to Israeli
territories. 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.

17

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Our operations could be
disrupted as a result of the obligation of key personnel to perform Israeli military
service.

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

The Israeli government
programs in which we currently participate, and the Israeli tax benefits we currently
receive, require us to meet several conditions, and they may be terminated or reduced in
the future. This could increase our costs and/or our taxes.

We
are entitled to certain tax benefits under Israeli government programs, largely as a
result of the Approved Enterprise status granted to some of our capital
investment programs by the Israeli Ministry of Industry and Trade. Taxable income derived
from each program is tax exempt for a period of ten years beginning in the year in which
the program first generates taxable income, up to 14 years from the date of approval or 12
years from the date of the beginning of production. Without such benefits our taxable
income from such programs would be taxed at the regular corporate tax rate (31% in 2006,
29% in 2007, 27% in 2008, 26% in 2009 and 25% in 2010 and thereafter). To maintain our
eligibility for these tax benefits, we must continue to meet conditions, including making
specified investments in property, plant and equipment, 30% of which must be from paid-in
capital. We cannot assure you that we will continue to receive these tax benefits at the
same rate or at all. From time to time, we submit requests for expansion of our approved
enterprise programs. These requests might not be approved. The termination or reduction of
these programs and tax benefits could increase our taxes and could have a material adverse
effect on our business.

Because we received
grants from the Israeli Office of the Chief Scientist, we are subject to ongoing restrictions
relating to our business

We
received royalty-bearing grants from the Office of the Chief Scientist of the Israeli
Ministry of Industry, Trade and Labor, or the OCS, for research and development programs
that meet specified criteria. We are obligated to pay royalties with respect to the grants
received. In addition, the terms of the OCS grants limit our ability to manufacture
products or transfer technologies outside of Israel if such products or technologies were
developed using know-how developed with or based upon OCS grants. Pursuant to the Israeli
Encouragement of Research and Development in the Industry Law, we and any non-Israeli who
becomes a holder of five percent or more of our share capital are generally required to
notify the OCS and such non Israeli shareholder is required to undertake to observe the
law governing the grant programs of the Chief Scientist, the principal restrictions of
which are the transferability limits described above.

It may be difficult to
enforce a U.S. judgment against us, our officers and directors or to assert U.S. securities
law claims in Israel.

We
are incorporated in Israel. None of our executive officers and directors is a resident of
the United States and a substantial portion of our assets and the assets of these persons
are located outside of the United States. Therefore, it may be difficult for an investor,
or any other person or entity, to enforce a U.S. court judgment based upon the civil
liability provisions of the U.S. federal securities laws in an Israeli court against us or
any of these persons or to affect service of process upon these persons in the United
States. Additionally, it may be difficult for an investor, or any other person or entity,
to enforce civil liabilities under U.S. federal securities laws in original actions
instituted in Israel.

Provisions of Israeli law
may delay, prevent or make undesirable an acquisition of all or a significant portion
of our shares or assets.

Israeli
Companies Law regulates acquisitions of shares through tender offers, requires special
approvals for transactions involving shareholders holding five percent or more of the
companys capital, 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.

18

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

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

We
were incorporated under the laws of the State of Israel on February 15, 1990.

Our
address is Z.H.R Industrial Zone, Rosh-Pina 12000, Israel. Our telephone number is
+972-4-686-8000. In 1998 we established a wholly-owned subsidiary in the United States,
OTI America, Inc., a Delaware corporation. OTI America, Inc. is located at 2 Executive
Drive, Suite 740, Fort Lee, New Jersey 07024, and its telephone number is (201) 944-5200.
Copies of this annual report and certain other documents referred to herein can be
obtained on our website, www.otiglobal.com, or upon request from our VP of Corporate
Relations, Ms. Galit Mendelson, at the following telephone number: (201) 944-5200 (#111).
The information on our website is not incorporated into this annual report.

Our
agent for service of process in the United States is OTI America Inc. Its address is 2
Executive Drive, Suite 740, Fort Lee, New Jersey 07024, and its telephone number is (201)
944-5200.

On
December 30, 1999, we acquired all of the outstanding shares of City Smart Ltd., a
Hong-Kong based systems integrator, in exchange for 6,686 of our ordinary shares (which,
as of that date, had an aggregate market value of approximately $451,300). On February 2,
2000, we entered into an agreement with an indirect wholly-owned subsidiary of Cheung Kong
Infrastructure Ltd., a Hong Kong-based infrastructure company, to establish the e-Smart
System joint venture in Hong Kong to, among other things, be the exclusive distributor for
our products in Greater China. In connection therewith, we contributed $3.1 million to the
joint venture. This joint venture acquired the assets of City Smart Ltd. in 2001. In June
2004, we sold our 50% stake in our e-Smart System joint venture to our partner.

On
January 28, 2000, we acquired all of the outstanding shares of SoftChip Israel Ltd. and
SoftChip Technologies (3000) Ltd., each an Israel-based developer and designer of
microprocessors and operating systems for smart cards, in exchange for 12,119 of our
ordinary shares (which, as of that date, had an aggregate market value of approximately
$1.3 million).

On
June 15, 2000 and in January 2001, we acquired 51% and the remaining 49%, respectively, of
the nominal share capital of two related German companies, Intercard Kartensysteme GmbH
and InterCard Systemelectronic GmbH, the former of which is a systems integrator for smart
card systems and the latter of which is a manufacturer of electronic devices, for an
aggregate purchase price of $5.8 million. In October 2004, we sold our InterCard
Kartensysteme subsidiary for approximately $2.5 million.

On
October 1, 2004 we completed the acquisition of ASEC, a Polish company that develops,
manufactures and markets card readers and reader modules, for a purchase price of
approximately $1.6 million, which was paid through the issuance of 186,264 of our ordinary
shares. In addition, the ASEC share purchase agreement provides for the payment of up to
an additional $350,000 to Nextel in the event that specified performance criteria are met
by ASEC for the years ended December 31, 2004 and 2005. In June 2005, we issued 14,298 of
our ordinary shares in consideration for $175,000 to be paid to Nextel based on the said
performance criteria. Based on ASECs 2005 results, the Company did not incur any
further liability in connection with the earn-out formula.

In July 2005, we completed the
acquisition of Pioneer Oriental International (POI), a Hong Kong company that develops and
manufactures machinery used to create smart cards inlays for smart cards and other
products, as well as to manufacture contact and contactless smart cards themselves, and
substantially the assets of Pioneer Oriental Engineering (POE) relating to the design and
manufacture of machinery for the manufacture of smart cards, for an aggregate purchase
price of approximately $1 million, which was paid through the issuance of 82,229 of our
ordinary shares. In July 2005, we also completed the acquisition of 71.5% of e-Pilot, a
Hong Kong-based company that develops, manufactures and markets smart card inlays for
smart cards and other products, for a purchase price of $661,000, which was paid through
the issuance of 52,572 of our ordinary shares. In September 1, 2006, the Company completed
a structural change in the Far-East, under which the operations of e-Pilot and of POI were
transferred to Millennium Cards Technology Limited (MCT), a subsidiary
which was established during 2006. Following the structural change, the Company has sold
POI and e-Pilot to a third party. In September 2008 we were issued additional shares in
MCT as a result of conversion of outstanding loans in an aggregate amount of $6.9 million,
which increased our holding in MCT to 90%.

19

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During
2005, we also established an affiliated company together with a Chinese governmental
entity, in the form of joint venture, for the manufacture and sale of OTI-based travel
document inlays for such government. The appropriate Chinese governments entities
approved the establishment of the joint venture.

In
May 2006, we completed the acquisition of InSeal SAS, a French company that provides an
operating system for contactless applications to a variety of customers in the payments
market, for a total of 243,800 of our ordinary shares and 180,000 warrants. The warrants,
which have a nominal exercise price, become exercisable in four equal annual installments.

In
December 2006, we completed the acquisition of the main assets of Vuance Ltd. (formerly
SuperCom Ltd.), an Israeli smart card company, in consideration of 2,827,200 of our
ordinary shares. The agreement provides for the purchase of Vuances International
Project Solution (IPS) business, whose activities accounted for substantially
all of Vuances revenue.

In
February 2007, we completed the purchase of the smart card module production line of Barun
Electronics Co. Ltd., a Korean company, in consideration of 480,000 of our ordinary
shares.

In
June 2008, we completed, through our subsidiary PARX Ltd., the acquisition of 100% of the
share capital of PARX France (formerly ID Parking), a French-based company that provides
electronic parking solutions across France, for a purchase price of euro 750,000 and
transaction costs of $319,000, which was paid partly (euro 250,000) in cash and partly
through the issuance of 300,698 of our ordinary shares (where additional funds may need to
be paid if the total value of such shares at determined dates does not equal to euro
500,000).

For
additional information concerning these transactions, see
C.  Organizational Structure below.

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

# General

We
design, develop and market secure contactless microprocessor-based smart card technology
to address the needs of a wide variety of markets. Because our cards contain a
microprocessor, they can store and process information and run multiple applications. Our
cards are referred to as contactless because they do not require physical
contact with a card reader, as power and data are transferred to a card through a magnetic
field generated by a card reader. Our products combine the benefits of both
microprocessors and contactless cards. We believe that we are one of the first companies
to deploy contactless microprocessor-based smart card products for commercial use. In
addition to contactless microprocessor-based smart cards, we also sell products that are
based on other card technologies.

Since
our incorporation in 1990, we have focused on the development of our core technologies and
our products based on our technological platform that consists of proprietary smart cards,
smart card readers, software tools and secure communication technology. We currently offer
three lines of solutions, each of which constitutes a complete system, as well as
components (such as smart cards and readers) that we sell to original equipment
manufacturers, or OEMs, for incorporation into their own products. Our three vertical
markets include:

| |  | Payment
Solutions: we offer a cashless system and loyalty program to replace cash,
which includes the contactless payments program offered by the major card associations
including MasterCards PayPass, Visas PayWave, American Express ExpressPay and
Discovers Zip. Our payment solutions also include EasyPark, our electronic
parking payment system as well as our mass transit electronic payment system. OTI also
offers the Hera, a completely automated laser-based production line for dual interface
smart cards as well as a manufacturing line for SIM cards;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Petroleum
Systems: OTIs EasyFuel is a wireless, cashless, cardless, and
paperless fuel management and petroleum solution which includes both our gasoline
management system, or GMS, and our EasyFuel system. EasyFuel is a loyalty program for
petroleum companies, fleets and retail customers. The system monitors and expedites the
fueling and payment process, permitting fueling of designated vehicles only while
eliminating fraud; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

20

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| |  | SmartID
Solutions: OTI offers complete end-to-end in-house solutions for
credentialing, identifying and verifying individuals by combining the capability to
support biometric identification with the portability of smart cards. The SmartID
solutions include MAGNA  a complete end-to-end in-house solution for
electronic passports (e-Passport) and national identity cards (national ID), Zeus e-Passport
and ID manufacturing line and MediSmart  a medical card for patient, doctor and
benefits verification.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

Our
products offer the following benefits:

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

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

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

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

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

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

We
intend to enhance our position in the design and development of contactless
microprocessor-based technology by expanding and strengthening our customer base through
product and vertical market alliances, focusing on high margin offerings with recurring
revenues such as transaction fees and licensing fee, leveraging our extensive patent and
intellectual property portfolio and maintaining our technology leadership position.

We
market our products through our global network of subsidiaries and strategic
relationships. Our sales and marketing efforts are directed from our headquarters in
Israel and carried out through our subsidiaries in the U.S., Israel, America, Europe,
Africa and the Far-East.

For
its great vision and commitment, the Company was awarded the Frost & Sullivan
2005 and 2006 Company of the Year Award in the field of smart cards.

# 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. Depending on the complexity of the chip that a smart card contains,
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.

21

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# What is a smart card
system?



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

# Types of smart card chips

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

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

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

Microprocessor
chip. Unlike ASIC chips, microprocessor chips can be reprogrammed after being
manufactured. 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.

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# Contact vs. Contactless

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

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

| |  | Support
of ISO standards. The International Standard Organization, or ISO, established 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
 have been approved by ISO. Because both standards are currently being used, only
readers, such as ours, 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. We have developed matched
antenna technology that allows the efficient transfer of power.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Support
of existing card-based infrastructure. Because of the large existing installed base of
contact-based systems, there is demand for technologies that can support both contact and
contactless applications with the same equipment. However, combined contact and
contactless cards have traditionally contained two chips, one for use by contact-based
systems and one for use by contactless-based systems. The use of two chips increases the
cost of the card and the likelihood of discrepancies between the information stored on
each chip by different applications. The use of two chips also limits the level of
security to the level offered by the ASIC chip. We believe that the shortcomings of these
dual contact/contactless cards create a need for a single chip that can work with both
contact and contactless systems.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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.

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# The OTI Solution

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

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

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

| |  | Ease
of transition from other card systems to contactless microprocessor-based systems. We
provide our customers with an easy upgrade of their existing systems by allowing card
issuers who currently utilize magnetic strip card systems or other contact-based systems
to switch to a contactless system without forcing them to replace their existing
infrastructure. For example, as part of a project for MasterCard PayPass, we upgraded
regular standard point-of-sales systems that supported only magnetic stripe to support
contactless microprocessor-based smart cards. We integrated our inlay solution with
plastic card manufacturers to allow quick upgrade from regular credit cards to
contactless operations.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 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. They can combine
our technology with their microprocessor, enabling the microprocessor to support contact
and contactless operations. By applying our patented hardware, customers can save months
of development time and reduce the time to market for their products.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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# Strategy

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

| |  | Enhance
our 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.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Expand
our global market presence. We market our products through a global network of
marketing subsidiaries in the U.S., Europe, Africa, the Far-East and our headquarters in
Israel. We intend to use these entities to strengthen our presence in existing markets,
penetrate new markets, provide local customer service and technical support, and adapt
our products to our local customers specific needs.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |  | Leverage
existing relationships and seek new relationships. We have entered into a
relationship with BP (formerly known as British Petroleum) to cover the South African
petroleum market. The relationship was extended and expanded so that we granted BP a
worldwide license for our petroleum payment solution. We have entered into this and other
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 that we have sold to BP in South Africa will have 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, research and development capabilities. In this way, we
plan to expand our product offerings and provide more comprehensive service to our
customers. Since our initial public offering in 1999, we have acquired the SoftChip
Group, an Israeli based developer and designer of microprocessors and operating systems
for smart cards (January 2000), InterCard Systemelectronic, a German company that
provides OEM and electronics manufacturing services (June 2000 and January 2001), ASEC, a
Polish company that develops, manufactures and markets card readers and reader modules
based on radio frequency identification technologies (October 2004), 71.5% of e-Pilot, a
Hong Kong-based company that develops, manufactures and markets smart card inlays for
smart cards and other products, POI, an engineering company that develops and
manufactures machinery used to create smart cards inlays for smart cards and other
products, and that also manufactures contact and contactless smart cards themselves (July
2005, where on September 1, 2006, we completed a structural change in the Far-East, under
which the operations of e-Pilot and of POI were transferred to Millennium Cards
Technology Limited (MCT), a subsidiary which was established during 2006,
following which we sold POI and e-Pilot to a third party), InSeal SAS, a French company
providing an operating system for contactless applications for a variety of customers in
the payments market (May 2006), the main assets of Vuance Ltd. (formerly SuperCom), an
Israeli smart card company, including the purchase of Vuances International Project
Solution (IPS) business (December 2006), the smart card module production
line of Barun Electronics Co. Ltd., a Korean company (February 2007) and ID Parking
(currently PARX France), a French Company providing electronic parking solutions across
France (June 2008).
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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# 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.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# 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.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

26

---

---

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 module

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

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

# Communications technology

We
have developed a unique communications technology that includes:

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

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

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

# Microprocessor chip and
operating system design know-how

Through
our acquisition of the SoftChip Group, we are 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.

# Production machinery and
testing tools

We
have introduced production machinery to support the demand for dual interface cards and
e-passports. Zeus is the product line of machinery for manufacturing electronic passports
and Hera is the product line of machinery for manufacturing of contact/contactless ID and
EMV compliant cards.

The
solutions offer completely automated production lines increasing efficiency, speeding up
the manufacturing process, saving on manpower and reducing the chance for human error.

The
manufacturing solutions was designed and developed based on years of extensive experience
and know-how at OTIs subsidiary, MCT, based in Shenzhen, China. The production line
implements cutting edge technologies, such as laser soldering and vision systems, meant to
provide customers with an advanced solution for manufacturing the most reliable and
durable Dual Interface Smartcards in a cost effective manner. The solution is based on
patented processes and on proprietary manufacturing methods and techniques. The machine
increases the yield of qualified products, reduces the time spent on trouble-shooting, and
is easy and relatively inexpensive to maintain.

27

---

---

In
addition to the dual interface card production line, OTI has also designed and developed a
series of electronic passport testing equipment to enable e-Passport manufacturers to
independently run ICAOs durability tests and assure that best products are shipped
to consumers. The lab equipment market consists of labs, government printing offices and
e-Passport manufacturers.

# Products

# The OTI Platform

Substantially
all of our products are based on a common platform, which we refer to as the OTI Platform.
The OTI Platform incorporates 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;
| | - | -------------------

| |  | smart
card operating system;
| | - | ----------------------------

| |  | 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:



Because
our microprocessors are programmable, they can support multiple applications on the same
card. This technology can eliminate consumers reluctance to carry multiple cards.
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 OTI Platform will reject the impaired
transmission and require that the information be re-transmitted. In addition, our OTI
Platform ensures that information is transmitted from the card in an encrypted form only
to readers that are authorized to receive and able to decipher the transmission.

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

Our Products

Our products consist of:

28

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# Payments Solutions

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

| |  | PayPass.
OTI is supplying key components of the technology for multiple contactless payment
programs, driven by major card associations: MasterCard Internationals PayPass program,
Visas PayWave, ExpressPay from American Express and Discovers Zip.
The program is focused on replacing cash. After initial pilots in the U.S., the program
has expanded to Europe, Canada and Asia. OTI is providing cards, key fobs, smart
stickers, operating system, readers and more for this program.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |  | 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 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. In 2005, the Union of
Local Authorities in Israel extended EasyParks contract for an additional five year
term. The program currently has about 600,000 subscribers, and is currently in use in 30
cities across the country. We are currently marketing the EasyPark system through our
global network of subsidiaries. In June 2008, we acquired, through PARX Ltd., our
subsidiary, PARX France (formerly ID Parking), a Paris based company that provides
electronic parking solutions. The transaction provides OTI with a platform to readily
access the French electronic parking payment market and offer multiple solutions for
parking payment.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 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. OTI is
marketing this product to system integrators that specialize in mass transit solutions.
For example, we have announced that we are working with Scheidt & Bachmann.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Petroleum Systems

Our
petroleum systems include EasyFuel and GMS (gasoline management system):

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

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

29

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The
following diagram illustrates a typical wireless GMS system:



We
commenced sales of GMS in 1995. Our petroleum solution is being used by a number of
petroleum companies, such as Chevron, BP South Africa and Turcas in Turkey

# Smart ID Solutions

Our
smart identification products combine the portability of smart cards with the capability
to support advanced identification and authentication technology and manage significant
amounts of information. OTIs MAGNA modular platform offers short
implementation and quick integration with the countrys existing border control
system and provides external interfaces to digital Certificate Authority (CA) for
signature verification. It offers a migration path to additional e-Gov applications and to
additional electronic ID documents, such as National IDs, Voter IDs Driver Licenses, and
more. Our MAGNA end-to-end system includes:

| |  | Enrollment
and personalization infrastructure including image and data enrollment, ePassport
personalization, secured materials management system, digital signature certificate
generator, and ePassport quality assurance and issuing stations.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | OTIs
ePassport based on OTIs Hercules operating system.
| | - | ----------------------------------------------------------

| |  | Border
control system based on passenger biometric identification applications, electronic
passport identification, and both optical and electronic means to detect forged
passports. The system, which is operable whether it is online or offline, enables border
control officers to receive unequivocal identification using a combination of two machine
readable biometric applications  fingerprints and facial recognition.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |  | We
have introduced production machinery to support the demand for dual interface cards and
e-passports. Zeus is the product line of machinery for manufacturing electronic passports
and Hera is the product line of machinery for manufacturing of contact/contactless ID and
EMV compliant cards. The solutions offer completely automated production lines increasing
efficiency, speeding up the manufacturing process, saving on manpower and reducing the
chance for human error.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

30

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# Technology licensing

In
2003, we entered into an agreement with Atmel Corporation for the purpose of collaborating
on the development of MasterCards PayPass contactless payment program.
Atmel was selected by MasterCard to supply the secure contactless microcontroller. Under
the agreement, Atmel has partnered with us to provide contactless solution expertise for
PayPass, including the operating system, application support and inlay technology.

In
2005, we partnered with STMicroelectronics to supply Visa International with a contactless
payment solution. Under the agreement, STMicroelectronics provides the contactless
microcontroller and OTI provides the operating system and application, as well as the
contactless card technology including the inlay technology.

In
2008, we partnered with Renesas Technology to supply MasterCard and Visa issuers with a
contactless payment solution. Under the agreement, Renesas Technology provides its
contactless microcontroller and OTI provides the operating system and application, as well
as the contactless card technology including the inlay technology.

# Customer service and
technical support

We
provide our customers with training and installation support and ongoing customer service
and technical support through our global network of subsidiaries. We have a support team
of 23 employees consisting of twelve employees located in our corporate headquarters in
Rosh Pina, Israel, five employees in Africa, two employees in the United States and four
employees in Europe. Our customer service team in Rosh Pina, Israel provides central
services to our network of local subsidiaries. The subsidiaries, in turn, provide 24-hour
customer support, through telephone and email for an ongoing fee. On-site technical
support is provided to customers for a fee.

# Sales and marketing

We
have built a global network of subsidiaries through which we sell and market our products.
As of December 31, 2008, we had a total sales and marketing staff of 41 employees in five
locations. We market our products in the Americas through OTI America, which employs four
people in sales and marketing. In Africa we sell and market through OTI Africa, which
employs eight people in sales and marketing. In Europe, we sell and market through
InterCard Systemelectronic, Inseal, ASEC and PARX France, which together employ ten people
in sales and marketing. In Israel, we sell and market through our headquarters in Rosh
Pina, which employs nine people in sales and marketing. In the Far East, we sell and
market through MCT, which employs ten people in sales and marketing. Our sales and
marketing staff implements marketing programs to promote our products and services and
enhance our global brand recognition. Our current marketing efforts include participation
in trade shows and conferences, press releases, our web site, and conducting speaking
engagements and advertising in industry publications. We also conduct technical seminars
to inform customers, distributors and other industry participants of the benefits of our
products and technologies.

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

# Seasonality

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

31

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# Manufacturing

# External manufacturers
and suppliers

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

# Smart cards

| |  | Microprocessors.
The current suppliers of microprocessors for our smart cards are STMicroelectronics,
Renesas, NXP and Atmel.
| | - | -----------------------------------------------------------------------------------------------------------------------------

| |  | 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 Southeast Asia.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| |  | Readers.
We purchase off-the-shelf components for our readers from various suppliers including
Infineon, Motorola, AMD and National Semiconductor. The readers are assembled for us in
Germany, mainly by our wholly-owned subsidiary InterCard Systemelectronic.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Operating
systems

We
have developed our Hercules operating system, a scalable multi-application operating
system. The design of OTIs Hercules operating system enables us to fulfill high
demands with regard to functionality, security, flexibility, maintenance and performance.

Quality
control

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

Internal
manufacturing capabilities

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

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

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

MCT,
our Chinese subsidiary, owns a secured manufacturing facility in China for the
manufacturing of inlays, cards machineries and module packaging. MCT has achieved
ISO9001:2000 for Quality Management System, ISO14001:2004 for Environmental Management
System, OHSAS18001:2007 for Certified Facility Occupational Health and Safety Management
Systems and is MasterCard CQM Certified as well as MasterCard Certified Vendor.

32

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# Description of Principal
Markets.

# See description under
Item 5. A.

# Government regulation

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

# Research and development

We
believe that our future success depends on our ability to maintain our technological
leadership, enhance our existing products and develop new products and technologies.
Accordingly, we intend to continue devoting substantial resources to research and
development. We pay royalties to the Government of Israel at a rate of 3%-3.5% of sales of
the products that the Government of Israel participated in financing through grants, up to
the amounts granted, linked to the U.S. dollar with annual interest at LIBOR as of the
date of the approval. The following table describes our research and development
activities during each of the past five years:

|                                                        | 2004 | 2005 | 2006 | 2007 | 2008
|------------------------------------------------------- | ---- | ---- | ---- | ---- | ----
|
|
|
|
|Our expenditures net of grants from the OCS             |      |      | $    | 3.2  |     
|Our net expenditures as a percentage of annual revenues |      |      |      | 14   | %   
|OCS grants                                              |      |      | $    | 0.4  |     

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
of December 31, 2008, we employed 115 employees in our research and development
activities. Our main research and development facilities are located at our headquarters
in Rosh Pina, Israel. We believe that our success is based on our experienced team of
senior engineers and technicians who have on average 12 years of experience in their
respective fields. Our research and development facilities are ISO 9001:2000 certified.

# Proprietary technologies

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

We
have over 100 different patents and patent applications in different areas of our
business, including patents and patent applications relating to smart card power and data
transmission, manufacturing processes and productions equipment of contactless smartcards
and dual interface smartcards, Smart ID solutions, electronic parking systems, fuel
management products all of them based on contactless. 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.

33

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# Competition

Contactless
microprocessor-based products and technologies. We anticipate competition in sales of
our products, systems and technologies from other providers of contactless
microprocessor-based smart card technologies. We expect competition to intensify as our
competitors commit greater resources to the development of contactless
microprocessor-based smart cards. Some of the larger chip manufacturers that operate in
the smart card market, including Atmel, STMicroelectronics, Infineon and NXP
Semiconductors, have announced that they are developing contactless microprocessor-based
smart cards.

Contactless
ASIC-based products and technologies. We compete with contactless ASIC-based
technologies developed primarily by NXP Semiconductors, which comply with ISO 14443 and
which are used by some of the largest manufacturers of smart cards, including Gemalto 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.
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 are not ISO-compliant.

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.

Machinery
and Card Production. We anticipate competition in sales from other providers of
machinery and card production felicities. We expect competition to intensify as our
competitors commit greater resources to the development of machinery and card production
facilities. Some of the larger chip manufacturers that operate in the smart card market
have announced that they are developing machinery and card production facilities.

34

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

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

On Track Innovations Ltd. Israel PARX France France Easy Park Israel. Ltd. Israel InSeal SAS France InterCard GMBH Systemelectronic Germany Millennium Cards Technology Limited Shenzhen, China Easy Park Ltd. Israel PARX Ltd. Israel OTI Africa (Pty), Ltd. South Africa Millennium Cards Technology Limited Hong Kong, China OTI America, Inc. Delaware, USA Chinese Joint Venture SoftChip Technologies (3000) Ltd. Israel SoftChip Israel Ltd. Israel ASEC Spolka Akcyjna Poland 94.33%(1)94.33%(8)100%100%                     
100%                          100%(4)90%(6) 100%(2)100%(9)49%(5)100%(7)100%(3)100%


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

| | (2) | Including
10% of the shares of Easy Park Israel Ltd. that is held directly by           On Track
Innovations Ltd.
| | --- | -----------------------------------------------------------------------------------------------------------------

| | (3) | We
acquired a 51% interest in InterCard Systemelectronic in June 2000. We           acquired
the remaining 49% interest in this company in January 2001.
| | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | (5) | We
established the joint venture during 2005
| | --- | --------------------------------------------

| | (6) | We
established Millennium Cards Technology Limited (MCT) during           2006
together with a partner. Our initial holding was 60%. In September 2008 we           were
issued additional shares in MCT, which increased our holding in MCT to 90%.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (7) | We
acquired InSeal SAS in May 2006.
| | --- | -----------------------------------

| | (8) | The
remaining shares of PARX Ltd. are held by two shareholders.
| | --- | ---------------------------------------------------------------

| | (9) | We
acquired PARX France (formerly ID Parking) in June 2008.
| | --- | -----------------------------------------------------------

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Easy Park Ltd.

Easy
Park Ltd. developed our EasyPark system. Easy Park is incorporated under the laws of the
State of Israel. By reason of our ownership of 94.33% of Easy Parks outstanding
shares, we currently have the right to appoint all of the members of its board of
directors.

Our
Easy Park system was selected as the national parking system for Israel.

The SoftChip Group

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

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

OTI America, Inc.

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

OTI Africa (Pty) Ltd.

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

The InterCard group

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

In
October 2004, we sold our InterCard Kartensysteme subsidiary. The purchase price for our
shares in InterCard Kartensysteme was $2.5 million, payable in two installments. The first
installment, in the amount of $1.25 million, which was paid in January 2005, consisted of
$685,000 in cash, a euro 325,000 interest-free promissory note ($432,000), payable in 32
monthly installments of euro 10,000 and a final installment of euro 5,000, beginning on
February 1, 2005, and a euro 100,000 promissory note, payable in 12 monthly installments
of euro 9,000, beginning on February 1, 2005. The second installment, in the amount of
$1.25 million, payable paid in 25 quarterly payments beginning on April 1, 2005. In
October 2005, we entered into a settlement agreement according to which the outstanding
balances of the two loans were reduced by euro 165,000 and combined to one loan, payable
in 24 monthly installments of euro 10,000 each and a final installment of euro 5,000.
During 2007 the purchaser settled the entire remaining debts. The gain from the sale, in
the amount of $374,000, was recognized in the consolidated financial statements in 2005.

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ASEC Spolka Akcyjna

On
October 22, 2004, we completed the acquisition of ASEC, which is headquartered in Krakow,
Poland, from Nextel Spolka Akcyjna, or Nextel. ASEC develops, manufactures and markets
card readers and reader modules based on radio frequency identification technologies,
including high-end programmable smart card as well as economically priced readers.
Pursuant to the Preliminary Share Purchase Agreement, dated as of September 14, 2004, as
amended in October 2004, between us and Nextel, the aggregate purchase price for the
acquisition was $1.6 million, which was paid to Nextel through the issuance of 186,264 of
our ordinary shares, calculated by dividing the purchase price by the average price of our
ordinary shares during the ten trading days prior to, but excluding, the closing date of
the acquisition ($8.59 per share). In addition, the agreement provides for additional
consideration of up to $350,000 to be paid to Nextel in the form of our ordinary shares,
subject to ASEC meeting specified performance criteria for the years ended December 31,
2004 and 2005, referred to as the earn-out formula. ASEC met the performance criteria for
the year ended December 31, 2004. Accordingly, as of December 31, 2004 we recognized a
liability of $175,000 in connection with the earn-out formula, which was settled by 14,298
ordinary shares that were issued by us to Nextel in June 2005.

Based
on ASECs 2005 performance, we did not incur any further liability in connection with
the earn-out formula. The results of operations of ASEC have been included in the
consolidated financial statements as from October 1, 2004.

Far East

Pioneer
Oriental International Ltd.

In
July 2005, we completed the acquisition of POI, a Hong Kong company, a subsidiary of POE,
a Hong Kong company. POI is an engineering company that develops and manufactures
machinery used to create smart card inlays for smart cards and other products, and also
manufactures contact and contactless smart cards themselves. Pursuant to an Asset Purchase
Agreement dated June 16, 2005, between us, POE, and its shareholders (together, referred
to as the Sellers), as amended, the aggregate purchase price for the acquisition was paid
to the Sellers through the issuance of an aggregate 40,441 of our ordinary shares.

In
July 2005, POI completed the acquisition of substantially all of the assets of POE
relating to the design and manufacture of machinery for the manufacture of smart cards,
including certain proprietary technologies related to the manufacturing process. Pursuant
to the Asset Purchase Agreement dated June 16, 2005, between POI and POE, POI also agreed
to make offers of employment to each of the employees of POE. The aggregate purchase price
for the acquisition was paid to POE through the issuance of an aggregate of 41,788 of our
ordinary shares. On September 1, 2006, we completed a structural change in the Far-East,
under which the operations of POI was transferred to Millennium Cards Technology
Limited. Following the structural change, the Company has sold its shares in POI.

e-Pilot
Ltd.

In July 2005, we completed the acquisition of a 71.5% interest in e-Pilot Ltd, a
British Virgin Islands company, from three of e-Pilots shareholders (collectively,
referred to as the e-Pilot Shareholders). e-Pilot, which is headquartered in Hong Kong,
develops, manufactures and markets smart card inlays for smart cards and other products.
Pursuant to share purchase agreements entered into with each of the e-Pilot Shareholders,
the aggregate purchase price for the acquisition was paid to the e-Pilot Shareholders
through the issuance of an aggregate of 52,572 of our ordinary shares. On September 1,
2006, we completed a structural change in the Far-East, under which the operations of
e-Pilot was transferred to Millennium Cards Technology Limited. Following the
structural change, the Company has sold its shares in e-Pilot.

Millennium
Cards Technology Limited

On
September 1, 2006, we completed a structural change in the Far-East, under which the
operations of POI and of e-Pilot were transferred to Millennium Cards Technology
Limited (MCT), a subsidiary which was established during 2006. Following the
structural change, the Company has sold its shares in POI and e-Pilot for a total
consideration of $200,000 and recorded a $122,000 gain from sale of subsidiaries. Our
initial holding in MCT was 60%. In September 2008 MCT issued additional 3,000 shares of
HK$1.00 against the conversion of the debt of MCT to us in the principle amount of
$6,900,000. Following the shares allotment, our holding in MCT was increased to 90%.

