UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION




Washington,
D.C. 20549










FORM
20-F




(Mark
One)




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


OR


x
            ANNUAL REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
the fiscal year ended December 31, 2008


OR


 ̈
            TRANSITION REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


OR


 ̈
            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







Commission
file number 000-50790







VUANCE
LTD.


(Exact
name of Registrant as specified in its charter)


Not
Applicable


(Translation
of Registrant’s Name into English)


Israel


(Jurisdiction
of incorporation or organization)


Sagid
House “Ha’Sharon Industrial Park”


P.O.B
5039, Qadima 60920


Israel


(Address
of principal executive offices)







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


None




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


Ordinary
Shares NIS 0.0588235 nominal value





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


None




Indicate
the number of outstanding shares of each of the issuer’s classes of capital or
common stock as of the close of the period covered by the annual report:
5,259,874 ordinary shares as of December 31, 2008.





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes   ̈    No  x





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.     ̈ Yes     ̈ 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 periods that the registrant was
required to file such reports), and (2) has been subject to such reporting
requirements for the past 90 days.


Yes  x    No   ̈    Not
applicable









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. (Check
one):


Large
accelerated filer  ̈             Accelerated
filer  ̈             Non-accelerated
filer x





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


Item
17   ̈    Item
18  x





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).


Yes   ̈    No  x





(APPLICABLE
ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE
YEARS)


Indicate
by check mark whether the registrant has filed all documents and reports
required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act
of 1934 subsequent to the distribution of securities under a plan confirmed by a
court.


Yes   ̈    No   ̈











TABLE
OF CONTENTS





PART
      INOTES
      REGARDING FORWARD-LOOKING STATEMENTS
              4ITEM
      1.  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT &
      ADVISORS
              6ITEM
      2.  OFFER STATISTICS AND EXPECTED TIMETABLES
              6ITEM
      3.  KEY INFORMATION
              6Selected
      Financial Data
              6Capitalization
      and Indebtedness
              8Reasons
      for the Offer and Use of Proceeds
              8Risk
      Factors
              8ITEM
      4.  INFORMATION ON THE CORPORATION
              26History
      and Development of the Corporation
              26Business
      Overview
              30Organizational
      Structure
              42Property,
      Plants and Equipment
              43ITEM
      4A.  UNSOLVED STAFF COMMENTS
              43ITEM
      5.  OPERATING AND FINANCIAL REVIEW AND PROSPECTS
              44Operating
      Results
              44Liquidity
      and Capital Resources
              56Research
      and Development
              59Trend
      Information
              59Off-Balance
      Sheet Arrangements
              60Tabular
      Disclosure of Contractual Obligation
              61ITEM
      6.  DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
              61Directors
      and Senior Management
              61Compensation
              64Board
      Practices
              65Employees
              67Share
      Ownership
              68ITEM
      7.  MAJOR SHAREHOLDERS AND RELATED PARTY
      TRANSACTIONS
              72Major
      shareholders
              72Related
      Party Transactions
              73Interests
      of Experts and Counsel
              74ITEM
      8.  FINANCIAL INFORMATION
              75Consolidated
      Statements and Other Financial Information (Audited)
              75Significant
      Changes
              77ITEM
      9  THE OFFER AND LISTING
              78Offer
      and Listing Details
              78Plan
      of Distribution
              80Markets
              80Selling
      Shareholders
              80Dilution
              80Expenses
      of the Issue
              80





2





ITEM
      10.  ADDITIONAL INFORMATION
                80Share
      Capital
                80Memorandum
      and Articles of Association
                80Material
      Contracts
                84Exchange
      Controls
                84Taxation
                84Dividends
      and Paying Agent
                92Statement
      by Experts
                92Documents
      on Display
                92Subsidiary
      Information
                92ITEM
      11.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK
                92Quantitative
      and Qualitative Information about Market Risk
                92ITEM
      12.  DESCRIPTION OF SECURITIES OTHER THAN EQUITY
      SECURITIES
                93PART
      IIITEM
      13.  DEFAULTS, DIVIDEND ARREARAGES AND
    DELINQUENCIES
                93ITEM
      14.  MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY
      HOLDERSAND
      USE OF PROCEEDS
                93ITEM
      15.  CONTROLS AND PROCEDURES
                94ITEM
      16.  RESERVED
                95ITEM
      16A.  AUDIT COMMITTEE FINANCIAL EXPERT
                95ITEM
      16B.  CODE OF ETHICS
                95ITEM
      16C.  PRINCIPAL ACCOUNTANT FEES AND SERVICES
                95ITEM
      16 D.  EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT
      COMMITTEES
                96ITEM
      16E.  PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND
      AFFILIATED PURCHASERS
                96PART
      IIIITEM
      17.  FINANCIAL STATEMENTS
                96ITEM
      18.  FINANCIAL STATEMENTS
                96ITEM
      19.  EXHIBITS
                148SIGNATURE
                149





3





NOTE
REGARDING FORWARD-LOOKING STATEMENTS





This Annual Report on Form 20-F
(“Annual Report”) contains “forward-looking statements” within the meaning of
the United States Private Securities Litigation Reform Act of 1995 that are not
historical facts but rather reflect our present expectations concerning future
results and events. Words such as “anticipate,” “estimate,” “expects,” “may,”
“projects,” “intends,” “plans,” “believes,” “would,” “could” and words and terms
of similar substance used in connection with any discussion of future operating
or financial performance may identify forward-looking statements. These forward
looking statements include, but are not limited to, statements regarding: (i)
our belief about our competitive position in the security access, tracking,
asset management and monitoring, active and passive radio frequency
identification (“RFID"), disaster recovery, Critical Situation Management System
("CSMS") and Credentialing ("RAPTOR") markets, and our ability to become a key
technological player in such markets; (ii) our belief about the commercial
possibilities for our products in such markets; (iii) our expectation to be able
to leverage our current products and technologies for the development of new
applications and penetration to additional markets; (iv) our expectation to be
able to continue to participate in the government market; (v) our belief about
our ability to leverage our public sector experience into the commercial sector;
(vi) our belief regarding the effects of competitive pricing on our margins,
sales and market share; (vii) our expectations regarding the effects of the
legal proceedings we are involved in on our sales and operating performance,
including, without limitation to, our belief regarding the merit of the claim of
the Department for Resources Supply of the Ministry of Ukraine against us and
regarding the Secu-System claim. (See “Legal Proceedings” in Item 8.A); (viii)
our belief regarding the fluctuations of our operating results, including our
belief about the effects of inflation and the fluctuation of the NIS/dollar
exchange rate on our operating results; (ix) our expectations about our future
revenues (or absence of revenues); (x) our expectations about the effects of
seasonality on our revenues and operating results; (xi) our expectations
regarding development and introduction of future products; (xii) our
expectations regarding revenues from our existing customer contracts and
purchase orders, including, without limitation, the value of our agreement for
our end-to-end system for a national multi-ID issuing and control system with
the government of a European country, the value of our agreement for our
perimeter security and border control at European International Airport and our
expectations for increased revenues from sales of additional technology and raw
materials to such government; (xiii) our expectations regarding the success of
our new active and passive RFID technology and our CSMS and RAPTOR products;
(xiv) our expectations regarding the effectiveness of our marketing programs and
generation of business from those programs, including our ability to continue to
sell products through strategic alliances and our belief about the role customer
service plays in our sales and marketing programs; (xv) our anticipation that
sales to a relatively small number of customers will continue to account for a
significant portion of our net sales; (xvi) our expectations regarding the mix
of our sources of revenues; (xvii) our belief about the sufficiency or
insufficiency  of our capital resources and other sources of liquidity
to fund our planned operations; (xiii) our expectations regarding our recurring
revenues and backlog; (xix) our belief that we have not been a passive foreign
investment company ("PFIC") for U.S. tax purposes; (xx) our belief regarding the
impact of recently issued accounting pronouncements (see note 2(aa) to the
financial statements included in this report) and adoption of new accounting
pronouncements in the future on our earnings and operating results; and (xxi)
our expectation regarding the success of the integration of the SHC business (as
defined in “Risk Factors” in Item 3.D). All forward-looking statements are based
on our management’s present assumptions and beliefs in light of the information
currently available to us. Actual results, levels of activity, performance or
achievements may differ materially from those expressed or implied in the
forward-looking statements for a variety of reasons, including: changes in
demand for our products; market conditions in our industry and the economy as a
whole; variations, expansions or reductions in the mix of our product offerings;
the timing of our product introductions; increased competition; introduction of
new competing technologies; the increase of unexpected expenses; and such other
factors discussed below under the captions “Risk Factors” in Item 3.D and
“Operating and Financial Review and Prospects” in Item 5 and elsewhere in this
Annual Report. We are not under any obligation, and expressly disclaim any
obligation, to update or alter any forward-looking statements, whether as a
result of new information, future events or otherwise. All subsequent
forward-looking statements attributable to us or any person acting on our behalf
are expressly qualified in their entirety by the cautionary statements contained
or referred to in this section, and you are cautioned not to place undue
reliance on these forward-looking statements which speak only as of the date of
this Annual Report.





In this
Annual Report, all references to "Vuance," the “Company,” "we," "us" or "our"
are to Vuance Ltd., a company organized under the laws of the State of Israel,
and its subsidiaries.





In
this Annual Report, unless otherwise specified or unless the context otherwise
requires, all references to "$" or "dollars" are to U.S. dollars and all
references to "NIS" are to New Israeli Shekels. Except as otherwise indicated,
the financial statements of and information regarding Vuance are presented in
U.S. dollars.





4




Note:Unless otherwise indicated herein,
the prices and quantities of our ordinary shares provided in this Annual Report
reflect the 1 to 5.88235 share consolidation (reverse share split) that we
completed on April 29, 2007 and which became effective for trading purposes as
of May 14, 2007.





5





PART
I




ITEM
1.    Identity of Directors, Senior
Management and Advisors.





Not
applicable.





ITEM
2.    Offer Statistics and Expected
Timetables.





Not
applicable.





ITEM
3.    Key
Information.





A.    Selected
Financial Data




The
following selected consolidated financial data as of December 31, 2004, 2005,
2006, 2007 and 2008 and for the years then ended have been derived from our
audited consolidated financial statements. These financial statements have been
prepared in accordance with generally accepted accounting principles in the
United States, or U.S. GAAP, and audited by Fahn Kanne & Co., a member of
Grant Thornton International. The selected consolidated financial data set forth
below should be read in conjunction with and are qualified by reference to Item
5, "Operating and Financial Review and Prospects" and the consolidated financial
statements and notes thereto and other financial information included elsewhere
in this Annual Report. Historical results are not necessarily indicative of
future results.





6





SUMMARY OF CONSOLIDATED
FINANCIAL DATA YEAR ENDED DECEMBER 31,





Audited(IN
      THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA)2004
                      
                      
                      2005
                      
                      
                      2006
                      
                      
                      2007
                      
                      
                      2008SUMMARY
      OF STATEMENT OF OPERATIONS:Revenues
                      
                      
                      7,344
                      
                      
                      
                      8,462
                      
                      
                      
                      8,941
                      (*)
                      
                      
                      13,314
                      (*)
                      
                      
                      20,653Cost
      of Revenues
                      
                      
                      3,730
                      
                      
                      
                      4,293
                      
                      
                      
                      3,494
                      
                      
                      
                      5,600
                      
                      
                      
                      8,452Inventory
      write-off
                      
                      
                      —
                      
                      
                      
                      287
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Gross
      Profit
                      
                      
                      3,614
                      
                      
                      
                      3,882
                      
                      
                      
                      5,447
                      
                      
                      
                      7,714
                      
                      
                      
                      12,201Operating
      Expenses:Research
      and Development
                      
                      
                      845
                      
                      
                      
                      1,182
                      
                      
                      
                      1,362
                      
                      
                      
                      1,716
                      
                      
                      
                      2,571Selling
      and Marketing
                      
                      
                      2,445
                      
                      
                      
                      3,003
                      
                      
                      
                      5,619
                      
                      
                      
                      9,041
                      
                      
                      
                      11,924General
      and Administrative
                      
                      
                      1,955
                      
                      
                      
                      2,968
                      
                      
                      
                      2,737
                      
                      
                      
                      3,192
                      
                      
                      
                      3,299Restructuring
      expenses
                      
                      
                      —
                      
                      
                      
                      496
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Impairment
      loss
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      3,235Litigation
      settlement expenses
                      
                      
                      —
                      
                      
                      
                      129
                      
                      
                      
                      108
                      
                      
                      
                      34
                      
                      
                      
                      8Total
      Operating Expenses
                      
                      
                      5,245
                      
                      
                      
                      7,778
                      
                      
                      
                      9,826
                      
                      
                      
                      13,983
                      
                      
                      
                      21,037Capital
      gain from the sale of the E-ID Division
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      10,536
                      
                      
                      
                      —Operating
      Income  (Loss)
                      
                      
                      (1,631
                      )
                      
                      
                      (3,896
                      )
                      
                      
                      6,157
                      
                      
                      
                      (6,269
                      )
                      
                      
                      (8,836
                      )Financial
      Income (Expenses), Net
                      
                      
                      (214
                      )
                      
                      
                      (25
                      )
                      
                      
                      (204
                      )
                      
                      
                      (4,652
                      )
                      
                      
                      (3,113
                      )OTHER
      INCOME (EXPENSES), NET
                      
                      
                      (27
                      )
                      
                      
                      (30
                      )
                      
                      
                      (367
                      )
                      
                      
                      —
                      
                      
                      
                      —Income
      Loss before Taxes on Income
                      
                      
                      (1,872
                      )
                      
                      
                      (3,951
                      )
                      
                      
                      5,586
                      
                      
                      
                      (10,921
                      )
                      
                      
                      (11,949
                      )Taxes
      on income
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      (146
                      )(*)
                      
                      
                      (390
                      )(*)
                      
                      
                      (137
                      )Net
      Income (Loss) from continuingoperations
                      
                      
                      (1,872
                      )
                      
                      
                      (3,951
                      )
                      
                      
                      5,440
                      
                      
                      
                      (11,311
                      )
                      
                      
                      (12,086
                      )Loss
      from discontinued operations
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      272Net
      income (loss)
                      
                      $
                      (1,872
                      )
                      
                      $
                      (3,951
                      )
                      
                      $
                      5,440
                      
                      
                      $
                      (11,311
                      )
                      
                      
                      (12,358
                      )PER
      SHARE DATA:Basic
      earning (loss) from continuing operations
                      
                      $
                      (0.75
                      )
                      
                      $
                      (1.25
                      )
                      
                      $
                      1.37
                      
                      
                      $
                      (2.57
                      )
                      
                      $
                      (2.34
                      )Diluted
      earning (loss) from continuing operations
                      
                      $
                      (0.75
                      )
                      
                      $
                      (1.25
                      )
                      
                      $
                      1.31
                      
                      
                      $
                      (2.57
                      )
                      
                      $
                      (2.34
                      )Basic
      and Diluted loss from discontinued operations
                      
                      $
                      —
                      
                      
                      $
                      —
                      
                      
                      $
                      —
                      
                      
                      $
                      —
                      
                      
                      $
                      (0.05
                      )Basic
      earning (loss) per share
                      
                      $
                      (0.75
                      )
                      
                      $
                      (1.25
                      )
                      
                      $
                      1.37
                      
                      
                      $
                      (2.57
                      )
                      
                      $
                      (2.39
                      )Diluted
      earning (loss) per share
                      
                      $
                      (0.75
                      )
                      
                      $
                      (1.25
                      )
                      
                      $
                      1.31
                      
                      
                      $
                      (2.57
                      )
                      
                      $
                      (2.39
                      )SUMMARY
      OF BALANCE SHEET DATA:Cash
      and Cash Equivalents
                      
                      
                      2,894
                      
                      
                      
                      2,294
                      
                      
                      
                      2,444
                      
                      
                      
                      2,114
                      
                      
                      
                      812Short
      term deposit
                      
                      
                      353
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Marketable
      debt securities
                      
                      
                      —
                      
                      
                      
                      650
                      
                      
                      
                      11,077
                      
                      
                      
                      4,054
                      
                      
                      
                      —Trade
      receivables (net of allowance for doubtful  accounts of $ 3,500
      and $ 3,478 as of  December 31, 2007 and 2008,
      respectively)
                      
                      
                      1,463
                      
                      
                      
                      1,053
                      
                      
                      
                      2,625
                      
                      
                      
                      2,463
                      
                      
                      
                      840Inventories
                      
                      
                      2,165
                      
                      
                      
                      2,205
                      
                      
                      
                      270
                      
                      
                      
                      566
                      
                      
                      
                      1,307Total
      Current Assets
                      
                      
                      9,254
                      
                      
                      
                      8,023
                      
                      
                      
                      17,992
                      
                      
                      
                      14,769
                      
                      
                      
                      6,443TOTAL
      ASSETS
                      
                      
                      13,938
                      
                      
                      
                      12,276
                      
                      
                      
                      23,098
                      
                      
                      
                      20,952
                      
                      
                      
                      8,935Total
      Current Liabilities
                      
                      
                      4,259
                      
                      
                      
                      3,218
                      
                      
                      
                      5,452
                      
                      
                      
                      8,916
                      
                      
                      
                      10,424Accrued
      Severance Pay
                      
                      
                      564
                      
                      
                      
                      616
                      
                      
                      
                      323
                      
                      
                      
                      362
                      
                      
                      
                      378SHAREHOLDERS’
      EQUITY/DEFICIT:TOTAL
      SHAREHOLDERS' EQUITY/DEFICIT
                      
                      
                      9,115
                      
                      
                      
                      8,247
                      
                      
                      
                      15,001
                      
                      
                      
                      9,233
                      
                      
                      
                      (1,867
                      )





(*)
Certain comparative figures have been reclassified to conform to the current
period presentation. The changes were not material and did not affect net
income, cash flow or stockholders equity.




7


B.
              Capitalization
      and Indebtedness





Not
applicable.





C.
              Reasons
      for the Offer and Use of
Proceeds





Not
applicable.





D.
            Risk
      Factors





You
should carefully consider the following risks together with the other
information in this Annual Report in evaluating our business, financial
condition and prospects. The risks and uncertainties described below are not the
only ones that we face. Additional risks and uncertainties not presently known
to us or that we consider immaterial may also impair our business operations,
financial results and prospects. If any of the following risks actually occur,
our business, financial results and prospects could be harmed. In that case, the
trading price of our ordinary shares could decline. You should also refer to the
other information set forth in this Annual Report, including our financial
statements and related notes and the Section captioned “Note Regarding
Forward-Looking Statements.”




We
have a history of operating losses and negative cash flows and may not be
profitable in the future.





We have
incurred substantial losses and negative cash flows since our inception. We had
an operating cash flow deficit in each of 2005, 2006, 2007 and 2008. As of
December 31, 2008, we had an accumulated deficit of approximately $42,294,000.
We incurred net losses of approximately $11,311,000 and $12,358,000 in the years
ended December 31, 2007 and 2008, respectively. For the year ended December 31,
2006, we would have incurred a net loss of $5,096,000, but for the $10,536,000
capital gain from the sale of the E-ID Division. We expect to spend significant
amounts of capital to enhance our products and services, develop further sales
and operations and fund expansion; and therefore, we may continue to have net
operating losses and negative cash flows for the foreseeable future. As a
result, we will need to generate significant revenue to achieve profitability.
Even if we do achieve profitability, we may not be able to sustain or increase
profitability on a quarterly or annual basis.





Parts of
our operating expense levels are based on internal forecasts for future demand
and not on firm customer orders for products or services. Our results may be
negatively affected by fluctuating demand for our products and services from one
quarter to the next and by increases in the costs of components and raw
materials acquired from suppliers.





We
will face a need for additional capital and may need to curtail our operations
if it is not available.





We have
partially funded our operations through the issuance of equity securities and
convertible bonds to investors and may not be able to generate a positive cash
flow from operations in the future. Continuation of our current operations after
utilizing our current cash reserves is dependent upon the generation of
additional financial resources either through the issuance of additional equity
or debt securities or other sources of financing or the sale of certain assets
of the Company. These matters raise substantial doubt about our ability to
continue as a going concern. The financial statements have been prepared
assuming that we will continue as a going concern. The financial statements do
not include any adjustments that might result from the outcome of this
uncertainty. Any additional financings will likely cause substantial dilution to
existing stockholders. If we are unable to obtain necessary additional
financing, we may be required to reduce the scope of, or cease, our operations.
Even if we raise such additional capital, we may be required to reduce the scope
of our operations and may need to implement certain operational changes in order
to decrease our expenditure level. Our need for additional capital to finance
our operations and growth will be greater should, among other things, our
revenue or expense estimates prove to be incorrect.




The current economic and financial
crisis may have a material adverse effect on our
results.




The
crisis of the financial and credit markets worldwide in the second half of 2008
has led to an economic slowdown worldwide, and the outlook for 2009 is
uncertain. A continuation or worsening of unfavorable economic conditions,
including the on-going credit and capital markets disruptions, could have an
adverse impact on our business, operating results or financial condition in a
number of ways. We may experience declines in revenues, profitability and cash
flows as a result of reduced orders, delays in receiving orders or in the
completion of projects, delays or defaults in payment or other factors caused by
the economic problems of our customers and prospective customers. We may
experience supply chain delays, disruptions or other problems associated with
financial constraints faced by our suppliers and subcontractors. In addition,
changes and volatility in the equity, credit and foreign exchange markets and in
the competitive landscape make it increasingly difficult for us to predict our
revenues and earnings into the future. Currently, we lack of short-term
visibility as customers are focused on maintaining flexibility, reducing
inventory and conserving their cash.





8




Adverse capital and credit market
conditions may impact our ability to access liquidity and
capital.





The
capital and credit markets have been experiencing extreme volatility and
disruption for more than eighteen months. In the second half of 2008, the
volatility and disruption reached unprecedented levels.  We need
liquidity in our day-to-day business activities to pay our operating expenses
and interest on our debt.





In the
event current resources do not satisfy our needs, we may have to seek additional
financing. The availability of additional financing will depend on a variety of
factors such as market conditions, the general availability of credit, the
volume of trading activities, the overall availability of credit to the
financial services industry, our credit ratings and credit capacity, as well as
the possibility that customers or lenders could develop a negative perception of
our long- or short-term financial prospects.. If our internal sources of
liquidity prove to be insufficient, there is a risk that external funding
sources might not be available or available at unfavorable terms.





Disruptions,
uncertainty or volatility in the capital and credit markets may also limit our
access to capital required to operate our business. Such market conditions may
limit our ability to raise additional capital to support business
growth.





This
would have the potential to decrease both our profitability and our financial
flexibility. Our results of operations, financial condition, cash flows and
regulatory capital position could be materially adversely affected by
disruptions in the financial markets.




Depending on the impact on our
business of the current economic crisis, we may face problems in managing any
decline in our business.




If the
current economic and financial crisis continues to have an adverse impact on the
demand for products or their profitability, we may face difficulties in managing
a decline in our business. Our success in handling a contraction of our business
will depend on our ability, among other things, to:




—
            develop efficient forecast
      methods for evaluating the prospective quantity of products that will be
      ordered by our customers;


—
            control inventories of components
      ordered by our contract manufacturers required to meet actual demand,
      including but not limited to handling the effects of excess inventories
      accumulated by such
manufacturers;


—
            reduce the costs of manufacturing
      our products;


—
            continue to collect receivables
      from our customers in full and in a timely manner;
    and


—
            properly balance the size and
      capabilities of our
workforce.




If we are
unable to manage a decline in business, we could fail to manage the costs
associated with all aspects of our business, which would have a material adverse
effect on our business and results of operations.





There is a material weakness in our
internal control over financial reporting and we may not be able to remedy this
material weakness or prevent future material weaknesses. If we fail to do
so there is a reasonable
possibility that a material misstatement of the annual or interim financial
statements will not be prevented or detected on a timely basis.




The
material weakness in our internal control over financial reporting as identified
by our management as of December 31, 2008 is summarized below.




Our
improper segregation of duties in our finance department has not reduced to an
acceptable low level the risk that material errors may occur and may not be
detected on a timely basis by management in the normal course of
business.




Notwithstanding
the steps we have taken and continue to take that are designed to remediate the
material weakness identified above, we may not be successful in remediating this
material weakness in the near or long term and we may not be able to prevent
other material weaknesses in the future. Any failure to maintain or implement
required new or improved internal control over financial reporting, or any
difficulties we encounter in their implementation, could result in additional
significant deficiencies or additional material weaknesses or result in material
misstatements in our financial statements. Any such failure could also adversely
affect the results of periodic management evaluations and annual auditor
attestations regarding the effectiveness of our internal control over financial
reporting required under Section 404 of the Sarbanes-Oxley Act of
2002.





9




The
existence of a material weakness could result in errors in our financial
statements that could result in a restatement of financial statements, cause us
to miss our reporting deadlines and cause investors to lose confidence in our
reported financial information, leading to a decline in the price of our shares.
See “Item 15, Controls and Procedures” for additional information.




We
may face a reduction in our revenues from our perimeter security and border
control projects associated with the European Airport Project.





The
revenues from our European International Airport Project for the years ended
December 31, 2007 and 2008 were $2,182,000 and $9,722,000,
respectively.  The revenues received from the European Airport Project
are almost fully recognized through December 31, 2008, and we expect that
approximately $1,896,000 will be recognized in 2009. Unless we have significant
growth in our active RFID, Passive RFID (EAC) CSMS and RAPTOR business lines, we
may face reduction in our revenues.





We
derive a substantial portion of our revenue from a small number of customers,
and the reduction of sales to any one of those customers could adversely impact
our operating results by causing a drop in revenues.





We depend
on a limited number of customers for a substantial portion of our revenue. In
the years 2006, 2007 and 2008, we derived 80%, 79% and 77% respectively, of our
consolidated net revenue from four individual customers. In the year ended
December 31, 2008, four of our customers accounted for 77% of our consolidated
net revenues as follows: the government of a European country, European
International Airport, Racine and the Israel government accounted for 47%, 26%,
2% and 1%, respectively, of our consolidated net revenues. A substantial
reduction in sales to, or loss of, any of our significant customers would
adversely affect our business unless we were able to replace the revenue we
received from those customers, which replacement we may not be able to find.
Specifically, changes that may negatively impact the political or economic
stability and environment of the European country, from which we derive 26% of
our consolidated net revenues under a 10-year contract, could adversely affect
our business and future operations in such country.





As a
result of this concentration of revenue from a limited number of customers, our
revenue has experienced wide fluctuations, and we may continue to experience
wide fluctuations in the future. Part of our sales is not recurring sales,
therefore quarterly and annual sales levels could fluctuate. Sales in any period
may not be indicative of sales in future periods.





We
are relying on On Track Innovations Ltd. as a subcontractor in projects not
transferred as part of the sale of our E-ID Division.





On
December 31, 2006, we sold our E-ID Division to On Track Innovations Ltd.
(“OTI”), an Israeli public company (NASDAQ: OTIV). Simultaneously, we entered
into a service and supply agreement with OTI under which OTI agreed to act as
our subcontractor and provide services, products and materials necessary to
carry out and complete our obligations with regard to certain projects that were
not transferred to OTI (the “Existing Projects”) (see description of this
transaction under the caption “The OTI Transaction” in Item 4.A).We will be dependent on
OTI to adequately provide such services, products, and materials in order for us
to be in good standing under, and successfully complete, these projects. If OTI
fails to fulfill its obligations and provide such services and products as
necessary for the Existing Projects, it could delay our receipt of revenues for
these projects, subject us to certain remedies available to our customers in the
Existing Projects, and damage our business reputation, and therefore could have
a material adverse effect on our business, operating results and financial
condition.





Our reliance on third party
technologies, raw materials and components for the development of some of our
products and our reliance on third parties for manufacturing may delay product
launches, impair our ability to develop and deliver products or hurt our ability
to compete in the market.





Most of
our products integrate third-party technology that we license and/or raw
materials and components that we purchase or otherwise obtain the right to use,
including: operating systems, microchips, security and cryptography technology
for card operating systems, which prevents unauthorized parties from tampering
with our cards, and dual interface technology, which enables cards to operate in
both contact and contactless mode. Our ability to purchase and license new
technologies and components from third parties is and will continue to be
critical to our ability to offer a complete line of products that meets customer
needs and technological requirements. We may not be able to renew our existing
licenses or to purchase components and raw materials on favorable terms, if at
all. If we lose the rights to a patented technology, we may need to stop selling
or may need to redesign our products that incorporate that technology, and we
may lose the potential competitive advantage such technology gave us. In
addition, competitors could obtain licenses for technologies for which we are
unable to obtain licenses, and third parties may develop or enable others to
develop a similar solution to security issues, either of which could adversely
affect our results of operations. Also, dependence on the patent protection of
third parties may not afford us any control over the protection of the
technologies upon which we rely. If the patent protection of any of these third
parties were compromised, our ability to compete in the market could also be
impaired.





10





We
usually do not have minimum supply commitments from our vendors for our raw
materials or components and generally purchase raw materialsand components on a
purchase order basis. Although we generally use standard raw materials and
components for our systems, some of the key raw materials or components are
available only from a single source or from limited sources. Many of our
products are only available from limited sources. Even where multiple sources
are available, we typically obtain components and raw materials from only one
vendor to ensure high quality, prompt delivery and low cost. If one of our
suppliers were unable to meet our supply demands and we could not quickly
replace the source of supply, it could have a material adverse effect on our
business, operating results and financial condition, for reasons including a
delay of receipt of revenues and damage to our business reputation.





Delays
in deliveries from our suppliers, defects in goods or components supplied by our
vendors, or delays in projects that are performed by our subcontractors could
cause our revenues and gross margins to decline.





We rely
on a limited number of vendors and subcontractors for certain components of the
products we are supplying and projects we perform. In some cases, we rely on a
single source vendor or subcontractor. Any undetected flaws in components or
other materials to be supplied by our vendors could lead to unanticipated costs
to repair or replace these parts or materials. Even though there are multiple
suppliers, we purchase some of our components from single suppliers to take
advantage of volume discounts, which presents a risk that the components may not
be available in the future on commercially reasonable terms, or at all. Although
we believe that there are additional suppliers for the equipment and supplies
that we require, we may not be able to make such alternative arrangements
promptly. If one of our suppliers were unable to meet our supply demands and we
could not quickly replace the source of supply, it could cause a delay of
receipt of revenues and damage our business reputation. We depend on
subcontractors to adequately perform a substantial part of our projects. If a
subcontractor fails to fulfill its obligations under a certain project, it could
delay our receipt of revenues for such project and damage our business
reputation, and therefore could have a material adverse effect on our business,
operating results and financial condition.





We
have entered into an agreement to acquire all of the issued and outstanding
stock capital of Security Holding Corporation. Certain unexpected outcomes of
this acquisition are not yet known and there is still no assurance that the
business combination will result in all of the benefits that we
anticipated.





In July
2007, we entered into an agreement to acquire all of the issued and outstanding
stock capital of Security Holding Corp. (“SHC”).  The main reason
behind the acquisition of SHCis our belief that the
combined company would be better positioned to offer competitive RFID security
solutions to existing and prospective customers.





Prior to completion of the
acquisition, we conducted a due diligence review of SHC; however, we cannot
guarantee that all contingent liabilities were brought to our knowledge. A
material liability that had not been discovered in the due diligence process, or
since, might affect our business.





In
addition, this acquisition resulted in the recording of amounts related to
goodwill and certain purchased intangible assets, that may result in additional
impairment charges arising out of the write-off of such goodwill and intangible
assets, which could negatively impact our business, financial condition and
results of operations, and cause the price of our ordinary shares to decline.
During 2008, we had to record goodwill impairment charges in the amount of
$3,235,000.





We
have entered into an agreement to acquire substantially all of the assets and
liabilities of Intelli-Site, Inc. Certain unexpected outcomes of this
acquisition are not yet known and there is still no assurance that the business
combination will result in all of the benefits that we anticipated.





In March 2009, we entered into an
agreement to acquire substantially all of the assets and liabilities of
Intelli-Site, Inc (“Intelli-Site”).  The main reason behind the
acquisition of Intelli-Siteis our belief that the
combined company will be better positioned to offer competitive RFID security
solutions to existing and prospective customers. It is not yet clear whether all
of the expected benefits of this business combination will be
achieved.  We believe that the following are among the factors that
may affect whether such benefits will indeed be achieved, and when such results
will be known:


·
            our
      ability to maintain and increase the sale of Intelli-Site
      products;


·
            our
      ability to combine the operating activities of Intelli-Site with those of
      our U.S. subsidiary, Vuance, Inc.;








11


·
            our
      ability to sell our products to Intelli-Site’s existing customers;
      and


·
            our
      ability to maintain key employees of
  Intelli-Site;





Prior to
completion of the acquisition, we conducted a due diligence review of
Intelli-Site; however, we cannot guarantee that all contingent liabilities were
brought to our knowledge. A material liability that had not been discovered in
the due diligence process might affect our business.





In
addition, this acquisition may result in the recording and later amortization of
amounts related to goodwill and certain purchased intangible assets, or later
impairment charges arising out of the write-off of such goodwill and intangible
assets, which could negatively impact our business, financial condition and
results of operations, and cause the price of our ordinary shares to
decline.





We
may pursue acquisitions or investments in complementary technologies and
businesses. We may be unsuccessful in integrating the acquired businesses and/or
assets of SHC and other complementary technologies and businesses, the
acquisition of which we may pursue in the future, and such integrations could
divert our resources and adversely affect our financial results.





Before the acquisition of SHC, we have
not made any other acquisitions and our management has not had significant
experience making acquisitions or integrating acquired businesses. Integrating
the newly acquired business or technologies into our business could divert our
management’s attention from other business concerns and could be expensive and
time-consuming. Acquisitions, such as our agreement to acquire the issued and
outstanding stock capital of SHC, could expose our business to unforeseen
liabilities or risks associated with entering new markets. Consequently, we
might not be successful in integrating the acquired businesses, technologies or
products into our existing business and products, and might not achieve
anticipated revenue or cost benefits. In the future, we may pursue acquisitions
of, or investments in, additional complementary technologies and businesses. We
may be unable to identify suitable acquisition candidates in the future or to
make these acquisitions on a commercially reasonable basis, or at all.
Acquisitions present a number of potential risks and challenges that could, if
not met, disrupt our business operations, increase our operating costs and
reduce the value to us of the acquired company. For example, if we identify an
acquisition candidate, we may not be able to successfully negotiate or finance
the acquisition on favorable terms. In addition, future acquisitions could
result in customer dissatisfaction, performance problems with an acquired
company, or require us to issue equity securities, incur debt, assume contingent
liabilities or have amortization expenses and write-downs of acquired assets,
which could adversely affect our profitability.





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 the
United States. We establish relationships with distributors and resellers
through 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 not long-term
contracts, do not have commitments for minimum sales, and could be terminated by
the distributor. We do not have agreements with all of our distributors. 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 a distributor who is not performing satisfactorily may be
limited. Inadequate performance by a distributor could adversely 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.





12




Third
parties could obtain access to our proprietary information or could
independently develop similar technologies.





Despite
the precautions we take, third parties may copy or obtain and use our
technologies, ideas, know-how and other proprietary information without
authorization or may independently develop technologies similar or superior to
our technologies. In addition, the confidentiality and non-competition
agreements between us and most of our employees, distributors and clients may
not provide meaningful protection of our proprietary technologies or other
intellectual property in the event of unauthorized use or disclosure. If we are
not able to successfully defend our industrial or intellectual property rights,
we may lose rights to technologies that we need to develop our business, which
may cause us to lose potential revenues, or we may be required to pay
significant license fees for the use of such technologies. To date, we have
relied primarily on a combination of patent, trade secret and copyright laws, as
well as nondisclosure and other contractual restrictions on copying, reverse
engineering and distribution to protect our proprietary technology. Our patent
portfolio currently consists of two issued U.S. patents, four U.S. patent
applications and one PCT. Generally, these patents, applications and PCTs relate
to our government solutions and access control technologies.





Our
patent applications may not result in issued patents, and even if they result in
issued patents, the patents may not have claims of the scope we seek. Even in
the event that these patents are not issued, the applications may become
publicly available and proprietary information disclosed in the applications
will become available to others.  In addition, any issued patents may
be challenged, invalidated or declared unenforceable. Our present and future
patents may provide only limited protection for our technology and may not be
sufficient to provide competitive advantages to us. For example, competitors
could be successful in challenging any issued patents or, alternatively, could
develop similar or more advantageous technologies on their own or design around
our patents. Any inability to protect intellectual property rights in our
technology could enable third parties to compete more effectively with us and/or
could reduce our ability to compete. In addition, these efforts to protect our
intellectual property rights could require us to incur substantial costs even
when our efforts are successful.





In
addition, the laws of certain foreign countries may not protect our intellectual
property rights to the same extent as do the laws of Israel or the United
States. Our means of protecting our intellectual property rights in Israel, the
United States or any other country in which we operate may not be adequate to
fully protect our intellectual property rights. For instance, the intellectual
property rights of our Asian subsidiary, SuperCom Asia Pacific Ltd., may not be
fully protected by the laws of Hong Kong and the People’s Republic of China
(“PRC”). The PRC does not yet possess a comprehensive body of intellectual
property laws. As a result, the enforcement, interpretation and implementation
of existing laws, regulations or agreements may be sporadic, inconsistent and
subject to considerable discretion. The PRC’s judiciary has not had sufficient
opportunity to gain experience in enforcing laws that exist, leading to a higher
than usual degree of uncertainty as to the outcome of any litigation. As the
legal system develops, entities such as ours may be adversely affected by new
laws, changes to existing laws (or interpretations thereof) and preemption of
provincial or local laws by national laws. Even when adequate law exists in the
PRC, it may not be possible to obtain speedy and equitable enforcement of the
law.





Third
parties may assert that we are infringing their intellectual property
rights.





We may face intellectual property
litigation, which could be costly, harm our reputation, limit our ability to
sell our products, force us to modify our products or obtain appropriate
licenses, and divert the attention of management and technical
personnel.





Our
products employ technology that may infringe on the proprietary rights of
others, and, as a result, we could become liable for significant damages and
suffer other harm to our business. Other than the ongoing litigation with
Secu-Systems Ltd., as described in Item 8 below under the caption “Legal
Proceedings,” we have not been subject to intellectual property litigation to
date. On August 8, 2003, we received a letter stating that we may be infringing
certain patents of third parties with respect to our hot lamination process for
plastic cards. We reviewed the claims made in the letter and we do not believe
that our products or technology infringe any third party's patents as claimed in
the letter. Since the initial letter, we received another letter dated July 13,
2004 from the same party requesting that we respond to their claim and stating
that attractive licenses are available. On August 11, 2004, we responded to this
letter and indicated that we were not infringing upon such parties’ patents. To
date, no infringement claims have been filed against us in connection with the
foregoing letters. We believe that hot lamination of plastic cards is a widely
known process that is used by most card manufacturers. Even if it were
determined that we are infringing such third party’s patents, we believe that we
could use another process to laminate plastic cards without materially affecting
our business. On December 2, 2005, we received a letter stating that we may be
infringing certain patents of third parties with respect to our Smart DSMS
product for incident response management. We reviewed the claims made in the
letter and we do not believe that our products or technology infringe any third
party's patents as claimed in the letter. On February 21, 2006, after thorough
investigation that included legal counseling, we responded to the letter while
declining the claims in the letter. Since the initial letter, we received
another letter dated August 1, 2007 from the same party stating that "at least
on the surface" it appears that we are infringing one of their patents based on
a line written in our website. On September 6, 2007, we responded to this letter
and indicated that we were not infringing upon such party’s patents. To date, no
infringement claims have been filed against us in connection with the foregoing
letters. We believe that the Smart DSMS product lacks key features recited in
each of the claims mentioned because the product does not perform steps of
assigning and recording as recited in the party's patent.





13





Litigation
may be necessary in the future to enforce any patents we may obtain and/or any
other intellectual property rights, to protect our trade secrets, to determine
the validity and scope of the proprietary rights of others, or to defend against
claims of infringement or invalidity, and we may not prevail in any such future
litigation. Litigation, whether or not determined in our favor or settled, could
be costly, could harm our reputation and could divert the efforts and attention
of our management and technical personnel from normal business operations. In
addition, adverse determinations in litigation could result in the loss of our
proprietary rights, subject us to significant liabilities, require us to seek
licenses from third parties, prevent us from licensing our technology or selling
or manufacturing our products, or require us to expend significant resources to
modify our products or attempt to develop non-infringing technology, any of
which could seriously harm our business.





Our
products may contain technology provided to us by third parties. Because we did
not develop such technology ourselves, we may have little or no ability to
determine in advance whether such technology infringes the intellectual property
rights of any other party. Our suppliers and licensors may not be required to
indemnify us in the event that a claim of infringement is asserted against us,
or they may be required to indemnify us only with respect to intellectual
property infringement claims in certain jurisdictions, and/or only up to a
maximum amount, above which we would be responsible for any further costs or
damages. In addition, we have indemnification obligations to certain customers,
as well as to OTI with respect to any infringement of third-party patents and
intellectual property rights by our products. If litigation were to be filed
against these parties in connection with our technology, we would be required to
defend and indemnify such customers.





We
may be plaintiff or defendant in various legal actions from time to
time.





From time
to time, we are the defendant or plaintiff in various legal actions, which arise
in the normal course of business. We are required to assess the likelihood of
any adverse judgments or outcomes to these matters as well as potential ranges
of probable losses. A determination of the amount of reserves required for these
contingencies, if any, which would be charged to earnings, is made after careful
and considered analysis of each individual action with our legal advisors. The
required reserves may change in the future due to new developments in each
matter or changes in circumstances, such as a change in settlement strategy. A
change in the required reserves would affect our earnings in the period the
change is made.





A
security breach of our internal systems or those of our customers could harm our
business by adversely affecting the market's perception of our products and
services, thereby causing our revenues to decline.





For us to
further penetrate the marketplace, the marketplace must be confident that we
provide effective security protection for national and other secured
identification documents and cards. Although we have not experienced any act of
sabotage or unauthorized access by a third party of our software or technology
to date, if an actual or perceived breach of security occurs in our internal
systems or those of our customers, regardless of whether we caused the breach,
it could adversely affect the market's perception of our products and services.
This could cause us to lose customers, resellers, alliance partners or other
business partners, thereby causing our revenues to decline. If we or our
customers were to experience a breach of our internal systems, our business
could be severely harmed by adversely affecting the market's perception of our
products and services.





We
may be exposed to significant liability for actual or perceived failure to
provide required products or services which could damage our reputation and
adversely affect our business by causing our revenues to decline and our costs
to rise.





Products
as complex as those we offer may contain undetected errors or may fail when
first introduced or when new versions are released. Despite our product testing
efforts and testing by current and potential customers, it is possible that
errors will be found in new products or enhancements after commencement of
commercial shipments. The occurrence of product defects or errors could result
in adverse publicity, delay in product introduction, diversion of resources to
remedy defects, loss of or a delay in market acceptance, or claims by customers
against us, or could cause us to incur additional costs or lose revenues, any of
which could adversely affect our business.





Because
our customers rely on our products for critical security applications, we may be
exposed to claims for damages allegedly caused to a customer as a result of an
actual or perceived failure of our products. An actual or perceived breach of
security systems of one of our customers, regardless of whether the breach is
attributable to our products or solutions, could adversely affect our business
reputation. Furthermore, our failure or inability to meet a customer's
expectations in the performance of our services, or to do so in the time frame
required by the customer, regardless of our responsibility for the failure,
could result in a claim for substantial damages against us by the customer,
discourage other customers from engaging us for these services, and damage our
business reputation. We carry product liability insurance, but existing coverage
may not be adequate to cover potential claims.





14





We carry
a combined products liability and professional liability insurance. We believe
that this insurance coverage is comparable to that of other similar companies in
our industry. However, that insurance may not continue to be available to us on
reasonable terms or in sufficient amounts to cover one or more large claims, or
the insurer may disclaim coverage as to any future claim. We do not maintain
insurance coverage for theft by employees, nor do we maintain specific insurance
coverage for any interruptions in our business operations. The successful
assertion of one or more large claims against us that exceed available insurance
coverage, or changes in our insurance policies, including premium increases or
the imposition of large deductibles or co-insurance requirements, could
adversely affect our business by significantly increasing our
costs.





Our
efforts to expand our international operations are subject to a number of risks,
any of which could adversely reduce our future international sales and increase
our losses.





Most of
our revenues to date have been generated in jurisdictions other than the United
States. Our inability to obtain or maintain federal or foreign regulatory
approvals relating to the import or export of our products on a timely basis
could adversely affect our ability to expand our international business.
Additionally, our international operations could be subject to a number of
risks, any of which could adversely affect our future international sales and
operating results, including:





·
            increased
      collection risks;


·
            trade
      restrictions;


·
            export
      duties and tariffs;


·
            uncertain
      political, regulatory and economic
developments;


·
            inability
      to protect our intellectual property
rights;


·
            highly
      aggressive competitors;


·
            lower
      gross margins in commercial sales in Hong Kong and
  China;


·
              business
      development issues in Hong Kong and China, where business development is
      time consuming and risky due to the uncertain political, regulatory and
      legal environment;
 ·
                      if
      we do not generate additional sales from the expansion, our losses may
      increase;
and
 ·
                    currency
      issues.





In
addition, in many countries the national security organizations require our
employees to obtain clearance before such employees can work on a particular
transaction. Failure to receive, or delays in the receipt of, relevant foreign
qualifications could also have a material adverse effect on our ability to
obtain sales at all or on a timely basis. Additionally, as foreign government
regulators have become increasingly stringent, we may be subject to more
rigorous regulation by governmental authorities in the future. If we fail to
adequately address any of these regulations, our business will be
harmed.





We
have sought in the past and may seek in the future to enter into contracts with
the U.S. government as well as state and local governmental agencies and
municipalities, which subjects us to certain risks associated with such types of
contracts.




Most
contracts with the U.S. government or state or local agencies or municipalities
(“Governmental Contracts”) are awarded through a competitive bidding process,
and some of the business that we expect to seek in the future will likely 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
      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




15




·
            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 U.S. government or the
applicable state or local agency or municipality 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 the 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, Governmental Contracts subject us to risks associated with public
budgetary restrictions and uncertainties, actual contracts that are less than
awarded contract amounts, and cancellation at any time at the option of the
governmental agency. Any failure to comply with the terms of any Governmental
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 Governmental
Contracts during the suspension period. Cancellation of any one of our major
Governmental Contracts could have a material adverse effect on our financial
condition.





The U.S.
government may be in a position to obtain greater rights with respect to our
intellectual property than we would grant to other entities. Governmental
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 Governmental 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 the fines and
penalties and prohibiting us from earning revenues from Governmental Contracts
during the suspension period.





Furthermore,
governmental programs can experience delays or cancellation of funding, which
can be unpredictable. For example, the U.S. military’s involvement in Iraq has
caused the diversion of some Department of Defense funding away from certain
projects in which we participate, thereby delaying orders under certain of our
governmental contracts. This makes it difficult to forecast our revenues on a
quarter-by-quarter basis.





The
markets that we target for a substantial part of our future growth are in very
early stages of development, and if they do not develop our business may not
grow as much or as profitably as we hope.





Many of the markets that we target for
our future growth are small or non-existent and need to develop if we are to
achieve our growth objectives. If some or all of these markets do not develop,
or if they develop more slowly than we anticipate, then we will not grow as
quickly or as profitably as we hope. In February 2006, we announced the
introduction of a new technology and solution for actively tracking people,
objects and assets, Active RFID Tracking Systems (“PureRF”). This new
technology, which expanded our homeland security offerings, was developed in
response to growing market demand for asset tracking solutions in the homeland
security and commercial markets. While the incident management and homeland
security benefits provided by PureRF are relatively obvious, we have also
identified other market opportunities in the public and private sectors of the
economy.





Our Credentialing suite has not been
widely adopted by state and local governments, largely due to the dependency on
federal grants, the cost of the necessary infrastructure and the relatively
limited capabilities of previous solutions. We are investing in credentialing,
identification, active RFID and security networks products and services, but so
far we have not deployed our systems on a widespread basis, other than to meet a
growing demand from our existing customer base.





In 2008, our revenues from the
government market totaled approximately $15,873,000 compared to $4,780,000 from
the commercial market. Although we believe the government market is critical to
our success in the short term, we believe that both the government and
commercial markets will be critical to our long-term success. The development of
these markets will depend on many factors that are beyond our control, including
the following factors (and other factors discussed elsewhere in the Risk
Factors): (i) there can be no assurances that we will be able to continue to
apply our expertise and solutions developed for the government market to the
commercial market; (ii) the ability of public safety and other government
agencies to access U.S. Department of Homeland Security and other homeland
security-related grants for incident management and related purposes; (iii) the
ability of the commercial markets to adopt and implement the active RFID
solutions; and (iv) the ability of our management to successfully market our
technologies to such government and/or commercial entities.





16


The
success of our new business lines, comprising of the active RFID, CSMS and
RAPTOR products, is dependent on several factors.





The
success of our active RFID, CSMS and RAPTOR products is dependent on several
factors, including proper new product definitions, product costs, timely
completion and introduction of the new products, differentiation of the new
products from those of our competitors, and market acceptance of these products,
as well as our existing and potential customers’ varying budgets for capital
expenditures and new product introduction. We have addressed the need to develop
new products through our internal development efforts and joint development
efforts with other companies. In light of the OTI Transaction, the active RFID,
CSMS and RAPTOR product lines will be our main revenue growth generators in the
future. There can be no assurance that we will successfully identify new product
opportunities and/or develop and bring new products to market in a timely
manner, or that the products and technologies developed by others will not
render our products or technologies obsolete or noncompetitive. The failure of
our new product development efforts could have a material adverse effect on our
business, results of operations and future growth.





If
our technology and solutions ceases to be adopted and used by government and
commercial organizations, we may lose some of our existing customers and
increase our losses.





Our
ability to grow depends significantly on whether governmental and commercial
organizations adopt our technology and solutions as part of their new standards
and whether we will be able to leverage our expertise with government products
into commercial products. If these organizations do not adopt our technology, we
might not be able to penetrate some of the new markets we are targeting, or we
might lose some of our existing customer base. There also can be no assurances
that we will be able to continue to apply our expertise and solutions developed
for the public sector to the commercial market.





In order
for us to achieve our growth objectives, our RFID and Credentialing technologies
must be adapted to and adopted in a variety of areas, including:





·      public
safety and emergency;


·      asset
management;


·      patient
and critical equipment tracking in the health care sector;


·      monitoring
and control of evidence in a crime scene environment;


·      transportation
applications using active RFID as method of monitoring and control;
and


·      access
control in such fields as education and health care.





Any or all of these areas may not adopt
our RFID and Credentialing technologies.





We cannot
accurately predict the future growth rate, if any, or the ultimate size of the
RFID and credentialing technology markets. The expansion of the market for our
products and services depends on a number of factors such as:





·
            the
      cost, performance and reliability of our products and services compared to
      the products and services of our
competitors;


·
            customer
      perception of the benefits of our RFID based
  solutions;


·
            public
      perception of the intrusiveness of these solutions and the manner in which
      organizations use the information
collected;


·
            public
      perception of the confidentiality of private
  information;


·
            customer
      satisfaction with our products and services;
and


·
            marketing
      efforts and publicity for our products and
  services.





Even if
RFID and Credentialing solutions gain wide market acceptance, our products and
services may not adequately address market requirements and may not gain wide
market acceptance. If our solutions or our products and services do not gain
wide market acceptance, our business and our financial results will
suffer.





17





We
need to develop our position as a provider of RFID enabled security solutions
and Credentialing systems and services to earn high margins from our technology,
and if we are unable to develop such position, our business will not be as
profitable as we hope, if at all.





The
increasing sophistication of our RFID and Credentialing technologies places a
premium on providing innovative software systems and services to customers, in
addition to manufacturing and supplying RFID and Credentialing technologies.
While we have had some early success positioning ourselves as a provider of such
services and systems, we may not continue to be successful with this strategy
and we may not be able to capture a significant share of the market for the
sophisticated services and systems that we believe are likely to produce
attractive margins in the future. A significant portion of the value of our RFID
and Credentialing technologies lies in the development of software and
applications that will permit the use of RFID and Credentialing technologies in
new markets. In contrast, the margins involved in manufacturing and selling RFID
and Credentialing technologies can be relatively small, and may not be
sufficient to permit us to earn an attractive return on our development
investments.





The
time from our initial contact with a customer to a sale may be long and subject
to delays, which could result in the postponement of our receipt of revenues
from one accounting period to the next, increasing the variability of our
results of operations and causing significant fluctuations in our revenue from
quarter to quarter.





The period between our initial contact
with a potential customer and the purchase of our products and services is often
long and subject to delays associated with the budgeting, approval and
competitive evaluation processes that frequently accompany significant capital
expenditures, particularly by governmental agencies. The typical sales cycle for
our government customers has, to date, ranged from three to 24 months and the
typical sales cycle for our commercial customers has ranged from one to six
months. A lengthy sales cycle may have an impact on the timing of our revenue,
which may cause our quarterly operating results to fall below investor
expectations. We believe that a customer's decision to purchase our products and
services is discretionary, involves a significant commitment of resources, and
is influenced by customer budgetary cycles. To successfully sell our products
and services, we generally must educate our potential customers regarding their
use and benefits, which can require significant time and resources. This
significant expenditure of time and resources may not result in actual sales of
our products and services.





Due
to the nature of our business, our financial and operating results could
fluctuate.





Our
financial and operating results have fluctuated in the past and could fluctuate
in the future from quarter to quarter and from year to year for the following
reasons:





·
            long
      customer sales cycles;


·
            reduced
      demand for our products and
services;


·
            price
      reductions


·
            new
      competitors, or the introduction of enhanced products or services from new
      or existing competitors;


·
            changes
      in the mix of products and services we or our customers and distributors
      sell;


·
            contract
      cancellations, delays or amendments by
  customers;


·
            the
      lack of government demand for our products and services or the lack of
      government funds appropriated to purchasing our products and
      services;


·
            unforeseen
      legal expenses, including litigation
costs;


·
            expenses
      related to acquisitions;


·
            fluctuations
      in OTI's share price;


·
            other
      non-recurring financial charges;


·
            the
      lack of availability, or increased cost, of key components and
      subassemblies;


·
            the
      inability to successfully manufacture in volume, and reduce the price of,
      certain of our products; and


·
            impairment
      loss of goodwill and intangible
assets.





The
fair value of Vuance, Inc., our U.S. subsidiary, has caused a significant
goodwill impairment loss.





As part
of the annual review for impairment in accordance with SFAS No. 142 and 144, in
November 2008, we examined the fair value of the intangible assets and the
goodwill and in doing so, considered in part, a third party expert services.
The valuation referred to Vuance, Inc. as a single reporting unit. The
valuation was conducted on a going concern basis. Since Vuance, Inc. is
closely-held, and thus without a public market for its ownership interests, the
appraisal was conducted according to common appraisal practices, and based on
the Free Discounted Cash-Flows ("DCF") method.  In addition, we
received market indication with respect to the fair value of Vuance, Inc. in the
first quarter of 2009. Based on the above we were required to recognize an
impairment loss in the amount of approximately $3,235,000.





18





The
lead time for ordering parts for and manufacturing our products can be
significantly long and therefore based on forecasted demands rather than actual
orders received.





The lead
time for ordering parts and materials and building many of our products can be
many months. As a result, we must order parts and materials and build our
products based on forecasted demand. If demand for our products lags
significantly behind our forecasts, we may produce more products than we can
sell, which can result in cash flow problems and write-offs or write-downs of
obsolete inventory.





Our
markets are highly competitive and competition could harm our ability to sell
products and services and could reduce our market share.





The
market for RFID enabled products and Credentialing is intensely competitive. We
expect competition to increase as the industry grows and as RFID and
Credentialing technology begins to converge with the access control and
information technology industry. We may not be able to compete successfully
against current or future competitors. We face competition from technologically
sophisticated companies, many of which have substantially greater technical,
financial, and marketing resources than we do. In some cases, we compete with
entities that have pre-existing relationships with potential customers. As the
active RFID enabled solutions market expands, we expect additional competitors
to enter the market.





Some of
our competitors and potential competitors have larger technical staffs, larger
customer bases, more established distribution channels, greater brand
recognition and greater financial, marketing and other resources than we do. Our
competitors may be able to develop products and services that are superior to
our products and services, that achieve greater customer acceptance or that have
significantly improved functionality as compared to our existing and future
products and services. In addition, our competitors may be able to negotiate
strategic relationships on more favorable terms than we are able to negotiate.
Many of our competitors may also have well-established relationships with our
existing and prospective customers. Increased competition may result in our
experiencing reduced margins, loss of sales or decreased market
share.





The
average selling prices for our products may decline as a result of competitive
pricing pressures, promotional programs and customers who negotiate price
reductions in exchange for longer-term purchase commitments. The pricing of
products depends on the specific features and functions of the products,
purchase volumes and the level of sales and service support required. As we
experience pricing pressure, the average selling prices and gross margins for
our products may decrease over product lifecycles. These same competitive
pressures may require us to write down the carrying value of any inventory on
hand, which could adversely affect our operating results and earnings per
share.





We
rely on the services of certain executive officers and key personnel, the loss
of which could adversely affect our operations by causing a disruption to our
business.





Our
future success depends largely on the efforts and abilities of our executive
officers and senior management and other key employees, including technical and
sales personnel. The loss of the services of any of these persons could disrupt
our business until replacements, if available, are found. We do not maintain any
key-person insurance for any of our employees.





Our
ability to remain competitive depends in part on attracting, hiring and
retaining qualified technical personnel; if we are not successful in such hiring
and retention, our business could be disrupted.





Our
future success depends in part on the availability of qualified technical
personnel, including personnel trained in software and hardware applications
within specialized fields. As a result, we may not be able to successfully
attract or retain skilled technical employees, which may impede our ability to
develop, install, implement and otherwise service our software and hardware
systems and to efficiently conduct our operations.





The
information technology and network security industries are characterized by a
high level of employee mobility and the market for technical personnel remains
extremely competitive in certain regions, including Israel. This competition
means that (i) there are fewer highly qualified employees available for hire,
(ii) the costs of hiring and retaining such personnel are high, and (iii) highly
qualified employees may not remain with us once hired. Furthermore, there may be
pressure to provide technical employees with stock options and other equity
interests in us, which may dilute our shareholders and increase our
expenses.





19





The
additions of new personnel and the departure of existing personnel, particularly
in key positions, can be disruptive, might lead to additional departures of
existing personnel and could have a material adverse effect on our business,
operating results and financial condition.





Our
planned growth will place significant strain on our financial and managerial
resources and may negatively affect our results of operations and ability to
grow more.





Our
ability to manage our growth effectively will require us:





·      to
continue to improve our operations, financial and management controls, reporting
systems and procedures;





·      to
train, motivate and manage our employees; and





·      as
required, to install new management information systems.





Our
existing management and any new members of management may not be able to augment
or improve existing systems and controls, or implement new systems and controls,
in response to anticipated future growth. If we are successful in achieving our
growth plans, such growth is likely to place a significant burden on the
operating and financial systems, resulting in increased responsibility for our
senior management and other personnel.





