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 THE SECURITIES EXCHANGE ACT OF 1934







For the fiscal year ended December 31, 2009




OR




o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 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 Relations


Tel: (732) 429-1900 (#111)


E-mail: galit@otiglobal.com


111 Wood Ave South, Suite 105, Iselin, New Jersey 08830, 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

Ordinary Shares, par value NIS 0.10 per share
Name of each exchange on which registered

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:   23,946,316 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           x  No





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           x  No





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





x YesoNo





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).





o Yes           o No





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. GAAPx
International Financial Reporting Standardsas issued by the International Accounting Boardo
Othero





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 oItem 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).





o Yes           x  No















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 (including the regulations promulgated thereunder); 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.  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 3D – "Risk Factors", 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, 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, Item 10C – "Material Contracts", 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 update 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.










ITEM 1.
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
6ITEM 2.
OFFER STATISTICS AND EXPECTED TIMETABLE
6ITEM 3.
KEY INFORMATION
6A.
SELECTED FINANCIAL DATA
6B.
CAPITALIZATION AND INDEBTEDNESS
7C.
REASONS FOR THE OFFER AND USE OF PROCEEDS
7D.
RISK FACTORS
7ITEM 4.
INFORMATION ON THE COMPANY
19A.
HISTORY AND DEVELOPMENT OF THE COMPANY
19B.
BUSINESS OVERVIEW
20C.
ORGANIZATIONAL STRUCTURE
35D.
PROPERTY, PLANT AND EQUIPMENT
36ITEM 4A.
UNRESOLVED STAFF COMMENTS
37ITEM 5.
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
37A.
OPERATING RESULTS
37B.
LIQUIDITY AND CAPITAL RESOURCES
44C.
RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC.
46D.
TREND INFORMATION
46E.
OFF BALANCE SHEET ARRANGEMENTS
47F.
TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS
47ITEM 6.
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
47A.
DIRECTORS AND SENIOR MANAGEMENT
47B.
COMPENSATION
50C.
BOARD PRACTICES
52D.
EMPLOYEES
56E.
SHARE OWNERSHIP
57ITEM 7.
MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
60A.
MAJOR SHAREHOLDERS
60B.
RELATED PARTY TRANSACTIONS
61C.
INTERESTS OF EXPERTS AND COUNSEL
62ITEM 8.
FINANCIAL INFORMATION
62A.
CONSOLIDATED FINANCIAL STATEMENTS AND OTHER FINANCIAL INFORMATION
62B.
SIGNIFICANT CHANGES
63ITEM 9.
THE OFFER AND LISTING
63A.
OFFER AND LISTING DETAILS
63B.
PLAN OF DISTRIBUTION
64C.
MARKETS
64D.
SELLING SHAREHOLDERS
64E.
DILUTION
64F.
EXPENSES OF THE ISSUE
65ITEM 10.
ADDITIONAL INFORMATION
65A.
SHARE CAPITAL
65B.
MEMORANDUM AND ARTICLES OF ASSOCIATION
65C.
MATERIAL CONTRACTS
69D.
EXCHANGE CONTROLS
71E.
TAXATION
71F.
DIVIDENDS AND PAYING AGENTS
82G.
STATEMENT BY EXPERTS
82H.
DOCUMENTS ON DISPLAY
82I.
SUBSIDIARY INFORMATION
82  
 ITEM 11.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
82ITEM 12.
DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
83ITEM 13.
DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
83ITEM 14.
MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
83ITEM 15T.
CONTROLS AND PROCEDURES
84ITEM 16A.
AUDIT COMMITTEE FINANCIAL EXPERT
85ITEM 16B.
CODE OF ETHICS
85ITEM 16C.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
85ITEM 16D.
EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
86ITEM 16E.
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
86ITEM 16F.
CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT
86ITEM 16G.
CORPORATE GOVERNANCE
86ITEM 17.
FINANCIAL STATEMENTS
87ITEM 18.
FINANCIAL STATEMENTS
87ITEM 19.
EXHIBITS
88








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, 2007, 2008 and 2009, and the selected consolidated balance sheet data as of December 31, 2008 and 2009, 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, 2005 and 2006 and the selected consolidated balance sheet data as of December 31, 2005, 2006 and 2007 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.




During the fourth quarter of 2009 we and our subsidiary, Millennium Card's Technology Ltd, or "MCT", entered into an agreement with SMARTRAC Singapore Trading PTE, a member of the SMARTRAC N.V. group, for the sale of the assets of MCT and the sale of our assets related to inlay production and machinery therefore (as is more fully described in Item 10 C. - "Material Contracts"). Accordingly,assets and liabilities related to the discontinued operation are presented separately in the balance sheets. The results of this operation and the cash flows from this operation, for the reporting periods, are presented in the statements of operations and in the statements of cash flow, as discontinued operations, separately from continuing operations. All data in this annual report derived from our financial statements, unless otherwise specified, excludes the results of this discontinuedoperation.




Year ended December 312005


2006


2007


2008


2009(In thousands, except share and per share data)REVENUESSales

$
28,933


$
29,045


$
33,467


$
32,387


$
28,488Licensing and transaction fees


3,398



5,382



2,631



2,635



2,949Total revenues


32,331



34,427



36,098



35,022



31,437COST OF REVENUESSales


19,838



17,004



20,372



19,789



16,782Total cost of revenues


19,838



17,004



20,372



19,789



16,782Gross profit


12,493



17,423



15,726



15,233



14,655OPERATING EXPENSESResearch and development


5,405



6,763



11,218



10,300



8,127Less — participation by the Office of the Chief Scientist


618



-



-



-



-Research and development, net


4,787



6,763



11,218



10,300



8,127Selling and marketing


7,470



6,765



9,148



10,370



10,371General and administrative


8,579



9,346



12,838



11,210



9,230Amortization and impairment of intangible assets


700



821



1,314



2,794



978Impairment of goodwill


-



-



-



24,217



-Gain from sale of subsidiary


(374
)


-



-



-



-Total operating expenses


21,162



23,695



34,518



58,891



28,706Operating loss


(8,669
)


(6,272
)


(18,792
)


(43,658
)


(14,051
)Financial income (expense), net


710



1,598



1,678



(474
)


(1,153
)Other income (expense), net


(250
)


(331
)


(23
)


-



-Loss before taxes on income


(8,209
)


(5,005
)


(17,137
)


(44,132
)


(15,204
)Tax benefits (taxes on income)


267



354



226



675



(89
)Equity in net losses of affiliated company


-



(1,087
)


(358
)


(1,270
)


-Net loss from continuing operations


(7,942
)


(5,738
)


(17,269
)


(44,727
)


(15,293
)Net loss from discontinued operations


(986
)


(1,491
)


(4,412
)


(5,211
)


(8,078
)Net loss


(8,928
)


(7,229
)


(21,681
)


(49,938
)


(23,371
)Net loss (income) attributable to noncontrolling interest


(185
)


625



1,038



(57
)


189Net loss attributable to shareholders

$
(9,113
)

$
(6,604
)

$
(20,643
)

$
(49,995
)

$
(23,182
)Basic and diluted net loss attributable to shareholders per ordinary shareFrom continuing operations

$
(0.85
)

$
(0.37
)

$
(0.86
)

$
(2.19
)

$
(0.67
)From discontinued operations

$
(0.11
)

$
(0.10
)

$
(0.23
)

$
(0.26
)

$
(0.35
)$
(0.96
)

$
(0.47
)

$
(1.09
)

$
(2.45
)

$
(1.02
)Weighted average number of ordinary shares used in computing net loss per ordinary share - basic and diluted


9,512,198



13,919,958



18,896,214



20,413,578



22,635,479




6




As of December 312005


2006


2007


2008


2009Balance Sheet Data:Cash and cash equivalents

$
29,657


$
30,049


$
35,470


$
27,196


$
26,884Total current assets


67,914



70,889



66,755



48,004



47,308Assets from discontinued operation – held for sale


-



-



-



-



12,358Total assets


85,058



117,174



118,460



70,309



76,676Total liabilities


14,513



17,016



28,112



22,208



38,213Long term loans, net of current maturities


1,535



2,117



2,432



1,762



2,642Liabilities related to discontinued operations


-



-



-



-



8,495Total shareholders’ equity


70,235



99,154



90,348



47,686



29,991Total ordinary shares outstanding


11,932,074



18,592,880



19,627,068



21,534,788



23,946,316





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





Risks Related to Our Business




We have a history of losses and we may continue to incur full-year losses in 2010 and in subsequent years.




We have incurred losses in each year since we commenced operations in 1990. We reported net losses attributable to shareholders of $9.1 million in 2005, $6.6 million in 2006, $20.6 million in 2007, $50.0 million in 2008 (including a goodwill impairment charge of $24.2 million) and $23.2 million in 2009. We may continue to incur full year losses in 2010 and afterwards, 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, invest in fixed assets that may generate revenues slowly than expected and enhance our research and development 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 devoting significant resources to developing new products and adapting our existing products for use in new markets,  such as mobile payment solutions, parking solutions, medical cards for use in hospitals and identity cards for use by governmental authorities. 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;




·
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.




8





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.




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.




9





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 sales 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 may 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.




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. However, other than our supply agreement with SMARTRAC N.V. as described below, we do not generally have long-term supply contracts under which our suppliers are committed to supply us with components at fixed or defined prices. 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. In connection with the sale of MCT's assets and other assets of OTI, we entered into a long-term supply agreement with SMARTRAC N.V. (as is more fully described in Item 10 C. "Material Contracts"), under which SMARTRAC N.V. became our exclusive supplier for wire-embedded and dual interface inlays, according to our needs, and our supplier for other products, at defined terms and prices. The potential adverse effects of dependence in third party suppliers apply in this case to a higher extent.




10





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.




Our products may infringe on 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 on 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 on 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.




11





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


Israel2005


12



29



6



43



102006


9



41



17



24



92007


13



50



5



21



112008


15



48



10



15



122009


12



37



8



31



12




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




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




·
changes in regulatory requirements and communications standards;




·
required licenses, tariffs and other trade barriers;




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




·
difficulties in staffing and managing international operations;




·
potentially adverse tax consequences; and




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




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




12





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, of our subsidiary in South Africa, OTI Africa, in South-African Rands and of our subsidiary in the Far East, MCT (the assets of which we sold during the forth quarter of 2009), in Yuan Renminbi. To the extent that we and our subsidiaries based in Israel, Europe, South-Africa 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;




·
failure to attract new customers or achieve market acceptance for our products; and




·
unexpected expenses to remedy errors.




13





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 tender processes (which many times include, third party challenges, long qualification period), 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 (sometimes due to challenges by third parties). 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, 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.




14




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, 2008 and 2009 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.




The general economic outlook may adversely affect our business.





The Company’s operations and performance depend on worldwide economic conditions and their impact on levels of business and public spending, which have deteriorated significantly in many countries and regions and may remain depressed for the foreseeable future.  This may adversely affect the budgeting and purchasing behavior of our customers and our potential customers, including shifting customers purchasing patterns to lower-cost options, which could adversely affect our product sales.





In addition, although economic conditions in many countries have stabilized somewhat following the widespread contraction in late 2008 and 2009, continuing uncertainties in the financial and credit markets may adversely affect the ability of our customers, suppliers, distributors and resellers to obtain financing for significant purchases and operations and to perform their contractual obligations with us. As a result, we could encounter, among other adverse effects, a decrease in or cancellation of orders for our products, and an increase in additional reserves for uncollectible accounts receivable being required.





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 2007, 2008 and 2009, 10%, 11% 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.




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.




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.




15





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 March 29, 2010, we had 24,376,137 outstanding ordinary shares, 1,253,431 warrants to purchase additional ordinary shares at a weighted average exercise price of $ 13.9 per share and 2,922,564 options to purchase additional ordinary shares at a weighted average exercise price of $ 2.029 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.




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.





Penny stocks are securities whose price is less than $5, which are speculative and issued by very small companies. If our shares are deemed to be “penny stock” for purposes of the Securities Exchange Act of 1934, as amended, or the “Exchange Act, brokers effecting transactions in our shares would be 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 stock. 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.


We may not be able to meet NASDAQ Global Market continued listing requirements and our shares may be delisted.




We may not be able to meet NASDAQ Global Market continued listing requirements in the NASDAQ Listing Rules, or the NASDAQ Rules, and our ordinary shares may be delisted.  For example, if the bid price of our ordinary shares is less than $1.00 for 30 consecutive business days or more, our shares may be moved to be traded on the NASDAQ Capital Market, or be delisted. After the bid price of a company goes below $1.00 for 30 consecutive business days, NASDAQ provides it a grace period before shares are being moved to be traded on the NASDAQ Capital Market or delisted. On March 29, 2010, the closing price of our ordinary share was $2.18.


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.




16





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. In August 2009 our board of directors approved the specific terms of the repurchase program, including the timing and the amount purchased. As of today, no shares were acquired under the repurchase program. According to the repurchase program 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.


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 2009, 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 may adversely 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





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, 25% in 2010, 24% in 2011, 23% in 2012, 22% in 2013, 21% in 2014, 20% in 2015 and 18% in 2016 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. All of our executive officers and most of our directors are not residents of the United States and a substantial portion of our assets and the assets of these persons is 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.




18





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.





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 111 Wood Ave South, Suite 105, Iselin, New Jersey 08830, and its telephone number is(732) 429-1900. 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: (732) 429-1900 (#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. Itsaddressis111 Wood Ave South, Suite 105, Iselin, New Jersey 08830, and its telephone number is (732) 429-1900.




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 September 2006, we completed a structural change in the Far-East, under which the operations of two of our subsidiaries there were transferred to Millennium Card’s Technology Limited (“MCT”), a subsidiary which was established during 2006. Following the structural change, we sold our shares in these two subsidiaries. Our initial holding in MCT was 60%. 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%. In July 2009 we were issued additional shares in MCT as a result of conversion of outstanding loans in an aggregate amount of $2.5 million, which increased our holding in MCT to 99.5%. During the fourth quarter of 2009 we and MCT entered into an agreement with SMARTRAC Singapore Trading PTE, a member of the SMARTRAC N.V. group,  for the  sale of the assets of MCT and the sale of our assets related to inlay production and machinery therefore (as is more fully described in Item 10 C. "Material Contracts").