InSeal SAS

In
May 2006, we completed the acquisition of all the share capital of InSeal SAS, for an
aggregate of 243,800 of our ordinary shares and 180,000 warrants. The warrants, which have
a nominal exercise price, become exercisable in four equal annual installments. InSeal SAS
is a Marseille, France based company currently providing an operating system for
contactless applications to a variety of customers in the payments market. InSeals
JayCOS® is currently in use in contactless payments programs in the US.

37

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PARX Ltd.

PARX
Ltd. is incorporated under the laws of the State of Israel. By reason of our ownership of
94.33% of PARXs outstanding shares, we currently have the right to appoint all of
the members of its board of directors.

PARX
is responsible for marketing electronic parking solutions in international markets, which
includes the successful EasyPark in-vehicle electronic parking product.

PARX France.

In
June 2008 we completed, through PARX Ltd., the acquisition of 100% of the share capital of
PARX France (formerly ID Parking) from Gilbert and Majeste Nadine Baup, for a purchase
price of euro 750,000 (after deducting transaction costs of $319,000), which was paid
partly (euro 250,000) in cash and partly through the issuance of 300,698 of our ordinary
shares (where additional funds may need to be paid if the total value of such shares at
determined dates does not equal to euro 500,000).

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

We
lease an aggregate of 10,639 square meters of land in Rosh Pina, Israel from the Israel
Lands Authority. Of the 10,639 square meters, 2,377 meters are leased under a 49 year
lease which expires on November 16, 2041, with an option to extend for a further period of
49 years. Our principal management, administration and marketing activities occupy a 1,188
square meter facility on the site. The remaining 8,262 square meters of land are leased
under a 49 year lease with the Israel Lands Authority which expires on September 14, 2047,
with an option to extend for a further period of 49 years. Our principal engineering,
research and development and part of our manufacturing activities occupy a 4,000 square
meter facility on this site. The rent for the initial 49-year term of each of these leases
was prepaid in its entirety at the beginning of the lease terms as is customary in Israel
for leases of property for industrial purposes from the Israel Lands Authority. Our rights
under these leases, including the facilities built on the site, are pledged for the
benefit of Bank Hapoalim. Our majority owned subsidiary, Easy Park Ltd., leases office
space in this complex from us. Easy Park also leases an aggregate of 137 meters in Tel
Aviv pursuant to a lease that expires on April 14, 2011, with an option to extend for a
further period of 3 years.

We
also lease an aggregate of 270 meters in Tzur Igal, Israel pursuant to a lease that
expires on February 28, 2011, with an option to extend it for additional three periods of
1 year each.

OTI
America, Inc. leases an aggregate of 4,375 square feet of office space in Fort Lee, New
Jersey pursuant to a lease that expires on August 31, 2009. OTI Africa (Pty) Ltd. owns an
aggregate of 770 square meters of office space in Century City, South Africa.

ASEC
leases an aggregate of 495 square meters of office space in Krakow, Poland pursuant to a
lease terminable by giving a three months notice, and 169 square meters of office
space in Warsaw, Poland pursuant to a lease that expires on March 29, 2013.

InterCard
Systemelectronic owns an aggregate of 5,201 square meters of land in Bad Durrheim,
Germany.  The area is being used commercially for its manufacturing facility.

MCT
leases office space in Futian, Shenzhen with areas of 4,779 square
meters and 2,732 square meters pursuant to leases that expires
on August 31, 2013 and January 16, 2012, respectively. The office space is
currently being used for its manufacturing facility. Additionally,
MCT leases office space in Causeway Bay, Hong Kong with areas of
132 square meters pursuant to a lease that expires on May 13, 2009. The
office space is used for administrative purpose.

InSeal
leases an aggregate of 220 square meters of office space in Paris, France, pursuant to a 9
years lease starting January 2007, with an option to terminate once every three years by
giving a 6 months notice.

|ITEM 4A. |  | UNRESOLVED STAFF COMMENTS
|-------- |  | -------------------------

Not applicable.

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

The following discussion and
analysis includes certain forward-looking statements with respect to the business,
financial condition and results of operations of our company. The words
estimate, project, intend, expect and
similar expressions are intended to identify forward-looking statements within the Private
Securities Litigation Reform Act of 1995 and other federal securities laws. These
forward-looking statements are subject to risks and uncertainties that could cause actual
results to differ materially from those contemplated by such forward-looking statements,
including those Risk Factors contained in this annual report. This discussion and analysis
should be read in conjunction with our consolidated financial statements and notes thereto
contained in Item 18. Financial Statements of this annual report.

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

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

# Overview

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

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

| |  | Payments
Solutions: we offer financial institutions a cashless system and loyalty
program to replace cash, which includes the PayPass system that we are installing
for MasterCard, our EasyPark system and our mass transit payment system as well as cards,
inlays and machineries for the production of SmartID solutions as well as production line
for SIM cards;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Petroleum
Systems: OTIs EasyFuel is a wireless, cashless, cardless, and
paperless fuel management and petroleum solution which includes both our gasoline
management system, or GMS, and our EasyFuel systems; and
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Smart
ID Solutions: OTIs solutions for credentialing, identifying and
verifying individuals combine the capability to support biometric identification with the
portability of smart cards. We also offer cards, inlays and machineries for the
production of SmartID solutions.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

We
began to market components for incorporation into the products of OEMs with our
acquisition of InterCard Systemelectronic in June 2000. During 2006, 2007 and 2008,
product sales to OEMs accounted for $7.8 million, $8.7 million and $8.9 million,
respectively, of our total revenues.

We
began marketing cards, inlays and machineries following our acquisitions of MCT, e-Pilot
and POE .

39

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We
have reported net losses for each year that we have been in business, and we expect to
incur full year losses at least through 2009. Our business tends to be seasonal, with
greater sales in the third and the fourth quarters of every year, we do not anticipate
having net earnings for either of the first two quarters of 2009 and we also cannot assure
you that we will be profitable in either of the last two quarters of 2009, or afterwards.

# Sources of Revenue

We
have historically derived a substantial majority of our revenues from the sale of our
products, including both complete systems and OEM components. Asubstantial
majority of our revenues has been, and is likely to continue to be, from the sale of
complete systems and its components. We anticipate that revenues from sales will continue
to represent the substantial majority of our revenues in the future. In addition, we
generate revenues from licensing and transaction fees, and also, less significantly, from
non-recurring engineering, customer services and technical support.

During
the past three years, the revenues that we have derived from sales and licensing and
transaction fees have been as follows (dollar amounts in thousands):

|                 | 2006 | 2007 | 2008
|---------------- | ---- | ---- | ----
|
|
|
|
|Sales            |      |      | $   
|                 |      |     
|Licensing and    |      |     
|transaction fees |      |      |     
|                 |      |      |     
|                 |      |      | $   
|                 |      |      |     

Sales
increased by $5.7 million in 2007 as compared to 2006 and decreased by $3.3 million in
2008 as compared to 2007. The increase in 2007 is mainly attributed to an increase in
sales of Petroleum products, Payments products and its components, and OEM. The decrease
in 2008 is mainly attributed to decrease in sales of Payments products and its components.

Licensing
and transaction fees include one-time and periodic payments for manufacturing or
distribution rights for our products. Transaction fees are paid by customers based on the
volume of transactions processed by systems that contain our products. The decrease in
2007 as compare to 2006 is primarily consisted of a decrease in transaction fees from the
China ID project.

We
expect to generate additional revenues from transaction fees in the future as the
installation and usage of systems that contain our products become more widespread.

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

|     | Africa | Europe | Far East
|---- | ------ | ------ | --------
|
|
|
|
|2006 |        |        | $       
|2007 |        |        | $       
|2008 |        |        | $       

|     | North, Central and South
America | Israel
|---- | -------------------------------- | ------
|
|
|
|
|2006 |                                  |       
|2007 |                                  |       
|2008 |                                  |       

We
anticipate that, over time, the revenues that we derive from the Americas will grow both
in absolute amounts and as a percentage of our total revenues. Our revenues derived from
outside the U.S., which are primarily received in currencies other than the U.S. dollar,
will have a varying impact upon our total revenues, as a result of fluctuations in such
currencies exchange rates against the U.S. dollar.

40

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# Cost of revenues and
gross margin

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

|                               | Year ended December 31
|------------------------------ | ----------------------
|
|
|
|
|Cost of revenues               |                       
|Sales                          |                       
|                               |                       
|Licensing and transaction fees |                       
|                               |                       
|                               |                       
|Total cost of revenues         |                       
|                               |                       
|                               |                       
|Gross profit                   |                       

---

Sales.
          Cost of revenues relating to sales consists primarily of materials, as well as
          salaries, fees payable to subcontractors and related costs for our technical
          staff who assemble our products. The increase in 2007 is primarily the result of
          increased sales which generated corresponding increased costs, and dueto
          increase in costs associated with the revenue mix in the year ended December 31,
          2007 as compared to the same period in 2006. The decrease in 2008 is primarily
          the result of decreased sales which generated corresponding decreased costs.

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

# Operating expenses

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

|                                          | Year ended December 31
|----------------------------------------- | ----------------------
|
|
|
|
|Operating expenses                        |                       
|Research and development                  |                       
|Selling and marketing                     |                       
|General and administrative                |                       
|Amortization and impairment of intangible |                       
|assets                                    |                       
|Impairment of goodwill                    |                       
|                                          |                       
|Gain from sale of subsidiary              |                       
|                                          |                       
|                                          |                       
|Total operating expenses                  |                       
|                                          |                       
|                                          |                       
|Operating loss                            |                       

---

Research
and development. Our research and development expenses consist primarily of salaries
and related expenses of our research and development staff, as well as subcontracting
expenses. All research and development costs are expensed as incurred. The increase in
2007 as compared to 2006 was primarily due to a $3.6 million increase in expenses related
to salaries that resulted from increase of 17 employees, mainly following the acquisitions
of InSeal during May 2006 and the IPS division of Vuance (formerly SuperCom) which took
place on December 31, 2006, a $862,000 increase in share-based compensation expenses, in
accordance with SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R),
and due to a $845,000 increase in expenses related to subcontractors, and rental expenses.
The decrease in 2008 was primarily due to a $1.0 million decrease in expenses related to
salaries resulting from a $426,000 decrease in share-based compensation expenses, in
accordance with SFAS 123R and from a decrease in number of research and development
employees. Our research and development expenses may increase in the future as we continue
to develop new products and new applications for our existing products.

41

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Selling
and marketing. Our selling and marketing expenses consist primarily of salaries and
substantially all of the expenses of our sales and marketing subsidiaries and offices in
the United States, South Africa, the Far East and Europe, as well as expenses related to
advertising, professional expenses, participation in exhibitions and tradeshows. The
increase in 2007 as compared to 2006 was primarily due to a $1.4 million increase in
expenses related to salaries that resulted from an increase of employees, mainly following
the acquisitions of InSeal during May 2006 and the IPS division of Vuance (formerly
SuperCom) which took place on December 31, 2006, and due to a $678,000 increase in
expenses related to our marketing efforts in new and existing markets. The increase in
2008 was primarily due to a $1.8 million increase in professional expenses resulting from
marketing services related to existing projects and future projects, legal expenses
related to the Smartrac law suit and increase in compensation expenses, in compliance with
SFAS 123R 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
(EITF 96-18).

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

General
and administrative. Our general and administrative
expenses consist primarily of salaries and related expenses of our executive management
and financial and administrative staff. These expenses also include costs of our
professional advisors (such as lawyers and accountants), office expenses and insurance and
vehicle expenses, which have collectively grown with the scope, magnitude and complexity
of our business, and provision for doubtful accounts. The increase in 2007 as compared to
2006 is primarily attributed to a $2.5 million provision for doubtful accounts for the
year ended December 31, 2007, a $1.2 million increase in share-based compensation
expenses, in accordance with SFAS No. 123R, and due to a $1 million increase in expenses
related to professional and rental expenses. The decrease in 2008 as compared to 2007 is
primarily due to a $2.0 million decrease in provision for doubtful accounts, a $947,000
decrease in share-based compensation expenses, in compliance with SFAS 123R and EITF
96-18, and a $703,000 decrease in professional expenses. General corporate and
administrative expenses may increase in the future as we continue to expand our
operations.

Amortization
and impairment of intangible assets. The increase in 2008 as compared to 2007 is
primarily due to a $1.4 million impairment charge against other intangible assets
(customers contracts and relationships) acquired in acquisition of InSeal SAS.

Impairment
of goodwill. We conducted a goodwill impairment
test on the goodwill acquired. The test was based on our single reporting unit structure.
As a result of the decrease in our market capitalization in 2008 and deteriorating global
economy, we determined that the carrying value of the goodwill exceeded its implied fair
value. We further concluded that all of the goodwill acquired had been impaired and
therefore, in the fourth quarter of 2008, we recorded an impairment charge of $24.2
million.

# Financing income
(expenses), net

Financing
income consists primarily of interest earned on our investments in U.S. treasury
securities and foreign exchange gains. Financing expenses consist primarily of interest
payable on bank loans and foreign exchange losses. The decrease in financing income is
mainly due to decrease in interest earned on investments in U.S. treasury securities and
the increase in financing expenses is mainly due to an increase in interest expenses from
short term loans and credit.

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

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

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# Net loss

Our
net loss increased in 2007 as compared to 2006 primarily due to an increase in our
operating expenses as mentioned above and a decrease in our gross margin primarily due to
a decrease in revenues from licensing and transaction fees. The increase in 2008 as
compared to 2007 is primarily due to an increase in the Companys operating expenses,
mainly due to the goodwill impairment charge as mention above, increase in financial
expenses, net as mentioned above, decrease in gross profit resulting from decrease in
sales, decrease in minority share in loss of subsidiaries and increase in equity loss of
affiliated company.

Our
net loss for each of the past three years has been as follows (in thousands):

|         | Year ended December 31
|-------- | ----------------------
|
|
|
|
|Net loss |                       
|         |                       

Critical Accounting Policies and Estimates

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

Revenue
recognition. We recognize product sale revenues upon delivery, provided there is
persuasive evidence of an agreement and the risks and rewards of ownership have
transferred to the buyer, delivery has occurred, the fee is fixed or determinable and
collection is probable and no further obligation exists. In the case of nonrecurring
engineering, revenue is recognized upon completion of testing and approval of the
customization of the product by the customer and provided that no further obligation
exists.

Technology
license revenues are recognized at the time the technology and license are 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 ratably over the period of the related contract.

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

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

Goodwill
and other intangible assets.Goodwill represents the excess of the aggregate
purchase price over the fair value of the net assets acquired in a purchase business
combination. Goodwill is reviewed for impairment at least annually, as of December every
year, in accordance with the provisions of FASB Statement No. 142, Goodwill and
Other Intangible Assets. The goodwill impairment test is a two-step test. Under the first
step, the fair value of the reporting unit is compared with its carrying value (including
goodwill). If the fair value of the reporting unit is less than its carrying value, an
indication of goodwill impairment exists for the reporting unit and the enterprise must
perform step two of the impairment test (measurement). Under step two, an impairment loss
is recognized for any excess of the carrying amount of the reporting units goodwill
over the implied fair value of that goodwill. The implied fair value of goodwill is
determined by allocating the fair value of the reporting unit in a manner similar to a
purchase price allocation, in accordance with FASB Statement No. 141, Business
Combinations. The residual fair value after this allocation is the implied fair value of
the reporting unit goodwill. If the fair value of the reporting unit exceeds its carrying
value, step two does not need to be performed.

43

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The Company conducted its goodwill
impairment test on the goodwill acquired. The test was based on the Companys single
reporting unit structure. As a result of the decrease in the Companys market
capitalization in 2008 and the deteriorating global economy, the Company determined that
the carrying value of the goodwill exceeded its implied fair value. The Company further
concluded that all the goodwill acquired had been impaired and therefore, in the fourth
quarter of 2008, it recorded an impairment charge of $24.2 million. No impairment losses
were recorded in 2007 and 2006.

Purchased
intangible assets are carried at cost, less accumulated amortization. Amortization is
computed over the estimated useful lives of the respective assets, generally three to
seven years.

Impairment
of long-lived assets. In accordance with FASB Statement No. 144 (SFAS 144),
Accounting for the Impairment or Disposal of Long-Lived Assets, long-lived
assets, such as property, plant, and equipment, and purchased intangible assets subject to
amortization, are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. If circumstances
require a long-lived asset be tested for possible impairment, the Company first compares
undiscounted cash flows expected to be generated by an asset to the carrying value of the
asset. If the carrying value of the long-lived asset is not recoverable on an undiscounted
cash flow basis, impairment is recognized to the extent that the carrying value exceeds
its fair value. Fair value is determined through various valuation techniques including
discounted cash flow models, quoted market values and third-party independent appraisals,
as considered necessary.

As of
December 2008 the Company conducted its impairment test on the intangible assets
recognized in the acquisition of InSeal, as a result of an uncertainty relating to a
customer of InSeal and the future revenues from that customer. As a result, the Company
recorded an impairment charge of $1.4 million in the fourth quarter of 2008. No impairment
charges were recoded in 2007 and 2006.

Other
intangible assets, net, amounted to approximately $2.5 million as of December 31, 2008. If
these estimates change in the future, we may be required to record impairment charges for
our other intangible assets.

Stock
option plans. Prior to January 1, 2006, the Company accounted for stock based employee
and director compensation by using the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (APB
25) and related interpretations, as permitted by SFAS No. 123, Accounting for
Stock-Based Compensation (SFAS 123). Accordingly, compensation cost for stock
options was measured as the excess of the market price of the underlying stock on the date
of grant over the exercise price and was recognized over the scheduled vesting.

On
January 1, 2006, the Company adopted SFAS 123R, which requires the measurement and
recognition of compensation expense for all share-based payment awards made to employees
and directors based on estimated fair values. The Company adopted SFAS 123R using the
modified-prospective-transition method. Under the modified-prospective-transition method,
compensation cost is recognized on a prospective basis for all share-based payments
granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair
value estimated in accordance with the original provisions of SFAS 123. For share-based
payment awards granted after January 1, 2006, the Company recognizes compensation cost
based on estimated grant date fair value using the Black-Scholes option pricing model. In
accordance with the modified prospective method, the Companys consolidated financial
statements for prior periods have not been restated to reflect, and do not include, the
impact of SFAS 123R. As a result of adopting SFAS 123R, the Companys loss before
taxes and minority interests and net loss for the year ended December 31, 2006, are
$2,354,000 larger, and loss per share for the year ended December 31, 2006 is $0.17
larger, than if it had continued to account for share-based compensation under APB 25.
Upon adoption of SFAS 123R, the $833,000 in Additional Paid-In Capital and the offsetting
amount in Deferred Stock-Based Compensation, that were both reflected in
shareholders equity at December 31, 2005, have been reversed as required by SFAS
123R. The net effect had no change in total shareholders equity.

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

44

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

These
estimates incorporate significant judgment in determining the fair value of stock-based
compensation awards.

During
2008 most of the options were granted with a par value exercise price. Due to the par
value nominal amount of NIS 0.1, the fair value of these options was estimated to be equal
to the Companys share price as of the day of grant.

# Recently Issued
Accounting Guidance

In
February, 2007, the FASB issued FASB Statement No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities  Including an amendment of FASB Statement
No. 115 (FAS 159). The statement allows the Company to irrevocably choose to measure many
financial assets and liabilities at fair value that are not currently required to be
measured at fair value. This Statement is effective as of the beginning of an
entitys first fiscal year that begins after November 15, 2007. The adoption of FAS
159 did not have an impact on the Companys consolidated results of operations and
financial position.

In
June 2007, the FASB reached a final consensus on Emerging Issues Task Force Issue 07-3,
Accounting for Advance Payments for Goods or Services to Be Used in Future Research
and Development Activities (EITF 07-03). The consensus reached by the
FASB requires companies involved in research and development activities to capitalize such
non-refundable advance payments for goods and services pursuant to an executory
contractual arrangement because the right to receive those services in the future
represents a probable future economic benefit. Those advance payments will be capitalized
until the goods have been delivered or the related services have been performed. The
consensus on EITF 07-03 is effective prospectively for financial statements issued for
fiscal years beginning after December 15, 2007, and interim periods within those
fiscal years. The adoption of the provisions of EITF 07-03 did not have an impact on its
financial position, results of operations or cash flows

In
December 2007, the FASB issued FASB Statement No. 141R, Business Combinations (Statement
141R) and FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial
Statements  an amendment to ARB No. 51 (Statement 160). Statements 141R and 160
require most identifiable assets, liabilities, noncontrolling interests, and goodwill
acquired in a business combination to be recorded at full fair value and
require noncontrolling interests (previously referred to as minority interests) to be
reported as a component of equity, which changes the accounting for transactions with
noncontrolling interest holders. Both statements are effective for periods beginning on or
after December 15, 2008, and earlier adoption is prohibited. Statement 141R will be
applied to business combinations occurring after the effective date. Statement 160 will be
applied prospectively to all noncontrolling interests, including any that arose before the
effective date. The Company will adopt the guidance in Statement 141R and Statement 160 to
future transactions. The Company will follow upon adoption the presentation and disclosure
requirements with respect to minority interests in subsidiaries, this will result in a
reclassification of immaterial amounts from minority interest liability classified balance
to an equity account.

Effective
January 1, 2008, the Company adopted the provisions of FASB Statement No. 157, Fair
Value Measurements, (SFAS 157), for fair value measurements of financial assets and
financial liabilities and for fair value measurements of nonfinancial items that are
recognized or disclosed at fair value in the financial statements on a recurring basis.
SFAS 157 defines fair value as the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market participants at the
measurement date. SFAS 157 also establishes a framework for measuring fair value and
expands disclosures about fair value measurements. FASB Staff Position FAS 157-2,
Effective Date of FASB Statement No. 157, delays the effective date of SFAS
157 until fiscal years beginning after November 15, 2008 for all nonfinancial assets and
nonfinancial liabilities that are recognized or disclosed at fair value in the financial
statements on a nonrecurring basis. On January 1, 2009, the Company will be required to
apply the provisions of SFAS 157 to fair value measurements of nonfinancial assets and
nonfinancial liabilities that are recognized or disclosed at fair value in the financial
statements on a nonrecurring basis. The Company is in the process of evaluating the
impact, if any, of applying these provisions on its financial position and results of
operations. In October 2008, the FASB issued FASB Staff Position FAS 157-3,
Determining the Fair Value of a Financial Asset When the Market for That Asset is
Not Active, which was effective immediately. FSP FAS 157-3 clarifies the application
of SFAS 157 in cases where the market for a financial instrument is not active and
provides an example to illustrate key considerations in determining fair value in those
circumstances. The adoption of FSP FAS 157-3 did not have an impact on the
Companys consolidated results of operations and financial position.

45

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In
March 2008, the FASB issued FASB Statement No. 161, Disclosures about Derivative
Instruments and Hedging Activities  an amendment of FASB Statement No.
133.  Statement 161 requires entities that utilize derivative instruments to
provide qualitative disclosures about their objectives and strategies for using such
instruments, as well as any details of credit-risk-related contingent features contained
within derivatives.  Statement 161 also requires entities to disclose additional
information about the amounts and location of derivatives located within the financial
statements, how the provisions of Statement 133 have been applied, and the impact that
hedges have on an entitys financial position, financial performance, and cash
flows.  Statement 161 is effective for fiscal years and interim periods
beginning after November 15, 2008.  The Company believes that the impact, if
any, of adopting Statement 161 will not have a material impact on the Companys
financial statement.

In
April 2008, the FASB issued FASB Staff Position FAS 142-3, Determination of the
Useful Life of Intangible Assets. FSP FAS 142-3 amends the factors that should be
considered in developing renewal or extension assumptions used to determine the useful
life of a recognized intangible asset under Statement 142. FSP FAS 142-3 is effective
for fiscal years beginning after December 15, 2008. The Company believes that the
impact, if any, of adopting FSP FAS 142-3 will not have a material impact on the
Companys financial statement.

In
June 2008, the FASBs Emerging Issues Task Force reached a consensus on EITF Issue
No. 07-5, Determining Whether an Instrument (or Embedded Feature) Is Indexed to an
Entitys Own Stock. This EITF Issue provides guidance on the determination of
whether such instruments are classified in equity or as a derivative instrument. The
Company will adopt the provisions of EITF 07-5 on January 1, 2009 and expect that the
impact, if any, of adopting EITF 07-5 will not have a material impact on the
Companys financial statement.

In
November 2008, the FASBs Emerging Issues Task Force reached a consensus on EITF
Issue No. 08-6, Equity Method Investment Accounting Considerations. EITF
08-6 continues to follow the accounting for the initial carrying value of equity method
investments in APB Opinion No. 18, The Equity Method of Accounting for Investments in
Common Stock, which is based on a cost accumulation model and generally excludes
contingent consideration. EITF 08-6 also specifies that other-than-temporary impairment
testing by the investor should be performed at the investment level and that a separate
impairment assessment of the underlying assets is not required. An impairment charge by
the investee should result in an adjustment of the investors basis of the impaired
asset for the investors pro-rata share of such impairment. In addition, EITF 08-6
reached a consensus on how to account for an issuance of shares by an investee that
reduces the investors ownership share of the investee. An investor should account
for such transactions as if it had sold a proportionate share of its investment with any
gains or losses recorded through earnings. EITF 08-6 also addresses the accounting for a
change in an investment from the equity method to the cost method after adoption of
Statement 160. EITF 08-6 affirms the existing guidance in APB 18, which requires cessation
of the equity method of accounting and application of FASB Statement No. 115, Accounting
for Certain Investments in Debt and Equity Securities, or the cost method under APB 18, as
appropriate. EITF 08-6 is effective for transactions occurring on or after December 15,
2008. The Company does not anticipate that the adoption of EITF 08-6 will materially
impact the Companys financial position or results of operations.

In
May 2009, the FASB issued Statement No. 165, Subsequent Events, addressing accounting and
disclosure requirements related to subsequent events. Statement 165 requires management to
evaluate subsequent events through the date the financial statements are either issued or
available to be issued, depending on the companys expectation of whether it will
widely distribute its financial statements to its shareholders and other financial
statement users. Companies will be required to disclose the date through which subsequent
events have been evaluated. Statement 165 is effective for interim or annual financial
periods ending after June 15, 2009 and should be applied prospectively. The adoption of
Statement 165 is not expected to have a material effect on the Companys financial
statements.

46

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

Our
principal sources of liquidity since our inception have been sales of equity securities,
borrowings from banks, and cash from the exercise of options and warrants. We had cash and
cash equivalents of $27.2 million as of December 31, 2008 and $35.5 million as of December
31, 2007. In addition, we had short-term investments of $904,000 (representing U.S.
treasury securities) as of December 31, 2008 and $6.4 million as of December 31, 2007. We
believe that our working capital is sufficient to meet our present requirements.

Operating
activities. For the year ended December 31 , 2008
we have used $12.2 million in operating activities primarily due to a $50.0 million net
loss, a $2.0 million decrease in other current liabilities, a $1.9 million decrease in
trade payables and a $711,000 decrease in deferred tax liability, partially offset by a
$24.2 million impairment of goodwill, a $6.3 million of stock based compensation issued to
employees and others, a $2.7 million decrease in trade receivables, a $3.0 million
depreciation, $2.8 million amortization and impairment of intangible assets, a $1.3
million equity in net losses of an affiliated company, a $869,000 decrease in inventories,
a $567,000 decrease in other receivables and prepaid expenses, a $548,000 increase in
allowance for doubtful accounts and a $78,000 increase in accrued severance pay, net. For
the year ended December 31, 2007 we have used $6.3 million in operating activities
primarily due to a $20.6 million net loss, a $2.8 million increase in inventories due to
purchasing for future and existing orders, a $1.0 million minority interest, and a
$686,000 increase in other receivables and prepaid expenses, partially offset by a $6.9
million of stock based compensation issued to employees and others, a $3.3 million
increase in trade payables, a $2.6 million depreciation, a $2.5 million increase in
allowance for doubtful accounts, a $2.0 million increase in other current liabilities, a
$1.3 million amortization of intangible assets, a $358,000 equity in net losses of an
affiliated company, a $283,000 increase in accrued severance pay, net, and a $104,000
decrease in trade receivables. For the year ended December 31, 2006 we used $3.5 million
of cash in operating activities primarily due to our net loss of $6.6 million, a $3.2
million increase in inventories, a $1.9 million increase in trade receivables, a $2.1
decrease in other current liabilities, $625,000 of minority share in loss of subsidiaries
and a $551,000 decrease in allowance for doubtful accounts, partially offset by a $3.8
million stock-based compensation related to options and shares issued to employees and
others, a $2.6 million increase in trade payables, a $1.9 million charge for depreciation
of our property and equipment, a $1.1 million decrease in other receivables and prepaid
expenses, a $1.1 million equity in net losses of an affiliated company, a $821,000
amortization of intangible assets and a $796,000 increase in accrued severance pay, net.

Investing
and financing activities. For the year ended December 31, 2008, net cash provided by
investing activities was$3.4 million, mainly due to $34.6 million proceeds from
maturity of available-for-sale securities, partially offset by a $29.0 million investment
in available-for-sale securities, a $1.5 million used in the purchase of property and
equipment and a $565,000 purchase of PARX France (formerly ID Parking). For the year ended
December 31, 2007, net cash provided by investing activities was $6.6 million, mainly due
to $148 million proceeds from maturity of available-for-sale securities and a $837,000
receipt on account of loans and receivables, partially offset by a $136.1 million
investment in available-for-sale securities and a $6.2 million purchase of property and
equipment. For the year ended December 31, 2006, net cash used in investing activities was
$1.1 million, mainly due to a $23.6 million investment in available-for-sale securities
and to a $3.1 million investment in equipment purchases, partially offset by $25.4 million
proceeds from maturity of available-for-sale securities and $350,000 receipts on account
of loans and receivables related to our disposition of a German subsidiary in 2004.

For
the year ended December 31, 2008, net cash provided by financing activities was $598,000,
mainly due to $1.5 million proceeds from receipt on account of share and exercise of
options and warrants, net, partially offset by $508,000 repayment of long-term bank loans
and $358,000 decrease in short-term bank credit. For the year ended December 31, 2007, net
cash provided by financing activities was $5.1 million, mainly due to $4.8 million
increase in short-term bank credit, net, and $739,000 proceeds from long-term loans,
partially offset by $495,000 repayment of long-term bank loans. For the year ended
December 31, 2006, net cash provided by financing activities was $4.9 million, mainly due
to $3.2 million due to exercise of options and warrants, $1.5 million of proceeds from
minority in subsidiary and $978,000 from long-term bank loans, partially offset by a
$570,000 repayment of long-term bank loans and by a $231,000 decrease in short term
credit.

Market Risks

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.

47

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Interest Rate Risks

We
are exposed to market risks resulting from changes in interest rates, relating primarily
from our loan obligations to banks. We do not currently use derivative financial
instruments to limit exposure to interest rate risk. As of December 31, 2008, we had fixed
interest rate loan obligations of $2.3 million. Of this amount, $1.4 million was
denominated in euro, $703,000 was denominated in USD, $120,000 was denominated in New
Israeli Shekel, $49,000 was denominated in Polish Zloty and $41,000 was denominated in
South African Rand. These loans will be repaid during the next five years.

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

Impact of Inflation and
Currency Fluctuations

Our
functional and reporting currency is the U.S. dollar. We generate a significant portion of
our revenues and we incur some of our expenses in other currencies. As a result, we are
exposed to the risk that the rate of inflation in countries in which we are active other
than the United States will exceed the rate of devaluation of such countries
currencies in relation to the dollar or that the timing of this devaluation will lag
behind inflation in such countries. To date, we have been affected by changes in the rate
of inflation or the exchange rates of other countries currencies compared to the
dollar, and we cannot assure you that we will not be adversely affected in the future.

The
annual rate of inflation (deflation) in Israel was 3.8% in 2008, 3.4% in 2007 and (0.1%)
in 2006. The NIS revalued by approximately 1.1% and 9.0% in 2008 and 2007, respectively,
against the U.S. dollar.

The
functional currency of InterCard Systemelectronic, Inseal SAS and PARX France is euro and
of ASEC Spolka Akcyjna is the Polish Zloty and the functional currency of MCT is the
Chinese Yuan Renminbi. Significantly all of these subsidiaries revenues are earned,
and significantly all of their expenses are incurred, in their functional currencies. To
the extent that there are fluctuations between the euro, the Polish Zloty and/or the
Chinese Yuan Renminbi against 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 cannot assure you that we will not be adversely
affected in the future.

Corporate Tax Rate

On
July 25, 2005 the Knesset, the Israeli Parliament, passed the Law for the Amendment of the
Income Tax Ordinance (No.147 and Temporary Order)  2005, or the Amendment. The
Amendment provides for a gradual reduction in the company tax rate in the following
manner: in 2006  31%, in 2007  29%, in 2008  27%, in 2009  26% and
from 2010 onward the tax rate will be 25%. Furthermore, as from 2010, upon reduction of
the company tax rate to 25%, real capital gains will be subject to tax of 25%. As of
December 31, 2008, our net operating loss carry-forwards for Israeli tax purposes amounted
to approximately $84.4 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, 2008, we have not yet utilized the tax benefits
for which we are eligible under the Approved Enterprise status. $4.5 million
of our investment programs in buildings, equipment and production facilities have been
granted Approved Enterprise status and we are, therefore, eligible for a tax
exemption under the Law for the Encouragement of Capital Investments, 1959. Subject to
compliance with applicable requirements, the portion of our income derived from the
Approved Enterprise programs is tax-exempt for a period of the earliest of (1)
ten years commencing in the first year in which it generates taxable income, (2) 14 years
from the date of approval or (3) 12 years from the date of beginning of production. If we
do not comply with these requirements, the tax benefits may be cancelled and we may be
required to refund the amount of benefits received, in whole or in part, with the addition
of linkage differences to the Israeli consumer price index and interest. As of the date of
this annual report, we believe that we are in compliance with these conditions.