Some
of our products are subject to government regulation of radio frequency
technology which could cause a delay in introducing, or an inability to
introduce, such products in the United States and other markets.





The rules
and regulations of the United States Federal Communications Commission (the
"FCC") limit the radio frequency used by and level of power emitting from
electronic equipment. Our readers, controllers and other radio frequency
technology scanning equipment are required to comply with these FCC rules which
may require certification, verification or registration of the equipment with
the FCC. Certification and verification of new equipment requires testing to
ensure the equipment's compliance with the FCC's rules. The equipment must be
labeled according to the FCC's rules to show compliance with these rules.
Testing, processing of the FCC's equipment certificate or FCC registration and
labeling may increase development and production costs and could delay
introduction of our verification scanning device and next generation radio
frequency technology scanning equipment into the U.S. market. Electronic
equipment permitted or authorized to be used by us through FCC certification or
verification procedures must not cause harmful interference to licensed FCC
users, and may be subject to radio frequency interference from licensed FCC
users. Selling, leasing or importing non-compliant equipment is considered a
violation of FCC rules and federal law, and violators may be subject to an
enforcement action by the FCC. Any failure to comply with the applicable rules
and regulations of the FCC could have a material adverse effect on our business,
operating results and financial condition by increasing our compliance costs
and/or limiting our sales in the United States.





Conditions
in Israel affect our operations in Israel and may limit our ability to sell our
products and services.





We are
incorporated under Israeli law and we also facilitate offices located in Israel.
Political, economic and military conditions in Israel may directly affect our
operations and business. Since the establishment of the State of Israel in 1948,
a number of armed conflicts have taken place between Israel and its Arab
neighbors and a state of hostility, varying from time to time in degree and
intensity, has led to security and economic problems for Israel. Although Israel
has entered into various agreements with its Arab neighbors and the Palestinian
Authority, there has been an increase in unrest and terrorist activity in
Israel, in varying levels of severity, since September 2000. The election in
early 2006 of representatives of Hamas, an Islamic resistance movement, to a
majority of seats in the Palestinian Legislative Council and the resulting
tension among the different Palestinian functions has created additional unrest
and uncertainty. Furthermore, several countries still restrict trade with
Israeli companies and additional countries may impose such restrictions as a
result of changes in the military and/or political conditions in Israel, which
may limit our ability to make sales in, or purchase components from, those
countries. Any future armed conflict, such as the armed conflict that occurred
during July and August, 2006 between Israel and Hezbollah, a Lebanese Islamist
Shiite militia group and political party, which involved rocket attacks on
populated areas in Northern Israel, or political instability, continued violence
in the region or restrictions could have a material adverse effect on our
business, operating results and financial condition. No predictions can be made
as to whether or when a final resolution of the area’s problems will be achieved
or the nature thereof and to what extent the situation will impact Israel’s
economic development or our operations.





20





Our
operations could be disrupted as a result of the obligation of management or key
personnel to perform military service in Israel.





Generally,
all nonexempt male adult citizens and permanent residents of Israel under the
age of 40, or older for reserves officers or citizens with certain occupations,
are obligated to perform annual military reserve duty and are subject to being
called for active duty at any time under emergency circumstances. We believe
that a maximum of three of our employees, approximately 6% of our employees at
any one time, could be called for active duty under emergency circumstances.
While we have operated effectively under these requirements since our
incorporation, we cannot predict the full impact of such conditions on us in the
future, particularly if emergency circumstances occur. If many of our employees
are called for active duty, our operations in Israel and our business, operating
results and financial condition may be adversely affected.





Your
rights and responsibilities as a shareholder will be governed by Israeli law and
differ in some respects from the rights and responsibilities of shareholders
under U.S. law.




We are
incorporated under Israeli law. The rights and responsibilities of holders of
our ordinary shares are governed by our Memorandum of Association and Articles
of Association, and by Israeli law. These rights and responsibilities differ in
some respects from the rights and responsibilities of shareholders in typical
U.S. corporations. In particular, a shareholder of an Israeli company has a duty
to act in good faith and customary manner in exercising his or her rights and
fulfilling his or her obligations toward the company and other shareholders, and
to refrain from misusing his power, including, among other things, when voting
at the general meeting of shareholders on certain matters. Israeli law provides
that these duties are applicable to shareholder votes on, among other things,
amendments to a company’s articles of association, increases in a company’s
authorized share capital and mergers and interested party transactions requiring
shareholder approval. A shareholder also has a general duty to refrain from
oppressing any other shareholder of his or her rights as a shareholder. In
addition, a controlling shareholder of an Israeli company or a shareholder who
knows that it possesses the power to determine the outcome of a shareholder vote
or who, under our Articles of Association, has the power to appoint or prevent
the appointment of a director or executive officer in the company, has a duty of
fairness toward the company. Israeli law does not define the substance of this
duty of fairness, but provides that remedies generally available upon a breach
of contract will apply also in the event of a breach of the duty to act with
fairness. Because Israeli corporate law has undergone extensive revision in
recent years, there is little case law available to assist in understanding the
implications of these provisions that govern shareholder behavior.





Provisions
of Israeli law may delay, prevent or otherwise encumber a merger with or an
acquisition of our company, which could prevent a change of control, even when
the terms of such transaction are favorable to us and our
shareholders.





Israeli corporate law regulates
mergers, requires tender offers for acquisitions of shares above specified
thresholds, requires special approvals for transactions involving directors,
officers or significant shareholders and regulates other matters that may be
relevant to these types of transactions. For example, a merger may not be
completed unless at least 50 days have passed from the date that a merger
proposal was filed by each merging company with the Israel Registrar of
Companies and at least 30 days from the date that the shareholders of both
merging companies approved the merger. In addition, a majority of each class of
securities of the target company is required to approve a merger. Furthermore,
Israeli tax considerations may make potential transactions unappealing to us or
to some of our shareholders whose country of residence does not have a tax
treaty with Israel exempting such shareholders from Israeli tax. For example,
Israeli tax law does not recognize tax-free share exchanges to the same extent
as U.S. tax law. With respect to mergers, Israeli tax law allows for tax
deferral in certain circumstances but makes the deferral contingent on the
fulfillment of numerous conditions, including a holding period of two years from
the date of the transaction during which time sales and dispositions of shares
of the participating companies are restricted. Moreover, with respect to certain
share swap transactions, the tax deferral is limited in time, and when the time
expires, tax then becomes payable even if no actual disposition of the shares
has occurred. These provisions of Israeli law could delay, prevent or impede a
merger with or an acquisition of our company, which could prevent a change of
control, even when the terms of such transaction are favorable to us and our
shareholders and therefore potentially depress the price of our
shares.




21




Our
shareholders may face difficulties in the enforcement of civil liabilities
against Vuance Ltd. and its officers and directors.





Certain
of our officers and directors and our professional advisors are residents of
Israel or otherwise reside outside of the U.S. Vuance Ltd. is incorporated under
Israeli law and its principal office and facilities are located in Israel. All
or a substantial portion of the assets of such persons are or may be located
outside of the U.S. It may be difficult to effect service of process within the
U.S. upon us or upon any such officers and directors or professional advisors or
to realize in the U.S. upon judgments of U.S. courts predicated upon the civil
liability of Vuance Ltd. or such persons under U.S. federal securities laws. We
have been advised by our Israeli counsel that there is doubt as to whether
Israeli courts would (i) enforce judgments of U.S. courts obtained against
Vuance Ltd. or such officers and directors or professional advisors predicated
solely upon the civil liabilities provisions of U.S. federal securities laws, or
(ii) impose liabilities in original actions against Vuance Ltd. or such officers
and directors and professional advisors predicated solely upon such U.S. laws.
However, in accordance with the Israeli Law on Enforcement of Foreign Judgments,
1958-5718, and subject to certain time limitations, an Israel court may declare
a foreign (including U.S.) civil judgment enforceable if it finds
that:





·
              the
      judgment was rendered by a court which was, according to the laws of the
      state of the court, competent to render the
  judgment;


·
              the
      judgment may no longer be
appealed;


·
              the
      judgment is executory in the jurisdiction in which it was
      given;


·
              the
      obligation, the subject matter of the judgment, is enforceable under
      Israeli laws of enforcement of judgments and is not contrary to public
      policy;


·
              due
      process has been observed;


·
              such
      judgment was rendered by a court which was competent to render such
      judgment according to the rules of private international law, as
      applicable in Israel;


·
              such
      judgment was not obtained by fraud and does not conflict with any other
      valid judgment in the same matter between the same parties;
      and


·
              an
      action between the same parties in the same matter is not pending in any
      Israeli court or tribunal at the time the law suit is instituted in the
      foreign court.





Even if
these conditions are satisfied, an Israeli court will not enforce a foreign
judgment if it was given in a state whose laws do not provide for the
enforcement of judgments of Israeli courts (subject to exceptional cases) or if
its enforcement is likely to prejudice the sovereignty or security of the State
of Israel. The term “prejudice the sovereignty or security of the State of
Israel” as used in the Israeli Law on Enforcement of Foreign Judgments has
rarely been interpreted by Israeli courts; therefore, there is only limited
guidance as to what criteria will be considered by an Israeli court in
determining whether the enforcement of a foreign judgment would prejudice the
sovereignty or security of the State of Israel.





An
investor may also find it difficult to bring an original action in an Israeli
court to enforce liabilities based upon U.S. federal securities laws against us
or against our directors or officers. Israeli courts may refuse to hear a claim
based on a violation of U.S. securities laws and rule that Israel is not the
most appropriate forum in which to bring such a claim. In addition, even if an
Israeli court agrees to hear such a claim, it may determine that Israeli law and
not U.S. law is applicable to the claim. If U.S. law is found to be applicable,
the content of applicable U.S. law must be proved as a fact, which can be a time
consuming and costly process. Certain matters of procedure will also be governed
by Israeli law. There is little binding case law in Israel addressing these
matters.





Fluctuations
in the exchange rate between the U.S. dollar and foreign currencies may affect
our operating results.





We incur
expenses for our operations in Israel in New Israeli Shekels ("NIS") and
translate these amounts into U.S. dollars for purposes of reporting consolidated
results. As a result, fluctuations in foreign currency exchange rates may
adversely affect our expenses and results of operations, as well as the value of
our assets and liabilities. Fluctuations may adversely affect the comparability
of period-to-period results. In addition, we hold foreign currency balances,
primarily NIS, that will create foreign exchange gains or losses, depending upon
the relative values of the foreign currency, at the beginning and end of the
reporting period, affecting our net income and earnings per share. Although we
may use hedging techniques in the future (which we currently do not use), we
will not be able to eliminate the effects of currency fluctuations. Thus,
exchange rate fluctuations could have a material adverse impact on our operating
results and stock price. (See also Item 15, "Impact of Inflation and Currency
Fluctuations")





We
are exposed to special risks in foreign markets which may make operating in
those markets difficult and thereby force us to curtail our business
operations.





In
conducting our business in foreign countries, we are subject to political,
economic, legal, operational and other risks that are inherent in operating in
other countries. For instance, business development in Hong Kong and China is
time consuming and risky due to the uncertain political, regulatory and legal
environment. Other risks inherent to operating in other countries range from
difficulties in settling transactions in emerging markets to possible
nationalization, expropriation, price control and other restrictive governmental
actions. We also face the risk that exchange controls or similar restrictions
imposed by foreign governmental authorities may restrict our ability to convert
local currency received or held by it in their countries into U.S. dollars or
other currencies, or to take those dollars or other currencies out of those
countries.





22





The
terrorist attacks of September 11, 2001, and the continuing threat of global
terrorism, have increased financial expectations in our industries that may not
materialize.





The
September 11, 2001 terrorist attacks and continuing concerns about global
terrorism, may have created an increased awareness for our security solutions in
general. However, it is uncertain whether the actual level of demand for our
products and services will grow as a result of such increased awareness.
Increased demand may not result in an actual increase in our revenues. In
addition, it is uncertain which security solutions, if any, will be adopted as a
result of terrorism and whether our products will be a part of those solutions.
The efforts of the U.S. in the war against terrorism, the war in Iraq, and the
post-war reconstruction efforts in Iraq, may actually delay funding for the
implementation of security solutions generally in the U.S. Even if our products
are considered or adopted as solutions to terrorism concerns, the level and
timeliness of available funding are unclear. These factors may adversely impact
us and create unpredictability in our revenues and operating
results.





We
are unlikely to pay dividends in the foreseeable future and any return on
investment may be limited to the value of our ordinary shares.





We
distributed a cash dividend to our shareholders on one occasion on August 26,
1997 in the aggregate amount of NIS 1 million and prior to that dividends in the
form of bonus shares were distributed on two other occasions. We do not expect
to declare or pay cash dividends in the foreseeable future and intend to retain
future earnings, if any, to finance the growth and development of our business.
If we do not pay dividends, our ordinary shares may be less valuable because a
return on your investment will only occur if our share price
appreciates.





Servicing
our debt obligations requires a significant amount of cash, and our ability to
obtain or generate cash depends on many factors beyond our control.





Our
ability to satisfy our debt service obligations, including making the payments
under the convertible bonds we issued in November 2006, to a financial investor
and to Special Situation Funds (the “Convertible Bonds”) will depend, among
other things, upon our future operating performance and our ability to refinance
indebtedness when necessary. Each of these factors is to a large extent
dependent on economic, financial, competitive, legislative, regulatory and other
factors that are beyond our control.





If, in
the future, we cannot generate sufficient cash from our operations to meet our
debt service obligations, we may need to reduce or delay capital expenditures or
curtail research and development efforts. In addition, we may need to refinance
our debt, obtain additional financing or sell assets, which we may not be able
to do on commercially reasonable terms, if at all. We cannot assure you that our
business will generate sufficient cash flow, or that we will be able to obtain
funding, sufficient to satisfy our debt service obligations. In addition, we may
need additional capital even to satisfy our present requirements if we undertake
large projects or have a delay in one of our anticipated projects. If we fail to
raise such additional capital, we may need to implement certain operational
changes in order to decrease our expenditure level. Our need for additional
capital to finance our operations and growth will be greater should, among other
things, our revenue or expense estimates prove to be incorrect.  In
addition, Continuation of the Company's current operations after utilizing its
current cash reserves is dependent upon the generation of additional financial
resources either through the issuance of additional equity or debt securities or
other sources of financing or the sale of certain assets of the Company.
These matters raise substantial doubt about the Company's ability to continue as
a going concern. The financial statements have been prepared assuming that we
will continue as a going concern. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.





Restrictions
imposed by our Convertible Bonds and other debt instruments may limit our
ability to finance future operations or capital needs or engage in other
business activities that may be in our interest. Our failure to comply with our
obligations under these instruments could lead to an acceleration of our
indebtedness.





The
indenture governing the Convertible Bonds contains certain covenants that will,
among other things, limit our ability and the ability of our restricted
subsidiaries to: (i) create liens; (ii) sell or otherwise dispose of assets;
(iii) engage in transactions with our affiliates; and (iv) merge or consolidate
with another entity or transfer all or substantially all of our assets. In
addition, we undertook to maintain a certain level of EBITDA for as long as the
Convertible Bonds are outstanding. These restrictions could limit our ability to
obtain future financing, make acquisitions or capital expenditures, withstand
economic downturns in our business, the industry or the economy in general,
conduct operations or otherwise take advantage of business opportunities that
arise.





23





Our
failure to make any payments due under our debt instruments, or to otherwise
comply with any of the restrictions or our obligations thereunder, could result
in an event of default under such instruments and lead to an acceleration of our
related indebtedness. We are not certain whether we would have, or would be able
to obtain, sufficient funds to make these accelerated payments. In that event,
certain lenders could proceed against those of our assets that secure their
debt.  As of December 31, 2008 and June 30, 2009, we are not in
compliance with certain covenants under our Convertible Bond agreements, in
which case the Convertible Bond holders could seek to accelerate payment of the
unpaid principal amount and accrued interest under its Convertible Bond, an
aggregate of approximately $4,420,000 as of June 30, 2009.  We are
currently negotiating with the Convertible Bond holders. See Item 5.B,
“Liquidity and Capital Resources,” regarding recent amendments to our agreements
with the holders of the Convertible Bonds.





The
number of ordinary shares that are available for sale upon exercise of our
outstanding warrants, options and convertible bonds is significant in relation
to our currently outstanding ordinary shares. Sales of a significant number of
our ordinary shares in the public market, or the perception that they may occur,
may depress the market price for our ordinary shares.





The
number of ordinary shares available for sale upon the exercise of our
outstanding warrants, options and convertible bonds is significant in relation
to the number of ordinary shares currently outstanding. As of May 31, 2009,
5,460,874 of our ordinary shares were outstanding. In addition, we had a total
of 1,254,101 ordinary shares issuable upon the exercise of outstanding options,
which we have issued to our employees and certain other persons at various
prices, some of which have exercise prices below the current market price for
our ordinary shares. As of May 31, 2009, we had a total of 857,185 ordinary
shares issuable upon the exercise of outstanding warrants issued to investors
and consultants, at various prices, which expire between 2009 and 2016. As of
May 31, 2009, we had a total of 980,055 ordinary shares issuable upon the
conversion of convertible bonds. As of May 31, 2009, our registered capital
permitted us to issue up to additional 3,447,785 ordinary shares in connection
with future grants of options, warrants, shares and other financial
instruments.





If our
warrant or option holders exercise their warrants or options, or holders of
convertible bonds covert their bonds into ordinary shares, and determine to sell
a substantial number of shares into the market at any given time, there may not
be sufficient demand in the market to purchase the shares without a decline in
the market price for our ordinary shares. Moreover, continuous sales into the
market of a number of shares in excess of the typical trading volume for our
ordinary shares, or even the availability of such a large number of shares or
the perception that these sales could occur, could cause substantial dilution to
existing shareholders, decrease the market price of our ordinary shares, and
impair our ability to raise capital in the future.




Our
ordinary shares may be delisted from The NASDAQ Capital Market, which could
negatively impact the price of our ordinary shares.




On
December 11, 2008, we received a letter from the NASDAQ Capital Market
(“NASDAQ") advising us that we did not comply with the continued listing
requirements of Listing Rule 5550(b) (formerly Marketplace Rule 4310(c)(3)),
which requires us to have a minimum of $2.5 million in stockholders’ equity, or
$35 million in market value of listed securities, or $500,000 of net income from
continuing operations for the most recently completed fiscal year or two of the
three most recently completed fiscal years (the “Listing
Requirements”).




As a
result, the NASDAQ Staff began reviewing our eligibility for continued listing
on NASDAQ. To facilitate their review, the NASDAQ Staff requested that we
provide on or before December 26, 2008, our specific plan to achieve and sustain
compliance with the NASDAQ listing requirements, including the time frame for
completion of the plan (the “Plan”).  After we submitted the Plan, on
March 30, 2009 we received further correspondence from NASDAQ that we did not
comply with the Listing Requirements, and therefore, trading of our ordinary
shares would be suspended at the opening of business on April 8, 2009, and a
form 25-NSE would be filed with the SEC removing our securities from listing and
registration on NASDAQ, unless we requested an appeal of the delisting decision
by NASDAQ.




We
appealed the NASDAQ determination to a NASDAQ Listings Qualifications Panel (the
“Panel”), which automatically stayed the delisting of our ordinary shares until
the Panel reached a decision.  On June 17, 2009, the Panel granted our
request for an extension of time to achieve full compliance with the Listing
Requirements.




The
Panel’s decision, and our continued listing on NASDAQ, is subject to our
compliance with certain conditions, including demonstration that we have
regained compliance with the Listing Requirements by September 28, 2009. While
we are executing on its plan to regain compliance, there can be no assurance
that we will be able to do so.  Should we be unable to meet the
exception requirement, the Panel will issue a final determination to delist our
shares and, unless the NASDAQ Listing and Hearings Review Council issues a stay,
will suspend trading of our shares on NASDAQ effective on the second business
day from the date of the final determination and our ordinary shares could be
eligible for quotation and trading on the OTC Bulletin Board in accordance with
applicable rules and regulations.





24





In light
of the foregoing, if we fail to comply with the listing standards applicable to
issuers listed on NASDAQ, our ordinary shares may be delisted from NASDAQ. Such
delisting of our ordinary shares would significantly affect the ability of
investors to trade our securities and would negatively affect the value and
liquidity of our ordinary shares. In addition, the delisting of our ordinary
shares could also have a material adverse affect on our ability to raise capital
on terms acceptable to us, or at all. Delisting from NASDAQ could also have
other negative results, including the potential loss of confidence by customers
and employees, the loss of institutional investor interest and fewer business
development opportunities.





"Penny
stock" rules may make buying or selling our ordinary shares difficult, severely
limiting the market price of our ordinary shares and the liquidity of our shares
in the U.S.





Trading
in our ordinary shares may be subject to the "penny stock" regulations adopted
by the SEC. These regulations generally define a "penny stock" to be any equity
security that has a market price of less than $5.00 per share, subject to
certain exceptions. These rules require that any broker-dealer who recommends
our securities to persons other than prior customers and accredited investors
must, prior to the sale, make a special written suitability determination for
the purchaser and receive the purchaser's written agreement to execute the
transaction. Unless an exception is available, the regulations require delivery,
prior to any transaction involving a "penny stock," of a disclosure schedule
explaining the penny stock market and the risks associated with trading in the
penny stock market. In addition, broker-dealers must disclose commissions
payable to both the broker-dealer and registered representative and current
quotations for the securities they offer. The additional burdens imposed upon
broker-dealers by such requirements may discourage broker-dealers from effecting
transactions in our stock, which could severely limit the market price and
liquidity of our stock.





Our
default under certain registration rights agreements may result in liquidated
damages.





In
connection with private placements completed in September 2004 and December
2005, in which we issued to the investors ordinary shares and warrants to
purchase our ordinary shares, we entered into registration rights agreements
pursuant to which we undertook to register such ordinary shares in accordance
with the Securities Act of 1933. Accordingly, we filed Forms F-1 on November
2004 and January 5, 2006. Our failure to properly update the Forms (and to make
subsequent registrations) in accordance with the registration rights agreements
could result in an event of default under such agreements and subject us to
liquidated damages.





We
have a shareholder that is able to exercise substantial influence over us and
all matters submitted to our shareholders which may make us difficult to be
acquired and less attractive to new investors.





Special
Situations Fund III, L.P. and its affiliates (collectively, “SSF”) beneficially
own 1,073,970 of our ordinary shares, representing approximately 26.95% of our
outstanding ordinary shares, based on 5,460,874 ordinary shares currently
outstanding. In addition, SSF own warrants exercisable for an additional 250,952
ordinary shares and Convertible Bond for additional 146,721 ordinary shares.
Such ownership interest gives SSF substantial influence over the outcome of all
matters submitted to our stockholders, including the election of directors and
the adoption of a merger agreement, and such influence could make us a less
attractive acquisition or investment target. In addition, our officers and
directors beneficially own a significant amount of our ordinary shares, which
may have a similar effect to SSF's ownership of our ordinary
shares.





If
persons engage in short sales of our ordinary shares, including sales of shares
to be issued upon the exercise of our outstanding warrants, options and
convertible bonds, the price of our ordinary shares may decline.




Selling
short is a technique used by a stockholder to take advantage of an anticipated
decline in the price of a security. In addition, holders of options, warrants
and convertible bonds will sometimes sell short knowing they can, in effect,
cover the sale through the exercise of an option, warrant or convertible bond,
thus locking in a profit. A significant number of short sales or a large volume
of other sales within a relatively short period of time can create downward
pressure on the market price of a security. Further sales of ordinary shares
issued upon exercise of our outstanding warrants, options or convertible bonds
could cause even greater declines in the price of our ordinary shares due to the
number of additional shares available in the market upon such exercise or
conversion, which could encourage short sales that could further undermine the
value of our ordinary shares. You could, therefore, experience a decline in the
value of your investment as a result of short sales of our ordinary
shares.





25





Costs
arising from our future acquisitions and dispositions could adversely affect our
financial condition.




Any
acquisition or disposition that we make could result in the use of our cash,
incurrence and assumption of debt, contingent liabilities, significant
acquisition-related expenses, amortization of certain identifiable intangible
assets, and research and development write-offs, and could require us to record
goodwill and other intangible assets that could result in future impairments
that could harm our financial results. We will likely incur significant
transaction costs pursuing acquisitions or dispositions, including acquisitions
or dispositions that may not be consummated. We may not be able to generate
sufficient revenues from our acquisitions or dispositions to offset their costs,
which could materially adversely affect our financial condition. The recognition
of impairments of tangible, intangible and financial assets results in a
non-cash charge on the income statement, which could adversely affect our
results of operations.




Being
a foreign private issuer exempts us from certain SEC requirements.





We are a
foreign private issuer within the meaning of rules promulgated under the U.S.
Securities and Exchange Act of 1934, as amended (the “Exchange Act”). As such,
we are exempt from certain provisions applicable to U.S. public companies
including:


·
            the
      rules under the Exchange Act requiring the filing with the SEC of
      quarterly reports on Form 10-Q or current reports on Form
    8-K;


·
            the
      sections of the Exchange Act regulating the solicitation of proxies,
      consents or authorizations in respect of a security registered under the
      Exchange Act;


·
            the
      provisions of Regulation FD aimed at preventing issuers from making
      selective disclosures of material information;
  and


·
            the
      sections of the Exchange Act requiring insiders to file public reports of
      their stock ownership and trading activities and establishing insider
      liability for profits realized from any “short-swing” trading transaction
      (i.e., a purchase and sale, or sale and purchase, of the issuer’s equity
      securities within less than six
months).





Because
of these exemptions, investors are not afforded the same protections or
information generally available to investors holding shares in public companies
organized in the U.S.





ITEM
4.    Information on the
Corporation.





A.    History
and Development of the Corporation





History
of the Company




Vuance
Ltd. was incorporated in Israel, as a company limited by shares, on July 4,
1988, under the provisions of the then-current Israeli Companies Ordinance. We
now operate under the Israeli Companies Law, 5759-1999 (the “Israeli Companies
Law”), which became effective on February 1, 2000, and the Israeli Companies
Ordinance (New Version) 1983, as amended.





From our
incorporation in 1988 until 1999, we were a development-stage company primarily
engaged in research and development, establishing relationships with suppliers
and potential customers and recruiting personnel with a focus on the
governmental market. In 2001, we implemented a reorganization plan, which we
completed in 2002. As a result of the reorganization, we expanded our marketing
and sales efforts to include the commercial market with a new line of advanced
smart card and identification technologies products, while maintaining our
governmental market business.





During
2002, we sold, in three separate transactions with third party purchasers, our
entire equity interest in a U.S. subsidiary, InkSure Technologies, Inc., for
which we received aggregate proceeds of approximately $6,600,000. In December
2002, we discontinued the operations, disposed of all of the assets and
terminated the employees of two U.S. subsidiaries, Genodus Inc. and Kromotek,
Inc.





We became
a publicly-traded company on NASDAQ Europe stock market (Formerly EASDAQ) on
April 19, 1999. On October 23, 2003, following the closing of the NASDAQ Europe
stock market, we transferred the listing of our ordinary shares to the Euronext
Brussels stock market under the symbol “SUP,” which became “VUNC” after our
corporate name change on May 14, 2007. We applied for delisting of our shares
from the Euronext Brussels stock market, and our application was approved on May
6, 2008, effective August 4, 2008.





26





On July
29, 2004, we filed a Registration Statement on Form 20-F under the Exchange Act.
When the Registration Statement became effective on September 29, 2004, we
became a foreign private issuer reporting company under the Exchange
Act.  On November 5, 2004, our ordinary shares began trading in the
U.S. on the OTC Bulletin Board under the symbol “SPCBF.OB," which following our
name change on May 14, 2007 became “VUNCF.OB.”  On August 23, 2007,
our ordinary shares were approved for trading on The NASDAQ Capital Market under
the symbol “VUNC” and the trading of our shares on the OTC Bulletin Board
ceased.





During
the fourth quarter of 2005, we established a new Delaware subsidiary (of which
we initially owned 80%), Vuance-RFID Inc. (formerly, Pure RF Inc.), which began
operations during the first quarter of 2006. During the first quarter of 2006,
Vuance-RFID Inc. established a wholly-owned Israeli subsidiary, Vuance RFID Ltd.
(formerly, Pure RF Ltd.). Vuance-RFID Inc. and Vuance RFID Ltd. focus on new
technologies and solutions for active tracking of people and objects. In
February 2007, we purchased the remaining 20% of the stock of Vuance - RFID Inc.
from its minority stockholders for an amount of $100,000, whereupon it became
our wholly-owned subsidiary. In August 2007, all the employees of Vuance RFID
Ltd. were transferred to Vuance Ltd., and on December 31, 2007 we purchased all
the assets and liabilities of Vuance RFID Ltd. During the year 2008, Vuance-RFID
Inc. engaged in an activity to distribute complementary locks and electronic
locks. This activity was terminated and it is presented in the financial
reports, as discontinued operations.





During
the fourth quarter of 2006, we established a new wholly-owned subsidiary, S.B.C.
Aviation Ltd., (incorporated in Israel) which began operations in 2007 and is
focused on executing information technology and security projects.





In 2006
we decided to sell our E-ID Division in order to focus on opportunities in the
U.S. for our CSMS and active RFID tracking businesses, and on December 31, 2006,
we sold the E-ID Division to On Track Innovations Ltd., for 2,827,200 restricted
ordinary shares of OTI (of which 212,040 shares are related to consultants, as
part of the direct expenses of this transaction). The ordinary shares were
issued to us subject to a lock-up agreement, where one-seventh of the shares
(403,885 ordinary shares) are released from the lock-up restrictions every three
months beginning on December 31, 2006. We executed an irrevocable proxy
appointing OTI's chairman, on behalf of the board of directors of the Company
(“Board of Directors”), or a person the Board of Directors will instruct, to
vote the 2,827,200 ordinary shares issued to us in connection with the
transaction. Under the terms of our agreement with OTI, OTI committed to file
with the SEC a registration statement covering these ordinary shares and made
such filing on April 24, 2007. As of December 31, 2008, we sold all the OTI
shares received in the OTI Transaction.





Simultaneously,
we entered into a service and supply agreement with OTI under which (i) OTI
agreed to act as our subcontractor and provide services, products and materials
necessary to carry out and complete certain projects that were not transferred
to OTI (the “Existing Projects”), and (ii) OTI granted us an irrevocable,
worldwide, non-exclusive, non-assignable and non-transferable license to use in
connection with our Existing Projects, certain intellectual property rights
transferred to OTI as part of the OTI Transaction, for the duration of such
projects. The sale of our E-ID division and the services and supply agreement
are collectively referred to herein as the “OTI Transaction.”





On July
3, 2007, we entered, through our wholly-owned subsidiary, Vuance, Inc., into an
agreement (the “SHC Purchase Agreement”) to acquire all of the issued and
outstanding stock capital of Security Holding Corp. (“SHC”) from Homeland
Security Capital Corporation (OTCBB: HOMS.OB(“HMSC”)) and other
minority shareholders (collectively, “Sellers”) for approximately $4,335,000 in
our ordinary shares and direct expenses of approximately $600,000 in our
ordinary shares. The closing date of this transaction was August 28, 2007
(“SHCClosingDate”). SHCwasa Delaware corporation
engaged in the business of manufacturing and distributing RFID-enabled
solutions, access control and security management systems. As consideration for
the acquisition of the stock capital of SHC, 1,097,426 ordinary shares of the
Company were issued to the Sellers.  Subject to certain terms and
conditions, in the event that we seek to register any of our ordinary shares
under the Securities Act of 1933 for sale to the public, for our own account or
the account of others, then at HMSC’s request, we will use our reasonable best
efforts to include our shares owned by HMSC in such registration. The Sellers
agreed to a lock-up period during which, subject to certain exceptions, they
will not sell or otherwise dispose of our shares. The restrictions on making
such transactions will expire for HMSC in eight equal installments, commencing
on the end of the first calendar quarter following the SHC Closing Date and each
of the seven calendar quarters thereafter, and for the other Sellers, in twelve
equal installments, commencing on the end of the first calendar quarter
following the SHC Closing Date and each of the eleven calendar quarters
thereafter. HMSC also agreed that during such restriction period, upon the
occurrence of any sale by HMSC of our shares due to HSMC’s bankruptcy,
insolvency or otherwise by operation of law, Vuance Inc. and the Company will
have a right of first refusal to purchase all (but not less than all) of our
shares held by HSMC on certain terms and conditions. HMSC further agreed that at
the SHC Closing Date it will grant an irrevocable power of attorney to the
Chairman of the Board of Directors of the Company to exercise all voting rights
related to its Vuance shares until the sale or transfer of such Vuance shares by
HMSC to an unaffiliated third party in an arm’s-length transaction. As part of
the SHC Purchase Agreement, certain Sellers will assume, subject to certain
exceptions, certain non-competition and employee non-solicitation undertakings
for a period of two years commencing on the SHC Closing Date. We guaranteed all
of the obligations of Vuance Inc. under the SHC Purchase Agreement. During the
fourth quarter of 2007, SHC and its subsidiaries were merged into Vuance
Inc.





27





In
September 2007, we announced that we had entered into a definitive agreement to
acquire, through our U.S. subsidiary, Vuance Inc., the credentialing division of
Disaster Management Solutions Inc., ("DMS") for approximately $100,000 in cash
and up to $650,000 in royalties that will be paid upon sales of the advanced
first responder credentialing system (named “RAPTOR”) during the first twelve
months following the acquisition (the closing was in August 2007). This
acquisition complemented our incident management solutions business and added
the RAPTOR to our Credentialing & Incident Management Suite.





Recent
Developments





On
December 11, 2008, we received a letter from NASDAQ advising us that we did not
comply with the Listing Requirements. As a result, the NASDAQ Staff began
reviewing our eligibility for continued listing on NASDAQ. To facilitate their
review, the NASDAQ Staff requested that we provide our specific
Plan.  After we submitted the Plan, on March 30, 2009, we received
further correspondence from NASDAQ that we did not comply with the Listing
Requirements, and therefore, trading of our ordinary shares would be suspended
at the opening of business on April 8, 2009, and a form 25-NSE would be filed
with the SEC removing our securities from listing and registration on NASDAQ,
unless we requested an appeal of the delisting decision by
NASDAQ.




We
appealed the NASDAQ determination to a NASDAQ Listings Qualifications Panel (the
“Panel”), which automatically stayed the delisting of our ordinary shares until
the Panel reached a decision.  On June 17, 2009, the Panel granted our
request for an extension of time to achieve full compliance with the Listing
Requirements.




The
Panel’s decision, and our continued listing on NASDAQ, is subject to our
compliance with certain conditions, including demonstration that we have
regained compliance with the Listing Requirements by September 28, 2009. While
we are executing on its plan to regain compliance, there can be no assurance
that we will be able to do so.  Should we be unable to meet the
exception requirement, the Panel will issue a final determination to delist our
shares and, unless the NASDAQ Listing and Hearings Review Council issues a stay,
will suspend trading of our shares on NASDAQ effective on the second business
day from the date of the final determination and our ordinary shares could be
eligible for quotation and trading on the OTC Bulletin Board in accordance with
applicable rules and regulations.





On March
25, 2009 we and our subsidiary, Vuance, Inc. (“Vuance Inc”), completed the
acquisition of certain of the assets and certain of the liabilities of
Intelli-Site, pursuant to an asset purchase agreement dated March 6, 2009 with
Intelli-Site and Integrated Security Systems, Inc (“ISSI”).  On the
date of closing, Vuance Inc agreed to pay Intelli-Site $262,000 payable in
twenty-five (25) consecutive installments.  The first twelve (12)
monthly installments shall be equal to $11,000 each, and thereafter, the
remaining thirteen (13) monthly installments shall be equal to $10,000 each (the
“Cash Consideration”).  In addition, we issued to ISSI 200,000 of our
ordinary shares (the “Consideration Shares”).  In addition to the
payment of the Cash Consideration and the issuance of the Consideration Shares,
Vuance Inc. agreed to pay Intelli-Site and ISSI, as applicable, in royalty
payments, an amount of up to $600,000 in the aggregate, based upon certain
conditions, which shall be paid on a quarterly basis, within thirty (30) days of
the close of each quarter, and will be made 50% in cash to Intelli-Site and 50%
in our ordinary shares (the “Royalty Shares”) to ISSI.  The number of
Royalty Shares to be issued to ISSI shall be calculated on the basis of the
weighted average closing price of our ordinary shares for the fifteen (15)
trading days preceding the quarterly payment, subject to a minimum of
$1.25.





ISSI, or
its permitted transferee, agreed to lock-up the Consideration Shares and Royalty
Shares, as applicable, pursuant to which ISSI or its transferee will not offer,
sell, transfer or otherwise dispose of the Consideration Shares or the Royalty
Shares, except the restrictions on the transfer of the Consideration Shares and
the Royalty Shares will expire in eight equal installments, commencing with the
end of the first calendar quarter following the date of closing and each of the
seven following calendar quarters thereafter.  If any Consideration
Shares or Royalty Shares are issued after the last day of the eighth calendar
quarter following the date of closing, such shares shall not be subject to any
transfer restrictions.





In January 2009, we announced that we
were selected to monitor and control all activity in the Decker Lake Youth
Complex, in West Valley City, Utah. This is a correctional facility designed for
housing youth in a Medium/High security setting.





In December 2008, we announced the
expansion of our RAPTOR solution with an existing customer, Chester County,
Pennsylvania.





28





In December 2008, we announced that we
have been awarded a stake in a government-funded project to develop a crime
scene security and evidentiary tracking system. This project, which is the
result of a grant sponsored by Vice President Joseph Biden, was awarded to
Delaware State University ("DSU"), the Delaware State Police and the Delaware
Department of Safety and Homeland Security. The total project value exceeds
$900,000 for the first year, with an opportunity for follow-on projects and
annual maintenance in future years. Our portion of the project is nearly
$700,000 for the first year.





In August 2008, we announced that we
entered into a 10-year services agreement with a European International Airport
to provide support for the integrated perimeter security system and border
control system which includes annual fees of approximately
$620,000.





On June 5, 2008, the Board of the
Brussels Stock Exchange (Euronext Brussels) approved our application to delist
our shares from the Euronext Stock Exchange. The delisting took effect as of
August 4, 2008.The
liquidity of our shares was limited on the Euronext Exchange, representing a
small fraction of the total trading volume of our shares globally. In addition,
the delisting of our shares from the Euronext Stock Exchange will result in
reduced expenses.





In June
2008, we reached an agreement with one of the investors (with a principal amount
of $2,500,000), under which, among other things, the investor waived our
compliance with certain covenants under its Convertible Bond, in exchange
for:




1.
            Increasing
      the interest rate to 10% starting March 31, 2008. Any withholding and
      other taxes payable with respect to the interest will be grossed up and
      paid by us (approximately 3% of the principal of the
  bond).


2.
            Reducing
      the exercise price of the bond and the warrants to $3 and $2.8,
      respectively.


3.
            We
      undertake to place a fixed charge on all incomes and/or rights in
      connection with a certain European Airport Project. This charge shall be
      senior to any indebtedness and/or other pledge and encumbrance, but shall,
      however, be subject to certain rights of the Company to use part of the
      income.


4.
            Certain
      anti-dilution rights with respect to the warrants held by the single
      investor.





In
addition, under certain circumstances, the investor may have the right to demand
an early payment of a partial or full amount of the Convertible Bonds (up to the
$2,500,000 as mentioned above).





As of
December 31, 2008 and June 30, 2009, we are not in compliance with certain
covenants under our Convertible Bond agreements. Thus, the Convertible Bond
holders could seek to accelerate payment of the unpaid principal amount and
accrued interest under its Convertible Bond, an aggregate of approximately
$4,420,000 as of June 30, 2009. We are currently negotiating with the
Convertible Bond holders.





In June
2008, we announced that we have been awarded a $1.4 million contract from the
Racine (WI) Unified School District, to install our MASC (Managed Automated
Security Controls) security solution into 31 school buildings, and two
administrative buildings, in the district. The school district is contemplating
additional buildings with the potential to expand this initial
project.





Principal
capital expenditures and divestitures





From
January 1, 2008 to December 31, 2008, our capital expenditures totaled
approximately $73,000 (compared to $116,000 during 2007 and $93,000 during
2006), of which approximately $39,000 (compared to $62,000 during 2007 and
$69,000 during 2006) can be attributed to our facilities in Israel, and
approximately $34,000 (compared to $54,000 during 2007 and $24,000 during 2006)
can be attributed to various facilities of our subsidiaries outside of
Israel.  During the first financial quarter of 2009, our capital
expenditures totaled approximately $10,150.





Corporate
information





Our U.S.
headquarters are located at 10125 South 52nd Street,
Franklin, Wisconsin 53132 and our telephone number is +1-414-855-1019. Our
Israeli headquarters are located at Sagid House “Ha’Sharon Industrial Park,”
Qadima 60920, Israel and our telephone number is +972-9-889-0800. Our Internet
website address is http://www.vuance.com. The information contained on our
corporate websites is not a part of this prospectus.





Our agent
for SEC matters in the U.S. is our subsidiary, Vuance, Inc., whose address is
10125 South 52nd Street,
Franklin, Wisconsin 53132.





29





B.    Business
Overview




From 1988
through 2006, our principal business was the design, development and marketing
of advanced smart card and identification technologies and products for
governmental and commercial customers in Europe, Asia and Africa. As described
above, in 2006 we decided to sell our E-ID Division in order to focus on
opportunities for our RFID and Credentialing businesses. On December 31, 2006,
we completed the OTI Transaction. (See full description above) We expect to
continue to receive revenues from the Existing Projects, which were not
transferred to OTI, until 2016.




On August
28, 2007, we completed the acquisition of all of the issued and outstanding
stock capital of SHC from HMSC and other minority shareholders for approximately
$4,335,000 in our ordinary shares and direct expenses of approximately $600,000.
As consideration for the acquisition of the stock capital of SHC, 1,097,426
ordinary shares of the Company were issued to the Sellers. (See “History and
Development of the Corporation” above.)




We believe that our exposure to the
governmental market and experience in customizing solutions in our former E-ID
Division, the acquisition of SHC and the acquisition of the assets of DMS will
contribute to our ability to develop and market products in our RFID and
Credentialing businesses. We currently concentrate our marketing efforts for our
RFID and Credentialing systems on U.S. distributers, state and local government
agencies that are also seeking to comply with U.S. Department of Homeland
Security requirements.





On March
25, 2009, we completed the acquisition of certain of the assets and certain of
the liabilities of Intelli-Site.  We believe this acquisition will
strengthen our ability to provide comprehensive end to end security solutions
and generate additional revenues with higher margins.





We currently operate in the U.S.
through our wholly-owned subsidiary, Vuance, Inc.





We currently operate in Asia Pacific
through our wholly-owned subsidiary, Supercom Asia Pacific Limited.





We develop and market innovative,
end-to-end security solutions in a wide range of applications for improved
credentialing, accountability, electronic access control, and tracking of assets
and personnel. Our solutions encompass access control, urban security, and
critical situation management systems (CSMS) as well as long-range active RFID
in the public safety, education, commercial, and government
sectors.





Our
Products





We offer
three principal products suites to our customers:





Active
RFID





Active
RFID is long, active radio frequency identification equipment that utilizes
active radio frequency communications to track assets, people and objects for
potential governmental agency and commercial customers. Our solutions are
programmable, small, sensitive and relatively cheap, providing significant
competitive advantages. Our branded active RFID solution, AAID, purchased in the
SHC transaction, is established and well-known in the market for tracking
vehicle and personnel.





Passive
RFID





Electronic
Access Control (“EAC”) Suite





EAC
applications provide increased security for enterprises, schools, office
buildings, warehouses and government facilities. Our solutions provide
credentials (secure badges), readers, door hardware, sensing devices, alarms,
controllers and host hardware and software to help maintain security at these
facilities. We provide these solutions through several branded
offerings:





•
              COMPASS


COMPASS
is used by schools and universities (Columbine, Virginia Tech and Rutgers, among
others) and by governmental agencies and commercial enterprises (such as Prince
Williams County).





30




•
            MASC


Managed
Automated Security Controls is an integrated solution designed for larger
commercial enterprises. MASC helps organizations (such as airports, banks,
hospitals, and correctional facilities) to control access, communications, and
other security solutions from an integrated platform.





•
              Insignia
      and Clarity


Insignia
and Clarity together constitute a software hardware solution sold by
distributors to smaller businesses.





•
              Intelli-Site
      Software Package


Intelli-Site
is a software package, used for integrated security control and as a management
software solution. This package is scalable from stand-alone applications that
can manage a variety of different applications from within a single, unified,
GUI platform that is used mainly for enterprise-level deployments. It also
provides flexibility for future system change or expansion and can
support both new and existing subsystems.





Credentialing & Incident
Management Suite





·
            Credentialing
      ("RAPTOR")


Cutting-edge
storage and secure retrieval system for credentialing, authenticating,
verifying, validating, and managing personnel, advanced tracking and logistics,
designed especially for state and local governments, critical infrastructure,
and first responders.





·
            Critical Situation Management
      System ("CSMS")


Management
system, for first responders currently in use in the U.S., CSMS offers a
customizable solution for credentialing, incident management, accountability and
virtual access control. We have an extensive product line, with smart cards,
both standalone and handheld readers, and interoperable communications
equipment. Credentialing and Incident Management systems utilize both passive
and active RFID technology, creating a unique and comprehensive solution
unmatched in the industry. CSMS applications target the following industries:
Law Enforcement, Fire Rescue, Homeland and Site Security and Emergency
Management.





Our
Strategy




In 2006,
we decided to sell our E-ID division in order to focus on opportunities mainly
in the U.S. for our active RFID enabled solutions and CSMS businesses. The sale
was completed on December 31, 2006 (see section captioned “The OTI Transaction”
in this Item 4.A). In August 2007, we completed the acquisition of SHC. SHC is a
Delaware corporation engaged in the business of manufacturing and distributing
RFID-enabled solutions, access control and security management systems. (See
“History and Development of the Corporation” above.) We currently concentrate
our marketing efforts for our active and passive RFID enabled solutions and CSMS
to U.S. distributers, state and local government agencies.




Our two-pronged sales strategy is
to:




·
            Develop
      strong strategic relationships with our business partners, including our
      systems integrators and distributors who introduce our solutions into
      their respective markets. These include: Graybar, NControl Security
      Integration Northern Video Nexus, Metroplex and Toshiba’s
    CDS.




·
            Employ
      dedicated sales teams to work closely with these business partners. Each
      of the teams is responsible for one of the
  following:




1.
            Active
      RFID sales through leading system integrators. This team customizes and
      adapts solutions that can then be installed and supported by these
      business partners.




2.
            EAC
      systems sold through regional system integrators (e.g., COMPASS, MASC and
      other defined products). The team provides needed product
      support.




3.
            CSMS
      and RAPTOR sales to government agencies and commercial enterprises. This
      team responds to bids through system integrators involving requests for
      proposal (RFPs) from these clients requiring commercial off-the-shelf
      solutions for many challenging
applications.





We have a
multi-pronged approach to growth:


·
            Grow
      organically:


1.
              Increase
      existing products’ value (e.g., offer products which are smaller, better
      and cost less);


2.
              Identify
      new applications for existing products and solutions;
  and


3.
              Develop
      new products/solutions that meet clients’
needs.





31




4.
              Build
      a superior sales force. We are dedicating sales teams, coordinated through
      our U.S. corporate office to sell more products/solutions through our
      growing number of business partners. Cross-selling products and solutions
      will increase sales to existing customers and create new
      opportunities.




·
            Make
      synergistic acquisitions. Continue to “leapfrog” growth through strategic
      acquisitions of companies with complementary products and/or relations
      with business partners, as we have with SHC, RAPTOR and recently
      with  Intelli-Site.




Due to
our strategies, we are emerging as a leading RFID enabled security solution
provider in a fast growing markets, mainly for public safety, educational &
correction facilities. This is accomplished because of our unique combination of
in-house security products, superior technology and team expertise coupled with
non-organic synergies.





Enhancing
Our Presence





We
decided to establish an advisory board (the “Advisory Board”) to assist us in
broadening our presence in the government, military, and law enforcement sectors
and to identify the core technology needs of the homeland security and related
markets, as well as new applications for our technologies.  We have
sought preeminent authorities to serve on the Advisory Board and in February
2006 we announced the creation of the Advisory Board and the appointment of R.
James Woolsey, former Director of Central Intelligence and one of America’s
preeminent authorities on security issues, as its Chairman. In August 2006, we
announced that Neil C. Livingstone, one of America’s preeminent authorities on
security issues was appointed to the Advisory Board. In April 2007, we announced
that Oliver "Buck" Revell, former Associate Deputy Director in charge of
Criminal Investigations, Counter-Terrorism and Counter-Intelligence at the
Federal Bureau of Investigation, and one of the world's most recognized experts
in the fight against terrorism, has joined our Advisory Board. On March 2008,
Morris A. Sandler, who has been a Managing Partner in a number of
merchant-banking and investment companies and has more than twenty years
experience in financial services, venture capital and merchant
banking  and more than twelve years experience in the telecom
industry, joined our Advisory Board.





We
currently concentrate our marketing efforts for our RFID and Credentialing
systems on U.S. distributors, state and local government agencies that are also
seeking to comply with U.S. Department of Homeland Security requirements. To
date, our Credentialing suite has been acquired and successfully deployed in Los
Angeles, CA (by the city and police department), in Columbus, OH (first
responders), in three Pennsylvania counties (first responders) and by the U.S.
Army (mobile access control unit). We are also currently developing the crime
scene evident tracking under a grant from the Department of Justice jointly with
DSU. We also plan to market our CSMS and active RFID tracking systems to
commercial customers.





In order
to expand our U.S. presence, we acquired SHC, the credential division of DMS,
and recently certain assets of Intelli-Site. We may pursue acquisitions of one
or more companies that have an existing customer base and revenues in the U.S.
or that can otherwise offer business synergies to us.





Identifying
New Applications for Our Technologies





Our
management and its external advisors are working to identify new applications
for our technologies in the homeland security, defense, healthcare, educational
and other markets. At a time when both government and the private sector are
faced with unprecedented challenges to protect public safety and personal
privacy, we expect our Advisory Board to help extend our forward-looking
technologies to the U.S. market.





Leveraging
Knowledge and Experience





We
believe that our exposure to the governmental market and experience in
customizing solutions in our former E-ID Division will contribute to our ability
to develop and market products in our RFID and Credentialing businesses. We
intend to leverage such knowledge and experience in order to respond to the
needs of existing and potential customers in the homeland security, healthcare,
educational and other markets.





Seeking
Partnerships With Other Relevant Companies





To
bolster our sales and marketing efforts, we may seek to partner with
distributors that can offer us new relationships within the homeland security
sector and with government agencies as well as with the commercial sector and
help us increase our geographic breadth and penetrate other selected vertical
markets. In addition, we may seek to partner with system integrators experienced
in handling large-scale governmental projects under government contracts, since
we believe such partners, by virtue of their recognition by government agencies,
may have an advantage in securing government contracts. Finally, we may seek to
enter into strategic partnerships with companies that offer technologies that
complement ours.





32





Current
Businesses




Active
RFID Business




In
February 2006, we introduced our active RFID technology, which utilizes active
radio frequency communications to track people and objects. We developed this
new technology to meet the growing market demand for asset and person tracking
solutions. The new technology expands our wide range of products aimed at the
homeland security market through a wireless asset tracking system.





In order
to focus on the growing market for this technology we acquired SHC, which owned
the AAID long range Active RFID security solution.





The
readers and tags have been sold by AAID since 1999. Currently, the majority of
the sales are vehicle-related including gated communities, employee parking
lots, and fleet management.  We believe in the future of this
technology in personnel and asset tracking and we will leverage AAID's market
positioning to introduce our Pure-RF technologies. Our AAID movement detection
solution can monitor and track a number of items simultaneously, providing an
active set of different signals and alerts. The software and hardware solution
employs small, low-powered RFID tags attached to an object or a person.
License-free radio bands are used to track the RFID tag from a base transmitter
that is programmable for periodic or event-driven transmissions.





Current
activities in our active RFID business involve the development and marketing of
a new product, the AAID Suite, which is described below. We plan to market the
AAID Suite in the industrial, healthcare, security and homeland security
sectors, and to further develop, improve and customize the AAID Suite to meet
customers’ needs in niche sectors.





Product





We expect
our AAID Suite, a complete location position (LP) system solution based on
active RFID tag technology, to offer commercial customers and governmental
agencies enhanced asset management capabilities. The system can be deployed in
physical security applications. The basic components of our AAID Suite
include:





·
            an
      active tag, which contains a microchip equipped transponder, an antenna
      and a capacitor, attached to the item to be identified, located or
      tracked;




·
            a
      web-based management system, which captures and processes the signal from
      the active tag, and may be configured to provide an alert upon the
      occurrence of a trigger event;




·
            one
      or more wireless receivers; and




·
            the
      tag's  initializer, which is used to configure the AAID
      tags.




The AAID
Suite provides a secure, precise and cost-effective means to positively
identify, locate, track, monitor, count and protect people and objects,
including inventory and vehicles. The ability to reliably identify and track the
movement of people and objects in real time will enable AAID Suite customers to
detect unauthorized movement of vehicles, trace packages and containers, control
personnel and vehicle access to premises, and protect personnel in hazardous
working environments and disaster management situations.





Customers





Our
customers are also our business partners, i.e., system integrators and
distributors who introduce our solutions into their perspective markets. These
include: Graybar, NControl Security Integration Northern Video Nexus, Metroplex
and Toshiba’s CDS, Simplex Grinnell and Sinsel, SA de CV., etc.





33





Market
Opportunity





Radio
frequency identification, or RFID, is a widely adopted technology in the
auto-identification market, which addresses electronic identification and
location of objects. Typically, an RFID tag or transponder is attached to or
incorporated into a product or person. A handheld or stationary device that
receives the radio frequency waves from these tags is used to determine their
locations. Prior to the adoption of RFID, users identified and tracked assets
manually as well as through the use of bar code technology. These solutions were
limited because of the need for ongoing human intervention and the lack of
instantaneous location capabilities. RFID technology possesses greater range,
accuracy, speed and lower line−of−sight requirements than bar code
technology.





Our AAID
Suite can track items simultaneously, providing an alert when a tagged item is
removed from a pre-determined area, passes through a marked checkpoint or
otherwise moves. We believe that potential customers for our AAID Suite include
the following:





·
            Civil and Military
      Governments. Our AAID Suite can provide secure access control into
      restricted areas and map and track visitors throughout a facility. Many
      high security facilities, including governmental and industrial
      facilities, need access monitoring. For example, nuclear power plants,
      national research laboratories and correctional facilities need to
      accurately and securely monitor inbound and outbound activity. Line of
      sight identifiers, such as identification cards, suffer from problems that
      our RFID technology readily overcomes, including reliance on human visual
      identification, forgery and tampering. Our AAID Suite also enables
      identification and location of individuals in restricted areas in real
      time.




·
            Airport and Port Security
      Infrastructure Providers. Our AAID Suite can offer solutions for
      the transportation sector by enabling common carriers to monitor, track,
      locate and manage multiple baggage items simultaneously, thereby reducing
      risk of lost baggage, increasing customer service and improving
      security.




·
            Businesses and Industrial
      Companies. Our AAID Suite can be used by businesses, shippers and
      warehouse operators to manage and track cartons, pallets, containers and
      individual items in order to facilitate movement, order picking, inventory
      verification and reduce delivery time. In addition, industrial companies
      can manage and track their mobile equipment and tools. We believe that our
      AAID Suite can increase efficiency at every stage of asset, inventory and
      supply chain management by enabling long-range identification and location
      of products and removing the need for their human visual identification.
      Our products also work in conjunction with existing bar coding and
      warehouse systems to reduce the risk of loss, theft and slow speed of
      transfer.




·
            Hospitals and Care
      Homes. The healthcare sector has successfully utilized RFID
      technologies for the purposes of infant protection in maternity wards and
      wander prevention in care homes similar to our asset and personnel
      location and identification system targeted at the secure facility and
      hazardous business sectors. Our AAID Suite can provide solutions for the
      healthcare sector for asset, staff, patient and medical record location
      and identification. We believe that as hospitals continue to upgrade their
      security measures, RFID technology will be utilized in real time location
      systems that are designed to immediately locate persons, equipment and
      objects within the hospital.




·
            Livestock Owners. Our
      AAID Suite can be used as a livestock identification, tracking and
      safeguarding system.




Credentialing  - CSMS and
RAPTOR Suite Business




Our CSMS
and RAPTOR suite represent a completely integrated solution for multiple
applications. The applications include enabling state and local public safety
agencies, such as police, fire and emergency medical services departments, and
other governmental agencies to comply with U.S. Department of Homeland Security
requirements regarding national incident management systems, security,
protection of infrastructure and incident command systems.





Product





We have a
range of access control, RFID, and credentialing product lines which are
integrated into an end-to-end comprehensive solution.





34





Credentialing:
CSMS and RAPTOR. These products are designed to meet the need for
comprehensive and mutually compatible credentials that governments and first
responders have noted as important in both the fight against terrorism and the
need to respond to any catastrophe.  This market suffered from low
expenditure levels due to a lack of clearly defined product
requirements.  Now that these requirements are not only defined, but
also codified into law, the purchasing decisions are returning to standard
procedures.  CSMS is an existing product with a full range of
accessories, which was designed primarily for temporary credentials created at
the scene of an incident. RAPTOR is a newer product targeted more specifically
to use credentials that meet the full range of government specifications with
user verification as well as identification.  RAPTOR has been recently
updated to use the latest technology and its RAPTOR Express version is
attracting a lot of attention. In order to better respond to the emerging need
we have combined the CSMS function into RAPTOR to deliver the more comprehensive
CSMS.  The target market for CSMS currently is mainly the state and
local governments.





Customers





Our first
customer for our CSMS products was the City of Columbus, Ohio, which deployed
the SmartDSMS system in April 2005 and subsequently expanded its capabilities.
In November 2006, we entered into a contract to provide a CSMS system to the
City of Los Angeles, CA for the Department of General Services—Office of Public
Safety, the Office of Personnel and the Police Department (Mobile Command Post
Unit). In January 2007, we entered into two additional contracts for the
deployment of CSMS systems with county governments in Pennsylvania. In October
2008, we entered into a MOU with Delaware State University to cooperate in order
to develop, test and deploy a Mobile Crime Scene system.  In December
2008, we announced that we have been awarded a stake in a government-funded
project to develop a crime scene security and evidentiary tracking system. In
December 2008, we also received an order for expansionof
our RAPTOR solution with Chester County, Pennsylvania.





Market
Opportunity





In 2002,
following the terrorist attacks on September 11, 2001, and in accordance with
The National Strategy for Homeland Security and the Homeland Security Act of
2002, the U.S. Department of Homeland Security, (“DHS”) was formed. The main
objective of the DHS is to provide the unifying core for the vast nationwide
network of organizations and institutions involved in efforts to provide
national security. DHS initiatives have emphasized “interoperability”—the
implementation of new systems that facilitate interaction between government
agencies, including first responders such as police, fire and emergency medical
services departments, in anticipation of and response to incidents that threaten
public safety. Presidential directives concerning homeland security call for the
development of:





·
            a
      National Incident Management System that will provide a consistent
      framework for incident management at all jurisdictional levels regardless
      of the cause, size or complexity of the incident and provide first
      responders with a common foundation for incident management of terrorist
      attacks, natural disasters and other emergencies;
  and




·
            a
      National Response Plan that will provide the structure and mechanisms to
      coordinate and integrate incident management activities and emergency
      support functions across federal, state, local and tribal government
      entities, the private sector and non-governmental
  agencies.