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. The agreement mentioned above for the sale of assets to SMARTRAC Singapore Trading PTE (as is more fully described in Item 10 C. "Material Contracts") includes the sale of the smart card module production line purchased from Barun.




19





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 $186,000 need to be paid since the total value of such shares at the determined dates was less than euro 500,000).


In May 2009, we established On Track Innovations Ltd (Ecuador branch), a branch of the Company in Ecuador, to support our activity in Ecuador, including the procurement of local services.




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:




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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 PayPassTM, Visa’s PayWaveTM, American Express’ ExpressPayTM and Discover’s ZipTM. Our payment solutions also include EasyPark, our electronic parking payment system as well as our mass transit electronic payment system;




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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




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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 MAGNATM - a complete end-to-end in-house solution for electronic passports (e-Passport) and national identity cards (national ID) 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.




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Our products offer the following benefits:




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




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




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




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Our products are easy to install and maintain.




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




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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. and other parts of the Americas, Israel, 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.




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.




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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.




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:




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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.




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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.




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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:




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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.




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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.




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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.




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.




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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 issuersBenefits of contactless cards compared to contact cardsFaster transaction time

Shorter time to complete a transaction

More transactions per minuteCards do not need to be inserted or put into readers

Easier to use and come in a variety of forms

Lower maintenance costsDurability

The card lasts longer

Reduce card replacement costBenefits of microprocessors compared to ASIC or memory chipsMultiple applications

The card has multiple uses

Generates revenues from additional applicationsEnhanced security

Information on the card is more secure

System is less vulnerable to fraud




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·
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 contactless inlay solution with plastic card manufacturers to allow quick upgrade from regular credit cards to contactless operations.




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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.




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




Strategy




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




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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.




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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.




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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, France, Italy and Bermuda 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. As part of this strategy we have also entered into an asset purchase agreement with SMARTRAC Singapore Trading PTE and a supply agreement with SMARTRAC N.V (as are more fully described in Item 10 C. "Material Contracts"), which enable us to focus on improving our operating margins and reducing operating costs, while maintaining our ability to continue and support our existing and future contracts and products.







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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.




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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.




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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 following companies:




m
SoftChip Group, an Israeli based developer and designer of microprocessors and operating systems for smart cards (January 2000);




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InterCard Systemelectronic, a German company that provides OEM and electronics manufacturing services (June 2000 and January 2001);




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ASEC, a Polish company that develops, manufactures and markets card readers and reader modules based on radio frequency identification technologies (October 2004);




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e-Pilot (71.5%) - 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 in September 2006 we completed a structural change in the Far-East, under which the operations of e-Pilot and of POI were transferred to our subsidiary MCT,  following which we sold POI and e-Pilot to a third party), and the smart card module production line of Barun Electronics Co. Ltd. ("Barun") - a Korean company (February 2007). During the fourth quarter of 2009 we and our subsidiary MCT entered into an agreement with SMARTRAC Singapore Trading PTE, a member of the SMARTRAC N.V. group, for the sale of the assets of MCT and the sale of our assets related to inlay production and machinery therefore (as is more fully described in Item 10 C. "Material Contracts"),  including the sale of the assets purchased from Barun;







m
InSeal SAS, a French company providing an operating system for contactless applications for a variety of customers in the payments market (May 2006);




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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); and




m
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:




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




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




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:




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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.




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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.




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Antenna module




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




Communications technology




We have developed a unique communications technology that includes:




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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;




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




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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 been involved in the production of machinery for manufacturing electronic passports (under the product line named Zeus) and for manufacturing contact/contactless ID and EMV compliant cards (under the product line named Hera). These activities were mainly carried out by our subsidiary, MCT, based in Shenzhen, China. In addition, we have also designed and developed a series of electronic passport testing equipment to enable e-Passport manufacturers to independently run ICAO's durability tests. These product lines and testing tools are part of the assets sold to SMARTRAC Singapore Trading PTE, a member of the SMARTRAC N.V. group, under the asset purchase agreement (as is more fully described in Item 10 C. "Material Contracts"). Following this transaction, we will cease our involvement in the production machinery manufacturing and testing tools business.




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:




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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;




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




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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:




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:




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PayPassTM. OTI supplies key components of the technology for multiple contactless payment programs, driven by major card associations: MasterCard International’s PayPassTM program, Visa’s PayWaveTM, ExpressPayTM from American Express and Discover’s ZipTM. The program is focused on replacing cash. After initial pilots in the U.S., the program has expanded to Europe, Canada and Asia. OTI provides cards, key fobs, smart stickers, operating system, readers and more for this program.




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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.




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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.




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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 650,000 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.




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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):




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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.




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




The 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




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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 MAGNATM 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  MAGNATM end-to-end system includes:




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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 HerculesTM 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. Since 2007, MediSmart is deployed in Kenya, through Smart Applications International Ltd., or SMART.
  ·
We have introduced production machinery to support the demand for dual interface cards and e-passports. These product lines are part of the assets sold to SMARTRAC Singapore Trading PTE, a member of the SMARTRAC N.V. group, under the asset purchase agreement entered into with SMARTRAC (as more fully described in Item 10 C. "Material Contracts"). Following this transaction, we will cease our involvement in the production machinery manufacturing business.


Technology co-operations




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. As of December 31, 2009, we had a support team of 20 employees consisting of eleven employees located in our corporate headquarters in Rosh Pina, Israel, five employees in Africa, one employee in the United States and three 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, 2009, we had a total sales and marketing staff of 37 employees in five locations.  We market our products in the Americas through OTI America, which employs two 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 nine 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 nine 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.




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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




In most of the previous years, including 2009, our revenues were subject to seasonal fluctuations, related to the slowdown in spending activities and the increased activity related to the second half of the year purchasing cycles of many end-users of our products.  Hence, our sales in the second half of most of years up to 2009 tended to be higher than in the first half. However, we cannot predict if we will experience this seasonality pattern in future years.




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 entered into a long-term supply agreement with SMARTRAC N.V. for the supply of wire-embedded and dual interface products on an exclusive basis, according to our needs, and for the supply of other products on a non-exclusive basis.  In addition, we purchase components on a purchase order basis.  Other than our said supply agreement with SMARTRAC, 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.




31





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..




MCT, our Chinese subsidiary, owned manufacturing assets 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. These manufacturing assets are part of the assets sold under the asset purchase agreement entered into with SMARTRAC Singapore Trading PTE (as is more fully described in Item 10 C. "Material Contracts")


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:




2005


2006


2007


2008


2009(Dollars in millions)Our expenditures net of grants from the OCS

$
4.8


$
6.8


$
11.2


$
10.3


$
8.1Our net expenditures as a percentage of annual revenues


15
%


20
%


31
%


29
%


26
%OCS grants

$
0.6


$
0


$
0


$
0


$
0





Our research and development activities focus on three areas:




·
implementing our core technologies in microprocessors and readers;




·
enhancing the functionality of our components and expanding the range of our products to serve new markets; and




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




As of December 31, 2009, we employed 114 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 extensive experience in their respective fields.  Our research and development facilities are ISO 9001:2000 certified.




32





Proprietary technologies and intellectual property




Our success and ability to compete depend in large part upon protecting our proprietary technology and intellectual property.  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, trademarks and designs. We have over 90 different patents and patent applications in different areas of our business, including patents and patent applications relating to smart card power and data transmission, , 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. We generally enter into non-disclosure agreements with our customers, partners, employees and consultants and generally control access to and distribution of our products, documentation and other proprietary information.


Competition




Contactless microprocessor-based products and technologies.  We experience 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.




33




C.           ORGANIZATIONAL STRUCTURE




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




On Track Innovations
Ltd.
Israel
     Easy Park Ltd.
 Israel
 Chinese
 Joint Venture
 Millennium Cards
 Technology Limited
 Shenzhen, China
 InSeal SAS
 InterCard GMBH
 Systemelectronic
 Germany
 France
   PARX France
 
 France
  PARX Ltd.
 Israel
  ASEC Spolka
 Akcyjna
 Poland
  100%
  99.5%(4)
   100%(3)
  100%
   94.33%(2)
  94.33%(1)
  OTI America, Inc.
 Delaware, USA
  100%(5)
  100%(7)
  100%(8)
  Millennium Cards
 Technology Limited
 Hong Kong, China
  100%
  OTI Africa (Pty), Ltd.
 South Africa
  49%(6)





(1)           The remaining shares of Easy Park Ltd.  are held by two individuals.


(2)           The remaining shares of PARX Ltd. are held by two individuals.


(3)           We acquired ASEC in October 2004.


(4)
We established Millennium Cards Technology Limited ("MCT") during 2006 together with a partner. Our initial holding was 60%. In September 2008 and July 2009 we were issued additional shares in MCT, which increased our total holding in MCT to 99.5%.


(5)           We acquired PARX France (formerly ID Parking) in June 2008.


(6)
We established the joint venture during 2005


(7)           We acquired InSeal SAS in May 2006.


(8)
We acquired a 51% interest in InterCard Systemelectronic in June 2000.  We acquired the remaining 49% interest in this company in January 2001.




34




Easy Park Ltd.




Easy Park Ltd. developed our EasyPark system and markets it in Israel.  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.




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.




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.




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.




Millennium Card’s Technology Limited




On September 1, 2006, we completed a structural change in the Far-East, under which the operations of two of our subsidiaries there were transferred to MCT, a subsidiary which was established during 2006. Following the structural change, the Company has sold its shares in these two subsidiaries. Our initial holding in MCT was 60%. In September 2008 MCT allotted to us 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, and in July 2009 MCT increased its share capital by 76,000 shares of HK$1.00, that were allotted to us against the conversion of an additional debt of MCT to us in the principle amount of $2,500,000. Following these shares allotments, our total holding in MCT was increased to 99.5%.




35





During the fourth quarter of 2009 we and our subsidiary MCT entered into an agreement with SMARTRAC Singapore Trading PTE, a member of the SMARTRAC N.V. group, for the sale of the assets of MCT and the sale of our assets related to inlay production and machinery therefore (as more fully described in Item 10 C. "Material Contracts").




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.




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 $186,000 need to be paid since the total value of such shares at the determined dates was less than euro 500,000).


PARX France distributes our electronic parking solutions in the French market.




On Track Innovations Ltd. (Ecuador branch)




We established On Track Innovations Ltd (Ecuador branch), a branch of us in Ecuador, to support our activity in Ecuador, including the procurement of local services.




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. We also lease an aggregate of 375.8 square 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.




Our majority owned subsidiary, Easy Park Ltd., leases from us office space in our site in Rosh Pina. Easy Park also leases an aggregate of 137 square 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.




36





OTI America, Inc. leases an aggregate of 2,200 square feet of office space in Iselin, New Jersey pursuant to a lease that expires on August 31, 2014. OTI Africa (Pty) Ltd. owns an aggregate of 770square 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. Following the agreement entered into with SMARTRAC Singapore Trading PTE, a member of the SMARTRAC N.V. group, for the sale of the assets of MCT and the sale of our assets related to inlay production and machinery therefore (as more fully described in Item 10 C. "Material Contracts"), MCT intends to terminate these leases during 2010. 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, 2011. 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




None.


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 theretocontained in “Item 18. Financial Statements” of this annual report.The results of the discontinued operation and the cash flows from the discontinued operation, have been removed from the results of continuing operations for all periods presented and are presented as a separate line item in the statement of operations and the statement of cash flows.




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 our U.S. subsidiary, OTI America, located in Iselin, New Jersey, Europe, South Africa and the Far East.  Our packaging, assembly and manufacturing facilities are located in Israel, Germany and the Far East (which includes the assets sold to SMARTRAC Singapore Trading PTE, a member of the SMARTRAC N.V. group, under the asset purchase agreement as is more fully described in Item 10 C. "Material Contracts). 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 and readers) that we sell to original equipment manufacturers, or OEMs, as well as other cards manufactures and companies for sale or incorporation into their own products. Our three complete system product lines include:




37




·
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 for the production of SmartID solutions. 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 PayPassTM micropayments system that we are installing for MasterCard International and we began to recognize product sale revenues from that system in 2004.




·
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. In 2003 we introduced and began to realize revenues from EasyFuel, our contactless petroleum system.




·
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. In 2007 we began to market our end-to-end eID smart card solutions based on the assets acquired from Vuance in the acquisition of Vuance's IPS division (as is more fully described in Item 10 C. "Material Contracts") and began to realize revenues from these assets.




We began to market components for incorporation into the products of OEMs with our acquisition of InterCard Systemelectronic in June 2000.  During 2007, 2008 and 2009, product sales to OEMs accounted for $8.7 million, $8.9 million and $5.9 million, respectively, of our total revenues.




We began marketing machineries following our acquisitions of e-Pilot and POI and the establishment of our subsidiary MCT. During the fourth quarter of 2009 we and our subsidiary, MCT, entered into an agreement with SMARTRAC Singapore Trading PTE, a member of the SMARTRAC N.V. group, for the sale of the assets of MCT and the sale of our assets related to inlay production and machinery therefore (as more fully described in Item 10 C. "Material Contracts").




We have reported net losses for each year that we have been in business, and we may continue to incur full year losses in 2010 and 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):




2007


2008


2009Sales

$
33,467



93
%

$
32,387



92
%

$
28,488



91
%Licensing andtransaction fees


2,631



7
%


2,635



8
%


2,949



9
%$
36,098



100
%

$
35,022



100
%

$
31,437



100
%




Salesdecreased by $1.1 million in 2008 as compared to 2007 and decreased by $3.6 million in 2009 as compared to 2008. The decrease in 2008 is mainly attributed to a decrease in sales of Payments products and its components and SmartID products.The decrease in 2009 is mainly attributed to a decrease in sales of OEM, Payments products and its components and Petroleum products, partially offset by an increase in sales of SmartID products, primarily in the Americas.