Government of Israel
Support Programs

Until
2005 we participated in programs offered by the Office of the Chief Scientist of the
Ministry of Industry and Trade (OCS) that support research and development
activities. Under the terms of these programs, a royalty of 3% to 3.5% of the sales of
products must be paid to the OCS, beginning with the commencement of sales of products
developed with grant funds and ending when the dollar value of the grant is repaid. In
2006 we decided to cease our participation with the OCS.

48

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Royalties
payable with respect to grants received under programs approved after January 1, 1999,
however, will be subject to interest on the dollar-linked value of the total grants
received at an annual rate of LIBOR applicable to dollar deposits. As of December 31,
2008, we have received a total of $5.0 million from the OCS net of royalties paid to it
(or accrued for). The terms of Israeli government participation also require that the
manufacturing of products developed with government grants be performed in Israel, unless
the OCS has granted special approval. If the OCS 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 OCS 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 OCS to the extent of our
sales of our products and related services for the foreseeable future.

Separate
OCS consent is required to transfer to third parties technologies developed through
projects in which the government participates. These restrictions do not apply to exports
from Israel of products developed with these technologies.

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

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

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

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

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

None.

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

As
of December 31, 2008, we and our subsidiaries had contractual obligations which are
expected to affect our consolidated cash flow in future periods as follows: (in thousands)

|                            | 2009 | 2010 | 2011 | 2012  | 2013 and
thereafter | Total
|--------------------------- | ---- | ---- | ---- | ----- | ------------------- | -----
|
|
|
|
|Operating lease obligations |      |      | $    | 751   |                     | $    
|Long-term debt obligations  |      |      | $    | 580   |                     | $    
|Deferred tax liability      |      |      | $    | 82    |                     | $    
|Total                       |      |      | $    | 1,413 |                     | $    

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

Our
liability for severance pay for some of our Israeli employees is calculated pursuant to
Israeli severance pay law based on the most recent salary of the employee multiplied by
the number of years of employment, as of the balance sheet date. Those employees are
entitled to one months salary for each year of employment or a portion thereof.
Certain senior executives are entitled to receive additional severance pay. Our liability
for those Israeli employees is partially provided for by monthly deposits for insurance
policies and by an accrual. The value of these policies is recorded as an asset in our
balance sheet. The deposited funds include profits and losses accumulated up to the
balance sheet date. The deposited funds may be withdrawn only upon the fulfillment of the
obligation pursuant to Israeli Severance Pay Law or labor agreements. The value of the
deposited funds is based on the cash redemption value of these policies. Our total
liability, net of deposited funds, at December 31, 2008 was $2.5 million. Timing of
payment of this liability is dependent on timing of the departure of the employees.

For
additional information on our contractual obligations as of December 31, 2008, under
long-term bank loans and operating leases, see Notes 8 and 9 to our consolidated financial
statements. For a description of liens on our assets see Note 9C to our consolidated
financial statements.

49

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

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

# Management

The
following table sets forth certain information concerning our current directors and
executive officers.

|Name                          | Age |  | Position                                                   
|----------------------------- | --- |  | -----------------------------------------------------------
|
|
|
|
|Oded Bashan (1)               | 62  |  | Chief Executive Officer, Chairman and Director             
|Ronnie Gilboa                 | 53  |  | Vice President - Projects and Director                     
|Guy Shafran                   | 36  |  | Chief Financial Officer (until
September 30, 2008),        
|                              |     |  | Chairman and President of Millennium Cards Technology Ltd.
|Tanir Horn                    | 33  |  | Chief Financial Officer (from October 1, 2008)             
|Moshe Aduk                    | 52  |  | Vice President - Gasoline Management System                
|Nehemya Itay                  | 60  |  | Vice President - Hardware Engineering                      
|Ohad Bashan                   | 38  |  | President, Chief Marketing Officer and Director;           
|                              |     |  | Chief Executive Officer, OTI America, Inc.                 
|Eliezr Manor (1)(2)(3)        | 62  |  | Director                                                   
|Ora Setter (1)(2)(3)          | 58  |  | Director                                                   
|Eli Akavia (1)(2)             | 61  |  | Director                                                   
|Raanan Ellran (1)(2)(3)       | 59  |  | Director                                                   
|Shlomo Tussia-Cohen (1)(2)(3) | 36  |  | 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 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 (Pty)
Ltd., SoftChip Technologies (3000) Ltd., SoftChip Israel Ltd., Easy Park Ltd., Easy Park
Israel Ltd. and PARX Ltd., President of InSeal SAS and a director of ASEC, Millennium
Cards Technology Ltd., 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.Sc and an M.Sc 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 has served as our Vice President-Projects. He serves on the board of directors of OTI
America, Inc., ASEC S.A, OTI Africa Ltd., Easy Park Ltd., Easy Park Israel Ltd., PARX
Ltd., Softchip Technologies (3000) Ltd., SoftChip Israel Ltd., and Origin GPS 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
Shafran served as our Chief Financial Officer until September 30, 2008, having served in
that position since June 2000, 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. Since 2005 Mr. Shafran
also serves as the President and Chairman of Millennium Cards Technology Ltd. Mr.
Shafran is also a director in Millennium Cards Technology Ltd. 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, and a MEI Graduate Degree in Management specializing in
International Management and Entrepreneurship from Swinburne University of Technology.

Tanir
Horn serves as our Chief Financial Officer since October 1, 2008. Ms. Horn is a
Certified Public Accountant and has been with OTI since 2006, acting first as a Deputy CFO
of OTIs joint venture in China and then as OTIs controller at its headquarters
in Israel. Prior to joining OTI, Ms. Horn worked as an examiner for large enterprises at
the head office of the Income Tax Division of the Israeli Treasury from 2001 until 2006.
She holds a BA in Business Administration and Accountancy from College of Business
Management, Tel Aviv, and has been a lecturer and instructor on taxation laws since 2002
in colleges and for the Tax Division of the Israeli Treasury.

50

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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 Organization 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 President and Chief Marketing Officer. Prior to thathe
served as our Head of Global Marketing and Strategy Development (since June 2000). Mr.
Bashan was appointed as the President of the Company commencing August 2007, pursuant to
which he relocated from the U.S. to the Companys headquarters in Israel and stepped
down from his office as the President of OTI America, however, remained his position as
Chief Executive Officer and a director of OTI America, Inc., which he holds since 1998. Mr
Bashan serves as a director of our board, as a director of Millennium Cards
Technology Ltd. since 2005 and as a director in PARX Ltd since 2008. From 1996 to August
1998, he was our business development manager. Mr. Bashan holds a B.A. in business from
the College of Business Management, Tel Aviv, with specializations in marketing and
finance, and an M.B.A. from Pepperdine University, California.  Ohad Bashan is the
son of Oded Bashan.

Eliezer
Manor serves as a director, having served in that position since July 2003. Mr. Manor
is a private businessman engaged in hi-tech entrepreneurship and venture capital. His
activities are carried out through his wholly owned company, Shirat Enterprises Ltd.,
which holds a portfolio of private investments and, in addition, carries out a broad
program dedicated to establishment of joint ventures between Israeli hi-tech companies and
Chinese industrial mature companies. In the past Mr. Manor was the co-founder and director
of several hi-tech start-up companies. He also served as a member of the international
team of WJ Hopper investment bank. Mr. Manor was also a co-founder and managing director
of two VC funds (Mofet in Israel and GCP in the Silicon Valley), and a founder of IVA
(Israel Venture Capital and Private Equity Association) and served as its first Executive
Director. Mr. Manor holds a B.Sc. Physics from the Tel Aviv University and a M.Sc. Applied
Physics from the Weizmann Institute of Science, Israel, specializing in electro-optics and
is a member of the Advisory Editorial Board of Photonics Spectra  the international
journal of electro-optical engineering. Mr. Manor is also engaged in venture philanthropy,
and he and his family established in the past and are supporting Schools-On-Line, a NGO
active among high-school children and teachers.

Ora
Setter (PhD) serves as a director, having served in that position since August 2006.
Until August 2006 Dr. Setter was the CEO and Academic Director of Lahav  Executive
Education Center in Tel Aviv University. Dr. Setter also served a as director in Sapanut
& Aspaka Ltd., Marnetics Inc., Topspin Medical Inc., Ravad Ltd, and Medcon Ltd. Dr.
Setter is an active lecturer at the Recanati Business School at Tel Aviv University, and
in other academic institutions. Dr. Setter is a consultant to many leading companies in
Israel, focusing on organizational development and business, and specializing in knowledge
management and implementation of knowledge management systems, and in building and
organizing training programs for organizations. She is also a well known lecturer and
writer. In the past Dr. Setter was the entrepreneur and Managing Director of Book A la
Carte, Inc.  as start up company dealing with publishing books through the Internet.
Dr. Setters areas of teaching and research include Psychological Contracts in
organizations, Leadership, Organizational Diagnosis & Development, Real and Virtual
Team Building, Organizational Politics and Power and Career Dynamics. Dr. Setter serves in
the board of several organizations  business companies and NGOs. She is the
organizing force and leader of the Women promoting women network in Israel,
including most of the women leaders in business, academia, public sector and NGOs.
These days Dr. Setter has completed her studies for a MA degree in Religions Science South
Asian Studies in Tel Aviv University, and is involved with several ventures as a partner
and business consultant.

Eli
Akavia, serves as a director, having served
in that position since December 2003. Mr. Akavia is an independent consultant and he
serves as a director of several other Israeli public companies (Eden Springs Ltd., Eshlad
Ltd., Starling Advanced Communications Ltd. and Rada Electronics Industry Ltd.). Mr.
Akavia worked for Luboshitz Kasierer, an Israeli auditing firm (formerly a member firm of
Arthur Andersen and currently merged with Ernst & Young, Israel) for 30 years and
until 2002, first as an employee and later as a senior partner. Mr. Akavias roles at
Luboshitz Kasierer included: Head of Audit Department, Head of Hi-Tech Division and
Partner in charge of the Firm Professional Standards Group. He specialized in hi-tech
companies and accumulated invaluable experience in US GAAP and SEC rules. Mr. Akavia has
participated in a large number of Israeli companies initial public offerings in the
United States.

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Raanan
Ellran served as a director between 1999- 2005, resuming the position in July 2007.
Since April 2009 Mr. Ellran is the CEO of CSB Home Appliances Ltd, and in addition, he
currently serves on the board of directors of AAI Ltd., an Israeli internet software
designer and of Rafael Advanced Defense Systems Ltd (between 2002-2005, resuming the
position in 2006), where he also serves as Chairman of the Finance Committee, and as
Chairman of the Investment Committee. Previous positions as board member include the First
International Bank, Dikla Mutual Funds Management Company, F.I.B.I. Holding Company Ltd.
(until October 2006), and First International Bank of Israel, Provident and Pension funds
(between 1993-1998). Between 1997- 2002 he served as the General Manager of Assuta Medical
Centers, between 1995 to 1997, he served as the General Manager of Ratfon Import Ltd., and
prior to that he was the General Manager of ACE Hardware (Israel) Ltd. (1994-1995).

Shlomo
Toussia-Cohen serves as a director, having served in that position since June 2005.
From 2002 to 2005 Mr. Toussia-Cohen worked as senior assistant to Director General of the
Israeli Broadcasting Authority  the Israeli Public TV and Radio and as chief
executive officer and member of the investment committee in the Education Fund for
Journalists (1977) Ltd. Holding a Master degree in Law (L.L.M.) with specialization in
private law from the Hebrew University of Jerusalem and a bachelor degree in Business
(B.A.) with specialization in finance from the Interdisciplinary Center of Herzelia, Mr.
Toussia-Cohen works as a Lawyer and is a member of both the Israeli Bar and the of New
York State bar.

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

# Executive Compensation

The
aggregate compensation paid by us and our subsidiaries to our executive directors and
executive officers listed above under Management, for the year ended December
31, 2008 was $1,945,000, of which approximately $45,000 relates to 2008 bonuses paid in
2009. This amount includes approximately $405,000 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. The
amounts mentioned above include the compensation paid to our current and previous Chief
Financial Officers in respect of their partial office periods during 2008.

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 to our non-executive directors
listed above under Management, in the year ended December 31, 2008 was
$176,287.

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

# Employment Agreements

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

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Agreement
with Oded Bashan. The employment agreement of Oded Bashan, dated July 1, 2004, as was
amended at our shareholders meetings dated June 3, 2005, August 24, 2006 and July 27,
2007, provides for a seven-year term ending on June 30, 2011. Mr. Bashan may terminate his
employment, and we may terminate his employment for reasonable and justifiable cause, in
either case upon six months notice. In the event of termination, Mr. Bashan is
entitled to receive severance pay equal to twice the rate of one months current
salary multiplied by the number of years of employment. In the event we terminate his
employment prior to June 30, 2011, unless the termination occurred as a result of
circumstances depriving him of the right to severance pay at law or as a result of a
breach of fiduciary duty or a material breach of confidentiality or noncompetition
undertakings, we are required to continue paying Mr. Bashan a monthly compensation,
including benefits but excluding bonuses, until June 30, 2011, and in any event, for a
period that shall not be less than six months following the notice period described above.
In addition to the compensation, contributions and bonus described above, Mr. Bashan is
entitled under his contract of employment to an additional bonus of $15,000 for every one
percent increase in our average share price quoted for the last two months of any year
over the average share price quoted for the last two months of the preceding year. The
total compensation that Mr. Bashan is entitled to under his employment agreement is paid
to Mr. Bashan partially as a salary, in his capacity as an employee of the company, and
partially as a service fee, in his capacity as a service provider.

Agreement
with Ronnie Gilboa. The employment agreement of Ronnie Gilboa, dated July 1, 1999, as
was amended at our shareholders meeting dated July 27, 2007, provides for a five-year term
ended on June 30, 2004, and was extended automatically for a non-determined period. Mr.
Gilboa may terminate his employment, and we may terminate his employment for reasonable
and justifiable cause, in either case upon six months notice. In the event of
termination, Mr. Gilboa is entitled to receive severance pay equal to twice the statutory
rate of one months current salary multiplied by the number of years of employment.
On July 2007, Mr. Gilboas employment agreement was amended to include a commission
of one (1%) percent from the net revenues and five (5%) percent from the net royalty
payments and net NRE payments (i.e., after deduction of applicable tax) from projects
resulting from his direct contribution.

Agreement
with Guy Shafran.  The employment agreement of Guy Shafran, dated January 1,
2006, as was renewed in 2008, provides for a three-year term ending on December 31, 2011,
and is automatically extended unless terminated as described below.  In the event of
termination, Mr. Shafran is entitled to receive severance pay equal to twice the rate of
one months current salary multiplied by the number of years of employment in OTI or
one of its subsidiaries.  Mr. Shafran is expected to work in Hong-Kong for three
years with option for an additional two years and in the event that the employment abroad
or in connection to it will be terminated before such period, Mr. Shafran will be paid in
full and will be entitled to all terms as if such a termination did not exist. Mr. Shafran
may terminate his employment on six months notice, and we may terminate his employment for
reasonable or justifiable cause on one year notice.  In the event of termination of
employment, unless the termination occurred as a result of circumstances depriving Mr.
Shafran of the right to severance pay at law or as a result of a breach of fiduciary duty
or a material breach of his confidentiality or noncompetition undertakings, Mr. Shafran
shall be entitled to additional six months severance payments with full terms and
benefits.

Agreement
with Tanir Horn The employment agreements of Tanir Horn, dated June 25, 2007, provides
for an undetermined employment period. Ms. Horn may terminate her employment, and we may
terminate her employment, in either case on two months notice. In the event of
termination, unless the termination occurred as a result of circumstances depriving her of
the right to severance pay at law, Ms. Horn is entitled to receive severance pay from
funds deposited by us in her name.

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

Agreement
with Ohad Bashan.  The employment agreement of Ohad Bashan with OTI America,
Inc., dated October 6, 2005, as was approved at our shareholders meeting dated November
12, 2005, and amended at our shareholders meetings dated July 27, 2007 and August 6, 2008,
provides for a four-year term ending on August 24, 2009. On June 2007 the Company assumed
his employment agreement and he was appointed as the President of the Company commencing
in August 2007, pursuant to which he relocated from the U.S. to the Companys
headquarters in Israel and stepped down from his office as the President of OTI America,
however, remained his position as Chief Executive Officer and a director of OTI America,
Inc. Mr. Bashan may terminate his employment on six months notice and we may terminate his
employment upon six months notice.  In the event we terminate his employment, Mr.
Bashan shall be entitled to six months severance payments with full terms and benefits,
and shall be entitled to severance payment in an amount equal to two monthly salaries for
each year Mr. Bashan was employed with the Company or OTI America, in addition to all
benefits and salary Mr. Bashan is entitled to during the six month period. In addition to
his monthly compensation, Mr. Bashan is entitled to receive a special annual bonus of 0.5%
of the annual sales in the Americas markets. The bonus is paid during the month of April
of the following year of the actual sales, as recognized in OTIs financial
statements. The total compensation that Mr. Bashan is entitled to under his employment
agreement is paid to Mr. Bashan partially as a salary, in his capacity as an employee of
the company, and partially as a service fee, in his capacity as a service provider.

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

# Election of Directors;
Appointment of Officers

Our
current board of directors consists of eight directors. Under our articles of association,
our board of directors may not consist at any time of more than nine members. A majority
of these directors must be non-executive directors, who are directors that are neither
office holders nor our employees. Directors are appointed, removed or replaced, by a
majority vote of our shareholders present in person or by proxy at a general meeting of
shareholders.

Once
elected at a shareholders meeting, our directors, except our external directors,
hold office until the first general meeting of shareholders held at least thirty six
months after their election, except for Mr. Oded Bashan and Mr. Ronnie Gilboa who may not
be replaced or removed unless by an affirmative vote of 75% of the Companys
shareholders entitled to vote and voting in person or by proxy at a general meeting of
shareholders. Incumbent directors may be reelected at that meeting. Unless contrary to the
law, a director may be elected for consecutive terms.

Under
the new Israeli Companies Law, which entered into effect on February 1, 2000 (the
Companies Law), the chief executive officer of a public company may not serve
as a chairman of the board of directors, and vice versa, unless authorized by a general
meeting of the shareholders and then only for a period of time that does not exceed three
years. On August 24, 2006 our shareholders authorized our Chairman, Oded Bashan, to act as
our Chief Executive Officer for an additional three-year period, after such date, we plan
to recommend to our shareholders to authorize Mr. Bashan to act as our Chief Executive
Officer for an additional 3-year period.

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 President and Chief Marketing
Officer, and Chief Executive Officer of OTI America, who is the son of Oded Bashan, our
co-founder and chairman of our board of directors, none of our directors or executive
officers has any family relationship with any other director or executive officer.

# External Directors

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

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

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 under legislation that apply to
Israeli companies whose shares that have been offered to the public outside of Israel or
traded on a stock exchange outside of Israel, may be extended for consecutive additional
three year periods (unlike other public companies, in which only one additional three year
period is allowed). 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.

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

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

In
addition, the audit committee of our board of directors must include at least three
independent directors within the meaning of the NASDAQ Global Market listing requirements.
Our directors Raanan Ellran, Shlomo Toussia-Cohen, Eliezer Manor and Ora Setter, qualify
as external directors under the Companies Law and independent directors under the NASDAQ
Global Market listing requirements. In addition, our director Eli Akavia, CPA is qualified
as an independent director under the NASDAQ Global 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.

# Directors Service
Contracts

Except
directors who are also officers of the Company, none of our directors have any services
contracts either with us, or with any of our subsidiaries, which provide for benefits upon
termination of employment or service.

# Directors
Compensation

In
accordance with the Israeli Companies Law, we pay each director (other than directors who
are also officers of the Company) annual compensation in the amount of NIS 73,124 (around
$17,410), and in addition an amount of NIS 2,813 (around $700) for each meeting of the
board or any one of its committee attended in person (and 50% of this amount for each
meeting attended via a conference call).

In
addition, we grant our directors, from time to time, options to purchase our ordinary
shares, subject to the approval of our shareholders meeting.

# Board Committees

Our
Board of Directors has established an audit committee, compensation committee and steering
committee.

# 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.

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The
current members of our compensation committee are Oded Bashan, Eliezer Manor, Shlomo
Toussia-Cohen, Ora Setter, Raanan Ellran and Eli Akavia. 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. Since our compensation committee is not
comprised solely of independent directors, all compensation arrangements of our executive
officers are determined by a majority of our independent directors in accordance with
NASDAQ Marketplace Rules.

# Steering Committee

Our
board of directors established our steering committee in November 2004. The duties of the
steering committee were to review the deployment of our company towards the implementation
of the Sarbanes-Oxley Act. Following the establishment of the required procedure pursuant
to the Sarbanes-Oxley Act, we concluded that the steering committee is no longer required.

# Audit Committee

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

The
current members of our audit committee are Shlomo Toussia-Cohen, Ora Setter, Eliezer
Manor, Raanan Ellran and Eli Akavia, all of which are independent directors.
Eli Akavia is the Audit Committees Chairman, and our board has determined that he is
an Audit Committee Financial Expert.

# Internal Auditor

Under
the Companies Law, the board of directors must appoint an internal auditor that is
recommended by the audit committee. The role of the internal auditor is to examine, among
other things, whether the companys actions comply with the law and orderly business
procedure. Under the Companies Law, the internal auditor may not be an office holder or an
interested party, as defined below, or a relative of an office holder or an interested
party, and he or she may not be the companys independent accountant or the
independent accountants representative. The Companies Law defines an
interested party as a holder of 5% or more of the issued shares or voting
rights of a company, a person or entity who has the right to designate at least one
director or the general manager of the company, and a person who serves as a director or
general manager. On January 1, 2008, our audit committee recommended the appointment of
Mr. Gali Gana, CPA, from the office of Rosenblum Holzman & Co., as our internal
auditor for the year 2008, and our board of directors approved the appointment.

# 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.

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

The
Companies Law further requires that an office holder discloses 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
transactionbetween 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 should 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 NASDAQ Marketplace Rule
4350(h), the Company should conduct an appropriate review of all related party
transactions for potential conflict of interest situations on an ongoing basis and all
such transactions should be approved by the companys audit committee or another
independent body of the Board of Directors.

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. Under NASDAQ Marketplace Rule 4350(c)(3)(A), compensation of the Chief
Executive Officer must be determined, or recommended to the Board for determination,
either by: (i) a majority of the independent directors, or (ii) a compensation committee
comprised solely of independent directors. The Chief Executive Officer may not be present
during voting or deliberations. Under NASDAQ Marketplace Rule 4350(c)(3)(B) compensation
of all executive officers, except the Chief Executive Officer, must be determined, or
recommended to the Board for determination, either by (i) a majority of the independent
directors, or (ii) a compensation committee comprised solely of independent directors.

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, a private placement in which the controlling
party has a personal interest and the engagement and terms of compensation of a
controlling party or his family members, require the approval of the audit committee, the
board of directors and the shareholders. Shareholders 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.

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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 his 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.

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

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

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

The
decrease in the number of our employees in 2008 compared to 2007 was mainly in
manufacturing and operation in the Far East and in research and development. Of our
employees, on December 31, 2008, 121 were based in Israel, 10 in the United States, 105 in
Europe, 34 in South Africa and 355 in the Far East.

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 or maintain
qualified personnel to our offices. We dedicate significant resources to employee
retention and have never experienced work stoppages and we believe that our relations with
our employees are good.

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

The
following table sets forth certain information as of June 23, 2009 regarding the
beneficial ownership of our ordinary shares by each of our directors and executive
officers. Beneficial ownership is determined in accordance with rules of the Securities
and Exchange Commission.

All information with respect to the beneficial ownership of any of the below shareholders
has been furnished by such shareholder and, unless otherwise indicated below, we believe
that persons named in the table have sole voting and sole investment power with respect to
all of the shares shown as beneficially owned, subject to community property laws, where
applicable. The shares beneficially owned by the directors and executive officers include
the shares owned by their family members to which such directors and executive officers
disclaim beneficial ownership.

58

---

---

The
share numbers and percentages listed below are based on 22,860,102 shares outstanding as
of June 23, 2009:

|Name of beneficial owner(1) | Number of Shares
Beneficially
Owned (2) | % of Class of Shares | Number of
Options
Beneficially
Owned (3) | Exercise Price | Date of Expiration
|--------------------------- | --------------------------------------- | -------------------- | ---------------------------------------- | -------------- | ------------------
|
|
|
|
|Oded Bashan(4)              | 2,417,509                               | 10.6%                |                                          |                |                   
|Ronnie Gilboa(5)            | 241,089                                 | 1.0%                 | 2,000                                    | USD 32.00      | March 1,2011      
|                            |                                         |                      | 2,000                                    | USD 9.00       | March 1,2011      
|                            |                                         |                      | 10,000                                   | NIS 0.10       | March 7,2012      
|                            |                                         |                      | 15,000                                   | NIS 0.10       | April 13,2012     
|                           
|Guy Shafran(6)              | 236,003                                 | 1.0%                 | 574                                      | NIS 0.10       | May 14,2012       
|                            |                                         |                      | 841                                      | NIS 0.10       | November 26, 2009 
|                            |                                         |                      | 34,000                                   | NIS 0.10       | March 7,2012      
|                            |                                         |                      | 75,000                                   | USD 2.48       | May 26, 2013      
|                            |                                         |                      | 75,000                                   | NIS 0.10       | May 26, 2013      
|                            |                                         |                      | 17,000                                   | NIS 0.10       | June 25, 2013     
|                           
|Tanir Horn(7)               | 32,469                                  | ***                  | 20,000                                   | NIS 0.10       | May 24, 2014      
|Moshe Aduk(8)               | 223,411                                 | 1.0%                 | 662                                      | NIS 0.10       | May 14,2012       
|                            |                                         |                      | 1,014                                    | NIS 0.10       | November 26, 2009 
|                            |                                         |                      | 10,000                                   | NIS 0.10       | March 7,2012      
|                            |                                         |                      | 15,000                                   | NIS 0.10       | April 13,2012     
|                           
|Nehemya Itay(9)             | 233,883                                 | 1.0%                 | 675                                      | NIS 0.10       | May 14,2012       
|                            |                                         |                      | 1,064                                    | NIS 0.10       | November 26, 2009 
|                            |                                         |                      | 5,000                                    | NIS 0.10       | August 17,2011    
|                            |                                         |                      | 10,000                                   | NIS 0.10       | March 7,2012      
|                            |                                         |                      | 12,000                                   | NIS 0.10       | December 3, 2007  
|Ohad Bashan                 | 237,268                                 | 1.0%                 |                                          |                |                   
|Shlomo Tussia-Cohen(10)     | 70,000                                  | ***                  | 40,000                                   | $11.23         | September 22, 2010
|                            |                                         |                      | 30,000                                   | NIS 0.10       | April 13,2012     
|                            |                                         |                      | 50,000                                   | $11.23         | September 22, 2010
|Eliezer Manor(11)           | 80,000                                  | ***                  | 30,000                                   | NIS 0.10       | April 13,2012     
|Ora Setter(12)              | 30,000                                  | ***                  | 30,000                                   | NIS 0.10       | April 13,2012     
|Eli Akavia(13)              | 50,000                                  | ***                  | 50,000                                   | $11.23         | September 22, 2010
|                            |                                         |                      | 1,200                                    | $42.50         | March 11, 2011    
|Raanan Ellran(14)           | 31,200                                  | ***                  | 30,000                                   | NIS 0.10       | April 13,2012     
|                            |                                         |                      |                                          |                |                   
|All executive officers     
|and directors as a group    | 3,882,832                               | 16.6 %               |                                          |                |                   

*** Less than 1%

59

---

---

|(1) | The
number of ordinary shares shown includes shares that each shareholder has
               the right to acquire within 60 days after June 23, 2009 (as determined in
               accordance with footnote (3)).
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | If
a shareholder has the right to acquire shares by exercising options (as
               determined in accordance with footnote (3)), these shares are deemed
outstanding                for the purpose of computing the percentage owned by the
specific shareholder                (that is, they are included in both the numerator and
the denominator), but they                are disregarded for the purpose of computing
the percentage owned by any other                shareholder.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Number
of options immediately exercisable or exercisable within 60 days from                June
23, 2009. The exercise price of some of these options is greater than our
               current share market price.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Includes
861,663 ordinary shares held by Mr. Bashan and 7,462 ordinary shares                held
by Mr. Bashans wife. Mr. Bashan disclaims beneficial ownership of the
               share held by his wife. Also includes 1,548,384 ordinary shares as to
which Mr.                Bashan has voting power pursuant to irrevocable proxy granted to
him.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Includes
197,089 ordinary shares held by Mr. Gilboa, 15,000 ordinary shares held                by
Mr. Gilboas wife and options held by Mr. Gilboa and his wife to
               purchase 29,000 ordinary shares.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Includes 33,588 ordinary shares held by Mr. Shafran and options to purchase
          202,415 ordinary shares. Mr. Shafran acted as our Chief Financial Officer until
          September 30, 2008.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Includes 12,469 ordinary shares held by Ms. Horn and options to purchase 20,000
          ordinary shares. Ms. Horn acts as our Chief Financial Officer commencing October
          1, 2008.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) | Includes 196,735 ordinary shares held by Mr. Aduk and options to purchase 26,676
          ordinary shares.
|--- | -----------------------------------------------------------------------------------------------------------

|(9) | Includes 205,144 ordinary shares held by Mr. Itay and options held by Mr. Itay
          and his wife to purchase 28,739 ordinary shares.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------

|(10) | Consists of options to purchase 70,000 ordinary shares.
|---- | -------------------------------------------------------

|(11) | Consists of options to purchase 80,000 ordinary shares.
|---- | -------------------------------------------------------

|(12) | Consists of options to purchase 30,000 ordinary shares.
|---- | -------------------------------------------------------

|(13) | Consists of options to purchase 50,000 ordinary shares.
|---- | -------------------------------------------------------

|(14) | Consists of options to purchase 31,200 ordinary shares
|---- | ------------------------------------------------------

# Share Option Plans

The
following is a description of the share option plans that we and our subsidiaries
maintain. In addition to the discussion below, please see Note 10 to our consolidated
financial statements. Under Israeli law, except for issuances of options to directors, or
members of their families, adoption of share option plans and revisions to these plans are
not subject to shareholder approval. Under NASDAQ Marketplace Rules, however, absent an
exemption, most new share option plans and material revisions are subject to shareholders
approval.

# 2008 Employee Stock
Purchase Plan

In
2008, the Company established an Employee Stock Purchase Plan pursuant to which 1,500,000
of our ordinary shares have been reserved for eligible employees of the Company and its
subsidiaries. The purchase price of the ordinary shares is 85% of the closing price on
certain dates specified in the plan. As of June 23, 2009, an aggregate of 1,009,213 of our
ordinary shares have been issued to eligible employees under this plan. In accordance with
the decision of our board of directors, the implementation of this plan has been suspended
with respect to the offering period of April-June 2009.

# 2006 Alternative Option
Exercise Mechanism

On
April 11, 2006, we offered to each of our and our subsidiaries employees, and its
directors and office holders (other than External Directors, as such term is
defined in the Israeli Companies Law of 1999) who held outstanding vested and unvested
options to purchase an aggregate of 4,485,017 of our ordinary shares, which were issued
pursuant to the terms of the our 2001 Share Option Plan, as amended, to replace all of
their outstanding vested and unvested options into a new number of ordinary shares, with
the same fair values, as determined using the Black-Scholes pricing model, and the same
vesting schedules. Our Board of Directors approved the Alternative Option Exercise
Mechanism (AOEM), on February 12, 2006. Further, our shareholders approved the
AOEM at an extraordinary meeting of the shareholders on March 21, 2006. As a result of the
AOEM, we issued a total of 2,437,075 ordinary shares in exchange for options to acquire a
total of 3,737,369 ordinary shares. A holder of options who did not participate in the
AOEM, the original terms of his or her option agreement and the Share Option Plan
continued to apply and such options are exercisable in accordance with their terms. In
accordance with SFAS 123 R we consider the AOEM as a short-term inducement. Since the fair
market value of the Companys ordinary shares newly issued to each employee equals
the fair value of the options replaced from him/her, no incremental compensation cost was
recognized pursuant to the AOEM.

60

---

---

# 2001 Share Option Plan

We
established our 2001 Share Option Plan in February 2001. The plan provides for the grant
of options to our employees, directors and consultants, and those of our subsidiaries and
affiliates. Upon establishment of the plan, we reserved 75,000 ordinary shares for
issuance. On February 26, 2002, on July 12, 2002, on March 28, 2003, on July 16, 2003, on
September 2, 2003, on November 17, 2003, on April 20, 2004, on March 25, 2005, on
September 25, 2005, and on December 3, 2007 our board of directors adopted certain
resolutions with regard to the 2001 Share Option Plan that increased the number of
available options under the plan by a total of 11,175,000 so that the aggregate number of
options available under the plan is now 11,250,000. Under NASDAQ Marketplace Rules, the
increase of the number of available options under the plan pursuant to the board of
directors resolutions dated March 28, 2003, July 16, 2003 and September 2, 2003 were
subject to either our shareholders approval or an exemption granted that such
approval is not required. We applied for an exemption in connection with such increases
approved by the board of directors and such exemption has been granted by NASDAQ due to
differences between the Israeli law and NASDAQ rules. On November 17, 2003, our board of
directors approved a further increase of 500,000 options subject to either
shareholders approval or additional exemption from NASDAQ. On April 20, 2004, our
board of directors approved a further increase of 2,500,000 options subject to either
shareholders approval or additional exemption from NASDAQ. On March 25, 2005, our
board of directors approved a further increase of 2,500,000 options subject to either
shareholders approval or additional exemption from NASDAQ. On September 25, 2005,
our board of directors approved a further increase of 2,000,000 options. On December 3,
2007, our board of directors approved a further increase of 1,500,000 options. Currently,
in accordance with Israeli law, increasing the shares pool in an option plan does not
require shareholders approval.

