**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**




**Washington,
      D.C. 20549**







**FORM
      20-F**




**(Mark
      One)**




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


**OR**


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


**For
      the fiscal year ended December 31, 2007**


**OR**


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


**OR**


x
            
            **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:
      5,124,779  ordinary
      shares as of December 31, 2007.





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





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter 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  o    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
                  I**NOTES
                  REGARDING FORWARD-LOOKING STATEMENTS
              4ITEM
                  1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT &
                  ADVISORS
              5ITEM
                  2. OFFER STATISTICS AND EXPECTED TIMETABLE
              5ITEM
                  3. KEY INFORMATION
              5Selected
                  Financial Data
              5Capitalization
                  and Indebtedness
              7Reasons
                  for the Offer and Use of Proceeds
              7Risk
                  Factors
              7ITEM
                  4. INFORMATION ON THE CORPORATION
              24History
                  and Development of the Corporation
              24Business
                  Overview
              28Organizational
                  Structure
              40Property,
                  Plants and Equipment
              41ITEM
                  4A. UNSOLVED STAFF COMMENTS
              42ITEM
                  5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
              42Operating
                  Results
              42Liquidity
                  and Capital Resources
              53Research
                  and Development
              56Trend
                  Information
              56Off-Balance
                  Sheet Arrangements
              57Tabular
                  Disclosure of Contractual Obligation
              58ITEM
                  6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
              58Directors
                  and Senior Management
              58Compensation
              60Board
                  Practices
              61Employees
              64Share
                  Ownership
              65ITEM
                  7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
              68Major
                  shareholders
              68Related
                  Party Transactions
              70Interests
                  of Experts and Counsel
              70ITEM
                  8. FINANCIAL INFORMATION
              71Consolidated
                  Statements and Other Financial Information (Audited)
              71Significant
                  Changes
              73ITEM
                  9 THE OFFER AND LISTING
              74Offer
                  and Listing Details
              74Plan
                  of Distribution
              76Markets
              76Selling
                  Shareholders
              76Dilution
              76Expenses
                  of the Issue
              76
  2
  ITEM
                  10. ADDITIONAL INFORMATION
              76Share
                  Capital
              76Memorandum
                  and Articles of Association
              80Material
                  Contracts
              80Exchange
                  Controls
              80Taxation
              80Dividends
                  and Paying Agent
              89Statement
                  by Experts
              89Documents
                  on Display
              89Subsidiary
                  Information
              90ITEM
                  11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
                  RISK
              90Quantitative
                  and Qualitative Information about Market Risk
              90ITEM
                  12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY
                  SECURITIES
              90**PART
                  II**ITEM
                  13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
              91ITEM
                  14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND
                  USE OF
                  PROCEEDS
              91ITEM
                  15. CONTROLS AND PROCEDURES
              91ITEM
                  16. RESERVED
              91ITEM
                  16A. AUDIT COMMITTEE FINANCIAL EXPERT
              91ITEM
                  16B. CODE OF ETHICS
              91ITEM
                  16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
              92ITEM
                  16 D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT
                  COMMITTEES
              92ITEM
                  16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
                  PURCHASERS
              92**PART
                  III**ITEM
                  17. FINANCIAL STATEMENTS
              92ITEM
                  18. FINANCIAL STATEMENTS
              92ITEM
                  19. EXHIBITS
              142SIGNATURE
              143
  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 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(z) 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.




**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 purpose as of May 14, 2007.*




4




**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 and 2007 and for the years ended December 31, 2003, 2004, 2005 2006 and
      2007 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.




5


SUMMARY
        OF CONSOLIDATED FINANCIAL DATA
 YEAR
        ENDED DECEMBER 31,
 
 Audited(IN THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE DATA)2003
              
              2004
              
              2005
              
              2006
              
              2007SUMMARY
                  OF STATEMENT OF OPERATIONS:Revenues
              
              
              7,244
              
              
              7,344
              
              
              8,462
              
              
              8,795
              
              
              12,961Cost
                  of Revenues
              
              
              3,102
              
              
              3,730
              
              
              4,293
              
              
              3,494
              
              
              5,600Inventory
                  write-off
              
              
              —
              
              
              —
              
              
              287
              
              
              —
              
              
              —Gross
                  Profit
              
              
              4,142
              
              
              3,614
              
              
              3,882
              
              
              5,301
              
              
              7,361Operating
                  Expenses:Research
                  and Development
              
              
              918
              
              
              845
              
              
              1,182
              
              
              1,362
              
              
              1,716Selling
                  and Marketing
              
              
              3,026
              
              
              2,445
              
              
              3,003
              
              
              5,619
              
              
              9,041General
                  and Administrative
              
              
              1,829
              
              
              1,955
              
              
              2,968
              
              
              2,737
              
              
              3,192Restructuring
                  expenses
              
              
              —
              
              
              —
              
              
              496
              
              
              —
              
              
              —Litigation
                  settlement expenses
              
              
              —
              
              
              —
              
              
              129
              
              
              108
              
              
              34Total
                  Operating Expenses
              
              
              5,773
              
              
              5,245
              
              
              7,778
              
              
              9,826
              
              
              13,983Capital
                  gain from the sale of the E-ID Division
              
              
              —
              
              
              —
              
              
              —
              
              
              10,536
              
              
              —Operating
                  Income (Loss)
              