38





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 increase in 2009 as compare to 2008 is primarily due to the transaction fees from the Warsaw Ticketing System project which started to generate revenues in 2009.





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


Americas


Israel2007

$
4,710



13
%

$
17,924



50
%

$
1,637



5
%

$
7,569



21
%

$
4,258



11
%2008

$
5,423



15
%

$
16,786



48
%

$
3,641



10
%

$
5,100



15
%

$
4,072



12
%2009

$
3,813



12
%

$
11,590



37
%

$
2,365



8
%

$
9,810



31
%

$
3,859



12
%





We anticipate that, in the near future, 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.


Cost of revenues and gross margin




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




Year ended December 312007


2008


2009Cost of revenuesSales

$
20,372


$
19,789


$
16,782Licensing and transaction fees


-



-



-Total cost of revenues

$
20,372


$
19,789


$
16,782Gross profit

$
15,726


$
15,233


$
14,655Gross margin percentage


44
%


43
%


47
%


________________________




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 decrease in 2008 compared to 2007 is primarily the result of decreased sales which generated corresponding decreased costs. The decrease in 2009 compared to 2008 is primarily the result of a decrease in material consumption and in expenses related to salaries resulting from the decreased sales and a change in the revenue mix.





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.




39





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 312007


2008


2009Operating expensesResearch and development

$
11,218


$
10,300


$
8,127Selling and marketing


9,148



10,370



10,371General and administrative


12,838



11,210



9,230Amortization and impairment of intangible assets


1,314



2,794



978Impairment of goodwill


-



24,217



-Total operating expenses


34,518



58,891



28,706Operating loss

$
(18,792
)

$
(43,658
)

$
(14,051
)




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 decrease in 2008 compared to 2007 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 ASC TOPIC 718 and from a decrease in the number of research and development employees. The decrease in 2009 compared to 2008 was primarily due to a $1.7 million decrease in expenses related to salaries resulting from a $583,000 decrease in share-based compensation expenses, in accordance with ASC TOPIC 718, from a decrease in the number of research and development employees in certain locations and from a pay cut. Our research and development expenses may increase in the future as we continue to develop new products and new applications for our existing products.




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 2008 as compared to 2007 was primarily due to a $1.3 million increase in professional expenses resulting from marketing services related to existing projectsand marketing efforts, andincrease in compensation expenses, in compliance with ASC TOPIC 718. In 2009 selling and marketing expenses remained in the same level as in 2008. The comparison between 2009 to 2008 shows a $471,000 increase in professional expenses resulting from marketing services related to existing projects and marketing efforts, offset by a $571,000 decrease in compensation expenses, in compliance with ASC TOPIC 718. 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, insurance and vehicle expenses, which have collectively grown with the scope, magnitude and complexity of our business, and provision for doubtful accounts. The decrease in 2008 as compared to 2007 is primarily due to a $947,000 decrease in share-based compensation expenses, in compliance with ASC TOPIC 718, and a $524,000 decrease in professional expenses. The decrease in 2009 as compared to 2008 is primarily due to a $2.3 million decrease in expenses related to salaries resulting from a $1.1 million decrease in share-based compensation expenses, in compliance with ASC TOPIC 718, from a decrease in number of general and administrative employees and from a pay cut of existing employees, a $625,000 decrease in doubtful account provision and a $198,000 decrease in business trips, partially offset by a $1.5 million increase 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 certain intangible assets (customers' contracts and relationships) acquired in acquisition of InSeal SAS. The decrease in 2009 as compared to 2008 is primarily due the impairment in intangible assets which took place in 2008.




Impairment of goodwill.In 2008 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. We did not record any goodwill impairment charge in 2007 or 2009.




40





Financing income (expenses), net




Financing income consists primarily of interest earned on our investments in U.S. and Israeli treasury securities, corporate bonds and foreign exchange gains. Financing expenses consist primarily of interest payable on bank loans and foreign exchange losses.  The decrease in financing income in 2008 compared to 2007 and in 2009 compared to 2008. is mainly due to a decrease in interest earned on investments in debt securities and an 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 312007


2008


2009Financing income

$
2,616


$
561


$
24Financing expenses


(938
)


(1,035
)


(1,177
)Financing income (expenses), net

$
1,678


$
(474
)

$
(1,153
)




Net loss from continuing operations




The increase in 2008 as compared to 2007 is primarilydue 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.  The decrease in 2009 as compared to 2008 is primarilydue to a decrease in the Company's operating expenses, mainly due to a decrease in the goodwill impairment charge as mentioned above, a decrease in the research and development expenses and a decrease in the general and administrative expenses, partially offset by a decrease in the gross profit and an increase in the financial expenses, net, as mentioned above.




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




Year ended December 312007


2008


2009Net loss from continuing operations

$
(17,269
)

$
(44,727
)

$
(15,293
)




Net loss from discontinued operations




The increase in 2009 as compared to 2008 is primarily due to $2.6 million of closing expenses in 2009 in respect of the discontinued operation.




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




Year ended December 312007


2008


2009Net loss from discontinued operations

$
(4,412
)

$
(5,211
)

$
(8,078
)




Net loss




Our net loss increased in 2008 as compared to 2007 is primarilydue 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. The decrease in 2009 as compared to 2008 is primarilydue to a decrease in the Company's operating expenses, mainly due to a decrease in the goodwill impairment charge as mentioned above, a decrease in the research and development expenses and a decrease in the general and administrative expenses, partially offset by a decrease in the gross profit, an increase in the financial expenses, net, as mentioned above and increase in net loss from discontinued operation, as mentioned above.




41





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




Year ended December 312007


2008


2009Net loss

$
(21,681
)

$
(49,938
)

$
(23,371
)





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, other intangible assets and long-lived 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 arrangement 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. 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. 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 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 2009.




42





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. 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 group to the carrying value of the asset group. If the carrying value of the long-lived asset group 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 2009.





Other intangible assets, net, amounted to approximately $1.5 million as of December 31, 2009. 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.




The company measures and recognizes compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. ASC Topic 718, Compensation – Stock Compensation ("ASC Topic 718"), requires estimating the fair value of share based payments awards on the date of the grant using an option pricing model. The Company uses the Black and Scholes option pricing model. The Company adopted ASC TOPIC 718 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. 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 ASC TOPIC 718.  As a result of adopting ASC TOPIC 718, 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 ASC TOPIC 718, 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. 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.




ASC TOPIC 718requires 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.




43





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




During 2009 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 October 2009, the FASB amended the accounting standards for revenue recognition with multiple deliverables. The amended guidance allows the use of management’s best estimate of selling price for individual elements of an arrangement when vendor specific objective evidence or third-party evidence is unavailable. Additionally, it eliminates the residual method of revenue recognition in accounting for multiple deliverable arrangements. This accounting guidance is effective for our annual reporting periods, and interim periods within them, beginning after June 15, 2010, early adoption is permitted. We are currently evaluating the impact that the adoption of this guidance will have on our consolidated financial statements.




In October 2009, the FASB amended the accounting standards for revenue arrangements with software elements. The amended guidance modifies the scope of the software revenue recognition guidance to exclude tangible products that contain both software and non-software components that function together to deliver the product’s essential functionality. This accounting guidance is effective for our annual reporting periods, and interim periods within them, beginning after June 15, 2010, early adoption is permitted. This guidance must be adopted in the same period an entity adopts the amended revenue recognition with multiple deliverables guidance described above. We are currently evaluating the impact that the adoption of this guidance will have on its consolidated financial statements.




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 $26.9 million as of December 31, 2009 and $27.2 million as of December 31, 2008.  In addition, we had short-term investments of $5.1 million (representing U.S. and Israeli treasury securities and corporate bonds) as of December 31, 2009 and $904,000 as of December 31, 2008. We believe that our working capital is sufficient to meet our present requirements.




Operating activities related to continuing operations. For the year ended December 31, 2009 net cash provided by continuingoperating activity was $3.8 million primarily due to a $12.8 million increase in other current liabilities, mainly due to advanced payment from a customer in connection with the commencement of the turnkey project (as is more fully described in Item 10 C "Material Contracts"), $3.7 million of stock based compensation issued to employees and others, a $1.4 million depreciation, a $1.3 million increase in trade payables, $978,000 amortization of intangible assets, a $663,000 decrease in other receivables and prepaid expenses and a $429,000 decrease in inventory, partially offset by a $15.3 million net loss, a $1.3 million increase in trade receivables, $538,000 decrease in allowance for doubtful accounts, , a $222,000 decrease in accrued severance pay, net, and a $82,000 decrease in deferred tax liabilities. For the Year ended December 31, 2008 net cash used in continuingoperating activities was $8.3 million primarily due to a $44.7 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 liabilities, partially offset by a $27.0 million amortization and impairment of intangible assets and goodwill, $6.3 million of stock based compensation issued to employees and others, a $2.7 million decrease in trade receivables,  a $1.7 million depreciation, 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 net cash used in continuingoperating activities was $3.1 million primarily due to a $17.3 million net loss, a $2.8 million increase in inventories due to purchasing for future and existing orders, and  a $686,000 increase in other receivables and prepaid expenses, partially offset by $6.9 million of stock based compensation issued to employees and others, a $3.3 million increase in trade payables, a $2.5 million increase in allowance for doubtful accounts, a $2.0 million increase in other current liabilities,  a $1.4 million depreciation, 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.





44





Operating activities related to discontinued operations.For the year ended December 31, 2009, net cash used in discontinued operating activities was $5.5 million. For the year ended December 31, 2008, net cash used in discontinued operating activities was $3.9 million. For the year ended December 31, 2007 net cash used in discontinued operating activities was $3.2 million.





Investing and financing activities related to continuing operations. For the year ended December 31, 2009, net cash used incontinuing investing activities was $8.3 million, mainly due to a $5.6 million investment in available-for-sale securities and a $4.1 million purchase of property and equipment partially offset by a $1.4 million proceeds from maturity of available-for-sale securities and deposits. For the year ended December 31, 2008, net cash provided bycontinuing 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 bycontinuing 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, 2009, net cash provided by continuing financing activities was $2.5 million mainly due to $1.6 million proceeds from long-term bank loans, a $911,000 increase in short-term bank credit, net and $521,000 proceeds from exercise of options and warrants, partially offset by a $543,000 repayment of long-term bank loans. For the year ended December 31, 2008, net cash provided by continuing 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 continuing 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.





Investing activities related to discontinued operations. For the year ended December 31, 2009, net cash provided by discontinued investing activities was $7.1 million, due to advances related to the sale of assets to SMARTAC group in the assets sale agreement (as is more fully described in Item 10 C "Material Contracts).





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.




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, 2009, we had fixed and variable interest rate long-term loan obligations of $3.5 million. Of this amount, $1.5 million was denominated in Polish Zloty, $1.3 million was denominated in euro, $369,000 was denominated in USD, $175,000 was denominated in New Israeli Shekel, and $103,000 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.




45





The annual rate of inflation (deflation) in Israel was 3.9% in 2009, 3.8% in 2008 and 3.4% in 2007. The NIS revalued by approximately 0.7% and 1.1% in 2009 and 2008, respectively, against the U.S. dollar.




The functional currency of InterCard Systemelectronic, Inseal SAS and PARX France is euro, of ASEC Spolka Akcyjna is the Polish Zloty, of OTI Africa is the South-African Rand and  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, the South-African Rand 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.




Corporation Tax Rate




The corporation tax rates applicable as from the 2009 tax year are as follows: In the 2009 tax year – 26%, in the 2010 tax year – 25%, in the 2011 tax year – 24%, in the 2012 tax year – 23%, in the 2013 tax year – 22%, in the 2014 tax year – 21%, in the 2015 tax year – 20% and as from the 2016 tax year the corporation tax rate will be 18%. As of December 31, 2009, our net operating loss carry-forwards for Israeli tax purposes amounted to approximately $101.7 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, 2009, 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.




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, 2009, we have received a total of $4.6 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 4.B. Business Overview.”




D.           TREND INFORMATION




Discussed above in “Item 5.A.  Overview.”




46





E.           OFF BALANCE SHEET ARRANGEMENTS




None.




F.           TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS




As of December 31, 2009, we and our subsidiaries had contractual obligations which are expected to affect our consolidated cash flow in future periods as follows: (in thousands)




Less than 1 year


1-3 years


3-5 years


More than 5 years


TotalOperating lease obligations

$
799


$
582


$
514


$
-


$
1,895Long-term debt obligations

$
870


$
1,135


$
581


$
926


$
3,512Deferred tax liability

$
36


$
31


$
24


$
29


$
120Total

$
1,705


$
1,748


$
1,119


$
955


$
5,527




We shall also pay royalties to the Office of the Chief Scientist as discussed above in B, Liquidity and Capital Resources. The total amount of grants received, until December 31, 2009, net of royalties paid, is approximately $4.6 million, including interest.




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 provided for partially by monthly deposits to insurance policies and/or pension funds and partially by an accrual. 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 Severance Pay Law, 1963 (the "Severance Pay Law"), according to which the severance pay deposits to insurance policies and/or pension funds in the names of such employees exempt the Company from any additional obligation which may otherwise exist under the Severance Pay Law towards these employees, with regards to the salary for which such deposits are made and in respect of the employment period for which they are made. The value of the severance pay deposits in these policies and funds 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, 2009 was $2.3 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, 2009, under long-term bank loans and operating leases, see Notes 9 and 10 to our consolidated financial statements.  For a description of liens on our assets see Note 10C to our consolidated financial statements.