Under this plan, as of June 23, 2009,
6,338,529 options had been exercised and 1,710,936 options are outstanding and
exercisable. Of the options that are outstanding, as of June 23, 2009, 657,029 options are
held by our directors and officers listed above under Item 6.A Directors and
Senior Management, and have a weighted average exercise price of $2.99.

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

61

---

---

# 2001 Employee Share
Purchase Plan

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

On
March 22, 2009 our board of directors resolved to terminate this plan.

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

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

The
following table provides summary information regarding the beneficial ownership by each
person or entity known to beneficially own more than 5% of our ordinary shares as of
December 31, 2008, or a different date, if so provided in the table below.

Beneficial
ownership of shares is determined under the rules of the Securities and Exchange
Commission All information with respect to the beneficial ownership of any of the below
shareholders has been furnished by such shareholder and, unless otherwise indicated below,
we believe that persons named in the table have sole voting and sole investment power with
respect to all of the shares shown as beneficially owned, subject to community property
laws, where applicable.

The table also includes the number of
shares underlying options and warrants that are exercisable within 60 days of December 31
of each of the year shown below in the table. Ordinary shares subject to these options and
warrants are deemed to be outstanding for the purpose of computing the ownership
percentage of the person holding these options and warrants, but are not deemed to be
outstanding for the purpose of computing the ownership percentage of any other person.

|                          | December 31, 2006 | December 31, 2007 | December 31, 2008
|------------------------- | ----------------- | ----------------- | -----------------
|
|
|
|
|Oded Bashan (1)           |                   |                   |                  
|Diker Management, LLC (2) |                   |                   |                  
|Trellus Management        |                   |                  
|Company, LLC (3)          |                   |                   |                  
|Crossfields Fund I LP (4) |                   |                   |                  

|(1) | Includes
ordinary shares held by Mr. Bashan. Also includes ordinary shares held                by
Mr. Bashans wife. Also includes options held by Mr. Bashan to purchase
               ordinary shares. Mr. Bashan disclaims beneficial ownership of the share
held by                his wife. Also includes ordinary shares as to which Mr. Bashan has
voting power                pursuant to irrevocable proxy granted to him.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | This
information is based solely on Forms 13F filed with the SEC by Diker
               Management, LLC. The percentage of beneficial ownership was computed by us
based                on the information included in the Forms 13F and the total number of
outstanding                ordinary shares as of December 31 of each of the years shown
in the table. Based                on the information provided in such Forms 13F, the
address of Diker Management                LLC. is: 745 Fifth Avenue Suite 1409, New
York, NY 10151. Diker Management LLC                reports shared voting power over
1,732,329shares and sole voting power over                151,559 shares as of December
31, 2008.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

62

---

---

|(3) | This information is based solely on
Forms 13G filed with the SEC by Trellus Management Company, LLC. The percentage of
beneficial ownership was computed by us based on the information included in the Forms 13G
and the total number of outstanding ordinary shares as of December 31 of each of the years
shown in the table. Based on the information provided in such Forms 13G, the address of
Terllus Fund Management Company, LLC. is: 350 Madison Avenue, 9th Floor New
York, NY 10017. Terllus Fund Management Company, LLC reports shared voting power over
1,768,855 shares as of December 31, 2008.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | This
information is as of December 31, 2008 and is based solely on a Form 13G
               filed with the SEC on February 12, 2009, by Crossfields Fund I LP. Based
on the                information provided in such Form 13G, the address of Crossfields
Fund I LP is:                800 Third Avenue, Suite 1701, New York, NY 10022.
Crossfields Fund I LP reports                shared voting power over 1,649,137 shares.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Major Shareholders
Voting Rights

Our
major shareholders do not have different voting rights.

# Record Holders

Based on a review of the information
provided to us by our transfer agent, as of June 23, 2009, there were 79 holders of record
of our ordinary shares, of which 21 record holders holding approximately 1% of our
ordinary shares had registered addresses in the United States. These numbers are not
representative of the number of beneficial holders of our shares nor is it representative
of where such beneficial holders reside since many of these ordinary shares were held of
record by brokers or other nominees (including one U.S. nominee company, CEDE & Co.,
which held approximately 90% of our outstanding ordinary shares as of said date).

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

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

# Agreement with HolyTech
Ltd.

In
January 1996, we entered into an agreement with HolyTech Ltd., a company owned by Varda
Bashan, Ora Gilboa and certain other of our shareholders, which formalized an arrangement
that had existed since 1992. Varda Bashan is the spouse of Oded Bashan, our co-founder and
chairman of our board of directors, and Ora Gilboa is the spouse of Ronnie Gilboa, our
co-founder and a director. Under the agreement, HolyTech provides us with management and
engineering services as needed. Mrs. Bashan provides administration services 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 $68,000 in 2006 , $73,000 in 2007 and $109,000 in 2008.

# Agreements with
Directors and Officers

We
have entered into employment agreements with all of our officers. In addition, we have
granted options to purchase our ordinary shares to our officers and directors. On January
31, 2003 the shareholders of OTI approved a bonus plan for our senior management and on
July 11, 2003 our general meeting of shareholders approved a plan to issue options to our
non-executive directors. See also Item 6.B. under Executive Compensation.

# Agreement Relating to
Insurance Services

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

63

---

---

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

Not
applicable.

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

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

The
financial statements required by this item are found in Item 18 of this annual report,
beginning on page F-1.

# Legal Proceedings

We
or our subsidiaries are a named defendant in the following litigations:

On May
20, 2008 a plaintiff filed a complaint against us and one of our subsidiaries, in the US
District Court for the District of Delaware, alleging infringement of two US patents and
requesting a declaration that we infringe these patents, and therefore asking for an
injunction, damages and attorneys fees. We filed our response on July 25, 2008,
denying infringement and identifying certain defenses. Further, we brought a counterclaim
against the plaintiff for infringement of a U.S. patent of us, seeking a declaration that
the plaintiff is infringing our patent, and therefore asking for an injunction, damages
and attorneys fees. At this stage, based on legal advice, we are unable to estimate
the chances of the claim and, therefore, no provision has been made in the financial
statements in respect of this claim.

On September 3, 2003, Edi Wuhl, a
former employee of us, filed a suit against us in the District Labor Court in Nazareth in
the amount of NIS 3,953,000 (approximately $1,040,000) claiming that we breached the
employment agreement with him, and that we owe him commission payment for certain sales.
On January 10, 2008, the district court resolved that Mr. Wuhl is entitled to
approximately $60,000, and therefore, during 2008 the Company paid this amount and
recorded it in the financial statements. On April 28, 2008 the plaintiff submitted an
appeal to the National Labor Court in Jerusalem. A hearing in the appeal was conducted in
June 2009. At this stage, based on legal advice, we are unable to estimate the chances of
the appeal and, therefore, no provision has been made in the financial statements in
respect of the appeal.

In
September 2007, a plaintifffiled against one of our subsidiaries, a motion to
approve a class action at the Tel Aviv District Court, at the sum of NIS 67.1 million
($17.6 million). The law suit was based on claims regarding the performance of certain
device product of the subsidiary. Based on the courts recommendation at the
preliminary hearing, on January 21, 2009 the plaintiffhad filed an application to
remove the motion, and the court had accepted this application and the motion was removed.

In
October 2007, a plaintiff filed against one of our subsidiaries, and other third parties a
motion to approve a class action at the Tel Aviv District Court, at the sum of
approximately NIS 2 million ($526,000). According to the plaintiff, the subsidiary and the
other defendants charged via the subsidiarys product, an amount per hour which
exceeds the amount that they are authorize to charge. On January 15, 2008, our subsidiary
submitted to court a notice in which it joins to the other defendants application to
dismiss the motion. On a preliminary hearing conducted on September 14, 2008, the court
accepted such defendants arguments that the motion should be dismissed. In addition,
the court instructed the parties to submit their summaries only with respect to the
consideration to be paid to the plaintiff and his legal counsel. At this stage, based on
legal advice, we are unable to estimate the chances of the motion and, therefore, no
provision has been made in the financial statements in respect of this motion.

On
June 16, 2008, a plaintiff (Plaintiff) filed a patent infringement suit in
Shenzhen Intermediate Court, Shenzhen, China (Lawsuit), alleging that one of
our subsidiaries infringes a Chinese patent assigned to the Plaintiff
(Patent). The Plaintiff requested an injunction, a relief of RMB 1 million
(approximately $146,000) for its damages, the expenses incurred by it in relation to the
efforts to cease the infringement and all court fees of the case. On May 5, 2009, the
Shenzhen Intermediate Court stayed the Lawsuit until a litigation between the Plaintiff
and a third party relating to the assignment of the Patent rights pending in the Beijing
1st Intermediate Court is resolved. At this stage, based on legal advice, we
are unable to estimate the chances of the Lawsuit and, therefore, no provision has been
made in the financial statements in respect of the Lawsuit.

64

---

---

Dividend Policy

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

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

Though
we never declared or paid a cash dividend, in November 2008 our board of directors has
authorized the repurchase of our shares in a total aggregate amount not to exceed $5
million conditioned approval by court, as required under Israeli law. In May 2009 the
court approved a repurchase program in a total amount of up to $2 million.

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

Except
as otherwise disclosed in this annual report, no significant change has occurred since
December 31, 2008.

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

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

Our
ordinary shares were quoted on the Neuer Market of the Frankfurt Stock Exchange since
August 31, 1999 until January 31, 2003. Since January 31, 2003, the shares have been
listed on the new Prime Standard Segment of the Frankfurt Stock Exchange. Following the
approval of our general shareholders meeting, our board of directors applied for the
delisting of our shares from the Frankfurt Stock Exchange, which has been approved. The
last day of trading of our ordinary shares on Frankfurt Stock Exchange was December 20,
2005. Our shares were quoted on the NASDAQ SmallCap Market from November 12, 2002 until
December 20, 2004. On December 16, 2004, we were approved for listing on the NASDAQ Global
Market, then known as the NASDAQ National Market, and our shares commenced trading on
NASDAQ Global Market on December 20, 2004.

The
following table shows, for the periods indicated, the high and low closing prices of our
ordinary shares in euros giving effect to the reverse split as reported on the Neuer
Market of the Frankfurt Stock Exchange. The closing prices that are indicated below
commencing January 31, 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 as 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 January 2004 until December 2004, the high and low
closing prices of our ordinary shares in U.S. dollars as reported on NASDAQ SmallCap, and
for the periods indicated since December 2004, the high and low closing prices of our
ordinary shares in U.S. dollars as reported on NASDAQ Global Market.

65

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|                          | Frankfurt Stock
Exchange (1)(3)
per
Share  | Frankfurt Stock
Exchange (1)(3)
per
Share $ | NASDAQ Global
Market (2)
per
Share $
|------------------------- | ------------------------------------------- | ------------------------------------------- | ------------------------------------
|
|
|
|
|Year                      |                                             |                                             |                                     
|                          |                                             |                                            
|2004                      |                                             |                                             |                                     
|2005                      |                                             |                                             |                                     
|2006                      |                                             |                                             |                                     
|2007                      |                                             |                                             |                                     
|2008                      |                                             |                                             |                                     
|                          |                                             |                                            
|2007                      |                                             |                                             |                                     
|First quarter             |                                             |                                             |                                     
|Second quarter            |                                             |                                             |                                     
|Third quarter             |                                             |                                             |                                     
|Fourth quarter            |                                             |                                             |                                     
|2008                      |                                             |                                             |                                     
|First quarter             |                                             |                                             |                                     
|Second quarter            |                                             |                                             |                                     
|Third quarter             |                                             |                                             |                                     
|Fourth quarter            |                                             |                                             |                                     
|2009                      |                                             |                                             |                                     
|First quarter             |                                             |                                             |                                     
|                          |                                             |                                            
|Month                     |                                             |                                            
|                          |                                             |                                            
|December 2008             |                                             |                                             |                                     
|January 2009              |                                             |                                             |                                     
|February 2009             |                                             |                                             |                                     
|March 2009                |                                             |                                             |                                     
|April 2009                |                                             |                                             |                                     
|May 2009                  |                                             |                                             |                                     
|June 2009 (until June 23) |                                             |                                             |                                     

|(1) | Our
ordinary shares were quoted on the Neuer Market of the Frankfurt Stock
               Exchange from August 31, 1999 until January 31, 2003, after which, until
               December 20, 2005, the shares were listed on the new Prime Standard
Segment of                the Frankfurt Stock Exchange. To the extent required, shares
prices are adjusted                to give effect to our 10-for-1 reverse share split
effective as of June 17,                2002.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

|(3) | Until
December 20, 2005
|--- | -----------------------

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

Not
applicable.

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

Our
ordinary shares are traded publicly on the NASDAQ Global Market under the symbol
OTIV since December 20, 2004, and were traded on the NASDAQ Small Cap Market
from November 12, 2002 until December 20, 2004. Until December 20, 2005, our ordinary
shares were traded publicly on the Prime Standard Market of the Frankfurt Stock Exchange
under the symbol OT5.

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

Not
applicable.

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

Not
applicable.

66

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

Not
applicable.

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

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

Not
applicable.

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

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

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

# Description of Shares

Our
authorized share capital consists of 50,000,000 ordinary shares, NIS 0.1 nominal value.

The
following table sets out changes in our authorized share capital that occurred during the
last four years:

|Date            | Nature of Action                                          | State of Authorized Share Capital After the
Action                             
|--------------- | --------------------------------------------------------- | -------------------------------------------------------------------------------
|
|
|
|
|April 6, 2004   | Increase in share capital by additional 20,000,000 shares | NIS 3,000,000 divided into 30,000,000 ordinary shares of nominal value NIS 0.1.
|                |                                                           |                                                                                
|               
|August 24, 2006 | Increase in share capital by additional 20,000,000 shares | NIS 5,000,000 divided into 50,000,000 ordinary shares of nominal value NIS 0.1.
|                |                                                           |                                                                                

Description of Ordinary
Shares

As
of June 23, 2009, our authorized share capital consists of 50,000,000 ordinary shares,
nominal value of NIS 0.1 per share, of which 22,860,102 were issued and outstanding.

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

# Dividend and Liquidation
Rights

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

67

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# Preemptive Rights

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

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

# Voting,
Shareholders Meetings and Resolutions

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

Under
the Companies Law, unless otherwise provided in the articles of association or by
applicable law, shareholders resolutions require the approval of holders of a simple
majority of our ordinary shares voting, in person or by proxy on the matter. Unless a
higher percentage for taking an action is required under our articles of association, 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.

# Election of Directors

Our
ordinary shares do not have cumulative voting rights for the election of directors.
Rather, under our articles of association our directors (other than external directors)
are elected at a shareholders meeting by a simple majority of our ordinary shares. As a
result, the holders of our ordinary shares that represent more than 50% of the voting
power represented at a shareholder meeting have the power to elect any or all of our
directors whose positions are being filled at that meeting, subject to the special
approval requirements for external directors. For more information see description under
Item 6.C  Board Practices  Election of Directors; Appointment of
Officers and Item 6.C  Board Practices  External Directors.

# Modification of Class
Rights

The
rights attached to any class, such as voting, liquidation and dividend rights, may be
amended by written consent of holders of three-fourth of the issued shares of that class,
or by adoption of a resolution by a simple majority of the shares of that class
represented at a separate class meeting.

# 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,
U.S. securities laws or the rules of a stock exchange on which the shares are traded.
Under the Companies Law and applicable regulations, unless otherwise provided in the
articles of association or by applicable law, shareholders of record are entitled to
receive 35 or 21 days prior notice of meetings of shareholders, based on the matters that
are on the agenda. Subject to the foregoing provisions of the Companies Law and applicable
regulations, 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. Under new regulations, a longer
advanced notice of at least 35 days is required in certain cases.

68

---

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Our
transfer agent and registrar for our ordinary shares 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.

# 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 Exchange Act and the regulations promulgated thereunder
will not be subject to this requirement.

# 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 special tender offer if as a result of the acquisition the purchaser would
become a 25% or greater shareholder of the company. This rule does not apply if there is
already another 25% shareholder of the company. As of the date of this annual report, we
are not aware of any single shareholder which holds 25% or more of our shares. Similarly,
the Companies Law provides that an acquisition of shares in a public company must be made
by means of a special 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. The special tender offer must be extended to all shareholders
but the offeror is not required to purchase shares representing more than 5% of the voting
power attached to the companys outstanding shares, regardless of how many shares are
tendered by shareholders. The special tender offer may be consummated only if (i) at least
5% of the voting power attached to the companys outstanding shares will be acquired
by the offeror and (ii) the number of shares tendered in the offer exceeds the number of
shares whose holders objected to the offer.

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 50 days have passed from the time that a proposal
          for approval of the merger has been filed with the Israeli Registrar of
          Companies.

69

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

# Other Anti-Takeover
Provisions

We
may also be subject to the tender offer provisions of the Exchange Act, as amended.

# Anti-Takeover Actions
Taken by the Company

In
January 2009, our board of directors approved the adoption of a Shareholders Rights Plan,
according to which each of our ordinary shares shall give its holder a right which will
become exercisable only after a person or a group becomes an Acquiring Person,
by obtaining beneficial ownership of, or by commencing a tender or exchange offer for, 15%
or more of the our issued and outstanding ordinary shares (our board of directors may
reduce this percentage to not less than 10%), unless our board of directors approves such
Acquiring Person or redeems the rights. Each right, once becomes exercisable,
will generally entitle its holder, other than the Acquiring Person, to
purchase from us either one or three ordinary shares (depending on our registered capital
on the date of exercising the rights), at par value. For more information about the said
rights see description under Item 14  Material Modifications to the Rights of
Security Holders and Use of Proceeds.

# Exculpation,
Indemnification and Insurance of Office Holders

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

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

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

| | 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; and
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

70

---

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

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

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

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

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

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

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

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

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

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

Our
articles of association allow us to indemnify and insure our office holders to the fullest
extent permitted by the Companies Law.

In
connection with such indemnification, we have undertaken to indemnify our directors and
officers for certain events listed in the indemnification letters given to them. The
aggregate amount payable to the directors and officers who may have been or will be given
such indemnification letters is limited to $20 million per case and per each director or
officer.

Our
office holders are currently covered by a directors and officers liability insurance
policy with an aggregate claim limit of $5 million. As of the date of this annual report,
no claims for directors and officers liability insurance have been filed under this
policy.

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

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

The
Rights Agreement

On
January 12, 2009, we entered into a Rights Agreement, with Continental Stock Transfer
& Trust Company, which provides for the implementation of the Shareholders Rights Plan
authorized by our board of directors. For more information about the Shareholders Rights
Plan see description under Item 14  Material Modifications to the Rights of
Security Holders and Use of Proceeds.

The
2005 financing

On
November 1, 2005 we completed an approximately $22.2 million private placement, or the
Private Placement, of new equity financing with institutional investors from the US,
Switzerland and England. The transaction involved the sale of 1,828,026 units, of which
(i) 1,544,568 consist of one ordinary share and a warrant to purchase three-fifths (3/5)
of an ordinary share and (ii) 283,458 consist of one ordinary share and a warrant to
purchase one-half (1/2) of an ordinary share. The purchase price for each of the 1,828,026
units was $12.15 per unit, which equaled the average closing price of our ordinary shares
on the NASDAQ Global Market during the last five trading days before pricing.

71

---

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In
addition to the issuance of warrants to the institutional investors, the Company issued an
aggregate of 127,961 warrants to the placement agent for the private placement of the
units and to certain other persons who facilitated the offering.

The
1,196,431 warrants, which are exercisable since May 1, 2006, are for the purchase of an
aggregate of up to 1,196,431 ordinary shares, they have terms of five years and an
exercise price of $14.58 per share, and may be redeemed by OTI after two years if the
market price of the underlying ordinary shares reaches $26.25 and certain other conditions
are met.

Vuance
(formerly SuperCom) Transaction

On
December 31, 2006, pursuant to an asset purchase agreement (the Agreement)
dated as of November 7, 2006 between us and Vuance Ltd., an Israeli corporation
(Vuance), we completed the acquisition of the main assets of Vuance ,
including the International Project Solution (IPS) division of Vuance . Vuance
is an Israeli based company, which through its IPS division develops and provides a
wide-range of complementary technologies and solutions for the smart card market. The
acquisition provides us with accesses to new growing markets and complementary security
technologies that safeguard against counterfeit and forgery.

The
aggregate purchase price for the acquisition was paid through the issuance of an aggregate
of 2,827,200 of the Companys ordinary shares. The 2,827,200 ordinary shares issued
to Vuance were subject to a lock-up agreement, where one-seventh of the shares (403,885
ordinary shares) were released from the lock-up restrictions every three months beginning
on the closing date, December 31, 2006, for an aggregate period of eighteen months. Vuance
executed an irrevocable proxy appointing our Chairman, on behalf of the board of
directors, or a person the board of directors will instruct, to vote the 2,827,200
ordinary shares issued to Vuance in connection with the transaction.

The
parties also entered into a service and supply agreement giving Vuance a license to use
applicable Vuance intellectual property transferred to the Company for the duration of
certain existing contracts and projects.

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

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

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

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

# Israeli Taxation,
Foreign Exchange Regulation and Investment Programs

THE FOLLOWING IS A SUMMARY OF THE
MATERIAL ASPECTS OF THE CURRENT TAX STRUCTURE APPLICABLE TO COMPANIES IN ISRAEL AND THEIR
EFFECT ON US. THE SUMMARY ALSO CONTAINS A DISCUSSION OF ISRAELI TAX CONSEQUENCES TO
PERSONS PURCHASING OUR ORDINARY SHARES NOT BY WAY OF ISSUANCE OF BONUS SHARES AND ISRAEL
GOVERNMENT PROGRAMS BENEFITING US. PORTIONS OF THIS DISCUSSION ARE BASED ON TAX
LEGISLATION THAT HAS NOT YET BEEN SUBJECT TO JUDICIAL OR ADMINISTRATIVE INTERPRETATION,
AND WE CANNOT ASSURE YOU THAT THE VIEWS EXPRESSED IN THIS DISCUSSION WILL BE ACCEPTED BY
THE TAX AUTHORITIES IN QUESTION. THE DISCUSSION SHOULD NOT BE RELIED ON AS LEGAL OR
PROFESSIONAL TAX ADVICE AND IS NOT EXHAUSTIVE OF ALL POSSIBLE TAX CONSIDERATIONS.

72

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WE URGE INVESTORS IN OUR ORDINARY
SHARES TO CONSULT THEIR OWN TAX ADVISORS AS TO THE ISRAELI OR OTHER TAX CONSEQUENCES OF
THE PURCHASE, OWNERSHIP AND DISPOSITION OF ORDINARY SHARES, INCLUDING, IN PARTICULAR, THE
EFFECT OF ANY FOREIGN, STATE OR LOCAL TAXES.

# Tax Reform

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

# Taxation of companies

General
Corporate Tax Structure. Israeli companies are subject to corporate tax at the rate of
34% of taxable income in the 2005 tax year, 31% in the 2006 tax year, 29% in the 2007 tax
year, 27% in the 2008 tax year, 26% in the 2009 tax year and 25% in the 2010 tax year and
thereafter. However, the effective tax rate payable by a company which derives income from
certain approved enterprises may be considerably lower, as discussed further below.

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

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

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

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

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.

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

A
company that has an approved enterprise program is eligible for further tax benefits if it
qualifies as a foreign investors company. A foreign investors company is a
company whose investees, comprising non-Israeli residents which: (a) directly or
indirectly hold more than 25% of the companys share capital and combined share and
loan capital; and (b) requires a minimal investment of NIS 5 million by non-Israeli
residents, which include the purchase of shares of a company from another shareholder,
provided that the companys outstanding and paid up share capital exceeds NIS 5
million. 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 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%               |         
|49% or more but less than 74%            |         
|74% or more but less than 90%            |         
|90% or more                              |         

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.

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

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

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

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

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| | 1. | The
enterprises main activity is in the area of biotechnology or
               nanotechnology as approved by the Head of the Administration of Industrial
               Research and Development, prior to the approval of the aforementioned
plan.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | The
enterprises revenues during the tax year from the plants sales
               in a certain market do not exceed 75% of total revenues from the plants
               total sales during that tax year. A market is defined as a
distinct                country or customs territory.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | 25%
or more of the enterprises total revenues from the plants sales
               during the tax year are from sales to a certain market that numbers at
least 12                million residents.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Upon
the establishment of an enterprise, an investment of at least NIS 300 thousand in
production machinery and equipment within three years is required.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | For
an expansion, a company is required to invest within three years the greater of NIS 300
thousand in production machinery and equipment or a certain percentage of its existing
production machinery and equipment.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

Under
the law for the Encouragement of Industrial Research and Development, 1984, commonly
referred to as the Research Law, research and development programs which meet specified
criteria and are approved by a governmental committee of the Office of the Chief Scientist
are eligible for grants of up to 50% of the projects expenditure, as determined by
the research committee, in exchange for the payment of royalties from the sale of products
developed under the program. Regulations under the Research Law generally provide for the
payment of royalties to the Chief Scientist of 3 to 3.5% on sales of products and services
derived from our technology developed using these grants until 100% of the dollar-linked
grant is repaid. For programs approved from 1999 and thereafter, the amount of the grant
to be repaid will include annual interest at LIBOR from the date of approval.

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

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

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

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

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

Tax
Benefits for Research and Development. Israeli tax law allows, under specific
conditions, a tax deduction in the year incurred for expenditures, including capital
expenditures, relating to scientific research and development projects, if the
expenditures are approved by the relevant Israeli government ministry, determined by the
field of research, and the research and development is for the promotion of the enterprise
and is carried out by or on behalf of the company seeking the deduction. Expenditures not
so approved are deductible over a three-year period. However, expenditures made out of
proceeds made available to us through government grants are not deductible according to
Israeli law.

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

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

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

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

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

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

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

Special
Provisions Relating to Taxation under Inflationary Conditions. The Income Tax Law
(Inflationary Adjustments), 1985, referred to as the Inflationary Adjustments Law,
represents an attempt to overcome the problems presented to a traditional tax system by an
economy undergoing rapid inflation. The Inflationary Adjustments Law is highly complex.
These are some of its important features:

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

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| |  | 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.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Until
December 31, 2006 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.

The
Israeli Tax Law and certain regulations promulgated there under allow
Foreign-Invested Companies, which maintain their accounts in U.S dollars in
compliance with the regulations published by the Israeli Minister of Finance to base their
tax returns on their operating results as reflected in the dollar financials statements or
to adjust their tax returns based on exchange rate changes rather than changes in the
Israeli CPI, in lieu of the of the principles set forth by the Inflationary Adjustments
Law, For these purpose, Foreign-Invested company is a company, more than 25% of whose
share capital, in terms of rights to profits, voting and appointment of directors, and of
whose combined share and loan capital is held by persons who are not residents of Israel.
A company that elects to measure its results for tax purpose based on the dollar exchange
rate cannot change that election for the period of three years following the election. The
Company and one of its Israeli subsidiaries are foreign investors companies, and
have elected, commencing January 1, 2007, to keep their books and records in dollars for
tax purposes, as permitted under the tax regulations.

However,
according to a legislation change, as of Mach 2008 the Inflationary Adjustment Law is
cancelled and its provisions are in force until the end of the fiscal year of 2007 (except
for certain specific provisions and regulations which, at this stage, are not yet
cancelled). The decision to cancel the Inflationary Adjustment Law was based on the fact
that the inflation rates in Israel in recent years are very low and are expected to stay
low, whereas originally the law was introduced to cope with the very high inflation rates
which exist in the 80s.

# Taxation of our
shareholders

Reform
in Taxation of Capital Market. As mentioned above, on July 24, 2002 and July 25, 2005,
the Israeli parliament, the Knesset, approved extensive amendments to the Income Tax
Ordinance. The amendments substantially changed the taxation in several areas, including
taxation of the capital market. Generally, the amendments 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, when selling our ordinary shares purchased after December 31, 2002, the
capital gains tax rate on the real gain imposed upon sale of capital assets acquired after
that date has been reduced to no more than 20% if the seller is an individual or 25% if an
individual sells shares in a company in which he is or was 12 months prior to sale the
owner of more than 10% of any means of control. The real capital gain tax rate for a
corporation is set at the ordinary corporate tax applicable; 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. Israeli taxpayers
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 creates 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 Israeli tax payers shall be subject to 25% tax on the real capital
gain in the case that they deduct interest expenses and linkage differences.

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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, foreign securities that are bought prior to January 1, 2006 and sold after
January 1, 2006 shall be subject to 35% capital gains tax on the real gains accrued until
January 1, 2005 and 20% or 25% capital gains tax on the real gains accrued thereafter.
However, according to tax legislation our ordinary shares are not considered foreign
traded securities.

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

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

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.

Capital
gain exemption to non Israeli shareholders which will apply even in circumstances that
Israel could tax according to the relevant tax treaty. Section 97(B3) determines that in
order for a non Israeli resident who is a resident of a contracting state [i.e. a country
with which Israel has a double taxation treaty] to be exempt from Israeli capital
gains on the sale of shares in an Israeli resident company, the seller must comply with
the following:

| |  | The
shares were purchased between 31.7.2005 to 31.12.2008
| | - | ---------------------------------------------------------

| |  | A
request must be filed at the time to report the future sale
| | - | -------------------------------------------------------------

| |  | The
capital gain is not attributed to a Permanent Establishment the foreign resident has in
                      Israel
| | - | ------------------------------------------------------------------------------------------------------------------------

| |  | He
was a resident of a contracting state for a period of at least 10 consecutive years
before                       the  purchase of the shares
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------

| |  | If
the foreign resident is a corporation then it is necessary that at least 75% of the
control in the corporation were held, consecutively by individuals who were
themselves, residents of a contracting state for at least 10 consecutive years
before the shares were purchased
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | The
shares were not purchased from a related party
| | - | --------------------------------------------------

| |  | A
notice on the purchase was given to the Israeli Tax Authorities 30 days from purchase
| | - | ---------------------------------------------------------------------------------------

| |  | A
report on the sale of shares was filed in country of his residency
| | - | --------------------------------------------------------------------

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

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

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

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

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

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

# Material United States
Federal Income Tax Consequences

THE FOLLOWING SUMMARY IS INCLUDED
HEREIN FOR GENERAL INFORMATION AND IS NOT INTENDED TO BE, AND SHOULD NOT BE CONSIDERED TO
BE, LEGAL OR TAX ADVICE. EACH U.S. HOLDER SHOULD CONSULT WITH HIS OR HER OWN TAX ADVISOR
AS TO THE PARTICULAR U.S. FEDERAL INCOME TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP AND
SALE OF ORDINARY SHARES, INCLUDING THE EFFECTS OF APPLICABLE STATE, LOCAL, FOREIGN OR
OTHER TAX LAWS AND POSSIBLE CHANGES IN THE TAX LAWS.

Subject
to the limitations described in the next paragraph, the following discussion summarizes
the material U.S. federal income tax consequences to a U.S. Holder arising
from the purchase, ownership and sale of the ordinary shares. For this purpose, a
U.S. Holder is a holder of ordinary shares that is: (1) an individual citizen
or resident of the United States, including an alien individual who is a lawful permanent
resident of the United States or meets the substantial presence residency test under U.S.
federal income tax laws; (2) a corporation (or entity treated as a corporation for U.S.
federal tax purposes) or a partnership (other than a partnership that is not treated as a
U.S. person under any applicable U.S. Treasury Regulations) created or organized under the
laws of the United States or the District of Columbia or any political subdivision
thereof; (3) an estate, the income of which is includable in gross income for U.S. federal
income tax purposes regardless of source; (4) a trust if a court within the United States
is able to exercise primary supervision over the administration of the trust and one or
more U.S. persons have authority to control all substantial decisions of the trust; (5) a
trust that has a valid election in effect to be treated as a U.S. person to the extent
provided in U.S. Treasury regulations, or (6) any person otherwise subject to U.S. federal
income tax on a net income basis in respect of the ordinary shares, if such status as a
U.S. Holder is not overridden pursuant to the provisions of an applicable tax treaty.

79

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This
summary is for general information purposes only and does not purport to be a
comprehensive description of all of the U.S. federal income tax considerations that may be
relevant to a decision to purchase our ordinary shares. This summary generally considers
only U.S. Holders that will own our ordinary shares as capital assets. Except to the
limited extent discussed below, this summary does not consider the U.S. federal tax
consequences to a person that is not a U.S. Holder, not does it describe the rules
applicable to determine a taxpayers status as a U.S. Holder. This summary is based
on the provisions of the Internal Revenue Code of 1986, as amended (the Code),
final, temporary and proposed U.S. Treasury Regulations promulgated thereunder,
administrative and judicial interpretations thereof, and the U.S./Israel Income Tax
Treaty, all as in effect as of the date hereof and all of which are subject to change,
possibly on a retroactive basis, and all of which are open to differing interpretations.
OTI will not seek a ruling from the U.S. Internal Revenue Service (IRS) with
regard to the U.S. federal income tax treatment of an investment in our ordinary shares by
U.S. Holders and, therefore, can provide no assurances that the IRS will agree with the
conclusions set forth below.