The
activities and projects necessary to achieve these goals are accomplished by
furnishing federal funding to state and local government agencies. Since 2002,
the DHS has allocated over $20 billion in grants and awards to state and local
government agencies for the implementation of a broad range of security projects
throughout the U.S. Much of the grants have not yet been spent by the recipient
government agencies. In January 2007, the DHS announced plans to grant an
additional $1.7 billion for specified security programs. During 2008, the
domestic preparedness funding streams from the federal government have continued
to be allocated each fiscal year in the multi-billion dollar range.  We
hope to leverage opportunities funded through the U.S. stimulus package centered
on the emergency services and educational markets.





We
believe that we are positioned to take advantage of the market opportunity
presented by DHS-funded security projects of state and local government agencies
throughout the U.S. Our CSMS systems can be used as standalone solutions for the
access control, accountability and credentialing needs of law enforcement and
first responder governmental agencies managing disaster sites, including sites
of natural disasters, terrorist attacks, crime scenes or large scale accidents.
The individual components of the CSMS system could also be marketed to the U.S.
military or the DHS for more general perimeter security
applications.





Passive
RFID





Electronic
Access Control (“EAC”) Suite





35




Product





EAC applications provide increased
security for enterprises, schools, office buildings, warehouses and government
facilities. Our solutions provide credentials (secure badges), readers, door
hardware, sensing devices, alarms, controllers and host hardware and software to
help maintain security at these facilities. We provide these solutions through
several branded offerings:





•
              COMPASS


COMPASS
is used by schools and universities (Columbine, Virginia Tech and Rutgers, among
others) and by governmental agencies and commercial enterprises (such as Prince
Williams County).





•
              MASC


Managed
Automated Security Controls is an integrated solution designed for larger
commercial enterprises. MASC helps organizations to control access,
communications, and other security solutions from an integrated platform (such
as banks, hospitals, and correctional facilities).





•
              Insignia
      and Clarity


Insignia
and Clarity together constitute a software hardware solution sold by
distributors to smaller businesses.





Customers





Our
customers are distributors, regional system integrators (e.g. COMPASS; MASC) and
dealers (e.g., Insignia Security Systems, Clarity Security and other providers
of security solutions). On rare occasions where the conditions allow we may sell
directly to large organizations such as local municipalities and large
organizations, which requires the direct intervention of our subject matter
experts.





Market
Opportunity





Our EAC
suite targets a wide range of customers from challenging environments, spanning
the commercial sectors, small businesses and the private sector. This is
achieved by presenting three product lines:





·
              MASC


EAC for correctional facilities,
airports, cities, and challenging environments.


·
              COMPASS


EAC for education and commercial
sector.


·
              Clarity/Insignia


EAC for small businesses and the
commercial and private sectors.


·
              Intelli-Site
      software


Intelli-Site
software package for managed integrated security solutions





Sectors
targeted include:





Health
Care


From
clinics in shopping malls to sprawling medical campuses, the challenges facing
the health care industry are immense. From coordinating access to secure areas
such as operating rooms and nurseries to preventing theft of valuable equipment
and monitoring corridors, stairways and departments, health care management
requires reliable solutions to meet the needs in a complex and rapidly changing
environment.





Education


Today’s
school campuses rival their counterparts in business and health care in terms of
sophistication and security requirements. From providing automated access
control for sporting events and concerts, and credentialing and verifying
faculty, staff (and students), to tracking equipment from building to building
or throughout districts and identifying vehicles, to securing buildings and
facilities in the event of disaster; educators are no longer “just teachers” and
administrators must enforce a number of requirements to keep students and assets
safe.





36




Transportation


Identifying
drivers, and controlling access to parking garages, parking lots or special
parking zones are only part of the challenges facing the transportation
industry. From connecting drivers to specific vehicles or connecting pilots with
specific aircrafts to monitoring fleet vehicles, or reducing theft and vandalism
in parking garages, transportation management involves more than just getting
from place to place.





Correctional
Facilities, Airports, Municipalities Facilities


From
correctional facilities to airports and municipalities facilities, the
challenges facing environments that require high security are enormous and
ever-changing. Coordinating access to secure areas and monitoring these
challenging environments efficiently despite multiple events requires reliable
intuitive solutions to meet the needs in complex and high security
sites.





Former
E-ID Division





From 1988
to 2006, our principal business was the design, development and marketing of
advanced smart card and identification technologies and products for
governmental and commercial customers in Europe, Asia and Africa. Our
applications and solutions included e-passports, visas and other border entry
documents, national identification and military, police and commercial access
identification. As detailed above, in 2006, we decided to sell our E-ID division
in order to focus on opportunities in the U.S. for our CSMS and active RFID
businesses.





In our
E-ID Division, we developed a fully automated production line for picture
identification contactless smart cards, and offered our customers raw materials,
maintenance and service agreements. We provided identification solutions and
contactless smart card production equipment for governmental and commercial
customers. The customers and contracts of our E-ID Division in 2006, 2007 and
2008 included the following:





National Multi ID with a European
Country





In 2006, we entered into an agreement
with a European country which we estimate will generate approximately $50
million in revenues during the 10-year term of the project. Under the agreement
we will provide the end-to-end system for a national multi-ID issuing and
control system. There can be no assurance, however, that we will realize the
full estimated value of this agreement.





The project, which commenced during the
third quarter of 2006, involves the implementation of an end-to-end national ID
issuing and control system based on our Magna system and includes the supply of
digital enrollment and production equipment, software, maintenance and supply of
secured raw material for the production of various national ID cards. In 2006,
2007 and 2008, we recognized revenue of $4,715,000, $6,179,000 and $5,468,000,
respectively, under this Agreement.





Perimeter Security and Border Control
at European International Airport





In 2007, we entered into a definitive
agreement (the “Agreement”) with a European international Airport to provide an
integrated perimeter security system and a border control system for a total of
$13.8 million. The establishment of the security and control system began during
the third quarter of 2007. Once the system has been fully implemented, we will
enter the ten-year maintenance period that could generate an additional $620,000
in annual revenues. In 2007 and 2008, we recognized revenue of $2,182,000 and
$9,722,000, respectively, under this Agreement.





Other
Projects





During
the years 2006, 2007 and 2008 we had the following projects:


·
            Passports
      and ID Card - Africa


·
            Passports
      - Hong Kong


·
            Hong
      Kong – China Re-Entry Cards


·
            Passports
      - United Kingdom


·
            Biometric
      Visa system to a European
Government


·
            National
      ID card deal with an African Governmental
Agency


·
            Automated
      Smart Card Production System to a European
  Government


·
            Biometric
      passport issuing and control system for a western European
      country


·
            E-Passport
      with a European Country





37




During
the years ended 2006, 2007 and 2008 we generated revenues from the above
mentioned projects in the total amounts of $3,316,000, $2,659,000 and $478,000,
respectively.




Research
and Development





Our
past research and development efforts helped us to achieve the goal of offering
our customers a complete line of products and solutions. We spent $1.4 million,
$1.7 million and $2.6 million on research and development in 2006, 2007 and
2008, respectively. These amounts were spent on the development or improvement
of our technologies and products, primarily in the areas of Active RFID and
Credentialing. We will continue to research and develop new technologies for
RFID and Credentialing. There can be no assurance that we can achieve any or all
of our research and development goals.





Sales
and Marketing





We
sell our systems and products worldwide through distribution channels that
include direct sales and traditional distributor or reseller sales. We have
approximately 19 employees that are directly engaged in the sale, distribution
and support of our products through centralized marketing offices in distinct
world regions, including the employees of Vuance, Inc., which markets our
products in the U.S. and of SuperCom Asia Pacific, which markets our products in
Asia. We are also represented by several independent distributors and resellers
with which we often have distribution agreements.





Our
distributors and resellers sell our systems and products to business enterprises
and government agencies and act as the initial customer service contact for the
systems and products they sell. 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 not
long-term contracts, do not have commitments for minimum sales and could be
terminated by the distributor. We do not have agreements with all of our
distributors.





Sales
Analysis





Sales
By Geographic Destination:





The following table provides a
breakdown of total revenue by geographic market (all amounts in thousands of
dollars):





Year ended December 31,2006
                  2007
                  
                  
                  2008Total
                  
                  
                  Total
                  
                  
                  Totalrevenues
                  
                  
                  revenues
                  
                  
                  revenuesEurope
                  
                  $
                  6,023
                  (*)
                  
                  $
                  9,003
                  (*)
                  
                  $
                  15,193Asia
      Pacific
                  
                  
                  1,730
                  
                  
                  
                  1,330
                  
                  
                  
                  310Africa
                  
                  
                  621
                  
                  
                  
                  823
                  
                  
                  
                  350United
      States
                  
                  
                  373
                  
                  
                  
                  1,787
                  
                  
                  
                  4,506Israel
                  
                  
                  194
                  
                  
                  
                  371
                  
                  
                  
                  294$
                  8,941
                  (*)
                  
                  $
                  13,314
                  (*)
                  
                  $
                  20,653





(*)
Certain comparative figures have been reclassified to conform to the current
period presentation.





The following table provides a
breakdown of total revenue by product category (all amounts in thousands of
dollars):





Year ended December 31,2006
                  
                  
                  2007
                  
                  
                  2008Raw
      materials and equipment
                  
                  $
                  6,529
                  
                  
                  $
                  9,315
                  
                  
                  $
                  17,589Maintenance,
      royalties and project management
                  
                  
                  2,412
                  (*)
                  
                  
                  3,999
                  (*)
                  
                  
                  3,064$
                  8,941
                  (*)
                  
                  $
                  13,314
                  (*)
                  
                  $
                  20,653





(*)
Certain comparative figures have been reclassified to conform to the current
period presentation.





38




Customer
Service





We
believe that customer support plays a significant role in our sales and
marketing efforts and in our ability to maintain customer satisfaction, which is
critical to our efforts to build our reputation and grow in our existing
markets, as well as to our efforts to penetrate and grow in new markets. In
addition, we believe that our interaction with our customers and the customers’
feedback involved in our ongoing support functions provide us with information
on customer needs and contribute to our product development efforts. We
generally provide maintenance services under separate, tailor made agreements.
We provide our service through customer training, local third-party service
organizations, our subsidiaries, or our personnel, including appropriate
personnel sent from any of our offices in U.S., Israel or Hong-Kong. We
generally provide our customers with a warranty for our products, varying in
length from 12 to 36 months. Costs incurred annually by us for product
warranties have to date been insignificant; however, there can be no assurance
that these costs will not increase significantly in the future.





Manufacturing
and Availability of Raw Materials





Our
manufacturing operations consist primarily of materials planning and
procurement, quality control of components, kit assembly and integration, final
assembly, and testing of fully-configured systems. A significant portion of our
manufacturing operations consists of the integration and testing of
off-the-shelf components. All of our products and systems, whether or not
manufactured by us, undergo several levels of testing, including configuration
to customer orders and testing with current release software, prior to
delivery.





Our
manufacturing consists of systems for the electronic security industries and
includes a range of access control, RFID and credentialing solutions. We
outsource the manufacturing for our PCB panels to a number of different
suppliers. We usually commit to a long-term relationship with such suppliers in
exchange for receiving competitive pricing. All panels and enclosures are built
to our engineering specifications. All panels are received in our manufacturing
facilities in the U.S. and then tested, assembled, and retested. Other products
are off-the-shelf products, which we purchase from a number of different
suppliers.





All
activities for Existing Projects, such as purchasing, logistics, making
integration, installation and testing, are done by third parties according to
our instructions and under our supervision. Moreover, we continue to be
responsible to the customers of the Existing Projects.





Competition





We assess
our competitive position from our experience and market intelligence, and from
reviewing third party competitive research materials.





While
many companies are active in the homeland security market, few companies offer
products similar to RAPTOR and CSMS in the area of access control/perimeter
security for incident management. Additionally, there are many companies in the
broader security market that may offer competing products, but these companies
do not target governmental customers. We believe that Enterprise Air, Salamander
Technologies, Raytheon and Corestreet may offer products that compete with
RAPTOR and CSMS in the governmental market, and that Zebra, RF Code, Axcess,
Ekahau, Pango Networks and Aeroscout are potential competitors, in niche areas,
to us with respect to our active RFID tracking products.  The EAC
market is also crowded with large companies like Lenel, Honeywell, Stanley
Works, UTC, Assa Abloy and HIRSCH, as well as certain smaller companies. We
offer unique capability of having the main ingredients (Active RFID, EAC
integrated software and Credentialing) in-house to provide day-to-day as well as
emergency situation solutions.





Our
management expects competition to intensify as the markets in which our products
and services compete continue to develop. Some of our competitors may be more
technologically sophisticated or have substantially greater technical,
financial, or marketing resources than we do, or may have more extensive
pre-existing relationships with potential customers. Although we believe that
our products combine technologies and features that provide customers with
complete and comprehensive solutions, we cannot assure you that other companies
will not offer similar products in the future or develop products and services
that are superior to our products and services, achieve greater customer
acceptance or have significantly improved functionality as compared to our
products and services. Increased competition may result in our experiencing
reduced margins, loss of sales or decreased market shares.





Due to
the developing nature of the markets for ourCSMS and RAPTOR and
active RFID tracking products and the ongoing changes in this market, the
above-mentioned list may not constitute a full list of all of our competitors
and additional companies may be considered our competitors.





39




Intellectual
Property





Our
ability to compete is dependent on our ability to develop and maintain the
proprietary aspects of our technology. We rely on a combination of trademark,
copyright, trade secret and other intellectual property laws, employee and
third-party nondisclosure agreements, licensing and other contractual
arrangements and have also applied for patent protection to protect our
proprietary technology and intellectual property. However, these legal
protections afford only limited protection for our proprietary technology and
intellectual property.





In addition, the laws of certain
foreign countries may not protect our intellectual property rights to the same
extent as do the laws of Israel or the U.S. Our means of protecting our
intellectual property rights in Israel, the U.S. or any other country in which
we operate may not be adequate to fully protect such rights. For instance, the
intellectual property rights of our Asian subsidiary, SuperCom Asia Pacific may
not be fully protected by the laws of Hong Kong and the People’s Republic of
China.





Patents





Our
patent portfolio currently consists of two issued U.S. patents, four U.S. patent
applications and one PCT. Generally, these patents, applications and PCTs relate
to our government solutions and access control technologies.





We intend
to file additional patent applications when and if appropriate. There is no
guarantee that patentable inventions will arise from our research and
development efforts and, if we do apply for patent protection for such
inventions, there is no guarantee that it will be granted.





In
addition, not all countries provide legal protection of proprietary technology
to the same extent. There can be no assurance that the measures taken by us to
protect our proprietary technologies are or will be sufficient to prevent
misappropriation of our technologies or portions thereof by unauthorized third
parties or independent development by others of similar technologies or
products. In addition, regardless of whether our products infringe on the
proprietary rights of third parties, infringement or invalidity claims may be
asserted or prosecuted against us and we could incur significant expenses in
defending them. Our costs could also increase if we become obligated to pay
license fees as a result of these claims.





Licenses





We
license technology and software, such as operating systems and database
software, from third parties for incorporation into our systems and products and
we expect to continue to enter into these types of agreements for future
products. Our licenses are either perpetual or for specific terms.





As part
of the OTI Transaction, we received an irrevocable, worldwide, non-exclusive,
non-assignable and non-transferable license to use, in connection with the
Existing Projects, the intellectual property that we transferred to OTI.
Generally speaking, the license will be valid for the duration of all Existing
Projects.





Government
Regulation





We are
subject to certain labor statutes and to certain provisions of collective
bargaining agreements between the Histadrut (the General Federation of Labor in
Israel) and the Coordinating Bureau of Economic Organizations, including the
Industrialists’ Association, with respect to our Israeli employees. In addition,
some of our Israeli employees are also subject to minimum mandatory military
service requirements. (See the discussion under the caption “Employees” in
Section D of Item 6.)





Generally,
we are subject to the laws, regulations and standards of the countries in which
we operate and/or sell our products, which vary substantially from country to
country. The difficulty of complying with these laws, regulations and standards
may be more or less difficult than complying with applicable U.S. or Israeli
regulations, and the requirements may differ.





Employees





As of
December 31, 2008 we had 52 full-time employees, compared to 70 full-time
employees as of December 31, 2007.  (See the discussion under the
caption “Employees” in Item 6.D.)





40




Our
ability to succeed depends, among other things, upon our continuing ability to
attract and retain highly qualified managerial, technical, accounting, sales and
marketing personnel.




Seasonality




Our
financial and operating results have fluctuated in the past and our financial
and operating results could fluctuate in the future. The period between our
initial contact with a potential customer and the sale of our products and
services is often long and subject to delays associated with the budgeting,
approval and competitive evaluation processes that frequently accompany
significant capital expenditures, particularly by governmental agencies. The
typical sales cycle for our government customers has to date ranged from three
to 36 months and the typical sales cycle for our commercial customers has ranged
from one to six months. A lengthy sales cycle may have an impact on the timing
of our revenue, which may cause our quarterly operating results to fall below
investor expectations. We believe that a customer's decision to purchase our
products and services is discretionary, involves a significant commitment of
resources, and is influenced by customer budgetary cycles or federal and state
grants. To successfully sell our products and services, we generally must
educate our potential customers regarding their use and benefits, which can
require significant time and resources. This significant expenditure of time and
resources may not result in actual sales of our products and
services.





The
lead-time for ordering parts and materials and building many of our products can
be many months. As a result, we must order parts and materials and build our
products based on forecasted demand. If demand for our products lags
significantly behind our forecasts, we may produce more products than we can
sell, which can result in cash flow problems and write-offs or write-downs of
obsolete inventory.





41





C.    Organizational
Structure





The diagram below shows Vuance Ltd.'s
holdings in its subsidiaries and affiliates as of June 20, 2009:











Vuance,
Inc. (formerly, SuperCom Inc.)


Vuance,
Inc., incorporated in Delaware, is our wholly-owned subsidiary, and is
responsible for our sales and marketing efforts in the U.S.





SuperCom
Asia Pacific Limited (“SuperCom Asia Pacific”)


SuperCom
Asia Pacific, incorporated in Hong Kong, has been our wholly-owned subsidiary
since November 2003, and is responsible for our sales and marketing efforts in
Asia Pacific.





Vuance
- RFID Inc.


Vuance -
RFID Inc. (formerly, Pure RF Inc.) incorporated in Delaware in November 2005.
Upon its incorporation we owned 80% of its shares. During January 2006, Vuance -
RFID Inc. established a wholly owned Israeli subsidiary, Vuance RFID Ltd.
(formerly, Pure RF Ltd.), which focuses on new technologies and solutions for
the tracking of people and assets. During February 2007, we purchased the
remaining 20% of Vuance - RFID Inc. for  $100,000, whereupon Vuance -
RFID Inc. became our wholly-owned subsidiary. In August 2007, all the employees
of Vuance RFID Ltd. were transferred to us, and on December 31, 2007 we
purchased all of the assets and liabilities of Vuance RFID Ltd. Commencing year
2008, Vuance RFID Inc. engages in an activity to distribute complementary locks
and electronic locks. This activity was terminated in the fourth quarter of 2008
and it is presented in the financial reports, as discontinued
operations.





SBC
Aviation Ltd.


SBC
Aviation Ltd., incorporated in Israel in the fourth quarter of 2006, is our
wholly-owned subsidiary, which commenced operations in 2007, and focuses on
executing information technology and security projects.





SuperCom
Slovakia A.S. (“SuperCom Slovakia”)


SuperCom
Slovakia, incorporated in Slovakia, was established to implement a national
documentation project in the Republic of Slovakia. SuperCom Slovakia is 66%
owned by us and 34% owned by EIB Group a.s., a privately held Czech company.
Despite our ownership of almost two-thirds of the economic interests of SuperCom
Slovakia, our voting power in SuperCom Slovakia is 50%.





42





D.    Property,
Plants and Equipment




We
do not own any real estate property.





We lease
approximately 2,224 square meters of facilities in Qadima, Israel under a
five-year lease contract, currently expiring on October 31, 2010. We have an
option to renew the lease for an additional period of five years. According to
the agreement, the monthly fee is approximately $16,000. As a result of the OTI
Transaction, we leased to OTI certain portions of our leased facilities for a
monthly fee of $11,000, for a period of one year, commencing on December 31,
2006. During the first quarter of 2008, OTI moved out and we currently sublease
this space to three different companies.





Vuance
Inc. leases several facilities in Franklin, WI, Peachtree City, GA and Gardner,
MA of approximately 391, 465 and 441 square meters, respectively. The monthly
fee of the facility in Franklin, WI is $6,200 and the total monthly fee of all
such other leased facilities is $3,700.





Vuance,
Inc. also leases a facility in Rockville, Maryland of approximately 214 square
meters for a monthly fee of $4,800 which is subleased for a monthly fee of
$4,100.





In 2009,
Vuance Inc. signed additional lease agreements in Wisconsin and Texas, of
approximately 836 and 228 square meters, respectively. The monthly lease amount
for the facilities is $4,500 with eight months free rent and $1,200, with six
months free rent, respectively.





SuperCom
Asia Pacific leases approximately 130 square meters of office space in Hong Kong
for a monthly lease amount of $4,300.





All such
leased properties in the U.S. and Hong Kong consist of office space for
management, administrative, operation, sales and marketing
activities.





The
total annual rental fees for 2006, 2007 and 2008 were $354,530, $376,295 and
$440,130, respectively. The total annual lease commitments for 2009 are
$464,000.





All
assets are held in the name of Vuance Ltd. and its subsidiaries.





The
following table details our fixed assets as of December 31, 2007 and
2008:


December 31,2007
                  
                  
                  2008(In thousands of US Dollars)Cost:Computers
      and peripheral equipment
                  
                  $
                  287
                  
                  
                  $
                  354Office
      furniture and equipment
                  
                  
                  193
                  
                  
                  
                  193Leasehold
      improvements
                  
                  
                  33
                  
                  
                  
                  39513
                  
                  
                  
                  586Accumulated
      depreciation:Computers
      and peripheral equipment
                  
                  
                  183
                  
                  
                  
                  243Office
      furniture and equipment
                  
                  
                  92
                  
                  
                  
                  103Leasehold
      improvements
                  
                  
                  20
                  
                  
                  
                  22295
                  
                  
                  
                  368Depreciated
      cost:
                  
                  $
                  218
                  
                  
                  $
                  218





Depreciation
expenses for the years ended December 31, 2006, 2007 and 2008 were $335,000,
$38,000 and $73,000, respectively.





ITEM
4A.    Unsolved Staff
Comments.





Not
applicable.





43





ITEM
5.    Operating and Financial Review and
Prospects.





A.    Operating
results





The
following section should be read in conjunction with our consolidated financial
statements and the related notes thereto, which have been prepared in accordance
with U.S. GAAP and which are included in Item 18. Some of the statements
contained in this section constitute “forward-looking statements.” These
statements relate to future events or to our future financial performance and
involve known and unknown risks, uncertainties and other factors that may cause
our actual results, levels of activity, performance or achievements to be
materially different from any future results, levels of activity, performance or
achievements expressed or implied by such forward-looking statements. (See “Note
Regarding Forward Looking Statements” at the beginning of this report, and “Risk
Factors” In Item 3.D)





Overview





We were
established in 1988 in Israel under the name “SuperCom Ltd.” On April 29, 2007,
our shareholders approved the change of the Company’s name to Vuance Ltd.,
effective as of May 14, 2007. Our ordinary shares have been listed for trading
on the Euronext Brussels stock market since October 23, 2003, initially under
the symbol “SUP,” and following our name change, under the symbol “VUNC.” We
applied for delisting of our shares from the Euronext Brussels stock market, and
our application was approved on May 6, 2008, effective August 4,
2008.





From
November 5, 2004 to August 23, 2007, the Company’s ordinary shares traded on the
OTC Bulletin Board, initially under the symbol "SPCBF.OB" and following our name
change, under the symbol, “VUNCF.OB.” Since August 23, 2007, our ordinary shares
have been listed for trading on NASDAQ under the symbol “VUNC.” Upon the
commencement of trading of our ordinary shares on NASDAQ, our ordinary shares
ceased to trade on the OTC Bulletin Board.





On
December 11, 2008, we received a letter from NASDAQ advising us that we did not
comply with the Listing Requirements. As a result, the NASDAQ Staff began
reviewing our eligibility for continued listing on NASDAQ. To facilitate their
review, the NASDAQ Staff requested that we provide our specific
Plan.  After we submitted the Plan, on March 30, 2009 we received
further correspondence from NASDAQ that we did not comply with the Listing
Requirements, and therefore, trading of our ordinary shares would be suspended
at the opening of business on April 8, 2009, and a form 25-NSE would be filed
with the SEC removing our securities from listing and registration on NASDAQ,
unless we requested an appeal of the delisting decision by
NASDAQ.




We
appealed the NASDAQ determination to a NASDAQ Listings Qualifications Panel (the
“Panel”), which automatically stayed the delisting of our ordinary shares until
the Panel reached a decision.  On June 17, 2009, the Panel granted our
request for an extension of time to achieve full compliance with the Listing
Requirements.




The
Panel’s decision, and our continued listing on NASDAQ, is subject to our
compliance with certain conditions, including demonstration that we have
regained compliance with the Listing Requirements by September 28, 2009. While
we are executing on its plan to regain compliance, there can be no assurance
that we will be able to do so.  Should we be unable to meet the
exception requirement, the Panel will issue a final determination to delist our
shares and, unless the NASDAQ Listing and Hearings Review Council issues a stay,
will suspend trading of our shares on NASDAQ effective on the second business
day from the date of the final determination and our ordinary shares could be
eligible for quotation and trading on the OTC Bulletin Board in accordance with
applicable rules and regulations.





We
develop and market innovative RFID enabled solutions, including active RFID,
electronic access control, credentialing, accountability and critical situation
management, for public safety agencies, commercial customers and governmental
organizations. We offer three principal suite to our customers, as
follows:





Active
RFID





Active
RFID is long, active radio frequency identification equipment that utilizes
active radio frequency communications to track assets, people and objects for
potential governmental agency and commercial customers. Our solutions are
programmable, small, sensitive and relatively cheap, providing significant
competitive advantages. Our branded active RFID solution, AAID, purchased in the
SHC transaction, is established and well-known in the market for tracking
vehicle and personnel.





44





Passive
RFID





Electronic
Access Control (“EAC”) Suite





EAC
applications provide increased security for enterprises, schools, office
buildings, warehouses and government facilities. Our solutions provide
credentials (secure badges), readers, door hardware, sensing devices, alarms,
controllers and host hardware and software to help maintain security at these
facilities. We provide these solutions through several branded
offerings:





•
              MASC


Managed
Automated Security Controls is an integrated solution designed for larger
commercial enterprises. MASC helps organizations to control access,
communications, and other security solutions from an integrated platform (such
as airports, banks, hospitals, and correctional facilities).





•
              COMPASS


COMPASS
is used by schools and universities (Columbine, Virginia Tech and Rutgers, among
others) and by governmental agencies and commercial enterprises (such as Prince
Williams County).





•
              Insignia
      and Clarity


Insignia
and Clarity together constitute a software hardware solution sold by
distributors to smaller businesses.





•
              Intelli-Site
      software


Intelli-Site
software package for managed integrated security solutions.





Credentialing
& Incident Management Suite:





·
            Credentialing
      ("RAPTOR")


Cutting-edge
storage and secure retrieval system for credentialing, authenticating,
verifying, validating, and managing personnel, advanced tracking and logistics,
designed especially for state and local governments, critical infrastructure,
and first responders.





·
            Critical Situation Management
      System ("CSMS")


Management
system, for first responders currently in use in the U.S., a customizable
solution for credentialing, incident management, accountability and virtual
access control. We have an extensive product line, with smart cards, both
standalone and handheld readers, and interoperable communications equipment.
Credentialing and Incident Management systems utilize both passive and active
RFID technology, creating a unique and comprehensive solution unmatched in the
industry. CSMS applications target the following industries: Law Enforcement,
Fire Rescue, Homeland and Site Security and Emergency Management.





In addition, we have several continuing
projects relating to the E-ID Division we sold to OTI (see the section captioned
“The OTI Transaction” in Item 4.A and the section captioned “Former E-ID
Division” in Item 4.B).





We sell
our products through centralized marketing offices in the U.S. and Hong-Kong. We
have two wholly-owned marketing subsidiaries: Vuance Inc. in the U.S. and
SuperCom Asia Pacific Limited in Hong Kong.





During the fourth quarter of 2005, we
established a new Delaware subsidiary in which we initially owned 80% of the
shares, Vuance - RFID Inc. (formerly, Pure RF Inc.), which began operations
during the first quarter of 2006. During the first quarter of 2006, Vuance -
RFID Inc. established a wholly-owned Israeli subsidiary, Vuance RFID Ltd.
(formerly, Pure RF Ltd.). Vuance - RFID Inc. and Vuance RFID Ltd. focus on new
technologies and solutions for active tracking of people and objects. During
February 2007, we purchased the remaining 20% of Vuance - RFID Inc. from its
minority shareholder for $100,000, whereupon Vuance - RFID Inc. became our
wholly-owned subsidiary. On August 2007, all the employees of Vuance RFID Ltd.
were transferred to Vuance, and on December 31, 2007, we purchased the assets
and liabilities of Vuance RFID Ltd. Commencing in 2008, Vuance - RFID Inc.
engaged in an activity to distribute complementary locks and electronic locks.
This activity was terminated in the fourth quarter of 2008 and it is presented
in the financial reports, as discontinued operations.




During
the fourth quarter of 2006, we established a new wholly-owned Israeli
subsidiary, S.B.C. Aviation Ltd., which commenced operations in 2007, and
focuses on executing information technology and security projects.





45





On
November 8, 2006, we announced the execution of the OTI Transaction (see Item
4.A above under the caption “The OTI Transaction”). As a result of the OTI
Transaction, we recognized $10,536,000 as capital gain on the sale of the E-ID
Division in fiscal year 2006. The capital gain was calculated based on OTI’s
share price on the closing date of the transaction, less a discount due to the
lock-up restrictions on the shares (based on an independent appraisal), the
carrying value of the assets that were transferred to OTI and direct expenses
(in an amount of $1,550) associated with the sale. As a result of the OTI
Transaction, we terminated the employment of certain employees that were
employed by us in the E-ID Division.





On July
3, 2007, we entered, through our wholly-owned subsidiary, Vuance, Inc., into an
agreement (the “SHC Purchase Agreement”) to acquire all of the issued and
outstanding stock capital of Security Holding Corp. (“SHC”) from Homeland
Security Capital Corporation (OTCBB: HMSC.OB) (“HMSC”) and other minority
shareholders (collectively, “Sellers”) for approximately $4,335,000 in our
ordinary shares and direct expenses of approximately $600,000. The closing date
of this transaction was August 28, 2007 (“SHC Closing Date”). SHC was a Delaware
corporation engaged in the business of manufacturing and distributing
RFID-enabled solutions, access control and security management systems. As
consideration for the acquisition of the stock capital of SHC, 1,097,426
ordinary shares of the Company were issued to the Sellers. Subject to certain
terms and conditions, in the event that we seek to register any of our ordinary
shares under the Securities Act of 1933 for sale to the public, for our own
account or the account of others, then at HMSC’s request, we will use our
reasonable best efforts to include our shares owned by HMSC in such
registration. The Sellers agreed to a lock-up period during which, subject to
certain exceptions, they will not sell or otherwise dispose of our shares. The
restrictions on making such transactions will expire for HMSC in eight equal
installments, commencing on the end of the first calendar quarter following the
SHC Closing Date and each of the seven calendar quarters thereafter, and for the
other Sellers, in twelve equal installments, commencing on the end of the first
calendar quarter following the SHC Closing Date and each of the eleven calendar
quarters thereafter. HMSC also agreed that during such restriction period, upon
the occurrence of any sale by HMSC of our shares due to HSMC’s bankruptcy,
insolvency or otherwise by operation of law, Vuance Inc. and the Company will
have a right of first refusal to purchase all (but not less than all) of our
shares held by HSMC on certain terms and conditions. HMSC further agreed to
grant an irrevocable power of attorney to the Chairman of the Board of Directors
of the Company to exercise all voting rights related to its Vuance shares until
the sale or transfer of such Vuance shares by HMSC to an unaffiliated third
party in an arm’s-length transaction. As part of the SHC Purchase Agreement,
certain Sellers will assume, subject to certain exceptions, certain
non-competition and employee non-solicitation undertakings for a period of two
years commencing on the SHC Closing Date. We guaranteed all of the obligations
of Vuance Inc. under the SHC Purchase Agreement. During the fourth quarter of
2007, SHC and its subsidiaries were dissolved and merged into Vuance
Inc.





In
September 2007, we announced that we had entered into a definitive agreement to
acquire, through our U.S. subsidiary, Vuance Inc., the credentialing division of
Disaster Management Solutions Inc., for approximately $100,000 in cash and up to
$650,000 in royalties that will be paid upon sales of the advanced first
responder credentialing system (named “RAPTOR”) during the first twelve months
following the acquisition (the closing was in August 2007). This acquisition
complemented our incident management solutions business and added RAPTOR to our
Credentialing & Incident Management Suite.





On March
25, 2009 we and our subsidiary, Vuance, Inc., completed the acquisition of
certain of the assets and certain of the liabilities of Intelli-Site., pursuant
to an asset purchase agreement dated March 6, 2009 with Intelli-Site and ISSI.
On the date of closing, Vuance Inc agreed to pay Intelli-Site the Cash
Consideration and we issued to ISSI the Consideration Shares.  In
addition to the payment of the Cash Consideration and the issuance of the
Consideration Shares, Vuance Inc. agreed to pay Intelli-Site and ISSI, as
applicable, in royalty payments, an amount of up to $600,000 in the aggregate,
based upon certain conditions, which shall be paid on a quarterly basis, within
thirty (30) days of the close of each quarter, and will be made 50% in cash to
Intelli-Site and the Royalty Shares to ISSI. The number of Royalty Shares to be
issued to ISSI shall be calculated on the basis of the weighted average closing
price of our ordinary shares for the fifteen (15) trading days preceding the
quarterly payment, subject to a minimum of $1.25. ISSI, or its permitted
transferee, agreed to lock-up the Consideration Shares and Royalty Shares, as
applicable, pursuant to which ISSI or its transferee will not offer, sell,
transfer or otherwise dispose of the Consideration Shares or the Royalty Shares,
except the restrictions on the transfer of the Consideration Shares and the
Royalty Shares will expire in eight equal installments, commencing with the end
of the first calendar quarter following the date of closing and each of the
seven following calendar quarters thereafter.  If any Consideration
Shares or Royalty Shares are issued after the last day of the eighth calendar
quarter following the date of closing, such shares shall not be subject to any
transfer restrictions.





46





Revenues





The
Company and its subsidiaries generate their revenues from the sale of products,
maintenance, royalties and long term contracts including training and
installation. The sale of products involves the sale of active and passive RFID
products, CSMS RAPTOR and raw materials. Following delivery of such systems,
often the significant portion of revenues generated from the agreement results
from ongoing maintenance fees and support.





Our
systems are tailored to meet the specific needs of our customers. In order to
satisfy these needs, the terms of each agreement, including the duration of the
agreement and prices for our products and services differ from agreement to
agreement.





Operating
Expenses





Our
costs associated with a particular project may vary significantly depending on
the specific requirements of the customer, the terms of the agreement, as well
as on the extent of the technology licensing. As a result, our gross profits
from each project may vary significantly.





Our
research and development expenses consist of salaries, raw material,
subcontractors, equipment costs and rent allocated to research and development
activities, as well as related supplies and travel and entertainment
costs.





Our
selling and marketing expenses consist primarily of salaries and commissions
earned by sales and marketing personnel, trade show, promotional expenses and
rent allocated to selling and marketing activities, as well as related supplies
and travel and entertainment costs.





Our
general and administrative expenses consist primarily of salaries, benefits,
allocated rent and supplies, and related costs for our executive, finance,
legal, human resource, information technology and administrative personnel, and
professional service fees, including legal counsel, insurance and audit
fees.





Net
Income





Our
operating results are significantly affected by, among other things, the timing
of contract awards and the performance of agreements. As a result, our revenues
and income may fluctuate substantially from quarter to quarter, and comparisons
over longer periods of time may be more meaningful. The nature of our
expenses  is mainly fixed or semi-fixed and any fluctuation in
revenues will generate a significant variation in gross profit and net
income.





Critical
Accounting Policies and Estimates





The
preparation of financial statements requires us to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent liabilities at the date of the financial statements,
and the reported amounts of revenues and expenses during the reporting period.
We evaluate our estimates and judgments on an ongoing basis, including those
related to revenue recognition, allowance for bad debts, contingencies,
stock-based compensation, and valuation of inventories and impairment of
long-lived assets (including goodwill and intangible assets).





We
base our estimates and judgments on historical experience and on various other
factors that we believe to be reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Under
different assumptions or conditions, actual results may differ from these
estimates.





Our
discussion and analysis of our financial condition and results of operations are
based on our consolidated financial statements, which have been prepared in
accordance with generally accepted accounting principles in the U.S. ("US
GAAP"). Our significant accounting principles are presented within Note 2 to our
Consolidated Financial Statements. While all the accounting policies impact the
financial statements, certain policies may be viewed to be critical. These
policies are those that are most important to the portrayal of our financial
condition and results of operations. Actual results could differ from those
estimates. Our management believes that the accounting policies which affect the
more significant judgments and estimates used in the preparation of our
consolidated financial statements and which are the most critical to fully
understanding and evaluating our reported results include the
following:




47




· Revenue
recognition;


·      Allowance for doubtful
accounts;


·      Contingencies;


·      Stock Based
Compensation;


·      Goodwill and other intangible
assets; and


·      Going concern.





Revenue
Recognition





We
generate our revenues from the sale of products, maintenance, royalties and long
term contracts including training and installation. The sale of products
involves the sale of active and passive RFID products, CSMS and raw materials.
We sell our products in the U.S. through distributors, through our local
subsidiary in Asia Pacific and directly in the rest of the world.





Product sales are recognized in
accordance with Staff Accounting Bulletin No. 104, “Revenue Recognition”
(“SAB No. 104”), when persuasive evidence of an agreement exists, delivery
of the product has occurred, the fee is fixed or determinable, collectability is
probable, and inconsequential or perfunctory performance obligations remain. If
the product requires specific customer acceptance, revenue is deferred until
customer acceptance occurs or the acceptance provision lapses.




We
recognize certain long-term contract revenues in accordance with Statement of
Position (“SOP”) 81-1, “Accounting for Performance of Construction-Type and
Certain Production Type Contracts.”




Pursuant
to SOP 81-1, revenues from these contracts are recognized under the percentage
of completion method.  We measure the percentage of completion based
on output or input criteria, such as contract milestones, percentage of
engineering completion or number of units shipped, as applicable in each
contract.




Provisions
for estimated losses on uncompleted contracts are made during the period in
which such losses are first identified, in the amount of the estimated loss on
the entire contract. As of December 31, 2008, no such estimated losses were
identified.




We
believe that the use of the percentage of completion method is appropriate,
since we have the ability, using the also independent subcontractor's
evaluation, to make reasonably dependable estimates of the extent of progress
made towards completion, contract revenues and contract costs.  In
addition, contracts executed include provisions that clearly specify the
enforceable rights of the parties to the contract, the consideration to be
exchanged and the manner and the terms of settlement. In all cases, we expect to
perform our contractual obligations and the parties are expected to satisfy
their obligations under the contract.




In
contracts that do not meet all the conditions mentioned above, we utilize zero
estimates of profits; equal amounts of revenue and cost are recognized until
results can be estimated with sufficient accuracy.




Revenues
and costs recognized pursuant to SOP 81-1 on contracts in progress are subject
to management estimates.  Actual results could differ from these
estimates.





We are
not obligated to accept returned products or issue credit for returned products,
unless a product return has been approved by us in advance and is according to
specific terms and conditions. As of December 31, 2008 we had an allowance for
customer's returns in the amount of $88,000.





We
applied the provisions of EITF Issue No. 00-21 “Revenue Arrangements with
Multiple Deliverables” for multiple element arrangements. EITF Issue No. 00-21
provides guidance on how to account for arrangements that involve the delivery
or performance of multiple products, services and/or rights to use assets. For
such arrangements, each element of the contract is accounted for as a separate
unit when it provides the customer value on a stand-alone basis and there is
objective evidence of the fair value of the related unit.





Maintenance
and support revenues included in multiple-element arrangements are deferred and
recognized on a straight-line basis over the term of the maintenance and support
agreement. For these multiple element arrangements, we account for each unit of
the contract (maintenance, support and services) as a separate unit, when each
unit provides value to the customer on a stand-alone basis and there is
objective evidence of the fair value of the stand-alone unit.





Deferred
revenues and customer advances include amounts received from customers for which
revenues have not been recognized.





48





We are
entitled to royalties upon of the issuance of a certificate. Such royalties are
recognized when the sales are reported to the Company (usually on a monthly
basis).





We derive
our revenues mainly from sale of hardware products and long term contracts that
include embedded software that management considers to be incidental. Such
revenues are recognized in accordance with SAB No. 104 and SOP 81-1, as
mentioned above. However, in limited circumstances, we provide software upgrades
with respect to the embedded software of hardware products sold to our customers
in the past. Such revenues are recognized when all criteria outlined in
Statement of Position No. 97-2 “Software Revenue Recognition” (“SOP No. 97-2”)
(as amended) are met: when persuasive evidence of an agreement exists, delivery
of the product has occurred (i.e. the services have been provided), no
significant obligations under the agreement remain, the fee is fixed or
determinable and collectability is probable.




Allowance for doubtful accounts





The
allowance for doubtful accounts is determined with respect to specific debts
that we have determined to be of doubtful collection.





We
perform ongoing credit evaluations of our customers' financial conditions and we
require collateral as we deem necessary. An allowance for doubtful accounts is
determined with respect to those accounts that we have determined to be doubtful
of collection. If the financial conditions of our customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances would be required. The allowance for doubtful accounts was $3,500,000
and $3,478,000 at December 31, 2007 and 2008, respectively.





Contingencies





From time
to time, we are the defendant or plaintiff in various legal actions, which arise
in the normal course of business. We are required to assess the likelihood of
any adverse judgments or outcomes to these matters as well as potential ranges
of probable losses. A determination of the amount of reserves required for these
contingencies, if any, which would be charged to earnings, is made after careful
and considered analysis of each individual action with our legal advisors. The
required reserves may change in the future due to new developments in each
matter or changes in circumstances, such as a change in settlement strategy. A
change in the required reserves would affect our earnings in the period the
change is made. Other than as described under the heading “Legal Proceedings” in
Item 8, there are no material pending legal proceedings in which we are a party
or of which our property is subject.





Stock-Based
Compensation




Until
December 31, 2005, we applied the intrinsic-value-based method of accounting
prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting
for Stock Issued to Employees,” and related interpretations to account for our
employee stock options. Under this method, compensation expense was recognized
only if the current market price of the underlying stock exceeded the exercise
price on the date of the grant.





However,
as more fully described in note 2(v) to the accompanying financial statement, on
January 1, 2006 we adopted SFAS No. 123R, “Share-Based Payment” (SFAS 123R), a
revision of SFAS 123. Among other items, SFAS 123R eliminated the use of APB 25
and the intrinsic value method of accounting, and requires companies to
recognize in their financial statements the cost of employee services received
in exchange for awards of equity instruments, based on the fair value of those
awards at the grant date.





We
adopted SFAS 123R, using the modified prospective method, as permitted under the
standard.  Under this method, the Company is required to record
compensation expense for all awards granted after the date of adoption in
accordance with the provisions of SFAS 123R and for the unvested portion of
previously granted awards that remain outstanding at the date of adoption in
accordance with the original provisions of SFAS 123.




Goodwill
and other intangible assets




Under
SFAS No. 142, Goodwill and Other Intangible Assets, goodwill acquired in a
business combination is deemed to have indefinite life and is not to be
amortized. SFAS No.142 requires goodwill to be tested for impairment at least
annually or between annual tests in certain circumstances, and written down when
impaired, rather than being amortized. Goodwill is tested for impairment by
comparing the fair value of the reporting unit with its carrying value. Fair
value is determined using the income approach. Significant estimates used in the
methodologies include estimates of future cash flows and estimates of discount
rates.





49




As part
of the annual review for impairment in accordance with SFAS No. 142 and 144, in
November 2008, we examined the fair value of the intangible assets and the
goodwill and in doing so, considered in part, a third party expert services.
The valuation referred to Vuance, Inc. as a single reporting unit. The
valuation was conducted on a going concern basis. Since Vuance, Inc. is
closely-held, and thus without a public market for its ownership interests, the
appraisal was conducted according to common appraisal practices, and based on
the Free Discounted Cash-Flows ("DCF") method.  In addition, we
received market indication with respect to the fair value of Vuance, Inc. in the
first quarter of 2009. Based on the above we were required to recognize an
impairment loss in the amount of approximately $3,235,000.




Going
concern




We
incurred substantial losses and negative cash flows from operations since our
inception. We had an operating cash flow deficit in each of 2006, 2007, and
2008. As of December 31, 2008, we had an accumulated deficit of
approximately $42,294,000. We incurred net losses of approximately $11,311,000
and $12,358,000 in the years ended December 31, 2007 and December 31, 2008,
respectively. For the year ended December 31, 2006, we would have incurred a net
loss of $5,096,000, excluding the $10,536,000 capital gain from the sale of the
e-ID Division. We expect to have net operating losses and negative cash flows
for the foreseeable future, and expect to spend significant amounts of capital
to enhance our products and services, develop further sales and operations and
fund expansion. As a result, we will need to generate significant revenue to
achieve profitability. Even if we do achieve profitability, we may not be able
to sustain or increase profitability on a quarterly or annual basis.
Continuation of our current operations after utilizing our current cash reserves
is dependent upon the generation of additional financial resources either
through fund raising or the sale of certain assets. These matters raise
substantial doubt about our ability to continue as a going concern. The
financial statements have been prepared assuming that we will continue as a
going concern. The financial statements do not include any adjustments that
might result from the outcome of this uncertainty.





50


Results
of Operations





The
following table sets forth selected consolidated income statement data for the
Company for each of the three years ended December 31, 2006, 2007 and 2008
expressed as a percentage of total revenues.





2006
                    
                    
                    2007
                    
                    
                    2008Revenues
                    
                    
                    100
                    %(**)
                    
                    
                    100
                    %(**)
                    
                    
                    100
                    %Cost
      of revenues
                    
                    
                    39.0
                    
                    
                    
                    42.1
                    
                    
                    
                    40.9Gross
      profit
                    
                    
                    61.0
                    
                    
                    
                    57.9
                    
                    
                    
                    59.1Operating
      expensesResearch
      and development
                    
                    
                    15.2
                    
                    
                    
                    12.9
                    
                    
                    
                    12.4Selling
      and marketing, net
                    
                    
                    62.8
                    
                    
                    
                    67.9
                    
                    
                    
                    57.7General
      and administrative
                    
                    
                    30.6
                    
                    
                    
                    24.0
                    
                    
                    
                    16.0Impairment
      loss
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    15.7Litigation
      settlement expenses
                    
                    
                    1.2
                    
                    
                    
                    0.3
                    
                    
                    
                    -
                    (*)Total
      operating expenses
                    
                    
                    109.8
                    
                    
                    
                    105.1
                    
                    
                    
                    101.8Capital
      gain from the sale of the E-ID Division
                    
                    
                    117.8
                    
                    
                    
                    -
                    
                    
                    
                    -Operating
      income (loss)
                    
                    
                    69.0
                    
                    
                    
                    (47.2
                    )
                    
                    
                    (42.7
                    )Financial
      income (expenses), net
                    
                    
                    (2.3
                    )
                    
                    
                    (34.9
                    )
                    
                    
                    (15.1
                    )Other
      income (expenses), net
                    
                    
                    (4.1
                    )
                    
                    
                    -
                    
                    
                    
                    -Income
      (loss) before income taxes
                    
                    
                    62.6
                    
                    
                    
                    (82.1
                    )
                    
                    
                    (57.8
                    )Taxes
      on income
                    
                    
                    (1.6
                    )(**)
                    
                    
                    (2.9
                    )(**)
                    
                    
                    (0.7
                    )Loss
      from discontinued operations
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (1.3
                    )Net
      income (loss)
                    
                    
                    61.0
                    
                    
                    
                    (85
                    )
                    
                    
                    (59.8
                    )





(*) Less
than 0.1%.


(**)
Certain comparative figures have been reclassified to conform to the current
period presentation.





51





Operating
Results





Year
Ended December 31, 2008 Compared to Year Ended December 31, 2007





Revenues





Our
revenues in 2008 were $20,653,000, compared to $13,314,000 in 2007, an increase
of 55%. The increase in our revenues is primarily due to our European Airport
Project for which we recognized revenues in 2008 in the amount of $9,722,000
compared to $2,181,000 in 2007 and due to the SHC transaction completed in
August 2007. Results for revenues in the year 2009 will be affected by our
ability to overcome the economic recession and generate sales in a more
difficult economic environment as well as our ability to perform under our new
agreements and purchase orders and collect the cash associated therewith. We
believe that the Existing Projects are essential to our success in the short
term and that the active RFID and Credentialing businesses will be critical to
our long-term success.





Gross
Profit





Our gross
profits in 2008 were $12,201,000 compared to $7,714,000 in 2007, an increase of
58.2%. The gross profit margin for the year 2008 increased by 1.2% to 59.1%. The
increase in our 2008 gross profit margin was primarily due to different mix of
products, which carry higher margins.





Expenses





Our
operating expenses in 2008 were $21,037,000, compared to $13,983,000 in 2007, an
increase of 50%. The increase in operating expenses was mainly due to (a) the
impairment loss of goodwill in the amount of $3,235,000 in 2008 compared to $0
in 2007, and (b) the SHC transaction and an increase in selling and marketing
expenses related to promotion and commissions expenses due to the increase in
revenues.




Research
and development expenses consist primarily of salaries, benefits,
subcontractors, allocated overhead expense, supplies and equipment for software
developers and architects, hardware engineers and program managers, as well as
legal fees associated with our intellectual property. Our research and
development expenses in 2008 were $2,571,000, compared to $1,716,000 in 2007, an
increase of 50%. The increase in the research and development expenses was
primarily due to research and development expenses associated with our new
technologies, CSMS and RAPTOR and active RFID due to the SHC
transaction.




Selling
and marketing expenses consist primarily of salaries and commission earned by
sales and marketing personnel, promotion expenses, trade show expenses,
allocated overhead and supplies and travel and entertainment costs. Our selling
and marketing expenses in 2008 were $11,924,000, compared to $9,041,000 in 2007,
an increase of 32%. The increase in the sales and marketing expenses was
primarily due to the increase in sales promotion and commission expenses related
to the increase in revenues, labor expenses and an increase in sales and
marketing activities in the U.S. due to the SHC transaction.




General
and administrative expenses consist primarily of salaries, benefits, allocated
overhead and supplies, and related costs for our executive, finance, legal,
human resource, information technology and administrative personnel, and
professional service fees, including legal counsel insurance and audit fees. Our
general and administrative expenses in 2008 were $3,299,000, compared to
$3,192,000 in 2007, an increase of 3%.




The
impairment loss consists of an impairment of goodwill resulting from our
acquisition of SHC. Our impairment loss in 2008 was $3,235,000, compared to $0
in 2007.




Additionally,
litigation settlement expenses consist of one-time expenses that relate to
litigations that settled during the reported periods as described in "Legal
Proceedings" in Item 8. Our litigation settlement expenses in 2008 were $8,000,
compared to $34,000 in 2007.




Financial
Expenses, net





Financial
expenses for the twelve months ended December 31, 2008 and 2007, were $3,113,000
and $4,652,000, respectively. The decrease in financial expenses is mainly due
to lower financial expenses related to our marketable securities. During 2008,
we realized losses from the sale of marketable securities in the amount of
$862,000, compared to $1,116,000 during 2007 and decrease in value of marketable
securities, net in the amount of $0 and $2,699,000 during the year ended 31,
December 2008 and 2007 respectively. This decrease was offset by an increase in
financial expenses with respect to Convertible Bonds in the amount of $2,214,000
and $745,000 in 2008 and 2007, respectively.





52




Taxes on
income





Taxes on
income are mainly expenses related to withholding tax at source related to our
project with a European country. Taxes on income for the twelve months ended
December 31, 2008 and 2007 were $137,000 and $390,000, respectively. The
decrease is mainly due to a change in the percentage of the withholding tax at
source.





Loss from
discontinued operations





Loss from
discontinued operations for the twelve months ended December 31, 2008 and 2007
were $272,000 and $0, respectively. The loss from discontinued operations in
2008 relates to Vuance - RFID Inc. activity to distribute complementary locks
and electronic locks which commenced in 2008 and was terminated in the fourth
quarter of 2008.





Net
Loss





As a
result of the factors described above, our net loss in 2008 was $12,358,000,
compared to a net income of $11,311,000 in 2007.





Year
Ended December 31, 2007 Compared to Year Ended December 31, 2006





Revenues





Our
revenues in 2007 were $13,314,000, compared to $8,941,000 in 2006, an increase
of 48.9%. The increase in our revenues is primarily due to our project with a
European airport for which we recognized revenues in 2007 in the amount of
$2,181,000, compared to $0 in 2006, our revenues from our National Multi ID
project with a European country which were $5,826,000 in 2007 compared to
$4,569,000 in 2006, and due to the SHC transaction. We believe that the Existing
Projects are critical to our success in the short term and that the active RFID
and Credentialing businesses will be critical to our long-term
success.





Gross
Profit





Our gross
profits in 2007 were $7,714,000 compared to gross profits of $5, 447,000 in
2006, an increase of 41.6%. The gross profit margin for the year 2007 decreased
by 3.1%, compared to 61% in 2006. The decrease in our 2007 gross profit margin
was primarily due to different mix of products, which carry lower
margins.





Expenses





Our
operating expenses in 2007 were $13,983,000, compared to $9,826,000 in 2006, an
increase of 42%. The increase in operating expenses was mainly due to the SHC
transaction and an increase in selling and marketing expenses related to
promotion and commissions expenses due to the increase in revenues.




Research
and development expenses consist primarily of salaries, benefits,
subcontractors’ allocated overhead expense, supplies and equipment for software
developers and architects, hardware engineers and program managers, as well as
legal fees associated with our intellectual property. Our research and
development expenses in 2007 were $1,716,000, compared to $1,362,000 in 2006, an
increase of 26%. The increase in the research and development expenses was
primarily due to research and development expenses associated with our new
technologies, CSMS and RAPTOR and active RFID due to the SHC
transaction.




Selling
and marketing expenses consist primarily of salaries and commission earned by
sales and marketing personnel, promotion expenses, trade show expenses,
allocated overhead and supplies and travel and entertainment costs. Our selling
and marketing expenses in 2007 were $9,041,000, compared to $5,619,000 in 2006,
an increase of 60.9%. The increase in the sales and marketing expenses was
primarily due to the increase in sales promotion expenses related to the
increase in revenues, labor expenses, an increase in sales and marketing
activities in the U.S. due to the SHC transaction and a different mix of
projects.





53





General
and administrative expenses consist primarily of salaries, benefits, allocated
overhead and supplies, and related costs for our executive, finance, legal,
human resource, information technology and administrative personnel, and
professional service fees, including legal counsel insurance and audit fees. Our
general and administrative expenses in 2007 were $3,192,000, compared to
$2,737,000 in 2006, an increase of 16.6%. This increase was primarily due to the
SHC transaction.




Additionally,
litigation settlement expenses consist of one-time expenses that relate to
litigations that settled during the reported periods as described in "Legal
Proceedings" in Item 8. Our litigation settlement expenses in 2007 were
$34,000, compared to $108,000 in 2006.





Financial
Expenses, net





Financial
expenses for the twelve months ended December 31, 2007 and 2006, were $4,652,000
and $204,000, respectively. The increase in financial expenses is mainly due to
a decrease in our marketable securities related to OTI's shares. During 2007, we
realized losses from the sale of marketable securities in the amount of
$1,116,000, compared to $0 during 2006 and decrease in value of marketable
securities, net in the amount of $2,699,000 and $0 during the year ended 31,
December 2007 and 2006 respectively and due to financial expenses with respect
to Convertible Bond that commenced in November 2006 in the amount of $75,000 and
$745,000 in 2006 and 2007, respectively.





Other
Expenses, Net





Other
expenses, net for the twelve months ended December 31, 2007, and 2006, were $0
and $367,000, respectively. Other expenses, net during 2006 consisted of the
write-down of a loan relating to an investment in an affiliated company and
other trade receivables in the amount of $321,000, compared to $0 during the
year 2007.





Taxes
on income





Taxes on
income are mainly expenses related to withholding tax at source related to our
project with a European country. Taxes on income for the twelve months ended
December 31, 2007 and 2006 were $390,000 and $146,000, respectively. The
increase is mainly due to the fact that the project commenced in August 2006 so
the revenue that are subject to withholding tax at source that were recognized
in 2006 reflect only 4.5 months compared to a full year during
2007.





Net
Loss





As a
result of the factors described above, our net loss in 2007 was $11,311,000,
compared to a net income of $5,440,000 in 2006. For the year ended December 31,
2006, we would have incurred a net loss of $5,096,000, excluding the $10,536,000
capital gain from the sale of the E-ID Division.





Impact
of Inflation and Currency Fluctuations





Because
the majority of our revenue is paid in or linked to the U.S. dollar, we believe
that inflation and fluctuation in the NIS/dollar exchange rate has limited
effect on our results of operations. However, a portion of the cost of our
Israeli operations, mainly personnel, is incurred in NIS. Because some of our
costs are in NIS, inflation in NIS/dollar exchange rate fluctuations do have
some impact on our expenses and, as a result, on our net income. Our NIS costs,
as expressed in dollars, are influenced by the extent to which any increase in
the rate of inflation in Israel is not offset, or is offset on a delayed basis,
by a devaluation of the NIS in relation to the dollar.





Historically,
the New Israeli Shekel has been devalued in relation to the U.S. dollar and
other major currencies principally to reflect the extent to which inflation in
Israel exceeds average inflation rates in Western economies. Such devaluations
in any particular fiscal period are never completely synchronized with the rate
of inflation and therefore may lag behind or exceed the underlying inflation
rate.





In 2008,
the rate of appreciation of the NIS against the U.S. dollar was 1.1% and the
rate of inflation, in Israel, was 3.8%. It is unclear what the
devaluation/evaluation and inflation rates will be in the future, and we may be
materially adversely affected if inflation in Israel exceeds the devaluation of
the NIS against the U.S. dollar or the evaluation of the NIS against the U.S.
Dollar, or if the timing of the devaluation lags behind increases in inflation
in Israel.





We do not
engage in any hedging or other transactions intended to manage risks relating to
foreign currency exchange rate or interest rate fluctuations. At December 31,
2008, we did not own any market risk sensitive instruments except for our
revolving line of credit. However, we may in the future undertake hedging or
other similar transactions or invest in market risk-sensitive instruments if our
management determines that it is necessary or advisable to offset these
risks.