ITEM 6.                 DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES




A.           DIRECTORS AND SENIOR MANAGEMENT




Management





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




Name

Age

PositionOded Bashan (1)(2)

63

Chief Executive Officer, Chairman and DirectorRonnie Gilboa

54

Vice President - Projects and DirectorTanir Horn

34

Chief Financial OfficerMoshe Aduk

53

Vice President - Gasoline Management SystemNehemya Itay

61

Vice President - Hardware EngineeringOhad Bashan

39

President, Chief Marketing Officer and Director; Chief Executive Officer, OTI America, Inc.Eliezr Manor (1)(3)(4)

63

DirectorOra Setter (1)(3)(4)

59

DirectorEli Akavia (1)(3) (4)

62

DirectorRaanan Ellran (1)(2)(3)(4)

60

DirectorShlomo Tussia-Cohen (4)

37

Director (until 29 March 2010)David P. Stone (4)

65

Director (from 29 March 2010)Mark Green (4)

43

Director (from 29 March 2010)





(1) Compensation committee member
 (2) Investment committee member
 (3) Audit committee member
 (4) Independent director




47




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 of PARX France 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.  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




Tanir Horn serves as our Chief Financial Officer since October 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.




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.




48





Ohad Bashanserves as our President (since August 2007), as a director (since 2005) and as our Chief Marketing Officer and prior to that as our Head of Global Marketing and Strategy Development (since June 2000). Mr. Bashan also serves as the Chief Executive Officer of OTI America, Inc. (since 1998). In addition to the forgoing, Mr Bashan serves as a member of the board of directors of OTI America, Millennium Card’s Technology Ltd., PARX Ltd and ASEC.A.  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. Dr. Setter holds a PhD degree in Management Sciences and an MA degree in Religions Science South Asian Studies from 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.




Raanan Ellran served as a director between 1999- 2005, resuming the position in July 2007. Mr. Ellran 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).  Mr. Ellran holds a B.A in Economics & Business Administration and an M.B.A. (Finance) from Bar-Ilan University.





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Shlomo Toussia-Cohen served as a director until March 29, 2010, 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. On March 29, 2010, Mr. Toussia-Cohen stepped down from his position as a director.




David P. Stone serves as a director from March 29, 2010. Mr. Stone retired as a senior partner in the New York-based international law firm of Weil, Gotshal & Manges LLP ("WGM") at the end of 2005.  For approximately 35 years prior to his retirement, Mr. Stone was engaged in the practice of law, specializing in corporate, securities and mergers and acquisitions law.  At WGM, he founded and led the firm's Israel Practice Group which, during his tenure, represented the issuers, underwriters or selling shareholders in connection with more than 90 public offerings of equity or debt securities by Israeli companies in the United States.  Both as a member of WGM and since his retirement from that firm, Mr. Stone has served from time to time as our counsel.  Since retiring, he has been primarily engaged as a trustee of, or manager of substantial projects for, philanthropic institutions with activities in both the United States and Israel.  In addition, during the fall of 2007 he taught a course in The International Regulation of Securities and Capital Markets at the Israel College of Management in Rishon L'Tzion.  Mr. Stone holds a Bachelor of Arts degree from Columbia University and a Juris Doctor degree from Harvard University. He does not currently serve as a director of any publicly-traded companies




Mark Green serves as a director from March 29, 2010. Mr. Green is head of Technology and International Banking at Merriman Curhan Ford, a New York based investment bank. Mr. Green previously headed C.E. Unterberg, Towbin’s (and later Collins Stewart’s) banking efforts in Israel, where he advised technology companies on cross-border public and private financings and mergers & acquisitions. Prior to joining Unterberg, he worked with the Salomon Smith Barney's (later Citigroup's) Israel Investment Banking group. Mr. Green received his Masters in Business Administration from the University of Bath School of Management, England and his Bachelor of Arts from the University of Westminster, London, England. Mr. Green is also an Associate of the Royal Institute of Chartered Surveyors, England




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, 2009 was $1,434,245, of which approximately $67,000 relates to 2009 bonuses to be paid in 2010.  This amount includes approximately $195,236 set aside or accrued to provide pension, severance, retirement or similar benefits or expenses, but does not include business travel, professional and business association dues and expenses reimbursed to officers, and other benefits commonly reimbursed or paid by companies in Israel. Non-executive directors are reimbursed for their expenses for each board meeting attended and in addition receive compensation for their service on the board.  Our executive directors do not receive compensation for their service on the board of directors or any committee of the board of directors.  The aggregate amount paid by us to our non-executive directors listed above under “Management,” in the year ended December 31, 2009 was $182,331.




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, July 27, 2007 and March 29, 2010, was extended until December 31, 2014. Mr. Bashan's agreement shall be automatically extended or terminated by either party upon six months’ notice, where if either party terminates the employment prior to December 31, 2014, we shall be required to continue paying Mr. Bashan his remuneration, including benefits but excluding bonuses, until such date, and in any event and without derogating from the foregoing, for a period that shall not be less than six months following the notice period. In the event of termination (by either party), 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, unless we terminate his employment 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. 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. As part of the amendment to Mr. Bashan's employment agreement, on March 29, 2010, our shareholders approved that the terms of Mr. Bashan's amended employment agreement, as described above, shall apply to his position as a Chairman of our Board of Directors and/or as CEO.




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 (by either party), 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, and in addition, we are required to continue paying him a monthly salary for six months following the notice period described above, 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 his confidentiality or noncompetition undertakings. On July 2007, Mr. Gilboa'semployment 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 Tanir Horn The employment agreements of Tanir Horn, dated June 25, 2007, as was amended by our board of directors on March 1, 2010, provides for a two year term ending on December 31, 2011.  Ms. Horn's agreement shall be automatically extended or terminated by either party upon six months’ notice. In case of termination of Ms. Horn's employment following a merger or acquisition of our company in which we are not the surviving entity, Ms. Horn shall be entitled to continue to receive her monthly salary and all benefits until December 31, 2011.In the event of termination (by either party), Ms. Horn.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 unless the termination occurred as a result of circumstances depriving her of the right to severance pay at law or as a result of a breach of fiduciary duty or a material breach of her confidentiality or noncompetition undertakings.




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 (by either party), 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, and in addition, we are required to continue paying each of them a monthly salary for three months following the notice period described above, 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 their confidentiality or noncompetition undertakings.




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Agreement with Ohad Bashan.  The employment agreement of Ohad Bashan, as was approved at our shareholders meeting dated December 11, 2009, provides for a five-year term ending on August 24, 2014.  Either party may terminate the employment on a six months notice period. In the event of termination (by either party), Mr. Bashan 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 case of termination of Mr. Bashan's employment following a merger or acquisition of our company in which we are not the surviving entity, Mr. Bashan shall be entitled to continue to receive his monthly salary and all benefits until the completion of his employment term. 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.


C.           BOARD PRACTICES




Election of Directors; Appointment of Officers




Our current board of directors consists of nine directors (which is the maximum number of directors that can serve on our board of directors at any time under our articles of association).  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 Israeli 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 December 11, 2009 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.




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External directors are elected by a majority vote at a shareholders’ meeting at which either the majority of shares voted at the meeting, including at least one-third of the shares held by non-controlling shareholders voted at the meeting, vote in favor of the election of the external director, or the total number of shares held by non-controlling shareholders voted against the election of the external director does not exceed one percent of the aggregate voting rights in the company.




The initial term of an external director is three years and under regulations 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.




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 Rule 5603(a) (2) to the NASDAQ Rules.  Our directors Raanan Ellran, Eliezer Manor and Ora Setter, qualify as external directors under the Companies Law and independent directors under the NASDAQ Rules.  In addition, our director Eli Akavia, CPA is qualified as an independent director under the NASDAQ Rules.




Under Rule 5605(b)(1) to the NASDAQ Rules, the majority of our board of directors should be comprised of independent directors. Between August 25, 2009 and December 11, 2009 the majority of our board of directors was not comprised of independent directors  (the board included six directors, out of which three directors were independent directors), since the term of office of two of our independent directors had expired in accordance with the provisions of the Israeli Companies Law. The term of office of these two independent directors was extended by our shareholder's meeting dated December 11, 2009, for an additional three year term effective from August 25, 2009. Notwithstanding the above, it is hereby clarified that during the entire year 2009 we complied with the requirement of the Israeli Companies Law to have at least two external directors on our board of directors and regarding the composition of our audit committee. In addition, during all relevant times we also complied with the NASDAQ Global Market listing requirement regarding the composition of our audit committee.




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.




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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




We pay each director (other than directors who are also officers of the Company) annual compensation in the amount of NIS 73,124 (around $18,607), and in addition an amount of NIS 2,813 (around $716) 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, steering committee and investment 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.




The current members of our compensation committee are Oded Bashan, Eliezer Manor, 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 Rules.


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 NASDAQ Rules, we are required to maintain an audit committee which is comprised of 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 Ora Setter, Eliezer Manor, Raanan Ellran and Eli Akavia, all of which are “independent directors.”  Eli Akavia is the Audit Committee’s Chairman. Our board has determined that both Eli Akavia and Raanan Ellran are “Audit Committee Financial Experts" within the meaning of SEC rules and have the requisite experience under NASDAQ Rules”




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Investment Committee




Our board of directors established an investment committee in August 2009.  The duties of the investment committee are to determine and implement our investment policy regarding short-term and medium-term liquidity investments with a view to preserve the value of our cash and cash equivalents, in accordance with the general guidelines set out by our board of directors.




The current members of the investment committee are Oded Bashan and Raanan Ellran (with Tanir Horn as our CFO attending the meetings of such committee).




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 February 28, 2010, 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 2010, and on March 1, 2010 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.




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 Rule 5630(a) to the NASDAQ Rules, 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.




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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 Rule 5605(d)(1) to the NASDAQ Rules, 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 Rule 5605(d)(2) to the NASDAQ Rules 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.


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 31Department

2007


2008


2009Sales and marketing


41



41



37Research and development


120



115



114Manufacturing and operations


373



322



576Customer support


22



23



20Management and administration


126



124



112Total


682



625



859





56





The increase in the number of our employees in 2009 compared to 2008 was mainly in manufacturing and operation in the Far East. We anticipate that the number of our manufacturing and operations employees in the Far East will decrease during 2010 as a result of the sale of the assets of MCT and the sale of our assets related to inlay production and machinery therefore to SMARTRAC Singapore Trading PTE, a member of the SMARTRAC N.V. group (as is more fully described in Item 10 C. "Material Contracts"). Of our employees, on December 31, 2009, 110 were based in Israel, 8 in the United States, 99 in Europe, 36 in South Africa and 606 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 March 29, 2010 regarding the ownership of our ordinary shares by each of our directors and executive officers.





All information with respect to the 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 owned, subject to community property laws, where applicable. The shares 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, as provided for below.




57




The share numbers and percentages listed below are based on 24,376,137 shares outstanding as of March 29, 2010:


Name of beneficial owner (1)
Number of Shares Owned (2)
% of Class of Shares
Number of Options Owned (3)
Exercise Price
Date of ExpirationOded Bashan (4)
2,187,689
8.97%Ronnie Gilboa (5)
246,089
1.01%
2,000

2,000

2,500
USD 32.00

USD 9.00

NIS 0.10
March 1,2011

March 1,2011

April 13,2012Tanir Horn (6)
176,938
***
45,000

20,000

90,000
$1.4

NIS 0.10

$1.36
November 30, 2013

May 24, 2014

March 1, 2015Moshe Aduk (7)
227,397
***

662

10,000

20,000
NIS 0.10

NIS 0.10

NIS 0.10
May 14,2012

March 7,2012

April 13,2012Nehemya Itay (8)
232,819
***

675
NIS 0.10
May 14,2012Ohad Bashan (9)
737,268
2.96%

500,000
$ 1.00
March 29, 2015Shlomo Tussia-Cohen (10)
70,000
***

40,000
$ 11.23
September 22, 2010Eliezer Manor (11)
80,000
***

50,000

30,000
$ 11.23

NIS 0.10
September 22, 2010

April 13,2012Ora Setter  (12)
30,000
***

30,000
NIS 0.10
April 13,2012Eli Akavia (13)
50,000
***

50,000
$ 11.23
September 22, 2010Raanan Ellran (14)
31,200
***

1,200

30,000
$ 42.50

NIS 0.10
March 11, 2011

April 13,2012All executive officers and directors as a group
3,387,200
13.39%

924,036




*** Less than 1%(1)
The number of ordinary shares shown includes shares that each shareholder has the right to acquire by exercising options.(2)
If a shareholder has the right to acquire shares by exercising options, 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)
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 1,318,564 ordinary shares as to which Mr. Bashan has voting power pursuant to irrevocable proxy granted to him. Mr. Bashan does not own any of the 1,318,564 ordinary shares.(5)
Includes 224,589 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 6,500 ordinary shares.(6)
Includes 21,938 ordinary shares held by Ms. Horn and options to purchase 155,000 ordinary shares.(7)
Includes 196,735 ordinary shares held by Mr. Aduk and options to purchase 30,662 ordinary shares.(8)
Includes 232,144 ordinary shares held by Mr. Itay and options held by Mr. Itay and his wife to purchase 675 ordinary shares.(9)
Includes 237,268 ordinary shares held by Mr. Bashan and options held by Mr. Bashan to purchase 500,000 ordinary shares.(10)
Includes 30,000 ordinary shares held by Mr. Toussia Cohen and options to purchase 40,000 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




58




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 11 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 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 March 29, 2010, an aggregate of 1,297,861of our ordinary shares have been issued to eligible employees under this plan.




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 ASC TOPIC 718 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.




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 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 March 29, 2010, 7,235,753 options had been exercised and 2,016,914 options are outstanding and exercisable.  Of the options that are outstanding, as of March 29, 2010, 924,036 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 $2.59.
 
 59





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.”




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 March 29, 2010, 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.