This
discussion does not address all of the aspects of U.S. federal income taxation that may be
relevant to a particular shareholder based on such shareholders particular
circumstances and in particular does not discuss any estate, gift, generation-skipping,
transfer, state, local or foreign tax considerations. In particular, this discussion does
not address the U.S. federal income tax treatment of a U.S. Holder who is: (1) a bank,
life insurance company, regulated investment company, or other financial institution or
financial services entity; (2) a broker or dealer in securities or foreign
currency; (3) a person who acquired our ordinary shares in connection with employment or
other performance of services; (4) a U.S. Holder that is subject to the U.S. alternative
minimum tax; (5) a U.S. Holder that holds our ordinary shares as a hedge or as part of a
hedging, straddle, conversion or constructive sale transaction or other risk-reduction
transaction for U.S. federal income tax purposes; (6) a tax-exempt entity; (7) real estate
investment trusts; (8) a U.S. Holder that expatriates out of the United States or a former
long-term resident of the United States; or (9) a person having a functional currency
other then the U.S. dollar. This discussion does not address the U.S. federal income tax
treatment of a U.S. Holder that owns, directly or constructively, at any time, ordinary
shares representing 10% or more of our voting power. Additionally, the U.S. federal income
tax treatment of persons who hold ordinary shares through a partnership or other
pass-through entity are not considered. Each prospective investor is advised to consult
his or her own U.S. tax advisor with respect to the specific U.S. federal and state income
tax consequences to such person of purchasing, holding or disposing of ordinary shares.

# Distributions on
Ordinary Shares

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 under the heading Passive Foreign
Investment Companies Considerations below, a U.S. Holder will be required to include
in gross income as ordinary income the amount of any distribution paid on ordinary shares
(including the amount of any Israeli tax withheld on the date of the distribution), to the
extent that such distribution does not exceed our current and accumulated earnings and
profits, as determined for U.S. federal income tax purposes. The amount of a distribution
which exceeds our earnings and profits will be treated first as a non-taxable return of
capital, reducing the U.S. Holders tax basis for the ordinary shares to the extent
thereof, and then capital gain. Corporate holders generally will not be allowed a
deduction for dividends received. In general, preferential tax rates not exceeding 15% for
qualified dividend income and long-term capital gains are applicable for U.S.
Holders that are individuals, estates or trusts (these preferential rates are scheduled to
expire for taxable years beginning after December 31, 2010, after which time dividends are
scheduled to be taxed at ordinary income rates and long-term capital gains are scheduled
to be taxed at rates not exceeding 20%). For this purpose, qualified dividend
income means, inter alia, dividends received from a qualified foreign
corporation. A qualified foreign corporation is a corporation that is
entitled to the benefits of a comprehensive tax treaty with the United States which
includes an exchange of information program. The IRS has stated that the Israel/U.S. Tax
Treaty satisfies this requirement and we believe we are eligible for the benefits of that
treaty.

In
addition, our dividends will be qualified dividend income if our shares are readily
tradable on NASDAQ or another established securities market in the United States.
Dividends will not qualify for the preferential rate if we are treated, in the year the
dividend is paid or in the prior year, as a passive foreign investment company
(PFIC). If our beliefs concerning our PFIC status are correct, dividend
distributions with respect to our shares should be treated as qualified dividend income,
subject to the U.S. Holder satisfying the holding period and other requirements. A U.S.
Holder will not be entitled to the preferential rate: (i) if the U.S. Holder has not held
our ordinary shares or ADRs for at least 61 days of the 121 day period beginning on the
date which is 60 days before the ex-dividend date, or (ii) to the extent the U.S. Holder
is under an obligation to make related payments on substantially similar property. Any
days during which the U.S. Holder has diminished its risk of loss on our ordinary shares
are not counted towards meeting the 61-day holding period. Finally, U.S. Holders who elect
to treat the dividend income as investment income pursuant to Code section
163(d)(4) will not be eligible for the preferential rate of taxation.

80

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The
amount of a distribution with respect to our ordinary shares will be measured by the
amount of the fair market value of any property distributed, and for U.S. federal income
tax purposes, the amount of any Israeli taxes withheld therefrom. (See discussion above
under Taxation of Non-Resident Holders of Shares.) Cash distributions paid by
us in NIS will be included in the income of U.S. Holders at a U.S. dollar amount based
upon the spot rate of exchange in effect on the date the dividend is includible in the
income of the U.S. Holder, and U.S. Holders will have a tax basis in such NIS for U.S.
federal income tax purposes equal to such U.S. dollar value. If the U.S. Holder
subsequently converts the NIS, any subsequent gain or loss in respect of such NIS arising
from exchange rate fluctuations will be U.S. source ordinary exchange gain or loss.

Distributions
paid by us will generally be foreign source income for U.S. foreign tax credit purposes.
Subject to the limitations set forth in the Code, U.S. Holders may elect to claim a
foreign tax credit against their U.S. income tax liability for Israeli income tax withheld
from distributions received in respect of the ordinary shares. In general, these rules
limit the amount allowable as a foreign tax credit in any year to the amount of regular
U.S. tax for the year attributable to foreign source taxable income. This limitation on
the use of foreign tax credits generally will not apply to an electing individual U.S.
Holder whose creditable foreign taxes during the year do not exceed $300, or $600 for
joint filers, if such individuals gross income for the taxable year from non-U.S.
sources consists solely of certain passive income. A U.S. Holder will be denied a foreign
tax credit with respect to Israeli income tax withheld from dividends received with
respect to the ordinary shares if such U.S. Holder has not held the ordinary shares for at
least 16 days out of the 31-day period beginning on the date that is 15 days before the
ex-dividend date or to the extent that such U.S. Holder is under an obligation to make
certain related payments with respect to substantially similar or related property. Any
day during which a U.S. Holder has substantially diminished his or her risk of loss with
respect to the ordinary shares will not count toward meeting the 16-day holding period. A
U.S. Holder will also be denied a foreign tax credit if the U.S. Holder holds the ordinary
shares in an arrangement in which the U.S. Holders reasonably expected economic
profit is insubstantial compared to the foreign taxes expected to be paid or accrued. The
rules relating to the determination of the U.S. foreign tax credit are complex, and U.S.
Holders should consult with their own tax advisors to determine whether, and to what
extent, the are entitled to such credit. U.S. Holders that do not elect to claim a foreign
tax credit may instead claim a deduction for Israeli income taxes withheld, provided such
U.S. Holders itemize their deductions.

# Sale, Exchange or Other
Taxable Disposition of Our Ordinary shares

Except
as provided under the PFIC rules described below, upon the sale, exchange or other
disposition of our ordinary shares, a U.S. Holder will recognize capital gain or loss in
an amount equal to the difference between such U.S. Holders tax basis for the
ordinary shares and the amount realized on the disposition (or its U.S. dollar equivalent
determined by reference to the spot rate of exchange on the date of disposition, if the
amount realized is denominated in a foreign currency). The gain or loss realized on the
sale or exchange or other disposition of ordinary shares will be long-term capital gain or
loss if the U.S. Holder has a holding period of more than one year at the time of the
disposition.

In
general, gain realized by a U.S. Holder on a sale, exchange or other disposition of
ordinary shares will generally be treated as U.S. source income for U.S. foreign tax
credit purposes. A loss realized by a U.S. Holder on the sale, exchange or other
disposition of ordinary shares is generally allocated to U.S. source income. However, U.S.
Treasury Regulations require such loss to be allocated to foreign source income to the
extent certain dividends were received by the taxpayer within the 24-month period
preceding the date on which the taxpayer recognized the loss. The deductibility of a loss
realized on the sale, exchange or other disposition of ordinary shares is subject to
limitations.

# Passive Foreign
Investment Company Considerations

Special
U.S. federal income tax rules apply to a U.S. Holder who owns shares of a corporation that
was at any time during the U.S. Holders holding period a passive foreign investment
company, or PFIC. A non-U.S. corporation will be classified as a PFIC for U.S. federal
income tax purposes in any taxable year in which, after applying look-through rules for
lower tier affiliates, either:

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| |  | 75%
or more of our gross income (including our pro rata share of gross income for any
company,               U.S. or foreign, in which we are considered to own 25% or more of
the shares by               value), in a taxable year is passive (the "Income Test"); or
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | At
least 50% of our assets, averaged over the year and generally determined based upon value
(including our pro rata share of the assets of any company in which we are considered to
own 25% or more of the shares by value), in a taxable year are held for the product of,
or produce, passive income (the Asset Test).
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Passive
income generally consists of dividends, interest, rents, royalties, annuities and income
from certain commodities transactions and from notional principal contracts. Cash is
treated as generating passive income.

If
we are or become a PFIC, each U.S. Holder who has not elected to treat us as a qualified
electing fund by making a QEF election, or who has not elected to mark the
shares to market (as discussed below), would, upon receipt of certain distributions by us
and upon disposition of our ordinary shares at a gain, be liable to pay U.S. federal
income tax at the then prevailing highest tax rates on ordinary income plus interest on
such tax, as if the distribution or gain had been recognized ratably over the
taxpayers holding period for the ordinary shares. In addition, when shares of a PFIC
are acquired by reason of death from a decedent that was a U.S. Holder, the tax basis of
such shares would not receive a step-up to fair market value as of the date of the
decedents death, but instead would be equal to the decedents basis if lower,
unless all gain were recognized by the decedent. Indirect investments in a PFIC may also
be subject to special U.S. federal income tax rules.

The
PFIC rules would not apply to a U.S. Holder who makes a QEF election for all taxable years
that such U.S. Holder has held the ordinary shares while were are a PFIC, provided that we
comply with certain reporting requirements. Instead, each U.S. Holder who has made such a
QEF election is required for each taxable year that we are a PFIC to include in income
such U.S. Holders pro rata share of our ordinary earnings as ordinary income
and such U.S. Holders pro rata share of our net capital gains as long-term
capital gain, regardless of whether we make any distributions of such earnings or gain. In
general, a QEF election is effective only if we make available certain required
information. The QEF election is made on a shareholder-by-shareholder basis and generally
may be revoked only with the consent of the IRS. Although we have no obligation to do so,
we intend to comply with the applicable information reporting requirements for U.S.
Holders to make a QEF election.

A
U.S. Holder of PFIC shares which are traded on certain public markets, including the
NASDAQ, can elect to mark the shares to market annually, recognizing as ordinary income or
loss each year an amount equal to the difference as of the close of the taxable year
between the fair market value of the PFIC shares and the U.S. Holders adjusted basis
in the PFIC shares. Loses are allowed only to the extent of net mark-to-market gain
previously included income by the U.S. Holder under the election for prior taxable years.

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 that we will not be considered a
PFIF for our current taxable year, and there is only a small chance that we will be a PFIC
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 the current and future years
depends on our assets and activities in those years. Because the market value of our
ordinary shares is likely to fluctuate and because the market price of the shares of a
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 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, a U.S. Holder 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 our ordinary shares.

If
we are or become a PFIC, as noted above, a U.S. Holder of our ordinary shares could make a
variety of elections (described above) 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 QEF 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 were
treated as a PFIC.

82

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# Backup Withholding and
Information Reporting

A
U.S. Holder may be subject to backup withholding (currently at a rate of 28%, but
scheduled to increase to 31% for taxable years beginning after December 31, 2010) with
respect to cash dividends and proceed from a disposition of ordinary shares. In general,
back-up withholding will apply only if a U.S. Holder fails to comply with certain
identification procedures. Backup withholding will not apply with respect to payments made
to certain exempt recipients, such as corporations and tax-exempt organizations. Backup
withholding is not an additional tax and may be claimed as a credit against the U.S.
federal income tax liability of a U.S. Holder, provided that the required information is
timely furnished to the IRS.

# Non-U.S. Holders of
Ordinary Shares

Except
as provided below, an individual, corporation, estate or trust that is not a U.S. Holder
generally will not be subject to U.S. federal income or withholding tax on the payment of
dividends on, and the proceeds from the disposition of, our ordinary shares.

A
non-U.S. Holder may be subject to U.S. federal income or withholding tax on a dividend
paid on our ordinary shares or the proceeds from the disposition of our ordinary shares
if: (i) if such item is effectively connected with the conduct by the non-U.S. Holder of a
trade or business in the United States or, in the case of a non-U.S. Holder that is a
resident of a country which has an income tax treaty with the United States, such item is
attributable to a permanent establishment or, in the case of gain realized by an
individual non-U.S. Holder, a fixed place of business in the U.S.; (ii) in the case of a
disposition of our ordinary shares, the individual non-U.S. Holder is present in the U.S.
for 183 days or more in the taxable year of the sale and certain other conditions are met;
(iii) if the non-U.S. Holder is subject to U.S. federal income tax pursuant to the
provisions of the U.S. tax law applicable to U.S. expatriates.

In
general, non-U.S. holders will not be subject to the 28% backup withholding with respect
to the payment of dividends on our ordinary shares if payment is made through a paying
agent, or office of a foreign broker outside the United States. However, if payment is
made in the United States or by a U.S. related person, non-U.S. Holders may be subject to
backup withholding, unless the non-U.S. Holder provides on an applicable Form W-8 (or a
substantially similar form) a taxpayer identification number, certifies to its foreign
status, or otherwise establishes an exemption. A U.S. related person for these purposes is
a person with one or more current relationships with the United States.

Non-U.S.
          holders generally may be subject to backup withholding at a rate of 28% on the
          payment of the proceeds from the disposition of our ordinary shares to or
          through the U.S. office of a broker, whether domestic or foreign, or the office
          of a U.S. related person, unless the non-U.S. Holder provides a taxpayer
          identification number, certifies to its foreign status or otherwise establishes
          an exemption. Non-U.S. Holders will not be subject to backup withholding with
          respect to the payment of proceeds from the disposition of ordinary shares by a
          foreign office of a broker.

The
amount of any backup withholding from a payment to a non-U.S. Holder will be allowed as a
credit against such holders U.S. federal income tax liability and may entitle such
holder to a refund, provided that the required information is timely furnished to the IRS.

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

Not
applicable.

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

Not
applicable.

83

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

We
are subject to the informational requirements of the Securities Exchange Act of 1934, as
amended, applicable to foreign private issuers and fulfill the obligation with respect to
such requirements by filing reports with the Securities and Exchange Commission. As a
foreign private issuer, we are exempt from the rules under the Exchange Act prescribing
the furnishing and content of proxy statements, and our officers, directors and principal
shareholders are exempt from the reporting and short-swing profit recovery
provisions contained in Section 16 of the Exchange Act. In addition, we are not required
under the Exchange Act to file periodic reports and financial statements with the
Securities and Exchange Commission as frequently or as promptly as United States companies
whose securities are registered under the Exchange Act. You may read and copy any document
we file with the Securities and Exchange Commission without charge at the Securities and
Exchange Commissions public reference room at 100 F Street, N.E., Washington D.C.
20549. Copies of such material may be obtained by mail from the Public Reference Branch of
the Securities and Exchange Commission at such address, at prescribed rates. Please call
the Securities and Exchange Commission at 1-800-SEC-0330 for further information on the
public reference room. A copy of each report submitted in accordance with applicable
United States law is also available for public review at our principal executive offices.

In
addition, the Securities and Exchange Commission maintains an Internet website at
http://www.sec.gov that contains reports and other material that are filed through the
Securities and Exchange Commissions Interactive Data Electronic Application.

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

Not
applicable.

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

We
are exposed to a variety of risks, including changes in interest rates affecting primarily
the interest received on cash equivalents, short-term investments and foreign currency
fluctuations. We may in the future undertake hedging or other similar transactions if our
management determines that it is necessary to offset these risks.

Interest
Rate Risk

Our
exposure to market risks for changes in interest rates relates primarily to our cash and
cash equivalents, short term investments and to loans we take that are based on a
floating/fixed interest rate. Our cash and cash equivalents and short term investments are
held substantially in U.S. dollars with financial banks and bear annual interest of
approximately 1.6%.

Foreign
Currency Exchange Risk

We
generate a significant portion of our revenues in U.S. dollars but we incur a large
portion of our expenses in other currencies, principally some employees salaries in
New Israeli Shekels, and the majority of the expenses of our German, French and Polish
subsidiaries, InterCard, InSeal, PARX France and ASEC, in euros and of our subsidiary in
the Far East, MCT, in Yuan Renminbi. To the extent that we and our subsidiaries based in
Israel, Europe and the Far East conduct our business in different currencies, our revenues
and expenses and, as a result, our assets and liabilities, are not necessarily accounted
for in the same currency. We are, therefore, exposed to foreign currency exchange rate
fluctuations. These fluctuations may negatively affect our results of operations. Our
operations could also be adversely affected if we are unable to limit our exposure to
currency fluctuations in the future. Accordingly, we may enter into currency hedging
transactions to decrease the risk of financial exposure to fluctuations in the exchange
rate of the U.S. dollar against the New Israeli Shekel or other currencies.

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

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

Not
applicable.

# 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
|-------- |  | ----------------------------------------------------------------------------

On
January 11, 2009, our board of directors adopted a Shareholder Rights Plan. Pursuant to
the terms of the plan, our board approved a distribution by way of bonus rights, of one
right for each of our outstanding ordinary share. The bonus rights were distributed on
January 12, 2009 to the shareholders of record as of the close of business on January 11,
2009.

The
rights are initially traded with, and are inseparable from our ordinary shares. The rights
are evidenced only by the balances indicated in the book-entry account system of the
transfer agent for our ordinary share or, in the case of certificated shares, the
certificates that represent such ordinary shares and any transfer of ordinary shares will
constitute a transfer of rights. New rights will accompany any new ordinary share we
issues after January 11, 2009 until the Distribution Date described below.

Each
right will allow its holder to purchase from us one ordinary shares when our authorized
share capital is NIS 5,000,000 and three ordinary shares when our authorized share capital
is NIS 20,000,000, at a price of NIS 0.10 per share, once the rights become exercisable.
Prior to exercise, a right does not give its holder any dividend, voting, or liquidation
rights.

84

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The
rights will not be exercisable until the earlier of the following (the Distribution
Date):

| |  | Ten
days (or such later date as may be determined by action of our board of directors prior
to such time as any person becomes an Acquiring Person) after the public announcement
that a person or group has become an Acquiring Person by obtaining beneficial
ownership of 15% or more of our outstanding ordinary shares, except if such person or
group has become an Acquiring Person pursuant to an offer approved by the
majority of our board of directors; or
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Ten
business days (or a later date determined by our board before any person or group becomes
an Acquiring Person) after a person or group begins a tender or exchange offer (except if
such person or group has become an Acquiring Person pursuant to an offer
approved by the majority of our board of directors) which, if completed, would result in
that person or group becoming an Acquiring Person.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

After
the Distribution Date, the rights will separate from the ordinary shares and will be
evidenced solely by rights certificates that we will mail to all eligible holders of
ordinary shares. Any rights held by an Acquiring Person or any associate or affiliate
thereof will be void and may not be exercised.

Our
board of directors may reduce the threshold at which a person or group becomes an
Acquiring Person from 15% to not less than 10% of our outstanding ordinary shares.

If
a person or group becomes an Acquiring Person, all holders of rights, except for the
Acquiring Person or any associate or affiliate thereof may, for NIS0.10 per share (subject
to adjustment as provided in the plan), purchase one or three ordinary shares, in
accordance with ratio mentioned above. In addition, if, after a person or group becomes an
Acquiring Person, we are later acquired in a merger or similar transaction after the
Distribution Date, all holders of rights, except for the Acquiring Person, or any
associate or affiliate thereof may, for NIS0.10 per share (subject to adjustment as
provided in the plan), purchase one or three ordinary shares, as specified above of the
acquiring corporations common stock.

The
rights will expire on January 11, 2012, unless previously redeemed, or such later date as
determined by our board of directors (so long as such determination is made prior to the
earlier of the Distribution Date or January 11, 2012).

Our
board of directors may redeem the rights for no consideration at any time prior to ten
days after such time that any person or group becomes an Acquiring Person. If our board of
directors redeems any rights, it must redeem all of the rights.

After
a person or group becomes an Acquiring Person, but before an Acquiring Person owns 50% or
more of our outstanding ordinary shares, our board of directors may extinguish the rights
by exchanging each right for ordinary shares at an exchange ratio equal to the effective
exercise ratio or an equivalent security for each right, other than rights held by the
Acquiring Person and its associates and affiliates.

The
terms of the plan may be amended (including terminated) by our board of directors without
the consent of the holders of the rights. However, our board of directors may not amend
the plan to lower the threshold at which a person or group becomes an Acquiring Person to
below 10% of our outstanding Ordinary Shares. In addition, our board of directors may not
cause a person or group to become an Acquiring Person by lowering this threshold below the
percentage interest that such person or group already owns. After a person or group
becomes an Acquiring Person, the board may not amend the plan in a way that adversely
affects holders of the rights.

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

Disclosure
Controls and Procedures

Our
management, including our chief executive officer, or CEO, and chief financial officer, or
CFO, are responsible for establishing and maintaining our disclosure controls and
procedures (within the meaning of Rule 13a-15(e) of the Securities Exchange Act of
1934). These controls and procedures were designed to ensure that information required to
be disclosed in the reports that we file under the Exchange Act, is recorded, processed,
summarized and reported within the time periods specified in the rules and forms of the
SEC and that such information was made known to our management, including our CEO and CFO,
by others within the Company, as appropriate to allow timely decisions regarding required
disclosure. We evaluated these disclosure controls and procedures under the supervision of
our CEO and CFO as of December 31, 2008. Based upon that evaluation, our management,
including our CEO and CFO, concluded that our disclosure controls and procedures are
effective.

85

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Managements
Annual Report on Internal Control Over Financial Reporting

Our
management is responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange
Act. Our internal control over financial reporting policies and procedures are designed
under the supervision of the CEO and CFO to provide reasonable assurance regarding the
reliability of the financial reporting and preparation of the financial statements for the
external reporting purposes in accordance with U.S. GAAP. Under the supervision and with
the participation of our management, including our chief executive officer and chief
financial officer, we conducted an evaluation of the effectiveness of our internal control
over financial reporting based on the framework inInternal ControlIntegrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission.

Because
of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may
deteriorate.

Based
on our evaluation under the framework inInternal ControlIntegrated
Framework, our management concluded that our internal control over financial reporting
was effective as of December 31, 2008.

This
annual report does not include an attestation report of our registered public accounting
firm regarding internal control over financial reporting. Managements report
regarding internal control over financial reporting was not subject to attestation by our
registered public accounting firm pursuant to temporary rules of the SEC that permit us to
provide only managements report in this annual report.

Changes
in Internal Control Over Financial Reporting

There
has been no change in our internal control over financial reporting (as defined in Rules
13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during our fiscal year ended
December 31, 2008 that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.

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

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

Our
board of directors has determined that Eli Akavia, a member of its audit committee, is an
audit committee financial expert, pursuant to Rule 10A-3 under the Securities Exchange Act
of 1934, as amended. Mr. Akavia qualifies as an independent director under the
applicable NASDAQ Marketplace Rules.

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

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

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

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

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

86

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# Principal Accountant
Fees and Services

The
following fees were billed by KPMG International for professional services rendered
thereby for the years ended December 31:

|               | 2007 | 2008
|-------------- | ---- | ----
|
|
|
|
|Audit fees (1) |      |     
|               |      |     
|Tax fees (2)   |      |     
|               |      |     
|               |      |     
|               |      |     
|               |      |     

(1)
          The audit fees for the years ended December 31, 2008 and 2007, are the
aggregate           fees billed or billable (for the year) for the professional services
rendered           for the audits of our 2008 and 2007 annual consolidated financial
statements,           review of consolidated quarterly financial statements of 2008 and
2007, and           services that are normally provided in connection with statutory
audits of us           and our subsidiaries, consents and assistance with review of
documents filed           with the SEC.

(2)
          Tax fees are the aggregate fees billed (in the year) for professional services
          rendered for tax compliance and tax advice other than in connection with the
          audit.

# Pre-Approval Policies
and Procedures

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

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

None.

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

None.

|ITEM 16F. |  | CHANGES IN REGISTRANTS CERTIFYING ACCOUNTANT
|--------- |  | ---------------------------------------------

Note
applicable

|ITEM 16G. |  | CORPORATE GOVERNANCE
|--------- |  | --------------------

As
a foreign private issuer whose shares are listed on the NASDAQ Global Market, we are
permitted to follow certain home country corporate governance practices instead of certain
requirements of the NASDAQ Marketplace Rules.

87

---

---

As
a foreign private issuer listed on the NASDAQ Global Market, we may follow home country
practice with regard to, among other things, composition of the board of directors,
directors nomination process and regularly scheduled meetings at which only independent
directors are present. In addition, we may follow our home country practice, instead of
the NASDAQ Marketplace Rules, which require that we obtain shareholder approval for
certain dilutive events, such as for the establishment or amendment of certain equity
based compensation plans, an issuance that will result in a change of control of the
company, certain transactions other than a public offering involving issuances of a 20%
or more interest in the company and certain acquisitions of the stock or assets of
another company. A foreign private issuer that elects to follow a home country practice
instead of NASDAQ requirements must submit to NASDAQ in advance a written statement from
an independent counsel in such issuers home country certifying that the issuers
practices are not prohibited by the home countrys laws. In addition, a foreign
private issuer must disclose in its annual reports filed with the Securities and Exchange
Commission or on its website each such requirement that it does not follow and describe
the home country practice followed by the issuer instead of any such requirement.
Accordingly, our shareholders may not be afforded the same protection as provided under
NASDAQs corporate governance rules.

See
Item 6 Directors, Senior Management and Employees  E. Share Ownership 
2001 Share Option Plan and Item 6 Directors, Senior Management and Employees
 C. Board Practices  Board Committees  Compensation Committee for
a detailed description of the significant ways in which our corporate governance practices
differ from those followed by U.S. companies under the listing standards of the NASDAQ
Global Market.

PART III

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

The
Company has elected to furnish financial statements and related information specified in
Item 18.

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

# Index to the Financial
Statements of the Registrant

|                                                                                  |         
|--------------------------------------------------------------------------------- | --------
|
|
|
|
|Report of Independent Registered Public Accounting Firm                           | F-2     
|Consolidated Balance Sheets                                                       | F-3-F-4 
|Consolidated Statements of Operations                                             | F-5     
|Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Loss | F-6     
|Consolidated Statements of Cash Flows                                             | F-7-F-8 
|Notes to the Consolidated Financial Statements                                    | F-9-F-43
|                                                                                  |         

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

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

|1 |  | Articles
of Association (4)
|- |  | ---------------------------

|2 |  | Shareholders
Rights Agreement, dated as of January 12, 2009, between the Registrant and Continental
                 Stock Transfer & Trust Company (4)
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------

|4.1 |  | Original
Section 102 Share Option Plan of the Registrant.(2)
|--- |  | ------------------------------------------------------------

|4.2 |  | Stock
Compensation Program and Stock Award Agreement of OTI America, Inc.(1)
|--- |  | ----------------------------------------------------------------------------

|4.3 |  | 2008
Employee Stock Purchase Plan of the Registrant. (3)
|--- |  | --------------------------------------------------------

|4.4 |  | 2001
Employee Share Purchase Plan of the Registrant.(1)
|--- |  | -------------------------------------------------------

|4.5 |  | 2001
Share Option Plan of the Registrant.(1)
|--- |  | --------------------------------------------

|4.6 |  | Application
to Approve a Trustee for an Option Plan pursuant to Section 102 of the Income Tax
                 Ordinance; and Deed of Trust. (2)
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------

|4.7 |  | Long
Term Lease Agreement, dated as of March 6, 2002 by and between the Israel Lands Authority
and                  the Registrant.(1)
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------

|4.8 |  | Form of Letter of Exemption and
Indemnification  between the Registrant and  its directors and officers. (5)
|--- |  | ------------------------------------------------------------------------------------------------------------

|4.9 |  | Form of Securities Purchase Agreement
between the Registrant and various investors, dated as of October 27, 2005. (6)
|--- |  | ---------------------------------------------------------------------------------------------------------------------

88

---

---

|8. |  | List
of subsidiaries (filed herewith).
|-- |  | --------------------------------------

|12.1 |  | Certification
of Chief Executive Officer, pursuant to Rule 13a-14(a) under the Securities Exchange Act
of 1934 (filed herewith).
|---- |  | --------------------------------------------------------------------------------------------------------------------------------

|12.2 |  | Certification
of Chief Financial Officer, pursuant to Rule 13a-14(a) under the Securities Exchange Act
of 1934 (filed herewith).
|---- |  | --------------------------------------------------------------------------------------------------------------------------------

|13.1 |  | Certification
of Chief Executive Officer, pursuant Rule 13a-14(b) under the Securities Exchange Act of
1934, and 18 U.S.C. Section 1350 (filed herewith).
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------

|13.2 |  | Certification
of Chief Financial Officer, pursuant Rule 13a-14(b) under the Securities Exchange Act of
1934, and 18 U.S.C. Section 1350 (filed herewith).
|---- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------

|15 |  | Consent
of Independent Registered Public Accounting Firm (filed herewith).
|-- |  | --------------------------------------------------------------------------

|(1) | Previously
filed with the Companys Registration Statement on Form F-1,                filed on
June 14, 2002.
|--- | --------------------------------------------------------------------------------------------------------------

|(2) | Previously
filed with an amendment to the Companys Registration                Statement
on Form F-1, filed with the SEC on September 11, 2002.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Previously
filed with the Companys Registration Statement on Form S-8,                filed
with the SEC on March 6, 2008.
|--- | ---------------------------------------------------------------------------------------------------------------------------

|(4) | Previously
filed with the Companys Registration Statement on Form 8-A/A
               (Amendment No. 1), filed with the SEC on January 12, 2009
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | Previously
filed with the Companys report on Form 6-K, as Schedule B to           such report,
filed with the SEC on June 25, 2008.
|--- | ------------------------------------------------------------------------------------------------------------------------------------

|(6) | Previously
filed with the Companys report on Form 6-K filed with SEC on           November 8,
2005.
|--- | ----------------------------------------------------------------------------------------------------

89

---

---

# On Track Innovations
Ltd. and its Subsidiaries

Consolidated Financial Statements As of December 31, 2008



---

---

|                                                          | On Track Innovations
Ltd.and its Subsidiaries
|--------------------------------------------------------- | ---------------------------------------------
|Consolidated Financial
Statements as of December 31, 2008 |                                              

---

Contents

|                                                                       | Page      
|---------------------------------------------------------------------- | ----------
|
|
|
|
|Report of Independent Registered Public Accounting Firm                | F-2       
|                                                                      
|Consolidated Balance Sheets                                            | F-3 - F-4 
|                                                                      
|Consolidated Statements of Operations                                  | F-5       
|                                                                      
|Consolidated Statements of Shareholders' Equity and Comprehensive Loss | F-6       
|                                                                      
|Consolidated Statements of Cash Flows                                  | F-7 - F-8 
|                                                                      
|Notes to the Consolidated Financial Statements                         | F-9 - F-43



---

---

Report of Independent
Registered Public Accounting Firm

# To the Board of
Directors and ShareholdersOn 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, 2008 and 2007 and the related consolidated statements of
operations, shareholders equity and comprehensive loss and cash flows for each of
the years in the three-year period ended December 31, 2008. These consolidated financial
statements are the responsibility of the Companys management. Our responsibility is
to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by the board of directors and management, as well as evaluating
the overall financial statements presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the
financial position of the Company and its subsidiaries as of December 31, 2008 and 2007
and the results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2008, in conformity with U.S. generally accepted
accounting principles.

As discussed in Note 2 to the
consolidated financial statements, effective January 1, 2006, the Company changed its
method of accounting for stock-based compensation upon adoption of Statement of Financial
Accounting Standards No. 123(R), Share-Based Payment.