54





Seasonality





Our
quarterly operations are subject to fluctuations due to several factors,
including the factors discused under the caption “Risk Factors—The time from our
initial contact with a customer to a sale is long and subject to delays which
could result in the postponement of our receipt of revenues from one accounting
period to the next, increasing the variability of our results of operations and
causing significant fluctuations in our revenue from quarter to quarter” in
Item 3.D.  It is our experience that, as a general matter, a majority of
our sales are made during the latter half of the calendar year consistent with
the budgetary, approval and order processes of our governmental agencies
customers. Additionally, the period between our initial contact with a potential
customer and the purchase of our products and services is often long and subject
to delays associated with the budgeting, approval and competitive evaluation
processes that frequently accompany significant expenses, particularly for
government and government agencies organizations. A lengthy sales cycle may have
an impact on the timing of our revenue, which may cause our quarterly operating
results to fall below investor expectations. We believe that a customer's
decision to purchase our products and services is discretionary, involves a
significant commitment of resources, and is influenced by customer budgetary
cycles. To successfully sell our products and services, we generally must
educate our potential customers regarding their use and benefits, which can
require significant time and resources. This significant expenditure of time and
resources may not result in actual sales of our products and services, which
could have an adverse effect on our results of operations.





New
Accounting Pronouncements





SFAS No. 141(R), “Business
Combinations”




In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations.”
This Statement will replace SFAS No. 141, “Business Combinations” (“SFAS
141(R)”). SFAS 141(R) retains the fundamental requirements of SFAS 141 with
respect to the implementation of the acquisition method of accounting ("the
purchase method") for all business combinations and for the identification of
the acquirer for each business combination. This Statement also establishes
principles and requirements for how the acquirer recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
and any noncontrolling interest in the acquiree, how the acquirer recognizes and
measures the goodwill acquired in a business combination and the disclosure
requirements to enable users of the financial statements to evaluate the nature
and financial effects of the business combination.




SFAS
141(R) will apply prospectively to business combinations for which the
acquisition date is on or after December 15, 2008 (January 1, 2009 for the
Company). Early adoption of SFAS 141(R) is prohibited. The Company believes that
the initial adoption of SFAS 141R will not have a material impact on its
financial position and results of operations. However, due to the changes
described above, consummation of business combinations after the adoption of
SFAS 141R could significantly impact the consolidated financial statements as
compared to prior acquisitions which were accounted for under existing GAAP
requirements.




SFAS
No. 160, “Noncontrolling Interests in Consolidated Financial
Statements”




In
December 2007, the SFASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements” (“SFAS 160”). This Statement amends ARB 51
and establishes accounting and reporting standards for the noncontrolling
(minority) interest in a subsidiary and for the deconsolidation of a subsidiary.
SFAS 160 clarifies that a noncontrolling interest in a subsidiary is an
ownership interest in the consolidated entity that should be reported as equity
in the consolidated financial statements. SFAS No. 160 is effective for
fiscal years beginning on or after December 15, 2008 (January 1, 2009 for the
Company). Early adoption of SFAS 160 is prohibited. The Company believes that
the adoption of SFAS 160 will not have a material impact on its financial
position and results of operations.




FSP
SFAS 142-3, “Determination of the Useful Life of Intangible
Assets”




In April
2008, the FASB issued FSP SFAS No. 142-3, “Determination of the Useful Life
of Intangible Assets” (“FSP FAS 142-3”). FSP SFAS 142-3 amends the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under FASB Statement
No. 142, “Goodwill and Other Intangible Assets.”





55





This
pronouncement requires enhanced disclosures concerning a company’s treatment of
costs incurred to renew or extend the term of a recognized intangible asset. FSP
SFAS No. 142-3 is effective for financial statements issued for fiscal years
beginning after December 15, 2008 (January 1, 2009 for the Company). Early
adoption is prohibited. The Company believes that the adoption of SFAS No.
142-3 will not have an impact on its financial position and results of
operations.




FSP
SFAS 115-2 and SFAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments (“FSP SFAS 115-2
and 124-2”)




On
April 9, 2009, the FASB issued FSP SFAS 115-2 and 124-2 which is
intended to make the guidance more operational and improve the presentation and
disclosure of other-than-temporary impairments (“OTTI”) on debt and equity
securities in the financial statements. FSP SFAS 115-2 and 124-2 applies to debt
securities and requires that the total OTTI be presented in the statement of
income with an offset for the amount of impairment that is recognized in other
comprehensive income, which amount represents the noncredit component. Noncredit
component losses are to be recorded in other comprehensive income if an investor
can assess that (a) it does not have the intent to sell or (b) it is
not more likely than not that it will have to sell the security prior to its
anticipated recovery. FSP SFAS 115-2 and 124-2 is effective for interim and
annual periods ending after June 15, 2009, with early adoption permitted
for periods ending after March 15, 2009. FSP SFAS 115-2 and 124-2 will be
applied prospectively with a cumulative effect transition adjustment as of the
beginning of the period in which it is adopted. An entity early adopting FSP
SFAS 115-2 and 124-2 must also early adopt FSP SFAS 157-4 (as described below).
The Company is currently evaluating the impact of FSP SFAS 115-2 and 124-2 on
the consolidated financial statements.




FSP
SFAS 157-4, Determining Fair Value When the Volume and Level of Activity
for the Asset or Liability Have Significantly Decreased and Identifying
Transactions that are not Orderly (“FSP SFAS 157-4”).




On April
9, 2009, the FASB issued FSP SFAS 157-4 which provides additional guidance
on determining whether a market for a financial asset is not active and a
transaction is not distressed for fair value measurements under SFAS 157,
Fair Value Measurements. FSP SFAS 157-4 will be applied prospectively and
retrospective application will not be permitted. FSP SFAS 157-4 will be
effective for interim and annual periods ending after June 15, 2009, with
early adoption permitted for periods ending after March 15, 2009. An entity
early adopting FSP SFAS 157-4 must also early adopt FSP SFAS 115-2
and 124-2.  The Company is currently evaluating the impact of FSP
SFAS 157-4 on the consolidated financial statements.





B.    Liquidity
and Capital Resources





Net cash
used in operating activities for the twelve months ended December 31, 2008 was
$5,264,000 compared to $4,890,000 during the period ended December 31, 2007, an
increase of $374,000, or 8%. Our net loss from continued operation for 2008 was
$12,086,000, less other adjustments reached to net cash used in operating
activities from continuing operations for the year 2008 of $4,732,000, less net
cash used in discontinued operation of $532,000 reached to net cash used in
operating activities for the year 2008 of $5,264,000 compared to a net loss for
2007 of $11,311,000, less other adjustments reached to net cash used in
operating activities for the year 2007 of $4,890,000.





Net cash
provided by investing activities during the period ended December 31, 2008 was
$4,136,000, compared to $4,774,000 during the period ended December 31, 2007, a
decrease of $638,000. This decrease was primarily due to the proceeds from the
sale of marketable securities in the amount of $3,192,000 during 2008, compared
to $7,639,000 during 2007. The decrease was offset by proceeds from restricted
cash deposit, net of $1,022,000 during 2008 compared to an investment in
restricted cash deposit, net of $2,313,000 during 2007, and capitalization of
software and intangible assets during 2008 of $0 compared to $509,000 in
2007.





Net cash
used in financing activities during the year ended December 31, 2008 was
$174,000, compared to $214,000 during the year ended December 31, 2007, a
decrease of $40,000.





As of
December 31, 2008, our cash and cash equivalents totaled $812,000, compared to
$2,114,000 as of December 31, 2007. Restricted cash totaled $2,150,000 as of
December 31, 2008, compared to $3,172,000 as of December 31, 2007. The main
decrease in restricted cash deposit is related to a bank deposit to secure a
guarantee to a supplier, related to a certain project of the Company with a
European country which was paid to the supplier according to the agreement,
offset by cash which is pledged to our major Convertible Bond holder in
2008.  Part of the Restricted cash is invested in  deposits,
which mature within up to one year, and is used to secure agreements with a
customer or a bank, and the other part is cash which is pledged to our major
convertible bond holder. Marketable securities totaled $0 as of December 31,
2008, compared to $4,054,000 as of December 31, 2007. The decrease in the
marketable securities compared to December 31, 2007 was due to the sale of our
remaining OTI shares.





56





We
have accumulated net losses of approximately $42,294,000 from our inception
through December 31, 2008, and we have continued to accumulate net losses since
December 31, 2008. Since May 1999, we have funded operations primarily through
cash generated from our initial public offering on NASDAQ Europe in April 1999,
which resulted in total net proceeds of approximately $23,600,000 (before
offering expenses), and, to a lesser extent, from our sale of the shares of our
former subsidiary, InkSure Technologies, Inc., from borrowings from financial
institutions, from private placements of our ordinary shares and warrants to
purchase our ordinary shares, in 2004 and 2005,  from issuance of
convertible bonds and warrants in 2006, 2007 and 2008 from the sale of OTI
shares that were received from the sale of the E-ID Division to OTI. As of
December 31, 2008, our principal source of liquidity was $812,000 of cash and
cash equivalents. As of December 31, 2008, we had $299,000 of debt outstanding
relating to obligations under our credit facility, Convertible Bonds of
$3,157,000 and an obligation for severance pay to Israeli employees of $378,000,
of which $314,000 is already covered by monthly deposits to severance pay funds
and insurance policies.





During
June and July 2004, we received aggregate gross proceeds of $1,225,000 from the
private placement of 265,001 ordinary shares and five-year warrants to purchase
106,001 ordinary shares at an exercise price of $6.47 per share. In connection
with the private placement, our placement advisors received warrants to purchase
77,941 ordinary shares at an exercise price of $6.47 per share.





In August
and September 2004, we received gross proceeds of $2,200,000 from a private
placement to accredited investors of 420,000 ordinary shares and five-year
warrants to purchase 168,000 ordinary shares at an exercise price of $6.47 per
share. In connection with the private placement, our placement agent received
warrants to purchase 30,240 ordinary shares at an exercise price of $6.47 per
share and 75,601 ordinary shares at an exercise price of $5.00 per share. All of
such warrants issued in this private placement, except 75,601 warrants with an
exercise price of $5.00, were called by us at a redemption price of $0.0588 per
warrant pursuant to our right to do so if the closing price (or closing bid
price) of our ordinary shares on an U.S. stock exchange, NASDAQ or the OTC
Bulletin Board was equal to or greater than $14.70 per share for 10 out of any
15 consecutive trading days. The investors exercised warrants to purchase an
aggregate of 194,627 ordinary shares. During the fourth quarter of 2004, 120,176
warrants were exercised for an aggregate amount of approximately $778,000, and
approximately $130,000 was received with respect to shares to be allotted in
2005. During the year 2005, 54,451 warrants were exercised for an aggregate
amount of approximately $352,000.





In
November and December of 2005, we received aggregate gross proceeds of
$3,050,000 from a private placement by certain investors of 836,292 ordinary
shares (of which 150,807 shares were issued after December 31, 2005) and
five-year warrants to purchase 292,701 ordinary shares at an exercise price of
$3.53 per share. The private placement was made to accredited investors pursuant
to Rule 506 of Regulation D, promulgated under the Securities Act of 1933, as
amended (the “Securities Act”) and to foreign private investors in offshore
transactions in reliance on Regulation S promulgated under the Securities Act.
In connection with the private placement, our placement agent received a cash
fee of $150,000 and our placement advisors received five-year warrants to
purchase 8,446 ordinary shares at an exercise price of $3.53 per share. The
investors that participated in this private placement were granted the right,
for one year following the closing of the private placement and subject to
certain limitations, to participate in future issuances of our capital stock or
securities (a “Subsequent Financing”) up to an amount which would permit each
investor to maintain its fully diluted percentage equity ownership at the same
level existing prior to the Subsequent Financing (after giving effect to such
Subsequent Financing). The warrants are callable, subject to certain
limitations, at our option if the closing bid price per ordinary share of our
ordinary shares equals or exceeds $7.06 for 20 trading days during the term of
the warrants. We may however only call, in any 3-month period, the lesser of (i)
20% of the aggregate amount of the warrants initially issued to a warrant
holder, or (ii) the total number of warrants then held by such
holder.





In
November 2006, we raised $3,156,500 through the issuance of Units consisting of
Convertible Bonds and Warrants. Units valued at $2,500,000 were issued to a
single investor, and Units valued at $656,5000 were issued to Special Situation
Funds (SSF), based on the participation rights provided in a private placement
during 2005, which were existing shareholders. According to their original terms
the Convertible Bonds mature three years from the date of issuance and bear
interest at an annual rate of 8% (which was updated as described below). Any
withholding and other taxes payable with respect to the interest will be grossed
up and paid by us (approximately 3% of the principal of the bonds); payment of
interest will be net of any tax. Subject to certain redemption provisions, as
described below, the Convertible Bonds may be converted at any time, at the
option of the investors, into our ordinary shares at a conversion price of $5
per share (see amendment below). The investors were also granted Warrants
entitling them to acquire a total of 134,154 ordinary shares at an exercise
price of $5 per share during the next five years. With respect to this
transaction, we paid approximately $215,000 cash as issuance expenses and
granted an option to acquire up to 25,000 shares to a third party, exercisable
at $5 per share. The fair market value of this grant was $ 40,000.





57





We have
considered the provisions of EITF Issue No.00-19, “The Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own
Stock,” and determined that the embedded conversion feature should not be
separated from the host instrument because it is qualified for equity
classification in paragraphs 12-32 of EITF Issue No.00-19. Therefore the
transaction was accounted for in accordance with EITF 00-27, "Application of
Issue No. 98-5 to Certain Convertible Instruments" and APB 14, "Accounting for
Convertible Debt and Debt Issued with Stock Purchase Warrants." The fair market
value of the Warrants was determined based on the fair value of the
instruments issued using the Black-Scholes pricing model, assuming a risk free
rate of 5%, a volatility factor of 78.21%, dividend yields of 0% and an expected
life of 2 years. The expiration date of the Warrants is November
2011.




As a
result, we recorded in 2006 an amount of $282,000 with respect to the Warrants
and an amount of $632,000 as beneficial conversion feature with respect to the
Convertible Bonds, as a credit to shareholders' equity (additional paid in
capital). The discount of the bonds as a result of the value assigned to the
warrants and the beneficial conversion feature is amortized during the
contractual term of the bonds.




In
November 2007, due to a breach of certain conditions of the convertible bonds,
the investors had the right to accelerate the repayment of the principal amount
of the bonds with all the interest payable until the maturity date of the bonds.
However, we signed an amendment to the agreement with the investors under which
we were required to pay to one of the investors the abovementioned interest
amount ($276,000) (with any withholding and other taxes payable with respect to
the interest (approximately 3% of the principal of the bonds)) and with respect
to the other investors we changed the conversion ratio of the bonds to $4.25. In
a consideration the investors waived their right to accelerate the repayment of
the bonds. We accounted for the amendment as a modification of the bonds (based
on the provisions of EITF 06-06 (We accounted for the amendment as a
modification of the Bonds.)




In June
2008, following a breach in the amended terms of the convertible bonds, we
reached an agreement with one of the investors (with a principal amount of
$2,500,000), under which, among other things, the investor waived our compliance
with certain covenants under its Convertible Bonds, in exchange
for:




1.
            Increasing
      the interest rate to 10% starting March 31, 2008. Any withholding and
      other taxes payable with respect to the interest will be grossed up and
      paid by us (approximately 3% of the principal of the
    bonds).




2.
            Reducing
      the exercise price of the bond and the warrants to $3 and $2.8,
      respectively.




3.
            We
      undertake to place a fixed charge on all income and/or rights in
      connection with a certain European Airport Project. This charge shall be
      senior to any indebtedness and/or other pledge and encumbrance, but shall,
      however, be subject to certain rights of us to use part of the
      income.




4.
            Certain
      anti-dilution rights with respect to the warrants held by the single
      investor.




In
addition, under certain circumstances the investor might have the right to
demand an early payment of partial or full amount of the Convertible Bonds (up
to the $2,500,000 as mentioned above). We accounted for the amendment as an
extinguishment of the Bonds.




Due to
the breach of certain convertible bonds covenants, we had to recognize, in 2008,
financial expenses in the amount of $553,000, to accelerate deferred expenses in
the amount of $138,000 and to accelerate the remaining discount amounts
(attributed to warrants and beneficial feature) in the amount of $724,000. In
addition the Convertible Bond was classified as a current
liability.




There
were no amendments signed with SSF since November 2007.




As of
December 31, 2008 and June 30, 2009, we are not in compliance with certain
covenants under our Convertible Bond agreements, in which case the Convertible
Bond holders could seek to accelerate payment of the unpaid principal amount,
accrued interest and other amounts under its Convertible Bond (an aggregate of
approximately $4,420,000 as of June 30, 2009). We are currently negotiating with
the Convertible Bond holders.





On
December 31, 2006, we concluded the OTI Transaction for 2,827,200 restricted
ordinary shares of OTI. One seventh of the restricted ordinary shares vest at
the end of each calendar quarter, beginning with the quarter ended December 31,
2006.





As a result of the OTI Transaction, we
recognized $10,536,000 as a capital gain on the sale of the E-ID Division in
fiscal year 2006.





The
capital gain was calculated based on OTI’s share price on the closing date, less
a discount due to the lock up restrictions of the shares (based on an
independent appraisal), the carrying value of the assets that were transferred
to OTI and direct expenses (in an amount of $1,550,000) associated with the
sale.





58





The
direct expenses included, inter alia, the fair value of 212,040 shares out of
the shares received by us from OTI that will be transferred to consultants, as a
finder and legal fee, in connection with the transaction.





In
connection with the completion of the sale, during January 2007, a financial
institution extended a $2,500,000 loan to us. In order to secure this loan we
deposited our OTI shares in favor of the financial institution.





During
2007 and 2008, we sold 1,414,716 and 1,200,444 shares of OTI for a total
consideration of $7,639,000 and $3,192,000, respectively.





As of
December 31, 2008, Vuance Inc. had an account receivable line of credit from
Bridge Bank in an aggregate amount of up to $1,000,000. The loan bears interest
at the WSJ Prime Rate plus an additional 2.5% annualized on the average daily
gross financed amount outstanding. Floor on Prime Rate to be 6%. Minimum monthly
interest of $1,500 Plus Facility fee of $7,500 annually. Bridge Bank has a
perfected first position security interest in all of Vuance Inc.'s current and
future assets, including intellectual property and general
intangibles.





The
weighted average interest rate on the credit line as of December 31, 2008 was
approximately 6%.





During
the period from January 1, 2008 to December 31, 2008, our capital expenditures
totaled approximately $73,000 (compared to $116,000 during 2007 and $93,000
during 2006), of which approximately $39,000 (compared to $62,000 during 2007
and $69,000 during 2006) was expended at or upon Vuance's facilities in Israel,
and approximately $34,000 (compared to $54,000 during 2007 and $24,000 during
2006) was expended upon various facilities of Vuance's subsidiaries outside
Israel. During the first financial quarter of 2009, our capital expenditures
totaled approximately $10,150.





Continuation
of our current operations after utilizing our current cash reserves is dependent
upon the generation of additional financial resources either through the
issuance of additional equity or debt securities or other sources of financing
or the sale of certain assets of the Company. These matters raise substantial
doubt about our ability to continue as a going concern. The financial statements
have been prepared assuming that we will continue as a going concern. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.





C.
            Research
      and Development





Our past
research and development efforts have helped us to achieve our goal of offering
our customers a complete line of products and solutions. As of December 31, 2008
the number of employees in our research and development activities was 11. We
focus on the new technology of our RFID and Credentialing, and expect to
maintain our current research and development efforts. We spent $1.4 million,
$1.7 million and $2.6 million on research and development in 2006, 2007 and
2008, respectively. These amounts were spent on the development or improvement
of our technologies and products, primarily in the areas of RFID and
Credentialing in 2008 and 2007 and during 2006 mainly in the areas of automatic
contactless smart card production line, data capture, management software,
population registry software packages, security printing, and document
authentication. We will continue to research and develop our RFID, Credentialing
and EAC. There can be no assurance that we can achieve any or all of our
research and development goals.




D.
            Trend
      Information





See -
“Results of operations” in Item 5.A for additional information.




Industry
Trends





The
increased demand for better security systems and services has positively
affected trends within the industry. Access control and asset management are now
leading security concerns in commercial and governmental enterprises. This has
created an increasing demand, both for physical security access to buildings and
logical security access to corporate networks, combined with real time tracking
and monitoring assets. Our mobile (CSMS and RAPTOR) and fixed access control
solutions, jointly with our RFID-enabled security and asset management
solutions, provide an optimal solution to these problems as they deliver
stronger authentication of network users and store personal data for highly
secure physical access control. In addition, we believe that the acquisition of
the Intelli-Site will expedite our ability to meet the demand for integrated
solutions and technology convergence operating under a unified
platform.





59





Market
and Operational Trends





Our
quarterly operations results may be subject to significant fluctuations due to
several factors. Some of these factors are based primarily on the timing of
large orders, which represent a significant percentage of our revenues, customer
budget cycles and impact on the timing for buying decisions, as well as
competitive pressures and the ability of our partners, distributors and system
integrators to become effective in selling and marketing our products, as well
as other factors.





We
have also observed a considerable increase in marketing leads from our growing
partnerships, distributions and systems integration network, and a particular
interest by federal as well as local government customers in public safety or
incident management. We expect to continue to benefit from marketing programs
and leads generated by this network, as well as sales opportunities identified
by them. We intend to expand our marketing and implementation capacity through
these third parties, including vendors of complementary products and providers
of service applications. By employing third parties in the marketing and
implementation process, we expect to enhance sales by taking advantage of their
market presence.





A
significant portion of our 2008 revenues was derived from our governmental
projects and the remainder was derived from commercial customers. Historically,
our revenues have been concentrated in a few large orders and in a relatively
small number of customers. We expect this trend to change and we expect that
future revenues will come from larger number of orders and
customers.





For more
information about our expectations regarding future cost of revenues, future
operating expenses and liquidity and capital resources, please refer to the
section captioned “Risk Factors” in Item 3.D., the sections captioned “Results
of Operations” in Item 5.A and “Liquidity and Capital Resources” in Item
5.B.





Our
development and marketing efforts for the solution and product platforms are
aimed at addressing several systems and service trends that we see developing in
the industry.





In
December 2006, we concluded the sale of our E-ID Division to OTI. The sale
allows management to focus primarily on the substantial market opportunities we
have identified for our Credentialing and active RFID solutions. Following the
events of September 11, 2001 and other major disasters it has become
increasingly important for agencies to track personnel, assets, and other
objects on a local positioning basis. Our CSMS and RAPTOR solutions can fulfill
critical homeland security requirements for public safety and emergency services
agencies and local counter-terrorism task forces. In recent months, we have
announced contracts for the deployment of our CSMS and RAPTOR Systems, and we
are currently discussing the deployments with additional governmental agencies
in North America.





As a
result of these trends and combined with our core strengths, we are focusing on
products and solutions that we believe will be significantly influential in the
present and future markets. As of the date of this Annual Report, we expect that
our 2009 revenues will be primarily derived from:





·
            Smart
      ID technologies;


·
            Passive
      RFID - Electronic Access Control;


·
            CSMS
      and RAPTOR Systems;


·
            Active
      RFID; and


·
            Integrated
      Managed Security solution software.





Recent
Developments and Outlook





We expect
revenues to continue to be derived from one-time sales and recurring fees, sales
of high-end solutions, sales of products, consumables and technology. Sales are
expected to continue through OEM partnerships and continual upgrades,
maintenance and support will continue to be provided to customers. For more
information see the section captioned “Recent Developments” in Item
4.





E.
            Off
      Balance Sheet Arrangements





We
do not have any off-balance sheet transactions that have or are reasonably
likely to have a material effect on our current or future financial condition,
changes in financial condition, revenues, expenses, results of operations,
liquidity, capital expenditures or capital resources.





60





F.
            Tabular
      Disclosure of Contractual
Obligations





Contractual
Obligations





The
following table summarizes our contractual obligations and commitments as of
December 31, 2008, which will require significant cash outlays in the
future:





Contractual Obligations
                
                Total
                
                
                Less than
                  1year
                
                
                1-3 years
                
                
                3-5 years
                
                
                More than
                  5yearsLong-term
      debt obligations
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —Capital
      (finance) lease obligations
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —
                
                
                
                —Operating
      lease obligations
                
                $
                770,000
                
                
                $
                464,000
                
                
                $
                306,000
                
                
                
                —
                
                
                
                —Purchase
      obligations(*)
                
                $
                646,500
                
                
                $
                346,500
                
                
                $
                300,000
                
                
                
                —
                
                
                
                —Convertible
      bonds(**)
                
                $
                4,306,000
                
                
                $
                4,306,000
                
                
                
                —
                
                
                
                —
                
                
                
                —Total
      contractual cash obligations
                
                $
                5,836,500
                
                
                $
                5,230,500
                
                
                $
                606,000
                
                
                
                —
                
                
                
                —





Long-term
debt consists of amounts due on loans from banks, which is described in Item 18,
Note 9 to the financial statements included in this Annual Report. Operating
lease obligations represent commitments under several lease agreements for our
facilities and the facilities of certain subsidiaries. Convertible bonds
represent the amount due to the investors under the convertible bonds assuming
there will no conversion to shares, which is described in Item 18, Note 13 to
the financial statements included in this Annual Report. Total contractual cash
obligations represent outstanding commitments for loans from banks, convertible
bonds, purchase obligations and lease agreements for facilities. We are not a
party to any capital leases.





(*)We are obligated, under
certain contracts with one of our manufacturers, to purchase certain frame
orders from such manufacturer, with no specific time requirements.





(**) As of December 31, 2008
and June 30, 2009, we are not in compliance with certain covenants under our
Convertible Bond agreements, in which case the Convertible Bond holders could
seek to accelerate payment of the unpaid principal amount and accrued interest
under its Convertible Bond (an aggregate of approximately $4,420,000 as of June
30, 2009). We are currently negotiating with the Convertible Bond
holders.




ITEM
6.    Directors, Senior Management and
Employees.




A.    Directors
and Senior Management




Board of Directors




We are managed by our Board of
Directors. Pursuant to our Articles of Association, the number of directors may
be determined from time to time by the Board of Directors, and unless otherwise
determined, the number of directors comprising the Board of Directors will be
between four and ten. Directors are elected for a one year term ending at the
following annual general meeting of shareholders, except for our external
directors, who are elected for three year terms in accordance with the Israeli
Companies Law. However, if no directors are elected at an annual meeting, then
the persons who served as directors immediately prior to the annual meeting
shall be deemed re-elected at the same meeting, The General Meeting may resolve
that a director be elected for a period longer than the time ending at the next
annual meeting but not longer than that ending at the third next annual meeting.
The Board of Directors elects one of its members to serve as the
Chairman.





61





The Board of Directors is composed as
follows (as of the date of this Annual Report):





Name
                
                Age
                
                PositionEli
      Rozen
                
                55
                
                Director,
      Chairman of the BoardAvi
      Landman
                
                55
                
                DirectorIlan
      Horesh
                
                57
                
                External
      Director (1)Jaime
      Shulman
                
                66
                
                DirectorMichal
      Brikman
                
                39
                
                External
      Director (2)





(1)  “External
Director” as defined in the Israeli Companies Law (see explanation
below).


(2)  The
reelection of Michal Brikman, who was elected as an external director on October
28, 2004 for a period of three years, was inadvertently left off of the agenda
of our 2007 annual general meeting of shareholders, and under Israeli
law, an external director cannot be deemed reelected or continue in office until
a successor is elected. Due to this oversight, since October 28, 2007, Ms.
Brikman has not qualified as our “external director,” but has continued to
function as such and as a member of certain committees of our Board of
Directors. At the annual general meeting of shareholders held on August 17,
2008, Ms. Brikman was reelected as an external director for an additional period
of three years commencing as of October 28, 2007. Additionally, our Board of
Directors and such committees ratified all of the actions that had been taken by
them since the expiration of Ms. Brikman's initial term as our external
director.





Eli Rozen
is one of our co-founders and serves as a director and as Chairman of our Board
of Directors. Mr. Rozen has served as Chairman since 2000. From 1988 until 2000,
Mr. Rozen served as our Chief Executive Officer and President. Mr. Rozen has a
Bachelor of Science in Industrial Engineering and Management from the Israel
Institute of Technology.





Avi
Landman is one of our co-founders and serves as a member of the Board of
Directors and as our Research Manager. Prior to co-founding Vuance in 1988, Mr.
Landman worked as a computer engineer at Gal Bakara Ltd. and prior to that as a
Practical Engineer at Eltam Ltd. Mr. Landman has a Bachelor of Science degree in
Computer Engineering from the Technion - Israel Institute of Technology and a
Practical Engineer Diploma in Electronics from Bosmat Haifa.




Ilan
Horesh,an
external director, became a member of the Board of Directors on September 17,
2006 and is a member of the audit committee. Mr. Horesh was also a board member
of Retalix Ltd. from 1998 to 2006. Since 2006, he has been an external director
of Ampa Investments LTD, and since 2007 has been a board member of Taldor
Computer System (1986) Ltd. and an external director of Rekah Pharmaceutical
Industry Ltd. Mr. Horesh was a department manager at Pelephone Communication
Ltd. From 1997 to 1998, Mr. Horesh served as the Chief Executive Officer of
"SHEFFA consumer club," a subsidiary of Macabi Health Services. From 1994 to
1997, Mr. Horesh was the manager of the Planning and Projects Department at Paz
Oil Corp. From 1994 to 1999, Mr. Horesh was a director of Hed-Artzi Ltd. Mr.
Horesh holds a Bachelor of Arts in History and Geography from Tel Aviv
University, a Master of Arts in Political Studies from Haifa University, and a
Bachelor of Arts degree in Business Administration.





Jaime
Shulman became a member of the Board of Directors on September 17, 2006.
From 2001 to 2003, Mr. Shulman was President and CEO of Logisticare, Ltd. From
1998 to 2000, Mr. Shulman was President and CEO of the Amcor Group. From 1993 to
1997, Mr. Shulman was President and CEO of the Magam Enterprises Group. From
1991 to 1998, Mr. Shulman was the active Chairman of the board (part time) of
Tana Industries. From 1991 to 1992, Mr. Shulman was a foreign consultant to and
subsequently CEO of Metrometer, Inc. (New York). From 1978 to 1991, Mr. Shulman
was CEO of Electra Israel. From 1970 to 1977, Mr. Shulman was Production Manager
at Tadiran, Plastic and Metal Plant. Mr. Shulman is an Electromechanical
Engineer (equivalent to M.Sc. in Israel) from Buenos Aires University,
Argentina.





Michal
Brikman,an
external director, became a member of the Board of Directors on October 28,
2004. Ms. Brikman is a Certified Public Accountant with extensive management and
accounting experience. From 2000 to 2005, Ms. Brikman was a business consultant
at Daniel Doron Business Consulting. Ms. Brikman received her Masters in Finance
from Baruch College in New York City and later relocated to
Israel.





62





Executive
Officers and Key Employees





As of June 15, 2009, our executive
officers and certain key employees who are not also directors are:





Name
                
                Age
                
                PositionEyal
      Tuchman
                
                41
                
                Chief
      Executive OfficerRon
      Peer
                
                59
                
                Deputy
      CEO, President of Vuance Inc.Lior
      Maza
                
                38
                
                Vice
      President of Corporate Finance, Chief Financial OfficerJoel
      Konicek
                
                59
                
                Chief
      Operating OfficerJim
      Peroutka
                
                55
                
                Chief
      Technology OfficerKyle
      John
                
                42
                
                Vice
      President Sales, North AmericaThomas
      W. Connell II
                
                42
                
                Vice
      President Government SolutionsKevin
      Michael
                
                48
                
                Vice
      President of OperationsJohn
      Ulibarri
                
                51
                
                Vice
      President of Integrated
Solutions





Eyal
Tuchman, Chief Executive Officer. In April 2006, Mr. Tuchman became
Vuance’s Chief Executive Officer, after four years of service as Vuance’s Chief
Financial Officer and Chief Operational Officer. Mr. Tuchman brings to Vuance
years of experience in business development, finance and operational management
in publicly traded companies. Prior to joining us in 2002, he served as Chief
Financial Officer of Magam Group, a company traded on the Tel-Aviv Stock
Exchange, from 1996 to 2002, and before that, was a Senior Auditor at Kesselman
& Kesselman (today, PriceWaterhouseCoopers). Mr. Tuchman holds a Bachelor of
Arts in Economics & Accounting from Ben Gurion University and is a certified
public accountant.




Ron
Peer,Deputy
CEO, Marketing, Technology and Business Development. Mr. Peer has over 30 years
of experience in the technology industry, where he has held top management
positions. Mr. Peer has proved to be a successful leader in the Israeli and U.S.
high-tech industries with broad and in-depth marketing and business vision. With
proven experience and expertise in brand counterfeiting and document security
solutions, he has directed startup and turnaround situations and also recruited
and developed strong management teams. With his technological and operational
experience background, rooted in the Israel Defense Forces as a Lieutenant
Colonel, Mr. Peer maintains a successful international business and management
career. Mr. Peer holds a Bachelor of Science degree in Electronic Engineering,
and Business and Marketing Diplomas from Tel-Aviv University.




Lior Maza,
Chief Finance Officer. Mr. Maza has over ten years of financial management
experience, having served, from 2004 to 2007, as Director of Finance at
PowerDsine, Ltd. (NASDAQ: PDSN), a pioneer in Power over Ethernet (PoE)
solutions that was acquired by Microsemi Corporation (NASDAQ: MSCC). Prior to
PowerDsine, Mr. Maza served for four years as the Corporate Controller of Invoke
Solutions, a leading innovator of real-time, interactive research technology.
Mr. Maza holds a Masters degree in Business Administration with distinction from
Heriot-Watt University, Edinburgh Business School. Mr. Maza is a certified
public accountant.




Joel Konicek,Chief Operating Officer. Mr. Konicek was the former CEO and President of
Security Holding Corp., and joined Vuance when SHC was acquired in 2007. He
published Security, IDSystemsand Locks: TheBook on Electronic Access
Controlin
1998.




Jim Peroutka,Chief Technology Officer. Mr. Peroutka was the former CTO of Security
Holding Corp., and joined Vuance in 2007. As a 30 year veteran of the security
industry, Mr. Peroutka is a specialist in RFID-empowered electronic access
control for wide area networks. Previously, he founded and led JRP Data
Systems.




Kyle John,Vice President Sales, North America. With over 14 years of security
industry experience, Mr. John joined the Company in 2007.  He
previously served as Regional Sales Manager for two Fortune 500 companies, ADT
Security Services and Cintas Corporation.




Thomas W. Connell
II,Director, Government Solutions.  Mr. Connell was the former
CEO of Special Rescue Services and COO of Disaster Management Solutions, and
joined Vuance in 2007. As a 15-year veteran of emergency services, he served on
national standards committees such as National Fire Protection Association
(NFPA), and worked with the Federal Emergency Management Agency, DHS, the
Department of Justice, and the Department of Health and Human Services on
multiple domestic preparedness initiatives after the September 11, 2001 terror
attacks.




Kevin
Michael,With over 15 years of
experience in the private sector, Mr. Michael has managed projects at EMC2,
Intel, and National Semiconductors. Mr. Michael has extensive experience in
operations including the integration of RFID technologies and facility
management applications to control space and assets.





63




John
Ulibarri, is the President and Chief Executive Officer of Intelli-Site,
Inc. Mr. Ulibarri joined Intelli-Site in April, 2001 as Vice President of
Engineering and Operations, was promoted to Executive Vice President in
December, 2002, and President in January, 2004.  Mr. Ulibarri brings more
than 25 years of experience in the Security Systems industry.  Prior to
joining our company, Mr. Ulibarri served in various senior management and
engineering positions with major security and communications systems integration
concerns throughout the US.  Mr. Ulibarri holds a B.S. in Computer
Engineering and an MBA.




B.    Compensation





The aggregate amount of compensation
paid by us to our board members, our Chief Executive Officer, Deputy CEO,
Marketing, Technology and Business Development, Vice President, Chief Financial
Officer, Chief Operating Officer and Chief Technology Officer (collectively, the
"Named Executive Officers") as a group for the twelve months ended December 31,
2008 was approximately $1,017. This sum includes amounts paid for salary and
social benefit. In addition, we have provided automobiles to our executive
officers at our expense.





In
accordance with the requirements of Israeli law, we determine our directors’
compensation in the following manner. First, our audit committee reviews the
proposal for compensation; second, provided that the audit committee approves
the proposed compensation, the proposal is then submitted to our Board of
Directors for review, except that a director who is the beneficiary of the
proposed compensation does not participate in any discussion or voting with
respect to such proposal; and finally, if our Board of Directors approves the
proposal, it must then submit its recommendation to our shareholders, which is
done in the forum of our shareholders’ general meeting. The approval of a
majority of our shareholders is required for any such compensation
proposal.





On January 26, 2003, at a special
general meeting, our shareholders approved the grant to each of our directors
who is not an external director, commencing on October 1, 2002, a monthly $1,000
fee and participation remuneration per meeting of the Board of Directors,
provided however, that each of the directors who is not an external director
shall be entitled to an aggregate sum of monthly remuneration and participation
remuneration of not more than $18,000 per year.





As of
December 31, 2008, we had set aside approximately $29,000 to provide pension,
retirement or similar benefits for our Board of Directors and Named Executive
Officers.





Option/SAR
Grants during the Year Ended December 31, 2008





During
the twelve months ended December 31, 2008, we granted options to purchase 23,000
ordinary shares under our Option Plan (as defined in “Share Options Plans”
below) to two of our Named Executive Officers at an exercise price of $1.88. All
options will expire in 2018.




In
September, 2008, the Board of Directors approved a re-pricing of options for
three executive officers for 149,600 options, which had exercise prices ranging
between $2.47 and $14.8235.  The re-pricing changed the exercise price
of the options to $1.86. The incremental compensation cost at the date of the
modification was $66,000, of which $59,000 was recognized during
2008.




On
January 9, 2009, according to the board resolution on October 27, 2008 and the
Special General Meeting dated December 21, 2008, the Company granted to (a) the
Chairman of our Board of Directors, (b) a member of the Company's Board of
Directors who is also one of the co-founders, (c) one of the co-founders of the
Company, and (d) another member of the Company's Board of Directors, options to
purchase up to 49,311, 34,702, 24,244 and 6,164 shares,
respectively.  The options have an exercise price of 0.0582235 NIS,
vesting immediately and will expire after ten years. Those options were granted
as a compensation for three months in exchange for waiving their cash payments
for those months, according to their agreement with the Company. In addition (a)
all options held by the Participants on October 27, 2008 shall be re-priced so
that the exercise price thereof shall be $1.1 (the closing price of the Ordinary
Share on said date), and (b) all such options with an expiration date prior to
October 27, 2013 shall nonetheless be exercisable until October 27,
2013.




Please
refer to the Section captioned “Share Option Plan” under Item 6.E below for a
description of our Option Plans.





64





C.    Board
Practices




Our Board
of Directors and senior management consider good corporate governance to be
central to our effective and efficient operations. The following table lists our
directors, the positions they hold with us and the dates the directors were
first elected or appointed:





Name
                      
                      Position
                      
                      Period
      Served in OfficeEli
      Rozen
                      
                      Director
                        Chairman
      of the Board
                      
                      1988-present
                        July
      25, 2000-presentAvi
      Landman
                      
                      Director
                      
                      1988-presentIlan
      Horesh
                      
                      External
      Director
                      
                      September
      17, 2006-presentJaime
      Shulman
                      
                      Director
                      
                      September
      17, 2006-presentMichal
      Brikman
                      
                      External
      Director
                      
                      October
      28, 2004-present
(*)





(*) The
reelection of Michal Brikman, who was elected as an external director on October
28, 2004 for a period of three years, was inadvertently left off the agenda
of our 2007 annual general meeting of shareholders, and under Israeli
law, an external director cannot be deemed reelected or continue in office until
a successor is elected. Due to this oversight, since October 28, 2007, Ms.
Brikman has not qualified as our “external director,” but has continued to
function as such and as a member of certain committees of our Board of
Directors. At the annual general meeting of shareholders held on August 17,
2008, Ms. Brikman was reelected as an external director for an additional period
of three years commencing on October 28, 2007. Additionally, our Board of
Directors and such committees ratified all of the actions that had been taken by
them since the expiration of Ms. Brikman's initial term as our external
director.





Our
Articles of Association provide that the number of directors may be determined
from time to time by the Board of Directors, and unless otherwise determined,
the number of directors comprising the Board of Directors will be between four
and ten. The Board of Directors is presently comprised of five members, two of
whom were elected as external directors under the provisions of the Israeli
Companies Law (discussed below).





All
directors hold office until their successors are elected at the next annual
general meeting of shareholders, except for our external directors, Michal
Brikman, who shall hold office until October, 2010, and Ilan Horesh, who shall
hold office until September, 2009.





Under the
Israeli Companies Law and the regulations promulgated pursuant thereto, Israeli
public companies, namely companies whose shares have been offered to the public
or are publicly traded, are required to appoint at least two natural persons as
“external directors.” A person may not be appointed as an external director if
the person, or a relative, partner or employer of the person, or any entity
under the person’s control, has or had, on or within the two years preceding the
date of the person’s appointment to serve as an external director, any
affiliation with the company to whose board the external director is proposed to
be appointed; with the controlling shareholder of such company or with any
entity controlling or controlled by such company or by the controlling
shareholder of such company. The term “affiliation” includes an employment
relationship, a business or professional relationship maintained on a regular
basis, control and service as an office holder (which term includes a
director).





In
addition, no person may serve as an external director if the person’s position
or other business activities create, or may create, a conflict of interest with
the person’s responsibilities as an external director or interfere with the
person’s ability to serve as an external director or if the person is an
employee of the Israel Securities Authority or of an Israeli stock exchange. If,
at the time of election of an external director, all other directors are of the
same gender, the external director to be elected must be of the other
gender.





Pursuant
to the Israeli Companies Law, at least one of the external directors, as well as
a number of the non-external directors to be determined by the Board of
Directors, are required to have “accounting and financial expertise” and the
other external directors are required to have "professional skills," as such
terms are defined in regulations recently promulgated under the Israeli
Companies Law.





Each
committee of a company’s Board of Directors that has the authority to exercise
powers of the Board of Directors is required to include at least one external
director and its audit committee must include all external
directors.





External
directors are elected at the general meeting of shareholders by a simple
majority, provided that the majority includes at least one-third of the
shareholders who are not controlling shareholders, who are present and voting,
or that the non-controlling shareholders who vote against the election hold one
percent or less of the voting power of the company.





65





At our
2003 Annual General Meeting held on June 30, 2003, Esther Koren and Avi Elkind
were each re-elected to serve as external directors for an additional term of
three years ending on June 30, 2006. However, Esther Koren resigned as a member
of our Board of Directors due to personal reasons effective July 14, 2004. Ms.
Michal Brikman was subsequently appointed to our Board of Directors as an
External Director, which appointment was approved by our shareholders at a
special general shareholder meeting on October 28, 2004. In addition, Ms.
Brikman has been appointed to the Audit Committee and several other committees.
Ms. Brikman's term as External Director, and consequently as a member of such
committees expired on October 27, 2007; however, at the annual general meeting
of shareholders held on August 17, 2008, Ms. Brikman was re-elected as an
external director for an additional period of three years commencing on October
28, 2007.  Our Board of Directors and such committees have ratified
all of the actions that had been taken by them since the expiration of Ms.
Brikman's initial term as our external director.




On
September 17, 2006, our general meeting appointed Mr. Ilan Horesh as an External
Director. In addition, Mr. Horesh has been appointed to the audit
committee.




Under
the Israeli Companies Law, an external director cannot be dismissed from office
unless: (i) the Board of Directors determines that the external director no
longer meets the statutory requirements for holding the office, or that the
external director has breached the external director's fiduciary duties, and the
shareholders vote, by the same majority required for the appointment, to remove
the external director after the external director has been given the opportunity
to present his or her position; (ii) a court determines, upon a request of a
director or a shareholder, that the external director no longer meets the
statutory requirements of an external director or that the external director has
breached his or her fiduciary duties to the company; or (iii) a court
determines, upon a request of the company or a director, shareholder or creditor
of the company, that the external director is unable to fulfill his or her duty
or has been convicted of specified crimes.





We
have the following committees:





Audit
Committee





The
IsraeliCompanies
Law requires public companies to appoint an audit committee comprised of at
least three directors, including all of the external directors, and further
stipulates that the chairman of the Board of Directors of a public company, any
director employed by or providing other services on a regular basis to the
company and the controlling shareholder or any relative of the controlling
shareholder of such company may not be members of the audit committee of the
company. Since the expiration of Ms. Brikman's term as an external director (on
October 27, 2007) and due to the oversight omission of her re-election for an
additional term of three years, we have not had an audit committee (the "Audit
Committee") which complies with the requirements of Israeli law. During that
period our “audit committee” continued to operate, however, no event or action,
which under the Israeli Companies Law requires approval by the Audit Committee,
occurred or was taken until Ms. Brikman was re-elected as an external director
at the annual general meeting of shareholders held on August 17, 2008, for an
additional period of three years commencing as of October 28, 2007. Our Board of
Directors and Audit Committee ratified all of the actions that have been taken
by them since the expiration of Ms. Brikman's initial term as external director.
In 2007 the Audit Committee adopted an audit committee charter which regulates
its operations. According to our Audit Committee charter, the objective of the
Audit Committee is to assist the Board of Directors’ oversight of the Company’s
accounting practices; the integrity of the Company’s financial statements; the
Company’s accounting and financial reporting processes; the Company’s compliance
with legal and regulatory requirements; the independent auditors’
qualifications, independence, and performance; audits of the Company’s financial
statements and the internal audit function, and to locate deficiencies in the
business management of the Company, among other things, in consultation with the
Company’s independent auditors and internal auditors, and to suggest to the
Board of Directors the measures to be taken regarding such deficiencies. Mr.
Ilan Horesh Mr. Jaime Shulman and Ms. Brikman are the members of the Audit
Committee.




Compensation
(Remuneration) Committee




We have a
compensation committee (the "Compensation Committee"). In 2007, the Compensation
Committee adopted a Compensation Committee charter, which regulates its
operations. According to the Compensation Committee charter it is responsible
for determining the compensation (including salaries, bonuses and equity
incentive compensation awards) of executive officers, including the Chief
Executive Officer, other senior management and members of the Board of
Directors. Ms. Michal Brikman, Mr. Ilan Horesh and Mr. Jaime Shulman are at the
present time the members of the Compensation Committee.




66




Nominating
and Corporate Governance Committee Charter





On May
15, 2007, our Board of Directors approved the establishment of a Nominating and
Corporate Governance Committee (the "Nominating and Corporate Governance
Committee"). The Nominating and Corporate Governance Committee is responsible
for identifying individuals qualified to become board members, consistent with
criteria approved by the Board of Directors, and recommending that the Board of
Directors select the director nominees for election at the general meeting of
shareholders. The Committee is also responsible for developing and recommending
to the Board of Directors a set of corporate governance guidelines applicable to
the Company, periodically reviewing such guidelines, recommending any changes
thereto, and overseeing the evaluation of the Board of Directors. The Nominating
and Corporate Governance Committee is currently comprised of Ms. Michal Brikman,
Mr. Ilan Horesh and Mr. Jaime Shulman.





Management
Employment Agreements





We
maintain written employment agreements with substantially all of our key
employees. These agreements provide, among other matters, for monthly salaries,
our contributions to Managers’ Insurance, an Education Fund and severance
benefits. All of our agreements with our key employees are subject to
termination by either party upon the delivery of notice of termination as
provided therein.





Internal
Auditor





Under the Israeli Companies Law, the
Board of Directors must appoint an internal auditor, proposed by the audit
committee. The role of the internal auditor is to examine, among other matters,
whether the company’s activities comply with the law and orderly business
procedure. Under the Israeli Companies Law, the internal auditor may be an
employee of the company but may not be an interested party or office holder, or
a relative of any interested party or office holder, and may not be a member of
the company’s independent accounting firm, or its representative. We have
appointed the office of Chaikin Cohen Rubin & Co. as our internal auditor in
accordance with the requirements of the Israeli Companies Law.





D.    Employees




As of
December 31, 2008 and 2007, we had 52 and 70 full-time employees, respectively.
The following table describes our employees and the employees of our
subsidiaries by department.





Dec. 31,
                    2006
                  
                  
                  Dec. 31,
                    2007
                  
                  
                  Dec. 31,
                    2008Research,
      Development & Manufacturing
                  
                  
                  26
                  
                  
                  
                  23
                  
                  
                  
                  21Marketing
      and Sales
                  
                  
                  20
                  
                  
                  
                  34
                  
                  
                  
                  20Administration
                  
                  
                  10
                  
                  
                  
                  13
                  
                  
                  
                  11Total
                  
                  
                  56
                  
                  
                  
                  70
                  
                  
                  
                  52





Over the
past three years, the number of our employees by geographic area was as
follows:





Dec. 31,
                    2006
                  
                  
                  Dec. 31,
                    2007
                  
                  
                  Dec. 31,
                    2008Israel
                  
                  
                  38
                  
                  
                  
                  22
                  
                  
                  
                  16United
      states
                  
                  
                  5
                  
                  
                  
                  43
                  
                  
                  
                  30Rest
      of the world
                  
                  
                  13
                  
                  
                  
                  5
                  
                  
                  
                  6Total
                  
                  
                  56
                  
                  
                  
                  70
                  
                  
                  
                  52





From time
to time, we have engaged temporary employees to fill open positions. These
temporary employees, however, historically have not comprised a material number
of our employees.





As a
result of the OTI Transaction we terminated the employment of approximately 19
employees that were employed by us in the E-ID Division (the above table
includes, as of December 31, 2006, the employees of the E-ID Division). Our
current total number of employees is 48.





67





Vuance’s
Israeli employees are not part of a collective bargaining agreement. However, in
Israel we are subject to certain labor statutes, and to certain provisions of
collective bargaining agreements between the Histadrut, the General Federation
of Labor in Israel, and the Coordinating Bureau of Economic Organizations,
including the Industrialists' Association. These are applicable to our employees
by virtue of expansion orders of the Israeli Ministry of Labor and Welfare.
These statutes and provisions principally concern the length of the workday,
minimum daily wages for professional workers, procedures for dismissing
employees, determination of severance pay, annual and other vacations, sick pay
and other conditions for employment. In addition, by virtue of such expansion
order, all employees in Israel are entitled to automatic adjustment of wages
relative to increases in the Consumer Price Index in Israel. The amount and
frequency of these adjustments are modified from time to time. We provide our
employees with benefits and working conditions that comply with the required
minimum.





Generally,
all nonexempt adult male citizens and permanent residents of Israel, under the
age of 40, or older for reserves officers or citizens with certain occupations,
are obligated to perform annual military reserve duty and are subject to being
called for active duty at any time under emergency circumstances. Some of our
officers and employees are obligated to perform annual reserve duty. While we
have operated effectively under these requirements since we began operations, no
assessment can be made as to the full impact of such requirements on our
workforce or business if conditions should change, and no prediction can be made
as to the effect on us of any expansion of such obligations.





All of
our employees have entered into confidentiality agreements. We have also granted
certain employees options to purchase shares of our ordinary shares under our
option plan. We consider our relationship with our employees to be good and we
have never experienced a strike or work stoppage.





E.    Share
Ownership





The
following table sets forth certain information regarding the beneficial
ownership of our ordinary shares by our directors and Named Executive Officers
as of May 31, 2009. As of that date, we had 5,460,874 ordinary shares
outstanding.





Name
                                          
                                          Ordinary
                                            Shares held
                                            directly and
                                            beneficially
                                          
                                          
                                          % of
                                            Outstanding
                                            Ordinary
                                            Shares as of
                                            May 31, 2009
                                          
                                          
                                          Number of
                                            options
                                            outstanding
                                          
                                          
                                          Exercise
                                            price
                                          
                                          Expiration dateEli
      Rozen
                                          
                                          
                                          741,439
                                          (1)
                                          
                                          
                                          12.81
                                          %
                                          
                                          
                                          194,817
                                          
                                          
                                          
                                          1.1
                                          
                                          October
      27, 201351,000
                                          
                                          
                                          
                                          1.1
                                          
                                          January
      11, 201551,000
                                          
                                          
                                          
                                          1.1
                                          
                                          January
      19, 201749,311
                                          
                                          
                                          
                                          0.01486
                                          
                                          January
      1, 2019Avi
      Landman
                                          
                                          
                                          464,082
                                          (2)
                                          
                                          
                                          8.40
                                          %
                                          
                                          
                                          8,500
                                          
                                          
                                          
                                          1.1
                                          
                                          October
      27, 20138,500
                                          
                                          
                                          
                                          1.1
                                          
                                          January
      11, 201520,400
                                          
                                          
                                          
                                          1.1
                                          
                                          January
      19, 201734,702
                                          
                                          
                                          
                                          0.01486
                                          
                                          January
      1, 2019Eyal
      Tuchman
                                          
                                          
                                          164,530
                                          (3)
                                          
                                          
                                          2.93
                                          %
                                          
                                          
                                          5,100
                                          
                                          
                                          
                                          1.86
                                          
                                          June
      19, 201212,750
                                          
                                          
                                          
                                          1.86
                                          
                                          March
      28, 201425,500
                                          
                                          
                                          
                                          1.86
                                          
                                          November
      7, 201421,250
                                          
                                          
                                          
                                          1.86
                                          
                                          October
      4, 201451,000
                                          
                                          
                                          
                                          1.86
                                          
                                          May
      29, 201643,980
                                          
                                          
                                          
                                          0.01486
                                          
                                          March
      12, 2019James
      Pertuka
                                          
                                          
                                          133,819
                                          (4)
                                          
                                          
                                          2.45
                                          %
                                          
                                          
                                          8,000
                                          
                                          
                                          
                                          4.64
                                          
                                          December
      18, 2017Joel
      Konicek
                                          
                                          
                                          133,819
                                          (5)
                                          
                                          
                                          2.45
                                          %
                                          
                                          
                                          8,000
                                          
                                          
                                          
                                          4.64
                                          
                                          December
      18, 2017Directors
      and Named Executive Officers as a Group ([10] persons)(7)
                                          
                                          
                                          1,743,025
                                          (6)
                                          
                                          
                                          28.45
                                          %
                                          
                                          
                                          752,464
                                          
                                          
                                          
                                          0.01486
      – 5.2353
                                          
                                          April
      2012 – March
2019





(1)
Includes (a) 412,311 shares held directly by Eli Rozen, and (b) options to
purchase 329,128 ordinary shares which are currently exercisable or exercisable
within 60 days of May 31, 2009, of which 152,317 ordinary shares are held by
Finel Architecture and Engineering Ltd., a company owned solely by Mr. Rozen
(“Finel”).





(2)
Includes (a) 398,780 ordinary shares held by Avi Landman, of which 85,000 shares
are held by Ashland Investments LLC, a limited liability company solely owned by
Mr. Landman (“Ashland”), and (b) options to purchase 65,302 ordinary shares
which are currently exercisable or exercisable within 60 days of May 31,
2009.





68




(3)
Includes (a) 4,950 shares held directly by Eyal Tuchman, and (b) options to
purchase 159,580 ordinary shares which are currently exercisable or exercisable
within 60 days of May 31, 2009.





(4)
Includes (a) 131,153 shares held directly by James Pertuka, and (b) options to
purchase 2,666 ordinary shares which are currently exercisable or exercisable
within 60 days of May 31, 2009.





(5)
Includes (a) 131,153 shares held directly by Joel Konicek, and (b) options to
purchase 2,666 ordinary shares which are currently exercisable or exercisable
within 60 days of May 31, 2009.





(6)
Includes options to purchase 664,678 ordinary shares which are currently
exercisable or exercisable within 60 days of May 31, 2009.





(7) See
notes 1, 2, 3, 4, 5 and 6. Each of the directors and executive officers not
separately identified in the above table beneficially owns less than 1% of our
outstanding ordinary shares (including options held by each such party, and
which are exercisable or exercisable within 60 days of May 31, 2009) and has
therefore not been separately disclosed.





All of
our ordinary shares have identical voting rights.





Share
Option Plans





On
February 14, 1999, the Board of Directors adopted, and our shareholders
subsequently approved, the 1999 Employee Stock Option Plan, which was amended
and restated in March 2002 (the "1999 Option Plan"). We no longer use the 1999
Option Plan to issue stock options. In 2003, we adopted a new stock option plan
under which we now issue stock options (the “Option Plan”). In December 2004, we
filed a Registration Statement on Form S-8 with the SEC registering (i) 170,000
ordinary shares available for issuance upon exercise of stock options reserved
for grant under the Option Plan, (ii) 594,034 ordinary shares issued or issuable
upon exercise of options previously granted under the Option Plan, and (iii)
109,412 ordinary shares issued or issuable upon exercise of options previously
granted under the 1999 Option Plan. The Option Plan is intended to provide
incentives to our employees, officers, directors and/or consultants by providing
them with the opportunity to purchase our ordinary shares. The Option Plan is
subject to the provisions of the Israeli Companies Law, administered by the
Compensation Committee, and is designed: (i) to comply with Section 102 of the
Israeli Tax Ordinance or any provision which may amend or replace it and the
rules promulgated thereunder and to enable us and grantees thereunder to benefit
from Section 102 of the Israeli Tax Ordinance and the Commissioner’s Rules; and
(ii) to enable us to grant options and issue shares outside the context of
Section 102 of the Israeli Tax Ordinance. Options granted under the Option Plan
will become exercisable ratably over a period of three to five years or
immediately in certain circumstances, commencing with the date of grant. The
options generally expire no later than 10 years from the date of grant. Any
options, which are forfeited or canceled before expiration, become available for
future grants. As of December 31, 2008, 3,913,660 ordinary shares are available
for future grants of options, warrants, shares and other financial
instruments.




As a
result of an amendment to Section 102 of the Israeli Tax Ordinance as part of
the 2003 Israeli tax reform, and pursuant to an election made by us thereunder,
capital gains derived by optionees arising from the sale of shares issued
pursuant to the exercise of options granted to them under Section 102 after
January 1, 2003 will generally be subject to a flat capital gains tax rate of
25%. Previously, such gains were taxed as salary income at the employee’s
marginal tax rate (which could be up to 50%). However, as a result of this
election, we will no longer be allowed to claim as an expense for tax purposes
the amounts credited to such employees as a benefit when the related capital
gains tax is payable by them, as we had previously been entitled to do under
Section 102. For certain information as to the Israeli tax reform, see
“Taxation.” in Item 10.





On June
27, 2007, our Compensation Committee and Board of Directors approved a
new option plan under which the Company may grant stock options to the U.S.
employees of the Company and its subsidiaries. Under this new option plan,
the Company may grant both qualified (for preferential tax treatment) and
non-qualified stock options. On August 15, 2007 the new option plan was approved
by the shareholders of the Company at the general shareholders
meeting.





On May
30, 2006, the Board of Directors approved a grant of options to acquire up to
93,501 ordinary shares to certain employees and officers. The exercise price of
these options is $4.42 per share.