              
              (1,631
              )
              
              (1,631
              )
              
              (3,896
              )
              
              6,011
              
              
              (6,622
              )Financial
                  Income (Expenses), Net
              
              
              (233
              )
              
              (214
              )
              
              (25
              )
              
              (204
              )
              
              (4,652
              )OTHER
                  INCOME (EXPENSES), NET
              
              
              (83
              )
              
              (27
              )
              
              (30
              )
              
              (367
              )
              
              —Income
                  Loss before Taxes on Income
              
              
              (1,947
              )
              
              (1,872
              )
              
              (3,951
              )
              
              5,440
              
              
              (11,274
              )Share
                  in Earnings (Loss) of an AffiliatedCompany
                  and impairment, Net of taxes
              
              
              (48
              )
              
              —
              
              
              —
              
              
              —
              
              
              —Taxes
                  on income
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              (37
              )Net
                        Income (Loss) from continuing operations
              
              
              (1,995
              )
              
              (1,872
              )
              
              (3,951
              )
              
              5,440
              
              
              (11,311
              )Loss
                  from discontinued operations
              
              
              —
              
              
              —
              
              
              —
              
              
              —
              
              
              —Net
                  income (loss)
              
              $
              (1,995
              )
              $
              (1,872
              )
              $
              (3,951
              )
              $
              5,440
              
              $
              (11,311
              )PER
                  SHARE DATA:Basic
                        earning (loss) from continuing
                        operations
              
              $
              (0.92
              )
              $
              (0.75
              )
              $
              (1.25
              )
              $
              1.37
              
              $
              (2.57
              )Diluted
                        earning (loss) from continuing operations
              
              $
              (0.92
              )
              $
              (0.75
              )
              $
              (1.25
              )
              $
              1.31
              
              $
              (2.57
              )Basic
                          and Diluted loss from Discontinued
                          operations
              
              $
              —
              
              $
              —
              
              $
              —
              
              $
              —
              
              $
              —Basic
                  earning (loss) per share
              
              $
              (0.92
              )
              $
              (0.75
              )
              $
              (1.25
              )
              $
              1.37
              
              $
              (2.57
              )Diluted
                  earning (loss) per share
              
              $
              (0.92
              )
              $
              (0.75
              )
              $
              (1.25
              )
              $
              1.31
              
              $
              (2.57
              )SUMMARY
                  OF BALANCE SHEET DATA:Cash
                  and Cash Equivalents
              
              
              1,729
              
              
              2,894
              
              
              2,294
              
              
              2,444
              
              
              2,114Short
                  term deposit
              
              
              697
              
              
              353
              
              
              —
              
              
              —
              
              
              —Marketable
                  debt securities
              
              
              117
              
              
              —
              
              
              650
              
              
              11,077
              
              
              4,054Trade
                        receivables (net of allowance for doubtful accounts of $
                        3,487 and $ 3,500
                        as of December 31, 2006 and 2007,
                        respectively)
              
              
              1,808
              
              
              1,463
              
              
              1,053
              
              
              2,625
              
              
              2,463Inventories
              
              
              3,236
              
              
              2,165
              
              
              2,205
              
              
              270
              
              
              566Total
                  Current Assets
              
              
              9,881
              
              
              9,254
              
              
              8,023
              
              
              17,992
              
              
              14,769TOTAL
                  ASSETS
              
              
              12,685
              
              
              13,938
              
              
              12,276
              
              
              23,098
              
              
              20,952Total
                  Current Liabilities
              
              
              4,450
              
              
              4,259
              
              
              3,218
              
              
              5,452
              
              
              8,916Accrued
                  Severance Pay
              
              
              436
              
              
              564
              
              
              616
              
              
              323
              
              
              362SHAREHOLDERS’
                  EQUITY:TOTAL
                  SHAREHOLDERS' EQUITY
              
              
              7,612
              
              
              9,115
              
              
              8,247
              
              
              15,001
              
              
              9,233




6




***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 2004, 2005, 2006 and 2007. As of
      December 31, 2007, we had an accumulated deficit of approximately $29,936,000.
      We incurred net losses of approximately $3,951,000 and $11,311,000 in the years
      ended December 31, 2005 and 2007, 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. If we are unable to generate sufficient
      cash
      flow from operations, we will need to seek additional funds through the issuance
      of additional equity or debt securities or other sources of financing. We may
      not be able to secure such additional financing on favorable terms, or at all.
      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. We believe that,
      as of the filing date of
      this Annual Report, our working capital (including current cash and cash
      equivalents and marketable securities, in addition to revenues expected to
      be
      generated from our business operations) is sufficient for the Company’s present
      requirements. However, 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.




7




**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 2005, 2006 and 2007, we derived 66%, 80% and 79%, respectively, of
      our
      consolidated net revenue from four individual customers. In the year ended
      December 31, 2007, four of our customers accounted for 79% of our consolidated
      net revenues as follows: the government of a European country, European
      International Airport, China Travel Services (CHK) Ltd. and an African
      governmental agency accounted for 50%, 17%, 8% and 4%, 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 50% 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, or
      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.