/s/ Somekh Chaikin
Certified Public Accountants (Isr.)
A Member Firm of KPMG International
Tel Aviv, Israel
June 29, 2009

F - 2

---

---

On Track Innovations Ltd.
and its Subsidiaries

|Consolidated
Balance Sheets
|---------------------------

---

US dollar in thousands except share and per share data

|                                                      | December 31
|----------------------------------------------------- | -----------
|
|
|
|
|Assets                                                |            
|                                                      |            
|Current assets                                        |            
|Cash and cash equivalents                             |            
|Short-term investments                                |            
|Trade receivables (net of allowance for doubtful      |            
|accounts of $2,767 and $3,315 as of December 31, 2007 |            
|and 2008, respectively)                               |            
|Other receivables and prepaid expenses                |            
|Inventories                                           |            
|                                                      |            
|                                                      |            
|Total current assets                                  |            
|                                                      |            
|                                                      |            
|Severance pay deposits fund                           |            
|                                                      |            
|Investment in an affiliated company                   |            
|                                                      |            
|Property, plant and equipment, net                    |            
|                                                      |            
|Intangible assets, net                                |            
|                                                      |            
|Goodwill                                              |            
|                                                      |            
|                                                      |            
|Total assets                                          |            
|                                                      |            

F - 3

---

---

On Track Innovations Ltd.
and its Subsidiaries

|Consolidated
Balance Sheets
|---------------------------

---

US dollar in thousands except share and per share data

|                                                            | December 31
|----------------------------------------------------------- | -----------
|
|
|
|
|Liabilities and Shareholders' Equity                        |            
|                                                            |            
|Current Liabilities                                         |            
|Short-term bank credit and current maturities               |            
|of long-term bank loans                                     |            
|Trade payables                                              |            
|Other current liabilities                                   |            
|                                                            |            
|Total current liabilities                                   |            
|                                                            |            
|                                                            |            
|Long-Term Liabilities                                       |            
|Long-term loans, net of current maturities                  |            
|Accrued severance pay                                       |            
|Deferred tax liability                                      |            
|                                                            |            
|Total long-term liabilities                                 |            
|                                                            |            
|                                                            |            
|Total liabilities                                           |            
|                                                            |            
|                                                            |            
|Commitments and Contingencies                               |            
|                                                            |            
|Minority interests                                          |            
|                                                            |            
|Shareholders' Equity                                        |            
|Ordinary shares of NIS 0.1 par value: Authorized -          |            
|50,000,000 shares as of December 31, 2007 and               |            
|December 31, 2008; issued 19,627,068 and 21,534,788         |            
|shares as of December 31, 2007 and December 31, 2008,       |            
|respectively; outstanding 19,434,011 and 21,495,409 shares  |            
|as of December 31, 2007 and December 31, 2008, respectively |            
|Additional paid-in capital                                  |            
|Accumulated other comprehensive income (loss)               |            
|Accumulated deficit                                         |            
|                                                            |            
|                                                            |            
|Total shareholder's equity                                  |            
|                                                            |            
|                                                            |            
|Total liabilities and shareholders' equity                  |            
|                                                            |            

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

F - 4

---

---

On Track Innovations Ltd.
and its Subsidiaries

|Consolidated Statements of Operations
|-------------------------------------

---

US dollar in thousands except share and per share data

|                                                 | Year ended December 31
|------------------------------------------------ | ----------------------
|
|
|
|
|Revenues                                         |                       
|Sales                                            |                       
|Licensing and transaction fees                   |                       
|                                                 |                       
|Total revenues                                   |                       
|                                                 |                       
|                                                 |                       
|Cost of Revenues                                 |                       
|Sales                                            |                       
|                                                 |                       
|Total cost of revenues                           |                       
|                                                 |                       
|                                                 |                       
|Gross profit                                     |                       
|                                                 |                       
|                                                 |                       
|Operating Expenses                               |                       
|Research and development                         |                       
|Selling and marketing                            |                       
|General and administrative                       |                       
|Amortization and impairment of intangible assets |                       
|Impairment of goodwill                           |                       
|Gain on sale of subsidiaries                     |                       
|                                                 |                       
|                                                 |                       
|Operating expenses                               |                       
|                                                 |                       
|                                                 |                       
|Operating loss                                   |                       
|                                                 |                       
|Financial income                                 |                       
|Financial expenses                               |                       
|                                                 |                       
|Financial income (expenses), net                 |                       
|Other expenses, net                              |                       
|                                                 |                       
|                                                 |                       
|Loss before taxes on income                      |                       
|Income tax benefit                               |                       
|Equity in loss of affiliated company             |                       
|Minority share in loss (income) of subsidiaries  |                       
|                                                 |                       
|Net loss                                         |                       
|                                                 |                       
|                                                 |                       
|Basic and diluted net loss per ordinary          |                       
|share                                            |                       
|                                                 |                       
|                                                 |                       
|Weighted average number of ordinary              |                       
|shares used in computing basic and               |                       
|diluted net loss per ordinary share              |                       
|                                                 |                       

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

F - 5

---

---

On Track Innovations Ltd.
and its Subsidiaries

|Consolidated Statements of Shareholders' Equity and Comprehensive Loss
|----------------------------------------------------------------------

---

US dollar in thousands except share and per share data

|                                                | Number of
Shares
issued | Share
capital | Additional
paid-in
capital | Deferred
stock
compensation | Accumulated
other
comprehensive
income | Accumulated
deficit | Total
shareholders'
equity
|----------------------------------------------- | ----------------------- | ------------- | -------------------------- | --------------------------- | -------------------------------------- | ------------------- | --------------------------
|
|
|
|
|Balance as of December 31, 2005                 |                         |               |                            | 11,932,074                  |                                        | $                   | 274                       
|                                                |                         |              
|Changes during the year ended                   |                         |              
|December 31, 2006:                              |                         |              
|                                                |                         |              
|Reclassification upon adoption of  SFAS         |                         |              
|123 (R)                                         |                         |               |                            | -                           |                                        |                     | -                         
|Stock-based  compensation related to            |                         |              
|options warrants and shares issued to           |                         |              
|employees and others                            |                         |               |                            | 192,393                     |                                        |                     | 6                         
|Exercise of options and warrants                |                         |               |                            | 748,338                     |                                        |                     | 17                        
|Issuance costs                                  |                         |               |                            | -                           |                                        |                     | -                         
|Shares issued under Alternative Option          |                         |              
|Exercise Mechanism                              |                         |               |                            | 2,437,075                   |                                        |                     | 56                        
|Shares issued in connection with the            |                         |              
|purchase of business operations                 |                         |               |                            | 3,083,000                   |                                        |                     | 73                        
|Shares issued in connection with the            |                         |              
|purchase of property plant and equipment        |                         |               |                            | 200,000                     |                                        |                     | 5                         
|Foreign currency translation adjustments        |                         |               |                            | -                           |                                        |                     | -                         
|Net unrealized gain on available-for-sale       |                         |              
|securities                                      |                         |               |                            | -                           |                                        |                     | -                         
|Net loss                                        |                         |               |                            | -                           |                                        |                     | -                         
|                                                |                         |               |                            |                             |                                        |                     |                           
|Balance as of December 31, 2006                 |                         |               |                            | 18,592,880                  |                                        | $                   | 431                       
|                                                |                         |               |                            |                             |                                        |                     |                           
|                                                |                         |              
|Changes during the year ended                   |                         |              
|December 31, 2007:                              |                         |              
|                                                |                         |              
|Stock-based compensation related to options and |                         |              
|shares issued to employees and others           |                         |               |                            | -                           |                                        |                     | -                         
|Exercise of options and warrants                |                         |               |                            | 458,788                     |                                        |                     | 11                        
|Shares, warrants and options issued in          |                         |              
|connection with the purchase of property        |                         |              
|plant and equipment                             |                         |               |                            | 575,400                     |                                        |                     | 12                        
|Foreign currency translation adjustments        |                         |               |                            | -                           |                                        |                     | -                         
|Net unrealized loss on available-               |                         |              
|for-sale securities                             |                         |               |                            | -                           |                                        |                     | -                         
|Net loss                                        |                         |               |                            | -                           |                                        |                     | -                         
|                                                |                         |               |                            |                             |                                        |                     |                           
|Balance as of December 31, 2007                 |                         |               |                            | 19,627,068                  |                                        | $                   | 454                       
|                                                |                         |               |                            |                             |                                        |                     |                           
|                                                |                         |              
|Changes during the year ended                   |                         |              
|December 31, 2008:                              |                         |              
|                                                |                         |              
|Stock-based compensation related to options and |                         |              
|shares issued to employees and others           |                         |               |                            | -                           |                                        |                     | -                         
|Exercise of options, warrants and               |                         |              
|receipts in respect of employee share           |                         |              
|purchase plan                                   |                         |               |                            | 1,607,022                   |                                        |                     | 45                        
|Receipt on account of shares                    |                         |               |                            | -                           |                                        |                     | -                         
|Shares and options issued in connection         |                         |              
|with the purchase of a subsidiary               |                         |               |                            | 300,698                     |                                        |                     | 9                         
|Adjustment to contingent consideration          |                         |              
|in connection with the purchase of a            |                         |              
|subsidiary                                      |                         |               |                            | -                           |                                        |                     | -                         
|Foreign currency translation adjustments        |                         |               |                            | -                           |                                        |                     | -                         
|Net unrealized loss on available-               |                         |              
|for-sale securities                             |                         |               |                            | -                           |                                        |                     | -                         
|Net loss                                        |                         |               |                            | -                           |                                        |                     | -                         
|                                                |                         |               |                            |                             |                                        |                     |                           
|                                                |                         |               |                            |                             |                                        |                     |                           
|Balance as of December 31, 2008                 |                         |               |                            | 21,534,788                  |                                        | $                   | 508                       
|                                                |                         |               |                            |                             |                                        |                     |                           

|                                                              | Year ended December 31
|------------------------------------------------------------- | ----------------------
|
|
|
|
|Total comprehensive loss:                                     |                       
|Net loss                                                      |                       
|Foreign currency translation adjustments                      |                       
|Net unrealized gain (loss) on available- for- sale securities |                       
|Reclassification adjustment for realized gain (loss) on       |                       
|available-for-sale securities                                 |                       
|                                                              |                       
|                                                              |                       
|Total comprehensive loss                                      |                       
|                                                              |                       

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

F - 6

---

---

On Track Innovations Ltd.
and its Subsidiaries

|Consolidated Statements of Cash Flows
|-------------------------------------

---

US dollar in thousands except share and per share data

|                                                                          | Year ended December 31
|------------------------------------------------------------------------- | ----------------------
|
|
|
|
|Cash flows from operating activities                                      |                       
|Net loss                                                                  |                       
|Adjustments required to reconcile net loss to                             |                       
|net cash used in operating activities:                                    |                       
|Stock-based compensation related to options and shares issued             |                       
|to employees and others                                                   |                       
|Gain on sale of subsidiaries                                              |                       
|Loss on sale of property and equipment                                    |                       
|Amortization and impairment of intangible assets                          |                       
|Impairment of goodwill                                                    |                       
|Depreciation                                                              |                       
|Equity in net losses of an affiliated company                             |                       
|                                                                          |                       
|Accrued severance pay, net                                                |                       
|Minority share in income (loss) of subsidiaries                           |                       
|Accrued interest and linkage differences on long-term loans               |                       
|Decrease in deferred tax liability                                        |                       
|Decrease (increase) in trade receivables                                  |                       
|Increase (decrease) in allowance for doubtful account                     |                       
|Decrease (increase) in other receivables and prepaid expenses             |                       
|Decrease (increase) in inventories                                        |                       
|Increase (decrease) in trade payables                                     |                       
|Increase (decrease) in other current liabilities                          |                       
|                                                                          |                       
|Net cash used in operating activities                                     |                       
|                                                                          |                       
|                                                                          |                       
|Cash flows from investing activities                                      |                       
|                                                                          |                       
|Receipts on account of loans and receivables                              |                       
|Acquisition of business  operations and consolidated  subsidiary,  net of |                       
|cash acquired (Supplement C)                                              |                       
|Sale of a consolidated subsidiary, net of cash disposed of                |                       
|(Supplement D)                                                            |                       
|Purchase of property and equipment                                        |                       
|Purchase of available-for-sale securities                                 |                       
|Proceeds from maturity of available-for-sale securities                   |                       
|Other, net                                                                |                       
|                                                                          |                       
|Net cash provide 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                                         |                       
|Proceeds from minority in subsidiary                                      |                       
|Proceeds from receipt on account of shares, exercise of options and       |                       
|warrants and receipts in respect of employee share purchase plan, net     |                       
|                                                                          |                       
|Net cash provided by financing activities                                 |                       
|                                                                          |                       
|                                                                          |                       
|Effect of exchange rate changes on cash                                   |                       
|                                                                          |                       
|                                                                          |                       
|Increase (decrease) in cash and cash equivalents                          |                       
|Cash and cash equivalents at the beginning of the year                    |                       
|                                                                          |                       
|                                                                          |                       
|Cash and cash equivalents at the end of the year                          |                       
|                                                                          |                       

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

F - 7

---

---

On Track Innovations Ltd.
and its Subsidiaries

|Consolidated Statements of Cash Flows
|-------------------------------------

---

US dollar in thousands except share and per share data

|                                     |                                                         | Year ended December 31
|------------------------------------ | ------------------------------------------------------- | ----------------------
|
|
|
|
|                                     |                                                         |                       
|Supplementary cash flows activities: |                                                         |                       
|                                     |                                                         |                       
|A.                                   | Cash paid during the period for:                        |                       
|                                     | Interest                                                |                       
|                                     |                                                         |                       
|                                     | Income taxes                                            |                       
|                                     |                                                         |                       
|                                     |                                                         |                       
|B.                                   | Non-cash transactions:                                  |                       
|                                     | Purchase of property and equipment                      |                       
|                                     |                                                         |                       
|                                     | Other receivables                                       |                       
|                                     |                                                         |                       
|                                     | Issuance expenses                                       |                       
|                                     |                                                         |                       
|                                     |                                                         |                       
|C.                                   | Acquisition of consolidated subsidiaries:               |                       
|                                     | Assets acquired and liabilities assumed of the          |                       
|                                     | subsidiaries at date of acquisition:                    |                       
|                                     | Working capital surplus, excluding cash                 |                       
|                                     | and cash equivalents                                    |                       
|                                     | Property and equipment                                  |                       
|                                     | Goodwill                                                |                       
|                                     | Customer contracts and relationships                    |                       
|                                     | Non competition agreement                               |                       
|                                     | Technology                                              |                       
|                                     | Long term liabilities                                   |                       
|                                     | Deferred tax liability                                  |                       
|                                     |                                                         |                       
|                                     |                                                         |                       
|                                     |                                                         |                       
|                                     | Issuance of shares in consideration for the acquisition |                       
|                                     | Direct costs of acquisitions paid via grant of options  |                       
|                                     |                                                         |                       
|                                     |                                                         |                       
|                                     |                                                         |                       
|                                     |                                                         |                       
|D.                                   | Sale of a consolidated subsidiary:                      |                       
|                                     | Assets and liabilities of the previously consolidated   |                       
|                                     | Subsidiary at the time it ceased being consolidated:    |                       
|                                     | Working capital surplus, excluding cash                 |                       
|                                     | and cash equivalents                                    |                       
|                                     | Long-term receivables                                   |                       
|                                     | Intangible assets                                       |                       
|                                     | Deferred tax liability                                  |                       
|                                     | Minority interests                                      |                       
|                                     | Gain and deferred gain on sale of the subsidiary        |                       
|                                     |                                                         |                       
|                                     |                                                         |                       
|                                     |                                                         |                       

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

F - 8

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 1  General

| | A. | Introduction
| | -- | ------------

| | On Track Innovations Ltd. (the
Company) was founded in 1990 under the laws of the State of Israel. The
Company and its subsidiaries (together the Group) are principally engaged in
the field of design, development, manufacture and sale of contactless microprocessor-based
smart card systems. In November 2002, the Companys shares began trading on NASDAQ.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Certain
definitions
| | -------------------

| | $
- United States Dollars          NIS - New Israeli Shekel
| | -----------------------------------------------------------

| | B. | Acquisition
of subsidiaries and business operations:
| | -- | ----------------------------------------------------

| | 1. | In
June 2008, the Company completed, through its subsidiary PARX Ltd, the
                    purchase of 100% of the share capital of ID Parking, a France-based
company that                     provides electronic parking solutions across France
(hereinafter- the ID                     Parking Transaction).
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ID Parking was purchased for a
purchase price of euro 750 and $319 transaction costs, comprised of euro 250 ($396) in
cash and euro 500 ($775) in the Companys ordinary shares. The aggregate share
consideration was 300,698 ordinary shares of the Company that were issued in June 2008.
The ID Parking Transaction shares are subject to a lock-up arrangement, under which one
third of those shares (approximately 100,233 ordinary shares) are released from lock-up
every six months for an aggregate period of 18 months following June 30, 2008 (closing
date). According to the lock up arrangement, the final number of shares will be calculated
according to the actual share price at the time of their release. In the case that the
aggregate share value exceeds euro 500, a respective amount of shares will be forfeited,
and if the value is less than euro 500, the Company will pay the difference in cash.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The acquisition was accounted for as
a purchase and the Company allocated the purchase price according to the fair value of the
tangible and intangible assets acquired and liabilities assumed.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ID Parking operations have been
included in the Companys consolidated financial statements since June 30, 2008. In
connection with the acquisition the Company recognized three intangible assets (net of
deferred taxes): customer contract, fair value of $455, non competition agreement, fair
value of $127 and technology, fair value of $48. The Company also recognized goodwill in
the amount of $830.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | International
Project Solution operations (IPS)
| | -- | -------------------------------------------------

| | On
December 31, 2006, pursuant to an asset purchase agreement (the Agreement)
dated as of November 7, 2006 between the Company and Vuance Ltd. (formerly SuperCom
Ltd.), an Israeli corporation (Vuance), the Company completed the acquisition
of the main assets of Vuance, including the International Project Solution (IPS)
division of Vuance. Vuance is an Israeli based company, which through its IPS division
developed and provided a wide-range of complementary technologies and solutions for the
smart card market. The acquisition provided the Company with accesses to new growing
markets and complementary security technologies that safeguard against counterfeit and
forgery.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 9

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---

On Track Innovations Ltd.
and Subsidiaries

|Notes to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 1  General
(contd)

| | B. | Acquisition
of subsidiaries and business operations: (contd)
| | -- | -------------------------------------------------------------

| | 2. | International
Project Solution operations (IPS)  (contd)
| | -- | ------------------------------------------------------------

| | The
aggregate purchase price for the acquisition was paid through the issuance of an
aggregate of 2,827,200 of the Companys ordinary shares. The 2,827,200 ordinary
shares issued to Vuance were subject to a lock-up agreement, where one-seventh of the
shares (403,885 ordinary shares) will be released from the lock-up restrictions every
three months beginning on the closing date, December 31, 2006, for an aggregate period of
eighteen months. Vuance executed an irrevocable proxy appointing the Companys
Chairman, on behalf of the Board of Directors, or a person instructed by the Board of
Directors, to vote the 2,827,200 ordinary shares issued to Vuance in connection with the
transaction.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
parties also entered into a service and supply agreement giving Vuance a license to use
applicable Vuance intellectual property transferred to the Company for the duration of
certain existing contracts and projects.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
acquisition was accounted for as a purchase and the Company allocated the purchase price
according to the fair value of the tangible and intangible assets acquired and
liabilities assumed. The purchase price was calculated in accordance with EITF No. 99-12
Determination of the Measurement Date for the Market Price of Acquirer Securities
Issued in a Purchase Business Combinations (EITF No. 99-12), based on
the date the business combination was announced and was $20,639 and $701 of transaction
costs. The results of operation acquired are included in the consolidated financial
statements of the Company commencing January 1, 2007.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Based
upon a fair value valuation of assets acquired and liabilities assumed, the Company has
allocated the total cost of acquisition to IPS assets and liabilities as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                 | At December 31
| | ----------------------------------------------- | --------------
|
|
|
|
| | Inventories                                     |               
| | Property and equipment                          |               
| | Technology (useful life of 6 years)             |               
| | Customer relationships (useful life of 5 years) |               
| | Goodwill                                        |               
| |                                                 |               
| |                                                 |               
| | Net assets acquired                             |               
| |                                                 |               

| | Goodwill included but was not limited
to the synergistic value, accesses to new growing markets and potential competitive
benefits that could have been realized by the Company from the acquisition.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Hereafter
are certain unaudited pro forma combined statements of operations data for the year ended
December 31, 2006, as if the acquisition of the IPS occurred on January 1, 2005, after
giving effect to purchase accounting adjustments, including amortization of certain
identifiable intangible assets and the issuance of the 2,827,200 of the Companys
ordinary shares.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 10

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 1  General
(contd)

| | B. | Acquisition
of subsidiaries and business operations: (contd)
| | -- | -------------------------------------------------------------

| | 2. | International
Project Solution operations (IPS)  (contd)
| | -- | ------------------------------------------------------------

| | The
pro forma financial information is not necessarily indicative of the combined results
that would have been attained had the acquisition taken place and the beginning of 2005,
nor is it necessarily indicative of future results.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                               | December 31
| | --------------------------------------------- | -----------
|
|
|
|
| | Revenues                                      |            
| |                                               |            
| | Net loss                                      |            
| |                                               |            
| | Basic and diluted net loss per ordinary share |            

| | 3. | InSeal
SAS
| | -- | ----------

| | In
May 2006, the Company completed the acquisition of 100% of the outstanding share capital
of InSeal SAS (InSeal). InSeal is a France-based company that provides
contactless applications to a variety of customers in the payments market in Europe.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Pursuant
to the share purchase agreement entered into with InSeals shareholders, the
purchase price for the acquisition was paid to InSeals shareholders through the
issuance of an aggregate of 243,800 of the Companys ordinary shares.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
acquisition was accounted for as a purchase and the Company allocated the purchase price
according to the fair value of the tangible and intangible assets acquired and
liabilities assumed. The purchase price was calculated in accordance with EITF No. 99-12
and was $2,948 and $661 of transaction costs. InSeals operations have been included
in the Companys consolidated financial statements since May 2006. In connection
with the acquisition the Company recognized two intangible assets: customer contracts,
fair value of $2,426, and technology, fair value of $164. The Company also recognized
goodwill in the amount of $1,620.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In addition to the foregoing
consideration, in connection with the acquisition, the Company also issued warrants to
purchase up to 180,000 of its ordinary shares to two of InSeals shareholders and one
employee. The warrants, which have a nominal exercise price of NIS 0.10 per share, are
fully exercisable in May 2007, and have a term of four years. However, each of the warrant
holders has made a lock-up undertaking to the Company, pursuant to which one
quarter of the warrants becomes freely transferable commencing in May 2007 and the
remaining warrants become freely transferable in three equal annual installments
thereafter (with all of the warrants becoming freely transferable on May 2010).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 11

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

Note 1  General
(contd)

| | B. | Acquisition
of subsidiaries and business operations: (contd)
| | -- | -------------------------------------------------------------

| | 3. | InSeal
SAS (contd)
| | -- | -------------------

| | In
the event that the warrant holders service with the Company or its subsidiaries is
terminated, for whatever reason, all of the holders warrant shares that are free
from the lock-up undertaking discussed above will be exercisable within 60 days from such
termination, and the balance of the portion of warrants not previously exercised will
become void. These warrants, with a fair value of $2,104 as of the closing date, have
been accounted for in accordance with EITF No 95-8, Accounting for Contingent
Consideration Paid to the Shareholders of an Acquired Enterprise in a Purchase Business
Combination, and are being recorded as compensation expense over the lock-up
undertaking period.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | Acquisitions
in the Far East
| | -- | ----------------------------

| | Pioneer
Oriental International Ltd
| | ----------------------------------

| | In
July 2005, the Company completed the acquisition of Pioneer Oriental International Ltd. (POI),
a Hong Kong company and a subsidiary of Pioneer Oriental Engineering Ltd., a Hong Kong
company (POE). POI is an engineering company that develops and manufactures
machinery used to create smart card inlays for smart cards and other products, as well as
to manufacture contact and/or contactless smart cards themselves. Pursuant to the Asset
Purchase Agreement dated June 16, 2005, among POE, its shareholders (together the Sellers)
and OTI (as amended, the POI Purchase Agreement), the aggregate purchase price for the
acquisition was paid to the Sellers through the issuance of an aggregate 40,441 of the
Companys ordinary shares.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
July 2005, the Companys new, wholly-owned subsidiary, POI, completed the
acquisition of substantially all of the assets of POE relating to the design and
manufacture of machinery for the manufacture of smart cards, including certain
proprietary technologies related to the manufacturing process. Pursuant to the Asset
Purchase Agreement dated June 16, 2005 between POI and POE (as amended, the POE
Purchase Agreement), POI also agreed to make offers of employment to each of the
employees of POE. The aggregate purchase price for the acquisition was paid to POE
through the issuance of an aggregate of 41,788 of the Companys ordinary shares.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
acquisitions were accounted for as a purchase and the Company allocated the purchase
price according to the fair value of the tangible assets and intangible assets acquired
and liabilities assumed. The purchase price was calculated in accordance with EITF No.
99-12, and was $1,041. The sum of the fair values of the assets acquired less liabilities
assumed exceeded the acquisition cost. Accordingly, the Company reduced the purchase
price allocated to the acquired non-current assets to zero. After the above allocation,
negative goodwill in the amount of $444 remained. In accordance with SFAS No. 141 Business
combinations, this amount was recognized in 2005 as an extraordinary gain.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 12

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

Note 1  General
(contd)

| | B. | Acquisition
of subsidiaries and business operations: (contd)
| | -- | -------------------------------------------------------------

| | 4. | Acquisitions
in the Far East (contd)
| | -- | -------------------------------------

| | e-Pilot
Group Ltd.
| | ------------------

| | In July 2005, the Company completed
the acquisition of a 71.5% interest in e-Pilot Group Limited (e-Pilot), a
British Virgin Islands company, from three of e-Pilots shareholders (collectively,
the e-Pilot Shareholders). e-Pilot, which is headquartered in Hong Kong,
develops, manufactures and markets smart card inlays for smart cards and other products.
Pursuant to share purchase agreements (as amended, the e-Pilot Purchase
Agreements) entered into with each of the e-Pilot Shareholders, the aggregate
purchase price for the acquisition was paid to the e-Pilot Shareholders through the
issuance of an aggregate of 52,572 of the Companys ordinary shares.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
acquisition was accounted for as a purchase and the Company allocated the purchase price
according to the fair value of the tangible assets and intangible assets acquired and
liabilities assumed. The purchase price in the amount of $661 was calculated in
accordance with EITF No. 99-12.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
connection with the acquisition, the Company recognized an intangible asset in the amount
of $1,183, which was assigned to customer relationships and is being amortized over five
years.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Millennium
Cards Technology Limited
| | ------------------------------------

| | On
September 1, 2006, the Company completed a structural change in the Far-East, under which
the operations of POI and of e-Pilot were transferred to Millennium Cards
Technology Limited (MCT), a subsidiary which was established during 2006.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Following
the structural change, the Company sold POI and e-Pilot for total consideration of $200
and recorded a $122 as gain on sale of subsidiaries.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------

| | In September 2008, MCT allotted an
additional 3,000 shares of HK$1.00 each to the Company against the waiver of a debt of MCT
to the Company in a principal amount of $6,900, so that such loan was converted into
MCTs 3,000 shares. Following the share allotment, the Company increased its share in
MCTs share capital from 60% to 90%. The increase was accounted for as step
acquisition in accordance with FASB Statement No. 141, Business
Combinations. As a result, the Company recognized minority interests and inventory in
the amount of $352 each.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 13

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 1  General
(contd)

| | B. | Acquisition
of subsidiaries and business operations: (contd)
| | -- | -------------------------------------------------------------

| | 5. | ASEC
Spolka Akcyjna
| | -- | -------------------

| | In
October 2004, the Company completed the acquisition of ASEC Spolka Akcyjna (ASEC)
from Nextel Spolka Akcyjna (Nextel), headquartered in Krakow, Poland. ASEC
develops, manufactures and markets card readers and reader modules based on radio
frequency identification technologies, including high-end programmable smart card as well
as economically priced readers. Pursuant to the Preliminary Share Purchase Agreement,
dated September 2004, as amended in October 2004, between Nextel and the Company (the
Agreement), the aggregate purchase price for the acquisition was $1,600,
which was paid to Nextel through the issuance of 186,264 of the Companys ordinary
shares, based on a market price of US $8.59 per share, which was the average closing
price of the Companys ordinary shares for the last ten trading days prior to
September 14, 2004. The acquisition was accounted for as a purchase and the Company
allocated the purchase price according to the fair value of the tangible assets and
intangible assets acquired and liabilities assumed. As of October 2004, the purchase
price was re-calculated in accordance with EITF No. 99-12, based on the date the business
combination was consummated, and was in the amount of $1,245.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
addition, the Agreement provides for an additional consideration of up to $350 to be paid
to Nextel (the earn-out right) in the form of the Companys ordinary
shares pursuant to the earn-out formula based on ASECs 2004 and 2005 results.
Accordingly, as of December 31, 2004, the Company recorded $175 from the earn-out right
against a liability in accordance with SFAS No. 150 Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity, which
was settled by 14,298 ordinary shares at the fair market value of $175 that were issued
by the Company to Nextel in June 2005. Based on ASECs 2005 results, the Company did
not incur any further liability in connection with the earn-out formula.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
connection with the acquisition, the Company recognized goodwill of $167. Out of $1,437
of acquired intangible assets, $579 was assigned to a brand, $406 was assigned to
contracts with customers which are both being amortized over up to five years and $452
was assigned to know how, which is being amortized over one-and-a-half years.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | Selling
of Intercard Gmbh Kartensysteme
| | -- | ---------------------------------------

| | On
September 14, 2004, the Company entered into an agreement under which, in October 2004,
the Company sold its wholly-owned German subsidiary InterCard GmbH Kartensysteme (KS)
in consideration of $2,500, payable in two installments. The first installment in the
amount of $1,250 was paid by receiving $685 in cash, offsetting an amount of euro 325
($432) against a loan granted to the buyer, which is repayable in 32 monthly installments
of euro 10 and a final installment of euro 5, beginning on February 1, 2005 and that is
interest-free and offsetting an amount of euro 100 ($133) against a loan granted to the
buyer, which is repayable in 12 monthly installments of euro 9, beginning on February 1,
2005.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 14

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 1  General
(contd)

| | C. | Selling
of Intercard Gmbh Kartensysteme (contd)
| | -- | ------------------------------------------------

| | The
second installment in the amount of $1,250 was to be paid in 25 quarterly payments
beginning on April 1, 2005. The total present value of the purchase price amounted to
$2,178. In October 2005, the Company entered into a settlement agreement according to
which the outstanding balances of the two loans were reduced by euro 115 ($136) and
combined into one loan which is payable in 24 monthly installments of euro 10 each and a
final installment of Euro 5. During 2007 the Buyer settled the entire remainder loan.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
gain on the sale of KS including the effect of the aforesaid deduction from the proceeds
was $374 and was recognized in 2005.
| | ---------------------------------------------------------------------------------------------------------------------------------

| | The
Companys control over KS ceased on the closing date, which was October 1, 2004, and
therefore the Company ceased to consolidate the financial statements of KS effective
October 1, 2004.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Investment
in affiliated company
| | -- | --------------------------------

| | During 2005, an affiliated company
was established together with a Chinese government entity, in the form of a joint venture,
for the manufacture and sale of OTI-based travel document inlays for such government. The
joint venture was approved for establishment by the Chinese government authorities. During
2008 the investment was fully written off (see Note 2H).
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 2 
Significant Accounting Policies

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

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

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

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

| | The
functional currencies of the remaining subsidiaries are their local currencies. The
financial statements of those companies are translated into U.S. dollars in accordance
with SFAS No. 52, using the exchange rate at the balance sheet date for assets and
liabilities, and weighted average exchange rates for revenues and expenses. Translation
adjustments resulting from the process of the aforesaid translation are included as a
separate component of shareholders equity (accumulated other comprehensive income
(loss)).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 15

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

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

| | B. | Principles
of consolidation
| | -- | ---------------------------

| | The
consolidated financial statements include the financial statements of the Company and its
majority owned subsidiaries. When the Company does not have a controlling interest in an
entity or joint venture, but exerts a significant influence over the entity or joint
venture, the Company applies the equity method of accounting. InterCompany transactions
and balances have been eliminated in consolidation.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | Estimates
and assumptions
| | -- | -------------------------

| | The
preparation of the consolidated financial statements requires management of the Company
to make a number of estimates and assumptions relating to the reported amounts of assets
and liabilities and the disclosure of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and expenses
during the period. Such estimates include the valuation of useful lives of long-lived
assets, valuation of accounts receivable and allowance for doubtful accounts, inventory,
investments, legal contingencies, share- based compensation, the assumptions used in the
calculation of income taxes and other contingencies. Estimates and assumptions are
periodically reviewed by management and the effects of any material revisions are
reflected in the period that they are determined to be necessary. Actual results,
however, may vary from these estimates. The current economic environment has increased
the degree of uncertainty inherent in those estimates and assumptions.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

| | Cash
equivalents are short-term highly liquid investments and debt instruments that are
readily convertible to cash with original maturities of three months or less from the
date of purchase. Cash equivalents include $18,900 and
$29,120 of U.S. Treasury securities with an original term of less than three months at
December 31, 2008 and 2007, respectively.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | E. | Short-term
investments
| | -- | ----------------------

| | The
Company accounts for investments in U.S. Treasury securities in accordance with SFAS No.
115, Accounting for Certain Investments in Debt and Equity Securities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Management
determines the appropriate classification of its investments in debt securities at the
time of purchase and reevaluates such determinations at each balance sheet date. At
December 31, 2007 and 2008, the Companys investments were classified as
available-for-sale and are stated at market value. Unrealized gains and losses, net of
tax are reported as a separate component of shareholders equity (accumulated other
comprehensive income (loss)) until realized. Interest income is recognized when earned
and included in the consolidated statement of operation in financial income. Realized
gains and losses are included in financial income or expenses.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
December 31, 2008, there was an unrealized gain on the Companys investment in
fixed-rate treasury securities in the amount of $6 the contractual maturity of all debt
securities is within one year.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | F. | Trade
receivables
| | -- | -----------------

| | Trade
accounts receivable are recorded at the invoiced amount and do not bear interest. Amounts
collected on trade accounts receivable are included in net cash provided by operating
activities in the consolidated statements of cash flows. The consolidated financial
statements include an allowance for loss from receivables for which collection is in
doubt. In determining the adequacy of the allowance consideration is given to the
historical experience, aging of the receivable, adjusted to take into account current
market conditions and to information available about specific debtors, including their
financial situation, the volume of their operations, and evaluation of the security
received from them or their guarantors.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 16

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

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

| | G. | Inventories
| | -- | -----------

| | Inventories
are stated at the lower of cost or market value. Cost is determined by calculating raw
materials, work in process and finished products on a moving average basis.
Inventory write-offs are provided to cover risks arising from slow moving items or
technological obsolescence. Such write-offs, which were not material for 2006, 2007 and
2008, have been included in cost of revenues.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company applies FASB Statement No. 151, Inventory Costs  an Amendment
of ARB No. 43, Chapter 4 (SFAS 151). Statement 151 clarifies the accounting for
abnormal amounts of idle facility expense, freight, handling costs, and wasted material
(spoilage) requiring that those items be recognized as current-period charges. In
addition, SFAS 151 requires that allocation of fixed production overheads be based on the
normal capacity of the production facilities.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | H. | Investment
in an affiliated company
| | -- | -----------------------------------

| | In the financial statements the term
affiliated company means a company held to the extent of 49%. The investment in an
affiliated company is accounted for under the equity method. Profits not yet realized on
transactions with the Group are eliminated at the same rate as the percentage holding in
the affiliated company. During 2008 the Company has fully written off its investment in
the affiliated company, its Chinese joint venture, resulted from uncertainty in future
revenues timing. As of December 31, 2007 and 2008 the investment in the affiliated company
amounted to $1,382 and $0, and includes the elimination of profits not yet realized of
$599 and $0, respectively, on the sale of equipment from the Group to the affiliated
company in 2006.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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