69





During
2007 the Board of Directors approved grants of options as follows:





Number of options
                      granted
                    
                    Exercise price37,400
                    
                    
                    4.41271,500
                    
                    
                    5.10021,000
                    
                    
                    4.90062,333
                    
                    
                    0.01447,372
                    
                    
                    0.0585,500
                    
                    
                    4.850141,500
                    
                    
                    4.64034,000
                    
                    
                    4.120




An
additional 217,600 options were granted during 2007 to related parties including
directors.





During
2008, the Board of Directors approved grants of options as follows:





Number of options
                    granted
                  
                  Exercise price2,000
                  
                  
                  3.3843,000
                  
                  
                  1.88





In
September 2008, the Board of Directors approved a re-pricing of options for
three executive officers for a total of 149,600 options, which had exercise
prices ranging from $2.47 to $14.8235. The re-pricing changed the exercise price
of the options to $1.86. The incremental compensation cost at the date of the
modification was $66,000 of which $59,000 was recognized during
2008.





In
December, 2008, according the Special General Meeting (see note 15f in the
financial reports), 20,400 options held by a director, with an exercise price of
$5, were re-priced to an exercise price of $1.1 and it was decided that all such
options with an expiration date prior to October 27, 2013 shall nonetheless
be exercisable until October 27, 2013. The Special General Meeting approved also
the re-pricing and the extension (if applicable) of 334,217 options held by
related parties. See notes 15a and 15b in the financial reports. The incremental
compensation cost at the date of the modification amounted to $44,000 and was
recognized as expense since all of the options were fully vested.





For
options grants after the balance sheet, see also note 19, in the financial
reports.





A summary
of our stock option activity and related information is as follows:





Year ended December 312006
                    
                    
                    2007
                    
                    
                    2008Number
                      of
                      options
                    
                    
                    Weighted
                      average
                      Exercise
                      price
                    
                    
                    Number
                      of
                      options
                    
                    
                    Weighted
                      Average
                      exercise
                      price
                    
                    
                    Number
                      of
                      options
                    
                    
                    Weighted
                      Average
                      exercise
                      priceOutstanding
      at beginning of year
                    
                    
                    595,971
                    
                    
                    $
                    5.77
                    
                    
                    
                    553,902
                    
                    
                    $
                    5.12
                    
                    
                    
                    1,076,756
                    
                    
                    $
                    4.43Granted
                    
                    
                    93,501
                    
                    
                    $
                    4.42
                    
                    
                    
                    638,205
                    
                    
                    $
                    3.86
                    
                    
                    
                    45,000
                    
                    
                    $
                    1.95Exercised
                    
                    
                    (43,152
                    )
                    
                    $
                    2.48
                    
                    
                    
                    (25,968
                    )
                    
                    $
                    3.16
                    
                    
                    
                    (27,032
                    )
                    
                    $
                    0.32Canceled
      and forfeited
                    
                    
                    (92,418
                    )
                    
                    $
                    9.95
                    
                    
                    
                    (89,383
                    )
                    
                    $
                    5.06
                    
                    
                    
                    (113,262
                    )
                    
                    $
                    6.17Outstanding
      at end of year
                    
                    
                    553,902
                    
                    
                    $
                    5.12
                    
                    
                    
                    1,076,756
                    
                    
                    $
                    4.43
                    
                    
                    
                    981,462
                    
                    
                    $
                    2.55
                    (*)Exercisable
      at end of year
                    
                    
                    481,651
                    
                    
                    $
                    5.18
                    
                    
                    
                    591,485
                    
                    
                    $
                    4.81
                    
                    
                    
                    663,021
                    
                    
                    $
                    2.51
                    (*)





(*) The
weighted average exercise price, presented of December 31, 2008, is after the
re-pricing made during 2008, as mentioned above and in note 15, in the financial
reports.





70





The
weighted average fair value of options granted during the reported period was
$1.89, $2.87 and $0.88, per option, for the years ended December 31, 2006, 2007
and 2008, respectively. The fair value of these options was estimated on the
date of grant using the Black & Scholes option pricing model. The following
weighted average assumptions were used for the 2006, 2007 and 2008 grants: risk
free rate of 5%, 4.05% and 4.24%, respectively; dividend yield of 0%; expected
volatility factor of 57.17, 57.2% and 52.29% respectively; and expected term of
3.09, 3.64 and four years, respectively.





The
expected volatility was based on the historical volatility of our stock. The
expected term was based on the historical experience and Management
estimate.





Compensation expenses recognized by us
related to our share-based employee compensation awards were $225,000,
$1,032,000 and $856,000 based on the provisions of SFAS 123R for the years ended
December 31, 2006, 2007 and 2008, respectively.








The
options outstanding and exercisable as of December 31, 2008, have been separated
into ranges of exercise prices as follows:





Range of exercise
                      price
                    
                    Options
                      outstanding
                      as of
                      December 31,
                      2008
                    
                    
                    Weighted
                      average
                      remaining
                      contractual
                      life (years)
                    
                    
                    Weighted
                      average
                      Exercise
                      price
                    
                    
                    Aggregate
                      intrinsic
                      value
                    
                    
                    Options
                      exercisable
                      as of
                      December 31,
                      2008
                    
                    
                    Weighted
                      average
                      exercise price
                    
                    
                    Aggregate
                      intrinsic
                      value$
      0.01 - $ 0.06
                    
                    
                    86,019
                    
                    
                    
                    8.56
                    
                    
                    
                    0.015
                    
                    
                    $
                    50
                    
                    
                    
                    28,673
                    
                    
                    
                    0.015
                    
                    
                    $
                    17$1.10
      - $ 1.88
                    
                    
                    547,217
                    
                    
                    
                    5.86
                    
                    
                    
                    1.37
                    
                    
                    
                    -
                    
                    
                    
                    424,598
                    
                    
                    
                    1.33
                    
                    
                    
                    -$
      2.47 - $ 3.38
                    
                    
                    35,626
                    
                    
                    
                    4.54
                    
                    
                    
                    3.01
                    
                    
                    
                    -
                    
                    
                    
                    33,626
                    
                    
                    
                    2.99
                    
                    
                    
                    -$
      4.18 - $ 4.90
                    
                    
                    192,400
                    
                    
                    
                    7.46
                    
                    
                    
                    4.52
                    
                    
                    
                    -
                    
                    
                    
                    98,124
                    
                    
                    
                    4.41
                    
                    
                    
                    -$
      5.00 - $ 5.24
                    
                    
                    103,200
                    
                    
                    
                    4.85
                    
                    
                    
                    5.06
                    
                    
                    
                    -
                    
                    
                    
                    61,000
                    
                    
                    
                    5.08
                    
                    
                    
                    -$
      14.82
                    
                    
                    17,000
                    
                    
                    
                    3.25
                    
                    
                    
                    14.82
                    
                    
                    
                    -
                    
                    
                    
                    17,000
                    
                    
                    
                    14.82
                    
                    
                    
                    -981,462
                    
                    
                    
                    
                    
                    
                    
                    2.55
                    
                    
                    
                    
                    
                    
                    
                    663,021
                    
                    
                    
                    2.51




The
aggregate intrinsic value of the above table represents the total intrinsic
value, based on the Company’s stock price of $0.60 as of December 31, 2008, less
the weighted average exercise price per range. This represents the potential
amount received by the option holders had all option holders exercised their
options as of that date.





A summary
of the status of the Entity’s non-vested options granted to employees as of
December 31, 2008 and changes during the year ended December 31, 2008 is
presented below:





Options
                  
                  
                  Weighted–
                    average grant-
                    date fair valueNon-vested
      at January 1, 2008
                  
                  
                  485,271
                  
                  
                  $
                  2.31Granted
                  
                  
                  45,000
                  
                  
                  $
                  0.88Vested
      (including cancelled and exercised)
                  
                  
                  (158,330
                  )
                  
                  $
                  2.18Forfeited
                  
                  
                  (53,500
                  )
                  
                  $
                  2.06Non-vested
      at December 31, 2008
                  
                  
                  318,441
                  
                  
                  $
                  2.21




As of
December 31, 2008, there was $353,000 total unrecognized compensation cost
related to non-vested share-based compensation arrangements granted under the
stock option plans, of which $261,000 is expected to be recognized during the
year 2009, $89,000 during the year 2010 and $3,000 during the year
2011.





71





ITEM
7.Major
Shareholders and Related Party Transactions.





A.    Major
shareholders




The
following table lists the beneficial ownership of our securities as of May 31,
2009 by each person known by us to be the beneficial owner of more than 5% of
the outstanding shares of any class of our securities.





Beneficial
ownership is determined in accordance with the rules of the SEC and generally
includes voting or investment power with respect to securities. The principal
address of our Beneficial Owners listed below (all but Jacob Hassan, Special
Situations Fund III, L.P., Special Situations Fund III, Q.P, Special Situations
Cayman Fund, L.P. and Homeland Security Capital Corporation) is c/o Vuance Ltd.,
Sagid House “Hasharon Industrial Park” P.O.B 5039, Qadima 60920 Israel. We
believe that all persons named in the table, except HMSC, have sole voting and
sole investment power with respect to all shares beneficially owned by them. All
figures include ordinary shares issuable upon the exercise of convertible bonds,
options and warrants exercisable within 60 days of May 31, 2009 and deemed to be
outstanding and beneficially owned by the person holding those bonds, options or
warrants for the purpose of computing the percentage ownership of that person,
but are not deemed to be outstanding for the purpose of computing the percentage
ownership of any other person. None of the following major shareholders have
different voting rights from the other holders of our ordinary
shares.





Name of Beneficial Owner
                      
                      Number of Shares
                        Beneficially Owned
                      
                      
                      Percentage of Shares
                        OutstandingJacob
      Hassan (1)
                      
                      
                      423,125
                      
                      
                      
                      7.71
                      %Avi
      Landman (2)
                      
                      
                      464,082
                      
                      
                      
                      8.40
                      %Eli
      Rozen (3)
                      
                      
                      741,439
                      
                      
                      
                      12.81
                      %Special
      Situations Fund III, L.P. (“SSF”)(4)
                      
                      
                      *
                      
                      
                      
                      *Special
      Situations Fund III, Q.P. (“SSFQP”)(5)
                      
                      
                      1,471,643
                      
                      
                      
                      25.12
                      %Special
      Situations Cayman Fund, L.P. (“Cayman”)(6)
                      
                      
                      **
                      
                      
                      
                      **Homeland
      Security Capital Corporation ("HMSC") (7)
                      
                      
                      692,660
                      
                      
                      
                      12.68
                      %Investor
      through convertible bond (8)
                      
                      
                      939,583
                      
                      
                      
                      14.68
                      %





(1)
            Mr.
      Hassan’s address is 21 Shnat Hayovel, Hod Hasharon, Israel. Includes (a)
      398,881 shares held directly by Jacob Hassan, and (b) options to purchase
      24,244 ordinary shares which are currently exercisable or exercisable
      within 60 days of May 31, 2009.


(2)
            Includes
      (a) 398,780 ordinary shares held by Avi Landman, of which 85,000 shares
      are held by Ashland, and (b) options to purchase 65,302 ordinary shares
      which are currently exercisable or exercisable within 60 days of May 31,
      2009.


(3)
            Includes
      (a) 412,311 shares held directly by Eli Rozen, and (b) options to purchase
      329,128 ordinary shares which are currently exercisable or exercisable
      within 60 days of May 31, 2009, of which 152,317 ordinary shares are held
      by Finel.


(4)
            *
      Includes (a) 66,610 ordinary shares, (b) 790,247 shares held by its
      affiliate, SSFQP, (c) warrants held by SSFQP to purchase 197,292 ordinary
      shares which are currently exercisable or exercisable within 60 days of
      May 31, 2009, (d) convertible bond which can be convert into 115,294
      ordinary shares (e) 217,113 ordinary shares held by its affiliate, Cayman,
      (f) warrants held by Cayman to purchase 53,660 ordinary shares which are
      currently exercisable or exercisable within 60 days of May 31, 2009 and
      (g) convertible bond which can be converted into 31,427 ordinary
      shares.


(5)
            Includes
      (a) 790,247 ordinary shares, (b) warrants to purchase 197,292 ordinary
      shares which are currently exercisable or exercisable within 60 days of
      May 31, 2009, (c) convertible bond which can be converted into 115,294
      ordinary shares, (d) 66,610 shares held by its affiliate,
      SSF,  (e) 217,113 ordinary shares held by its affiliate, Cayman,
      and (f) warrants held by Cayman to purchase 53,660 ordinary shares which
      are currently exercisable or exercisable within 60 days of May 31, 2009
      and (g) convertible bond which can be convert into 31,427 ordinary
      shares.


(6)
            **Includes
      (a) 217,113 ordinary shares, (b) warrants to purchase 53,660 ordinary
      shares which are currently exercisable or exercisable within 60 days of
      May 31, 2009, (c) convertible bond which can be convert into 31,427
      ordinary shares, (d) 790,247 shares held by its affiliate, SSFQP, (e)
      warrants held by SSFQP to purchase 197,292 ordinary shares which are
      currently exercisable or exercisable within 60 days of May 31, 2009, (f)
      convertible bond which can be convert into 115,294 ordinary shares and (g)
      66,610 ordinary shares held by its affiliate,
  SSF.





72





(7)
            HMSC
      granted an irrevocable power of attorney to our Chairman of the Board of
      Directors to exercise all voting rights related to its Vuance Shares until
      the sale or transfer of such Vuance Shares by HMSC to an unaffiliated
      third party in an arm’s-length transaction. (The shares are subject to a
      lock-up and are not registered (see note 1a to the financial reports
      below).)


(8)
            Includes
      (a) warrants to purchase 106,250 ordinary shares which are currently
      exercisable or exercisable within 60 days of May 31, 2009, (b) convertible
      bond which could be converted into 833,333 ordinary
  shares.





To the
best of our knowledge based on the information known to us, there has not been
any significant change in the percentage ownership of the our major shareholders
during the last three years other than changes resulting from our private
placements in 2005, the issuance of convertible bonds in November, 2006, the
shares issued according to the acquisition of SHC, the exercise of warrants
issued in those offerings, and the grant of options to Messrs. Rozen, Landman
and Jacob Hassan.





As of
December 31, 2008 and June 19, 2009, to the best of our knowledge based on the
information available to us, we had approximately 29 registered holders of our
ordinary shares, and approximately 425 beneficial holders of our ordinary
shares, respectively.





To the
best of our knowledge based on the information currently available to us, there
are no existing arrangements that may at a future date result in a change of
control of Vuance.





B.
            Related Party Transactions





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





On
October 1, 2001, we entered into a consulting agreement with a company owned by
the Chairman of our Board of Directors who was one of our co-founders. In
consideration of these consulting services, we have undertaken to
pay         $10,500 per month plus
motor vehicle expenses. In addition, we pay $1,500 per month as a director’s
fee. During 2008 we paid $121,000 pursuant to this agreement. (Regarding the
deduction in the amount paid during 2008, see note 15f, in the financial
reports.)





In
December, 2008, according the Special General Meeting (see note 15f in the
financial reports), 296,817 options with an exercise price in the range of
$2.4706 to $5 were re-priced to $1.1 and all such options with an expiration
date prior to October 27, 2013, shall nonetheless be exercisable until October
27, 2013.





On
October 1, 2001, we entered into a consulting agreement with a company owned by
a member of our Board of Directors, who was also one of our co-founders and a
principal shareholder. On January 13 2005, the General Shareholders Meeting
approved the following amendments to the consulting agreement:


·
            As
      of the date of the approval of the General Shareholders Meeting, the
      consideration shall be to an amount of $7,000 per
  month.


·
            Upon
      the termination of the car lease agreement, to increase the car lease, to
      a price of up to NIS 4,200 (approximately $ 1,100 as of December 31,
      2008), (excluding tax) per month.


·
            To
      grant a one-time bonus of NIS 130,000 including VAT which was paid during
      the year 2005.





In addition, the Company pays $1,500
per month as a director’s fee. In 2008, we paid $84,000 pursuant to this
agreement.  (Regarding the deduction in the amount paid during 2008,
see note 15f, in the financial reports.)


In
December, 2008, according the Special General Meeting (see note 15f in the
financial reports), 37,400 options with an exercise price in the range of
$2.4706 to $5 were re-priced to $1.1 and all such options with an expiration
date prior to October 27, 2013 shall nonetheless be exercisable until October
27, 2013.





On
October 1, 2001, we entered into a consulting agreement with a company owned by
one of the co-founders of the Company. In consideration for these services, we
have undertaken to pay $4,600 per month plus motor vehicle expenses. During
2008, we paid $58,000, pursuant to this agreement. (Regarding the deduction in
the amount paid during 2008, see note 15f, in the financial
reports.)





73





On
January 13, 2005, the General Shareholders Meeting approved, among other things,
the Board of Directors’ decision dated October 4, 2004 to grant options to
acquire up to 51,001 ordinary shares to the Chairman of the Board of Directors
and 8,500 ordinary shares to each of the two directors of the Company, who are
not “outside directors.” The exercise price of the options is $5 per share.
Those options were granted as compensation for their efforts in completing a
private placement during 2004.





On
January 21, 2007, the General Shareholders Meeting approved the grant of options
to the Chairman of the Board of Directors and to a director who is one of the
co-founders to acquire up to 51,000 and 20,400 ordinary shares of the Company,
respectively, at an exercise price of $5.





On April
29, 2007, the General Shareholders Meeting approved the grant of options to the
Chairman of the Board of Directors and to two external directors to acquire up
to 85,000 and 40,800 ordinary shares of the Company, respectively, at an
exercise price of $4.118 and $5, respectively.





On August
15, 2007, the General Meeting of Shareholders approved the grant of options to a
director to acquire up to 20,400 ordinary shares of the Company, at an exercise
price of $5. In December 2008 according the Special General Meeting (see Note
15f below), the options were re-priced to $1.1 and all such options shall
nonetheless be exercisable until October 27, 2013.





On December 21, 2008, the Special
General Shareholders Meeting approved that as part of a cost cutting plan, all
of our non-external directors will join a temporary arrangement pursuant to
which the remuneration payable to them shall be paid in fully vested options to
purchase shares of the Company instead of in cash, effective October 1, 2008,
for a minimum period of three months, with an option to us to extend it from
time to time for additional consecutive periods of up to twelve (12) months in
the aggregate. In addition (a) all options held by the Participants on October
27, 2008 shall be re-priced so that the exercise price thereof shall be $1.10
(the closing price of our Ordinary Shares on October 27, 2008), and (b) all such
options with an expiration date prior to October 27, 2013 shall nonetheless be
exercisable until October 27, 2013.





On
January 9, 2009, according to the board resolution on October 27, 2008 and the
Special General Meeting dated December 21, 2008, we granted to (a) our Chairman
of the Board of Directors, (b) a member of our Board of Directors who is also
one of our co-founders, (c) one of the co-founders, and (d) another member of
our Board of Directors options to purchase up to 49,311, 34,702, 24,244 and
6,164 shares, respectively. The options have an exercise price of 0.0582235 NIS
per share, vesting immediately, and will expire after ten years. The options
were granted as a compensation for three months of waiving their cash payment
according to their agreement with us.




C.  
Interests of Experts and Counsel




Not
applicable.




74





ITEM
8.    Financial
Information.




A. 
   Consolidated Statements and Other Financial Information
(Audited)




Refer to
Item 18, which contains the following financial statements:





•
            Consolidated
      Balance Sheets




•
            Consolidated
      Statements of Operations





•
            Statements
      of Changes in Shareholders’ Equity





•
            Consolidated
      Statements of Cash Flows




•
            Notes
      to Consolidated Financial
Statements




Export
Sales





Sales in
Israel during each of the years 2006, 2007 and 2008 was $194,000, $371,000 and
$294,000, respectively. Export sales during each of the years 2006, 2007 and
2008 was $8,747,000 (98% of the total sales volume), $12,943,000 (97% of the
total sales volume) and $20,359,000 (99% of the total sales volume),
respectively.





Legal
Proceedings





We
are party to legal proceedings in the normal course of our business. Other than
as described below, there are no material pending legal proceedings to which we
are a party or of which our property is subject. Although the outcome of claims
and lawsuits against us cannot be accurately predicted, we do not believe that
any of the claims and lawsuits described in this paragraph, individually or in
the aggregate, will have a material adverse effect on our business, financial
condition, results of operations or cash flows for any quarterly or annual
period.





On
January 20, 2008, the Manufacturers Association of Israel (the "Plaintiff")
filed a lawsuit with the labor court in Tel Aviv-Jaffa (the "Court") against us,
seeking an amount of NIS 82,789 + VAT (as of June 20, 2008 approximately $25,700
+ VAT) for service fees for the years 2001-2007, as well as legal expenses and
attorney's fees of the
Plaintiff. In addition, the Plaintiff has asked the Court to instruct us to
submit the necessary documentation, certified by the Company's accountant, needed to
calculate the service fees sought by the Plaintiff.  During 2008, we
and the Plaintiff reached a settlement; accordingly, we will pay $8,000, as a
compromise that was included in the financial reports in 2008.





On May 1,
2006, Evilia Investments Ltd. ("Evilia") filed in the Magistrate's Court in
Tel-Aviv-Jaffa a claim for damages against InkSure and against us, jointly and
severally, for payment of NIS 2,366,868 (as of June 15, 2006, approximately
$530,000) plus interest, allegedly due as rent payments and related management
fees for a certain real estate property in Rehovot, leased to InkSure under a
lease agreement entered into by Evilia and InkSure on October 10, 2000, as
amended on May 25, 2001 (the "Agreement"), as to which we are a guarantor. A
motion for leave to defend the lawsuit was filed with the Magistrate’s Court by
both InkSure and us on June 15, 2006. On August 6, 2006, a settlement agreement
was submitted to the Magistrate’s Court, pursuant to which InkSure agreed to pay
Evilia the amount of $130,000 plus VAT. On August 13, 2006, the Magistrate’s
Court approved the settlement agreement. We agreed to pay (and paid) InkSure
half of the settlement amount.





In April
2004, the Department for Resources Supply of the Ministry of Ukraine (the
"Department") filed with the International Commercial Arbitration Court at the
Ukrainian Chamber of Commerce and Industry (the “Arbitration Court”) a claim to
declare Contract No. 10/82 (the “Contract”), dated April 9, 2002, between us and
the Ministry of Internal Affairs of Ukraine (the "Ministry") void due to defects
in the proceedings by which we were awarded the Contract. In July, 2004, the
Arbitration Court declared the Contract void. On April 27, 2005, we appealed the
decision in the High Commercial Court of Ukraine. In May, 2005, the Department
filed with the Arbitration Court a new statement of claim for restitution of
$1,047,740, paid to us by the Department under the Contract. On September 27,
2005, we received a negative award issued by the Arbitration Court in the second
claim (the "Award"). On December 12, 2005, we were informed that the Supreme
Court of Ukraine had dismissed our appeal regarding the July, 2004 decision. On
June 29, 2006, the Supreme Court of Ukraine held that the Arbitration Court
award was valid and legal under applicable law.





75





On
September 28, 2008, the Department filed a petition (the "Petition") in the
Central District Court of Israel (the "Court"), under which the Department
requested the approval of the Award as a valid foreign arbitral award under the
laws of the State of Israel.





During
November 2008, we filed with the Court an objection to the Petition and a
petition to declare the Award null and void. Our objection and petition rely on
what we believe to be well-based evidence that we have against the manner under
which the arbitration proceedings were conducted by the Arbitration Court and
against their validness and legality. We believe that the arbitration
proceedings were conducted partially and jeopardized our basic rights. Our
claims are also corroborated by a contrary legal opinion written in the
arbitration decision by one of the arbitrators ("Arbitrator").





On
February 16, 2009 the Department filed its response to our claims (the
"Response"). The Department raised in its Response procedural and other claims,
including a claim that we filed in Ukraine a monetary claim which is based on
the Award and the filing of such claim basically affirms our acknowledgment that
the Award is valid. On March 25, 2009, we filed a response to the Department's
response and a requisition to order the Arbitrator to testify in the scope of
the Petition proceedings (the Court's decision regarding the said request has
not been given yet).





On June
6, 2009, a preliminary court session was held regarding the Petition. During the
session, the Department's counsel claimed that one of the two machines that we
previously supplied pursuant to the Contract (which machine is priced higher
than the amount of the Department's claim), was not supplied to the Department
and was transferred by us to another Ukrainian governmental authority. It is
noted that we have documents that evidence that, contrary to the Department's
claim, we supplied both of the machines directly to the Department. The file was
scheduled for an additional session on September 23, 2009.





Based on
the opinion of our legal advisors, we believe that the above mentioned Ukraine
Arbitration Court decision is incorrect, as a matter of law, that the Ukrainian
government’s claim has no merit and that the Ukrainian Arbitration Proceedings
were legally defective. We further believe that there is a good chance that
Petition will be denied. Therefore no provision has been made in the financial
statements with respect to the claim for restitution of $1,047,740.





We did
not have any revenues from this project in 2006, 2007 or 2008.





On
October 30, 2003, SuperCom Slovakia, a subsidiary (66%) of Vuance Ltd., received
an award from the International Arbitral Centre of the Austrian Federal Economic
Chamber ("IAC"), in a case against the Ministry of Interior of the Slovak
Republic relating to the agreement on delivery of Technology, Cooperation and
Services signed on March 17, 1998. Upon the Arbitral Award, the Ministry of
Interior of the Slovak Republic was ordered to pay SuperCom Slovakia the amount
of SKK 80,000,000 (approximately $3,758,000 as of December 31, 2008) plus
interest accruing from March, 1999. In addition, the Ministry of Interior of the
Slovak Republic was ordered to pay the costs of arbitration in the amount of EUR
42,716 (approximately $60,000 as of December 31, 2008) and SuperCom Slovakia's
legal fees in the amount of EUR 63,611 (approximately $89,000 as of December 31,
2008). We have begun an enforcement proceeding to collect the arbitral award.
The Ministry of Interior of the Slovak Republic filed a claim with the
Commercial Court in Vienna, Austria on February 10, 2004, whereby it challenged
and requested to set aside the arbitral award. During September, 2005, the
commercial court of Vienna dismissed the claim. On October 21, 2005, the
Ministry of the Interior of the Slovak Republic filed an appeal. On August 25,
2006, the Austrian Appellate Court rejected the appeal and ordered the Ministry
to reimburse Supercom Slovakia ́s costs of the appellate proceeding in the amount
of EUR 6,688 within 14 days. On October 3, 2006, we were informed that the
Ministry had decided not to file an extraordinary appeal to the Austrian Supreme
Court’s decision rejecting its appeal. To date, our efforts to enforce the
Commercial Court’s decision have been unsuccessful.




On
December 16, 1999, Secu-Systems Ltd. ("Secu-systems") filed a lawsuit with the
District Court in Tel-Aviv-Jaffa jointly and severally against us and InkSure
Ltd. ("InkSure") (our former subsidiary, which became a subsidiary of InkSure
Technologies, Inc.) seeking a permanent injunction and damages arising from the
printing method applied to certain products developed by Inksure. In its
lawsuit, the plaintiff asserted claims of breach of a confidentiality agreement
between the plaintiff and us, unjust enrichment by us and InkSure, breach of
fiduciary duties owed to Secu-systems by us and InkSure, misappropriation of
trade secrets by us and InkSure, and damage to Secu-systems’ property. On March
15, 2006, the Court denied the breach of contract claim, but upheld the claim
for misappropriation of trade secrets and ordered InkSure and us to cease all
activity involving the use of the confidential knowledge and/or confidential
information of the plaintiff. In addition, the court ordered us and Inksure to
provide a report certified by an accountant setting forth in full the income
and/or benefit received by InkSure and us as a result of the misappropriation
activity through the date of the judgment, and ordered us and Inksure, jointly
and severally, to pay to Secu-systems compensation in the sum of NIS 100,000
($26,000 as of December 31, 2008) and legal expenses as well as attorney’s fees
in the sum of NIS 30,000 ($8,000 as of December 31, 2008). Secu-systems has
filed an appeal, and we and InkSure filed a counter-appeal, on the ruling above.
On November 1, 2007, the Supreme Court accepted Secu-systems’ appeal, and stated
that Inksure and us have breached the confidentiality agreement. Consequently,
the appeal that had been filed by Inksure and us was dismissed. The Supreme
Court instructed that the case will be returned to the District Court for
determining the remedies to which Secu-Systems is entitled.





76





On
February 18, 2008, the Plaintiff filed a petition with the District Court asking
the court to allow Secu-systems to amend the amount for which it sued as stated
in the Statement of Claims to NIS 25,000,000 (approximately $6,575,000 as of
December 31, 2008). The petition is mainly based on the fact that in 2002,
Inksure was sold by us to a third party for a consideration of approximately
$6,000,000 and upon Secu-systems’ assertion that such amount of consideration
constitutes a benefit and/or profit which seems to have been derived from the
breach of the confidentiality agreement and upon the assertion that Secu-systems
is entitled, in light of the Supreme Court's ruling with respect to the breach
of the confidentiality agreement, to receive such amount. Another argument made
by Secu-systems relates to the profit which Inksure, allegedly, generated from
the breach of the confidentiality agreement; this argument is based on a gross
profit of $6,400,000 according to the financial statements of Inksure for the
years 2002-2007.





On March
24, 2008, we provided our lawyers with an opinion of subject matter consultant,
according to which, the following conclusions can be drawn:


a.
            In
      light of the costs analysis, we had no economical profit from the sale of
      Inksure's shares.


b.
            The
      examination of the results of Inksure's business activity in 2002-2007, as
      reflected in its financial reports, show that Inksure has not made any
      profits, and even suffered losses in the said period. The financial
      reports also show that Inksure had a negative cash flow in these years,
      which was financed by bank loans and fund
  raising.





On
December 8, 2008, a court session with respect to the petition was held and we
are waiting for the court decision.





In light
of the above, provided that the subject matter consultant's opinion is adopted
by the court, and further provided that Inksure's financial reports indeed
reflect its business results, our lawyers are of the opinion that no material
amounts will be awarded to Secu-systems in these proceedings.





Due to
the circumstances described above, we made an allowance of $100,000 that
reflects the expected legal expenses related to this litigation.





Dividend
Policy





We
have not distributed a cash dividend since August 27, 1997 and we do not
anticipate any dividend distribution in the foreseeable future. Under the
Israeli Companies Law, dividends may only be paid out of profits legally
available for distribution (the “Profits Criteria”) and provided that there is
no reasonable concern that such payment will prevent us from satisfying our
existing and foreseeable obligations as they become due. In addition, a
competent court may approve, as per a motion to be filed by a company in
accordance with the Israeli Companies Law requirements, a payment which does not
meet the Profit Criteria, provided that the court was convinced that there is no
reasonable concern that such payment will prevent the company from satisfying
its existing and foreseeable obligations as they become due.





In
accordance with our Articles of Association, our Board of Directors may from
time to time declare and cause the Company to pay to the shareholders such
interim or final dividends as the Board of Directors deems appropriate
considering the profits of the Company and in compliance with the provisions of
the Israeli Companies Law.





Subject
to the rights of the holders of shares as to dividends, and to the provisions of
our Articles of Association, dividends, whether in cash or in bonus shares,
shall be paid or distributed, as the case may be, to shareholders pro rata to
the amount paid up or credited as paid up on account of their shares, without
taking into consideration any premium paid thereon.





B.    Significant
Changes




There
have not been any significant changes since the date of the annual financial
statements included under Item 18 of this Annual Report.





77





ITEM
9.    The
Offer And Listing.





Offer and Listing
Details





The
tables included below set forth information regarding the price history of the
ordinary shares on the Euronext Brussels stock market and the OTC Bulletin
Board/NASDAQ for the periods indicated.





We were
traded on the NASDAQ Europe stock market since April 19, 1999. On October 23,
2003, following the closing of the NASDAQ Europe stock market, we transferred
the listing of our shares to Euronext Brussels stock market where we traded
under the symbol “VUNC.” We applied for delisting of our shares from the
Euronext Brussels stock market, and our application was approved on May 6, 2008,
effective August 4, 2008.





Our
ordinary shares were quoted on the OTC Bulletin Board Market under the symbol
“VUNC.OB,” from November 5, 2004 until August 22, 2007.





Our
ordinary shares approved for listing on NASDAQ and began trading effective
August 23, 2007. The shares are traded on NASDQ under the symbol
“VUNC.”





On
December 11, 2008, we received a letter from NASDAQ advising us that we did not
comply with the Listing Requirements. As a result, the NASDAQ Staff began
reviewing our eligibility for continued listing on NASDAQ. To facilitate their
review, the NASDAQ Staff requested that we provide our specific
Plan.  After we submitted the Plan, on March 30, 2009 we received
further correspondence from NASDAQ that we did not comply with the Listing
Requirements, and therefore, trading of our ordinary shares would be suspended
at the opening of business on April 8, 2009, and a form 25-NSE would be filed
with the SEC removing our securities from listing and registration on NASDAQ,
unless we requested an appeal of the delisting decision by
NASDAQ.




We
appealed the NASDAQ determination to a NASDAQ Listings Qualifications Panel (the
“Panel”), which automatically stayed the delisting of our ordinary shares until
the Panel reached a decision.  On June 17, 2009, the Panel granted our
request for an extension of time to achieve full compliance with the Listing
Requirements.




The
Panel’s decision, and our continued listing on NASDAQ, is subject to our
compliance with certain conditions, including demonstration that we have
regained compliance with the Listing Requirements by September 28, 2009. While
we are executing on its plan to regain compliance, there can be no assurance
that we will be able to do so.  Should we be unable to meet the
exception requirement, the Panel will issue a final determination to delist our
shares and, unless the Nasdaq Listing and Hearings Review Council issues a stay,
will suspend trading of our shares on NASDAQ effective on the second business
day from the date of the final determination and our ordinary shares could be
eligible for quotation and trading on the OTC Bulletin Board in accordance with
applicable rules and regulations.





The
following table shows, for the periods indicated, the high and low closing
prices of our ordinary shares in Euros as reported on the NASDAQ Europe stock
market or the Euronext Brussels stock market, as applicable until August 4, 2008
(conversion to U.S. dollars is based on the exchange rate published by the Bank
of Israel). The following table also shows, for the periods indicated since
November 5, 2004, the high and low closing prices of our ordinary shares on the
OTC Bulletin Board Market or NASDAQ, as applicable.





The
Company has not issued any securities in connection with a pre-emptive
issue.





78





Period
                              
                              European market (1)
                              
                              
                              US market (2)Per share ($)
                              
                              
                              Per share ($)High
                              
                              
                              Low
                              
                              
                              High
                              
                              
                              LowAnnual2004
                              
                              
                              15.65
                              
                              
                              
                              3.24
                              
                              
                              
                              15.59
                              
                              
                              
                              122005
                              
                              
                              16.41
                              
                              
                              
                              3.12
                              
                              
                              
                              15.06
                              
                              
                              
                              3.292006
                              
                              
                              6.71
                              
                              
                              
                              3.18
                              
                              
                              
                              6.59
                              
                              
                              
                              3.242007
                              
                              
                              5.28
                              
                              
                              
                              3.58
                              
                              
                              
                              6.18
                              
                              
                              
                              3.822008
                              
                              
                              3.90
                              (1)
                              
                              
                              2.40
                              (1)
                              
                              
                              4.69
                              
                              
                              
                              0.29Financial quarters2007First
      quarter
                              
                              
                              5.24
                              
                              
                              
                              3.58
                              
                              
                              
                              5.41
                              
                              
                              
                              3.82Second
      quarter
                              
                              
                              5.28
                              
                              
                              
                              3.58
                              
                              
                              
                              6.18
                              
                              
                              
                              5.10Third
      quarter
                              
                              
                              4.97
                              
                              
                              
                              4.21
                              
                              
                              
                              5.22
                              
                              
                              
                              4.42Fourth
      quarter
                              
                              
                              5.11
                              
                              
                              
                              3.74
                              
                              
                              
                              5.15
                              
                              
                              
                              4.112008First
      quarter
                              
                              
                              4.15
                              
                              
                              
                              2.81
                              
                              
                              
                              4.69
                              
                              
                              
                              2.94Second
      quarter
                              
                              
                              2.91
                              
                              
                              
                              2.40
                              
                              
                              
                              3.60
                              
                              
                              
                              2.75Third
      quarter
                              
                              
                              2.57
                              (1)
                              
                              
                              2.41
                              (1)
                              
                              
                              2.97
                              
                              
                              
                              1.76Fourth
      quarter
                              
                              
                              N/A
                              
                              
                              
                              N/A
                              
                              
                              
                              2.00
                              
                              
                              
                              0.292009First
      quarter
                              
                              
                              N/A
                              
                              
                              
                              N/A
                              
                              
                              
                              0.68
                              
                              
                              
                              0.24Most recent six monthsDecember
      2008
                              
                              
                              N/A
                              
                              
                              
                              N/A
                              
                              
                              
                              0.75
                              
                              
                              
                              0.29January
      2009
                              
                              
                              N/A
                              
                              
                              
                              N/A
                              
                              
                              
                              0.68
                              
                              
                              
                              0.35February
      2009
                              
                              
                              N/A
                              
                              
                              
                              N/A
                              
                              
                              
                              0.63
                              
                              
                              
                              0.28March
      2009
                              
                              
                              N/A
                              
                              
                              
                              N/A
                              
                              
                              
                              0.39
                              
                              
                              
                              0.24April
      2009
                              
                              
                              N/A
                              
                              
                              
                              N/A
                              
                              
                              
                              0.64
                              
                              
                              
                              0.30May
      2009
                              
                              
                              N/A
                              
                              
                              
                              N/A
                              
                              
                              
                              0.49
                              
                              
                              
                              0.38





(1) Our
shares were quoted on the NASDAQ Europe stock market since April 19, 1999 and
since October 23, 2003, on the Euronext Brussels stock market. We applied for
delisting of our shares from the Euronext Brussels stock market, and our
application was approved on May 6, 2008, effective August 4, 2008.




(2)Our ordinary shares were quoted on
the OTC bulletin board from November 5, 2004 and since August 23, 2007, our
ordinary shares were approved for trading on NASDAQ under the symbol “VUNC” and
the trade on the OTC Bulletin Board ceased.





(3)
Share prices are adjusted to give effect to our 1-for-5.88235 reverse share
split effective for trading purposes on May 14, 2007.




On
June 17, 2009, the last reported sale price of our ordinary shares on NASDAQ was
$0.28 per share.





79





B.
              Plan of
      Distribution





Not
applicable.





C.
              Markets




Our
ordinary shares were listed for trade on the Euronext Brussels stock market,
from October 23, 2003 under the symbol “SUP,” which became “VUNC” after our
corporate name change on May 14, 2007. We applied for delisting of our shares
from the Euronext Brussels stock market, and our application was approved on May
6, 2008, effective August 4, 2008.





Since
November 5, 2004, our ordinary shares have also traded on the OTC Bulletin Board
under the symbol "SPCBF.OB," which, following our recent name change became
“VUNCF.OB.” Since August 23, 2007, our ordinary shares were approved for trading
on NASDAQ under the symbol “VUNC” and the trade on the OTC Bulletin Board
ceased.





D.
              Selling
      Shareholders





Not
applicable.





G.
              Dilution





Not
applicable.





H.
              Expenses
      of the Issue





Not
applicable.





ITEM
10.    Additional
Information.




A.
              Share
      Capital




Not
applicable.





B.    Memorandum
and Articles of Association




Our
memorandum of association and articles of association are attached hereto as
noted in Item 19.




We are a
public company organized in the State of Israel under the Israeli Companies Law.
We are registered with the Registrar of Companies of the State of Israel and we
have been assigned company number 52-00-4407-4.




Set forth
below is a summary of certain provisions of our Memorandum of Association (the
"Memorandum"), the Articles of Association (the "Articles") and the Companies
Law. This description does not purport to be complete and is qualified in its
entirety by reference to the full text of the Memorandum and Articles and by
Israeli law. The Memorandum, which integrates into the text all amendments
thereto since our incorporation, and the Articles, which were adopted in August
2007, are incorporated by reference as exhibits to this Form 20-F.




OBJECTS
OF THE COMPANY




Pursuant
to Section 2 of the Memorandum, the principal object for which we were
established is to engage in the development, manufacture, implementation and
marketing of computerized systems in general and computerized systems for
producing tags, computerized photograph databases for the purpose of
identification and for issuing various certificates in particular; consultation
in the above fields; development, manufacture, implementation and marketing of
any product based on the knowledge and expertise of the parties; and the
purchase, sale, import, export and implementation of any action required to
realize the above objectives.





80





DIRECTORS




Our
Articles provide that the number of directors may be determined from time to
time by the Board of Directors, and unless otherwise determined, the number of
directors comprising the Board of Directors will be between four and ten. With
the exception of our external directors, who are elected for three year terms
and may only be elected for two three year terms in accordance with the Israeli
Companies Law, our directors are elected for a one year term ending at the
following annual general meeting of shareholders, However, if no directors are
elected at an annual meeting, then the persons who served as directors
immediately prior to the annual meeting shall be deemed reelected at the same
meeting. The general meeting may resolve that a director be elected for a period
longer than by the next annual general meeting, but not longer than the third
next annual meeting. Directors may resign or in certain circumstances be removed
by our general meeting prior to the expiration of his term.




The board
may appoint additional directors (whether to fill a vacancy or create new
directorship) to serve until the next annual shareholders meeting. In case an
office of a director has been vacated, the remaining directors may continue to
act in every matter so long as the number of its members is not less than the
quorum required at the time for meetings of the board. If the number of members
of the board decreases below said quorum, the board will not be entitled to act
except in case of emergency or for appointing additional directors in order to
fill vacant positions on the board or to call a general meeting of the
shareholders. The Board of Directors elects one of its members to serve as the
Chairman.




The Board
of Directors may meet and adjourn its meetings as it deems fit, provided,
however, that the board must meet at least once in every three months period. A
meeting of the board may be called at the request of each director. The quorum
required for a meeting of the board is not less than 30% of the number of
directors and in any event not less than two directors. Issues arising at any
Board of Directors’ meeting are decided by a majority of votes cast at the
meeting. In lieu of a board meeting a resolution may be adopted in writing if
signed by all directors, and a meeting may also be held through telephone
conference or other communications means, provided however that all participants
may hear each other simultaneously.




Subject
to the Companies Law, the board may delegate any of its powers to committees
consisting of at least three directors, provided that each such committee shall
include at least one external director. The Board of Directors may from time to
time revoke such delegation or alter the composition of any such committee. Any
committee so formed must exercise its powers in accordance with any directions
given to it by the board. Under the Companies Law the Board of Directors must
appoint an audit committee, comprised of at least three directors and including
all of the external directors. The function of the audit committee is to review
irregularities in the management of our business and recommend remedial
measures. The committee is also required, under the Companies Law, to approve
certain related party transactions.




FIDUCIARY
DUTIES OF OFFICERS




The
Companies Law codifies the fiduciary duties that "office holders," including
directors and executive officers, owe to a company. An office holder's fiduciary
duties consist of a duty of care and a duty of loyalty. The duty of loyalty
includes avoiding any conflict of interest between the office holder's position
in the company and his personal affairs, avoiding any competition with the
company, avoiding exploiting any business opportunity of the company in order to
receive personal advantage for himself or others, and revealing to the company
any information or documents relating to the company's affairs which the office
holder has received due to his position as an office holder.




APPROVAL
OF CERTAIN TRANSACTIONS




Under the
Companies Law, all arrangements as to compensation of office holders who are not
directors, or controlling parties, require approval of the Board of Directors.
Arrangements regarding the compensation of directors also require approval by
the audit committee and the shareholders.




The
Companies Law requires that an office holder of the company promptly disclose
any personal interest that he or she may have and all related material
information known to him or her, in connection with any existing or proposed
transaction by the company. In addition, if the transaction is an extraordinary
transaction as defined under Israeli law, the office holder must also disclose
any personal interest held by the office holder's spouse, siblings, parents,
grandparents, descendants, spouse's descendants and the spouses of any of the
foregoing. In addition, the office holder must also disclose any interest held
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 at
least one director or the general manager. An extraordinary transaction is
defined as a transaction other than in the ordinary course of business,
otherwise than on market terms, or that is likely to have a material impact on
the company's profitability, assets or liabilities.





81




In the
case of a transaction which is not an extraordinary transaction, after the
office holder complies with the above disclosure requirement, only board
approval is required unless the articles of association of the company provide
otherwise. The transaction must not be adverse to the company's interest.
Furthermore, if the transaction is an extraordinary transaction, then, in
addition to any approval stipulated by the articles of association, it also must
be approved by the company's audit committee and then by the Board of Directors,
and, under certain circumstances, by a meeting of the shareholders of the
company. An office holder who has a personal interest in a matter that is
considered at a meeting of the Board of Directors or the audit committee may not
be present at the deliberations or vote on this matter. If a majority of the
directors has a personal interest in a transaction with us, such directors may
be present at the deliberations and vote in this matter, and shareholder
approval of the transaction is required.




The
Companies Law applies the same disclosure requirements to a controlling
shareholder of a public company, which includes a shareholder that holds 25% or
more of the voting rights if no other shareholder owns more than 50% of the
voting rights in the company. Extraordinary transactions with a controlling
shareholder or in which a controlling shareholder has a personal interest, and
the terms of compensation of a controlling shareholder who is an office holder,
require the approval of the audit committee, the Board of Directors and the
shareholders of the company by simple majority, provided that either such
majority vote must include at least one-third of the shareholders who have no
personal interest in the transaction and are present at the meeting (without
taking into account the votes of the abstaining shareholders), or that the total
shareholdings of those who have no personal interest in the transaction who vote
against the transaction represent no more than one percent of the voting rights
in the company.




In
addition, a private placement of securities that will increase the relative
holdings of a shareholder that holds five percent or more of the company's
outstanding share capital (assuming the exercise or conversion of all securities
held by such person that are exercisable for or convertible into shares) or
voting rights or that will cause any person to become, as a result of the
issuance, a holder of more than five percent of the company's outstanding share
capital or voting rights, requires approval by the Board of Directors and the
shareholders of the company. However, if the receiving party is not a director
in the company, its CEO, or a controlling shareholder, and will not become a
controlling shareholder as a result of the private placement, shareholder
approval is not required if the allotted securities amount to less than twenty
percent of the company's outstanding voting rights before the allotment. Since
our shares are traded and were offered to the public only outside of Israel, and
as long as our shares are not offered to the public or registered for trade in
Israel, we are exempted from these limitations concerning private
placements.




Under the
Companies Law and as long as our Articles are not amended to determine
otherwise, certain resolutions, such as resolutions regarding mergers, and
windings up, require approval of the holders of 75% of the shares represented at
the meeting and voting thereon.




DUTIES
OF SHAREHOLDERS




Under the
Companies Law, a shareholder has a duty to act in good faith and in a customary
way towards the company and other shareholders and to refrain from abusing his
or her power in the company including, among other things, when voting in a
general meeting of shareholders on the following matters:




·
            any
      amendment to the articles of
association;




·
            an
      increase of the company's authorized share
  capital;




·
            a
      merger; or




·
            approval
      of interested party transactions which require shareholder
      approval.




In
addition, any controlling shareholder, any shareholder who knows that it
possesses power to determine the outcome of a shareholder vote and any
shareholder who, pursuant to the provisions of a company's articles of
association, has the power to appoint or prevent the appointment of an office
holder in the company, is under a duty to act with fairness towards the company.
The Companies Law does not describe the substance of this duty but provides that
a breach of his or her duty is tantamount to a breach of fiduciary duty of an
officer of the company.




EXEMPTION,
INSURANCE AND INDEMNIFICATION OF DIRECTORS AND OFFICERS EXEMPTION OF OFFICE
HOLDERS




Under the
Companies Law, an Israeli company may not exempt an office holder from liability
for breach of his duty of loyalty, but may exempt in advance an office holder
from liability to the company, in whole or in part, for a breach of his duty of
care, provided the articles of association of the company allow it to do so. Our
Articles allow us to exempt our office holders from liability towards us for
breach of duty of care to the maximum extent permitted by law.





82




OFFICE
HOLDER INSURANCE




Our
Articles provide that, subject to the provisions of the Companies Law, we may
enter into a contract for the insurance of the liability of any of our office
holders for any act done by him or her by virtue of being an office holder, in
respect of any of the following:




·
            a
      breach of duty of care towards us or any other
  person,




·
            a
      breach of fiduciary obligations towards us, provided that the office
      holder acted in good faith and had reasonable grounds to assume that his
      or her act would not be to our
detriment,




·
            a
      financial liability imposed on him or her in favor of another person,
      or




·
            any
      other event for which insurance of an office holder is or may be
      permitted.




INDEMNIFICATION
OF OFFICE HOLDERS




Our
Articles provide that we may indemnify an office holder for the following cases
of liability and expenses incurred by him or her as a result of an act done by
him or her by virtue of being an office holder:




·
            financial
      liability imposed upon said office holder in favor of another person by
      virtue of a decision by a court of law, including a decision by way of
      settlement or a decision in arbitration which has been confirmed by a
      court of law;




·
            reasonable
      expenses of the proceedings, including lawyers’ fees, expended by the
      office holder or imposed on him by the court
  for:




(1)
              proceedings
      issued against him by or on behalf of the Company or by a third
      party;




(2)
              criminal
      proceedings in which the office holder was acquitted;
  or




(3)
              criminal
      proceedings in which he was convicted in an offense, which did not require
      proof of criminal intent; or




·
            any
      other liability or expense for which the indemnification of an officer
      holder is not precluded by law.




We have
obtained directors and officers liability insurance for the benefit of our
office holders.




LIMITATIONS
ON EXEMPTION, INSURANCE AND INDEMNIFICATION




The
Israeli Companies Law provides that a company may not exempt or indemnify an
office holder, or enter into an insurance contract, which would provide coverage
for any monetary liability incurred as a result of any of the
following:




·
            a
      breach by the office holder of his or her duty of loyalty towards the
      company unless, with respect to insurance coverage, the office holder
      acted in good faith and had a reasonable basis to believe that the act
      would not prejudice the company;




·
            a
      breach by the office holder of his or her duty of care if the breach was
      done intentionally or recklessly;




·
            any
      act or omission done with the intent to derive an illegal personal
      benefit; or




·
            any
      fine levied against the office
holder.




REQUIRED
APPROVALS




In
addition, under the Companies Law, any exemption of, indemnification of, or
procurement of insurance coverage for, our office holders must be approved by
our audit committee and our Board of Directors and, if the beneficiary is a
director, an additional approval by our shareholders is required.




83





RIGHTS
OF ORDINARY SHARES




Our
Ordinary Shares confer upon our shareholders the right to receive notices of,
and to attend, shareholder meetings, the right to one vote per Ordinary Share at
all shareholders' meetings for all purposes, and to share equally, on a per
share basis, in such dividends as may be declared by our Board of Directors; and
upon liquidation or dissolution, the right to participate in the distribution of
any surplus assets of the Company legally available for distribution to
shareholders after payment of all debts and other liabilities of the Company.
All Ordinary Shares rank pari passu in all respects with each other. Our Board
of Directors may, from time to time, make such calls as it may think fit upon a
shareholder in respect of sum unpaid in respect of shares held by such
shareholder which is not payable at a fixed time, and each shareholder shall pay
the amount of every call so made upon him (and of each installment thereof if
the same is payable in installments).




MEETINGS
OF SHAREHOLDERS




An annual
general meeting of our shareholders will be held at least once in every calendar
year, not later than 15 months after the last annual general meeting at such
time and at such place either within or without the State of Israel as may be
determined by our Board of Directors.




Our Board
of Directors may, whenever it deems fit, convene a special general meeting.
Special general meetings may also be convened upon requisition in accordance
with the Companies Law. Our Board is obligated to convene a special general
meeting if it receives a written request from any of (a) two Directors or 25% of
the total number of Directors; (b) one or more Shareholders, holding at least 5%
of our issued share capital and at least 1% of the shareholders’ voting power;
or (c) one or more shareholders holding no less than 5% of the our issued voting
shares.




MERGERS




A merger
of the Company shall require resolution adopted by a simple vote cast at a
general meeting, not taking into account abstentions.





C.
            Material
      Contracts




Except
for the material contracts described under the sections captioned “Employment
Agreements, Termination of Employment and Change-In-Control Arrangements” and
“Share Option Plans” under Sections B and E, respectively, under Item 6, we are
not a party to any other material contracts outside of the ordinary course of
business.




D.
            Exchange
      Controls




Pursuant to a general permit issued in
1998 by the Israeli Controller of Foreign Exchange under the Currency Control
Law, 1978 (the "Currency Control Law"), there are virtually no restrictions on
foreign exchange in the State of Israel, except for certain reporting
obligations.





E.
            Taxation




To the
extent that the following discussion is based on new or existing tax or other
legislation that has not been subject to judicial or administrative
interpretation, there can be no assurance that the views expressed herein will
be accepted by the tax or other authorities in question.  This
discussion is not intended, nor should it be construed, as legal or professional
tax advice and it is not exhaustive of all possible tax
considerations.




Israeli
Taxation




The
following is a summary of the current material Israeli tax laws applicable to
companies in Israel with special reference to its effect on us. This section
also contains a discussion of certain Israeli government programs from which we
may benefit. This summary does not discuss all the acts of Israeli tax law that
may be relevant to a particular investor in light of his or her personal
investment circumstances or to some types of investors subject to special
treatment under Israeli law. Some parts of this discussion are based on new tax
legislation that has not been subject to judicial or administrative
interpretation. Accordingly, we cannot assure you that the views expressed in
the discussion will be accepted by the tax authorities in question. The
discussion is not intended and should not be construed as legal or professional
tax advice and does not cover all possible tax considerations.





84




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




The
following discussion describes the material Israeli tax consequences regarding
ownership and disposition of Vuance’s ordinary shares applicable to non-Israeli
shareholders, including U.S. shareholders.




General
Corporate Tax Structure




Israeli
companies are generally subject, in 2008, to corporate tax at the rate of 27% on
their taxable income. This rate was 31% in the 2006 tax year, 29% for the 2007
tax year and will be 26% for the 2009 tax year and 25%
thereafter.




Protection
against the effects of inflation or changes in the US dollar exchange
rate




In the
past, in order to avoid erosion of corporate capital in times of high inflation,
Israeli companies implemented the Income Tax Law (Adjustment for Inflation) 1985
that adjusted taxable income for changes in the Israeli Consumer Price Index.
Since inflation in Israel in recent years has not been significant, the Income
Tax Law (Adjustment for Inflation) 1985 was canceled as from the 2008 tax year
subject to provisions that were set out.





Taxation
of Capital Gains Applicable to Israeli Shareholders and Non-Israeli
Shareholders




General




Israeli
law generally imposes a capital gains tax on the sale of any capital assets by
residents of Israel, as defined for Israeli tax purposes, and on the sale of
assets located in Israel, including shares in Israeli companies, by both
residents and non-residents of Israel, unless a specific exemption is available
or unless a tax treaty between Israel and the shareholder’s country of residence
provides otherwise. The law distinguishes between real gain and inflationary
surplus. The inflationary surplus is a portion of the total capital gain which
is equivalent to the increase of the relevant asset’s purchase price which is
attributable to the increase in the Israeli consumer price index or, in certain
circumstances, a foreign currency exchange rate, 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.




Israeli
residents




Individuals:





Commencing
in January 1, 2006, a real capital gain deriving to an individual will be taxed
at a rate of 20%, on condition that the income is not classified as business
income from the vantage point of the individual. This will apply to the entire
real capital gain accrued since the date of purchase, or since January 1, 2003
if the purchase preceded that date.




Notwithstanding
the above, the real capital gain will be taxed at a rate of 25% in the following
instances:




1. The
individual deducts interest expenses and linkage
differentials.




2.       
The seller is a "significant shareholder" at the date of the sale of the
securities or at any time during the 12-month period preceding the sale. A
"significant shareholder" is defined in general as shareholder who holds, either
directly or indirectly, alone or together with another, at least 10% of any form
of a means of control in a company. The term "together with another" means
together with a relative, or together with someone who is not a relative with
which the individual, either directly or indirectly, has a regular cooperative
agreement regarding the affairs of the company.




Companies
not subject to the provisions of the Adjustment Law:




Companies
not subject to the provisions of the Adjustment Law in 2005, will be taxed at a
rate of 25% upon the capital gain on the sale of securities in the period 2006 –
2009. In 2010 and thereafter, capital gains will be taxed at a corporate rate,
which in 2010 is expected to be 25%.





85





Companies:




The real
capital gain on the sale of securities by a company will be taxed at the
corporate tax rate applicable during the year of sale, as follows: 2006 – 31%,
2007 – 29%, 2008 – 27%, 2009 – 26%, 2010 – 25%.




Companies
that prior to January 1, 2006 were not subject to the Income Tax Law
(Adjustments for Inflation) – 1985, will be taxed at a rate of 25% upon the
capital gain on the sale of securities in the period 2006-2009. In 2010 and
thereafter, a capital gain will be taxed at the corporate rate, which in 2010 is
expected to be 25%.




Non-Israeli
residents:




Generally
speaking, Non-residents of Israel will be exempt from capital gain tax in
relation to the sale of ordinary shares traded in a stock exchange as long as
(a) the capital gains are not accrued or derived by the nonresident
shareholder’s permanent establishment in Israel, (b) the ordinary shares in
relation to which the capital gains are derived were acquired by the nonresident
after the initial listing of the ordinary shares and (c) neither the shareholder
nor the capital gain is subject to certain sections of the Israeli income tax
ordinance.




However,
non-Israeli corporations will not be entitled to such exemption if an Israeli
resident (i) has a controlling interest of 25% or more in such non-Israeli
corporation, or (ii) is the beneficiary or is entitled to 25% or more of the
revenues or profits of such non-Israeli corporation, whether directly or
indirectly.




In
addition, pursuant to the Income Tax Treaty between Israel and the U.S. (the
“Tax Treaty”), gains derived from the sale, exchange or disposition of our
ordinary shares by a person who qualifies as a resident of the U.S. within the
meaning of the Tax Treaty and who is entitled to claim the benefits afforded to
US residents under the Tax Treaty, referred to as a Treaty US Resident, would
not be subject to Israeli capital gains tax, unless such US Resident owned,
directly or indirectly, shares representing 10% or more of the voting power of
our company at any time during the 12-month period preceding such sale, exchange
or disposition.




In some
instances where our shareholders may be liable to Israeli tax on the sale of
their ordinary shares, the payment of the consideration may be subject to the
withholding of Israeli tax at the source. However, under the Tax Treaty, such
U.S. resident would be permitted to claim a credit for such taxes against the
U.S. federal income tax imposed with respect to such sale, exchange or
disposition, subject to the limitations in U.S. laws applicable to foreign tax
credits. The Tax Treaty does not relate to U.S. state or local
taxes.





U.S.
Federal Income Taxation





General





The following is a summary of the
material U.S. federal income tax consequences of the ownership and disposition
of our ordinary shares and warrants. The following discussion is not exhaustive
of all possible tax considerations. This summary is based upon the Internal
Revenue Code of 1986, as amended (the “Code”), regulations promulgated under the
Code by the U.S. Treasury Department (including proposed and temporary
regulations), rulings, current administrative interpretations and official
pronouncements of the Internal Revenue Service (the “IRS”), and judicial
decisions, all as currently in effect and all of which are subject to differing
interpretations or to change, possibly with retroactive effect. Such change
could materially and adversely affect the tax consequences described below. No
assurance can be given that the IRS would not assert, or that a court would not
sustain, a position contrary to any of the tax consequences described
below.