We
      usually do not have minimum supply commitments from our vendors for our raw
      materials or components and generally purchase raw materials **** and
      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 various chips and toners 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.




8




**Delays
      in deliveries from our suppliers or 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
      suffered and may continue to suffer a loss on our investment in the OTI
      Transaction due to a decrease in the price of OTI’s
      shares.**





As
      of
      December 31, 2007, our investment in OTI’s ordinary shares consisted of
      $4,054,000 in marketable securities (current assets). We recognized a loss
      realized in 2007 from the sale of OTI's shares in the amount of $1,116,000
      and a
      decrease in value of marketable securities, n et
      in the
      amount of $2,699,000. The shares were restricted and are 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 the
      closing date, December 31, 2006 (see description of this transaction under
      the
      caption “The OTI Transaction” in Item 4.A). As of December 31, 2007,
      two-sevenths of the OTI shares were still subject to the lock-up restriction.
      OTI shares are traded on The NASDAQ Global Market. Profitability of our investment in OTI’s ordinary shares will depend on the
      share price and our ability to sell the OTI ordinary shares.





**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 which 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 SHC **** is
      our
      belief that the combined company would 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 SHC
                products;


·
            our
                ability to combine the operating activities of SHC’s subsidiaries with
                those of our U.S. subsidiary, Vuance,
                Inc.;


·
            our
                ability to sell our products to SHC’s existing customers;
                and


·
            our
                ability to maintain key employees of
                SHC;





SHC
      had
      substantial operation expenses; if we will not be able to increase revenues
      of
      the combined company, we will not be able to achieve profitability.





Prior
      to
      completion of the acquisition, we have 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 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.




9




**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 acquisition or integrating
      acquired business. 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
      recent 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.





**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 defend successfully our industrial or intellectual property rights,
      we might lose rights to technologies that we need to develop our business,
      which
      may cause us to lose potential revenues, or we might 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 one issued U.S. patent, two U.S. patent
      applications and two PCT applications. Generally, these patents and patent
      applications cover inventions relating to our products.





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.




10




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 feel that we could use another process to laminate
      plastic cards and our business would not be materially affected. 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 which 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 patent 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 parties’ 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
      since the product does not perform steps of assigning and recording as recited
      in the party's patent.





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.





11


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 will be required
      to
      defend and indemnify such customers.





**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.





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.




12




**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




·
            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.




13




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 might
      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
      2007,
      our revenues from the government market totaled approximately $10,904,000
      compared to $2,057,000 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.





14


**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.




15




**We
      need to develop our position as a provider of RFID 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; and


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





**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.




16




**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, can be 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 and, 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.





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.





17


**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 or 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.





18


**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. Generally,
      between five and ten, representing approximately 8% to 17%, of our officers
      and
      employees are at any one time obligated to perform annual reserve duty. We
      believe that a maximum of 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, and to refrain from misusing his
      power in exercising his or her rights and fulfilling his or her obligations
      toward the company and other shareholders and to refrain from abusing his power
      in the company, 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.




19


**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;


·
            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, and is not contrary to public
                policy;


·
            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")





20


**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.





**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 smart card security
      solutions generally. 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. We believe that,
      as
      of the filing date of this Annual Report, our working capital (including current
      cash, cash equivalents and marketable securities, in addition to the revenues
      generated from our business operations) is sufficient for the Company’s present
      requirements. However, 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.





21


**Restrictions
      imposed by our Convertible Bonds and other debts 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, industry or the economy in general, conduct
      operations or otherwise take advantage of business opportunities that
      arise.





Our
      failure to make any payments due under our debt instruments, or to otherwise
      comply with any of the restrictions or our obligations there under, 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 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. 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, 2008,
      5,151,269 of our ordinary shares were outstanding. In addition, we had a total
      of 1,035,252 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, 2008, we had a total of 782,685 ordinary shares issuable upon the exercise
      of outstanding warrants issued to investors and consultants, at various prices,
      which expire between 2009 and 2012. As of May 31, 2008, we had a total of
      654,486 ordinary shares issuable upon the conversion of convertible bonds.
      As of
      December 31, 2007, our registered capital permitted us to issue up to additional
      4,361,294 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**




Our
      ordinary shares are listed on The NASDAQ Capital Market. The listing standards
      of The NASDAQ Capital Market provide, among other things, that a company may
      be
      delisted if the bid price of its stock drops below $1.00 for a period of 30
      consecutive business days. Recently our shares have traded at about $3 per
      share. If we fail to comply with the listing standards applicable to issuers
      listed on The NASDAQ Capital Market, our ordinary shares may be delisted from
      The NASDAQ Capital Market. 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
      our ability to raise capital on terms acceptable to us or at all. Delisting
      from
      The NASDAQ Capital Market 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.