December 31, 2007


December 31, 2008


March 29, 2010Name of Beneficial Owner

Number of Shares Beneficially Owned


% of Class of Shares


Number of Shares Beneficially Owned


% of Class of Shares


Number of Shares Beneficially Owned


% of Class of SharesOded Bashan (1)


3,906,989



19.9
%


2,643,384



12.2
%


2,187,689



8.97
%Diker Management, LLC (2)


1,848,741



9.42
%


1,883,888



8.75
%


1,976,588



8.10
%Fortress Partners Securities LLC, Fortress Partners Fund LP, Fortress Partners GP LLC, Fortress Principal Investment Holdings IV LLC, Fortress Partners Offshore Securities LLC, Fortress Partners Master Fund L.P., Fortress Partners Offshore Master GP LLC, Fortress Partners Advisors LLC, Fortress Investment Holdings II LLC, Fortress Operating Entity I LP, FIG Corp., and Fortress Investment Group LLC (3)


--



--



--



--



1,732,925



7.11
%





(1)
Includes ordinary shares held by Mr. Bashan. Also includes ordinary shares held by Mr. Bashan’s wife. 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 each of the dates 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 1,798,326 shares and sole voting power over 178,262 shares as of December 31, 2009.(3)
This information is based solely on Forms 13G filed with the SEC by Fortress Partners Securities LLC, Fortress Partners Fund LP, Fortress Partners GP LLC, Fortress Principal Investment Holdings IV LLC, Fortress Partners Offshore Securities LLC, Fortress Partners Master Fund L.P., Fortress Partners Offshore Master GP LLC, Fortress Partners Advisors LLC, Fortress Investment Holdings II LLC, Fortress Operating Entity I LP, FIG Corp., and Fortress Investment Group LLC (hereinafter referred to jointly as "Fortress Group") on February 12, 2010. The percentage of beneficial ownership was computed by us based on the information included in the Form 13G and the total number of outstanding ordinary shares as of March 29, 2010. Based on the information provided in such Form 13G, the address of Fortress Group is c/o Fortress Investment Group LLC, 1345 Avenue of the Americas, 46th Floor, New York, NY 10105. Fortress Group reports shared voting power over 1,732,925 shares as of February 4, 2010.




60







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 March 29, 2010, there were 72 holders of record of our ordinary shares, of which 12 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 93% 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 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 $73,000 in 2007, $109,000 in 2008 and $90,000 in 2009.




61





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.




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 SMARTRAC group ("the 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. On September 30, 2009, as part of the agreements between the Company and SMARTRAC (as are more fully described in Item 10 C. "Material Contracts") this lawsuit and these claims were dismissed.





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. On October 14, 2009, the National Labor Court has rendered its decision that Mr. Whul is entitled to receive additional payments of 36,982 NIS and 5,825 NIS for costs (approximately $11,500 in total).





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. On September 24, 2009 the Court dismissed the motion to approve a class action against the Company and other defendants.




62




On June 16, 2008, SMARTRAC IP B.V. ("the 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. On September 28, 2009, as part of the agreements between us and SMARTRAC (as are more fully described in Item 10 C. "Material Contracts"), the Lawsuit was withdrawn.




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 Companies law. In May 2009 the court approved a repurchase program in a total amount of up to $2 million. In August 2009 our board of directors approved the specific terms of the repurchase program, including the timing and the amount that may be purchased. As of today's date, no shares were acquired under the repurchase program.


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 (now known as NASDAQ Capital 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 on the Neuer Market of the Frankfurt Stock Exchange.  The closing prices that are indicated below 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 the high and low closing prices of our ordinary shares in U.S. dollars as reported on NASDAQ Global Market.




63


Prime Standard

Segment of the

Frankfurt Stock

Exchange (1)

per

Share €


Prime Standard

Segment of the

Frankfurt Stock

Exchange (1)

per

Share $


NASDAQ Global

Market

per

Share $High


Low


High


Low


High


LowYear2005


13.0



8



16.1



10.4



13.80



10.32006


--



--



--



--



17.23



6.162007


--



--



--



--



8.43



3.602008


--



--



--



--



3.57



1.072009


--



--



--



--



1.94



0.832008First quarter


--



--



--



--



3.57



2.65Second quarter


--



--



--



--



3.06



2.31Third quarter


--



--



--



--



3.10



2.10Fourth quarter


--



--



--



--



2.70



1.072009First quarter


--



--



--



--



1.94



0.96Second quarter


--



--



--



--



1.69



0.88Third quarter


--



--



--



--



1.68



1.01Fourth quarter


--



--



--



--



1.41



0.832010First quarter


--



--



--



--



2.65



1.40MonthSeptember 2009


--



--



--



--



1.22



1.01October 2009


--



--



--



--



0.99



0.83November 2009


--



--



--



--



1.15



0.87December 2009


--



--



--



--



1.41



1.03January 2010


--



--



--



--



2.65



1.40February 2010


--



--



--



--



2.50



2.19March 2010 (until March 29)


--



--



--



--



2.38



2.12




(1)
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.




D.           SELLING SHAREHOLDERS




Not applicable.




E.           DILUTION




Not applicable.




64





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 ActionAugust 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 March 29, 2010, our authorized share capital consists of 50,000,000 ordinary shares, nominal value of NIS 0.1 per share, of which 24,376,137 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.




65





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. Rule 5620(c) to NASDAQ Rules requires that an issuer listed on NASDAQ should have a quorum requirement that in no case be less than 33 1/3% of the outstanding shares of the company’s common voting stock. However, as mentioned above, our articles of association, consistent with the Companies Law, provide for a lower quorum requirement in an adjourned meeting.




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.
 
 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.
 
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Special Notification Duties




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




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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 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.





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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 $10 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.


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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.




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.




SMARTRAC Transaction




During the fourth quarter of 2009 we and our subsidiary, MCT, entered into an asset purchase agreement with SMARTRAC Singapore Trading PTE for the sale of  assets of MCT the sale of our assets related to inlay production and machinery therefore , for a total purchase price of euro 8.5 million (approximately $12.5 million) to be paid in cash, whereof euro 5 million were paid during 2009 and the balance of euro 3.5 million will be paid in eight equal quarterly installments starting the first quarter of 2010. Simultaneously with the execution of the asset purchase agreement, we also entered into a supply agreement with SMARTRAC N.V., a Netherlands' company and an indirect holding company of SMARTRAC Singapore Trading PTE, by which SMARTRAC N.V became our exclusive supplier for wire-embedded and dual interface inlays, according to our needs, and our supplier for other products, at defined terms.




The exclusivity apply to Card-Prelams (inlays) of all sizes, white RFID cards, government document inlays, Dual Interface Product, e-Passports inlays, each using a wire embedded transponder. In the asset purchase agreement the parties also agreed to mutually accept and respect each others' patents and to cease all patent litigations and in particular all patent infringement legal proceedings between SMARTRAC group and us.




BOT contract for an eID related product




In November 2009 we entered into a contract with a government agency for the supply, transfer, maintenance and operation of an electronic identification related product. The project is funded based on a Build-Operate-Transfer (BOT) model. The project will be carried out via a joint venture between us and a reputable system integrator that will be responsible for project management and local operation in the country, in which joint venture we will have 50% (in ownership and profit). The contract provides for an initial three-year period and minimum guaranteed amount of $17 million, starting in 2010.


Contracts for a turnkey National eID project




In December 2009 we entered into contracts with a government agency relating to a turnkey national eID project. The contracts include the supply of electronic ID system and ID cards. The total consideration of the transaction exceeds $30 million. An advance payment has already been received in 2009 to support the initial stages of the project.




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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.




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 29%of  taxable income in the 2007 tax year, 27% in the 2008 tax year, 26% in the 2009 tax year and 25% in the 2010 tax year, 24% in the 2011 tax year, 23% in the 2012 tax year, 22% in the 2013 tax year, 21% in the 2014 tax year, 20% in the 2015 tax year, and as from the 2016 tax year the company tax rate will be 18%. 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.




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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.




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 RateOver 25% but less than 49%


25
%49% or more but less than 74%


20
%74% or more but less than 90%


15
%90% or more


10
%





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




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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:




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.




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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 Grantless than 50%

120%between 50% and less than 90%

150%90% and more

300%





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




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




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




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




74




·
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.




·
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.




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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.




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.




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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




·
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.




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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.





U.S. Federal Income Taxation





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.





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, or 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, or the 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 addition, 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 such person’s own tax advisor with respect to the specific U.S. federal and state income tax consequences to such person of purchasing, holding or disposing of the ordinary shares, including the effects of applicable state, local, foreign or other tax laws and possible changes in the tax laws.





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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” 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 ordinary sharesare 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, or PFIC. 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.





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, they 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.





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Disposition of 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 Companies





Special U.S. federal income tax laws 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) PFIC.  We would be treated as a PFIC for U.S. federal income tax purposes for any tax year if, in such tax year, either:





·
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 production of, or produce, passive income (the “Asset Test”).




For this purpose, 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 we 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 tax basis in the PFIC shares. Losses 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.




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Based on our estimated gross income, the average value of our gross assets (assuming that we are entitled to value our intangible assets using the methods suggested for publicly traded corporations) and the nature of our business, we believe 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.





Information Reporting and Withholding





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) 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) 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 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.




81




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.




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 and NIS with financial banks and bear annual interest of approximately 0.5%.




As of December 31, 2009, we had fixed and variable interest rate long-term loan obligations of $3.5 million. Of this amount, $1.5 million was denominated in Polish Zloty, $1.3 million was denominated in euro, $369,000 was denominated in USD, $175,000 was denominated in New Israeli Shekel, and $103,000 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.




82





Foreign Currency Exchange and Inflation Risks





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 3.9% in 2009, 3.8% in 2008 and 3.4% in 2007. The NIS revalued by approximately 0.7% and 1.1% in 2009 and 2008, respectively, against the U.S. dollar.




The functional currency of InterCard Systemelectronic, Inseal SAS and PARX France is euro, of ASEC Spolka Akcyjna is the Polish Zloty, of OTI Africa is the South-African Rand and  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, the South-African Rand 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 anticipate that our exposure to the exchange rate of the US dollar against the Yuan Renminbi will decrease following the sale of assets of MCT the sale of our assets related to inlay production and machinery therefore (as is more fully described in Item 10 C "Material Contracts").




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




The Company does not have any outstanding American Depositary Shares or American Depositary Receipts.





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.
  83
 
 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.
  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




(a)           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, 2009.  Based upon that evaluation, our management, including our CEO and CFO, concluded that our disclosure controls and procedures are effective.




84




(b)           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, 2009.




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.




(c)           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, 2009  that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.




ITEM 16A.                  AUDIT COMMITTEE FINANCIAL EXPERTS




Our board of directors has determined that Eli Akavia and Raanan Ellran, members of our audit committee, are audit committee financial experts, as that term is defined in Item 16A of Form 20-F and are independent as that term is defined in NASDAQ Listing Rule 5605(a)(2).


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.




85





Principal Accountant Fees and Services




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




2008


2009(in thousands)Audit fees (1)

$
301


$
318Tax fees (2)

$
13


$
12$
314


$
330




(1) The audit fees for the years ended December 31, 2009 and 2008, are the aggregate fees billed or billable (for the year) for the professional services rendered for the audits of our 2009 and 2008 annual consolidated financial statements, review of consolidated quarterly financial statements of 2009 and 2008, 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
  Not 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 Rules.
  86
 
 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 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.
  Rule 5620(c) to NASDAQ Listing Rules requires that an issuer listed on NASDAQ should have a quorum requirement that in no case be less than 33 1/3% of the outstanding shares of the company’s common voting stock.  However, the Company’s articles of association, consistent with the Companies Law, provide for a lower quorum in the event that a quorum is not present within half an hour following the time appointed for a meeting that was adjourned.  Our quorum requirements for an adjourned meeting do not comply with the NASDAQ requirements and we instead follow our home country practice.


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-2Consolidated Balance Sheets
F-3—F-4Consolidated Statements of Operations
F-5Consolidated Statements of Changes in Shareholders’ Equity and  Non Controlling Interest
F-6Consolidated Statements of Comprehensive Loss
F-7Consolidated Statements of Cash Flows
F-8—F-9Notes to the Consolidated Financial Statements
F-10—F-40





87





ITEM 19.                      EXHIBITS




Exhibit No.

Description1

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 Indemnificationbetween 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)4.10

Contract between the Registrant and a government agency for the supply of the electronic ID system and ID cards (filed herewith)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.




88




On Track Innovations Ltd.
 and its Subsidiaries
  Consolidated Financial Statements
 As of December 31, 2009
  On Track Innovations Ltd.
 and its Subsidiaries
 
 Consolidated Financial Statements as of December 31, 2009
 Contents
  PageReport of Independent Registered Public Accounting Firm
F-2Consolidated Balance Sheets
F-3 - F-4Consolidated Statements of Operations
F-5Consolidated Statements of Shareholders' Equity and Noncontrolling Interest
F-6Consolidated Statements of Comprehensive Loss
F-7Consolidated Statements of Cash Flows
F-8 - F-9Notes to the Consolidated Financial Statements
F-10 - F-40
 
 
 
 Report of Independent Registered Public Accounting Firm
 
 The Board of Directors and Shareholders
 On 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, 2009 and 2008 and the related consolidated statements of operations, shareholders’ equity and non controlling interest, comprehensive loss and cash flows for each of the years in the three-year period ended December 31, 2009. 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 statement presentation.  We believe that our audits provide a reasonable basis for our opinion.
 