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

| |                                                              | Years
| | ------------------------------------------------------------ | -----
|
|
|
|
| | Leasehold land (over the terms of the lease, see note 6A(1)) |      
| | Buildings                                                    |      
| | Computers, software and manufacturing equipment              |      
| | Office furniture and equipment                               |      
| | Motor vehicles                                               |      

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

| | In
accordance with FASB Statement No. 144 (SFAS 144), Accounting for the Impairment or
Disposal of Long-Lived Assets, long-lived assets, such as property, plant, and
equipment, and purchased intangible assets subject to amortization, are reviewed for
impairment whenever events or changes in circumstances indicate that the carrying amount
of an asset may not be recoverable. If circumstances require a long-lived asset be tested
for possible impairment, the Company first compares undiscounted cash flows expected to
be generated by an asset to the carrying value of the asset. If the carrying value of the
long-lived asset is not recoverable on an undiscounted cash flow basis, impairment is
recognized to the extent that the carrying value exceeds its fair value. Fair value is
determined through various valuation techniques including discounted cash flow models,
quoted market values and third-party independent appraisals, as considered necessary.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The Company recorded an
impairment loss of $1,427 in 2008. See Note 5B. No impairment losses were recoded in 2007 and 2006.
| | ---------------------------------------------------------------------------------------------------------------------------

F - 17

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

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

| | K. | Goodwill
and purchased intangible assets
| | -- | ----------------------------------------

| | Goodwill represents the excess of the
aggregate purchase price over the fair value of the net assets acquired in a purchase
businesses combination. Goodwill is reviewed for impairment at least annually, as of December
every year, in accordance with the provisions of FASB Statement No. 142,
Goodwill and Other Intangible Assets. The goodwill impairment test is a two-step
test. Under the first step, the fair value of the reporting unit is compared with its
carrying value (including goodwill). If the fair value of the reporting unit is less than
its carrying value, an indication of goodwill impairment exists for the reporting unit and
the enterprise must perform step two of the impairment test (measurement). Under step two,
an impairment loss is recognized for any excess of the carrying amount of the reporting
units goodwill over the implied fair value of that goodwill. The implied fair value
of goodwill is determined by allocating the fair value of the reporting unit in a manner
similar to a purchase price allocation, in accordance with FASB Statement
No. 141, Business Combinations. The residual fair value after this allocation
is the implied fair value of the reporting unit goodwill. If the fair value of the
reporting unit exceeds its carrying value, step two does not need to be performed.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The  Company  recorded  an  impairment  loss of $24,217 in 2008.  See Note No. 5A. No  impairment  losses were
         recorded in 2007 and 2006.
| | --------------------------------------------------------------------------------------------------------------------------------------------------

| | Purchased intangible assets are
carried at cost, less accumulated amortization. Amortization is computed over the
estimated useful lives of the respective assets, generally three to seven years (see Note
2J).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | L. | Revenue
recognition
| | -- | -------------------

| | The
Group generates revenues from product sales, licensing and transaction fees. Revenues are
also generated from non-recurring engineering, customer services and technical support.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenues
from products sales and non-recurring engineering are recognized in accordance with Staff
Accounting Bulletin (SAB) No. 104 Revenue Recognition, when
delivery has occurred provided there is persuasive evidence of an agreement, the fee is
fixed or determinable and collection of the related receivable is probable and no further
obligations exist. In the case of non-recurring engineering, revenue is recognized on
completion of testing and approval of the customization of the product by the customer
and provided that 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, a persuasive
evidence of an agreement exists, no significant obligation remains under the sale or
licensing agreement and no significant customer acceptance requirements exist after
delivery of the technology.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Transaction
fees are recognized as earned based on actual usage. Usage is determined by receiving
confirmation from the users.
| | ------------------------------------------------------------------------------------------------------------------------------

| | Revenues
relating to customer services and technical support are recognized as the services are
rendered ratably over the term of the related contract.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | M. | Research
and development costs
| | -- | ------------------------------

| | Research
and development costs are charged to operations as incurred.
| | ---------------------------------------------------------------------

| | Participation
and grants from the Government of Israel (Office of the Chief Scientist OCS)
in approved programs for research and development are recognized as a reduction of a
research and development expense as the related costs are incurred.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 18

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

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

| | N. | Stock-based
compensation
| | -- | ------------------------

| | Employees
| | ---------

| | Prior
to January 1, 2006, the Company accounted for stock based employee and directors
compensation by using the intrinsic value method prescribed in Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and
related interpretations, as permitted by SFAS No. 123, Accounting for Stock-Based
Compensation (SFAS 123). Accordingly, compensation cost for stock options was
measured as the excess of the market price of the underlying stock on the date of grant
over the exercise price and was recognized over the scheduled vesting.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Effective
January 1, 2006, the Company has adopted SFAS No. 123 (revised 2004), Share-Based Payment
(SFAS 123(R)) which requires the measurement and recognition of compensation
expense for all share-based payment awards made to employees and directors based on
estimated fair values. The Company adopted SFAS 123(R) using the
modified-prospective-transition method. Under the modified-prospective-transition method,
compensation cost is recognized on a prospective basis for all share-based payments
granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair
value estimated in accordance with the original provisions of SFAS 123. For share-based
payment awards granted after January 1, 2006, the Company recognizes compensation cost
based on estimated grant date fair value using the Black-Scholes option pricing model. In
accordance with the modified prospective method, the Companys consolidated
financial statements for prior periods have not been restated to reflect, and do not
include, the impact of SFAS 123(R).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Upon
adoption of SFAS 123(R), in 2006, the $833 in Additional Paid-In Capital and the
offsetting amount in Deferred Stock-Based Compensation, that are both reflected in
shareholders equity at December 31, 2005, have been reversed as required by SFAS
123 (R). The net effect has no change in total shareholders equity.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Employees
| | ---------

| | During
2007 and 2008 most of the options were granted with a par value exercise price and during
2006 all options were granted with a par value exercise price. Due to the par value
nominal amount of NIS 0.1, the fair value of these options was estimated to be equal to
the Companys market share price at the grant date.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of each option granted during 2007 and 2008, for which the exercise price was
greater than par value, was estimated on the date of grant, using the Black-Scholes model
using the following assumptions:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | Dividend
yield of zero percent for all periods.
| | -- | -----------------------------------------------

| | 2. | Risk-free
interest rate of 2.93% and 1.63% for, 2007 and 2008, respectively.
| | -- | ----------------------------------------------------------------------------

| | 3. | Estimated
expected lives of 2.5-5 years for all periods.
| | -- | --------------------------------------------------------

| | 4. | Expected
average volatility of 46% and 44%-53% for 2007 and 2008, respectively,
                    which represent a weighted average standard deviation rate for the
price of the                     Companys Ordinary Shares in the NASDAQ Global
Market.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
additional information see Note 10C.
| | ----------------------------------------

| | Non-Employees
| | -------------

| | The
Company applies SFAS No. 123 and EITF 96-18, Accounting for Equity Instruments that
are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods
or Services with respect to options issued to non-employees. SFAS No. 123 requires
use of an option valuation model to measure the fair value of these options at the grant
date. During 2007 and 2008 all options were granted with a par value exercise price. Due
to the par value nominal amount of NIS 0.1, the fair value of these options was estimated
to be equal to the Companys market share price at the grant date.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 19

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

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

| | O. | Basic
and diluted net loss per share
| | -- | ------------------------------------

| | Basic
and diluted net loss per ordinary share is computed based on the weighted average number
of ordinary shares outstanding during each year.
| | -----------------------------------------------------------------------------------------------------------------------------------------------

| | All outstanding stock options and
warrants (3,488,145, 5,394,790 and 6,210,112 for December 31, 2006, 2007 and 2008,
respectively), have been excluded from the calculation of the diluted net loss per
ordinary share because all such securities are anti-dilutive for all periods presented.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | P. | Fair
value of financial instruments
| | -- | -----------------------------------

| | Effective
January 1, 2008, the Company adopted the provisions of FASB Statement No. 157, Fair
Value Measurements, (SFAS 157), for fair value measurements of financial assets and
financial liabilities and for fair value measurements of nonfinancial items that are
recognized or disclosed at fair value in the financial statements on a recurring basis.
SFAS 157 defines fair value as the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market participants at the
measurement date.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | SFAS
157 also establishes a framework for measuring fair value and expands disclosures about
fair value measurements. FASB Staff Position FAS 157-2, Effective Date of FASB
Statement No. 157, delays the effective date of SFAS 157 until fiscal years
beginning after November 15, 2008 for all nonfinancial assets and nonfinancial liabilities
that are recognized or disclosed at fair value in the financial statements on a
nonrecurring basis.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On January 1, 2009, the Company will
be required to apply the provisions of SFAS 157 to fair value measurements of nonfinancial
assets and nonfinancial liabilities that are recognized or disclosed at fair value in the
financial statements on a nonrecurring basis. The Company is in the process of evaluating
the impact, if any, of applying these provisions on its financial position and results of
operations. In October 2008, the FASB issued FASB Staff Position FAS 157-3,
Determining the Fair Value of a Financial Asset When the Market for That Asset is
Not Active, which was effective immediately. FSP FAS 157-3 clarifies the application
of SFAS 157 in cases where the market for a financial instrument is not active and
provides an example to illustrate key considerations in determining fair value in those
circumstances. The adoption of SFAS 157 and FSP FAS 157-3 did not have an impact on
the Companys consolidated results of operations and financial position.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company, in estimating fair value for financial instruments, used the following methods
and assumptions:
| | ------------------------------------------------------------------------------------------------------------

| | The  carrying  amounts of cash and cash  equivalents,  trade  receivables,  short-term  bank  credit and trade
         payables  are  equivalent  to, or  approximate  their  fair  value  due to the  short-term  maturity  of these
         instruments.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
fair value of marketable securities is based on quoted market prices.
| | -------------------------------------------------------------------------

| | The carrying amounts of long-term loans are equivalent or approximate to their fair value as they bear
interest at approximate market rates.
| | --------------------------------------------------------------------------------------------------------------------------------------------

F - 20

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

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

| | Q. | Taxes
on income
| | -- | ---------------

| | The
Company accounts for taxes on income in accordance with SFAS No. 109, Accounting
for Income Taxes. Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement carrying
amounts of existing assets and liabilities and their respective tax bases, and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in the consolidated
statement of operations in the period that includes the enactment date. The Company
provides a valuation allowance to reduce deferred tax assets to the amount that is more
likely than not to be realized.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | R. | Severance
pay
| | -- | -------------

| | The
Companys liability for severance pay for some of its Israeli employees is
calculated pursuant to Israeli severance pay law based on the most recent salary of the
employee multiplied by the number of years of employment, as of the balance sheet date.
Those employees are entitled to one months salary for each year of employment or a
portion thereof. Certain senior executives are entitled to receive additional severance
pay. The Companys liability for those Israeli employees is partially provided for
by monthly deposits for insurance policies and by an accrual. The value of these policies
is recorded as an asset in the Companys balance sheet.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
deposited funds include profits and losses accumulated up to the balance sheet date. The
deposited funds may be withdrawn only upon the fulfillment of the obligation pursuant to
Israeli Severance Pay Law or labor agreements. The value of the deposited funds is based
on the cash redemption value of these policies.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
respect of other Israeli employees, the Company has an approval from the Israeli Ministry
of Labor and Welfare, pursuant to the terms of Section 14 of the Israeli Severance Pay
Law, 1963, according to which the current deposits in the pension fund and/or with the
insurance company exempt the Company from any additional obligation to these employees
for whom the said depository payments are made.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Severance
pay expenses for the years ended December 31, 2006, 2007 and 2008 amounted to
approximately $816, $304 and $715, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------

| | S. | Advertising
expenses
| | -- | --------------------

| | Advertising
expenses are charged to the statements of operations as incurred. Advertising expenses
for the years ended December 31, 2006, 2007 and 2008 amounted to approximately $662, $780
and $1,059, respectively.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | T. | Concentrations
of credit risk
| | -- | -----------------------------

| | Financial
instruments that potentially subject the Company to concentrations of credit risk consist
principally of cash equivalents, U.S. treasury securities, long-term receivables and
trade receivables.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Cash
equivalents are invested mainly in U.S. dollars with major banks in Israel and Canada.
Management believes that the financial institutions that hold the Groups
investments are financially sound and, accordingly, minimal credit risk exists with
respect to these investments.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | U.S.
                     treasury securities are denominated in U.S. dollars. Management
believes that                     minimal credit risk exists with respect to these
securities.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 21

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

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

| | T. | Concentrations
of credit risk (contd)
| | -- | --------------------------------------

| | Most
of the Companys trade receivables are derived from sales to large and financially
secure organizations located mainly in the United States, Far East, Africa and Europe. An
allowance for doubtful accounts is determined on the basis of specific identification of
balances, the collection of which, in managements opinion, is doubtful. In
determining the adequacy of the provision, management bases its opinion, inter alia, on
the estimated risks, current market conditions, in reliance on available information with
respect to the debtors financial position. As for major customers, see Note 13.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
activity in the allowance for doubtful accounts for the years ended December 31, 2006,
2007 and 2008 is as follows:
| | -----------------------------------------------------------------------------------------------------------------------

| |                                                      | 2006 | 2007 | 2008
| | ---------------------------------------------------- | ---- | ---- | ----
|
|
|
|
| | Allowance for doubtful accounts at beginning of year |      |      | $   
| | Additions charged to provision doubtful accounts     |      |      |     
| | Write-downs charged against the allowance            |      |      |     
| | Translation differences                              |      |      |     
| |                                                      |      |      |     
| |                                                      |      |     
| | Allowance for doubtful accounts at end of year       |      |      | $   
| |                                                      |      |      |     
| |                                                      |      |      |     

| | U. | Commitments
and contingencies
| | -- | -----------------------------

| | Liabilities
for loss contingencies arising from claims, assessments, litigations, fines and penalties
and other sources are recognized when it is probable that a liability has been incurred
and the amount of the assessment can be reasonably estimated.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | V. | Accumulated
other comprehensive loss
| | -- | ------------------------------------

| | The
Companys comprehensive loss consists of net loss, net unrealized gains (losses) on
available for sale securities and on the change in foreign currency translation
adjustments, and is presented in the consolidated statement of comprehensive income
(loss).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | W. | Accounting
pronouncements adopted in 2008
| | -- | -----------------------------------------

| | 1. | Refer
to Note 2 (P) for Fair Value measurement of financial instruments.
| | -- | ------------------------------------------------------------------------

| | 2. | In
February, 2007, the FASB issued FASB Statement No. 159, The Fair Value Option
          for Financial Assets and Financial Liabilities  Including an amendment of
          FASB Statement No. 115 (FAS 159). The statement allows the Company to
          irrevocably choose to measure many financial assets and liabilities at fair
          value that are not currently required to be measured at fair value. This
          Statement is effective as of the beginning of an entitys first fiscal
year           that begins after November 15, 2007. The adoption of FAS 159 did not have
an           impact on the Companys consolidated results of operations and
financial           position.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 22

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

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

| | W. | Accounting
pronouncements adopted in 2008 (contd)
| | -- | --------------------------------------------------

| | 3. | In
June 2007, the FASB reached a final consensus on Emerging Issues Task Force
          Issue 07-3, Accounting for Advance Payments for Goods or Services to Be
          Used in Future Research and Development Activities (EITF
          07-03). The consensus reached by the FASB requires companies involved in
          research and development activities to capitalize such non-refundable advance
          payments for goods and services pursuant to an executory contractual
arrangement           because the right to receive those services in the future
represents a probable           future economic benefit. Those advance payments will be
capitalized until the           goods have been delivered or the related services have
been performed. The           consensus on EITF 07-03 is effective prospectively for
financial statements           issued for fiscal years beginning after December 15,
2007, and interim           periods within those fiscal years. The adoption of the
provisions of EITF 07-03           did not have an impact on its financial position,
results of operations or cash           flows.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | X. | Recently
issued accounting pronouncements not yet adopted
| | -- | ---------------------------------------------------------

| | 1. | In
December 2007, the FASB issued FASB Statement No. 141R, Business Combinations
          (Statement 141R) and FASB Statement No. 160, Noncontrolling Interests in
          Consolidated Financial Statements  an amendment to ARB No. 51 (Statement
          160). Statements 141R and 160 require most identifiable assets, liabilities,
          noncontrolling interests, and goodwill acquired in a business combination to be
          recorded at full fair value and require noncontrolling interests
          (previously referred to as minority interests) to be reported as a component of
          equity, which changes the accounting for transactions with noncontrolling
          interest holders. Both Statements are effective for periods beginning on or
          after December 15, 2008, and earlier adoption is prohibited. Statement 141R
will           be applied to business combinations occurring after the effective date.
          Statement 160 will be applied prospectively to all noncontrolling interests,
          including any that arose before the effective date. The Company will adopt the
          guidance in statement 141R and statement 160 to future transactions. The
Company           will follow upon adoption the presentation and disclosure requirements
with           respect to minority interests in subsidiaries, this will result in
         a reclassification of immaterial amounts from minority interest liability
          classified balance to an equity account.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
March 2008, the FASB issued FASB Statement No. 161, Disclosures about
          Derivative Instrumentsand Hedging Activitiesan amendment of FASB
          Statement No. 133.  Statement 161 requires entities that utilize
          derivative instruments to provide qualitative disclosures about their
objectives           and strategies for using such instruments, as well as any details of
          credit-risk-related contingent features contained within           derivatives.  Statement
161 also requires entities to disclose           additional information about the amounts
and location of derivatives located           within the financial statements, how the
provisions of Statement 133 have been           applied, and the impact that hedges have
on an entitys financial position,           financial performance, and cash flows.  Statement
161 is effective for           fiscal years and interim periods beginning after November
15,           2008.  The Company believes that the impact, if any, of adopting
          Statement 161 will not have a material Impact on the Companys financial
          statements.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | In
April 2008, the FASB issued FASB Staff Position FAS 142-3,           Determination
of the Useful Life of Intangible Assets. FSP FAS 142-3           amends the factors
that should be considered in developing renewal or extension           assumptions used
to determine the useful life of a recognized intangible asset           under Statement 142.
FSP FAS 142-3 is effective for fiscal years beginning           after December 15,
2008. The Company believes that the impact, if any, of           adopting FSP FAS 142-3
will not have a material Impact on the Companys           financial statements.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 23

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

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

| | X. | Recently
issued accounting pronouncements not yet adopted (contd)
| | -- | ------------------------------------------------------------------

| | 4. | In
June 2008, the FASBs Emerging Issues Task Force reached a consensus on
          EITF Issue No. 07-5, Determining Whether an Instrument (or Embedded
          Feature) Is Indexed to an Entitys Own Stock. This EITF Issue
          provides guidance on the determination of whether such instruments are
          classified in equity or as a derivative instrument. The Company will adopt the
          provisions of EITF 07-5 on January 1, 2009 and expect that the impact, if any,
          of adopting EITF 07-5 will not have a material Impact on the Companys
          financial statements.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | In
November 2008, the FASBs Emerging Issues Task Force reached a consensus
               on EITF Issue No. 08-6, Equity Method Investment Accounting
               Considerations. EITF 08-6 continues to follow the accounting for the
               initial carrying value of equity method investments in APB Opinion No. 18,
The                Equity Method of Accounting for Investments in Common Stock, which is
based on a                cost accumulation model and generally excludes contingent
consideration. EITF                08-6 also specifies that other-than-temporary
impairment testing by the investor                should be performed at the investment
level and that a separate impairment                assessment of the underlying assets
is not required. An impairment charge by the                investee should result in an
adjustment of the investors basis of the                impaired asset for the
investors pro-rata share of such impairment. In                addition, EITF 08-6
reached a consensus on how to account for an issuance of                shares by an
investee that reduces the investors ownership share of the                investee.
An investor should account for such transactions as if it had sold a
               proportionate share of its investment with any gains or losses recorded
through                earnings. EITF 08-6 also addresses the accounting for a change in
an investment                from the equity method to the cost method after adoption of
Statement 160. EITF                08-6 affirms the existing guidance in APB 18, which
requires cessation of the                equity method of accounting and application of
FASB Statement No. 115,                Accounting for Certain Investments in Debt and
Equity Securities, or the cost                method under APB 18, as appropriate. EITF
08-6 is effective for transactions                occurring on or after December 15,
2008. The Company does not anticipate that                the adoption of EITF 08-6 will
materially impact the Companys financial                position or results of
operations.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 6. | In
May 2009, the FASB issued Statement No. 165, Subsequent Events, addressing
               accounting and disclosure requirements related to subsequent events.
Statement                165 requires management to evaluate subsequent events through
the date the                financial statements are either issued or available to be
issued, depending on                the companys expectation of whether it will
widely distribute its                financial statements to its shareholders and other
financial statement users.                Companies will be required to disclose the date
through which subsequent events                have been evaluated. Statement 165 is
effective for interim or annual financial                periods ending after June 15,
2009 and should be applied prospectively. The                adoption of Statement 165 is
not expected to have a material effect on the                Companys financial
statements.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 3  Other
Receivables and Prepaid Expenses

| |                         | December 31
| | ----------------------- | -----------
|
|
|
|
| | Government institutions |            
| | Prepaid expenses        |            
| | Other receivables       |            
| |                         |            
| |                         |            
| |                         |            
| |                         |            
| |                         |            

F - 24

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 4  Inventories

| |                   | December 31
| | ----------------- | -----------
|
|
|
|
| | Raw materials     |            
| | Work in progress  |            
| | Finished products |            
| |                   |            
| |                   |            
| |                   |            
| |                   |            
| |                   |            

# Note 5  Goodwill
and Intangible Assets, Net

| | A. | Goodwill
| | -- | --------

| |                                                            | December 31
| | ---------------------------------------------------------- | -----------
|
|
|
|
| | Balance as of January 1                                    |            
| | Changes during the year - Goodwill resulting from business |            
| | combination                                                |            
| | Impairment loss*                                           |            
| |                                                            |            
| |                                                            |            
| | Balance as of December 31                                  |            
| |                                                            |            
| |                                                            |            

| | * | The
Company conducted its annual goodwill impairment test on the goodwill acquired. The test
was based on the Companys single reporting unit structure. As a result of the
decrease in the Companys market capitalization in 2008 and deteriorating global
economy, the Company determined that the carrying value of the goodwill exceeded its
implied fair value. The Company further concluded that all the goodwill acquired had been
impaired and therefore, in the fourth quarter of 2008, it recorded an impairment charge
of $24.2 million.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Intangible
assets, net
| | -- | ----------------------

| |                                          | December 31
| | ---------------------------------------- | -----------
|
|
|
|
| | Cost                                     |            
| | Technology                               |            
| | Brand                                    |            
| | Know-how                                 |            
| | Non competition agreement                |            
| | Customer contracts and relationships     |            
| |                                          |            
| | Total cost                               |            
| |                                          |            
| |                                          |            
| | Accumulated amortization and impairments |            
| | Technology*                              |            
| | Brand                                    |            
| | Know-how                                 |            
| | Non competition agreement                |            
| | Customer contracts and relationships**   |            
| |                                          |            
| | Total Accumulated amortization           |            
| |                                          |            
| |                                          |            
| |                                          |            
| |                                          |            
| |                                          |            

| | * | include
$78 impairment loss
| | - | ---------------------------

| | ** | include
$1,349 impairment loss
| | -- | ------------------------------

F - 25

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 5  Goodwill
and Intangible Assets, Net (contd)

| | B. | Intangible
assets, net (contd)
| | -- | -------------------------------

| | i. | Amortization
expense amounted to $821, $1,314 and $1,367 for the years ended           December 31,
2006, 2007 and 2008, respectively.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------

| | As of December 2008 the Company
conducted an impairment test on the intangible assets recognized in the acquisition of
InSeal, as a result of an uncertainty relating to a customer of InSeal and the future
revenues from that customer. As a result, the Company recorded an impairment charge of
$1,427 in the fourth quarter of 2008.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Both
amortization expenses and impairment loss of intangible assets were recorded to the
statement of operations in the year incurred
| | -------------------------------------------------------------------------------------------------------------------------------------

| | ii. | Estimated
amortization expense for the years ending:
| | --- | ----------------------------------------------------

|December 31 | 
|----------- | 
|
|
|
|
|2009        | 
|2010        | 
|2011        | 
|2012        | 
|2013        | 
|            | 

# Note 6  Property,
Plant and Equipment, Net

| | A. | Consist
of:
| | -- | -----------

| |                                                 | December 31
| | ----------------------------------------------- | -----------
|
|
|
|
| | Cost                                            |            
| | Land                                            |            
| | Leasehold land (1)                              |            
| | Buildings on leasehold land (1)                 |            
| | Buildings                                       |            
| | Computers, software and manufacturing equipment |            
| | Office furniture and equipment                  |            
| | Motor vehicles                                  |            
| |                                                 |            
| | Total cost                                      |            
| |                                                 |            
| |                                                 |            
| | Total accumulated depreciation                  |            
| |                                                 |            
| | Net book value                                  |            
| |                                                 |            
| |                                                 |            

| | (1) | The
leasehold land consists of two plots owned by the Israel Lands           Administration.
Rights to leasehold land on the first plot extend over the           original period of
49 years ending in the year 2041 with an option to extend for           an additional 49
years, and on the second plot for a period of 49 years, which           will end in the
year 2047 with an option to extend for a further 49 years. The           amount includes
payments on account of land development and payments of the           capitalization of
leasing payments. The rent for the initial 49-year term of           each of these leases
was prepaid in its entirety at the beginning of the lease           terms as is customary
in Israel for leases of property for industrial purposes           from the Israel Lands
Authority.
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 26

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 6  Property,
Plant and Equipment, Net (contd)

| | B. | As
to liens  See Note 9C.
| | -- | --------------------------

| | C. | Depreciation
expenses amounted to $1,862, $2,580 and $3,044 for the years ended           December 31,
2006, 2007 and 2008, respectively.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------

| | D. | During
2005, the Company entered into a Production Line Equipment Supply           Agreement
(the Equipment Agreement) with POE, under which POE agreed           to
supply the Company with specified equipment and machinery for the manufacture
          of smart cards for an aggregate purchase price of $1,700, which was paid to POE
          through the issuance of 137,208 of the Companys ordinary shares in August
          2005. The equipment and machinery were received during 2006.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | E. | Pursuant to an agreement by and among
the Company, InterCard Systemelectronic GmbH (InterCard,), the Companys
wholly owned German subsidiary and Queisser GmbH, as general contractor, during July 2006,
the Company issued to Queisser an aggregate of 200,000 of its ordinary shares, value at
approximately $1.5 million as consideration for Queisser performance as general contractor
under the agreement. The agreement was entered into in connection with our construction of
a new building facility in Germany with production and assembly halls, manufacturing line
equipment and offices.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | F. | On
February 16, 2007, the Company completed the acquisition of the smart card
          module production line of Barun Electronics Co. Ltd. (Barun), a
          Korean company, for consideration of 480,000 of its ordinary shares and 50,000
          warrants at par value, valued at approximately $3.3 million. As of December 31,
          2008 the equipment has not been commenced operative. Pursuant to the
acquisition           agreement, the Company has registered under the Securities Act the
resale of the           480,000 ordinary shares issued to Barun.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The 480,000 ordinary shares issued to
Barun in connection with the transaction are subject to a lock-up agreement, whereby (i)
126,000 ordinary shares are releasable upon presentation by Barun to the escrow agent of a
confirmation that certain specified machinery has been received by the Company, (ii)
189,000 ordinary shares are releasable in 12 equal monthly installments (of 15,750
ordinary shares each) on the first day of each calendar month following the arrival
confirmation date, and (iii) 165,000 ordinary shares shall be released in 12 equal monthly
installments (of 13,750 ordinary shares each) on the first day of each calendar month
commencing at the end of the 12-month period referred to in the foregoing clause. As of December 31, 2007 and 2008 291,000 and 110,000 ordinary shares are still subject
to the lock-up agreement.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | G. | During
2007 and 2008 the Company issued 45,400 and 53,760 options to service           providers
at exercise price of par value, valued at approximately $288 and $137,
          respectively, in connection with property, plant and equipment.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 27

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 7  Other
Current Liabilities

| |                                | December 31 | December 31
| | ------------------------------ | ----------- | -----------
|
|
|
|
| | Employees and related expenses |             |            
| | Accrued expenses               |             |            
| | Customer advances              |             |            
| | Other current liabilities      |             |            
| |                                |             |            
| |                                |             |            
| |                                |             |            
| |                                |             |            

# Note 8  Long-Term
Loans

| | A. | Composition
of Long-Term Loans:
| | -- | -------------------------------

| |                           | December 31 | December 31
| | ------------------------- | ----------- | -----------
|
|
|
|
| | Long-term loans           |             |            
| | Less - current maturities |             |            
| |                           |             |            
| |                           |             |            
| |                           |             |            
| |                           |             |            

| | As
of December 31, 2008, the loans are from banks and are denominated in: U.S. dollars
($703; matures in the years 2010  2012), Euro ($1,429; mature in the years 2010
2012), New Israeli Shekel ($120; matures in 2012) South African Rand ($41; matures
in 2011) and Polish Zloty ($49; matures in 2010). As of December 31, 2008 these loans
bear interest at rates raging from 3.9%-12% (mainly 4.6%) per annum.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Repayment
Dates of Long-Term Loans Subsequent to December 31, 2008:
| | -- | -------------------------------------------------------------------

| |            | 
| | ---------- | 
|
|
|
|
| | 2009       | 
| | 2010       | 
| | 2011       | 
| | 2012       | 
| | 2013       | 
| | Thereafter | 
| |            | 
| |            | 
| |            | 
| |            | 

| | C. | Composition of Short-Term loans, Bank
Credit and Current Maturities of Long-Term Loans:
| | -- | ---------------------------------------------------------------------------------------

| |                       | December 31 | December 31
| | --------------------- | ----------- | -----------
|
|
|
|
| | In NIS                |             |            
| | In USD                |             |            
| | In Euro               |             |            
| |                       |             |            
| |                       |             |            
| | Current maturities of |             |            
| | long-term loans       |             |            
| |                       |             |            
| |                       |             |            
| |                       |             |            
| |                       |             |            

| | The
weighted average interest rate of the short-term bank credit for the years ended December
31, 2007 and 2008 were 6.8% and 6.4%, respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------

F - 28

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 8  Long-Term
Loans (contd)

| | D. | Liens for short-term and long-term borrowings  see Note 9C.
| | -- | ------------------------------------------------------------

| | E. | As of December 31, 2008, the Group has authorized and used credit lines of
          approximately $4.3 million and $3.3 million, respectively.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------

| | F. | Agreements that were made with banks,
in order to secure bank services and obtain bank credit and loans, include financial
covenants and restrictive covenants. As of the balance sheet date the Company is in
compliance with all of its covenants.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 9 
Commitments and Contingencies

| | A. | Commitments
and Contingencies:
| | -- | ------------------------------

| | The
Company and its Israeli subsidiary, EasyPark, have entered into several research and
development agreements, pursuant to which the Company and EasyPark are obligated to pay
royalties to the Government of Israel at a rate of 3% and 3.5% of its sales up to the
amounts granted (linked to the U.S. dollar with annual interest at LIBOR as of the date
of approval, for programs approved from January 1, 1999 and thereafter). As of December
31, 2008, the total amount of grants received, net of royalties paid, was approximately
$5,033 including interest.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Royalties
paid or accrued amounted to $661, $698 and $640 for the years ended December 31, 2006,
2007 and 2008, respectively, and were charged to cost of revenues.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Leases
| | -- | ------

| | The
Group operates from leased facilities in the United States, Israel, Poland, South Africa,
China and France, leased for periods expiring in years 2009 through 2013.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Minimum
future rentals of premises under non-cancelable operating lease agreements at rates in
effect as of December 31, 2008 are as follows:
| | ---------------------------------------------------------------------------------------------------------------------------------------------

| |      | 
| | ---- | 
|
|
|
|
| | 2009 | 
| | 2010 | 
| | 2011 | 
| | 2012 | 
| | 2013 | 
| |      | 
| |      | 
| |      | 
| |      | 

| | Rent
expense amounted to $1,106, $1,193 and $1,114 for the years ended December 31, 2006, 2007
and 2008, respectively.
| | ----------------------------------------------------------------------------------------------------------------------