22


**"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
      ordinary shares are traded on more than one market and this may result in price
      variations.**




Our
      ordinary shares are traded primarily on The NASDAQ Capital Market in the U.S.
      and on the Euronext Brussels stock market in Belgium. Trading in our ordinary
      shares on these markets is made in different currencies (U.S. dollars on The
      NASDAQ Capital Market Board and Euro on Euronext Brussels) and at different
      times (resulting from different time zones, different trading days and different
      public holidays in the U.S. and Belgium). Consequently, the trading prices
      of
      our ordinary shares on these two markets often differ. Any decrease in the
      trading price of our ordinary shares on one of these markets could cause a
      decrease in the trading price of our ordinary shares on the other 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. Once
      our
      shares are traded only on The NASDAQ Capital Market, this risk of price
      variations will no longer be applicable to our shares.





**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 1,076,269 of our ordinary shares, representing approximately 20.89% of
      our
      outstanding ordinary shares, based on 5,151,269 ordinary shares currently
      outstanding. In addition, SSF own warrants exercisable for an additional 267,823
      ordinary shares and Convertible Bond for additional 154,486 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.




23




**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 theSECof
                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.





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. On 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.




24




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.





*The
      OTI Transaction*


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, 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. During 2007, we sold
      1,414,716, shares. We may gradually dispose of all of the OTI shares in order
      to
      finance our operation and in order to finance future acquisitions.





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. We expect that due to the revenues from the Existing Projects, our
      income in the short term will not be materially adversely affected. 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: 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 in our ordinary
      shares. The closing date of this transaction was August 28, 2007 (“SHC Closing
      Date”). SHC is 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 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.





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 the RAPTOR
      to
      our Credentialing & Incident Management Suite.




25




***Recent
      Developments***





In
        June
        2008, we
        reached an agreement
        with one of the investor (with a principle 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 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 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).
 As
        of
        June 30, 2008, we may be deemed not to be in compliance with certain covenants
        under our Convertible Bond with SSF in which case SSF could seek to accelerate
        payment of the unpaid principal amount and accrued interest under its
        Convertible Bond (an aggregate of approximately $740,000 as of June 30,
        2008).




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


In
      May
      2008, we announced that Eyal Tuchman, our Chief Executive Officer, had purchased
      $15,000 worth of shares.





In
      December 2007, we announced that we had recently entered into amendment
      agreements with holders of our Convertible Bonds to modify certain terms of
      such
      bonds.




In
        November 2007, we
        reached an agreement with our investors whereby one investor waived our
        compliance with certain covenants under the Convertible Bond in exchange
        for a
        one-time payment by
        us totaling
        $276,000 (before gross-up for withheld taxes )
        and to
        the other holder, modification of the conversion ratio of the bonds to
        $4.25.
        We accounted for the amendment as a modification of the  bond.


In
      September 2007, we announced that we had moved our corporate headquarters to
      U.S, in order to better serve the U.S. market.





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.





On
      September 9, 2007, we announced that we had entered into a definitive 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. While revenues from the contract are expected to be recognized over
      the
      next two years, we have already received a substantial portion of it as an
      advance payment. Once the system has been implemented, there is likely to be
      an
      additional maintenance agreement that could generate additional annual
      revenues.





In
      August
      2007, we announced that our ordinary shares had been approved for listing on
      The
      NASDAQ Capital Market and would begin trading on Thursday, August 23, 2007.
      The
      shares trade on the NASDAQ Capital Market under the symbol “VUNC.”





26


On
      August
      15, 2007, at an extraordinary general meeting of our shareholders, the
      shareholders resolved:


·
            To
                re-elect Eli Rozen, Avi Landman and Jaime Shulman to our Board of
                Directors;


·
            To
                ratify and approve the grant to Mr. Jaime Shulman of options to purchase
                20,400 of our ordinary shares, at an exercise price of $5.00 per
                ordinary
                share, under the terms of the our 2003 Israeli Share Option Plan,
                which
                options vest in three consecutive, equal yearly installments commencing
                on
                November 15, 2006;


·
            To
                approve our 2007 U.S. Stock Option
                Plan;


·
            To
                approve the purchase agreement, dated July 3, 2007, between Vuance
                Inc.
                and the shareholders of SHC;


·
            To
                increase the Company’s authorized share capital to NIS 705,882, consisting
                of 12,000,000 ordinary shares, par value NIS 0.0588235
                each;


·
            To
                replace our then-existing Articles of Association of us with new
                Articles
                of Association ; and


·
            To
                appoint Fahn Kanne & Co. as our independent external
                accountant-auditor for fiscal year 2007 and to authorize our Board
                of
                Directors (or, the Audit Committee, if authorized by the Board of
                Directors) to fix the remuneration of such independent accountant-auditor
                in accordance with the volume and nature of their
                services.





In
      addition, during this meeting, our audited financial statements as of December
      31, 2006 were presented to and discussed by our shareholders.




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)




On
      June
      14, 2007, we announced that Mr. Lior Maza has joined the Company’s executive
      management team as Chief Financial Officer. Mr. Maza replaced Mr. Yaron Shalom.




In
      May
      2007, we announced that a t
      an
      extraordinary general meeting held on April 29, 2007, our shareholders approved
      (1) a change of our name from SuperCom Ltd. to Vuance Ltd., and (2) a
      1-for-5.88235 ‘reverse split’ of our ordinary shares. Our name change and the
      reverse share split became effective
      for trading purposes on May 14, 2007.