 In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company and its subsidiaries as of December 31, 2009 and 2008 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.
  /s/Somekh Chaikin
 Certified Public Accountants (Isr.)
 A Member Firm of KPMG International
 
 Tel Aviv, Israel
 March 28, 2010
 
 F - 2
 
 On Track Innovations Ltd.
 and its Subsidiaries
 
 Consolidated Balance Sheets
 US dollar in thousands except share and per share data
  December 312008


2009AssetsCurrent assetsCash and cash equivalents

$
27,196


$
26,884Short-term investments


904



5,086Trade receivables (net of allowance for doubtful

accounts of $3,315 and $2,777 as of December 31, 2008

and December 31, 2009, respectively)


4,567



6,595Other receivables and prepaid expenses


2,994



2,478Inventories


12,343



6,265Total current assets


48,004



47,308Severance pay deposits fund


1,189



1,112Property, plant and equipment, net


18,613



14,366Intangible assets, net


2,503



1,532Assets from discontinued operation – held for sale


-



12,358Total Assets

$
70,309


$
76,676
  The accompanying notes are an integral part of the consolidated financial statements.
  F - 3
  On Track Innovations Ltd.
 and its Subsidiaries
 
 Consolidated Balance Sheets
 US dollar in thousands except share and per share data
 
 December 312008


2009Liabilities and Shareholders' EquityCurrent LiabilitiesShort-term bank credit and current maturities

of long-term bank loans

$
4,984


$
6,255Trade payables


8,071



9,649Other current liabilities


3,517



16,174Total current liabilities


16,572



32,078Long-Term LiabilitiesLong-term loans, net of current maturities


1,762



2,642Accrued severance pay


3,672



3,373Deferred tax liability


202



120Total long-term liabilities


5,636



6,135Total Liabilities


22,208



38,213Liabilities related to discontinued operation


-



8,495Commitments and ContingenciesEquityShareholders' EquityOrdinary shares of NIS 0.1 par value: Authorized –

50,000,000 shares as of December 31, 2008 and

December 31, 2009; issued 21,534,788 and 23,946,316

shares as of December 31, 2008 and December 31, 2009,

respectively; outstanding 21,495,409 and 23,946,316 shares

as of December 31, 2008 and December 31, 2009, respectively


508



571Additional paid-in capital


182,944



187,473Accumulated other comprehensive income (loss)


(325
)


570Accumulated deficit


(135,441
)


(158,623
)Shareholder’s equity


47,686



29,991Noncontrolling interest


415



(23
)Total Equity


48,101



29,968Total Liabilities and Shareholders’ Equity

$
70,309


$
76,676
  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 312007


2008


2009RevenuesSales

$
33,467


$
32,387


$
28,488Licensing and transaction fees


2,631



2,635



2,949Total revenues


36,098



35,022



31,437Cost of revenuesCost of sales


20,372



19,789



16,782Total cost of revenues


20,372



19,789



16,782Gross profit


15,726



15,233



14,655Operating expensesResearch and development


11,218



10,300



8,127Selling and marketing


9,148



10,370



10,371General and administrative


12,838



11,210



9,230Amortization and impairment of intangible assets


1,314



2,794



978Impairment of goodwill


-



24,217



-Total operating expenses


34,518



58,891



28,706Operating loss


(18,792
)


(43,658
)


(14,051
)Financial income (expense), net


1,678



(474
)


(1,153
)Other expenses, net


(23
)


-



-Loss before taxes on income


(17,137
)


(44,132
)


(15,204
)Tax benefits (taxes on income)


226



675



(89
)Equity in loss of affiliate


(358
)


(1,270
)


-Net loss from continuing operations


(17,269
)


(44,727
)


(15,293
)Net loss from discontinued operations


(4,412
)


(5,211
)


(8,078
)Net loss


(21,681
)


(49,938
)


(23,371
)Net loss (income) attributable to noncontrolling interest


1,038



(57
)


189Net loss attributable to shareholders


(20,643
)


(49,995
)


(23,182
)Basic and diluted net loss attributable to shareholders per ordinary shareFrom continuing operations

$
(0.86
)

$
(2.19
)

$
(0.67
)From discontinued operations

$
(0.23
)

$
(0.26
)

$
(0.35
)$
(1.09
)

$
(2.45
)

$
(1.02
)Weighted average number of ordinary shares used in computing basic and diluted net loss per ordinary share


18,896,214



20,413,578



22,635,479
 
 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 Noncontrolling Interest
 US dollar in thousands, except share and per share data
 
 
 AccumulatedAdditional


other








TotalNumber of


Share


paid-in


comprehensive


Accumulated


Noncontrolling


shareholders'Shares issued


capital


capital


income


deficit


interest


equityBalance as of December  31, 2006


18,592,880


$
431


$
163,102


$
424


$
(64,803
)

$
1,004


$
100,158Changes during the year ended

December 31, 2007:Stock-based compensation related to options and

shares issued to employees and others


-



-



7,797



-



-



-



7,797Exercise of options and warrants


458,788



11



-



-



-



-



11Shares, warrants and options issued in

connection with the purchase of property

plant and equipment


575,400



12



3,595



-



-



-



3,607Foreign currency translation adjustments


-



-



-



487



-



34



521Net unrealized loss on available- for-sale

securities


-



-



-



(65
)


-



-



(65
)Net loss


-



-



-



-



(20,643
)


(1,038
)


(21,681
)Balance as of December  31, 2007


19,627,068


$
454


$
174,494


$
846


$
(85,446
)

$
-


$
90,348Changes during the year ended

December 31, 2008:Stock-based compensation related to options and

shares issued to employees and others


-



-



6,460



-



-



-



6,460Exercise of options, warrants and receipts in respect

of employeeshare purchase plan


1,607,022



45



1,111



-



-



-



1,156Receipt on account of shares


-



-



308



-



-



-



308Shares and options issued in connection withthepurchase of asubsidiary


300,698



9



916



-



-



-



925Adjustment to contingent consideration in connection with thepurchase of a subsidiary


-



-



(345
)


-



-



-



(345
)Foreign currency translation adjustments


-



-



-



(1,144
)


-



6



(1,138
)Increase of the Company's ownership interests in a subsidiary


-



-



-



-



-



352



352Net unrealized loss on available- for-salesecurities


-



-



-



(27
)


-



-



(27
)Net loss


-



-



-



-



(49,995
)


57



(49,938
)Balance as of December  31, 2008


21,534,788


$
508


$
182,944


$
(325
)

$
(135,441
)

$
415


$
48,101Changes during the year ended

December 31, 2009:Stock-based compensation related to options and

shares issued to employees and others


-



-



3,662



-



-



-



3,662Exercise of options, warrants and receipts in respect of

employee share purchase plan


2,411,528



63



458



-



-



-



521Adjustment to contingent consideration in connection with the purchase of a subsidiary


-



-



162



-



-



-



162Foreign currency translation adjustments


-



-



-



894



-



(2
)


892Increase of the Company's ownership interests in a subsidiary


-



-



247



-



-



(247
)


-Net unrealized loss on available- for-salesecurities


-



-



-



1



-



-



1Net loss


-



-



-



-



(23,182
)


(189
)


(23,371
)Balance as of December  31, 2009


23,946,316


$
571


$
187,473


$
570


$
(158,623
)

$
(23
)

$
29,968
  The accompanying notes are an integral part of the consolidated financial statements.
 
 F - 6
  On Track Innovations Ltd.
 and its Subsidiaries
 
 Consolidated Statements of Comprehensive Loss
 US dollar in thousands, except share and per share data
  Year ended December 312007


2008


2009Total comprehensive loss:Net loss

$
(21,681
)

$
(49,995
)

$
(23,371
)Foreign currency translation adjustments


521



(1,138
)


892Net unrealized gain (loss) on available-for-sale securities


43



(14
)


(13
)Reclassification adjustment for gain on

available-for-sale securities


(108
)


(13
)


14Total comprehensive loss

$
(21,225
)

$
(51,160
)

$
(22,478
)Comprehensive loss attributable to the non-controlling interest


(1,004
)


63



(191
)Total comprehensive loss attributable to shareholders

$
(22,229
)

$
(51,097
)

$
(22,669
)
 
 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 312007


2008


2009Cash flows from operating activitiesNet loss from continuing operations

$
(17,269
)

$
(44,727
)

$
(15,293
)Adjustments required to reconcile net loss to net cash used in operating activities:Stock-based compensation related to options and shares issuedto employees and others


6,947



6,253



3,662Loss (gain) on sale of property and equipment


13



25



(3
)Amortization and impairment of intangible assets and goodwill


1,314



27,011



978Depreciation


1,402



1,708



1,413Equity in net losses of an affiliated company


358



1,270



-Accrued severance pay, net


283



78



(222
)Accrued interest and linkage differences on long-term loans


(294
)


(27
)


36Decrease in deferred tax liability


(262
)


(711
)


(82
)Decrease (increase) in trade receivables


104



2,702



(1,326
)Increase (decrease) in allowance for doubtful account


2,533



548



(538
)Decrease (increase) in other receivables and prepaid expenses


(686
)


567



663Decrease (increase) in inventories


(2,776
)


869



429Increase (decrease) in trade payables


3,314



(1,859
)


1,334Increase (decrease) in other current liabilities


1,966



(2,008
)


12,788Net cash provided by (used in) continuing operating activities


(3,053
)


(8,301
)


3,839Cash flows from investing activitiesReceipts on account of loans and receivables


837



-



-Acquisition of consolidated subsidiary, net of cash acquired


-



(565
)


-Purchase of property and equipment


(6,190
)


(1,518
)


(4,124
)Purchase of available-for-sale securities


(136,094
)


(29,068
)


(5,623
)Proceeds from maturity of available-for-sale securities


148,049



34,551



1,418Other, net


-



30



22Net cash provided by (used in) continuing investing activities


6,602



3,430



(8,307
)Cash flows from financing activitiesIncrease (decrease) in short-term bank credit, net


4,804



(358
)


911Proceeds from long-term bank loans


739



-



1,636Repayment of long-term bank loans


(495
)


(508
)


(543
)Proceeds from receipt on account of shares and exercise of options andwarrants, net


11



1,464



521Net cash provided by continuing financing activities


5,059



598



2,525Cash flows from discontinued operationsNet cash used in discontinued operating activities


(3,234
)


(3,875
)


(5,544
)Net cash provided by discontinued investing activities


-



-



7,060Total net cash provided by (used in) discontinued activities


(3,234
)


(3,875
)


1,516Effect of exchange rate changes on cash


47



(126
)


115Increase (decrease) in cash and cash equivalents


5,421



(8,274
)


(312
)Cash and cash equivalents at the beginning of the year


30,049



35,470



27,196Cash and cash equivalents at the end of the year

$
35,470


$
27,196


$
26,884
  The accompanying notes are an integral part of the consolidated financial statements.
  F - 8
 
 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 312007


2008


2009Supplementary cash flows activities:A.           Cash paid during the period for:Interest

$
112


$
58


$
37Income taxes

$
19


$
5


$
125B.           Non-cash transactions:Purchase of property and equipment

$
3,607


$
137


$
-Other receivables

$
850


$
70


$
70C.           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


-



(31
)


-Goodwill


-



(830
)


-Customer contracts and relationships


-



(561
)


-Non competition agreement


-



(194
)


-Technology


-



(59
)


-Long term liabilities


-



-



-Deferred tax liability


-



185



--



(1,490
)


-Issuance of shares in consideration for the acquisition


-



775



-Direct costs of acquisitions paid via grant of options


-



150



-$
-


$
(565
)

$
-
  The accompanying notes are an integral part of the consolidated financial statements.
 
 F - 9
 
 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:
 
 
 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. As of December 31, 2009 this difference amounted to $186, and the Company recorded liability in the same amount.
  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. Amortization is computed over the estimated useful lives of the respective assets, generally three to ten years. The Company also recognized goodwill in the amount of $830 (for goodwill impairment in 2008 see note 6A).
 
 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: (cont'd)
 
 2.            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").
 
 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 which is headquartered in Hong Kong.
  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 issued 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%. As a result, the Company recognized an increase to non-controlling interests and inventory in the amount of $352 each.
 
 In July 2009, MCT has allotted additional 76,000 shares of HK$1.00 to the Company against the waiver of the debt of MCT to the Company in the principle amount of $2,500 so that such debt shall be converted into the said 76,000 shares. Following the shares allotment, the Company holds 99.5% of MCT’s share capital. As a result, the Company recognized a decrease in non-controlling interests and additional paid-in capital in the amount of $247 each.
  During December 2009 the Company and MCT entered into an assets purchase agreement with SMARTRAC Singapure Trading PTE (“SMARTRAC”) for the sale of certain assets and production intellectual property (IP) relating to inlay production from the Company and MCT, for a total purchase price of euro 8,500 ( approximately $12,253) to be paid in cash, whereof euro 5,000 were paid during 2009 and the balance of euro 3,500 will be paid in eight equal quarterly installments starting the first quarter of 2010. Accordingly, assets and liabilities related to the discontinued operation are presented separately in the balance sheets and are anticipated to be disposed of in 2010. The results from this operation and the cash flows for the reporting periods are presented in the statements of operations and in the statements of cash flow, as discontinued operations separately from continuing operations. (See note 13).
 
 F - 11
 
 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
 
 The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”).
 
 In June 2009, the Financial Accounting Standards Board (“FASB”) issued the FASB Accounting Standards Codification (“Codification” or “ASC”).  The Codification became the single authoritative source for U.S. GAAP and changed the way in which the accounting literature is organized. The guidance is effective for financial statements issued for interim and annual periods ending after September 15, 2009.  The Company adopted the ASC for the year ended December 31, 2009 and implemented the Codification in its consolidated financial statements by providing references to the ASC Topics.  The Codification does not change GAAP and does not have an effect on the Company’s financial position or results of operations.
 
 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 ASC Topic 830, Foreign Currency Matters.  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 ASC Topic 830, 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 loss).
 
 F - 12
 
 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 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 $0 of U.S. Treasury securities with an original term of less than three months at December 31, 2008 and 2009, respectively.
 
 E.           Short-term investments
 
 The Company accounts for investments in U.S and ILS treasury securities, corporate bonds in accordance with ASC Topic 320, Investments – 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, 2008 and 2009, 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 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.
  In April 2009, the FASB issued ASC Topic 320, Recognition and Presentation of Other-Than-Temporary Impairments, which amends the recognition guidance for other-than-temporary impairments (OTTI) of debt securities and expands the financial statement disclosures for OTTI on debt and equity securities. When an other-than-temporary impairment has occurred, the amount of the other-than-temporary impairment recognized in earnings depends on whether the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss. If the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary impairment is recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary impairment is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to other factors is recognized in other comprehensive income, net of applicable income taxes.
    F - 13
 
 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)
  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 information available about specific debtors, including their financial condition, the amount of receivables in dispute, current payment patterns, the volume of their operations, and evaluation of the security received from them or their guarantors.
 