This discussion does not address state,
local, or foreign tax consequences of the ownership and disposition of ordinary
shares and warrants. (See “Israeli Taxation” above).





This summary is for general information
only and does not address all aspects of the U.S. federal income taxation that
may be important to a particular holder in light of its investment or tax
circumstances or to holders subject to special tax rules, such
as:  banks; financial institutions; insurance companies; dealers in
stocks, securities, or currencies; traders in securities that elect to use a
mark-to-market method of accounting for their securities holdings; tax-exempt
organizations; real estate investment trusts; regulated investment companies;
qualified retirement plans, individual retirement accounts, and other
tax-deferred accounts; expatriates of the U.S.; persons subject to the
alternative minimum tax; persons holding ordinary shares or warrants as part of
a straddle, hedge, conversion transaction, or other integrated transaction;
persons who acquired ordinary shares or warrants pursuant to the exercise of any
employee stock option or otherwise as compensation for services; persons
actually or constructively holding 10% or more of our voting stock; and U.S.
Holders (as defined below) whose functional currency is other than the U.S.
dollar.





86




This discussion is not a comprehensive
description of all of the U.S. federal tax consequences that may be relevant
with respect to the ownership and disposition of our ordinary shares and
warrants. We urge you to consult your own tax advisor regarding your particular
circumstances and the U.S. federal income and estate tax consequences to you of
owning and disposing of our ordinary shares and warrants, as well as any tax
consequences arising under the laws of any state, local, or foreign or other tax
jurisdiction and the possible effects of changes in U.S. federal or other tax
laws.





This summary only addresses ordinary
shares and warrants that are held as capital assets within the meaning of
Section 1221 of the Code, which generally means as property held for investment,
and were acquired upon original issuance at their initial public offering price.
For purposes of this discussion, the term “U.S. Holder” means a beneficial owner
of our ordinary shares and warrants that is any of the following:





·
            a
      citizen or resident of the U.S. or someone treated as a U.S. citizen or
      resident for U.S. federal income tax
purposes;


·
            a
      corporation (or other entity taxable as a corporation for U.S. federal
      income tax purposes) created or organized in or under the laws of the
      U.S., any state thereof, or the District of
  Columbia;


·
            an
      estate, the income of which is subject to U.S. federal income taxation
      regardless of its source;


·
            a
      trust if a U.S. court can exercise primary supervision over the trust’s
      administration and one or more U.S. persons are authorized to control all
      substantial decisions of the trust;
or


·
            a
      trust in existence on August 20, 1996 that has a valid election in effect
      under applicable Treasury Regulations to be treated as a U.S.
      person.





The term “Non-U.S. Holder” means a
beneficial owner of our ordinary shares and warrants that is not a U.S. Holder.
As described in “Taxation of Non-U.S. Holders” below, the tax consequences to a
Non-U.S. Holder may differ substantially from the tax consequences to a U.S.
Holder.





If a partnership (including for this
purpose any entity treated as a partnership for U.S. federal income tax
purposes) is a beneficial owner of our ordinary shares and warrants, the U.S.
federal income tax consequences to a partner in the partnership will generally
depend on the status of the partner and the activities of the partnership. A
holder of our ordinary shares and warrants that is a partnership and the
partners in such partnership should consult their own tax advisors regarding the
U.S. federal income tax consequences of the ownership and disposition of our
ordinary shares and warrants.





Taxation
of U.S. Holders





The discussion in “Distributions on
Ordinary Shares” and “Dispositions of Ordinary Shares or Warrants” below assumes
that we will not be treated as a passive foreign investment company (“PFIC”) for
U.S. federal income tax purposes. For a discussion of the rules that apply if we
are treated as a PFIC, see the discussion in “Passive Foreign Investment
Company” below.





Distributions
on Ordinary Shares





General. Subject to the
discussion in “Passive Foreign Investment Company” below, if you actually or
constructively receive a distribution on ordinary shares, you must include the
distribution in gross income as a taxable dividend on the date of your receipt
of the distribution, but only to the extent of our current or accumulated
earnings and profits, as calculated under U.S. federal income tax principles.
Such amount must be included without reduction for any Israeli tax withheld.
Dividends paid by us generally will not be eligible for the dividends received
deduction allowed to corporations with respect to dividends received from
certain domestic corporations. Dividends paid by us may or may not be eligible
for preferential rates applicable to qualified dividend income, as described
below.





To the extent a distribution exceeds
our current and accumulated earnings and profits, it will be treated first as a
non-taxable return of capital to the extent of your adjusted tax basis in the
ordinary shares, and thereafter as capital gain. Preferential tax rates for
long-term capital gain may be applicable to non-corporate U.S.
Holders.





87





We do not intend to calculate our
earnings and profits under U.S. federal income tax principles. Therefore, you
should expect that a distribution will generally be reported as a dividend even
if that distribution would otherwise be treated as a non-taxable return of
capital or as capital gain under the rules described above.





Qualified Dividend
Income.  With respect to non-corporate U.S. Holders (i.e.,
individuals, trusts, and estates), for taxable years beginning before January 1,
2011, dividends that are treated as qualified dividend income (“QDI”) are
taxable at a maximum tax rate of 15%. Among other requirements, dividends
generally will be treated as QDI if either (i) our ordinary shares are readily
tradable on an established securities market in the U.S., or (ii) we are
eligible for the benefits of a comprehensive income tax treaty with the U.S.
which includes an information exchange program and which is determined to be
satisfactory by the U.S. Treasury. It is expected that our ordinary shares will
be “readily tradable” as a result of being listed on The NASDAQ Capital
Market.





In addition, for dividends to be
treated as QDI, we must not be a PFIC (as discussed below) for either the
taxable year in which the dividend was paid or the preceding taxable year. We do
not believe that we will be a PFIC for our current taxable year.However, please see the
discussion under “Passive Foreign Investment Company” below. Additionally, in
order to qualify for QDI treatment, you generally must have held the ordinary
shares for more than 60 days during the 121-day period beginning 60 days prior
to the ex-dividend date. However, your holding period will be reduced for any
period during which the risk of loss is diminished.





Moreover, a dividend will not be
treated as QDI to the extent you are under an obligation (whether pursuant to a
short sale or otherwise) to make related payments with respect to positions in
substantially similar or related property. Since the QDI rules are complex, you
should consult your own tax advisor regarding the availability of the
preferential tax rates for dividends paid on ordinary shares.





Foreign Currency
Distributions.  We have the right to pay dividends in Israeli
currency. A dividend paid in Israeli currency must be included in your income as
a U.S. dollar amount based on the exchange rate in effect on the date such
dividend is received, regardless of whether the payment is in fact converted
into U.S. dollars. If the dividend is converted to U.S. dollars on the date of
receipt, you generally will not recognize a foreign currency gain or loss.
However, if you convert the foreign currency into U.S. dollars on a later date,
you must include in income any gain or loss resulting from any exchange rate
fluctuations. The gain or loss will be equal to the difference between (i) the
U.S. dollar value of the amount you included in income when the dividend was
received and (ii) the amount that you receive on the conversion of the foreign
currency into U.S. dollars. Such gain or loss will generally be ordinary income
or loss and U.S. source for U.S. foreign tax credit purposes.





In-Kind
Distributions.  Distributions to you of new ordinary shares or
rights to subscribe for new ordinary shares that are received as part of a pro
rata distribution to all of our shareholders will not be subject to U.S. federal
income tax. The adjusted tax basis of the new ordinary shares or rights so
received will be determined by allocating your adjusted tax basis in the old
ordinary shares between the old ordinary shares and the new ordinary shares or
rights received, based on their relative fair market values on the date of
distribution. However, in the case of a distribution of rights to subscribe for
ordinary shares, the adjusted tax basis of the new rights will be zero if the
fair market value of the new rights is less than 15% of the fair market value of
the old ordinary shares on the date of distribution and you do not make an
election to determine the adjusted tax basis of the rights by allocation as
described above. Your holding period for the new ordinary shares or rights will
generally include the holding period for the old ordinary shares on which the
distribution was made.





Foreign Tax
Credits.  Subject to certain conditions and limitations,
including potential limitations under the U.S.-Israel Tax Treaty, Israeli taxes
paid on or withheld from distributions from us and not refundable to you may be
credited against your U.S. federal income tax liability or, alternatively, may
be deducted from your taxable income. This election is made on a year-by-year
basis and applies to all foreign taxes paid by you or withheld from you that
year.





Distributions will constitute foreign
source income for foreign tax credit limitation purposes. The foreign tax credit
limitation is calculated separately with respect to specific classes of income.
For this purpose, distributions characterized as dividends distributed by us
will generally constitute “passive category income” or, in the case of certain
U.S. Holders, “general category income.”  Special limitations may
apply if a dividend is treated as QDI (as defined above).





Special rules may apply to individuals
whose foreign source income during the taxable year consists entirely of
“qualified passive income” and whose creditable foreign taxes paid or accrued
during the taxable year do not exceed $300 ($600 in the case of a joint
return).





Since the rules governing foreign tax
credits are complex, you should consult your own tax advisor regarding the
availability of foreign tax credits in your particular
circumstances.





88





Exercise
or Lapse of Warrants





Upon the exercise of our warrants, a
U.S. Holder will not recognize gain or loss and will have a tax basis in the
ordinary shares received equal to the U.S. Holder’s tax basis in the warrant
plus the exercise price of the warrant. The holding period for the shares
purchased pursuant to the exercise of a warrant will begin on the day following
the date of exercise and will not include the period during which the U.S.
Holder held the warrant. If a warrant lapses unexercised, a U.S. Holder will
recognize a capital loss in an amount equal to its tax basis in the warrant.
Such loss will be long-term if the warrant has been held for more than one year.
See “Disposition of Ordinary Shares or Warrants” below for a discussion of
capital gains tax rates and limitations on deductions for losses. The loss will
generally be from U.S. sources, but the loss may be from a non-U.S. source under
some circumstances under the U.S.-Israel Tax Treaty. U.S. Holders should consult
their own independent tax advisors regarding the sourcing of any losses due to
the lapse of our warrants before exercise.





Dispositions
of Ordinary Shares or Warrants





Subject to the discussion in “Passive
Foreign Investment Company” below, you generally will recognize taxable gain or
loss realized on the sale or other taxable disposition of ordinary shares or
warrants equal to the difference between the U.S. dollar value of (i) the amount
realized on the disposition (i.e., the amount of cash plus the fair market value
of any property received), and (ii) your adjusted tax basis in the ordinary
shares or warrants. Such gain or loss will be capital gain or loss.





If you have held the ordinary shares or
warrants for more than one year at the time of disposition, such capital gain or
loss will be long-term capital gain or loss. Preferential tax rates for
long-term capital gain (currently, with a maximum rate of 15% for taxable years
beginning before January 1, 2011) will apply to non-corporate U.S. Holders. If
you have held the ordinary shares or warrants for one year or less, such capital
gain or loss will be short-term capital gain or loss taxable as ordinary income
at your marginal income tax rate. The deductibility of capital losses is subject
to limitations.





Generally, any gain or loss recognized
will not give rise to foreign source income for U.S. foreign tax credit
purposes, unless a different result is achieved under the U.S.-Israel Tax
Treaty. You should consult your own tax advisor regarding the effect of such
treaty on the source of income.





You should consult your own tax advisor
regarding the U.S. federal income tax consequences if you receive currency other
than U.S. dollars upon the disposition of ordinary shares or
warrants.





Passive
Foreign Investment Company





We generally will be a PFIC under
Section 1297 of the Code if, for a taxable year, either (a) 75% or more of our
gross income for such taxable year is passive income (the “income test”) or (b)
50% or more of the average quarterly percentage, generally determined by fair
market value, of our assets either produce passive income or are held for the
production of passive income (the “asset test”). “Passive income” includes, for
example, dividends, interest, certain rents and royalties, certain gains from
the sale of stock and securities, and certain gains from commodities
transactions.





Certain “look through” rules apply for
purposes of the income and asset tests described above. If we own, directly or
indirectly, 25% or more of the total value of the outstanding shares of another
foreign corporation, we will be treated as if we (a) held directly a
proportionate share of the other corporation’s assets, and (b) received directly
a proportionate share of the other corporation’s income. In addition, passive
income does not include any interest, dividends, rents, or royalties that are
received or accrued by us from a “related person” (as defined in Section
954(d)(3) of the Code), to the extent such items are properly allocable to
income of such related person that is not passive income.





Under the income and asset tests,
whether or not we are a PFIC will be determined annually based upon the
composition of our income and the composition and valuation of our assets, all
of which are subject to change. In determining that we are not a PFIC, we are
relying on our projected revenues and projected capital expenditures. If our
actual revenues and capital expenditures do not match our projections, we may
become a PFIC. For example, if we do not spend enough of the cash (a passive
asset) we raise from any financing transactions we may undertake, the relative
percentage of our passive assets will increase. In addition, our determination
is based on a current valuation of our assets, including goodwill. In
calculating goodwill, we have valued our total assets based on our market
capitalization, determined using the market price of our ordinary shares. Such
market price may fluctuate. If our market capitalization is less than
anticipated or subsequently declines, this will decrease the value of our
goodwill and we may become a PFIC. Furthermore, we have made a number of
assumptions regarding the amount of value allocable to goodwill. We believe our
valuation approach is reasonable. However, it is possible that the IRS will
challenge the valuation of our goodwill, which may result in our being a
PFIC.





89




We do not believe that we are currently
a PFIC. However, because the PFIC determination is highly fact intensive and
made at the end of each taxable year, there can be no assurance that we will not
be a PFIC for the current or any future taxable year or that the IRS will not
challenge our determination concerning our PFIC status. If we determine that we
are a PFIC, we will take reasonable steps to notify you.





Default PFIC Rules under Section
1291 of the Code. If we are a PFIC, the U.S. federal income tax
consequences to a U.S. Holder of the ownership and disposition of ordinary
shares and warrants will depend on whether such U.S. Holder makes an election to
treat us as a qualified electing fund (“QEF”) under Section 1295 of the Code (a
“QEF Election”) or a mark-to-market election under Section 1296 of the Code (a
“Mark-to-Market Election”). A U.S. Holder owning ordinary shares and warrants
while we were or are a PFIC that has not made either a QEF Election or a
Mark-to-Market Election will be referred to in this summary as a “Non-Electing
U.S. Holder.”





If you are a Non-Electing U.S. Holder,
you will be subject to the default tax rules of Section 1291 of the Code with
respect to:





·
            any
      “excess distribution” paid on ordinary shares and warrants, which means
      any distribution received by you which, together with all other
      distributions received in the current taxable year, exceeds 125% of the
      average distributions received by you during the three preceding taxable
      years (or during your holding period for the ordinary shares and warrants,
      if shorter); and


·
            any
      gain recognized on the sale or other taxable disposition (including a
      pledge) of ordinary shares and
warrants.




Under
these default tax rules:





·
            any
      excess distribution or gain will be allocated ratably over your holding
      period for the ordinary shares and
warrants;


·
            the
      amount allocated to the current taxable year and any period prior to the
      first day of the first taxable year in which we were a PFIC will be
      treated as ordinary income in the current
year;


·
            the
      amount allocated to each of the other years will be treated as ordinary
      income and taxed at the highest applicable tax rate in effect for that
      year; and


·
            the
      resulting tax liability from any such prior years will be subject to the
      interest charge applicable to underpayments of
  tax.





In
addition, notwithstanding any election you may make, dividends that you receive
from us will not be eligible for the preferential tax rates applicable to QDI
(as discussed above in “Distributions on Ordinary Shares”) if we are a PFIC
either in the taxable year of the distribution or the preceding taxable year,
but will instead be taxable at rates applicable to ordinary income.





Special rules for Non-Electing U.S.
Holders will apply to determine U.S. foreign tax credits with respect to
withholding taxes imposed on distributions on ordinary shares.





If we are a PFIC for any taxable year
during which you hold ordinary shares or warrants, we will continue to be
treated as a PFIC with respect to you for all succeeding years during which you
hold ordinary shares or warrants, regardless of whether we actually continue to
be a PFIC. You may terminate this deemed PFIC status by electing to recognize
gain (which will be taxed under the default tax rules of Section 1291 of the
Code discussed above) as if your ordinary shares or warrants had been sold on
the last day of the last taxable year for which we were a PFIC.





If we are a PFIC in any year with
respect to you, you will be required to file an annual return on IRS Form 8621
regarding distributions received on ordinary shares and any gain realized on the
disposition of ordinary shares or warrants.





QEF Election.  If
you make a QEF Election, you generally will not be subject to the default rules
of Section 1291 of the Code discussed above. Instead, you will be subject to
current U.S. federal income tax on your pro rata share of our ordinary earnings
and net capital gain, regardless of whether such amounts are actually
distributed to you by us. However, you can make a QEF Election only if we agree
to furnish you annually with certain tax information, and we currently do not
intend to prepare or provide such information.





90





Mark-to-Market
Election.  U.S. Holders may make a Mark-to-Market Election, but
only if the ordinary shares are marketable stock. The ordinary shares will be
“marketable stock” as long as they remain listed on NASDAQ, and are regularly
traded. Stock is “regularly traded” for any calendar year during which it is
traded (other than in de minimis quantities) on at least fifteen days during
each calendar quarter. There can be no assurances, however, that our ordinary
shares will be treated, or continue to be treated, as regularly
traded.





If the ordinary shares are marketable
stock and you make a Mark-to-Market Election, you generally will not be subject
to the default rules of Section 1291 of the Code discussed above. Rather, you
generally will be required to recognize ordinary income for any increase in the
fair market value of the ordinary shares and warrants for each taxable year that
we are a PFIC. You will also be allowed to deduct as an ordinary loss any
decrease in the fair market value to the extent of net marked-to-market gain
previously included in prior years. Your adjusted tax basis in the ordinary
shares and warrants will be adjusted to reflect the amount included or
deducted.





The Mark-to-Market Election will be
effective for the taxable year for which the election is made and all subsequent
taxable years, unless the ordinary shares and warrants cease to be marketable
stock or the IRS consents to the revocation of the election. You should consult
your own tax advisor regarding the availability of, and procedure for making, a
Mark-to-Market Election.





Since the PFIC rules are complex, you
should consult your own tax advisor regarding them and how they may affect the
U.S. federal income tax consequences of the ownership and disposition of
ordinary shares and warrants.





Information
Reporting and Backup Withholding





Generally, information reporting
requirements will apply to distributions on ordinary shares or proceeds on the
disposition of ordinary shares and warrants paid within the U.S. (and, in
certain cases, outside the U.S.) to U.S. Holders other than certain exempt
recipients, such as corporations. Furthermore, backup withholding (currently at
28%) may apply to such amounts if the U.S. Holder fails to (i) provide a correct
taxpayer identification number, (ii) report interest and dividends required to
be shown on its U.S. federal income tax return, or (iii) make other appropriate
certifications in the required manner. U.S. Holders who are required to
establish their exempt status generally must provide such certification on IRS
Form W-9.





Backup withholding is not an additional
tax.  Amounts withheld as backup withholding from a payment to you may
be credited against your U.S. federal income tax liability and you may obtain a
refund of any excess amounts withheld by filing the appropriate claim for refund
with the IRS and furnishing any required information in a timely
manner.





Taxation
of Non-U.S. Holders





Distributions
on Ordinary Shares





Subject to the discussion in
“Information Reporting and Backup Withholding” below, as a Non-U.S. Holder, you
generally will not be subject to U.S. federal income tax, including withholding
tax, on distributions received on ordinary shares, unless the distributions are
effectively connected with a trade or business that you conduct in the U.S. and
(if an applicable income tax treaty so requires) attributable to a permanent
establishment that you maintain in the U.S.





If distributions are effectively
connected with a U.S. trade or business and (if applicable) attributable to a
U.S. permanent establishment, you generally will be subject to tax on such
distributions in the same manner as a U.S. Holder, as described in “Taxation of
U.S. Holders – Distributions on Ordinary Shares” above. In addition, any such
distributions received by a corporate Non-U.S. Holder may also, under certain
circumstances, be subject to an additional “branch profits tax” at a 30% rate or
such lower rate as may be specified by an applicable income tax
treaty.





Dispositions
of Ordinary Shares and Warrants





Subject to the discussion in
“Information Reporting and Backup Withholding” below, as a Non-U.S. Holder, you
generally will not be subject to U.S. federal income tax, including withholding
tax, on any gain recognized on a sale or other taxable disposition of ordinary
shares and warrants, unless (i) the gain is effectively connected with a trade
or business that you conduct in the U.S. and (if an applicable income tax treaty
so requires) attributable to a permanent establishment that you maintain in the
U.S., or (ii) you are an individual and are present in the U.S. for at least 183
days in the taxable year of the disposition, and certain other conditions are
present.





91





If you meet the test in clause (i)
above, you generally will be subject to tax on any gain that is effectively
connected with your conduct of a trade or business in the U.S. in the same
manner as a U.S. Holder, as described in “Taxation of U.S. Holders –
Dispositions of Ordinary Shares and Warrants” above. Effectively connected gain
realized by a corporate Non-U.S. Holder may also, under certain circumstances,
be subject to an additional “branch profits tax” at a 30% rate or such lower
rate as may be specified by an applicable income tax treaty.





If you meet the test in clause (ii)
above, you generally will be subject to tax at a 30% rate on the amount by which
your U.S. source capital gain exceeds your U.S. source capital
loss.





Information
Reporting and Backup Withholding





Payments to Non-U.S. Holders of
distributions on, or proceeds from the disposition of, ordinary shares and
warrants are generally exempt from information reporting and backup withholding.
However, a Non-U.S. Holder may be required to establish that exemption by
providing certification of non-U.S. status on an appropriate IRS Form
W-8.





Backup withholding is not an additional
tax.  Amounts withheld as backup withholding from a payment to you may
be credited against your U.S. federal income tax liability and you may obtain a
refund of any excess amounts withheld by filing the appropriate claim for refund
with the IRS and furnishing any required information in a timely
manner.




F.
            Dividends
      and Paying Agent





Not
applicable.





G.
            Statement
      by Experts





Not
applicable.





H.
            Documents
      on Display




We are
subject to the informational requirements of the Exchange Act, applicable to
foreign private issuers. We, as a “foreign private issuer,” are exempt from the
rules under the Exchange Act prescribing certain disclosure and procedural
requirements for proxy solicitations, 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, with respect to their
purchases and sales of shares. In addition, we are not required to file annual,
quarterly and current reports and financial statements with the SEC as
frequently or as promptly as U.S. companies whose securities are registered
under the Exchange Act. However, we will file with the SEC, within 180 days
after the end of each fiscal year, an annual report on Form 20-F containing
financial statements audited by an independent accounting firm. We will also
furnish quarterly reports on Form 6-K containing unaudited interim financial
information for the first three quarters of each fiscal year, within 60 days
after the end of such quarter.





You
may read and copy any document we file or furnish with the SEC at reference
facilities at 450 Fifth Street, NW, Washington, DC 20549. You may also obtain
copies of the documents at prescribed rates by writing to the Public Reference
Section of the SEC at 450 Fifth Street, NW, Washington, DC 20549. Please call
the SEC at 1-800-SEC-0330 for further information on the operation of the public
reference facilities. You can review our SEC filings and the registration
statement by accessing the SEC’s internet site at
http://www.sec.gov.




I.
            Subsidiary
      Information





Not
applicable.





ITEM
11.    Quantitative and Qualitative
Disclosures About Market Risk.





Quantitative
and Qualitative Information about Market Risk




The
primary objective of our investment activities is to preserve principal while at
the same time maximizing the income we receive from investments without
significantly increasing risk. Some of the securities in which we may invest may
be subject to market risk. This means that a change in prevailing interest rates
and foreign currency rates against the NIS may cause the value of the investment
to fluctuate. For example, if we purchase a security that was issued with a
fixed interest rate and the prevailing interest rate later rises, the value of
our investment will probably decline. To minimize this risk, we intend to
maintain our portfolio of cash equivalents and short-term investments in a
variety of securities, including U.S. dollars, NIS bank deposits, money market
funds and government and non-government debt securities. In general, money
market funds are not subject to market risk because the interest paid on such
funds fluctuates with the prevailing interest rate.





92




Our
financial market risk includes risks related to international operations and
related foreign currencies. We anticipate that sales outside of North America
will continue to account for a significant portion of our consolidated revenue
in 2009. To date, most of our sales have been valued in dollars. In future
periods, we expect our sales to continue to be principally valued in dollars,
narrowing foreign currency exchange risk.





We value
part of our expenses in some of our international operations, such as Israel and
Hong Kong, in each country's local currency, and therefore are subject to
foreign currency exchange risk. However, through December 31, 2008, we have not
experienced any significant negative impact on our operations as a result of
fluctuations in foreign currency exchange rates; we have incurred an income of
$62,000 in the year ended December 31, 2008 due to fluctuations in foreign
exchange rates. We do not use financial instruments to hedge operating expenses
in Israel or Hong Kong that are valued in local currency. We intend to continue
to assess the need to utilize financial instruments to hedge currency exposures
on an ongoing basis.





We do not
use derivative financial instruments for speculative trading purposes, nor do we
hedge our foreign currency exposure to offset the effects of changes in foreign
exchange rates.





Our
exposure to market risks for changes in interest rates relates primarily to our
credit facility. At December 31, 2008, our financial market risk related to this
debt was immaterial. Our general policy is to limit the risk of principal loss
and ensure the safety of invested funds by limiting market and credit
risk.





Foreign
currency risk




Most of
our sales are denominated in U.S. dollars, and we incur most of our expenses in
U.S. dollars, Euros and Israeli Shekels. According to the salient economic
factors indicated in SFAS No. 52, “Foreign Currency Translation,” our cash flow,
sale price, sales market, expense, financing and inter-company transactions and
arrangement indicators are predominantly denominated in U.S. dollars. In
addition, the U.S. dollar is the primary currency of the economic environment in
which we operate, and thus the U.S. dollar is our functional and reporting
currency.




In our
balance sheet, we remeasure into U.S. dollars all monetary accounts (principally
cash and cash equivalents and liabilities) that are maintained in other
currencies. For this remeasurement we use the foreign exchange rate at the
balance sheet date. Any gain or loss that results from this remeasurement is
reflected in the statement of income as financial income or financial expense,
as appropriate.




We
measure and record non-monetary accounts in our balance sheet (principally fixed
assets, prepaid expenses and share capital) in U.S. dollars. For this
measurement we use the U.S. dollar value in effect at the date that the asset or
liability was initially recorded in our balance sheet (the date of the
transaction).





ITEM
12.   Description of
Securities Other than Equity Securities.





Not applicable.




PART
II





ITEM
13.   Defaults,
Dividend Arrearages and Delinquencies.





A.
            None.





B.
            None.





ITEM
14.Material
Modifications to the Rights of Security Holders and Use of
Proceeds.





A.
            None.





B.
            None.




C.
            Not
      applicable.




93




D.
            No
      changes.





E.
            None.





ITEM
15.   Controls and Procedures.




Disclosure
controls and procedures




Our
management, including our Chief Executive Officer and Chief Financial Officer,
has evaluated the effectiveness of our disclosure controls and procedures (as
such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange
Act) as of December 31, 2008. Our disclosure controls and procedures include
components of our internal control over financial reporting. Based on that
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures, as of December 31, 2008,
were effective, except as described below, to provide reasonable assurance that
(i) information required to be disclosed in filings and submissions under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commission’s rules and forms,
and (ii) information required to be disclosed in reports that we file or submit
under the Exchange Act is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate to allow timely decisions regarding required
disclosure.




Based further
upon that evaluation, our Chief Executive Officer and Chief Financial Officer
have concluded that our disclosure controls and procedures were not effective as
of December 31, 2008, due solely to the material weakness in our internal
control over financial reporting as described below in "Management's Report on
Internal Control over Financial Reporting." In light of this material weakness,
the Company performed additional analysis as deemed necessary to ensure that the
consolidated financial statements were prepared in accordance with U.S.
generally accepted accounting principles. Accordingly, management believes that
the consolidated financial statements included in this report present fairly, in
all material respects, our financial position, results of operations and cash
flows for the period presented.




Management report on internal control
over financial reporting




Our
management, under the supervision of our Chief Executive Officer and Chief
Financial Officer, is responsible for establishing and maintaining adequate
internal control over our financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) of the Securities Exchange Act) to provide reasonable assurance
regarding the reliability of our financial reporting and the preparation of
financial statements for external purposes in accordance with U.S. GAAP., and
includes policies and procedures that:




·
            pertain
      to the maintenance of records that in reasonable detail accurately and
      fairly reflect our transactions and asset
  dispositions;




·
            provide
      reasonable assurance that transactions are recorded as necessary to permit
      the preparation of our financial statements in accordance with generally
      accepted accounting principles;




·
            provide
      reasonable assurance that receipts and expenditures are made only in
      accordance with authorizations of our management and Board of Directors
      (as appropriate); and




·
            provide
      reasonable assurance regarding the prevention or timely detection of
      unauthorized acquisition, use or disposition of assets that could have a
      material effect on our financial
statements.




Our
management assessed the effectiveness of internal control over financial
reporting as of December 31, 2008, the end of our fiscal year. In making this
assessment, management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO) in the report
entitled “Internal Control – Integrated Framework.”




Based on
our assessment, our management has concluded that we did not maintain effective
internal control over financial reporting as a result of the material weakness
that is discussed below.




We had
one significant deficiency that is inherent and continuing, and therefore
constitutes a material weakness in the financial statement closing process. The
control deficiency relates to the improper segregation of duties in our finance
department.





94





Management’s
report was not subject to attestation by our registered public accounting firm
pursuant to temporary rules of the Securities and Exchange Commission that
permit us to provide only management’s report in this annual report.
Accordingly, this Annual Report does not include an attestation report of our
registered public accounting firm regarding internal control over financial
reporting.




Inherent
limitations on effectiveness of controls.




Internal
control over financial reporting has inherent limitations. Internal control over
financial reporting is a process that involves human diligence and compliance
and is subject to lapses in judgment and breakdowns resulting from human
failures. Internal control over financial reporting also can be circumvented by
collusion or improper management override. Because of such limitations, there is
a risk that material misstatements will not be prevented or detected on a timely
basis by internal control over financial reporting. However, these inherent
limitations are known features of the financial reporting process. Therefore, it
is possible to design into the process safeguards to reduce, though not
eliminate, this risk.




Changes in internal controls over
financial reporting




During
the year ended December 31, 2008, due to headcount cuts, we have made
adjustments to internal control over financial reporting. Such adjustments are
not deemed by our management to materially affect, or to reasonably be likely to
materially affect, our internal controls over financial reporting. Therefore, we
do not believe our material weakness that discussed above will be remediated in
2009.





ITEM
      16.
            Reserved





ITEM
      16A.
            Audit Committee Financial
      Expert





Our Board of Directors has determined
that Ms. Michal Brikman, who chairs our audit committee, is an “audit committee
financial expert.” Mr. Jaime Shulman is an independent director under NASDAQ
Market Place Rule 4200(a)(15).





ITEM
      16B.
            Code of
      Ethics





Our Board of Directors adopted a code
of ethics that applies to our chief executive officer, chief financial officer,
director of finance, controller, and other persons performing similar functions
a copy of which is previously filed and incorporated by reference to this Annual
Report. A copy of our code of ethics will be provided, without charge, upon
written request of any person delivered as follows: Sagid House “Ha’Sharon
Industrial Park” P.O.B 5039, Qadima 60920 Israel.





ITEM
      16C.
            Principal Accountant Fees and
      Services





The
following table presents the fees to our external auditors for professional
services rendered in the years ended December 31, 2008 and 2007:


2008
                  
                  
                  2007Audit
      Fees
                  
                  
                  91,000
                  
                  
                  
                  108,000Audit-Related
      Fees
                  
                  
                  23,000
                  
                  
                  
                  29,000Tax
      Fees
                  
                  
                  7,000
                  
                  
                  
                  5,000Total
                  
                  
                  121,000
                  
                  
                  
                  142,000




Pre-Approval
Policies for Non-Audit Services





The Audit Committee has adopted
policies and procedures relating to the approval of all audit and non-audit
services that are to be performed by our independent auditors. These policies
generally provide that we will not engage our independent auditors to render
audit or non-audit services unless the service is specifically approved in
advance by the Audit Committee or the engagement is entered into pursuant to the
pre-approval procedure described below.





From
time to time, the Audit Committee may pre-approve specified types of services
that are expected to be provided to us by our independent auditors during the
next 12 months. Any such pre-approval is detailed as to the particular service
or type of services to be provided and is also generally subject to a maximum
dollar amount.





95




ITEM
16D.  Exemptions
from the Listing Standards for Audit Committees





Not
applicable.





ITEM
16E.Purchases of
Equity Securities by the Issuer and Affiliated Purchasers





None.





PART
III


ITEM
17.   Financial
Statements.





Not
applicable.





ITEM
18.   Financial
Statements.





96





Report of
the Independent Registered Public Accounting Firm





To
the Board of Directors of


SuperCom
Asia Pacific Limited





We have
audited the accompanying balance sheets of SuperCom Asia Pacific Limited (the
“Company”) as of December 31, 2006 and 2005, and the related statements of
income, stockholders’ deficit and cash flows for the years ended December 31,
2006 and 2005.  These financial statements are the responsibility of
the Company’s management. Our responsibility is to express an opinion on these
financial statements based on our audits.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  The
Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting.  Our audits include
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting.  Accordingly, we express no
such opinion.  Our audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, 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 financial statements referred to above present fairly, in all
material respects, the financial position of the Company as of December 31, 2006
and 2005 and the results of its operations and cash flows for the years ended
December 31, 2006 and 2005 in conformity with accounting principles generally
accepted in the United States of America.





BDO
McCabe Lo Limited


Certified
Public Accountants





Hong
Kong, 22 March 2007





97







98





VUANCE
LTD. AND SUBSIDIARIES





CONSOLIDATED
FINANCIAL STATEMENTS





AS OF
DECEMBER 31, 2008





IN U.S.
DOLLARS





INDEX





PageReport
      of Independent Registered Public Accounting Firm
                100Consolidated
      Balance Sheets
                101-102Consolidated
      Statements of Operations
                103Statements
      of Changes in Shareholders' Equity (Deficit)
                104Consolidated
      Statements of Cash Flows
                105-106Notes
      to Consolidated Financial Statements
                107-147





- - - - -
- - - - - - - - - - - - - - - -





99











REPORT
      OF INDEPENDENT
                REGISTERED
      PUBLIC ACCOUNTING FIRM
                TO
      THE SHAREHOLDERS OF
                VUANCE
      LTD.
              Fahn
      Kanne & Co.
                Head
      Office
                Levinstein
      Tower
                23
      Menachem Begin Road
                Tel-Aviv
      66184, ISRAEL
                P.O.B.
      36172, 61361
                
                T
      +972 3 7106666
                F
      +972 3 7106660
                www.gtfk.co.il




We have
audited the accompanying consolidated balance sheets of Vuance Ltd. (the
"Company") and subsidiaries as of December 31, 2008 and 2007, and the
related consolidated statements of operations, changes in shareholders’ equity
(deficit) and cash flows for each of the three years in the period ended
December 31, 2008.  These consolidated financial statements are the
responsibility of the Board of Directors and management of the
Company.  Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.




We did
not audit the financial statements of Supercom Asia Pacific Limited (Supercom
Asia Pacific), a subsidiary, which statements reflect total assets of 0.5% and
0.4% as of December 31, 2008 and 2007, respectively, of the related
consolidated totals, and total revenues of 1.6%, 10% and 20%, for each of the
three years in the period ended December 31, 2008, of the related
consolidated totals. Those financial statements were audited by other auditors,
whose reports thereon have been furnished to us. Our opinion, insofar as it
relates to the amounts included for Supercom Asia Pacific, is based solely on
the reports of the other auditors.




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.  The
Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting.  Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting.  Accordingly, we express no
such opinion.  An audit also includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by the
Board of Directors and management, as well as evaluating the overall financial
statement presentation.  We believe that our audits and the report of
the other auditors provide a reasonable basis for our opinion.




In our
opinion, based on our audits and the report of the other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of the Company and
subsidiaries as of December 31, 2008 and 2007, and the consolidated results
of their operations, and their cash flows for each of the three years in the
period ended December 31, 2008, in conformity with accounting principles
generally accepted in the United States of America.




The
financial statements have been prepared assuming the Company will continue as a
going concern. As described in Note 1d, the Company has incurred substantial
losses and negative cash flows from operations since its inception and as of
December 31, 2008, the Company had an accumulated deficit of $42,294 thousands
and total shareholders' deficit of $1,867 thousands. These factors raise
substantial doubt about the Company's ability to continue as a going concern.
Management plans with respect to these matters are described in Note 1d. The
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.





Fahn
Kanne & Co.


Certified
Public Accountants (Isr.)


Tel-Aviv,
ISRAEL


June 30,
2009




Certified
Public Accountants
 Fahn
Kanne & Co. is the Israeli member firm of Grant Thornton International
Ltd





100







VUANCE
LTD. AND SUBSIDIARIES




CONSOLIDATED
BALANCE SHEETS





U.S.
dollars in thousands





December 31,2007
                                        
                                        
                                        2008ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
                                        
                                        $
                                        2,114
                                        
                                        
                                        $
                                        812Restricted
      cash deposits
                                        
                                        
                                        3,172
                                        
                                        
                                        
                                        2,150Marketable
      securities
                                        
                                        
                                        4,054
                                        
                                        
                                        
                                        -Trade
      receivables (net of allowance for doubtful accounts of $ 3,500 and
      $ 3,478 as of December 31, 2007 and 2008,
    respectively)
                                        
                                        
                                        2,463
                                        
                                        
                                        
                                        840Other
      accounts receivable and prepaid expenses
                                        
                                        
                                        2,400
                                        
                                        
                                        
                                        1,074Inventories,
      net
                                        
                                        
                                        566
                                        
                                        
                                        
                                        1,307Assets
      attributed to discontinued operations
                                        
                                        
                                        -
                                        
                                        
                                        
                                        260Total current
      assets
                                        
                                        
                                        14,769
                                        
                                        
                                        
                                        6,443SEVERANCE
      PAY FUND
                                        
                                        
                                        309
                                        
                                        
                                        
                                        314PROPERTY
      AND EQUIPMENT, NET
                                        
                                        
                                        218
                                        
                                        
                                        
                                        218OTHER
      ASSETS:Goodwill
                                        
                                        
                                        3,644
                                        
                                        
                                        
                                        685Intangible
      assets and deferred charges, net
                                        
                                        
                                        2,012
                                        
                                        
                                        
                                        1,275Total other
      assets
                                        
                                        
                                        5,656
                                        
                                        
                                        
                                        1,960Total
      assets
                                        
                                        $
                                        20,952
                                        
                                        
                                        $
                                        8,935





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





101




VUANCE
LTD. AND SUBSIDIARIES




CONSOLIDATED
BALANCE SHEETS


U.S.
dollars in thousands, except share data





December 31,2007
                          
                          
                          2008LIABILITIES
      AND SHAREHOLDERS' EQUITYCURRENT
      LIABILITIES:Short-term
      bank credit and current maturities of long-term loan
                          
                          $
                          478
                          
                          
                          $
                          299Trade
      payables
                          
                          
                          1,498
                          
                          
                          
                          1,714Employees
      and payroll accruals
                          
                          
                          299
                          
                          
                          
                          247Accrued
      expenses and other liabilities
                          
                          
                          6,641
                          
                          
                          
                          5,007Convertible
      bonds
                          
                          
                          -
                          
                          
                          
                          3,157Total current
      liabilities
                          
                          
                          8,916
                          
                          
                          
                          10,424LONG-TERM
      LIABILITIES:Convertible
      bonds
                          
                          
                          2,441
                          
                          
                          
                          -Accrued
      severance pay
                          
                          
                          362
                          
                          
                          
                          378Total long-term
      liabilities
                          
                          
                          2,803
                          
                          
                          
                          378COMMITMENTS
      AND CONTINGENT LIABILITIESSHAREHOLDERS'
      EQUITY (DEFICIT):Share
      capital:
                            Ordinary
      shares of NIS 0.0588235 par value -Authorized
      12,000,000 shares as of December 31, 2007 and 2008;Issued
      and outstanding: 5,124,779 and 5,259,874 shares as of December 31,
      2007 and 2008, respectively
                          
                          
                          80
                          
                          
                          
                          82Additional
      paid-in capital
                          
                          
                          39,089
                          
                          
                          
                          40,345Accumulated
      deficit
                          
                          
                          (29,936
                          )
                          
                          
                          (42,294
                          )Total
      shareholders' equity (deficit)
                          
                          
                          9,233
                          
                          
                          
                          (1,867
                          )Total
      liabilities and shareholders' equity (deficit)
                          
                          $
                          20,952
                          
                          
                          $
                          8,935





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





102




VUANCE
LTD. AND SUBSIDIARIES




CONSOLIDATED
STATEMENTS OF OPERATIONS





U.S.
dollars in thousands, except share data




Year ended
                    December 31,2006
                  
                  
                  2007
                  
                  
                  2008Revenues
                  
                  $
                  8,941
                  (*)
                  
                  $
                  13,314
                  (*)
                  
                  $
                  20,653Cost
      of revenues
                  
                  
                  3,494
                  
                  
                  
                  5,600
                  
                  
                  
                  8,452Gross
      profit
                  
                  
                  5,447
                  
                  
                  
                  7,714
                  
                  
                  
                  12,201Operating
      expenses:Research
      and development
                  
                  
                  1,362
                  
                  
                  
                  1,716
                  
                  
                  
                  2,571Selling
      and marketing
                  
                  
                  5,619
                  
                  
                  
                  9,041
                  
                  
                  
                  11,924General
      and administrative
                  
                  
                  2,737
                  
                  
                  
                  3,192
                  
                  
                  
                  3,299Impairment
      loss
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  3,235Litigation
      settlement expenses
                  
                  
                  108
                  
                  
                  
                  34
                  
                  
                  
                  8Total
      operating expenses
                  
                  
                  9,826
                  
                  
                  
                  13,983
                  
                  
                  
                  21,037Capital
      gain from the sale of the e-ID Division
                  
                  
                  10,536
                  
                  
                  
                  -
                  
                  
                  
                  -Operating
      income (loss)
                  
                  
                  6,157
                  
                  
                  
                  (6,269
                  )
                  
                  
                  (8,836
                  )Financial
      expenses, net
                  
                  
                  (204
                  )
                  
                  
                  (4,652
                  )
                  
                  
                  (3,113
                  )Other
      expenses, net
                  
                  
                  (367
                  )
                  
                  
                  -
                  
                  
                  
                  -Income
      (loss) before taxes on income
                  
                  
                  5,586
                  
                  
                  
                  (10,921
                  )
                  
                  
                  (11,949
                  )Taxes
      on income
                  
                  
                  (146
                  )(*)
                  
                  
                  (390
                  )(*)
                  
                  
                  (137
                  )Net
      income (loss) from continuing operations
                  
                  
                  5,440
                  
                  
                  
                  (11,311
                  )
                  
                  
                  (12,086
                  )Loss
      from discontinued operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  272Net
      income (loss)
                  
                  $
                  5,440
                  
                  
                  $
                  (11,311
                  )
                  
                  $
                  (12,358
                  )Income
      (loss) per shareBasic:Income
      (loss) from continuing operations
                  
                  $
                  1.37
                  
                  
                  $
                  (2.57
                  )
                  
                  $
                  (2.34
                  )Loss
      from discontinuing operations
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  (0.05
                  )Net
      income (loss) per share
                  
                  $
                  1.37
                  
                  
                  $
                  (2.57
                  )
                  
                  $
                  (2.39
                  )Weighted
      average number of ordinary shares used in computing basic earnings (loss)
      per share
                  
                  
                  3,969,212
                  
                  
                  
                  4,391,860
                  
                  
                  
                  5,171,406Diluted:Income
      (loss) from continuing operations
                  
                  $
                  1.31
                  
                  
                  $
                  (2.57
                  )
                  
                  $
                  (2.34
                  )Loss
      from discontinuing operations
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  (0.05
                  )Net
      income (loss) per share
                  
                  $
                  1.31
                  
                  
                  $
                  (2.57
                  )
                  
                  $
                  (2.39
                  )Weighted
      average number of ordinary shares used in computing diluted income ( loss)
      per share
                  
                  
                  4,212,791
                  
                  
                  
                  4,391,860
                  
                  
                  
                  5,171,406




(*)
Reclassified (See Note 2y)




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





103




VUANCE
LTD. AND SUBSIDIARIES




STATEMENTS
OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)


U.S.
dollars in thousands, except share data





Ordinary sharesNumber of
                      Shares
                    
                    
                    Share
                      capital
                    
                    
                    Additional
                      paid-in
                      capital
                    
                    
                    Deferred
                      stock
                      compensation
                    
                    
                    Accumulated
                      Deficit
                    
                    
                    Receipt on
                      account of
                      shares
                    
                    
                    Total
                      comprehensive
                      income (loss)
                    
                    
                    Total
                      shareholders'
                      equity (deficit)Balance
      as of January 1, 2006
                    
                    
                    3,807,167
                    
                    
                    $
                    61
                    
                    
                    $
                    31,702
                    
                    
                    $
                    (15
                    )
                    
                    $
                    (24,065
                    )
                    
                    $
                    564
                    
                    
                    
                    -
                    
                    
                    $
                    8,247Reclassification
      upon adoption of SFAS 123(R)
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (15
                    )
                    
                    
                    15
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Issuance
      of shares in a private placement, net
                    
                    
                    150,807
                    
                    
                    
                    2
                    
                    
                    
                    455
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (550
                    )
                    
                    
                    -
                    
                    
                    
                    (93
                    )Exercise
      of options
                    
                    
                    43,152
                    
                    
                    
                    1
                    
                    
                    
                    105
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (14
                    )
                    
                    
                    -
                    
                    
                    
                    92Amounts
      attributed to warrants issued in connection with convertible
      bonds
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    282
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    282Beneficial
      conversion feature on convertible bonds
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    632
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    632Stock-
      based compensation
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    401
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    401Net
      income
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    5,440
                    
                    
                    
                    -
                    
                    
                    $
                    5,440
                    
                    
                    
                    5,440Total
      comprehensive income
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    5,440Balance
      as of December 31, 2006
                    
                    
                    4,001,126
                    
                    
                    $
                    64
                    
                    
                    $
                    33,562
                    
                    
                    $
                    -
                    
                    
                    $
                    (18,625
                    )
                    
                    $
                    -
                    
                    
                    
                    
                    
                    
                    $
                    15,001Issuance
      of shares in connection with acquisition of subsidiary (see note
      1a)
                    
                    
                    1,097,426
                    
                    
                    
                    16
                    
                    
                    
                    4,319
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    4,335Exercise
      of options
                    
                    
                    25,968
                    
                    
                    
                    -
                    *
                    
                    
                    82
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    82Increase
      in the fair value of conversion feature of convertible bonds due to
      modification of conversion terms
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    84
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    84Stock-
      based compensation
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,072
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,072Expenses
      related to the issuance of shares in a private placement which occurred in
      previous years
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (30
                    )
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (30
                    )Issuance
      of shares due to reverse split
                    
                    
                    259
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Net
      loss
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (11,311
                    )
                    
                    
                    -
                    
                    
                    $
                    (11,311
                    )
                    
                    
                    (11,311
                    )Total
      comprehensive loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    (11,311
                    )Balance
      as of December 31, 2007
                    
                    
                    5,124,779
                    
                    
                    $
                    80
                    
                    
                    $
                    39,089
                    
                    
                    $
                    -
                    
                    
                    $
                    (29,936
                    )
                    
                    $
                    -
                    
                    
                    
                    
                    
                    
                    $
                    9,233Issuance
      of shares see Note 14c
                    
                    
                    108,063
                    
                    
                    
                    2
                    
                    
                    
                    247
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    249Exercise
      of options
                    
                    
                    27,032
                    
                    
                    
                    -
                    *
                    
                    
                    8
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    8Beneficial
      conversion feature on convertible bonds terms
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    94
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    94Stock-
      based compensation
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    907
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    907Net
      loss
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (12,358
                    )
                    
                    
                    -
                    
                    
                    $
                    (12,358
                    )
                    
                    
                    (12,358
                    )Total
      comprehensive loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    (12,358
                    )Balance
      as of December 31, 2008
                    
                    
                    5,259,874
                    
                    
                    $
                    82
                    
                    
                    $
                    40,345
                    
                    
                    $
                    -
                    
                    
                    $
                    (42,294
                    )
                    
                    $
                    -
                    
                    
                    
                    
                    
                    
                    $
                    (1,867
                    )





*Less
than 1





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





104




VUANCE
LTD. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS





U.S.
dollars in thousands




Year ended December 31,2006
                          
                          
                          2007
                          
                          
                          2008Cash flows from
      operating activities:Net
      Income (loss)
                          
                          $
                          5,440
                          
                          
                          $
                          (11,311
                          )
                          
                          $
                          (12,358
                          )Less:
      Loss for the period from discontinued operations
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          (272
                          )Net
      income (loss) from continuing operations
                          
                          
                          5,440
                          
                          
                          
                          (11,311
                          )
                          
                          
                          (12,086
                          )Adjustments
      to reconcile net income/loss from continuing operations to net cash used
      in operating activities from continuing operations:Depreciation
      and amortization
                          
                          
                          355
                          
                          
                          
                          225
                          
                          
                          
                          651Impairment
      loss
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          3,235Accrued
      severance pay
                          
                          
                          128
                          
                          
                          
                          (382
                          )
                          
                          
                          16Stock-
      based compensation
                          
                          
                          361
                          
                          
                          
                          1,072
                          
                          
                          
                          907Capital
      gain from the sale of the e-ID Division
                          
                          
                          (10,536
                          )
                          
                          
                          -
                          
                          
                          
                          -Amortization
      of discount on convertible bonds
                          
                          
                          30
                          
                          
                          
                          268
                          
                          
                          
                          810Amortization
      of deferred charges
                          
                          
                          6
                          
                          
                          
                          90
                          
                          
                          
                          159Write
      down of loan regarding an investment in an affiliated
    company
                          
                          
                          275
                          
                          
                          
                          -
                          
                          
                          
                          -Realized
      loss from sale of marketable securities
                          
                          
                          -
                          
                          
                          
                          1,116
                          
                          
                          
                          862Unrealized
      loss from marketable securities, net
                          
                          
                          -
                          
                          
                          
                          2,699
                          
                          
                          
                          -Loss
      on sale of property and equipment
                          
                          
                          8
                          
                          
                          
                          58
                          
                          
                          
                          -Exchange
      differences on principal of long-term loan
                          
                          
                          12
                          
                          
                          
                          9
                          
                          
                          
                          5Decrease
      (increase) in trade receivables
                          
                          
                          (1,442
                          )
                          
                          
                          883
                          
                          
                          
                          1,610Decrease
      (increase) in other accounts receivable and prepaid
    expenses
                          
                          
                          254
                          
                          
                          
                          (1,943
                          )
                          
                          
                          1,373Decrease
      (increase) in inventories
                          
                          
                          212
                          
                          
                          
                          32
                          
                          
                          
                          (741
                          )Increase
      in trade payables
                          
                          
                          53
                          
                          
                          
                          95
                          
                          
                          
                          216Increase
      (decrease) in employees and payroll accruals
                          
                          
                          211
                          
                          
                          
                          (234
                          )
                          
                          
                          (86
                          )Increase
      (decrease) in accrued expenses and other liabilities
                          
                          
                          1,586
                          
                          
                          
                          2,433
                          
                          
                          
                          (1,663
                          )Net
      cash used in operating activities from continuing
    operations
                          
                          
                          (3,047
                          )
                          
                          
                          (4,890
                          )
                          
                          
                          (4,732
                          )Net
      cash  used in operating activities from discontinued
      operations
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          (532
                          )Net
      cash used in operating activities
                          
                          
                          (3,047
                          )
                          
                          
                          (4,890
                          )
                          
                          
                          (5,264
                          )Cash flows from
      investing activities:Purchase
      of property and equipment
                          
                          
                          (93
                          )
                          
                          
                          (116
                          )
                          
                          
                          (73
                          )Acquisition
      of subsidiaries net of cash acquired. (Appendix A)
                          
                          
                          -
                          
                          
                          
                          (153
                          )
                          
                          
                          -Decrease
      (increase) in severance pay fund
                          
                          
                          (95
                          )
                          
                          
                          278
                          
                          
                          
                          (5
                          )Capitalization
      of software and intangible assets
                          
                          
                          -
                          
                          
                          
                          (509
                          )
                          
                          
                          -Restricted
      cash deposits, net
                          
                          
                          229
                          
                          
                          
                          (2,313
                          )
                          
                          
                          1,022Proceeds
      from sale of marketable securities
                          
                          
                          650
                          
                          
                          
                          7,639
                          
                          
                          
                          3,192Amounts
      carried to deferred charges
                          
                          
                          (163
                          )
                          
                          
                          (52
                          )
                          
                          
                          -Cash
      paid in respect of sale of the e-ID Division (Appendix B)
                          
                          
                          (52
                          )
                          
                          
                          -
                          
                          
                          
                          -Net
      cash provided by investing activities
                          
                          
                          476
                          
                          
                          
                          4,774
                          
                          
                          
                          4,136Cash flows from
      financing activities:Short-term
      bank credit, net
                          
                          
                          (307
                          )
                          
                          
                          (336
                          )
                          
                          
                          254Proceeds
      from issuance of convertible bonds and warrants, net
                          
                          
                          3,139
                          
                          
                          
                          -
                          
                          
                          
                          -Issuance
      of share capital, net of issuance costs
                          
                          
                          (183
                          )
                          
                          
                          (30
                          )
                          
                          
                          2Proceeds
      from exercise of options and warrants, net
                          
                          
                          92
                          
                          
                          
                          82
                          
                          
                          
                          8Long-term
      loan received
                          
                          
                          204
                          
                          
                          
                          2,850
                          
                          
                          
                          -Principal
      repayment of long-term loan
                          
                          
                          (224
                          )
                          
                          
                          (2,780
                          )
                          
                          
                          (438
                          )Net
      cash provided by (used in) financing activities
                          
                          
                          2,721
                          
                          
                          
                          (214
                          )
                          
                          
                          (174
                          )Increase
      (decrease) in cash and cash equivalents
                          
                          
                          150
                          
                          
                          
                          (330
                          )
                          
                          
                          (1,302
                          )Cash
      and cash equivalents at the beginning of the year
                          
                          
                          2,294
                          
                          
                          
                          2,444
                          
                          
                          
                          2,114Cash
      and cash equivalents at the end of the year
                          
                          $
                          2,444
                          
                          
                          $
                          2,114
                          
                          
                          $
                          812





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





105





VUANCE
LTD. AND SUBSIDIARIES
  CONSOLIDATED
STATEMENTS OF CASH FLOWS (Cont.)


U.S.
dollars in thousands




Year ended
                                December 31,2006
                              
                              
                              2007
                              
                              
                              2008Supplemental disclosure of cash flows
      information:Appendix
      A:Acquisition
      of subsidiaries net of cash acquired:Assets
      and liabilities of the subsidiaries, as of date of
    purchase:Working
      capital (excluding cash and cash equivalents)
                              
                              
                              -
                              
                              
                              $
                              1,157
                              
                              
                              
                              -Property
      and  equipment, net
                              
                              
                              -
                              
                              
                              
                              (38
                              )
                              
                              
                              -Intangible
      assets
                              
                              
                              -
                              
                              
                              
                              (1,531
                              )
                              
                              
                              -Goodwill
      recognized
                              
                              
                              -
                              
                              
                              
                              (3,644
                              )
                              
                              
                              -Shares
      issued
                              
                              
                              -
                              
                              
                              
                              3,903
                              
                              
                              
                              -$
                              -
                              
                              
                              $
                              (153
                              )
                              
                              $
                              -Appendix
      B:Cash paid in respect
      of sale of the e-ID DivisionAssets
      and liabilities of the division, at the date of sale:Working
      Capital, net
                              
                              $
                              2,073
                              
                              
                              
                              -
                              
                              
                              
                              -Fixed
      assets, net
                              
                              
                              2,800
                              
                              
                              
                              -
                              
                              
                              
                              -Intangible
      assets
                              
                              
                              47
                              
                              
                              
                              -
                              
                              
                              
                              -Fair
      value of marketable securities received as proceeds, net
                              
                              
                              (15,508
                              )
                              
                              
                              -
                              
                              
                              
                              -Capital
      gain on the sale of the e-ID Division
                              
                              
                              10,536
                              
                              
                              
                              -
                              
                              
                              
                              -$
                              (52
                              )
                              
                              
                              -
                              
                              
                              
                              -Cash paid during the
      year for:Interest
                              
                              $
                              76
                              
                              
                              $
                              415
                              
                              
                              $
                              171Taxes
      on income
                              
                              $
                              146
                              
                              
                              $
                              353
                              
                              
                              $
                              137Supplemental disclosure of non-cash investing and
      financing activities:Share
      capital issuance against redemption of note payable to former shareholder
      of a subsidiary
                              
                              $
                              -
                              
                              
                              $
                              432
                              
                              
                              $
                              -Accrued
      issuance costs
                              
                              $
                              19
                              
                              
                              $
                              -
                              
                              
                              $
                              -Issuance
      of shares to service providers and officer
                              
                              $
                              40
                              
                              
                              $
                              -
                              
                              
                              $
                              247
  1.
                            During
      the year 2008 additional goodwill in an amount of $276 was recorded with
      respect to the acquisition of SHC as a result of clarification of certain
      provisions of the acquired entity.
 2.
                            During
      2008, a modification of terms of convertible bonds in an amount of $2,500
      was determined to be a debt
extinguishment.





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





106




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 U.S.
dollars in thousands (except per share data)


NOTE
      1:-
            GENERAL




a.
              Vuance
      Ltd. (formally Supercom Ltd.) (the “Company") was incorporated in 1988 in
      Israel. The Company’s ordinary shares have been listed for trade on the
      Euronext Brussels stock market since October 23, 2003. The Company
      applied for delisting of its shares from the Euronext Brussels stock
      market, and its application was approved on May 6, 2008, effective August
      4, 2008. Since November 5, 2004, the Company’s ordinary shares have also
      traded on the OTC Bulletin Board. Since August 23, 2007, the ordinary
      shares of the Company were approved for trade on the NASDAQ Capital Market
      under the symbol “VUNC” and trading of the stock on the OTC Bulletin Board
      ceased.




On
December 11, 2008, the Company received a letter from the NASDAQ Capital Market
advising the Company that it did not comply with the continued listing
requirements of Listing Rule 5550(b) (formerly Marketplace Rule 4310(c)(3)),
which requires companies to have a minimum of $2,500 in stockholders’ equity, or
$35,000 in market value of listed securities, or $500 of net income from
continuing operations for the most recently completed fiscal year or two of the
three most recently completed fiscal years (the “Listing
Requirements”).