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, joined our Advisory Board. (See the
      section captioned “Enhancing Our Presence” in Item 4.B for more information on
      our Advisory Board).





***Principal
      capital expenditures and divestitures***





From
      January 1, 2007 to December 31, 2007, our capital expenditures totaled
      approximately $116,000 (compared to $93,000 during 2006 and $315,000 during
      2005), of which approximately $62,000 (compared to $69,000 during 2006 and
      $293,000 during 2005) can be attributed to our facilities in Israel, and
      approximately $54,000 (compared to $24,000 during 2006 and $22,000 during 2005)
      can be attributed to various facilities of our subsidiaries outside of Israel.
      During the first financial quarter of 2008, our capital expenditures totaled
      approximately $44,000.





***Corporate
      information***





Our
      U.S.
      headquarters are located at 15850 Crabbs Branch Way, Suite 120, Rockville,
      MD
      20850 and our telephone number is +1-240-268-1125. 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
      15850 Crabbs Branch Way, Suite 120, Rockville, MD 20850.




27




***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.





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


COMPAS
      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 (such as 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 solutions sold by
      distributors to smaller businesses.




28




***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 and passive 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 client's
                needs.


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 open 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 and
                RAPTOR.




29


***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. distributers, 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 in IRAQ (mobile access control unit). 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, and we may pursue acquisitions
      of
      one or more companies which 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.





30


**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 that 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 etc.





***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.




31




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 to an end-to-end comprehensive solution.




***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 and demand. The first RAPTOR Express systems will be provided within
      few months. 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 the state and local governments.




32




***Communications
      Interoperability.*** **** Our
      interoperability bridges link mobile and portable radios of all kinds, military
      and civilian, as well as cell/satellite/direct-connect and land-line
      telephones, allowing responders to communicate across technological and
      organizational boundaries, without changing equipment or monopolizing their
      communications systems.  These bridges are P25 and VoIP compatible,
      allowing users the ability of utilizing our robust 900 MHz tripods as repeaters
      if no other communication networks are available.





***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 July 2006, we entered into an agreement with H.M.S. Telecom, LLC, a leading
      oil and gas industry consulting group from Houston, Texas to represent and
      market our CSMS products to the oil and gas industry. 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.





***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.





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.





33


**Passive
      RFID**





Electronic
      Access Control (“EAC”) Suite





***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 solutions 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 allows 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 wide range of customers from challenging environments through
      the
      commercial sectors to small businesses and private sector. This can be achieved
      by presenting three product lines:





·
            Compass


EAC
      for
      education and commercial sector


·
            MASC


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


·
            Clarity/Insignia


EAC
      for
      small businesses and the commercial and private sector





**Sectors
      targeted include:**





Health
      Care


From
      clinics in shopping malls to sprawling medical campuses, the challenges facing
      the health care industry go beyond anything people could have imagined. 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 to
      credentialing and verifying faculty, staff (and students) to tracking equipment
      from building to building or throughout districts , from identifying vehicles
      to
      securing buildings and facilities in the event of disaster; educators are no
      longer “just teachers” and administrators must enforce any number of
      requirements in place to keep students and assets safe.




34




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, to 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 which require high security are enormous and
      ever-changing. Coordinating access to secure areas, monitor these environments
      efficiently despite multiple events, challenging environment requires reliable
      intuitive solutions to meet the needs in a complex and highly 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 RAPTOR 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
      and 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 2005, 2006 and
      2007 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 and 2007, we recognized revenue
      of $4,569,000 and $5,826,000, 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. While
      revenues from the contract are expected to be recognized over the next two
      years, we have already received a substantial portion of it as an advance
      payment. Once the system has been implemented, there is likely to be an
      additional ten-year maintenance agreement that could generate an additional
      $620,000 in annual revenues. In 2007, we recognized revenue of $2,182,000,
      under
      this agreement.





***Other
      Projects***





During
      the years 2005, 2006 and 2007 we had the following projects:


·
            Passports
                and ID Card - Africa


·
            National
                Documentation - Moldova


·
            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




35




During
      the years ended 2005, 2006 and 2007 we generated revenues from the above
      mentioned project, in the total amount of, $7,186,000, $2,846,000 and
      $2,618,000, 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 $1.2 million,
      $1.4
      million and $1.7 million on research and development in 2005, 2006 and 2007,
      respectively. These amounts were spent on the development or improvement of
      our
      technologies and products, primarily in the areas of 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 28 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 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,****2005**
            
            **2006**
            
            **2007****Total**
            
            **Total**
            
            **Total****revenues**
            
            **revenues**
            
            **revenues**Europe
            
            $
            3,719
            
            $
            5,877
            
            $
            8,650Asia
                Pacific
            
            
            2,173
            
            
            1,730
            
            
            1,330Africa
            
            
            2,158
            
            
            621
            
            
            823United
                States
            
            
            202
            
            
            373
            
            
            1,787Israel
            
            
            210
            
            
            194
            
            
            371$
            8,462
            
            $
            8,795
            
            $
            12,961





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





**Year
                ended December 31,****2005**
            
            **2006**
            
            **2007**Raw
                materials and equipment
            
            $
            6,538
            
            $
            6,529
            
            $
            9,315Maintenance,
                royalties and project management
            
            
            1,924
            
            
            2,266
            
            
            3,646$
            8,462
            
            $
            8,795
            
            $
            12,961





36





**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 Vuance 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's 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 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 our ** CSMS
      and
      RAPTOR and active RFID tracking products and the ongoing changes in this market,
      the above-mentioned list might not constitute a full list of all of our
      competitors and additional companies may be considered our competitors.