F - 29

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 9 
Commitments and Contingencies (contd)

| | C. | Liens
| | -- | -----

| | Leasehold
land and a vehicle are pledged in favor of a bank in relation to both long-term and
short-term borrowings.
| | --------------------------------------------------------------------------------------------------------------------

| | The
Company and certain subsidiaries have recorded floating charges on all of its tangible
assets in favor of banks.
| | --------------------------------------------------------------------------------------------------------------------

| | The
Companys manufacturing facilities have been pledged as security in respect of a
loan received from a bank.
| | ---------------------------------------------------------------------------------------------------------------

| | D. | Guarantees
| | -- | ----------

| | As
of December 31, 2008, the company granted guarantees to third parties in the sum of
$1,368. The expiration dates of the guarantees are from January 2009 to July 2010.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | E. | Legal
claims
| | -- | ------------

| | 1. | On September 3, 2003, Edi Wuhl (in
this paragraph, the Plaintiff), a former employee of the Company, filed a suit
against the Company in the District Labor Court in Nazareth in the amount of NIS 3,953
(approximately $1,040). The suit is based on the Plaintiffs claims that the Company
breached the employment agreement with him, and that the Company owes him commission
payment for certain sales. On January 10, 2008, the district court has resolved that the
Plaintiff is entitled to approximately $60, therefore, during 2008 the Company paid this
amount and recorded it in the financial statements. On April 28, 2008 the Plaintiff
submitted an appeal to the National Labor Court. A hearing in the appeal was conducted in
June 2009. At this stage, the Company, based on legal advice, is unable to estimate the
chances of the appeal and, therefore, no provision has been made in the financial
statements in respect of the appeal.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In September 2007, a Plaintiff had
filed against one of the subsidiaries of the Company (the Subsidiary) a motion
to approve a class action at the Tel Aviv District Court (the Motion), at the
sum of NIS 67.1 million ($17.6 million). The law suit is based on claims regarding the
performance of certain device product of the Subsidiary. The Subsidiary filed its response
during January 2008. Based on the courts recommendation at the preliminary hearing,
which took place on December 31, 2008, the Plaintiff had filed an application to remove
the Motion on January 21, 2009. The court had accepted this application and the Motion was
removed.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | In October 2007, a Plaintiff has
filed against one of the subsidiaries of the Company (the Subsidiary) and
other third parties a motion to approve a class action at the Tel Aviv District Court (the
Motion), at the sum of approximately NIS 2 million ($526). According to the
Plaintiff, the Subsidiary and the other defendants charged via the subsidiarys
product, an amount per hour which exceeds the amount that they are authorize to charge. In
January 2008, the Subsidiary submitted to court a notice in which it joins to the other
defendants application to dismiss the motion. On a preliminary hearing conducted in
September 2008, the court accepted the defense arguments that the Motion should be
dismissed. In addition, the court instructed the parties to submit their summaries only
with respect to the consideration to be paid the plaintiff and his legal counsel. At this
stage, the Company, based on legal advice, is unable to estimate the chances of the Motion
against the Subsidiary and, therefore, no provision has been made in the financial
statements in respect of the Motion.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 30

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 9 
Commitments and Contingencies (contd)

| | E. | Legal
claims (contd)
| | -- | ---------------------

| | 4. | On May 20, 2008 a plaintiff filed a
complaint against the Company and one of its subsidiaries, in the US District Court for
the District of Delaware (Claim), alleging infringement of two US patents
(Patents) and requesting a declaration that the Company infringes the Patents,
and therefore asking for an injunction, damages and attorneys fees. The Company
filed its response on July 25, 2008, denying infringement, and identifying certain
defenses. Further, the Company has brought a counterclaim against the Plaintiff for
infringement of a Companys U.S. patent, the Company is seeking a declaration that
the Plaintiff is infringing the Companys patent, and therefore asking for an
injunction, damages and attorneys fees. At this stage, the Company, based on legal
advice, is unable to estimate the chances of the Claim and, therefore, no provision has
been made in the financial statements in respect of this Claim.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | On June 16, 2008, a plaintiff
(Plaintiff) filed a patent infringement suit in Shenzhen Intermediate Court,
Shenzhen, China (Lawsuit), alleging that one of the Companys
subsidiaries infringes a Chinese patent assigned to the Plaintiff (Patent).
The Plaintiff requested an injunction, a relief of RMB 1 million (approximately $146) for
its damages, the expenses incurred by it in relation to the efforts to stop the
infringement and all court fees of the case. On May 5, 2009, the Shenzhen Intermediate
Court stayed the Lawsuit until a litigation between the Plaintiff and a third party
relating to the assignment of the Patent rights pending in the Beijing 1st
Intermediate Court is resolved. At this stage, the Company, based on legal advice, is
unable to estimate the chances of the Lawsuit and, therefore, no provision has been made
in the financial statements in respect of this Lawsuit.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 10 
Shareholders Equity

| | A. | Share
capital
| | -- | -------------

| | 1. | In
December 2003, pursuant to stock and warrant purchase agreements, the Company
          issued to an investor 650,000 ordinary shares in consideration for $3,413.
          Concurrently with the above share issuance, the Company issued to the investor
          warrants to purchase 325,000 ordinary shares at a per share exercise price of
          $6.5. All warrants were already exercised.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company incurred, in respect of the above, finders fee expenses equivalent to 4% of the
amount raised by the Company and, in addition, issued warrants to purchase 45,500
ordinary shares at a per share exercise price of $6.5. During 2004 15,166 warrants were
exercised into ordinary shares and on December 1, 2008 30,334 warrants were expired.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Following
a private placement agreement signed on October 23, 2003, on January           7, 2004
the Company entered into a stock purchase agreement pursuant to which           the
Company issued to investors 100,000 ordinary shares in consideration of           $315.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | On
April 6, 2004, the Companys shareholders approved the increase of the
          Companys authorized share capital by NIS 2,000,000 comprising of
          20,000,000 ordinary shares of NIS 0.1 par value each. Following the increase,
          the Companys authorized share capital was comprised of 30,000,000
ordinary           shares of NIS 0.1 par value each.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | On
April 29, 2004, pursuant to a Securities Purchase Agreement, the Company           issued
to investors 1,300,000 ordinary shares in consideration for $15,132.
          Concurrently, with the above share issuance, the Company issued to the
investors           warrants to purchase 780,000 ordinary shares at a per share exercise
price of           $13.97. The warrants are fully exercisable and expired in April 2009.
As of           December 31, 2008 a total of 738,000 warrants are still exercisable. The
Company           incurred, in respect of the above, finders fee expenses
equivalent to           approximately 6% of the amount raised by the Company and, in
addition, issued           warrants to purchase 124,800 ordinary shares at a per share
exercise price of           $13.97. The warrants are fully exercisable and expired in
April 2009.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 31

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 10 
Shareholders Equity (contd)

| | A. | Share
capital (contd)
| | -- | ----------------------

| | 5. | On
November 1, 2005, the Company issued and sold to certain financial
          institutions, in a private placement, 1,828,026 units, 1,544,568 of which
          consisted of one ordinary share and a warrant to purchase three-fifths of an
          ordinary share and 283,458 of which consisted of one ordinary share and a
          warrant to purchase one-half of an ordinary share. The aggregate purchase price
          of the units was $22,211, based on a market price of $12.15 per unit, which was
          the average closing price of the Companys ordinary shares for the last
          five trading days prior to October 24, 2005, the pricing date. The warrants,
          which are for the purchase of an aggregate of up to 1,068,471 ordinary shares,
          are immediately exercisable, have terms of five years and an exercise price of
          $14.58 per share, and may be redeemed by the Company after two years if the
          market price of the underlying ordinary shares reaches $26.24 and certain other
          conditions are met. The Company did not receive any additional consideration
for           its issuance of the warrants to the financial institutions, which purchased
its           ordinary shares. In addition to the issuance of warrants to the financial
          institutions, the Company issued an aggregate of 127,961 warrants to the
          placement agent for the private placement of the units and to certain other
          persons who facilitated the offering. In respect of the warrants issued to the
          agent, the Company recorded issuance expenses in the amount of $1,048.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Since
both the shares and the underlying warrants were classified within equity, an allocation
of the proceeds between shares and warrants was not considered necessary.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 6. | On
June 18, 2006, the board of directors approved increasing the authorized           share
capital from 30,000,000 to 50,000,000 ordinary shares. This increase was
          approved by the shareholders on August 24, 2006.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 7. | Pursuant
to an agreement dated as of July 10, 2006 by and among OTI, Easy Park           Ltd., or
Easy Park, one of the Companys Israeli subsidiaries,           and one
of the minority holders, the Company acquired 2,595 ordinary shares, par           value
NIS 0.01 per share, of Easy Park for an aggregate consideration of 12,000           of
the Companys ordinary shares. Following the transaction, the Company           owns
approximately 94% of the outstanding ordinary shares of Easy Park.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 8. | During
2006, warrants to purchase 37,139 ordinary shares were exercised into           ordinary
shares in consideration of $44.
| | -- | -------------------------------------------------------------------------------------------------------------------------------

| | 9. | During
2007, warrants to purchase 66,438 ordinary shares were exercised into           ordinary
shares in consideration of $1.
| | -- | ------------------------------------------------------------------------------------------------------------------------------

| | 10. | During
2008, warrants to purchase 90,000 ordinary shares were exercised into           ordinary
shares in consideration of $2.
| | --- | ------------------------------------------------------------------------------------------------------------------------------

F - 32

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 10 
Shareholders Equity (contd)

| | B. | Options
to non-employees
| | -- | ------------------------

| | The
Company issued options to non-employees, which are accounted for in accordance with SFAS
No. 123R and EITF No. 96-18 Accounting For Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods and Services as
follows:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 1. | In
2006, the Company issued 159,675 par value options and shares to           non-employees
with respect to services rendered. The aggregate fair value of the           options was
$1,251 based on the share market price as of day of grant.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
2007, the Company issued 637,765 par value options and shares to           non-employees
with respect to services rendered. The aggregate fair value of the           options was
$2,604 based on the share market price as of day of grant.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | In
2008, the Company issued 945,313 par value options and shares to           non-employees
with respect to services rendered. The aggregate fair value of the           options was
$2,409 based on the share market price as of day of grant.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | C. | Stock option plans
| | -- | ------------------

| | 1. | In
1995, the Companys Board of Directors approved a stock option plan,           under
which up to 45,000 share options may be granted to the Groups           employees,
directors and consultants. The vesting period for the options ranges           from
immediate vesting to ratable vesting over a ten-year period. The exercise           price
of options under the plan is at varying prices ranging from $0 to market           value
at the date of grant. Those options will expire up to ten years after the           date
of the grant. Any options which are forfeited or cancelled before           expiration
become available for future grants. During the years 1998 to 2002 the           Companys
Board of Directors resolved to expand the plan with an additional           85,300 share
options to be granted.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
February 2001, the Companys Board of Directors approved an additional
          option plan, under which up to 75,000 share options are to be granted to the
          Companys employees, directors and consultants and those of the
          Companys subsidiaries and affiliates.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
the years 2002 to 2007 the Companys Board of Directors approved an increase of
11,175,000 shares options to be reserved under the Companys share option plan.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
vesting period for the options ranges from immediate vesting to ratable vesting over a
ten-year period. The exercise price of options under the plan is at varying prices
ranging from $0 to market value at the date of the grant. Those options will expire up to
ten years after the date of the grant. Any options which are forfeited or cancelled
before expiration become available for future grants.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | On
April 11, 2006, the Company offered to each of its and its subsidiaries          employees,
and its directors and office holders (other than External           Directors,
as such term is defined in the Israeli Companies Law of 1999)           who held
outstanding vested and unvested options to purchase an aggregate of           4,485,017
of its ordinary shares, which were issued pursuant to the terms of the           Companys
2001 Share Option Plan, as amended, to replace all of his or her           outstanding
vested and unvested options into a new number of ordinary shares,           with the same
fair values, as determined using the Black-Scholes pricing model,           and the same
vesting schedules.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 33

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 10 
Shareholders Equity (contd)

| | C. | Stock
option plans (contd)
| | -- | ---------------------------

| | 3. | (contd)
| | -- | --------

| | The
Companys Board of Directors approved the Alternative Option Exercise Mechanism (AOEM),
on February 12, 2006. Further, the Companys shareholders approved the AOEM at an
extraordinary meeting of the shareholders on March 21, 2006. As a result of the AOEM, the
Company issued a total of 2,437,075 ordinary shares in exchange for options to acquire a
total of 3,737,369 ordinary shares. If a holder of options did not participate in the
AOEM, the original terms of his or her option agreement and the Share Option Plan
continue to apply and such option may be exercised in accordance with its terms.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
accordance with SFAS 123 (R) the Company considers the AOEM as a short-term inducement.
Since the fair market value of the Companys ordinary shares newly issued to each
employee equals the fair value of the options replaced from him/her, no incremental
compensation cost was recognized pursuant to the AOEM.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Companys options activity (including options to non-employees) and options
outstanding as of December 31, 2006, 2007 and 2008 are summarized in the following table:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                  | Number of
options
outstanding | Weighted
average exercise
price per share
| | ------------------------------------------------ | ----------------------------- | -----------------------------------------
|
|
|
|
| | Outstanding - December 31, 2005                  |                               |                                          
| | Options granted                                  |                               |                                          
| | Options cancelled or forfeited                   |                               |                                          
| | Options replaced under the AOEM (see C3 above)   |                               |                                          
| | Options exercised                                |                               |                                          
| |                                                  |                               |                                          
| | Outstanding - December 31, 2006                  |                               |                                          
| | Options granted                                  |                               |                                          
| | Options cancelled or forfeited                   |                               |                                          
| | Options exercised                                |                               |                                          
| |                                                  |                               |                                          
| | Outstanding - December 31, 2007                  |                               |                                          
| | Options granted                                  |                               |                                          
| | Options cancelled or forfeited                   |                               |                                          
| | Options exercised                                |                               |                                          
| |                                                  |                               |                                          
| | Outstanding - December 31, 2008                  |                               |                                          
| |                                                  |                               |                                          
| |                                                  |                               |                                          
| | Exercisable as of:                               |                               |                                          
| |                                                  |                               |                                          
| | December 31, 2006                                |                               |                                          
| |                                                  |                               |                                          
| | December 31, 2007                                |                               |                                          
| |                                                  |                               |                                          
| | December 31, 2008                                |                               |                                          
| |                                                  |                               |                                          
| | Vested and expected to vest at December 31, 2008 |                               |                                          
| |                                                  |                               |                                          
| |                                                  |                               |                                          

F - 34

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 10 
Shareholders Equity (contd)

| | C. | Stock
option plans (contd)
| | -- | ---------------------------

| | The
following table summarizes information about options outstanding and exercisable
(including options to non-employees) as of December 31, 2008:
| | --------------------------------------------------------------------------------------------------------------------------------------------------

| |              | Options outstanding | Options Exercisable
| | ------------ | ------------------- | -------------------
|
|
|
|
| | $       0.02 |                     |                    
| | 1.4-4.82     |                     |                    
| | 6.11-8.16    |                     |                    
| | 8.56-9.85    |                     |                    
| | 10.00-14.00  |                     |                    
| | 21.00-32.00  |                     |                    
| | 42.50-123.60 |                     |                    
| |              |                     |                    
| |              |                     |                    
| |              |                     |                    
| |              |                     |                    

| | The
weighted average fair values of options (including non-employees) granted during the
years ended December 31, 2006, 2007 and 2008 were:
| | -------------------------------------------------------------------------------------------------------------------------------------------

| |                  | For exercise price on the grant date that:
| | ---------------- | ------------------------------------------
|
|
|
|
| | Weighted average |                                           
| | exercise prices  |                                           
| | Weighted average |                                           
| | fair values on   |                                           
| | grant date       |                                           
| |                  |                                           

| | The
total intrinsic value of options exercised during the year ended December 31, 2008, was
$4.2 million. The total intrinsic value of options expected to vest at December 31, 2008,
is $3.9 million. The total intrinsic value of options vested and exercisable at December
31, 2008, is $4.9 million.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Following
is a summary of non-vested options activity as of December 31, 2008, under the Companys
stock-based compensation plans:
| | ----------------------------------------------------------------------------------------------------------------------------------

| |                                 | Number of
options | Weighted
average grant
date fair value
| | ------------------------------- | ----------------- | --------------------------------------
|
|
|
|
| | Non-vested at January 1, 2008   |                   |                                       
| | Granted                         |                   |                                       
| | Vested                          |                   |                                       
| | Forfeited                       |                   |                                       
| |                                 |                   |                                       
| |                                 |                   |                                       
| | Non-vested at December 31, 2008 |                   |                                       
| |                                 |                   |                                       
| |                                 |                   |                                       

F - 35

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 10 
Shareholders Equity (contd)

| | C. | Stock
option plans (contd)
| | -- | ---------------------------

| | As
of December 31, 2008, there was $3.5 million of total unrecognized compensation cost
related to non-vested share based compensation arrangements. That cost is expected to be
recognized over a weighted-average period of 2.5 years. The total fair value of shares
vested during the year ended December 31, 2008 was $5.3 million.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | During
2006, 2007 and 2008, the company recorded share-based compensation expenses in the amount
of $3,783, $6,947 and $6,253, respectively, in accordance with SFAS No. 123(R).
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | D. | Warrants
| | -- | --------

| | 1. | The Company issued warrants with
respect to investments made in the Company and property plant and equipment. The number of
warrants issued by the Company during the years ended December 31, 2006, 2007 and 2008
were 226,438, 50,000 and 90,000 respectively, with a per share weighted average exercise
price of NIS 0.1 (par value  of approximately $0.02), for each year.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Pursuant to a marketing platform purchase agreement dated as of June 25, 2008,
          by and between OTI and Structure Financial Group (SFG), the Company
          granted to SFG and TheSpearhead Capital Ltd. (TheSpearhead) equally,
          warrants to purchase in aggregate up to 1,000,000 of the Companys ordinary
          shares (the Warrants) (500,000 each) as an aggregate consideration
          for the Companys purchase of SFGs marketing platform together with
          certain consulting services (SFG Transaction). The Warrants shall be
          vested in quantities of 100,000 (one hundred thousand) Warrants each time to
          each of SFG and TheSpearhead, upon the Companys receiving a firm order or
          a tender award, of which SFG has been directly involved in the promotion and/or
          funding, in an amount of not less than $1 million and with a potential amount of
          no less than $5 million. Notwithstanding the above, upon the Company receiving a
          firm order or a tender award, in which SFG has been directly involved in the
          promotion and/or funding of, in the amount of at least $60 million, the entire
          amount of the Warrants shall become immediately vested.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In the event that the Warrants shall
be exercised into shares, SFG and/or TheSpearhead may be required to grant proxies for
such shares according to the Companys instructions. In any event, vested Warrants
may not be exercised before May 30, 2010 and following the earlier of (i) the termination
date of the marketing platform purchase agreement, or (ii) 5:00 P.M., New York City time
on May 1, 2018. The exercise price of the Warrants is $3.0 per each Warrant, but if SFG
contributes to a cumulative sum of sales and/or funding and/or proceeds of $10 million to
the Company, the exercise price of the Warrants which have not been exercised by SFG
and/or TheSpearhead shall be reduced by $0.50 per Warrant until the lower limit of the par
value of the Companys ordinary shares which is NIS 0.10. In accordance with the
agreement, the Company granted SFG a right of first refusal for three years from the date
of the agreement to allow SFG sufficient time to procure and secure financing for its
projects contemplated by the agreement. As of December 31, 2008 none of the Warrants were
vested.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 36

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 10 
Shareholders Equity (contd)

| | D. | Warrants
(contd)
| | -- | -----------------

| | 3. | As part of the mediation and consulting services provided by a service provider
          to the Company in connection with the SFG Transaction, the Companys board
          of directors has approved the issuance of 50,000 warrants to the service
          provider as consideration for his services. These warrants shall have the same
          terms and conditions (e.g., vesting terms, exercise period, exercise price) as
          the Warrants issued in the SFG Transaction. As of December 31, 2008 none of the
          warrants were vested.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
following table summarizes information about warrants outstanding and exercisable as of
December 31, 2008:
| | --------------------------------------------------------------------------------------------------------------

| |                     | Warrants outstanding
| | ------------------- | --------------------
|
|
|
|
| | NIS 0.1 (par value) |                     
| | $              3.00 |                     
| | $11.42 - $14.58     |                     
| |                     |                     
| |                     |                     
| |                     |                     
| |                     |                     

| | E. | Employee
Share Purchase Plan
| | -- | ----------------------------

| | 1. | 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. Subsequent to balance sheet date the           board of
directors resolved to terminate this plan.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | In
2008, the Company established an Employee Share Purchase Plan pursuant to           which
1.5 million shares have been reserved for employees including the           Companys
subsidiaries. The purchase price of the shares will be 85% of the           trading price
on the date of purchase. During 2008, 480,289 shares have been           issued to
employees under this plan in consideration of $1,125.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
at December 31, 2008, the Company recorded to shareholders equity an amount of $308
in respect to amounts received from employees on account of shares to be issued (a total
of 254,098 shares were issued subsequently in 2009).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Total
expenses recognized in the consolidated statement of operating with respect to the 2008
plan amounted to $256.
| | --------------------------------------------------------------------------------------------------------------------

F - 37

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---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 11  Income
Taxes

| | A. | The
Company and its Israeli subsidiaries
| | -- | ----------------------------------------

| | 1. | Measurement
of taxable income under the Income Tax (Inflationary Adjustments)           Law, 1985
| | -- | -------------------------------------------------------------------------------------------------

| | Until
December 31, 2006, the results of the company and its Israeli subsidiaries for tax
purposes were measured and adjusted in accordance with the change in the Israeli Consumer
Price Index (CPI). As explained in Note 2A, the consolidated financial
statements are presented in U.S. dollars. The differences between the change in the
Israeli CPI and in the NIS/U.S. dollar exchange rate causes a difference between the
Companys and its Israeli subsidiaries taxable income or loss and their income
or loss before taxes reflected in the consolidated financial statements. In accordance
with paragraph 9(f) of SFAS No. 109, the Company and its Israeli subsidiaries have not
provided deferred income taxes on this difference between the financial reporting basis
and the tax basis of assets and liabilities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company and one of its Israeli subsidiaries are foreign invested companies, and have
elected, commencing January 1, 2007, to maintain their books and records in U.S dollars
for tax purposes, as permitted under the tax regulations.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | Tax
benefits under the Law for the Encouragement of Capital Investments, 1959
| | -- | -----------------------------------------------------------------------------

| | The
Company maintains three investment programs in buildings, equipment and production
facilities, which have been granted the status of Approved Enterprise under
the Law for the Encouragement of Capital Investments, 1959. The Company elected to adopt
the Alternative Benefits Program status. This status entitles the Company to
an exemption from taxes on income derived therefrom for a period of 10 years starting in
the year in which the Company first generates taxable income, but not later than 14 years
from the date of approval (the last of which was received in February 2000) or 12 years
from commencement of operations. The tax-exempt profits that are earned by the Companys
Approved Enterprises can be distributed to shareholders, without additional
tax liability on the Company only upon its complete liquidation.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | If
these retained tax-exempt profits are distributed in a manner other than in the complete
liquidation of the Company, they would be taxed at the regular corporate tax rate
applicable to such profits as if the Company had not elected the alternative system of
benefits (depending on the level of foreign investment in the Company) currently between
10% to 25% for an Approved Enterprise. As the Company has not yet reported
any taxable income, the benefit period has not yet commenced as of December 31, 2008.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Income
from sources other than the Approved Enterprise during the benefit period
will be subject to tax at the regular corporate tax rate (see 4 below).
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
entitlement to the above mentioned benefits is conditional upon the Companys
fulfilling the conditions stipulated by the above mentioned law, regulations published
thereunder and the certificates of approval for the specific investments in the Approved
Enterprises. In the event of failure to comply with these conditions, the benefits may be
canceled and the Company may be required to refund the amount of the benefits, in whole
or in part, with the addition of linkage differences to the CPI and interest. Management
believes that the Company is in compliance with the above-mentioned conditions as of
December 31, 2008.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 38

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 11  Income
Taxes (contd)

| | A. | The
Company and its Israeli subsidiaries (contd)
| | -- | -------------------------------------------------

| | 3. | The
Law for the Encouragement of Industry (taxes), 1969
| | -- | -------------------------------------------------------

| | The
Company believes that it qualifies as an Industrial Company under the Law for
the Encouragement of Industry. The principal tax benefits for the Company are the
deductibility of costs in connection with public offerings and accelerated depreciation.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | Tax
rates
| | -- | ---------

| | On
July 25, 2005, the Knesset The Israeli Parliament passed the Law for the
Amendment of the Income Tax Ordinance (No.147 and Temporary Order)  2005. The
Amendment provides for a gradual reduction in the company tax rate in the following
manner: in 2006 -31%, in 2007  29%, in 2008  27%, in 2009  26% and from
2010 onward the tax rate will be 25%. Furthermore, as from 2010, upon reduction of the
company tax rate to 25%, real capital gains will be subject to tax at 25%.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | B. | Non-Israeli
subsidiaries are taxed based on the income tax laws in their country           of
residence.
| | -- | --------------------------------------------------------------------------------------------------------

| | C. | Deferred
income taxes:
| | -- | ----------------------

| |                                    | December 31 | December 31
| | ---------------------------------- | ----------- | -----------
|
|
|
|
| | Deferred tax assets:               |             |            
| | Net operating loss carryforwards   |             |            
| | Goodwill                           |             |            
| | Other                              |             |            
| |                                    |             |            
| |                                    |             |            
| | Total gross deferred tax assets    |             |            
| | Less - valuation allowance         |             |            
| |                                    |             |            
| |                                    |             |            
| | Net deferred tax assets            |             |            
| |                                    |             |            
| | Deferred tax liability:            |             |            
| |                                    |             |            
| | Goodwill                           |             |            
| | Intangible assets                  |             |            
| |                                    |             |            
| | Total gross deferred tax liability |             |            
| |                                    |             |            
| | Net deferred tax liability         |             |            
| |                                    |             |            

F - 39

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 11  Income
Taxes (contd)

| | C. | Deferred
income taxes: (contd)
| | -- | -------------------------------

| | The
valuation allowance for deferred tax assets as of December 31, 2007 and 2008 was $19,229
and $30,844, respectively. The net change in the total valuation allowance for each of
the years ended December 31, 2006, 2007 and 2008, was an increase of $1,578, $4,912 and
$11,615, respectively. In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some or all of the deferred tax assets
will not be realized. The ultimate realization of deferred tax assets depends on the
generation of future taxable income during the periods in which those temporary
differences are deductible. Based on the level of historical taxable losses, management
believes that it is more likely than not that the Company will not realize the benefits
of these deductible differences.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Subsequently
recognized tax benefits related to the valuation allowance for deferred tax assets as of
December 31, 2008, will be allocated as follows:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                                               | 
| | ------------------------------------------------------------- | 
|
|
|
|
| | Income tax benefit that would be reported in the consolidated | 
| | statements of operations                                      | 
| | Additional paid-in capital                                    | 
| |                                                               | 
| | Total                                                         | 
| |                                                               | 
| |                                                               | 

| | D. | As
of December 31, 2008, the net operating loss carryforwards for tax purposes
          relating to Israeli companies amounted to approximately $84,400. Tax loss
          carryforwards in Israel may be carried forward indefinitely to offset against
          future taxable income. Under the Income Tax (Inflationary Adjustments) Law,
          1985, tax loss carryforwards are linked to the USD. Tax loss carryforwards
          relating to non-Israeli companies aggregate approximately $9,462, which will
          expire as follows: 2010  $68, 2012  $668, 2013  $9, 2014- $7,
          2025  $395, 2026  $3,206 and 2027- $533. The remaining balance
           $4,576 can be utilized with no expiration date.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | E. | The Company has not recognized a deferred tax liability for the undistributed
          earnings of its foreign subsidiaries that arose in 2008 and prior years, because
          the Company considers these earnings to be indefinitely reinvested. A deferred
          tax liability will be recognized when the Company can no longer demonstrate that
          it plans to indefinitely reinvest these undistributed earnings. As of December
          31, 2008, the undistributed earnings of these foreign subsidiaries were
          approximately $2,081. It is impracticable to determine the additional taxes
          payable when these earnings are remitted.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | F. | No current or deferred taxes were recorded in Israel. Non-Israeli income tax
          benefit (expense) included in the consolidated statements of operations are as
          follows:
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                    | Year ended December 31
| | ------------------ | ----------------------
|
|
|
|
| | Current            |                       
| | Deferred           |                       
| |                    |                       
| |                    |                       
| | Income tax benefit |                       
| |                    |                       
| |                    |                       

F - 40

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

| | F. | (cont'd)
| | -- | --------

# Note 11  Income
Taxes (contd)

| | Income tax benefit (expense) for the
years ended December 31, 2006, 2007 and 2008, differed from the amounts computed by
applying the Israeli statutory tax rates of 31%, 29% and 27% to loss before taxes on
income as a result of the following:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                             | Year ended December 31
| | ------------------------------------------- | ----------------------
|
|
|
|
| | Computed "expected" income tax benefit      |                       
| | Increase (decrease) in income tax benefit   |                       
| | resulting from:                             |                       
| | Change in valuation allowance, net          |                       
| | Stock-based compensation related to options |                       
| | issued to employees                         |                       
| | Impairment of goodwill                      |                       
| | Non-deductible expenses                     |                       
| | Other                                       |                       
| |                                             |                       
| |                                             |                       
| | Total income tax benefit                    |                       
| |                                             |                       

| | G. | Loss
before taxes on income consists of the following:
| | -- | ------------------------------------------------------

| |            | Year ended December 31
| | ---------- | ----------------------
|
|
|
|
| | Israel     |                       
| | Non-Israel |                       
| |            |                       
| |            |                       
| |            |                       
| |            |                       
| |            |                       

| | H. | Accounting
for uncertainty in income taxes
| | -- | ------------------------------------------

| | In
June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty
in Income Taxes (FIN 48). FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprises financial statements in
accordance with SFAS No. 109. This interpretation prescribes a minimum recognition
threshold a tax position is required to meet before being recognized in the financial
statements. FIN 48 also provides guidance on derecognition of tax positions,
classification on the balance sheet, interest and penalties, accounting in interim
periods, disclosure, and transition. FIN 48 requires significant judgment in
determining what constitutes an individual tax position as well as assessing the outcome
of each tax position.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The Company adopted the provisions of
FIN 48 as of January 1, 2007, and there was no effect on the financial statements. As
a result, the Company did not record any cumulative-effect adjustment related to adopting
FIN 48.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | As
of January 1, 2007, and for the twelve-month periods ended December 31, 2007 and 2008,
the Company did not have any unrecognized tax benefits. In addition, the Company does not
expect that the amount of unrecognized tax benefits will change significantly within the
next twelve months.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 41

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 11  Income
Taxes (contd)

| | H. | Accounting
for uncertainty in income taxes (contd)
| | -- | ---------------------------------------------------

| | The
Company accounts for interest and penalties related to unrecognized tax benefits as a
component of income tax expense. As of January 1, 2007 and for the twelve-month periods
ended December 31, 2007 and 2008, no interest and penalties related to unrecognized tax
benefits have been accrued.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company and its major subsidiaries file income tax returns in Israel, Hong Kong, Poland
and Germany. With few exceptions, the income tax returns of the Company and its major
subsidiaries are open to examination by the Israeli and the respective foreign tax
authorities for the tax years beginning in 2003.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# Note 12  Related
Party Balances and Transactions

| | A. | Transactions
| | -- | ------------

| |                      | Year ended December 31
| | -------------------- | ----------------------
|
|
|
|
| | Revenues             |                       
| |                      |                       
| |                      |                       
| | Costs and expenses** |                       
| |                      |                       
| |                      |                       

| | * | See
Note 2H.
| | - | ------------

| | ** | Cost
and expenses relate to services provided to the Company by related parties.
| | -- | --------------------------------------------------------------------------------

# Note 13 
Geographic Information and Major Customers

| | The
Company manages its business on the basis of one reportable segment. The data is
presented in accordance with SFAS 131, Disclosures About Segments of an Enterprise
and Related Information.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |                                     | Year ended December 31
| | ----------------------------------- | ----------------------
|
|
|
|
| | Revenues by geographical areas from |                       
| | external customers                  |                       
| | America                             |                       
| | Far East                            |                       
| | Africa                              |                       
| | Europe                              |                       
| |                                     |                       
| | Total export                        |                       
| | Domestic (Israel)                   |                       
| |                                     |                       
| |                                     |                       
| |                                     |                       
| |                                     |                       

F - 42

---

---

On Track Innovations Ltd.
and Subsidiaries

|Notes
to the Consolidated Financial Statements
|----------------------------------------------

---

# In thousands, except
share and per share data

# Note 13 
Geographic Information and Major Customers (contd)

| |                                         | December 31 | December 31
| | --------------------------------------- | ----------- | -----------
|
|
|
|
| | Long lived assets by geographical areas |             |            
| | Domestic (Israel)                       |             |            
| | Germany                                 |             |            
| | Poland                                  |             |            
| | France                                  |             |            
| | Far East                                |             |            
| | Other                                   |             |            
| |                                         |             |            
| |                                         |             |            
| |                                         |             |            
| |                                         |             |            
| |                                         |             |            

| | Major
Customers
| | ---------------

| | There
were no major customers (customers representing 10% or more of total revenues) in the
years ended December 31, 2007 and 2008.
| | -----------------------------------------------------------------------------------------------------------------------------------

# Note 14 
Subsequent Events

| | On
January 12, 2009, the Companys Board of Directors approved the adoption of a
Shareholders Rights Plan, according to which each ordinary share of the Company shall
give its holder one right. Each such right will become exercisable only after a person or
a group becomes an Acquiring Person, by obtaining beneficial ownership of, or
by commencing a tender or exchange offer for, 15% or more of the Companys ordinary
shares (the Board may reduce this percentage to not less than 10%), unless the Board
approves such Acquiring Person or redeems the rights. Each right, once it
becomes exercisable, will generally entitle its holder, other than the Acquiring
Person, to purchase from the Company either one or three ordinary shares (depending on
the Companys registered capital on the date of exercising the rights), at par
value.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

F - 43

---

---

# 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 BashanChief Executive Officerand Chairman of the Board
| |  | -----------------------------------------------------------------------------------------------------------------------

| |  | By: /s/ Tanir Horn 
Tanir HornChief Financial Officer
| |  | -------------------------------------------------------------------

Date:  June 29,
2009

90

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---