As a
result, the NASDAQ Capital Market Staff began reviewing the Company’s
eligibility for continued listing on the NASDAQ Capital Market. To facilitate
their review, the NASDAQ Capital Market Staff requested that the Company provide
on or before December 26, 2008, the Company’s specific plan to achieve and
sustain compliance with the NASDAQ Capital Market listing requirements,
including the time frame for completion of the plan (the
“Plan”).  After the Company submitted the Plan, on March 30, 2009 the
Company received further correspondence from NASDAQ that it did not comply with
the Listing Requirements, and therefore, trading of the Company’s ordinary
shares would be suspended at the opening of business on April 8, 2009, and a
form 25-NSE would be filed with the SEC removing the Company’s securities from
listing and registration on The NASDAQ Capital Market, unless the Company
requested an appeal of the delisting decision by NASDAQ.




The
Company appealed the NASDAQ determination to a NASDAQ Listings Qualifications
Panel (the “Panel”), which automatically stayed the delisting of the Company’s
ordinary shares until the Panel reached a decision.  On June 17, 2009, the
Panel granted the Company’s request for an extension of time to achieve full
compliance with the Listing Requirements.




The
Panel’s decision, and the Company’s continued listing on the NASDAQ Capital
Market, is subject to the Company’s compliance with certain conditions,
including demonstration by the Company that it has regained compliance with the
Listing Requirements by September 28, 2009. While the Company is executing on
its plan to regain compliance, there can be no assurance that the Company will
be able to do so.  Should the Company be unable to meet the exception
requirement, the Panel will issue a final determination to delist the Company’s
shares and, unless the NASDAQListing and Hearings
Review Council issues a stay, will suspend trading of the Company’s shares on
the NASDAQ Capital Market effective on the second business day from the date of
the final determination and the Company's ordinary shares could be eligible for
quotation and trading on the OTC Bulletin Board in accordance with applicable
rules and regulations.





107


VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      1:-
            GENERAL
      (Cont.)


a.
              (cont.)


The
Company develops and markets security solutions for viewing, tracking, locating,
credentialing, and managing essential assets and personnel. The Company's
solutions encompass electronic access control, urban security, and critical
situation management systems as well as long-range Active RFID for public
safety, commercial, and government sectors. The Company’s comprehensive product
line enables end-to-end solutions that can be employed to overcome security
challenges. Its Critical Situation Management System (CSMS) is a mobile
credentialing and access control system, designed to meet the needs of Homeland
Security and other public initiatives. Regarding the e-ID activity after the
closing of the sale of the e-ID Division to OTI, see below.




The
Company is headquartered in Franklin, WI.




The
Company sells its products through centralized marketing offices in U.S, Israel
and Hong-Kong. The Company has two wholly-owned marketing subsidiaries: Vuance
Inc. (formally Supercom Inc.) in the United States and SuperCom Asia Pacific
Limited in Hong Kong.




During
the fourth quarter of 2005, the Company set up a new subsidiary (80%), Vuance
RFID Inc., (formally: Pure RF Inc.,) (incorporated in Delaware) which began
operations during the first quarter of 2006. During the first quarter of 2006
Vuance RFID Inc., set up Vuance RFID Ltd (formally Pure RF Ltd.) (100%)
(incorporated and operating in Israel), and focuses on new technology and
solutions for active tracking of people and objects. During February 2007, the
Company purchased the remaining 20% from the minority of Vuance RFID Inc. for an
amount of $100.




Commencing
in 2008, Vuance RFID Inc engaged in the distribution of locks. This activity was
terminated in the fourth quarter of 2008 and it is presented as discontinued
operations.




The
assets attributed to the discontinued operations consist of inventory of the
activity which includes a write down in an amount of $65.




The
results of the discontinued operation for the year ended December 31, 2008, is
presented below:




Year ended
                            December 31, 2008Revenues
                          
                          $
                          5Net
      loss
                          
                          $
                          272





During
the fourth quarter of 2006, the Company set up a new wholly-owned subsidiary,
S.B.C. Aviation Ltd., (incorporated in Israel) which began operations in 2007,
and focuses on executing perimeter security and border control project at a
European International Airport.





108




VUANCE
LTD. AND SUBSIDIARIES





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)





U.S.
dollars in thousands (except per share data)




NOTE
      1:-
            GENERAL
      (Cont.)




a.
              (cont.)




On July
3, 2007, through its wholly-owned subsidiary, Vuance Inc., the Company entered
into an agreement (the “Purchase Agreement”) to acquire all of the issued and
outstanding share capital of Security Holding Corp. (“SHC”) from Homeland
Security Capital Corporation (OTCBB: HOMS.OB) (“HMSC”) and other minority
shareholders (collectively, “Sellers”) for approximately $4,335 in Vuance
ordinary shares (and direct expenses of approximately $600 as describe below).
The closing date was August 28, 2007. SHC is a Delaware corporation engaged,
directly and through its subsidiaries in the business of manufacturing and
distributing RFID-enabled solutions, access control and security management
systems. As consideration for the acquisition of SHC, the Company issued to the
sellers 1,097,426 ordinary shares of the Company.  Subject to certain
terms and conditions, in the event that the Company seeks to register any of its
ordinary shares under the Securities Act of 1933 for sale to the public, then at
HMSC’s request, the Company will use its reasonable best efforts to include the
Company's Shares owned by HMSC in such registration. The Sellers agreed to a
lock-up period during which, subject to certain exceptions, they will not sell
or otherwise dispose of the Company's Shares. The restrictions on making such
transactions will expire for HMSC - in eight equal installments, commencing on
the end of the first calendar quarter following the Closing and each of the
seven calendar quarters thereafter, and for the other Sellers - in twelve equal
installments, commencing on the end of the first calendar quarter following the
Closing and each of the eleven calendar quarters thereafter. HMSC also agreed
that during such restriction period, upon the occurrence of any sale by HMSC of
the Company's Shares due to HSMC’s bankruptcy, insolvency or otherwise by
operation of law, Vuance Inc and the Company will have a right of first refusal
to purchase all (but not less than all) of the Company's Shares held by HSMC on
certain terms and conditions. HMSC further agreed that at the Closing it will
grant an irrevocable power of attorney to the Chairman of the Board of Directors
of the Company, to exercise all voting rights related to its Vuance Shares until
the sale or transfer of such Vuance Shares by HMSC to an unaffiliated third
party in an arm’s-length transaction. As part of the Purchase Agreement, certain
Sellers will assume, subject to certain exceptions, certain non-competition and
employee non-solicitation undertakings for a period of two years commencing on
the date of Closing. According to the Purchase Agreement, the Company guaranteed
all of the obligations of Vuance Inc under such agreement.




During
the fourth quarter of 2007, the acquired companies (SHC and its subsidiaries)
were merged into Vuance Inc.




The
acquisition was accounted for under the purchase method and the Company
allocated the purchase price according to the fair value of the tangible and
intangible assets acquired and liabilities assumed. The purchase price was
calculated in accordance with EITF No 99-12 “Determination of the Measurement
Date for the Market Price of Acquirer Securities Issued in a Purchase Business
Combination” (“EITF No. 99-12”) after consideration with the lock-up mechanism
of the shares issued to the sellers. The results of operation acquired were
included in the consolidated financial statements of the Company commencing
August 28, 2007. (See also Note 8)





109




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      1:-
            GENERAL
      (Cont.)


a.
              (cont.)




The
consideration for the acquisition was attributed to net assets on the basis of
fair value of assets acquired and liabilities assumed, as follows:




August 28, 2007Intellectual
      Property
                    
                    $
                    525Brand
      name
                    
                    
                    500Customer
      Base
                    
                    
                    506Liabilities
                    
                    
                    (240
                    )Goodwill
                    
                    
                    3,644
                    (*)Total
                    
                    $
                    4,935





(*)
Regarding impairment of goodwill recognized in the fourth quarter of 2008, see
Note 8 below.




Goodwill
includes but is not limited to the synergistic value, accesses to new growing
markets and potential competitive benefits that could be realized by the Company
from the acquisition.




Below are
certain pro forma combined statements of income data for the years ended
December 31, 2006 and 2007, as if the acquisition of SHC had occurred on
January 1, 2006 and 2007, respectively, after giving effect to: purchase
accounting adjustments and amortization of identifiable intangible assets. This
pro forma financial information is not necessarily indicative of the combined
results that would have been attained had the acquisition taken place at the
beginning of 2006 and 2007, respectively, nor is it necessarily indicative of
future results.




Year ended December 31,2006
                          
                          
                          2007UnauditedNet
      sales
                          
                          $
                          12,500
                          
                          
                          $
                          15,300Net
      income (loss)
                          
                          $
                          2,170
                          
                          
                          $
                          (13,950
                          )Basic
      earnings (loss) per share
                          
                          $
                          0.429
                          
                          
                          $
                          (2.728
                          )Diluted
      earnings (loss) per share
                          
                          $
                          0.423
                          
                          
                          $
                          (2.728
                          )




In
September 2007, the Company announced that it had entered into a definitive
agreement to acquire, through its US subsidiary, Vuance Inc., the Credentialing
Division of Disaster Management Solutions Inc., for approximately $100 in cash.
In addition the Company undertook an obligation to pay up to $650 in royalties
that will be paid upon sales of the advanced first responder credentialing
system (named “RAPTOR”) during the first twelve months following the acquisition
(the closing was in August 2007). During the year 2008 there weren’t any sales
of RAPTOR.




Regarding
acquisition, after the balance sheet date, of certain of the assets and certain
of the liabilities of Intelli-Site, Inc., see Note 19d.





110




VUANCE
LTD. AND SUBSIDIARIES





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)





U.S.
dollars in thousands (except per share data)




NOTE
      1:-
            GENERAL
      (Cont.)


a.
              (cont.)




On
November 8, 2006, the Company announced that it had entered into an agreement
with On Track Innovations Ltd. ("OTI") (NASDAQ: OTIV), under which OTI agreed to
acquire the assets of the Company’s e-ID Division (including, inventory, fixed
assets and intangible assets) for consideration consisting of 2,827,200
restricted ordinary shares of OTI. The transaction was completed on December 31,
2006. At the closing, the parties entered into a service and supply agreement
pursuant to which the Company agreed to continue to provide services and receive
revenues under certain existing ID and e-ID contracts for governmental and
commercial projects in Europe, Asia and Africa. OTI agreed to serve as a
subcontractor for these projects. The 2,827,200 ordinary shares issued to the
Company were subject to a lock-up agreement, whereby 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. On April 24, 2007, OTI filed a registration Form F-3,
for the registration of the above mentioned shares, which became effective on
May 2, 2007. The Company executed an irrevocable proxy appointing OTI's
chairman, on behalf of the Board of Directors, or a person the Board of
Directors will instruct, to vote the 2,827,200 ordinary shares issued to the
Company in connection with the transaction. As a result of the sale of the e-ID
Division, the Company recognized $10,536 as a capital gain on the sale of the
e-ID Division in fiscal year 2006.




The
capital gain was calculated based on OTI’s share price on the closing date, less
a discount due to the lock up restrictions of the shares, the carrying value of
the assets that were transferred to OTI and direct expenses (in an amount of
$1,550) associated with the sale.




The
direct expenses included, inter alia, the fair value of 212,040 shares out of
the shares received by the Company from OTI that will be transferred to
consultants, as a finder and legal fee, in connection with the transaction (the
investment of the Company in OTI’s shares includes the shares held by the
Company, net of the shares that will be transferred to the consultants). As of
December 31, 2008 and 2007, the Company holds 63,768 and 1,308,484 shares of OTI
of which 63,768 and 108,040 are held by the Company but relate to consultants,
respectively. See Note 3.




As a
result of the transaction, the Company terminated the employment of certain
employees that were employed by the Company in the e-ID Division.




In
connection with the completion of the sale, during January 2007, a $2,500 loan
was extended to the Company by a financial institution. In order to secure this
loan, the Company deposited OTI shares in favor of the financial institution.
The loan was repaid during the year 2007.




b.
            Concentration
      of risk that may have a significant impact on the
  Company:




The
Company derives most of its revenues from several major customers. See also Note
16c.




The
Company purchases certain services and products used by it to generate revenues
in its projects and sales from several sole suppliers. Although there are only a
limited number of manufacturers of those particular services and products,
management believes that other suppliers could provide similar services and
products on comparable terms without affecting operating results.




c.
              On
      November 21, 2006 the Company announced that it had raised $3,156.5
      through the issuance of Units consisting of Convertible Bonds and
      Warrants. As of December 31, 2008, the Company is not in compliance with
      certain covenants under the Convertible Bond. See Note
  13.




111




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      1:-
            GENERAL
      (Cont.)


d.
              The
      Company has incurred substantial losses and negative cash flows from
      operations since its inception. The Company had an operating cash flow
      deficit in each of 2006, 2007, and 2008. As of December 31, 2008, the
      Company had an accumulated deficit of approximately $42,294 and the total
      shareholders' deficit amounted $1,867. The Company incurred net losses of
      approximately $11,311 and $12,358 in the years ended December 31, 2007 and
      December 31, 2008, respectively. For the year ended December 31, 2006, the
      Company would have incurred a net loss of $5,096, excluding the $10,536
      capital gain from the sale of the e-ID Division. The Company expects to
      have net operating losses and negative cash flows for the foreseeable
      future, and expects to spend significant amounts of capital to enhance its
      products and services, develop further sales and operations and fund
      expansion. As a result, the Company will need to generate significant
      revenue to achieve profitability. Even if the Company does achieve
      profitability, the Company may not be able to sustain or increase
      profitability on a quarterly or annual basis. Continuation of the
      Company's current operations after utilizing its current cash reserves is
      dependent upon the generation of additional financial resources either
      through fund raising or the sale of certain assets of the Company. These
      matters raise substantial doubt about the Company's ability to continue as
      a going concern. The Company is currently involves in negotiation with the
      convertible bonds holders to extend the payment schedule and is examining
      options to sale certain assets of the Company. The financial statements
      have been prepared assuming the Company will continue as a going concern.
      The financial statements do not include any adjustments that might result
      from the outcome of this
uncertainty.





NOTE
      2:-
            SIGNIFICANT
      ACCOUNTING POLICIES


The
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United
States.




a.
              Use
      of estimates:


The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.





b.
              Financial
      statements in U.S. dollars:


Most of
the revenues of the Company and its subsidiaries are received in U.S. dollars.
In addition, a substantial portion of the costs of the Company and its
subsidiaries are incurred in U.S. dollars. Therefore, management believes that
the dollar is the currency of the primary economic environment in which the
Company and its subsidiaries operate. Thus, the functional and reporting
currency of the Company and its subsidiaries is the U.S.
dollar.





Monetary
accounts maintained in currencies other than the U.S. dollar are re-measured
into U.S. dollars in accordance with Statement No. 52 of the Financial
Accounting Standards Board ("FASB") "Foreign Currency Translation" (“SFAS No.
52”). All transaction gains and losses from the re-measurement of monetary
balance sheet items are reflected in the statements of operations as financial
income or financial expenses as appropriate.





c.
              Principles
      of consolidation:


The
consolidated financial statements include the accounts of the Company and its
subsidiaries (unless the minority shareholders have certain approval or veto
rights) in Israel, the United States and Hong-Kong. Material intercompany
transactions and balances were eliminated upon consolidation. Material profits
from intercompany sales, not yet realized outside the group, were also
eliminated.





d.
              Cash
      equivalents:


The
Company considers unrestricted short-term highly liquid investments originally
purchased with maturities of three months or less to be cash
equivalents.





112




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      2:-
            SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)


e.
              Restricted
      cash deposits:




Restricted
cash includes: investments in certificates of deposit, which mature within one
year, and which are used to secure agreements with customers or banks, and cash
which is pledged to the Company's major convertible bond holder.





f.
              Marketable
      securities:




The
Company accounts for investments in marketable securities in accordance with
Statement of Financial Accounting Standard No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("SFAS No. 115"). Management
determines the appropriate classification of its investments in marketable
securities and commercial paper at the time of purchase and reevaluates such
determinations at each balance sheet date.





The
entire balance of marketable securities as of December 31, 2007, consists of
marketable securities received in connection with the OTI transaction, (see Note
1a).




Such
securities were classified as available-for-sale and were stated at fair value,
with unrealized gains and losses reported in accumulated other comprehensive
income in a separate component of shareholders’ equity, net of taxes. Realized
gains and losses on the sale of such securities, as determined on a specific
identified basis, are included in the consolidated statement of operations. SFAS
115, SAB 59, "Noncurrent Marketable Equity Securities" and other related
pronouncements require the company to perform periodic reviews of individual
securities to determine whether a decline in the value of a security is other
than temporary. Impairment of the value of an investment may be indicated by
conditions such as a prolonged period during which the quoted market value of
the investment is less than its original cost, severe losses by the investee in
the current year or current and prior years, continued losses by the investee
for a period of years, suspension of trading in the securities, liquidity or
going concern problems of the investee or a current fair value of the investment
that is less than its carrying value.




When
persuasive evidence exists that causes the Company to determine that a decline
in market value of equity securities is other than temporary, the unrealized
losses that are considered to be other than temporary are charged to income as
an impairment charge.




Since all
OTI securities were received by the Company on December 31, 2006, (upon the
closing of the OTI transaction) no unrealized gains or losses were recognized
during fiscal 2006.  During 2007, the Company recorded write down
expenses in an amount of $ 2,699 due to a decline in the fair value of OTI
securities that is considered other than temporary and recognized a loss in an
amount of $1,116. (See also Note 3)




During
2008, the Company sold all its OTI's shares and recognized a loss in an amount
of $862.





g.
              Allowance
      for doubtful accounts:


The
allowance for doubtful accounts is determined with respect to specific amounts
the Company has determined to be doubtful of collection. In determining the
allowance for doubtful accounts, the Company considers, among other things, its
past experience with such customers and the information available regarding such
customers.





h.
            Inventories:




Inventories
are stated at the lower of cost or market value. Inventory write-offs are mainly
provided to cover risks arising from slow-moving items or technological
obsolescence. Cost is determined as follows:




Raw
materials, parts and supplies - using the “moving average cost"
method.




Finished
products - on the basis of direct manufacturing costs, with the addition of
allocable, indirect manufacturing costs or, using the “moving average cost"
method.





113




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      2:-
            SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)




i.
            Investment
      in a certain majority owned
subsidiary:




The
investment in a certain majority-owned company is presented using the equity
method of accounting in accordance with Accounting Principle Bulletin No. 18,
“The Equity Method of Accounting for Investments in Common Stock”, due to
substantive participation rights held by the minority, which impact the
Company’s ability to exert control over the subsidiary. See Note 6.





j.
              Property
      and equipment:




Property
and equipment are stated at cost, net of accumulated depreciation.




Depreciation
is computed using the straight-line method, over the estimated useful lives, at
the following annual rates:





%Computers
      and peripheral equipment
                  
                  33Office
      furniture and equipment
                  
                  6 -
      15Leasehold
      improvements
                  
                  Over
      the shorter of the term of the lease or the life of the
    asset





k.
              Impairment
      of long-lived assets and intangible
assets:




The
Company's long-lived assets and certain identifiable intangible assets are
reviewed for impairment in accordance with Statement of Financial Accounting
Standard No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS No. 144") whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to the future undiscounted cash flows expected to be generated by the
asset. If such asset is considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the asset
exceeds the fair value of the asset. Assets to be disposed of by sale are
reported at the lower of the carrying amount or fair value, less costs to
sell.





l.
              Convertible
      Bonds:


1.
              Beneficial
      conversion feature:


The
Company has considered the provisions of EITF Issue No.00-19, “Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock”, and determined that the embedded conversion feature should
not be separated from the host instrument because it qualifies for equity
classification in paragraphs 12-32 of EITF Issue No.00-19. Furthermore, the
Company applied Emerging Issues Task Force Issue No. 00-27
(EITF 00-27). “Application of EITF Issue No. 98-5, Accounting for
Convertible Securities with Beneficial Conversion Features or Contingency
Adjustable Conversion Ratios, to Certain Convertible Instruments,” which is
effective for such instruments.  This EITF Issue clarified the
accounting for instruments with beneficial conversion features or contingency
adjustable conversion ratios.




The
beneficial conversion feature has been calculated by allocating the proceeds
received in financing transactions to the convertible instrument and to any
detachable warrants included in the transaction, and by measuring the intrinsic
value of the convertible instrument based on the effective conversion price as a
result of the allocated proceeds.





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NOTE
      2:-
            SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)


l.
              Convertible
      Bonds (cont.):


1.
              Beneficial
      conversion feature (cont.):


The
amount of the beneficial conversion feature with respect to convertible bonds
was recorded as a discount on the convertible bonds with a corresponding amount
credited directly to shareholders’ equity as additional paid in capital. After
the initial recognition, the discount on the convertible bonds is amortized as
interest expenses over the term of the bonds.




As stated
in Note 13, during 2008 the entire discount was recognized as an expense due to
a breach of the terms of the convertible bonds.





2.
              Issuance
      costs of convertible bonds – deferred
charges:


Costs
incurred in respect of obtaining financing through issuance of convertible bonds
are deferred and expensed as financing expenses over the contractual term of the
bonds.





3.
              Modification
      (or exchange) of a convertible
bonds


The
Company applied the provisions of EITF Issue 06-06 "Debtor's Accounting for a
Modification (or Exchange) of Convertible Debt Instruments" ("EITF No. 06-6")
and the provisions of EITF No. 96-19, "Debtor's Accounting or a Modification or
Exchange of Debt Instruments", with respect to the modification of terms of
convertible debt instruments. According to these pronouncements, the Company
concluded that the modification of convertible bonds that occurred during
November 2007 did not result in a debt extinguishment and the modification that
occurred in June 2008 was determined to be a debt extinguishment. See Note
13.




m.
              Accrued
      severance pay and severance pay
fund:




The
liabilities of the Company for severance pay of its Israeli employees are
calculated pursuant to Israel's Severance Pay Law. Employees are entitled to one
month's salary for each year of employment, or portion thereof. The Company's
liability for all its employees is presented under accrued severance pay. The
Company deposits on a monthly basis to severance pay funds and insurance
policies. The value of these policies is presented as an asset on the Company's
balance sheet.




The
deposited funds include accrued income up to the balance sheet date. The
deposited funds may be withdrawn only upon the fulfillment of the Company’s
obligation pursuant to Israel's Severance Pay Law or labor
agreements.




Severance
expenses for the years ended December 31, 2006, 2007 and 2008 amounted to $159,
$57 and $108, respectively.





n.
              Goodwill
      and Intangible assets:




Intangible
assets are amortized over their useful lives using the straight line method of
amortization that reflects the pattern in which the economic benefits of the
intangible assets are consumed or otherwise used up, in accordance with SFAS No.
142, “Goodwill and Other Intangible Assets". (SFAS No. 142)




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 not
amortized, but rather is tested for impairment at least annually or between
annual tests, if certain events or indications of impairment occur in accordance
with SFAS No. 142. Goodwill is tested for impairment at the reporting unit level
by comparing the fair value of the reporting unit with its carrying
value.




During
2008, the Company recorded an impairment of goodwill in an amount of $3,235. See
Note 8.





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NOTE
      2:-
            SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)




o.
            Revenue
      recognition:




The
Company and its subsidiaries generate their revenues from the sale of products,
maintenance, royalties and long term contracts (including training and
installation).




The sale
of products involves the sale of active and passive RFID products, CSMS and raw
materials. The Company sells its products in the USA through distributors and
directly, in Asia Pacific through a local subsidiary and directly in the rest of
the world.




Product
sales are recognized in accordance with Staff Accounting Bulletin No. 104,
“Revenue Recognition” (“SAB No. 104”), when persuasive evidence of an
agreement exists, delivery of the product has occurred, the fee is fixed or
determinable, collectability is probable, and inconsequential or perfunctory
performance obligations remain. If the product requires specific customer
acceptance, revenue is deferred until customer acceptance occurs or the
acceptance provision lapses.




The
Company recognized certain long-term contract revenues in accordance with
Statement of Position (“SOP”) 81-1, “Accounting for Performance of
Construction-Type and Certain Production Type Contracts.”




Pursuant
to SOP 81-1, revenues from these contracts are recognized under the percentage
of completion method.  The Company measure the percentage of
completion based on output or input criteria, such as contract milestones,
percentage of engineering completion or number of units shipped, as applicable
to in each contract.




Provisions
for estimated losses on uncompleted contracts are made during the period in
which such losses are first identified, in the amount of the estimated loss on
the entire contract. As of December 31, 2008, no such estimated losses were
identified.




The
Company believes that the use of the percentage of completion method is
appropriate, since the Company has the ability, using also independent
subcontractor's evaluation, to make reasonably dependable estimates of the
extent of progress made towards completion, contract revenues and contract
costs.  In addition, contracts executed include provisions that
clearly specify the enforceable rights of the parties to the contract, the
consideration to be exchanged and the manner and terms of
settlement.  In all cases, the Company expects to perform our
contractual obligations and the parties are expected to satisfy their
obligations under the contract.




In
contracts that do not meet all the conditions mentioned above, the Company
utilized zero estimates of profits; equal amounts of revenue and cost are
recognized until results can be estimated with sufficient accuracy.




Revenues
and costs recognized pursuant to SOP 81-1 on contracts in progress are subject
to management estimates.  Actual results could differ from these
estimates.




The
Company is not obligated to accept returned products or issue credit for
returned products, unless a product return has been approved by us in advance
and according to specific terms and conditions. As of December 31, 2008 the
Company had an allowance for customer's returns in the amount of
$88.




The
Company applied the provisions of EITF Issue No. 00-21 “Revenue Arrangements
with Multiple Deliverables” for multiple element arrangements. EITF Issue No.
00-21 provides guidance on how to account for arrangements that involve the
delivery or performance of multiple products, services and/or rights to use
assets. For such arrangements, each element of the contract is accounted for as
a separate unit when it provides the customer value on a stand-alone basis and
there is objective evidence of the fair value of the related unit.





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NOTE
      2:-
            SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)




o.
            Revenue
      recognition (cont.):




Maintenance
and support revenues included in multiple-element arrangements are deferred and
recognized on a straight-line basis over the term of the maintenance and support
agreement. For these multiple element arrangements, the Company accounts for
each unit of the contract (maintenance, support and services) as a separate
unit, when each unit provides value to the customer on a stand-alone basis and
there is objective evidence of the fair value of the stand-alone
unit.




Deferred
revenues and customer advances include amounts received from customers for which
revenues have not been recognized.




The
Company is entitled to royalties upon the issuance of certificates. Such
royalties are recognized when the sales are reported to the Company (usually on
a monthly basis).




The
Company derives our revenues mainly from sale of hardware products and long term
contracts that include embedded software that management considers to be
incidental. Such revenues are recognized in accordance with SAB No. 104 and SOP
81-1, as mentioned above. However, in limited circumstances, the Company
provides software upgrades in respect of the embedded software of hardware
products sold to our customers in the past. Such revenues are recognized when
all criteria outlined in Statement of Position No. 97-2 “Software Revenue
Recognition” (“SOP No. 97-2”) (as amended) are met: when persuasive evidence of
an agreement exists, delivery of the product has occurred (i.e. the services
have been provided), no significant obligations under the agreement remain, the
fee is fixed or determinable and collectability is probable.





p.
            Shipping
      and handling costs:




Shipping
and handling fees billed to customers are reflected as revenues while the
related shipping and handling costs are included in cost of revenues. To date,
shipping and handling costs have not been material.





q.
            Research
      and development costs:




Research
and development costs (other than software) are expensed as
incurred.




Research
and development costs incurred in the process of software production before
establishment of technological feasibility, are expensed as incurred. Costs of
the production of a product master incurred subsequent to the establishment of
technological feasibility are capitalized according to the principles set forth
in SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold,
Leased or Otherwise Marketed". Based on the Company's product development
process, technological feasibility is established upon completion of a detailed
program design or a working model.




Capitalized
software development costs are amortized on a product-by-product basis
commencing with general product release by the greater of the amount computed
using: (i) the ratio that current gross revenues from sales of the software
product bear to the total of current and anticipated future gross revenues from
sales of that software, or (ii) the straight-line method over the estimated
useful life of the software product (three years).





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NOTE
      2:-
            SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)




r.
            Income
      taxes:




The
Company and its subsidiaries account for income taxes in accordance with
Statement of Financial Accounting Standard (SFAS) 109, "Accounting for Income
Taxes". This Statement prescribes the use of the liability method whereby
deferred tax asset and liability account balances are determined based on
differences between the financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. The Company and its
subsidiaries provide a valuation allowance, if necessary, to reduce deferred tax
assets to their estimated realizable value.




Effective
January 1, 2007, the Company adopted FASB Interpretation No. 48 (FIN 48),
“Accounting for Uncertainty in Income Taxes” ("FIN 48 "). FIN 48 prescribes
detailed guidance for the financial statement recognition, measurement and
disclosure of uncertain tax positions recognized in an enterprise’s financial
statements in accordance with SFAS No. 109. According to FIN 48, tax positions
must meet a more-likely-than-not recognition threshold. The Company’s accounting
policy, pursuant to the adoption of FIN 48 is to classify interest and penalties
relating to uncertain tax positions under income taxes, however the Company did
not recognize such items in its fiscal 2007 and 2008 financial
statements.   The adoption of FIN 48 did not have a material
effect on the financial position and results of operations of the
Company.





s.
            Concentrations
      of credit risk:




Financial
instruments that potentially subject the Company to concentrations of credit
risk consist principally of cash and cash equivalents, restricted cash deposits,
marketable securities (on December 31, 2007) and trade receivables. The
Company's trade receivables are derived from sales to customers located
primarily in Europe (including Eastern Europe), the United States, Asia Pacific,
Africa, and Israel. The Company performs ongoing credit evaluations of its
customers' financial conditions. The allowance for doubtful accounts is
determined with respect to specific debts that the Company has determined to be
doubtful of collection. See Note 2g.




Cash and
cash equivalents, restricted cash deposits and marketable securities are
deposited with major banks in the United States, Israel and Hong-Kong.
Management believes that such financial institutions are financially sound and,
accordingly, minimal credit risk exists with respect to these financial
instruments.




The
Company has no significant off-balance-sheet concentration of credit risk, such
as foreign exchange contracts, option contracts or other foreign hedging
arrangements.





t.
            Basic
      and diluted earnings (loss) per
share:


Basic
earnings (loss) per share are computed based on the weighted average number of
ordinary shares outstanding during each year. Diluted earnings (loss) per share
are computed based on the weighted average number of ordinary shares outstanding
during each year, plus the dilutive potential of stock options and warrants
outstanding during the year using the treasury stock method and the dilutive
potential of convertible bonds using the “if-converted method”, in accordance
with SFAS No. 128, "Earnings per Share".





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NOTE
      2:-
            SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)




t.
            Basic
      and diluted earnings (loss) per share
(cont.):


The net
income (loss) and the weighted average number of shares used in computing basic
and diluted earning (loss) per share for the reported periods are as
follows:




Year ended December 31,2006
                    
                    
                    2007
                    
                    
                    2008Net
      income (loss) used for the computation of basic earnings (loss) per
      share
                    
                    
                    5,440
                    
                    
                    
                    (11,311
                    )
                    
                    
                    (12,358
                    )Interest
      expenses on convertible bonds
                    
                    
                    75
                    
                    
                    
                    -
                    
                    
                    
                    -Net
      income (loss) used for the computation diluted earnings (loss) per
      share
                    
                    
                    5,515
                    
                    
                    
                    (11,311
                    )
                    
                    
                    (12,358
                    )





Year ended December 31,2006
                    
                    
                    2007
                    
                    
                    2008Weighted
      average number of shares used in the computation of basic earnings (loss)
      per share
                    
                    
                    3,969,212
                    
                    
                    
                    4,391,860
                    
                    
                    
                    5,171,406Add:Additional
      shares from the assumed exercise of employee stock options and warrants,
      net
                    
                    
                    164,016
                    
                    
                    
                    -
                    
                    
                    
                    -Weighted
      average number of additional shares issued upon the assumed conversion of
      convertible bonds
                    
                    
                    79,563
                    
                    
                    
                    -
                    
                    
                    
                    -Weighted
      average number of shares used in the computation of diluted earnings
      (loss) per share
                    
                    
                    4,212,791
                    
                    
                    
                    4,391,860
                    
                    
                    
                    5,171,406





All
outstanding stock options, warrants and convertible bonds have been excluded
from the calculation of the diluted net loss per share for the years ended
December 2007 and 2008 since the effect of the shares issuable with respect of
these instruments was anti-dilutive.


The
number of potential shares from the conversion of convertible bonds, options and
warrants that have been excluded from the calculation were 795,279, 2,513,927
and 2,826,466 for the years ended December 31, 2006, 2007 and 2008
respectively.





u.
            Fair
      value of financial instruments:




The
following methods and assumptions were used by the Company and its subsidiaries
in determining their fair value disclosures for financial
instruments:




At
December 31, 2008 and 2007, the carrying amounts of cash and cash equivalents,
restricted cash deposits, marketable securities, current trade receivables,
other accounts receivable, trade payables, short-term bank credit and other
accounts payable approximate their fair value due to the short-term maturity of
such instruments. Regarding the fair value of marketable securities received
from the OTI transaction, see Notes 2f and Note 3.




As of
December 31, 2008, the carrying amount of the convertible bonds approximates
their fair value due to the fact that the bonds are presented at the principal
amount and the investors are entitled to demand immediate
repayment.





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NOTE
      2:-
            SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)




v.
            Accounting
      for stock-based compensation:




The
Company accounts for stock based compensation in accordance with FASB Statement
No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), which was
adopted effectively commencing January 2006.




SFAS 123R
requires an entity to estimate the fair value of equity-based payment awards on
the date of grant using an option-pricing model. The value of the portion of the
award that is ultimately expected to vest is recognized as an expense over the
requisite service periods in the Company’s consolidated statement of
operations.




The
Company estimates the fair value of employee stock options using a Black-Scholes
valuation model. The Company amortizes compensation costs using the graded
vesting attribution method over the vesting period, net of estimated
forfeitures.





w.
            Advertising
      costs:




The
Company expenses advertising costs as incurred. Advertising expenses for the
years ended December 31, 2006, 2007 and 2008, were approximately $18, $139 and
$58, respectively.





x.
            Comprehensive
      Income:




The
Company has no comprehensive income components other than net income (loss) in
the reporting periods.





y.
            Reclassifications:




Certain
comparative figures have been reclassified to conform to the current period
presentation. The changes were not material and did not affect net income, cash
flow or stockholders equity.





z.
            Fair
      value measurements:




In
September 2006, the FASB issued SFAS No.157, “Fair Value Measurements”
(“SFAS 157”). This Statement clarifies the definition of fair value, establishes
a framework for measuring fair value, and expands the disclosures on fair value
measurements. However, FAS 157 does not require any new fair value measurement.
The Company chose to apply the provisions of SFAS No. 157 early, beginning
January 1, 2007.




According
to SFAS 157, fair value is an exit price, representing the amount that would be
received to sell an asset or the amount that would be paid to transfer a
liability in an orderly transaction between market participants. As such, fair
value is a market-based measurement that is required to be determined based on
the assumptions that market participants would use to determine the price of an
asset or a liability.




As a
basis for considering such assumptions, SFAS 157 establishes the following fair
value hierarchy, which prioritizes the inputs used in the valuation
methodologies in measuring fair value:




Level 1 -
Quoted prices (unadjusted) in active markets that are accessible at the
measurement date for assets or liabilities. The fair value hierarchy gives the
highest priority to Level 1 inputs.




Level 2 -
Observable prices that are based on inputs not quoted on active markets, but
corroborated by market data.




Level 3 -
Unobservable inputs are used when little or no market data is available. Level 3
inputs are considered as the lowest priority under the fair value
hierarchy.





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NOTE
      2:-
            SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)




z.
            Fair
      value measurements (cont.):




In
determining fair value, companies are required to utilize valuation techniques
that maximize the use of observable inputs and minimize the use of unobservable
inputs to the extent possible as well as to consider counterparty credit risk in
the assessment of fair value.




As of
December 31, 2007, the Company measured the investments in marketable securities
at fair value in accordance with the provisions of SFAS 157. Such financial
instruments are classified within Level 1 due to the fact that these assets are
valued using quoted market prices. See Note 3.




Effective
October 10, 2008, the Company adopted FSP SFAS 157-3, “Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active” (“FSP SFAS
157-3”), which clarifies the application of SFAS 157, in an inactive market and
illustrates how an entity would determine fair value in an inactive market. FSP
SFAS 157 was issued in October 2008 and is effective immediately and applies to
prior periods for which financial statements have not been issued. The adoption
of FSP SFAS 157-3 did not have an impact on the Company’s consolidated results
of operations and financial position.




In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities - Including an amendment of FASB Statement
115” (“SFAS 159”). This pronouncement permits all entities to choose to
elect, at specified election dates, to measure eligible financial instruments at
fair value. Effective January 1, 2008, the Company adopted SFAS 159.
The adoption did not impact the financial position and results of operations of
the Company.




aa.
            Recently
      issued accounting pronouncements:




SFAS No.
141(R), “Business Combinations”




In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations”.
This Statement will replace SFAS No. 141, “Business Combinations” (“SFAS
141(R)”). SFAS 141(R) retains the fundamental requirements of SFAS 141 with
respect to the implementation of the acquisition method of accounting ("the
purchase method") for all business combinations and for the identification of
the acquirer for each business combination. This Statement also establishes
principles and requirements for how the acquirer recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
and any noncontrolling interest in the acquiree, how the acquirer recognizes and
measures the goodwill acquired in a business combination and the disclosure
requirements to enable users of the financial statements to evaluate the nature
and financial effects of the business combination.




SFAS
141(R) will apply prospectively to business combinations for which the
acquisition date is on or after December 15, 2008 (January 1, 2009 for the
Company). Early adoption of SFAS 141(R) is prohibited. The Company believes that
the initial adoption of SFAS 141R will not have a material impact on its
financial position and results of operations. However, due to the changes
described above, consummation of business combinations after the adoption of
SFAS 141R, could significantly impact the consolidated financial statements as
compared to prior acquisitions which were accounted for under existing GAAP
requirements.





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NOTE
      2:-
            SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)




aa.
            Recently
      issued accounting pronouncements
(cont.):




SFAS
No. 160, “Noncontrolling Interests in Consolidated Financial
Statements”




In
December 2007, the SFASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements” (“SFAS 160”). This Statement amends ARB 51
and establishes accounting and reporting standards for the noncontrolling
(minority) interest in a subsidiary and for the deconsolidation of a subsidiary.
SFAS 160 clarifies that a noncontrolling interest in a subsidiary is an
ownership interest in the consolidated entity that should be reported as equity
in the consolidated financial statements. SFAS No. 160 is effective for
fiscal years beginning on or after December 15, 2008 (January 1, 2009 for the
Company). Early adoption of SFAS 160 is prohibited. The Company believes that
the adoption of SFAS 160 will not have a material impact on its financial
position and results of operations.




FSP
SFAS 142-3, “Determination of the Useful Life of Intangible
Assets”




In April
2008, the FASB issued FSP SFAS No. 142-3, “Determination of the Useful Life of
Intangible Assets” (“FSP FAS 142-3”). FSP SFAS 142-3 amends the factors
that should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under FASB Statement
No. 142, “Goodwill and Other
Intangible Assets”.




This
pronouncement requires enhanced disclosures concerning a company’s treatment of
costs incurred to renew or extend the term of a recognized intangible asset. FSP
SFAS No. 142-3 is effective for financial statements issued for fiscal years
beginning after December 15, 2008 (January 1, 2009 for the Company). Early
adoption is prohibited. The Company believes that the adoption of SFAS No.
142-3 will not have an impact on its financial position and results of
operations.




FSP
SFAS 115-2 and SFAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments (“FSP SFAS 115-2
and 124-2”)




On
April 9, 2009, the FASB issued FSP SFAS 115-2 and 124-2 which is
intended to make the guidance more operational and improve the presentation and
disclosure of other-than-temporary impairments (“OTTI”) on debt and equity
securities in the financial statements. FSP SFAS 115-2 and 124-2 applies to debt
securities and requires that the total OTTI be presented in the statement of
income with an offset for the amount of impairment that is recognized in other
comprehensive income, which amount represents the noncredit component. Noncredit
component losses are to be recorded in other comprehensive income if an investor
can assess that (a) it does not have the intent to sell or (b) it is
not more likely than not that it will have to sell the security prior to its
anticipated recovery. FSP SFAS 115-2 and 124-2 is effective for interim and
annual periods ending after June 15, 2009, with early adoption permitted
for periods ending after March 15, 2009. FSP SFAS 115-2 and 124-2 will be
applied prospectively with a cumulative effect transition adjustment as of the
beginning of the period in which it is adopted. An entity early adopting FSP
SFAS 115-2 and 124-2 must also early adopt FSP SFAS 157-4 (as described below).
The Company is currently evaluating the impact of FSP SFAS 115-2 and 124-2 on
the consolidated financial statements.




FSP
SFAS 157-4, Determining Fair Value When the Volume and Level of Activity
for the Asset or Liability Have Significantly Decreased and Identifying
Transactions that are not Orderly (“FSP SFAS 157-4”).





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            SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)




aa.
            Recently
      issued accounting pronouncements
(cont.):




On April
9, 2009, the FASB issued FSP SFAS 157-4 which provides additional guidance
on determining whether a market for a financial asset is not active and a
transaction is not distressed for fair value measurements under SFAS 157,
Fair Value Measurements. FSP SFAS 157-4 will be applied prospectively and
retrospective application will not be permitted. FSP SFAS 157-4 will be
effective for interim and annual periods ending after June 15, 2009, with
early adoption permitted for periods ending after March 15, 2009. An entity
early adopting FSP SFAS 157-4 must also early adopt FSP SFAS 115-2
and 124-2.  The Company is currently evaluating the impact of FSP
SFAS 157-4 on the consolidated financial statements.





NOTE
      3:-
            MARKETABLE
      SECURITIES




The
entire balance of marketable securities as of December 31, 2007 consists of
marketable securities received in connection with the OTI
transaction.




As stated
in Note 1a, 2,827,200 ordinary shares were issued to the Company in connection
with the OTI transaction (hereinafter – "OTI shares") (of which 212,040 shares
were received by the Company but relate to its consultants).




Securities
which were not considered restricted according to the provisions of SFAS No. 115
(securities that were subject to a lockup of less than one year), were
classified as available-for-sale and were stated at fair value (after
consideration with the relevant restriction period of each portion). There were
no securities that are considered to be restricted under the provisions of SFAS
No. 115, as of December 31, 2007.




During
2007, the Company sold 1,414,716 shares of the OTI shares for a total amount of
$7,639 and recorded net realized losses in an amount of $1,116. As of December
31, 2007, the Company recorded write-down expenses in an amount of $2,699, due
to the decline in the fair market value of OTI securities that was considered
other than temporary. As of that date, the Company held 1,308,484 OTI shares (of
which 108,040 were held by the Company but relate to its consultants in the OTI
transaction) of which 373,594 and 373,594 (excluding the shares related to the
consultant as mentioned above) were subject to the abovementioned lock-up
agreement and were restricted for three month and six month periods,
respectively.




During
2008, the Company sold the remaining, 1,200,444 OTI shares, for a total amount
of $3,192 and recorded net realized losses in an amount of $862. As of December
31, 2008, the Company holds 63,768 shares of OTI of which 63,768 are held by the
Company but relate to consultant.




As
required under SFAS No. 115 for available for sale securities, OTI securities
were stated at fair value. The fair value of OTI shares was measured on a
recurring basis at each balance sheet date based on the market value of OTI
securities, using quoted prices in active market (Level 1 inputs as defined in
SFAS 157), and after consideration of the discount due to the
lockup.





123




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LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      4:-
            OTHER
      ACCOUNTS RECEIVABLE AND PREPAID
EXPENSES




December
      31,2007
                        
                        
                        2008Prepaid
      expenses
                        
                        $
                        689
                        
                        
                        $
                        496Government
      authorities
                        
                        
                        204
                        
                        
                        
                        413Advance
      payment to suppliers
                        
                        
                        1,455
                        
                        
                        
                        63Others
                        
                        
                        52
                        
                        
                        
                        102$
                        2,400
                        
                        
                        $
                        1,074





NOTE
      5:-
            INVENTORIES




December
      31,2007
                    
                    
                    2008Raw
      materials, parts and supplies
                    
                    $
                    94
                    
                    
                    $
                    170Finished
      products
                    
                    
                    472
                    
                    
                    
                    1,137$
                    566
                    
                    
                    $
                    1,307





As of
December 31, 2007 and 2008 the inventory is presented net of allowance for slow
inventory in the amount of approximately $100, and $109,
respectively.





NOTE
      6:-
            INVESTMENT
      IN A CERTAIN MAJORITY OWNED
SUBSIDIARY




In
December 1997, the Company set up SuperCom Slovakia, owned equally with another
third-party investor, in order to execute a transaction with the Ministry of
Interior of the Slovak Republic.




In March
2000, the Company purchased an additional 16% of SuperComSlovakia, at a nominal value of $1, and
granted such third-party investor a loan in an amount of $275, bearing interest
of 0.7% per month, for any amounts outstanding. Interest is compounded on the
outstanding principal balance of the loan and is to be repaid under the same
conditions as the outstanding principal balance.




The
third-party investor has an option to buy back 16% of the shares, for $1, upon
repayment of the loan to the Company.




The
Company currently owns 66% of SuperCom Slovakia's outstanding shares and
accounts for the investment using the equity method of accounting, due to the
substantive participation rights held by the minority, which impact the
Company’s ability to exert control over the subsidiary.




During
the fourth quarter of 2006, the Company wrote down the entire loan balance in
that company due to litigation developments regarding this issue and due to low
probability of collection. See Note 11c2. During the reported periods, the
subsidiary had no operating activity.





124




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LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      7:-
            PROPERTY
      AND EQUIPMENT





December
      31,2007
                    
                    
                    2008Cost:Computers
      and peripheral equipment
                    
                    $
                    287
                    
                    
                    $
                    354Office
      furniture and equipment
                    
                    
                    193
                    
                    
                    
                    193Leasehold
      improvements
                    
                    
                    33
                    
                    
                    
                    39513
                    
                    
                    
                    586Accumulated
      depreciation:Computers
      and peripheral equipment
                    
                    
                    183
                    
                    
                    
                    243Office
      furniture and equipment
                    
                    
                    92
                    
                    
                    
                    103Leasehold
      improvements
                    
                    
                    20
                    
                    
                    
                    22295
                    
                    
                    
                    368Depreciated
      cost
                    
                    $
                    218
                    
                    
                    $
                    218





Depreciation
expenses for the years ended December 31, 2006, 2007 and 2008, were $335, $38
and $73, respectively.





NOTE
      8:-
            OTHER
      ASSETS




a.
              Goodwill


The
changes in the carrying amount of goodwill for the years ended December 31, 2007
and 2008 are as follows:





December
      31,2007
                                
                                
                                2008Balance
      as of January 1
                                
                                $
                                -
                                
                                
                                $
                                3,644Goodwill
      resulting from acquisition of SHC (see Note 1a)
                                
                                
                                3,644
                                
                                
                                
                                -Adjustment
      (*)
                                
                                
                                -
                                
                                
                                
                                276Impairment
      loss (**)
                                
                                
                                -
                                
                                
                                
                                (3,235
                                )Balance
      as of December 31
                                
                                $
                                3,644
                                
                                
                                $
                                685




(*)
              During
      2008, the Company adjusted the amount of goodwill resulted from the
      acquisition of SHC due to:




·
              Allowance
      for sales prior to the acquisition in the amount of
  $202




·
              Liabilities
      to employees prior to the transaction date, in the amount of $
      34




·
              Direct
      expenses related to the acquisition in the amount of
  $40




(**)
              As
      part of the annual review for impairment in accordance with SFAS No. 142
      and 144, in November 2008, the Company examined the fair value of the
      intangible assets and the goodwill and in doing so, considered in part, a
      third party expert services. The valuation referred to the U.S.
      subsidiary as a single reporting
unit.




The
valuation was conducted on a going concern basis. Since the U.S. subsidiary is
closely-held, and thus without a public market for its ownership interests, the
appraisal was conducted according to common appraisal practices, and was based
on the Free Discounted Cash-Flows ("DCF") method.




In
addition, the Company received market indication with respect to the fair value
of the U.S. subsidiary in the first quarter of 2009. Based on the above the
Company was required to recognize an impairment loss in the amount of
$3,235.





125




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LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      8:-
            OTHER
      ASSETS (Cont.)




b.
              Intangible assets and
      deferred charges




December 31,Amortization
                                          period
                                        
                                        2007
                                        
                                        
                                        2008CostDeferred
      charges (a)
                                        
                                        Over
      the contractual life of the bonds
                                        
                                        $
                                        255
                                        
                                        
                                        $
                                        255Capitalized
      research and development costs (b)
                                        
                                        3
      Years
                                        
                                        
                                        280
                                        
                                        
                                        
                                        280Patents
      (c)
                                        
                                        3
      Years
                                        
                                        
                                        104
                                        
                                        
                                        
                                        104Intellectual
      Property (d), (e)
                                        
                                        3
      Years (*)
                                        
                                        
                                        650
                                        
                                        
                                        
                                        650Brand
      name (e)
                                        
                                        5
      Years (*)
                                        
                                        
                                        500
                                        
                                        
                                        
                                        500Customer
      Base (e)
                                        
                                        5
      Years (*)
                                        
                                        
                                        506
                                        
                                        
                                        
                                        506$
                                        2,295
                                        
                                        
                                        $
                                        2,295Accumulated amortizationDeferred
      charges
                                        
                                        
                                        
                                        $
                                        96
                                        
                                        
                                        $
                                        255Capitalized
      research and development costs
                                        
                                        
                                        
                                        
                                        43
                                        
                                        
                                        
                                        136Patent
                                        
                                        
                                        
                                        
                                        16
                                        
                                        
                                        
                                        55Intellectual
      Property
                                        
                                        
                                        
                                        
                                        61
                                        
                                        
                                        
                                        306Brand
                                        
                                        
                                        
                                        
                                        33
                                        
                                        
                                        
                                        133Customer
      Base
                                        
                                        
                                        
                                        
                                        34
                                        
                                        
                                        
                                        135283
                                        
                                        
                                        
                                        1,020Amortized
      cost
                                        
                                        
                                        
                                        $
                                        2,012
                                        
                                        
                                        $
                                        1,275




(*)
            Commencing
      on the closing date of the acquisition of SHC on August 28, 2007. See also
      Note 1a.




a.
              The
      deferred charges were incurred in respect of the issuance of convertible
      bonds during November, 2006 (an additional amount of $52 was recognized
      during 2007 with respect to those convertible bonds). Due to a breach of
      certain convertible bonds covenants in 2008, among other things, the
      Company had to accelerate deferred expenses in the amount of $138. See
      Note 13




b.
              During
      2007, the Company capitalized an amount of $280, related to the
      development of its CSMS
product.




c.
              During
      February 2007, the Company purchased the remaining 20% of Vuance RFID from
      the minority for an amount of $100, which was attributed to
      patents.




d.
              During
      the third quarter of 2007, the Company acquired the Credentialing Division
      of Disaster Management Solutions Inc. for an amount of $125. As a result
      of this transaction the Company allocated costs to Intellectual
      Property.




e.
              During
      the third quarter of 2007, the Company acquired all of the issued and
      outstanding stock capital of SHC. As described in Note 1a, the Company
      allocated cost to:




Intellectual
Property, Brand name, Customer Base and Goodwill.




Amortization
of intangible assets and deferred charges amounted to $20, $277 and $737 for the
years ended December 2006, 2007 and 2008, respectively.




Estimated
amortization expenses for the next years are $548, $388, $203, and $136 in the
years 2009, 2010, 2011 and 2012, respectively.





126




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


NOTE
      9:-
            BANK
      CREDIT





a.
              As
      of December 31, 2008, Vuance Inc had an account receivable line of credit
      from Bridge Bank in an aggregate amount of up to $ 1,000, and as of
      that date the amount of the loan was $296. The credit line bears interest
      at the WSJ Prime Rate plus an additional 2.5% annualized on the average
      daily gross financed amount outstanding. The Floor on Prime Rate is 6%. In
      addition Vuance Inc is required to pay minimum monthly interest of $1.5,
      plus a Facility fee of $7.5 annually. Bridge Bank has a perfect first
      position security interest in all of Vuance Inc's current and future
      assets, including intellectual property and general
      intangibles.





The
weighted average interest rate on the credit line as of December 31, 2008 was
approximately 8.5%.





Other
than the loan from Bridge Bank, the Company has no other line from a
bank.





b.
              Long-term
      loans:





December 31,2007
                                  
                                  
                                  2008Banks
                                  
                                  $
                                  438
                                  
                                  
                                  $
                                  -Less
      - current maturities of long-term loans
                                  
                                  
                                  438
                                  
                                  
                                  
                                  -$
                                  -
                                  
                                  
                                  $
                                  -





c.
            Regarding
      guarantees and liens - see Note
11b.





NOTE
      10:-
            ACCRUED
      EXPENSES AND OTHER LIABILITIES





December
      31,2007
                    
                    
                    2008Customer
      advances (*)
                    
                    $
                    4,334
                    
                    
                    $
                    1,521Deferred
      revenues
                    
                    
                    258
                    
                    
                    
                    234Accrued
      expenses (**)
                    
                    
                    2,024
                    
                    
                    
                    3,161Other
                    
                    
                    25
                    
                    
                    
                    91$
                    6,641
                    
                    
                    $
                    5,007





(*)
              As
      of December 31, 2007 and 2008, an amount of $4,318 and $1,330,
      respectively, relates to advances from customers with respect to long term
      contract.





(**)
              As
      of December 31, 2007 and 2008, includes $141 and $1,260, respectively, of
      interest and financing charges related to convertible bonds, $1,099 and
      $192, respectively, related to marketing expenses and $26 and $876,
      respectively, related to subcontractors of long term
    contract.





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


NOTE
      11:-
            COMMITMENTS
      AND CONTINGENT LIABILITIES




a.
            Lease
      commitments:




The
Company's facilities and those of certain subsidiaries are rented under several
operating lease agreements for periods ending in 2009 - 2011.




On April
18, 2005, the Company signed a lease for new offices in Qadima, (Israel). The
lease is for a period of five years commencing on November 1, 2005. The Company
has an option to extend the lease period for an additional five years on similar
terms. According to the lease, the monthly fee is $16. The Company subleases a
portion of these leased facilities.




The
Company's subsidiary in the USA has several leased facilities in Franklin WI,
Peachtree City, GA and Gardner, MA. The monthly fee of the facility in Franklin,
WI is $6 and the total monthly fee of all such other leased facilities is
$4.




Vuance,
Inc. also leases a facility in Rockville, Maryland for a monthly fee of $4.8
which is subleased for a monthly fee of $4.1.




SuperCom
Asia Pacific leases a facility in Hong Kong for a monthly fee of
$4.3.




Future
minimum lease commitments under non-cancelable operating leases (including the
portion leased to subsidiary lessees as describe above) for the years ended
December 31, are as follows:




2009
                          
                          $
                          4642010
                          
                          
                          2672011
                          
                          
                          39$
                          770




Rent
expenses for the years ended December 31, 2006, 2007 and 2008, were
approximately $355, $376 and $440, respectively.





b.
              Guarantees,
      indemnity and liens:


1.
              The
      Company issued bank guarantees in the amount of $48 to secure a certain
      lease of the Company. As a condition of these guarantees, the Company
      deposited $49, which is included as part of the restricted cash
      deposits.




2.
              The
      Company issued a bank guarantee in the amount of $1,487 to a supplier,
      related to a certain project of the Company with a European country. As a
      condition of this guarantee, the Company deposited $1,492, which is
      included as part of the restricted cash
  deposits.




3.
              Under
      the sale agreement of the e-ID Division to OTI, the Company agreed to
      indemnify OTI for any breaches of the Company’s representations,
      warranties, covenants and obligations for twelve months from the closing
      date (December 31, 2006).  The indemnification also covers any
      claim based on the Company’s alleged infringement on the intellectual
      property of any third party. As of the date of the approval of these
      financial statements there was no claim for breach from the
      OTI.




4.
              In
      order to secure the line of credit from Bridge Bank, the Bank received a
      first position security interest in all of Vuance Inc's current and future
      assets, including intellectual property and general intangibles. See also
      Note 9a above.




5.
              The
      Company pledged $534 to the Company's major convertible bond holder, which
      amount is presented in restricted cash. As of December 31, 2008, the
      principal amount of this convertible bond is
  $2,500.




6.
              In
      order to secure an agreement with a customer, the Company provided bank
      guarantees in the amount $75. As a condition of this guarantee, the
      Company deposited $75 in the bank, which is included as part of restricted
      cash.





128




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


NOTE
      11:-
            COMMITMENTS
      AND CONTINGENT LIABILITIES (Cont.)




c.
              Litigation:




1.
              In
      April 2004, the Department for Resources Supply of the Ministry of Ukraine
      (the "Department") filed a claim with the International Commercial
      Arbitration Court at the Ukrainian Chamber of Commerce and Industry (the
      “Arbitration Court”) to declare Contract No. 10/82 (the “Contract”), dated
      April 9, 2002, between the Company and the Ministry of Internal Affairs of
      the Ukraine (the "Ministry"), as void due to defects in the proceedings by
      which the Company was awarded the Contract.  In July, 2004, the
      Arbitration Court declared the Contract as void.  On April 27,
      2005, the Company appealed the decision to the High Commercial Court of
      the Ukraine.  In May 2005, the Department filed a new statement
      of claim with the Arbitration Court for restitution of $1,048 paid to the
      Company by the Department under the Contract.  On September 27,
      2005, the Company received a negative award issued by the Arbitration
      Court in the second claim (the "Award").  On December 12, 2005,
      the Company was informed that the Ukrainian Supreme Court had dismissed
      its appeal regarding the July 2004 decision. On June 29, 2006, the
      Ukrainian Supreme Court held that the Arbitration Court award was valid
      and legal under applicable
law.




On
September 28, 2008 the Department filed a petition (the "Petition") in the
Central District Court of Israel (the "Court"), under which the Department
requested the approval of the Award as a valid foreign arbitral award under the
laws of the State of Israel.




During
November 2008, the Company filed with the Court an objection to the Petition and
a petition to declare the Award null and void. The Company's objection and
petition rely on what the Company believes to be well-based evidence which the
Company has against the manner under which the arbitration proceedings were
conducted by the Arbitration Court and against their validness and legality. The
Company believes that the arbitration proceedings were conducted partially and
jeopardized its basic rights. The Company's claims are also corroborated by a
contrary legal opinion written in the scope arbitration decision by one of the
arbitrators ("Arbitrator").




On
February 16, 2009, the Department filed its response to the Company's claims
(the "Response"). The Department raised in its Response procedural and other
claims, including a claim that the Company filed in the Ukraine a monetary claim
which is based on the Award and the filing of such claim basically affirms the
Company’s acknowledgment that the Award is valid. On March 25, 2009 the Company
filed a response to the Department's response and a requisition to order the
Arbitrator, to testify in the scope of the Petition proceedings (the Court's
decision regarding the said request has not been given yet).