37





**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***





As
      part
      of the OTI Transaction, we transferred our entire portfolio of patents related
      to the E-ID Division to OTI.


Our
      patent portfolio currently consists of one issued patent, two U.S patent
      application and two PCT applications. Generally, these patents and patent
      applications cover inventions relating to our products.





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.





38


**Employees**





As
      of
      December 31, 2007 we had 67 full-time employees, compared to 56 full-time
      employees as of December 31, 2006. (See the discussion under the caption
“Employees” in Item 6.D)





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.




39




***C.    Organizational
      Structure***














**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 purchase all
      the
      assets and liabilities of Vuance RFID Ltd.





**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.




**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%.





**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.




**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.





40


***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 subleased a portion
      of its space.





Vuance,
      Inc. leases approximately 214 square meters of office space in Rockville,
      Maryland, U.S. As a result of the acquisition of SHC, Vuance Inc. now leases
      several additional facilities in Franklin, Wisconsin, Peachtree City, Georgia
      and Exton, Pennsylvania of approximately 391, 465 and 258 square meters,
      respectively. Also, as a result of the acquisition of the assets of DMS, a
      lease
      of a facility in Gardner, Massachusetts was transferred to Vuance Inc. the
      lease
      is of approximately 441 square meters. The monthly fee of the facility in
      Franklin, Wisconsin is $5,000 and the total monthly fee of all such other
      facilities is $14,500.





SuperCom
      Asia Pacific leases approximately 300 square meters of office space in Hong
      Kong.





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





The
      total
      annual rental fees for 2005, 2006 and 2007 were $369,560, $354,530 and $376,295,
      respectively. The total annual lease commitments for 2008 are
      $602,803.





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





The
      following table details our fixed assets as of December 31, 2006 and
      2007:




**December 31,****2006**
            
            **2007****(In thousands of US Dollars)****Cost:**Computers
                and peripheral equipment
            
            $
            300
            
            $
            287Office
                furniture and equipment
            
            
            211
            
            
            193Leasehold
                improvements
            
            
            75
            
            
            33586
            
            
            513**Accumulated
                depreciation:**Computers
                and peripheral equipment
            
            
            259
            
            
            183Office
                furniture and equipment
            
            
            92
            
            
            92Leasehold
                improvements
            
            
            75
            
            
            20426
            
            
            295**Depreciated
                cost:**
            
            $
            160
            
            $
            218





Depreciation
      expenses for the years ended December 31, 2005, 2006 and 2007 were $746,000,
      $335,000 and $38,000, respectively.





During
      fiscal year 2005, the Company relocated its offices from Ra'anana to Qadima.
      As
      a result the Company wrote down an unamortized balance of leasehold improvement
      in the amount of $471,000. This expense was recorded in the statement of
      operations as part of “Restructuring expenses.”





On
      December 31, 2006, as part of the OTI Transaction, all property and equipment
      related to the E-ID Division were transferred to OTI.





41


**ITEM
      4A.** ***Unsolved
      Staff Comments.***





Not
      applicable.





**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.” . 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 the NASDAQ Capital Market under the symbol
      “VUNC.” Upon the commencement of trading of our ordinary shares on The NASDAQ
      Capital Market, our ordinary shares ceased to trade on the OTC Bulletin
      Board.





We
      develop and market incident response management and tracking solutions for
      public safety agencies, commercial customers and governmental organizations.
      We
      offer three principal suite to our customers, as follow:





***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


COMPAS
      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 solutions sold by distributors
        to smaller businesses.





42


***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 different regions of
      the
      world. 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.





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.





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 is 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 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.




43




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 the RAPTOR
      to
      our Credentialing & Incident Management Suite.





***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 and raw materials.


Following
      delivery of such systems, the majority 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.
      On an
      ongoing basis, we evaluate our estimates and judgments, including those related
      to revenue recognition, allowance for bad debts, and valuation of inventories
      and impairment of long-lived 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.




44




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:





·
              Revenue
                  recognition;


·
              Allowance
                  for doubtful accounts;


·
            Contingencies;


·
            Stock
                Based Compensation; and


·
            Other
                than temporary impairment of Available for sale
                securities.


·
            Goodwill
                and other intangible assets





***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
      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 according to
      specific terms and conditions. As of December 31, 2007 we had an allowance
      for
      customer's returns in the amount of $57,000.





Based
      on
      past experience, we do not provide for warranty costs when revenue is
      recognized.





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.





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





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 stipulated in each
      contract.




45




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, 2007, 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 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, 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
      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
      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.