 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 2007, 2008 and 2009, have been included in cost of revenues.
 
 The Company applies ASC Topic 330, Inventory which 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, the above topic 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 had fully written off its investment in the affiliated company, its Chinese joint venture, resulted from uncertainty in future revenues timing.
 
 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:
  YearsLeasehold land (over the terms of the lease, see note 7A(1))
49Buildings
25Computers, software and manufacturing equipment
3-5Office furniture and equipment
5-16Motor vehicles
6
 
 F - 14
 
 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)
 
 J.           Impairment 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 with respect to its intangible assets in the amount of $1,427 in 2008 (See Note 6B). No impairment losses were recoded in 2009 and 2007.
 
 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.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. 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. 6A). No impairment losses were recorded in 2009 and 2007.
  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 ten 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 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 arrangement 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.
 
 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)
 
 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 reduction of a research and development expense as the related costs are incurred.
 
 N.
Stock-based compensation
 
 Employees
 
 The company measures and recognizes compensation expense for all share-based payment awards made to employees and directors based on estimated fair values.
 
 ASC Topic 718, Compensation – Stock Compensation, requires estimating the fair value of share based payments awards on the date of the grant using an option pricing model. The Company uses the Black and Scholes option pricing model.
  During 2007, 2008 and 2009 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’s market price at the grant date.
  The fair value of each option granted during 2007, 2008 and 2009, 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%, 1.63% and 1.47% for, 2007, 2008 and 2009, respectively.
 3.
Estimated expected lives of 2.5-5 years for all periods, or contractual life.
 4.
Expected average volatility of 46%, 49% and 63% for 2007, 2008 and 2009, 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 11C.
 
 Non-Employees
 The Company uses an option valuation model to measure the fair value of these options at the grant date and at each subsequent reported periods until the exercise date is reached. During 2007 and 2008 all options were granted with a par value exercise price and during 2009 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 market share price at the grant date.
 
 The fair value of each option granted during 2009 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 1.69%.
 3.
Estimated expected lives of 2.5-5 years for all periods.
 4.
Expected average volatility of 63%, which represent a weighted average standard deviation rate for the price of the Company's Ordinary Shares in the NASDAQ Global Market.
 
 
 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)
 
 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 (5,394,790, 6,210,112 and 3,676,315 for December 31, 2007, 2008 and 2009, 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
 
 The Company's financial instruments consist mainly of cash and cash equivalents, short-term interest bearing investments, accounts receivable, accounts payable and short-term and long-term loans.
 
 Fair value for the measurement of financial assets and liabilities is defined 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. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. The Company utilizes a valuation hierarchy for disclosure of the inputs for fair value measurement. This hierarchy prioritizes the inputs into three broad levels as follows:
 
 
 ·
Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities;
 ·
Level 2 inputs are quoted prices for identical or similar assets or liabilities in less active markets or model-derived valuations in which significant inputs are observable for the asset or liability, either directly or indirectly through market corroboration.
 ·
Level 3 inputs are unobservable inputs based on the Company's assumptions used to measure assets and liabilities at fair value.
 
 By distinguishing between inputs that are observable in the market place, and therefore more objective, and those that are unobservable and therefore more subjective, the hierarchy is designed to indicate the relative reliability of the fair value measurements. A financial asset or liability's classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
 
 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 short term investments is based on quoted market prices and thus is based on level 1 inputs.
 
 The carrying amounts of long-term loans are equivalent or approximate to their fair value as they bear interest at approximate market rates.
 
 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)
 
 Q.           Taxes on income
 
 The Company accounts for taxes on income in accordance with ASC Topic 740, 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.           Noncontrolling Interest
  On January 1, 2009, the Company adopted ASC Topic 810- Consolidation, which requires certain changes to the presentation of the financial statements. This amendment requires noncontrolling interests (previously referred to as “minority interest”) to be classified in the consolidated statements of income as part of consolidated net earnings ($1,038, ($57) and $189 for the years ended December 31, 2007, 2008 and 2009, respectively) and to include the accumulated amount of noncontrolling interests in the consolidated balance sheets as part of shareholders' equity ($415 and ($23) at December 31, 2008 and December 31, 2009, respectively). The amount previously reported as net losses now presented as net loss attributable to shareholders. If a change in ownership of a consolidated subsidiary results in loss of control and deconsolidation, any retained ownership interests are remeasured with the gain or loss reported in net earnings.
 S.           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 the remainder 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, 2007, 2008 and 2009 amounted to approximately $304, $510 and $124, respectively.
 
 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)
 
 T.           Advertising expenses
 
 Advertising expenses are charged to the statements of operations as incurred. Advertising expenses for the years ended December 31, 2007, 2008 and 2009 amounted to approximately $1,329, $874 and $942, respectively.
 
 U.           Concentrations of credit risk
 
 Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash equivalents, U.S and ILS treasury securities, corporate bonds 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. ILS treasury securities are denominated in NIS Corporate bonds are in both U.S dollars and NIS.  Management believes that minimal credit risk exists with respect to these securities.
 
 Most of the Company’s trade receivables are derived from sales to large and financially secure organizations. 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 15.
 
 The activity in the allowance for doubtful accounts for the years ended December 31, 2007, 2008 and 2009 is as follows:
 2007


2008


2009Allowance for doubtful accounts at beginning of year

$
234


$
2,767


$
3,315Additions charged to provision doubtful accounts


2,560



535



123Write-downs charged against the allowance


(29
)


-



(685
)Translation differences


2



13



24Allowance for doubtful accounts at end of year

$
2,767


$
3,315


$
2,777
 
 V.           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.
 
 W.           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 loss.
 
 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)
 
 X.           Recently issued accounting pronouncements not yet adopted
 
 1.
In October 2009, the FASB amended the accounting standards for revenue recognition with multiple deliverables. The amended guidance allows the use of management’s best estimate of selling price for individual elements of an arrangement when vendor specific objective evidence or third-party evidence is unavailable. Additionally, it eliminates the residual method of revenue recognition in accounting for multiple deliverable arrangements. This accounting guidance is effective for the Company’s annual reporting periods, and interim periods within them, beginning after June 15, 2010, early adoption is permitted. The Company is currently evaluating the impact that the adoption of this guidance will have on its consolidated financial statements.
 
 2.
In October 2009, the FASB amended the accounting standards for revenue arrangements with software elements. The amended guidance modifies the scope of the software revenue recognition guidance to exclude tangible products that contain both software and non-software components that function together to deliver the product’s essential functionality. This accounting guidance is effective for the Company’s annual reporting periods, and interim periods within them, beginning after June 15, 2010, early adoption is permitted. This guidance must be adopted in the same period an entity adopts the amended revenue recognition with multiple deliverables guidance described above. The Company is currently evaluating the impact that the adoption of this guidance will have on its consolidated financial statements.
 
 F - 20
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
  Note 3 – Investment Securities
 
 The carrying amount, gross unrealized holding gains, gross unrealized holding losses, and fair value of available-for-sale debt securities by major security type and class of security at December 31, 2009 and 2008 were as follows:
  Aggregate

cost basis


Gross

unrealized

holding

gains


Gross

unrealized

holding

(losses)


Aggregate

fair valueAt December 31, 2009Available for sale:U.S. Treasury securities

$
1,605



—



(8
)


1,597ILS Treasury securities


2,152



—



(13
)


2,139Corporate bonds


1,352



—



(2
)


1,350$
5,109



—



(23
)


5,086At December 31, 2008Available for sale:U.S. Treasury securities

$
851



8



—



858$
851



8



—



858
  Maturities of debt securities classified as available-for-sale were as follows at December 31, 2009:
  Carrying

amount


Fair valueAvailable for sale:Due after six months through five years

$
3,829



3,829Due after five years through ten years


1,257



1,257$
5,086



5,086
  Note 4 - Other Receivables and Prepaid Expenses
  December 312008


2009Government institutions

$
591


$
393Prepaid expenses


546



685Other receivables


1,857



1,400$
2,994


$
2,478
 
 Note 5 – Inventories
  December 312008


2009Raw materials

$
4,435


$
3,128Work in progress


3,747



916Finished products


4,161



2,221$
12,343


$
6,265
 
 F - 21
  On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
  Note 6 - Goodwill and Intangible Assets, Net
 
 A.           Goodwill
  December 312008


2009Balance as of January 1

$
23,387


$
-Changes during the year – Goodwill resulting from businesscombination


830



-Impairment loss*


(24,217
)


-Balance as of December 31

$
-


$
-
  *
During 2008 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 $24,217
 
 B.           Intangible assets, net
  December 312008


2009CostTechnology

$
1,639


$
1,639Brand


579



579Know-how


452



452Non competition agreement


194



194Customer contracts and relationships


6,141



6,141Total cost


9,005



9,005Accumulated amortization and impairmentsTechnology*


1,286



1,419Brand


464



582Know-how


452



452Non competition agreement


34



102Customer contracts and relationships**


4,266



4,918Total Accumulated amortization


6,502



7,473$
2,503


$
1,532
  *
include $78 impairment loss which was recorded in 2008.
 **
include $1,349 impairment loss which was recorded in 2008.
 
 F - 22
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
  Note 6 - Goodwill and Intangible Assets, Net (cont’d)
 
 B.           Intangible assets, net (cont’d)
 i.
Amortization expense amounted to $1,314, $1,367 and $978 for the years ended December 31, 2007, 2008 and 2009, 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 in the statement of operations in the year incurred‏.
 
 ii.
Estimated amortization expense for the years ending:
 
 December 312010

$
5752011


4952012


1722013


532014 and thereafter


239
  Note 7 - Property, Plant and Equipment, Net
 
 A.           Consist of:
  December 312008


2009CostLand

$
482


$
496Leasehold land (1)


272



272Buildings on leasehold land (1)


4,355



4,356Buildings


6,960



5,841Computers, software and manufacturing equipment


15,151



10,826Office furniture and equipment


2,206



1,857Motor vehicles


479



626Total cost


29,905



24,274Total accumulated depreciation


11,292



9,908Net book value

$
18,613


$
14,366
 
 (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 - 23
 
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
  Note 7 - Property, Plant and Equipment, Net (cont’d)
  B.
As to liens - See Note 10C.
 
 C.
Depreciation expenses amounted to $1,402, $1,708 and $1,413 for the years ended December 31, 2007, 2008 and 2009, respectively.
 
 D.
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, 2009 the equipment has not commenced being 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, 2008 110,000 ordinary shares are still subject to the lock-up agreement. As of December 31, 2009 all the ordinary shares have been released.
 
 This smart card module production line is part of the assets acquired by SAMRTEC and as of December 31, 2009 is classified as assets from discontinued operation – held for sale assets in the balance sheet (see note 13).
 
 E.
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 - 24
 
 On Track Innovations Ltd. and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
  Note 8 - Other Current Liabilities
  December 31


December 312008


2009Employees and related expenses

$
1,730


$
1,869Accrued expenses


989



1,155Customer advances


196



*12,692Other current liabilities


602



458$
3,517


$
16,174
 
 * The Company received an advance payment from a customer amounting to $11.2 million for the commencement of a turnkey project.
 
 Note 9 - Long-Term Loans
 
 A.           Composition of Long-term Loans:
  December 31


December 312008


2009Long-term loans

$
2,342


$
3,512Less - current maturities


580



870$
1,762


$
2,642
 
 As of December 31, 2009, the loans are from banks and are denominated in: U.S. dollars ($369; matures in the years 2010 - 2012), Euro ($1,342; mature in the years 2010 - 2026), New Israeli Shekel ($175; matures in 2012) South African Rand ($103; matures in 2014) and Polish Zloty ($1,523; matures in 2014). As of December 31, 2009 these loans bear interest at rates ranging from 3.0%-9.5% (mainly 5.8%) per annum.
 
 B.           Repayment Dates of Long-term Loans Subsequent to December 31, 2009:
 
 2010

$
8702011


6242012


5122013


4732014


108Thereafter


925$
3,512
 
 C.           Composition of Short-term loans, Bank Credit and Current Maturities of Long-term Loans:
 
 December 31


December 312008


2009


2008


2009%


%Interest rateIn NIS


7.07



4.25



1,850



2,733In USD


6.4



4.09



1,122



1,296In Euro


5.5



5.5



1,432



1,3564,404



5,385Current maturities oflong-term loans










580



870$
4,984


$
6,255
 
 The weighted average interest rate of the short-term bank credit for the years ended December 31, 2008 and 2009 were 6.4% and 4.53%, respectively.
  F - 25
  On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
  Note 9 - Long-Term Loans (cont’d)
  D.            Liens for short-term and long-term borrowings - see Note 10C.
 
 E.
As of December 31, 2009, the Group has authorized and used credit lines of approximately $4.3 million and $3.0 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 10 - 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).  The total amount of grants received until December 31, 2009 , net of royalties paid, was approximately $4,635 including interest.
 
 Royalties paid or accrued amounted to $698, $640 and $412 for the years ended December 31, 2007, 2008 and 2009, respectively, and were charged to cost of revenues.
 
 We entered into a long term supply agreement with SMARTRAC under which SMARTRAC became our exclusive supplier for wire-embedded and dual interface inlays, according to our needs, and our supplier for other products at defined terms and prices.
 
 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 2010 through 2014.
 
 Minimum future rentals of premises under non-cancelable operating lease agreements at rates in effect as of December 31, 2009 are as follows:
 
 2010

$
7992011


2962012


2862013


2882014


226$
1,895
 
 Rent expense amounted to $1,193, $1,114 and $1,197 for the years ended December 31, 2007, 2008 and 2009, respectively.
 
 F - 26
 
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
 
 Note 10 - 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, 2009, the company granted guarantees to third parties including performance guarantees and guarantees to secure customers advances in the sum of $17,518.
 
 The expiration dates of the guarantees are from January 2010 to October 2010.
 