On June
6, 2009 a preliminary court session was held regarding the Petition. During the
session, the Department's counsel claimed that one of the two machines that the
Company previously supplied pursuant to the Contract (which machine is priced
higher than the amount of the Department's claim), was not supplied to the
Department and was transferred by the Company to another Ukrainian governmental
authority. It is noted that the Company has documents that evidence that,
contrary to the Department's claim, the Company supplied both of the machines
directly to the Department. The file was scheduled for an additional session on
September 23, 2009.





129




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 U.S.
dollars in thousands (except per share data)


NOTE
      11:-
            COMMITMENTS
      AND CONTINGENT LIABILITIES (Cont.)




c.
              Litigation
      (cont.):


1.
              (cont.)


Based on
the opinion of its legal advisors, the Company believes that the above mentioned
Ukrainian Arbitration Court decision is incorrect, as a matter of law, that the
Ukrainian government’s claim has no merit and that the Ukrainian Arbitration
Proceedings were legally defective.  The Company, based on its legal
counsels, further believes that there is a good chance that the Petition will be
denied. Therefore no provision has been made in the financial statements in
respect of the claim for restitution of $1,048.




The
Company did not have any revenues from this project in 2006, 2007 and
2008.




2.
              On
      October 30, 2003, SuperCom Slovakia, a subsidiary (66%) of Vuance Ltd.,
      received an award from the International Arbitral Center of the Austrian
      Federal Economic Chamber, in a case against the Ministry of Interior of
      the Slovak Republic (“the Ministry”) relating to the Agreement on Delivery
      of Technology, Cooperation and Services signed on March 17,
      1998.  Upon the Arbitral Award, the Ministry of Interior of the
      Slovak Republic was ordered to pay SuperCom Slovakia the amount of SKK
      80,000,000 (approximately $3,758 as of December 31, 2008) plus interest
      accruing from March 1999. In addition, the Ministry of Interior of the
      Slovak Republic was ordered to pay the costs of arbitration in the amount
      of EUR 42,716 (approximately $60 as of December 31, 2008) and SuperCom
      Slovakia’s legal fees in the amount of EUR 63,611 (approximately $89 as of
      December 31, 2008).  The Company has begun an enforcement
      proceeding to collect the arbitral awards.  The Ministry of
      Interior of the Slovak Republic filed a claim with the Commercial Court in
      Vienna, Austria on February 10, 2004, whereby it challenged and requested
      to set aside the arbitral award.  During September 2005, the
      Commercial Court of Vienna dismissed the claim.  On October 21,
      2005, the Ministry of the Interior of the Slovak Republic filed an
      appeal.  On August 25, 2006, the Austrian Appellate Court
      rejected the appeal and ordered the Ministry to reimburse Supercom
      Slovakia ́s costs of the appellate proceeding in the amount of EUR 6,688
      within 14 days.  On October 3, 2006, the Company was informed
      that the Ministry had decided not to file an extraordinary appeal to the
      Austrian Supreme Court’s decision rejecting its appeal. To date, the
      Company’s efforts to enforce the Commercial Court’s decision have been
      unsuccessful.




130




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


NOTE
      11:-
            COMMITMENTS
      AND CONTINGENT LIABILITIES (Cont.)


c.
              Litigation
      (cont.):


3.
              On
      December 16, 1999, Secu-Systems Ltd. filed a lawsuit with the District
      Court in Tel-Aviv-Jaffa jointly and severally against the Company and its
      former subsidiary, InkSure Ltd. (“InkSure”), seeking a permanent
      injunction and damages arising from the printing method applied to certain
      products developed by InkSure. In its lawsuit, Secu-Systems asserted
      claims of breach of a confidentiality agreement between Secu-Systems and
      the Company, unjust enrichment of the Company and InkSure, breach of
      fiduciary duties owed to Secu-Systems by the Company and InkSure and
      misappropriation of trade secrets and damage to Secu-Systems’
      property.  On March 15, 2006, the Court denied the breach of
      contract claim, but upheld the claim for misappropriation of trade secrets
      and ordered InkSure and the Company to cease all activity involving the
      use of the confidential knowledge and/or confidential information of
      Secu-Systems. In addition, the court ordered the Company and Inksure to
      provide a report certified by an accountant setting forth in full the
      income and/or benefit received by InkSure and the Company as a result of
      the infringing activity through the date of the judgment, and ordered the
      Company and Inksure, jointly and severally, to pay to Secu-Systems
      compensation in the sum of NIS 100,000 ($26 as of December 31, 2008) and
      legal expenses as well as attorney’s fees in the sum of NIS 30,000 ($8 as
      of December 31, 2008) (which was paid during 2006). Secu-Systems has filed
      an appeal, and the Company and InkSure filed a counter-appeal, on the
      above ruling.   On November 1, 2007, the Supreme Court
      accepted Secu-Systems' appeal and stated that Inksure and the Company have
      breached the confidentiality agreement. Consequently, the appeal that had
      been filed by Inksure and the Company was dismissed. The Supreme Court
      instructed that the case be returned to the District Court for determining
      the remedies to which Secu-Systems is
entitled.




On
February 18, 2008, Secu-System filed a petition with the District Court asking
that the court allow Secu-System to amend the amount for which it sued as stated
in the Statement of Claims to NIS 25,000,000 (approximately $6,575 as of
December 31, 2008). The petition is mainly based on the fact that in 2002,
Inksure was sold by the Company to a third party for a consideration of
approximately $6,000 and upon Secu-System's assertion that such amount of
consideration constitutes a benefit and/or profit which seems to have been
derived from the breach of the confidentiality agreement and upon the assertion
that Secu-System is entitled, in light of the Supreme Court's ruling with
respect to the breach of the confidentiality agreement, to receive such amount.
Another argument made by Secu-System relates to the profit which Inksure
allegedly generated from the breach of the confidentiality agreement; this
argument is based on an aggregate gross profit of $6,400 according to the
financial statements of Inksure for the years 2002-2007.




On March
24, 2008, the Company provided its lawyers with an opinion of a consultant on
the subject matter, whereby the following conclusions can be drawn:




a.
              In
      light of the cost analysis, the Company had no economic profit from the
      sale of Inksure's shares.




b.
              The
      examination of the results of Inksure's business activity in 2002-2007, as
      reflected in its financial reports, shows that Inksure has not made any
      profits, and even suffered losses in the said period. The financial
      reports also show that Inksure had a negative cash flow in these years,
      which was financed by bank loans and fund
  raising.




On
December 8, 2008, a court session with respect to the petition was held and the
Company is waiting for the court decision.





131




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LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      11:-
            COMMITMENTS
      AND CONTINGENT LIABILITIES (Cont.)


c.
              Litigation
      (cont.):


3.
              (cont.)


In light
of the above, provided that the consultant's opinion on the subject matter is
adopted by the court, and provided further that Inksure's financial reports
indeed reflect its business results, the Company's lawyers are of the opinion
that no material amounts will be awarded to Secu-System in these
proceedings.




Due to
the circumstances described above, the Company made an allowance of $100, in
2007 that reflects the expected legal expenses related to this
litigation.




5.
              On
      May 1, 2006, Evilia Investments Ltd. (“Evilia”) filed a claim in the Tel
      Aviv- Jaffa Magistrate’s Court for damages against InkSure Ltd. and
      against the Company, jointly and severally, for payment of NIS 2,366,868
      (as of June 15, 2006, approximately $530) plus interest allegedly due as
      rent payments and related management fees for a certain real estate
      property in Rehovot, leased to InkSure under a lease agreement entered
      into between Evilia and InkSure on October 10, 2000, as amended on May 25,
      2001 (the “Agreement”), in respect of which the Company was a
      guarantor.  A motion for leave to defend the lawsuit was filed
      with the Court by both InkSure and the Company on June 15, 2006. On August
      6, 2006, a settlement agreement was submitted to the Court, pursuant to
      which InkSure agreed to pay Evilia the amount of $130 plus
      VAT.  On August 13, 2006, the Court approved the settlement
      agreement.  The Company agreed to pay (and paid) InkSure half of
      the settlement amount.




5.
              On
      January 20, 2008, the Manufacturers Association of Israel (the
      "Plaintiff") filed a lawsuit with the labor court in Tel Aviv-Jaffa (the
      "Court") against Vuance Ltd. ("the Company"), seeking an amount of NIS
      82,789 + VAT (as of June 20, 2008 approximately $26 + VAT) for service
      fees for the years 2001-2007 as well as legal expenses and attorney's fees of
      the Plaintiff. In addition, the Plaintiff has asked the Court to instruct
      the Company to submit the necessary documentation, certified by the
      Company's
      accountant, needed to calculate the service fees sought by the Plaintiff.
      During 2008, the Company and the Plaintiff reached a settlement whereby
      the Company will pay $8, as compromise which amount was included in the
      2008 financial statements.




6.
              Regarding
      a breach of certain convertible bonds covenants, see Note
    13.




d.
              In
      a certain transaction, the Company is obligated to pay a certain
      percentage of the revenues to third
parties.





e.
              The
      Company is obligated, under certain contracts with one of our
      manufacturers, to purchase certain frame orders from such manufacturer,
      with no specific time
requirements.





NOTE
      12:-
            TAXES
      ON INCOME


a.
              Measurement
      of results of operations for tax purposes under the Israeli Income Tax Law
      (Inflationary Adjustments),
1985.




Until
December 31, 2007, the results of operations for tax purposes were measured in
terms of earnings in NIS after adjustments for changes in Israel's Consumer
Price Index ("CPI"). Commencing January 1, 2008, this law is void and in its
place there are transition provisions, whereby the results of operations for tax
purposes are to be measured on a nominal basis. As explained in Note 2b, the
financial statements are measured in U.S. dollars. The difference between the
annual change in Israel's CPI and in the NIS/dollar exchange rate causes a
further difference between taxable income and income before taxes shown in the
financial statements. In accordance with paragraph 9(f) of SFAS No. 109, the
Company has not provided for deferred income taxes on the above difference
between the functional currency and the tax bases of assets and
liabilities.





132




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      12:-
            TAXES
      ON INCOME (cont.)


b.
              Reduction
      in corporate tax rates:




On July
25, 2005, the Israeli Parliament passed an amendment to the Income Tax Ordinance
(No. 147) - 2005, gradually reducing the tax rate applicable to the
Company  as follows: in 2006 - 31%, in 2007 - 29%, in 2008 - 27%, in
2009 - 26% and in 2010 and thereafter - 25%.




c.
              Non-Israeli
      subsidiaries:




Non-Israeli
subsidiaries are taxed according to the tax laws of the countries in which they
are located.




d.
            Deferred
      income taxes:




Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. Significant components of the deferred
tax assets of the Company and its subsidiaries are as
follows:




December
      31,Tax
      Benefits:
                      
                      2007
                      
                      
                      2008Operating
      loss carryforward
                      
                      $
                      7,951
                      
                      
                      $
                      10,106Reserves
      and allowances
                      
                      
                      2,125
                      (*)
                      
                      
                      921Net
      deferred tax asset before valuation allowance
                      
                      
                      10,076
                      
                      
                      
                      11,027Valuation
      allowance
                      
                      
                      (10,076
                      )
                      
                      
                      (11,027
                      )Net
      deferred tax asset
                      
                      $
                      -
                      
                      
                      $
                      -Deferred
      income taxes consist of the following:Domestic
                      
                      $
                      7,040
                      
                      
                      $
                      6,760Valuation
      allowance
                      
                      
                      (7,040
                      )
                      
                      
                      (6,760
                      )Foreign
                      
                      
                      3,036
                      
                      
                      
                      4,267Valuation
      allowance
                      
                      
                      (3,036
                      )
                      
                      
                      (4,267
                      )$
                      -
                      
                      
                      $
                      -





(*)
              Includes
      an amount of $1,197 related to fair value adjustment of marketable
      securities (which were sold during 2008.) See also "e"
    below.





As of
December 31, 2008, the Company and its subsidiaries have provided valuation
allowances of $11,027 in respect of deferred tax assets resulting from tax loss
carryforwards and other temporary differences. Management currently believes
that since the Company and its subsidiaries have a history of losses, the
deferred tax assets are not considered more likely than not to be realized in
the foreseeable future.





e.
              Net
      operating loss carryforwards and loss on marketable
      securities:


Vuance
Ltd. has accumulated losses for tax purposes as of December 31, 2008, in an
amount of approximately $23,466, which may be carried forward and offset against
taxable income in the future for an indefinite period. VuanceLtd. also has a loss on marketable
securities in an amount of $11,261 which may be carried forward and offset
against gains on marketable securities and capital gains for an indefinite
period. VuanceLtd. also has a capital
loss in an amount of $888 which may be carried forward and offset against
capital gains for an indefinite period.





133




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      12:-
            TAXES
      ON INCOME (cont.)


e.
              Net
      operating loss carryforwards and loss on marketable securities
      (cont.):




As of
December 31, 2008, Vuance's subsidiaries in the United States and Hong Kong have
estimated total available carryforward tax losses of $12,011 and $ 893,
respectively. In Hong-Kong tax losses are available to offset against taxable
income, if any, for an indefinite period. In the U.S., tax losses can be carried
forward for 20 years. However, utilization of U.S. net operating losses may be
subject to a substantial annual limitation due to the "change in ownership"
provisions of the Internal Revenue Code of 1986 and similar state provisions.
These annual limitations may result in the expiration of net operating losses
before utilization. An amount of $3,413 of the carryforward tax losses of the
Company's subsidiary in the U.S, is subject to such limitation, due to the SHC
acquisition.




f.
              Vuance
      Ltd has received final assessments until the tax year ended December 31,
      2002.




Vuance’s
subsidiaries in the United States and Israel have not received final assessments
since their incorporation.




Vuance’s
subsidiary in Hong-Kong has an assessment that is considered to be final until
the tax year ended December 31, 2000.




g.
              Net
      income (loss) before taxes on income consists of the
      following:




Year ended December 31,2006
                                
                                
                                2007
                                
                                
                                2008Domestic
                                
                                $
                                6,396
                                
                                
                                $
                                (8,173
                                )
                                
                                $
                                (4,854
                                )Foreign
                                
                                
                                (810
                                )
                                
                                
                                (2,748
                                )
                                
                                
                                (7,095
                                )$
                                5,586
                                
                                
                                $
                                (10,921
                                )
                                
                                $
                                (11,949
                                )





h.
              Reconciliation
      of the theoretical tax expense (benefit) to the actual tax expense
      (benefit):




A
reconciliation of theoretical tax expense, assuming all income is taxed at the
statutory rate applicable to the income of companies in Israel, and the actual
tax expense, is as follows:




Year ended December 31,2006
                        
                        
                        2007
                        
                        
                        2008Net
      income (loss) before taxes on income, as reported in the consolidated
      statements of operations
                        
                        $
                        5,586
                        
                        
                        $
                        (10,921
                        )
                        
                        $
                        (
      11,949
                        )Statutory
      tax rate in Israel
                        
                        
                        31
                        %
                        
                        
                        29
                        %
                        
                        
                        27
                        %Theoretical
      tax expenses (benefit)
                        
                        $
                        1,732
                        
                        
                        $
                        (3,167
                        )
                        
                        $
                        (
      3,226
                        )Carryforward
      losses and other deferred taxes for which a full valuation allowance was
      recorded
                        
                        
                        384
                        
                        
                        
                        3,170
                        
                        
                        
                        3,676Decrease
      in taxes resulting from utilization of carryforward tax losses for which
      deferred taxes were not created in the past
                        
                        
                        (2,402
                        )
                        
                        
                        -
                        
                        
                        
                        -Tax
      expenses related to withholding tax at source
                        
                        
                        146
                        
                        
                        
                        353
                        
                        
                        
                        137Differences
      in taxes resulting from rate applicable to foreign subsidiary and
      others
                        
                        
                        286
                        
                        
                        
                        34
                        
                        
                        
                        (450
                        )Actual
      income tax (*)
                        
                        $
                        146
                        
                        
                        $
                        390
                        
                        
                        $
                        137





(*)       Reclassified
(See Note 2y).





134




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      13:-
            CONVERTIBLE
      BONDS




In
November 2006, the Company raised $3,156.5 through the issuance of Units
consisting of Convertible Bonds and Warrants. Units valued at $2,500 were issued
to a single investor, and Units valued at $656.5 were issued to Special
Situation Funds (SSF), based on the participation rights provided in a private
placement during 2005, which were existing shareholders of the Company.
According to their original terms the Convertible Bonds mature three years from
the date of issuance and bear interest at an annual rate of 8% (which was
updated as described below). Any withholding and other taxes payable with
respect to the interest will be grossed up and paid by the Company
(approximately 3% of the principal of the bonds), payment of interest will be
net of any tax. Subject to certain redemption provisions, as described below,
the Convertible Bonds may be converted at any time, at the option of the
investors, into the Company's ordinary shares at a conversion price of $5 per
share (see amendment below). The investors were also granted Warrants entitling
them to acquire a total of 134,154 ordinary shares at an exercise price of $5
per share during the next five years. In respect of this transaction, the
Company paid approximately $215 cash as issuance expenses and granted an option
to acquire up to 25,000 shares of the Company to a third party, exercisable at
$5 per share. The fair market value of this grant was $ 40.




If the
Company fails to fulfill certain conditions, the investors may accelerate
repayment of the principal amount of $3,156.5 of the Convertible Bonds, in which
case all interest payable until Maturity Date will immediately become due and
payable.




The
Company has considered the provisions of EITF Issue No.00-19, “The Accounting
for Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock”, and determined that the embedded conversion feature should
not be separated from the host instrument because it is qualified for equity
classification in paragraphs 12-32 of EITF Issue No.00-19. Therefore the
transaction was accounted for in accordance with EITF 00-27, "Application of
Issue No. 98-5 to Certain Convertible Instruments" and APB 14, "Accounting for
Convertible Debt and Debt Issued with Stock Purchase Warrants". The fair market
value of the Warrants was determined based on the fair value of the
instruments issued using the Black-Scholes pricing model, assuming a risk free
rate of 5%, a volatility factor of 78.21%, dividend yields of 0% and an expected
life of 2 years. The expiration date of the Warrants is November
2011.




As a
result, the Company recorded in 2006 an amount of $282 in respect of the
Warrants and an amount of $632 as beneficial conversion feature in respect of
the Convertible Bonds, as a credit to shareholders' equity (additional paid in
capital). The discount of the bonds as a result of the value assigned to the
warrants and the beneficial conversion feature is amortized during the
contractual term of the bonds.




In
November 2007, due to a breach of certain conditions of the convertible bonds,
the investors had the right to accelerate the repayment of the principal amount
of the bonds with all the interest payable until the maturity date of the bonds.
However, the Company signed an amendment to the agreement with the investors
under which the Company was required to pay to one of the investors the
abovementioned interest amount ($276) (with any withholding and other taxes
payable with respect to the interest (approximately 3% of the principal of the
bonds)) and in respect of the other investors the Company changed the conversion
ratio of the bonds to $4.25. In a consideration the investors waived their right
to accelerate the repayment of the bonds. The Company accounted for the
amendment as a modification of the bonds (based on the provisions of EITF 06-06
(The Company accounted for the amendment as a modification of the
Bonds.)





135




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      13:-
            CONVERTIBLE
      BONDS (Cont.)




In June
2008, following a breach of the amended terms of the convertible bonds, the
Company reached an agreement with one of the investors (with a principal amount
of $2,500), under which, among other things, the investor waived the Company's
compliance with certain covenants under its Convertible Bonds, in exchange
for:




a.
            Increasing
      the interest rate to 10% starting March 31, 2008. Any withholding and
      other taxes payable with respect to the interest will be grossed up and
      paid by the Company (approximately 3% of the principal of the
      bonds).




b.
            Reducing
      the exercise price of the bond and the warrants to $3 and $2.8,
      respectively.




c.
            The
      Company undertakes to place a fixed charge on all income and/or rights in
      connection with a certain European Airport Project. This charge shall be
      senior to any indebtedness and/or other pledge and encumbrance, but shall,
      however, be subject to certain rights of the Company to use part of the
      income.




d.
            Certain
      anti-dilution rights with respect to the warrants held by the single
      investor.




In
addition, under certain circumstances the investor might have the right to
demand an early payment of partial or full amount of the Convertible Bonds (up
to the $2,500 as mentioned above). The Company accounted for the amendment as an
extinguishment of the Bonds.




Due to
the breach of certain convertible bonds covenants, the Company had to recognize,
in 2008, financial expenses in the amount of $553, to accelerate deferred
expenses in the amount of $138 and to accelerate the remaining discount amounts
(attributed to warrants and beneficial feature) in the amount of $724. In
addition the Convertible Bond was classified as a current liability




There
were no amendments signed with SSF since November 2007.




As of
December 31, 2008, the Company is not in compliance with certain covenants under
the Convertible Bonds Agreements, therefore the convertible bonds holders, could
seek to accelerate of unpaid principal, penalties and interest.




The
Company is currently negotiating with the major holder about optional remedies
to the violation.





NOTE
      14:-
            SHARE
      CAPITAL




a.
              The
      Company’s ordinary shares have been listed for trade on the Euronext
      Brussels stock market, under the symbol “SUP”, (since October 23, 2003)
      which became “VUNC” after the Company's name change on May 14, 2007. The
      Company applied for delisting of its shares from the Euronext Brussels
      stock market, and its application was approved on May 6, 2008, effective
      August 4, 2008. Since November 5, 2004, the Company’s ordinary shares have
      also traded on the OTC Bulletin Board under the symbol "SPCBF.OB"
      which, following the recent name change of the Company became “VUNCF.OB”.
      Since August 23, 2007, the ordinary shares of the Company were approved
      for trade on the NASDAQ Capital Market under the symbol “VUNC” and trading
      on the OTC Bulletin Board
ceased.




On
December 11, 2008, the Company received a letter from the NASDAQ Capital Market
advising the Company that it did not comply with the Listing
Requirements.





136




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      14:-
            SHARE
      CAPITAL




a.
              (cont.)




As a
result, the NASDAQ Capital Market Staff began reviewing the Company’s
eligibility for continued listing on the NASDAQ Capital Market. To facilitate
their review, the NASDAQ Capital Market Staff requested that the Company provide
on or before December 26, 2008, the Plan.  After the Company submitted
the Plan, on March 30, 2009 the Company received further correspondence from
Nasdaq that it did not comply with the Listing Requirements, and therefore,
trading of the Company’s ordinary shares would be suspended at the opening of
business on April 8, 2009, and a form 25-NSE would be filed with the SEC
removing the Company’s securities from listing and registration on The Nasdaq
Capital Market, unless the Company requested an appeal of the delisting decision
by Nasdaq.




The
Company appealed the Nasdaq determination to the Panel, which automatically
stayed the delisting of the Company’s ordinary shares until the Panel reached a
decision.  On June 17, 2009, the Panel granted the Company’s request for an
extension of time to achieve full compliance with the Listing
Requirements.




The
Panel’s decision, and the Company’s continued listing on the NASDAQ Capital
Market, is subject to the Company’s compliance with certain conditions,
including demonstration by the Company that it has regained compliance with the
Listing Requirements by September 28, 2009. While the Company is executing on
its plan to regain compliance, there can be no assurance that the Company will
be able to do so.  Should the Company be unable to meet the exception
requirement, the Panel will issue a final determination to delist the Company’s
shares and, unless the Nasdaq Listing and Hearings Review Council issues a stay,
will suspend trading of the Company’s shares on the NASDAQ Capital Market
effective on the second business day from the date of the final determination
and our ordinary shares could be eligible for quotation and trading on the OTC
Bulletin Board in accordance with applicable rules and regulations.




On May,
14 2007 a 1 for 5.88235 reverse split of the Company’s ordinary shares became
effective for trading purpose. Pursuant to this reverse share split, each
5.88235 ordinary shares of NIS 0.01 par value became 1 ordinary share of NIS
0.0588235 par value. Unless otherwise noted, all share and per share amounts for
all periods presented (including numbers of options, warrants and convertible
bonds) have been retroactively restated to give effect to this reverse
split.




b.
              During
      2007, the Company increased its authorized share capital to 12,000,000
      ordinary shares.




c.
              During
      2008, 104,513 ordinary shares were issued as a consideration to settle
      liabilities to an officer and other payables in an aggregate amount of
      $247 and 3,550 ordinary shares were issued due to the 2007 reverse
      split.




d.
            Shareholders'
      rights:




The
ordinary shares confer upon the holders the right to receive notice to
participate and vote in the general meetings of the Company, and the right to
receive dividends, if declared.





137




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LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      14:-
            SHARE
      CAPITAL (Cont.)




e.
              Stock
      options:




1.
              On
      February 14, 1999, the Board of Directors adopted, and the Company’s
      shareholders subsequently approved, the 1999 Employee Stock Option Plan,
      which was amended and restated in March 2002 (the “1999 Option
      Plan”).  The Company no longer uses the 1999 Option Plan. In
      2003, the Company adopted a new stock option plan under which the Company
      issues stock options (the “Option Plan”). The Option Plan is intended to
      provide incentives to the Company’s employees, officers, directors and/or
      consultants by providing them with the opportunity to purchase ordinary
      shares of the Company. The Option Plan is, subject to the provisions of
      the Israeli Companies Law, administered by the Compensation Committee, and
      is designed: (i) to comply with Section 102 of the Israeli Tax Ordinance
      or any provision which may amend or replace it and the rules promulgated
      thereunder and to enable the Company and grantees thereunder to benefit
      from Section 102 of the Israeli Tax Ordinance and the Commissioner’s
      Rules; and (ii) to enable the Company to grant options and issue shares
      outside the context of Section 102 of the Israeli Tax Ordinance. Options
      granted under the Option Plan will become exercisable ratably over a
      period of three to five years or immediately in certain circumstances,
      commencing with the date of grant. The options generally expire no later
      than 10 years from the date of grant. Any options which are forfeited or
      canceled before expiration become available for future
    grants.




As a
result of an amendment to Section 102 of the Israeli Tax Ordinance as part of
the 2003 Israeli tax reform, and pursuant to an election made by the Company
thereunder, capital gains derived by optionees arising from the sale of shares
issued pursuant to the exercise of options granted to them under Section 102
after January 1, 2003, will generally be subject to a flat capital gains tax
rate of 25%.  Previously, such gains were taxed as salary income at
the employee’s marginal tax rate (which could be up to 50%).  However,
as a result of this election, the Company will no longer be allowed to claim as
an expense for tax purposes the amounts credited to such employees as a benefit
when the related capital gains tax is payable by them, as the Company had
previously been entitled to do under Section 102.




On June
27, 2007, the Compensation Committee and board of directors of the
Company approved a new option plan under which the Company may grant stock
options to the U.S. employees of the Company and its subsidiaries. Under
this new option plan, the Company may grant both qualified (for preferential tax
treatment) and non-qualified stock options. On August 15, 2007 the new option
plan was approved by the shareholders of the Company at the general shareholders
meeting. As of December 31, 2008, 3,913,660 ordinary shares are available
for future grants of options, warrants, shares and other financial
instruments.





138




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      14:-
            SHARE
      CAPITAL (Cont.)




e.
              Stock
      options (cont.):




2.
              On
      May 30, 2006, the Board of Directors approved a grant of options to
      acquire up to 93,501 ordinary shares to certain employees and officers.
      The exercise price of these options is $ 4.42 per
  share.




During
2007, the Board of Directors approved grants of options as follows:




Number of
                      options
                      granted
                    
                    Exercise
                      price37,400
                    
                    4.41271,500
                    
                    5.10021,000
                    
                    4.90062,333
                    
                    0.01447,372
                    
                    0.0585,500
                    
                    4.850141,500
                    
                    4.64034,000
                    
                    4.120




An
additional 217,600 options were granted during 2007 to related parties including
directors. See Note 15e.




During
2008, the Board of Directors approved grants of options as follows:




Number of
                  options
                  granted
                
                Exercise
                  price2,000
                
                3.3843,000
                
                1.88





In
September 2008, the Board of Directors approved a re-pricing of options for 3
executive officers for a total of 149,600 options, which had exercise prices
ranging between $2.47 and $14.8235.  The re-pricing changed the
exercise price of the options to $1.86. The incremental compensation cost at the
date of the modification was $66 of which $59 was recognized during
2008.




In
December 2008 the Special General Meeting approved the re-pricing and the
extension (if applicable) of 354,617 options held by related parties. See Notes
15a, 15b and 15e. The incremental compensation cost at the date of the
modification amounted to $44 and was recognized as expense since all the options
were fully vested.




For
option grants after the balance sheet, see also Note 19.





139




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LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      14:-
            SHARE
      CAPITAL (Cont.)




e.
              Stock
      options (cont.):




3.
              A
      summary of the Company's stock option activity and related information is
      as follows:




Year ended December 312006
                  
                  
                  2007
                  
                  
                  2008Number of
                    options
                  
                  
                  Weighted
                    average
                    exercise
                    price
                  
                  
                  Number of
                    options
                  
                  
                  Weighted
                    average
                    exercise
                    price
                  
                  
                  Number of
                    options
                  
                  
                  Weighted
                    average
                    exercise priceOutstanding
      at beginningof
      year
                  
                  
                  595,971
                  
                  
                  $
                  5.77
                  
                  
                  
                  553,902
                  
                  
                  $
                  5.12
                  
                  
                  
                  1,076,756
                  
                  
                  $
                  4.43Granted
                  
                  
                  93,501
                  
                  
                  $
                  4.42
                  
                  
                  
                  638,205
                  
                  
                  $
                  3.86
                  
                  
                  
                  45,000
                  
                  
                  $
                  1.95Exercised
                  
                  
                  (43,152
                  )
                  
                  $
                  2.48
                  
                  
                  
                  (25,968
                  )
                  
                  $
                  3.16
                  
                  
                  
                  (27,032
                  )
                  
                  $
                  0.32Canceled
      and forfeited
                  
                  
                  (92,418
                  )
                  
                  $
                  9.95
                  
                  
                  
                  (89,383
                  )
                  
                  $
                  5.06
                  
                  
                  
                  (113,262
                  )
                  
                  $
                  6.17Outstanding
      at end of year
                  
                  
                  553,902
                  
                  
                  $
                  5.12
                  
                  
                  
                  1,076,756
                  
                  
                  $
                  4.43
                  
                  
                  
                  981,462
                  
                  
                  $
                  2.55
                  (*)Exercisable
      at end of year
                  
                  
                  481,651
                  
                  
                  $
                  5.18
                  
                  
                  
                  591,485
                  
                  
                  $
                  4.81
                  
                  
                  
                  663,021
                  
                  
                  $
                  2.51
                  (*)





(*)
              The
      weighted average exercise price, presented as of December 31, 2008, is
      after the re-pricing made during 2008, as mentioned above and in Note
      15.




The
weighted average fair value of options granted during the reported periods was
$1.89, $2.87 and $0.88, per option, for the years ended December 31, 2006, 2007
and 2008, respectively.




The fair
value of these options was estimated on the date of grant using the Black &
Scholes option pricing model. The following weighted average assumptions were
used for the 2006, 2007 and 2008 grants: risk-free rate of 5%, 4.05% and 4.24%,
respectively, dividend yield of 0%, expected volatility factor of 57.17%, 57.20%
and 52.29%, respectively and expected term of 3.09, 3.64 and 4 years,
respectively.




The
expected volatility was based on the historical volatility of the Company’s
stock. The expected term was based on the historical experience and based on
Management estimate.




Compensation
expenses recognized by the Company related to its share-based employee
compensation awards were $ 225 $1,032 and $856 based on the provisions of SFAS
123R for the years ended December 31, 2006, 2007 and 2008,
respectively.




The
following table summarizes the allocation of the stock-based compensation
charge




Year ended December 31,2006
                          
                          
                          2007
                          
                          
                          2008Cost
      of revenues
                          
                          $
                          -
                          
                          
                          $
                          5
                          
                          
                          $
                          16Research
      and development expenses
                          
                          
                          32
                          
                          
                          
                          336
                          
                          
                          
                          353Selling
      and marketing expenses
                          
                          
                          90
                          
                          
                          
                          158
                          
                          
                          
                          151General
      and administrative expenses
                          
                          
                          103
                          
                          
                          
                          533
                          
                          
                          
                          336$
                          225
                          
                          
                          $
                          1,032
                          
                          
                          $
                          856





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 NOTES
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 U.S.
dollars in thousands (except per share data)


NOTE
      14:-
            SHARE
      CAPITAL (Cont.)




3.
              A
      summary of the Company's stock option activity and related information is
      as follows (cont.):




The
options outstanding and exercisable as of December 31, 2008, have been separated
into ranges of exercise prices as follows:




Range of
                        exercise price
                      
                      
                      Options
                        outstanding
                        as of
                        December 31,
                        2008
                      
                      
                      Weighted
                        average
                        remaining
                        contractual life
                        (years)
                      
                      
                      Weighted
                        average
                        exercise price
                      
                      
                      Aggregate
                        intrinsic
                        value
                      
                      
                      Options
                        exercisable
                        as of
                        December 31,
                        2008
                      
                      
                      Weighted
                        average
                        exercise price
                      
                      
                      Aggregate
                        intrinsic
                        value$
      0.01 - $ 0.06
                      
                      
                      
                      86,019
                      
                      
                      
                      8.56
                      
                      
                      
                      0.015
                      
                      
                      $
                      50
                      
                      
                      
                      28,673
                      
                      
                      
                      0.015
                      
                      
                      $
                      17$
      1.10 - $ 1.88
                      
                      
                      
                      547,217
                      
                      
                      
                      5.86
                      
                      
                      
                      1.37
                      
                      
                      
                      -
                      
                      
                      
                      424,598
                      
                      
                      
                      1.33
                      
                      
                      
                      -$
      2.47 - $ 3.38
                      
                      
                      
                      35,626
                      
                      
                      
                      4.54
                      
                      
                      
                      3.01
                      
                      
                      
                      -
                      
                      
                      
                      33,626
                      
                      
                      
                      2.99
                      
                      
                      
                      -$
      4.18 - $ 4.90
                      
                      
                      
                      192,400
                      
                      
                      
                      7.46
                      
                      
                      
                      4.52
                      
                      
                      
                      -
                      
                      
                      
                      98,124
                      
                      
                      
                      4.41
                      
                      
                      
                      -$
      5.00 - $ 5.24
                      
                      
                      
                      103,200
                      
                      
                      
                      4.85
                      
                      
                      
                      5.06
                      
                      
                      
                      -
                      
                      
                      
                      61,000
                      
                      
                      
                      5.08
                      
                      
                      
                      -$
      14.82
                      
                      
                      
                      17,000
                      
                      
                      
                      3.25
                      
                      
                      
                      14.82
                      
                      
                      
                      -
                      
                      
                      
                      17,000
                      
                      
                      
                      14.82
                      
                      
                      
                      -981,462
                      
                      
                      
                      
                      
                      
                      
                      2.55
                      
                      
                      
                      
                      
                      
                      
                      663,021
                      
                      
                      
                      2.51





The
aggregate intrinsic value of the above table represents the total intrinsic
value, based on the Company’s stock price of $0.6 as of December 31, 2008, less
the weighted average exercise price per range. This represents the potential
amount received by the option holders had all option holders exercised their
options as of that date.




The total
intrinsic value of options exercised during the years ended December 31, 2006,
2007 and 2008 was $109, $62 and $53 respectively, based on the Company’s average
stock price of $5.38, $5.57 and $2.26 during the years ended
respectively.




A summary
of the status of the Entity’s non-vested options granted to employees as of
December 31, 2008 and changes during the year ended December 31, 2008 is
presented below:




Options
                          
                          
                          Weighted–
                            average grant-
                            date fair valueNon-vested
      at January 1, 2008
                          
                          
                          485,271
                          
                          
                          $
                          2.31Granted
                          
                          
                          45,000
                          
                          
                          $
                          0.88Vested
      (including cancelled and exercised)
                          
                          
                          (158,330
                          )
                          
                          $
                          2.18Forfeited
                          
                          
                          (53,500
                          )
                          
                          $
                          2.06Non-vested
      at December 31, 2008
                          
                          
                          318,441
                          
                          
                          $
                          2.21





As of
December 31, 2008, there was $353 total unrecognized compensation cost related
to non-vested share-based compensation arrangements granted under the stock
option plans, of which, $261 is expected to be recognized during the year 2009,
$89 during the year 2010 and $3 during the year 2011.





141




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LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      14:-
            SHARE
      CAPITAL (Cont.)


f.
              Private
      placements and warrants:




1.
              In
      November and December of 2005, the Company received aggregate gross
      proceeds of $3,050 from a private placement of 836,292 ordinary shares
      (out of which 150,807 shares were issued after December 31, 2005) and
      five-year warrants to purchase up to 292,701 ordinary shares at an
      exercise price of $3.53 per share. The private placement was made to
      accredited investors pursuant to Rule 506 of Regulation D, promulgated
      under the Securities Act of 1933, as amended (the “Securities Act”) and to
      foreign private investors in offshore transactions in reliance on
      Regulation S promulgated under the Securities Act. In connection with the
      private placement, the Company’s placement agent received a cash fee of
      $150 and the Company’s placement advisors received five-year warrants to
      purchase up to 8,446 ordinary shares at an exercise price of $3.53 per
      share.




The
warrants granted to the placement advisors as described above were fully vested
on the date of grant. The fair value of the warrants was $15 as computed using
the Black & Scholes pricing model with the following weighted average
assumption: risk-free interest of
4%, dividend yield of 0, volatility factor of the excepted market price of the
Company’s ordinary shares of 74%, and expected term of 2 years of the warrants.
The Company recorded the issuance costs directly to additional paid in
capital.




As of
December 31, 2008 none of the above mentioned warrants were
exercised.




2.
              During
      2005, 4,251 warrants were issued to a consultant. The fair value of the
      warrants was $13 as computed using the Black & Scholes pricing model
      with the following assumption: risk-free interest of 3.5%, dividend yield
      of 0, volatility factor of the excepted market price of the Company’s
      ordinary shares of 117.03%, and expected term of the warrants of 2 years.
      During the years 2005 and 2006, the Company recognized $8 and $5,
      respectively, as compensation
expenses.




3.
              During
      2006, 2007 and 2008, the Board of Directors approved a grant of warrants
      to acquire up to 75,651, 44,000 and 100,000 shares respectively, to
      certain consultants. The exercise prices under the terms of the options
      range between $0.65 to $5.47 per share. The fair market value of the
      warrants is $162, $55 and $64, respectively, as computed using the Black
      & Scholes pricing model with the following weighted average
      assumption: risk-free interest of 3.00% - 4.25%, dividend yield of 0,
      volatility factor of the excepted market price of the Company’s ordinary
      shares of 73.46%, 36% and 101.44%, respectively, and expected term of the
      warrants of 2.47, 2.38 and 2.90 average years respectively. During 2006,
      2007 and 2008, the Company recognized $131, $38 and $51, as compensation
      expenses, respectively.







142




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LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      14:-
            SHARE
      CAPITAL (Cont.)


f.
              Private
      placements and warrants
(cont.):




4.
              A
      summary of the Company's warrants activity to consultants, investors
      (including warrants issued in connection with convertible bonds), and
      related information is as
follows:




Year ended December 312006
                    
                    
                    2007
                    
                    
                    2008Number of
                      options
                    
                    
                    Weighted
                      average
                      exercise
                      price
                    
                    
                    Number of
                      options
                    
                    
                    Weighted
                      average
                      exercise
                      price
                    
                    
                    Number of
                      options
                    
                    
                    Weighted
                      average
                      exercise
                      priceOutstanding
      at beginningof
      year
                    
                    
                    525,111
                    
                    
                    $
                    4.53
                    
                    
                    
                    759,916
                    
                    
                    $
                    4.65
                    
                    
                    
                    782,685
                    
                    
                    $
                    4.64Granted
                    
                    
                    234,805
                    
                    
                    $
                    4.95
                    
                    
                    
                    44,000
                    
                    
                    $
                    4.72
                    
                    
                    
                    100,000
                    
                    
                    $
                    1.20Exercised
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Canceled
      and forfeited
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    (21,231
                    )
                    
                    $
                    5.00
                    
                    
                    
                    (25,500
                    )
                    
                    $
                    5.04Outstanding
      at end of year
                    
                    
                    759,916
                    
                    
                    $
                    4.65
                    
                    
                    
                    782,685
                    
                    
                    $
                    4.64
                    
                    
                    
                    857,185
                    
                    
                    $
                    3.92Exercisable
      at end of year
                    
                    
                    737,250
                    
                    
                    $
                    4.65
                    
                    
                    
                    747,185
                    
                    
                    $
                    4.63
                    
                    
                    
                    763,852
                    
                    
                    $
                    4.27




The
warrants to consultants, investors (including warrants issued in connection with
convertible bonds), outstanding and exercisable as of December 31, 2008, have
been separated into ranges of exercise prices as follows:




Range of
                        exercise price
                      
                      
                      Options
                        outstanding as of
                        December 31,
                        2008
                      
                      
                      Weighted
                        average
                        remaining
                        contractual
                        life (years)
                      
                      
                      Weighted
                        average
                        exercise
                        price
                      
                      
                      Aggregate
                        intrinsic
                        value
                      
                      
                      Options
                        exercisable as of
                        December 31,
                        2008
                      
                      
                      Weighted
                        average
                        exercise
                        price
                      
                      
                      Aggregate
                        intrinsic
                        value$
      0.65
                      
                      
                      
                      80,000
                      
                      
                      
                      4.87
                      
                      
                      $
                      0.65
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      
                      -$
      2.50 - $ 3.53
                      
                      
                      
                      432,502
                      
                      
                      
                      2.30
                      
                      
                      $
                      3.27
                      
                      
                      
                      -
                      
                      
                      
                      419,169
                      
                      
                      $
                      3.26
                      
                      
                      
                      -$
      4.42 - $ 4.85
                      
                      
                      
                      71,200
                      
                      
                      
                      5.34
                      
                      
                      $
                      4.67
                      
                      
                      
                      -
                      
                      
                      
                      71,200
                      
                      
                      $
                      4.67
                      
                      
                      
                      -$ 5
      - $ 5.48
                      
                      
                      
                      150,605
                      
                      
                      
                      2.42
                      
                      
                      $
                      5.07
                      
                      
                      
                      -
                      
                      
                      
                      150,605
                      
                      
                      $
                      5.07
                      
                      
                      
                      -$
      6.47
                      
                      
                      
                      122,878
                      
                      
                      
                      0.62
                      
                      
                      $
                      6.47
                      
                      
                      
                      -
                      
                      
                      
                      122,878
                      
                      
                      $
                      6.47
                      
                      
                      
                      -857,185
                      
                      
                      
                      
                      
                      
                      $
                      3.92
                      
                      
                      
                      
                      
                      
                      
                      763,852
                      
                      
                      $
                      4.27




5.
              The
      fair value of all the warrants granted as described above was measured
      based on the fair value of the instruments issued on the date of grant,
      since, based on the opinion of Company Management, such measurement is
      more reliable than the fair value of
services.




As of
December 31, 2008, there was $18 total unrecognized compensation cost related to
non-vested share-based compensation arrangements granted under the warrants, of
which, $12 is expected to be recognized during the year 2009, $5 during the year
2010 and $1 during the year 2011.




g.
              Dividends:




In the
event that cash dividends are declared in the future, such dividends will be
paid in NIS. The Company does not intend to distribute cash dividends in the
foreseeable future.




h.
              Convertible
      bonds and warrants – see Note
13.





143




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      15:-
            RELATED
      PARTY TRANSACTIONS


a.
              On
      October 1, 2001, the Company entered into a consulting agreement with a
      company owned by the Chairman of the Board of Directors, who was one of
      the co-founders of the
Company.




In
consideration of these consulting services, the Company has undertaken to pay
$10.5 per month plus motor vehicle expenses. In addition the Company pays $1.5
per month as a director’s fee. During 2006, 2007 and 2008, the Company paid
$144, $144 and $121, respectively, pursuant to this agreement. (Regarding the
reduction in the amount paid during 2008, see below Note
15f.)




In
December 2008 according the Special General Meeting (see Note 15f below),
296,817 options with an exercise price in the range of $2.4706 to $5 were
re-priced to $1.1 and all such options with an expiration date prior to October
27, 2013, shall nonetheless be exercisable until October 27,
2013.




b.
              On
      October 1, 2001, the Company entered into a consulting agreement with a
      company owned by a member of the Company's Board of Directors, who was one
      of the Company's co-founders and a principal shareholder. On January 13
      2005, the General Shareholders Meeting approved the following amendments
      to the consulting agreement:




·
              As
      of the date of the approval of the General Shareholders Meeting, the
      consideration shall be an amount of $7 per
  month.




·
              Upon
      the termination of the car lease agreement in March 2005, to increase the
      car lease, to a price of up to NIS 4,200 (approximately $1.1 as of
      December 31, 2008), (excluding tax) per
month.




·
              To
      grant a one-time bonus of NIS 130,000 including VAT, which was paid during
      2005.




In
addition, the Company pays $1.5 per month as a director’s fee.  During
2006, 2007 and 2008, the Company paid $102, $102 and $84, pursuant to this
agreement. (Regarding the reduction in the amount paid during 2008, see below
Note 15f.)




In
December 2008 according the Special General Meeting (see Note 15f below), 37,400
options with an exercise price in the range of $2.4706 to $5 were re-priced to
$1.1 and all such options with an expiration date prior to October 27, 2013,
shall nonetheless be exercisable until October 27, 2013.




c.
              On
      October 1, 2001, the Company entered into a consulting agreement with a
      company owned by one of the co-founders of the
  Company.




In
consideration for these services, the Company has undertaken to pay $4.6 per
month plus motor vehicle expenses. During 2006, 2007 and 2008, the Company paid
$72, $71 and $58 respectively, pursuant to this agreement. (Regarding the
reduction in the amount paid during 2008, see below Note
15f.)




d.
              On
      January 13, 2005, the General Shareholders Meeting approved, among other
      things, the Board of Directors’ decision dated October 4, 2004, to grant
      options to acquire up to 51,001 ordinary shares of the Company to the
      Chairman of the Board of Directors and 8,500 ordinary shares of the
      Company to each of the two directors of the Company, who are not “external
      directors”.  The exercise price of the options is $5 per share.
      Those options were granted as compensation for their efforts in completing
      a private placement during
2004.





144




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      15:-
            RELATED
      PARTY TRANSACTIONS (Cont.)


e.
              On
      January 21, 2007, the General Shareholders Meeting approved the grant of
      options to the Chairman of the Board of Directors and to a director who is
      one of the co-founders of the Company to acquire up to 51,000 and 20,400,
      respectively ordinary shares of the Company, at an exercise price of
      $5.




On April
29, 2007, the General Shareholders Meeting approved the grant of options to the
Chairman of the Board of Directors and to two external directors to acquire up
to 85,000 and 40,800, respectively ordinary shares of the Company, at an
exercise price of $4.118 and $5 respectively.




On August
15, 2007, the General Shareholders Meeting approved the grant of options to a
director to acquire up to 20,400, respectively ordinary shares of the Company,
at an exercise price of $5. In December 2008 according the Special General
Meeting (see Note 15f below), the options were re-priced to $1.1 and all such
options shall nonetheless be exercisable until October 27, 2013.




f.
              On
      December 21, 2008, the Special General Meeting of Shareholders approved
      that as part of a cost cutting plan, all of the Company's non-external
      directors, will join a temporary arrangement pursuant to which the
      remuneration payable to them shall be paid in fully vested options to
      purchase shares of the Company instead of in cash, effective October 1,
      2008 for a minimum period of three months, with an option to the Company
      to extend it from time to time for additional consecutive periods of up to
      twelve (12) months in the aggregate. In addition (a) all options held by
      the Participants on October 27, 2008, shall be re-priced so that the
      exercise price thereof shall be $1.1 (the closing price of the Ordinary
      Share on said date), and (b) all such options with an expiration date
      prior to October 27, 2013, shall nonetheless be exercisable until October
      27, 2013.




g.
              Regarding
      subsequent events see Note
19.





NOTE
      16:-
            SEGMENTS,
      MAJOR CUSTOMERS AND GEOGRAPHIC
INFORMATION


a.
              Summary
      information about geographic areas:


The
Company manages its business on the basis of one reportable segment (see Note 1
for a brief description of the Company's business) and follows the requirements
of SFAS 131, "Disclosures about Segments of an Enterprise and Related
Information".




The
following is a summary of operations within geographic areas, based on the
location of customers and data regarding long-lived assets:




Year ended December 31,2006
                    
                    
                    2007
                    
                    
                    2008Total
                    
                    
                    Long-lived
                    
                    
                    Total
                    
                    
                    Long-lived
                    
                    
                    Total
                    
                    
                    Long-livedrevenues
                    
                    
                    assets
                    
                    
                    revenues
                    
                    
                    Assets (*)
                    
                    
                    revenues
                    
                    
                    Assets(*)Europe
                    
                    $
                    6,023
                    (**)
                    
                    $
                    -
                    
                    
                    $
                    9,003
                    (**)
                    
                    $
                    -
                    
                    
                    $
                    15,193
                    
                    
                    $
                    -Asia
      Pacific
                    
                    
                    1,730
                    
                    
                    
                    18
                    
                    
                    
                    1,330
                    
                    
                    
                    13
                    
                    
                    
                    310
                    
                    
                    
                    7Africa
                    
                    
                    621
                    
                    
                    
                    -
                    
                    
                    
                    823
                    
                    
                    
                    -
                    
                    
                    
                    350
                    
                    
                    
                    -United
      States
                    
                    
                    373
                    
                    
                    
                    54
                    
                    
                    
                    1,787
                    
                    
                    
                    5,248
                    
                    
                    
                    4,506
                    
                    
                    
                    1,842Israel
                    
                    
                    194
                    
                    
                    
                    88
                    
                    
                    
                    371
                    
                    
                    
                    613
                    
                    
                    
                    294
                    
                    
                    
                    329$
                    8,941
                    (**)
                    
                    $
                    160
                    
                    
                    $
                    13,314
                    (**)
                    
                    $
                    5,874
                    
                    
                    $
                    20,653
                    
                    
                    $
                    2,178


(*)
              Long
      lived asset data includes allocation of intangible assets and goodwill
      amounts.




(**)
              Reclassified
      (See Note 2y).




145




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      16:-
            SEGMENTS,
      MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION
  (cont.)




b.
              Summary
      of operations based on products and
services:


Year ended December 31,2006
                    
                    
                    2007
                    
                    
                    2008Raw
      materials and equipment
                    
                    $
                    6,529
                    
                    
                    $
                    9,315
                    
                    
                    $
                    17,589Maintenance,
      royalties and project management
                    
                    
                    2,412
                    (*)
                    
                    
                    3,999
                    (*)
                    
                    
                    3,064$
                    8,941
                    (*)
                    
                    $
                    13,314
                    (*)
                    
                    $
                    20,653





(*)
              Reclassified
      (See Note 2y).





c.
              Major
      customer data as a percentage of total
sales:


Year ended December 31,2006
                      
                      
                      2007
                      
                      
                      2008Customer
      A
                      
                      
                      59
                      %
                      
                      
                      50
                      %
                      
                      
                      26
                      %Customer
      B
                      
                      
                      -
                      
                      
                      
                      17
                      %
                      
                      
                      47
                      %Customer
      C
                      
                      
                      10
                      %
                      
                      
                      8
                      %
                      
                      
                      *





(*)
              Less
      than 10%.





NOTE
      17:-
            FINANCIAL
      EXPENSES, NET




Year ended December 31,2006
                      
                      
                      2007
                      
                      
                      2008Financial
      expenses:Interest,
      amortization of discount, bank charges and fees (*)
                      
                      $
                      (178
                      )
                      
                      $
                      (962
                      )
                      
                      $
                      (2,301
                      )Exchange
      differences
                      
                      
                      (109
                      )
                      
                      
                      (109
                      )
                      
                      
                      -Unrealized
      loss on  marketable securities, net
                      
                      
                      -
                      
                      
                      
                      (2,699
                      )
                      
                      
                      -Realized
      loss on sale of marketable securities
                      
                      
                      -
                      
                      
                      
                      (1,116
                      )
                      
                      
                      (862
                      )Others
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (118
                      )Total
      financial expenses
                      
                      
                      (287
                      )
                      
                      
                      (4,886
                      )
                      
                      
                      (3,281
                      )Financial
      income:Exchange
      differences
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      62Interest
                      
                      
                      83
                      
                      
                      
                      234
                      
                      
                      
                      106Total
      financial income
                      
                      
                      83
                      
                      
                      
                      234
                      
                      
                      
                      168Net
      total
                      
                      $
                      (204
                      )
                      
                      $
                      (4,652
                      )
                      
                      $
                      (3,113
                      )





*
              In
      2006, 2007 and 2008, includes $75, $745 and $2,214 expenses related to
      convertible bonds, respectively. (See Note 13
  above).





146




VUANCE
LTD. AND SUBSIDIARIES
 
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)
 
 U.S.
dollars in thousands (except per share data)


NOTE
      18:-
            OTHER
      EXPENSES, NET




2006
                          
                          
                          2007
                          
                          
                          2008Year
      ended December 31,Write-down
      of loan regarding an investment in an affiliated company and other trade
      receivables
                          
                          $
                          (321
                          )
                          
                          $
                          -
                          
                          
                          $
                          -Loss
      on sale of property and equipment, net
                          
                          $
                          (8
                          )
                          
                          
                          -
                          
                          
                          
                          -Other
                          
                          
                          (38
                          )
                          
                          
                          -
                          
                          
                          
                          -$
                          (367
                          )
                          
                          $
                          -
                          
                          
                          $
                          -





NOTE
      19:-
            SUBSEQUENT
      EVENTS


a.
              Regarding
      the Company's non-compliance with NASDAQ requirements for continued
      listing on the Nasdaq Capital Market set forth in Marketplace Rule
      4310(c)(3), see Note 1a.




b.
              On
      January 9, 2009, according to the board resolution on October 27, 2008 and
      the Special General Meeting dated December 21, 2008, the Company granted
      to: a) Chairman of the Board of Directors; b) a member of the Company's
      Board of Directors who is also one of the co-founders; c) one of the
      co-founders of the Company and d) another member of the Company's Board of
      Directors options to purchase up to: 49,311, 34,702, 24,244 and 6,164
      shares of the Company, respectively. The options have an exercise price of
      NIS 0.0582235 per share, vested immediate and will expire after ten years.
      The options were granted as compensation for waiver of three months’ cash
      payments according to their agreement with the
  Company.




c.
              On
      March 12, 2009, the Company granted options to purchase up to 125,142
      shares to several employees as compensation for waiving part of their
      payroll. The options have an exercise price of NIS 0.0582235, vested
      immediate and will expire after ten
years.




d.
              On
      March 25, 2009 the Company, through its subsidiary Vuance Inc., completed
      the acquisition of certain assets and liabilities of Intelli-Site, Inc.
      (“Intelli-Site”), pursuant to an asset purchase agreement dated March 6,
      2009 with Intelli-Site and Integrated Security Systems, Inc.
      (“ISSI”).  On the date of closing, Vuance Inc. agreed to pay
      Intelli-Site $262, payable in twenty-five (25) consecutive
      installments.  The first twelve (12) monthly installments shall
      be equal to $11 each, and thereafter, the remaining thirteen (13) monthly
      installments shall be equal to $10 each (the “Cash
      Consideration”).  In addition, the Company issued to ISSI
      200,000 of its ordinary shares (the “Consideration Shares”).  In
      addition to the payment of the Cash Consideration and the issuance of the
      Consideration Shares, Vuance Inc. agreed to pay Intelli-Site and ISSI, as
      applicable, in royalty payments, an amount of up to $600 in the aggregate,
      based upon certain conditions, which shall be paid on a quarterly basis,
      within thirty (30) days of the close of each quarter, and will be made 50%
      in cash and 50% in the Company's ordinary shares (the “Royalty
      Shares”).  The number of Royalty Shares to be issued to ISSI
      shall be calculated on the basis of the weighted average closing price of
      the Company ordinary shares for the fifteen (15) trading days preceding
      the quarterly payment, subject to a minimum of
  $1.25.




ISSI, or
its permitted transferee, agreed to lock-up the Consideration Shares and Royalty
Shares, if any, as applicable, pursuant to which ISSI or its transferee will not
offer, sell, transfer or otherwise dispose of the Consideration Shares or the
Royalty Shares. The restrictions on the transfer of the Consideration Shares and
the Royalty Shares will expire in eight equal installments, commencing with the
end of the first calendar quarter following the date of closing and each of the
seven following calendar quarters thereafter.  If any Consideration
Shares or Royalty Shares are issued after the last day of the eighth calendar
quarter following the date of closing, such shares shall not be subject to any
transfer restrictions.





-
- - - - - - - - - - -





147





ITEM
19.    Exhibits.





1.1*
                
                Memorandum
      of Association of the Company.1.2**
                
                Articles
      of Association of the Company.2.1*
                
                Forms
      of Stock Certificates Representing Ordinary Shares.4.1*
                
                The
      Vuance Ltd. 1999 Employee Stock Option Plan (as Amended and Restated in
      2002).4.1(a)***
                
                The
      Vuance Ltd. 2003 Israeli Share Option Plan4.2*
                
                Stock
      Purchase Agreement between Vuance and Elad Ink, dated as of March 4,
      2002.4.3*
                
                Stock
      Purchase Agreement between Vuance and ICTS BV, dated as of April 29,
      2002.4.4*
                
                Stock
      Purchase Agreement between Vuance and ICTS-USA, Inc., dated as of
      September 27, 2002.4.5
                
                Asset
      Purchase Agreement by and among Intelli-Site, Inc., Integrated Security
      Systems, Inc., Vuance, Inc. and Vuance Ltd. dated as of March 6,
      2009.8****
                
                List
      of Subsidiaries of Vuance Ltd.11.1****
                
                Code
      of Ethics12.1
                
                Certification
      pursuant to Section 302 of the Sarbanes-Oxley Act.12.2
                
                Certification
      pursuant to Section 302 of the Sarbanes-Oxley Act.13.1
                
                Certification
      pursuant to Section 906 of the Sarbanes-Oxley Act.15.1
                
                Consent
      of Fahn, Kanne & Co., a member of Grant Thornton, dated June 30,
      2008.15.2
                
                Consent
      of BDO McCabe Lo & Company, independent public accountants, dated June
      29, 2008.15.3
                
                Consent
      of PKF, independent public accountants, dated June 26,
    2008.







*
Previously filed as exhibits to, and incorporated herein by reference from, the
Company’s Registration Statement on Form 20-F filed on September 14, 2004 (File
No.: 0-50790).


**
Previously submitted to the Securities and Exchange Commission on, and
incorporated herein by reference to, Exhibit A to Exhibit 1 to the Company’s
report on Form 6-K submitted on July 5, 2007 (File No.: 000-50790).


***
Previously filed as Exhibit 99.2 to, and incorporated herein by reference from,
the Company’s Registration Statement on Form S-8 (File No. 333-121231 filed on
December 14, 2004).


****
Previously filed as exhibits to, and incorporated herein by reference from, the
Company’s Annual Report on Form 20-F filed on June 30, 2008 (File No.:
001-33668).





148





SIGNATURE




Vuance
Ltd. 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.




VUANCE
      LTD./s/
      Eyal TuchmanBy:
                
                Eyal
      TuchmanIts:
                
                Chief
      Executive Officer





Date: June
30, 2009




149