***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 $3,487,000 and $3,500,000 at December 31,
      2006 and 2007, 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 including Financial
      Accounting Standards Board (FASB) Interpretation No. 44, “Accounting for Certain
      Transactions involving Stock Compensation,” an interpretation of APB Opinion No.
      25 issued in March 2000 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 grant. SFAS
      No.
      123, “Accounting for Stock-Based Compensation, (SFAS 123)” and FASB Statement
      No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure,” an
      amendment to FASB Statement No. 123, established accounting and disclosure
      requirements using a fair-value-based method of accounting for stock-based
      employee compensation plans. As permitted, through December 31, 2005, we elected
      to apply the intrinsic-value-based method of accounting described above, and
      have adopted only the disclosure requirements of SFAS No. 123, as amended.




46




However,
      as more fully described in note 2(w) 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. Accordingly, prior period amounts have not been restated. 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.





***Other
      than temporary impairment of Available for sale
      securities***





The
      Company applies the provisions of SFAS 115, "Accounting for Certain Investments
      in Debt and Equity Securities", SAB 59, "Noncurrent Marketable Equity
      Securities" and other related pronouncements with respect to its available
      for
      sale securities. These pronouncements require companies to perform periodic
      reviews of individual securities in its investment portfolio to determine
      whether a decline in the value of a security is other than temporary. A review
      for other than temporary impairment requires companies to make certain
      forward-looking assumptions regarding the probability, extent and timing of
      a
      valuation recovery, the materiality of the decline and its effect on the
      financial statements, and the Company's ability and intent to hold the security.
      Specifically, 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 exist 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.




***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 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 included estimates of future cash flows and estimates of discount
      rates. On December 31, 2007, we had total goodwill of $3,644,000 on our balance
      sheet (such goodwill resulted from the acquisition of SHC during August 2007).
      In assessing the recoverability of our goodwill and other intangible assets,
      we
      must make assumptions regarding the estimated future cash flows and other
      factors to determine the fair value of the respective assets. If these estimates
      or their related assumptions change in the future, we may be required to record
      impairment charges for these assets. No impairment losses of goodwill or other
      intangible assets have been recognized during the reported periods.




47





**Results
      of Operations**





The
      following table sets forth selected consolidated income statement data for
      Vuance for each of the three years ended December 31, 2005, 2006 and 2007
      expressed as a percentage of total revenues.





2005
            
            2006
            
            2007Revenues
            
            
            100
            %
            
            100
            %
            
            100
            %Cost
                of revenues
            
            
            50.7
            
            
            39.7
            
            
            43.2Inventory
                write-off
            
            
            3.4
            
            
            —
            
            
            —Gross
                profit
            
            
            45.9
            
            
            60.3
            
            
            56.8Operating
                expenses:Research
                and development
            
            
            14.0
            
            
            15.5
            
            
            13.2Selling
                and marketing, net
            
            
            35.5
            
            
            63.9
            
            
            69.8General
                and administrative
            
            
            35.0
            
            
            31.1
            
            
            24.6Restructuring
                expenses
            
            
            5.9
            
            
            —
            
            
            —Litigation
                settlement expenses
            
            
            1.5
            
            
            1.2
            
            
            0.3Total
                operating expenses
            
            
            91.9
            
            
            111.7
            
            
            107.9Capital
                gain from the sale of the E-ID Division
            
            
            —
            
            
            119.7
            
            
            —Operating
                income (loss)
            
            
            (46.0
            )
            
            68.3
            
            
            (51.1
            )Financial
                income (expenses), net
            
            
            (0.3
            )
            
            (2.3
            )
            
            (35.8
            )Other
                income (expenses), net
            
            
            (0.4
            )
            
            (4.2
            )
            
            —Income
                (loss) before income taxes
            
            
            (46.7
            )
            
            61.8
            
            
            (86.9
            )Taxes
                on income
            
            
            —
            
            
            —
            
            
            (
                0.3
            )Loss
                from discontinued operations
            
            
            —
            
            
            —
            
            
            —Net
                income (loss)
            
            
            (46.7
            )
            
            61.8
            
            
            (87.2
            )





48




**Operating
      Results**





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





***Revenues***





Our
      revenues in 2007 were $12,961,000, compared to $8,795,000 in 2006, an increase
      of 47%. The increase in our revenues is primarily due to our new project with
      a
      European air port 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 anticipate that our
      revenues in 2008 will continue to increase primarily due to the SHC transaction
      and the airport project. 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 $7,361,000 compared to gross profits of $5,301,000 in
      2006,
      an increase of 38.9%. The gross profit margin for the year 2007 decreased by
      3.5%, compared to 60.2% 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
      commissions due to the increase in revenues.




Research
      and development expenses consist primarily of salaries, benefits, subcontractors
      allocated rent 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 and due to the SHC transaction.




Selling
      and marketing expenses consist primarily of salaries and commission earned
      by
      sales and marketing personnel, trade show and promotional expenses, allocated
      rent 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 different mix of projects.




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. 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.




49




***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.





***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.




**Year
      Ended December 31, 2006 Compared to Year Ended December 31, 2005**





***Revenues***





Our
      revenues in 2006 were $8,795,000 compared to $8,462,000 in 2005, an increase
      of
      4%.