 E.           Legal claims
  1.
On May 20, 2008 SMARTRAC group (“the 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. On September 30, 2009, as part of the agreements between the Company and SMARTRAC, this lawsuit and these claims were dismissed.
 
 2.
On June 16, 2008, SMARTRAC IP B.V. ("the 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. On September 28, 2009, as part of the agreements between the Company and SMARTRAC, this Lawsuit was withdrawn by the Plaintiff.
 
 F - 27
 
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
 
 .Note 11 - Shareholders’ Equity
 
 A.           Share capital
 
 1.
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.
 
 2.
During 2007, warrants to purchase 66,438 ordinary shares were exercised into ordinary shares in consideration of $1.
  3.
During 2008, warrants to purchase 90,000 ordinary shares were exercised into ordinary shares in consideration of $2.
  4.
During 2009, warrants to purchase 61,500 ordinary shares were exercised into ordinary shares in consideration of $1.
  B.           Options to non-employees
 
 The Company issued options to non-employees as follows:
  1.
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.
 
 2.
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.
 
 3.
In 2009, the Company issued 1,294,000 par value options and shares to non-employees with respect to services rendered.  The aggregate fair value of the options was $1,546 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.
 
 F - 28
 
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
 
 Note 11 - Shareholders’ Equity (cont'd)
 
 C.           Stock option plans (cont’d)
 
 2.
In February 2001, the Company’s Board of Directors approved an additional option plan, under which up to 75,000 share options are to be granted to the Company’s employees, directors and consultants and those of the Company’s subsidiaries and affiliates.
 
 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.
 
 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.
 
 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.
 
 F - 29
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
 Note 11 - Shareholders’ Equity (cont'd)
 
 C.           Stock option plans (cont’d)
 
 The Company’s options activity (including options to non-employees) and options outstanding as of December 31, 2007, 2008 and 2009 are summarized in the following table:
 
 WeightedNumber of

options


average

exerciseoutstanding


price per shareOutstanding – December 31, 2006


1,146,616



6.30Options granted


2,102,015



0.31Options cancelled or forfeited


(138,605
)


2.24Options exercised


(457,750
)


0.02Outstanding – December 31, 2007


2,652,276



2.85Options granted


1,585,313



0.33Options cancelled or forfeited


(212,491
)


1.20Options exercised


(1,104,217
)


0.02Outstanding – December 31, 2008


2,920,881



2.69Options granted


1,596,000



0.16Options cancelled or forfeited


(506,484
)


5.65Options exercised


(1,669,512
)


0.02Outstanding – December 31, 2009


2,340,885



2.23Exercisable as of:December 31, 2007


1,412,138


$
4.53December 31, 2008


1,846,024


$
3.71December 31, 2009


1,586,626


$
2.91Vested and expected to vest at December 31, 2009


2,340,885


$
2.23
 
 F - 30
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
 
 Note 11 - 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, 2009:
 
 Options outstanding


Options ExercisableNumber


Weighted





Numberoutstanding


average


Weighted


Outstanding


Weightedas of


remaining


Average


As of


AverageDecember 31,


contractual


Exercise


December 31,


ExerciseRange ofexercise price


2009


life (years)


Price


2009


Price$0.02



1,514,125



3.36


$
0.02



1,040,791


$
0.020.99-1.46



210,000



4.40



1.20



25,500



1.202.00-3.91



282,000



3.28



3.09



191,825



3.149.00-11.24



247,730



0.90



11.03



241,480



11.0312.66-32.00



84,630



0.48



14.20



84,630



14.2042.50



2,400



1.19



42.50



2,400



42.502,340,885











1,586,626
 
 The weighted average fair values of options (including non-employees) granted during the years ended December 31, 2007, 2008 and 2009 were:
 
 For exercise price on the grant date that:Equals market price


Exceeds market price


Less than market priceYear ended December 31


Year ended December 31


Year ended December 312007


2008


2009


2007


2008


2009


2007


2008


2009Weighted average

exercise prices

$
3.88


$
2.08


$
1.14


$
-


$
2.00


$
1.89


$
0.02


$
0.02


$
0.03Weighted average

fair values on grant date

$
1.29


$
0.67


$
0.52


$
-


$
0.38


$
0.47


$
5.35


$
2.20


$
1.58
 
 The total intrinsic value of options exercised during the years ended December 31, 2007, 2008 and 2009, was $2.7 million, $4.2 million and $4.3 million, respectively. The total intrinsic value of options expected to vest at December 31, 2007, 2008 and 2009, was $5.9 million, $3.9 million and $1.8 million, respectively. The total intrinsic value of options vested and exercisable at December 31, 2007, 2008 and 2009, was $7.2 million, $4.9 million and $3.7 million, respectively.
 
 Following is a summary of non-vested options activity as of December 31, 2009, under the Company’s stock-based compensation plans:
  WeightedNumber of


average grantoptions


date fair valueNon-vested at January 1, 2009


1,074,857



4.97Granted


1,596,000



1.15Vested


(1,796,483
)


2.44Forfeited


(120,116
)


5.74Non-vested at December 31, 2009


754,258



2.78
 
 F - 31
 
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
  Note 11 - Shareholders’ Equity (cont'd)
 
 C.           Stock option plans (cont’d)
 
 As of December 31, 2009, there was $1.5 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 1 year. The total fair value of shares vested during the year ended December 31, 2009 was $4.3 million.
 
 During 2007, 2008 and 2009, the company recorded share-based compensation expenses in the amount of $6,947, $6,253 and $3,662, respectively, in accordance with ASC topic 718.
  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, 2007 and 2008 were 50,000, 90,000 respectively, with a per share weighted average exercise price of NIS 0.1 (par value – of approximately $0.02), for each year. No such warrants were issued in 2009.
  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 expired during 2009 in accordance with their terms.
  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 had the same terms and conditions (e.g., vesting terms, exercise period, exercise price) as the Warrants issued in the SFG Transaction. The warrants expired during 2009, in accordance with their terms.
  
 The following table summarizes information about warrants outstanding and exercisable as of December 31, 2009:
  Warrants outstandingNumber


WeightedOutstanding


Average


Weightedas of


Remaining


AverageDecember 31


Contractual


ExerciseRange of exercise price

2009


Life (Years)


PriceNIS 0.1 (par value)


118,500



6.37


NIS 0.1$11.42 - $14.58


1,196,431



0.84


$
14.581,314,931






$
13.07
  F - 32
  On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements 
 In thousands, except share and per share data
 Note 11 - Shareholders’ Equity (cont'd)
 
 E.           Employee Share Purchase Plan
 
 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).
 
 During 2009, 817,572 shares have been issued to employees under this plan in consideration of $787.
 
 Total expenses recognized in the consolidated statement of operating with respect to the 2008 plan amounted to $256 and $86 for the years end December 31, 2008 and 2009, receptively.
 
 F - 33
 
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements 
 In thousands, except share and per share data
 
 Note 12 - Income Taxes
 
 A.           The Company and its Israeli subsidiaries
 
 1.
Measurement of taxable income under the Income Tax (Inflationary Adjustments) Law, 1985
  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 18% 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, 2009.
 
 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, 2009.
 
 F - 34
 
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
  Note 12 - 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.
  On July 14, 2009, the Knesset passed the Economic Efficiency Law (Legislation Amendments for Implementation of the 2009 and 2010 Economic Plan) – 2009, which provided, inter alia, an additional gradual reduction in the company tax rate to 18% as from the 2016 tax year. In accordance with the aforementioned amendments, the company tax rates applicable as from the 2009 tax year are as follows: In the 2009 tax year – 26%, in the 2010  tax year – 25%, in the 2011 tax year – 24%, in the 2012 tax year – 23%, in the 2013 tax year – 22%, in the 2014 tax year  – 21%, in the 2015 tax year – 20% and as from the 2016 tax year the company tax rate will be 18%.
  B.
Non-Israeli subsidiaries are taxed based on the income tax laws in their country of residence.
  C.            Deferred income taxes:
  December 31


December 312008


2009Deferred tax assets:Net operating loss carryforwards

$
23,735


$
22,291Goodwill


3,524



2,220Other


3,585



2,477Total gross deferred tax assets*


30,844



26,988Less – valuation allowance*


(30,844
)


(26,988
)Net deferred tax assets

$
-


$
-Deferred tax liability:Intangible assets


(202
)


(120
)Total gross deferred tax liability


(202
)


(120
)Net deferred tax liability

$
(202
)

$
(120
)
 
 * Including as of December 31, 2008 and 2009 $2,037 and $3,492 respectively, gross deferred tax assets and valuation allowance related to discontinue operations.
 
 F - 35
 
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
  Note 12 - Income Taxes (cont'd)
 
 C.           Deferred income taxes: (cont'd)
 
 The valuation allowance for deferred tax assets as of December 31, 2008 and 2009 was $30,844 and $26,988, respectively. The net change in the total valuation allowance for each of the years ended December 31, 2007, 2008 and 2009, was an increase of $4,912, $11,615 and a decrease of $3,856, 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, 2009, will be allocated as follows:
 
 Income tax benefit that would be reported in the consolidatedstatements of operations

$
25,170Additional paid-in capital


1,818Total

$
26,988
 
 D.
As of December 31, 2009, the net operating loss carryforwards for tax purposes relating to Israeli companies amounted to approximately $101,699. 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 $15,948, which will expire as follows: 2010 - $13, 2012 - $477, 2013 - $9, 2014- $75, 2025 - $313, 2026 - $3,206 and 2027- $533. The remaining balance - $11,322 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 2009 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, 2009, the undistributed earnings of these foreign subsidiaries were approximately $1,910. 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 312007


2008


2009Current

$
(38
)

$
(36
)

$
(171
)Deferred


264



711



82Income tax benefit (expenses)

$
226


$
675


$
(89
)
 
 F - 36
 
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
  Note 12 - Income Taxes (cont'd)
 
 F.           (cont'd)
 
 Income tax benefit  (expense) for the years ended December 31, 2007, 2008 and 2009, 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 312007


2008


2009Computed “expected” income tax benefit

$
4,970


$
11,916


$
3,953Decrease in income tax benefitresulting from:Change in valuation allowance, net


(3,633
)


(8,411
)


(3,102
)Stock-based compensation related to optionsissued to employees


(1,506
)


(1,078
)


(564
)Impairment of goodwill


-



(1,781
)


-Non-deductible expenses


(18
)


(57
)


(201
)Other


413



86



(175
)Total income tax benefit (expenses)

$
226


$
675


$
(89
)
  G.
Loss before taxes on income consists of the following:
 
 Year ended December 312007


2008


2009Israel

$
(15,071
)

$
(35,064
)

$
(14,017
)Non-Israel


(2,198
)


(9,663
)


(1,187
)$
(17,269
)

$
(44,727
)

$
(15,204
)
 
 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, 2008 and 2009, 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 - 37
  On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
  Note 12 - 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, 2008 and 2009, 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 13 – Discontinued operations
 
 A.
During December 2009 the Company and MCT entered into an assets purchase agreement with SMARTRAC for the sale of certain assets and production intellectual property (IP) relating to inlay production from the Company and MCT, for a total purchase price of euro 8,500 (approximately $12,253) to be paid in cash, whereof euro 5,000 were paid during 2009 and the balance of euro 3,500 will be paid in eight equal quarterly installments starting the first quarter of 2010. Accordingly, assets and liabilities related to the discontinued operation are presented separately in the balance sheets and are anticipated to be disposed of in 2010. The results from this operation and the cash flows for the reporting periods are presented in the statements of operations and in the statements of cash flow, as discontinued operations separately from continuing operations.
  B.
Set forth below are details of assets from discontinued operation- held for sale and liabilities related to discontinued operation:
  As of December 312008


2009AssetsInventories

$
-


$
5,815Property, plant and equipment, net


-



6,423Other assets


-



120$
-


$
12,358LiabilitiesAccrued expenses

$
-


$
1,435Advances related to sale of assets


-



7,060$
-


$
8,495
 
 F - 38
 
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
 
 Note 13 – Discontinued operations (cont’d)
  C.
Set forth below are the results of operations of the discontinued operations:
  Year ended December 312007


2008


2009Revenues

$
7,387


$
5,195


$
6,720Expenses


(11,799
)


(10,406
)


(14,798
)Results of the discontinued operation

$
(4,412
)

$
(5,211
)

$
(8,078
)
  Note 14 - Related Party Balances and Transactions
 
 Transactions
  Year ended December 312007


2008


2009Costs and expenses*

$
73


$
112


$
90
 
 * Cost and expenses relate to services provided to the Company by related parties.
  Note 15 - Geographic Information and Major Customers
 
 The Company manages its business on the basis of one reportable segment. The data is presented in accordance with ASC topic 280, "Disclosures About Segments of an Enterprise and Related Information".
 
 Year ended December 312007


2008


2009Revenues by geographical areas fromexternal customersAmerica

$
7,569


$
5,100


$
9,810Far East


1,637



3,641



2,365Africa


4,710



5,423



3,813Europe


17,924



16,786



11,590Total export


31,840



30,950



27,578Domestic (Israel)


4,258



4,072



3,859$
36,098


$
35,022


$
31,437
 
 F - 39
 
 On Track Innovations Ltd.
 and Subsidiaries
 Notes to the Consolidated Financial Statements In thousands, except share and per share data
  Note 15 - Geographic Information and Major Customers (cont’d)
 
 December 31


December 312008


2009Long lived assets by geographical areasDomestic (Israel)

$
10,740


$
5,471Germany


5,019



4,957Poland


315



3,031France


771



625Far East


2,881



76Other


1,390



1,738$
21,116


$
15,898
 
 Major Customers
 
 Revenues from one customer represent approximately 21% of the consolidated revenues for the year ended December 31, 2009.There were no major customers (customers representing 10% or more of total revenues) in the years ended December 31, 2007 and 2008.
 
 F - 40


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 BashanOded BashanChief Executive Officerand Chairman of the Board




By:
/s/ Tanir HornTanir HornChief Financial Officer





Date:  March 31, 2010




89