***Gross
      Profit***





Our
      gross
      profits in 2006 were $5,301,000 compared to gross profits of $3,882,000 in
      2005,
      an increase of 36.6%. The gross profit margin for the year 2006 increased by
      14.4% as compared to 46% in 2005. The increase in our 2006 gross profit margin
      was primarily due to different mix of products, which carry higher margins.





***Expenses***





Our
      operating expenses in 2006 were $9,826,000 compared to $7,778,000 in 2005,
      an
      increase of 26%. The increase in operating expenses was mainly due to the
      increase in selling and marketing.




Selling
      and marketing expenses consist primarily of salaries and commission earned
      by
      sales and marketing personnel, trade show and promotional expenses, allocated
      rent and supplies and travel and entertainment costs. Our selling and marketing
      expenses in 2006 were $5,619,000 compared to $3,003,000 in 2005, an increase
      of
      87%. 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. and
      different mix of projects.




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. Our general
      and
      administrative expenses in 2006 were $2,737,000 compared to $2,968,000 in 2005,
      a decrease of 7.8%.




Research
      and development expenses consist primarily of salaries, benefits, allocated
      rent
      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 2006 were
      $1,362,000 compared to $1,182,000 in 2005, an increase of 15%. The increase
      in
      the research and development expenses was primarily due to research and
      development expenses associated with our new technologies, CSMS and active
      RFID.




Restructuring
      expenses contains certain financial measures related to expenses totaling
      $496,000 that are associated with cost-cutting measures implemented by us in
      2005.




Additionally,
      litigation settlement expenses consist of one time expenses that relate to
      litigations that settled during the years 2005 and 2006, as described in "Legal
      Proceedings" in Item 8. Our litigation settlement expenses in 2006 were $108,000
      compared to $129,000 in 2005.




50





***Capital
      gain from the OTI Transaction***





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, 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.





The
      direct expenses included, inter alia, the fair value of 212,040 shares out
      of
      the shares we received from OTI that were partly transferred to consultants,
      as
      a finder and legal fee, in connection with the transaction (Our investment
      in
      OTI’s shares includes the shares held by us, net of the shares that will be
      transferred to the consultants).





***Financial
      Interest Expense, net***





Financial
      expense for the twelve months ended December 31, 2006, and 2005, were $204,000
      and $25,000, respectively. The increase in financial expense is mainly due
      to
      the financial expenses with respect to convertible bond that were issued in
      November 2006 in the amount of $75,000.





***Other
      Expenses, Net***





Other
      expenses, net for the twelve months ended December 31, 2006, and 2005, was
      $
      367,000 and $30,000, respectively. Other expenses, net during the year 2006
      consisted write down of loan regarding an investment in an affiliated company
      and other trade receivables in the amount of $321,000 compared to $0 during
      the
      year 2005.





***Net
      Loss***





As
      a
      result of the factors described above, our net income in 2006 was $5,440,000
      compared to a net loss of $3,951,000 in 2005.




**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 expenses and, as a result, on 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
      2007,
      the rate of evaluation of the NIS against the U.S. dollar was 8.9% and the
      rate
      of inflation, in Israel, was 3.4%. 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,
      2007, 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
      management determines that it is necessary or advisable to offset these
      risks.




51





**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 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 capital expenditures, particularly for government
      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**




In
      September 2006, the FASB issued SFAS No. 157, “ Fair
      Value Measurements”. This Statement clarifies the definition of fair value,
      establishes a framework for measuring fair value, and expands the disclosures
      on
      fair value measurements. However, SFAS No. 157 does not require any new
      fair value measurement. FAS No. 157 is effective for fiscal years beginning
      after November 15, 2007, and interim periods within those fiscal years and
      its provisions should be applied prospectively (with a limited retrospective
      application). The Company chose to early apply the provisions of SFAS
      No. 157 beginning January 1, 2007.





In
      February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
      for Financial Assets and Financial Liabilities - Including an amendment of
      SFASB
      Statement No. 115” (“SFAS 159”). This pronouncement permits all entities to
      choose to elect, at specified election dates, to measure eligible financial
      instruments at fair value. An entity shall report unrealized gains and losses
      on
      items for which the fair value option has been elected in earnings at each
      subsequent reporting date, and recognize upfront costs and fees related to
      those
      items in earnings as incurred and not deferred. SFAS  159 applies to fiscal
      years beginning after November 15, 2007, with early adoption permitted for
      an entity that has also elected to apply the provisions of SFAS No. 157. An
      entity is prohibited from retrospectively applying SFAS No. 159, unless it
      chooses early adoption of SFAS 157 also. The Company is currently assessing
      the
      impact of SFAS No. 159 , if any on its financial position and results of
      operations.





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 has not
      yet
      evaluated this statement for the impact, if any, that SFAS 141(R) will have
      on
      its financial position and results of operations.





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 has not yet
      determined the impact, if any, that SFAS No. 160 will have on its financial
      position and results of operations.




52




In
      December 2007, the SEC issued Staff Accounting Bulletin No. 110 (“SAB 110”)
      regarding the use of a "simplified" method, as discussed in SAB No. 107 ("SAB
      107"), in developing an estimate of expected term of "plain vanilla" share
      options in accordance with SFAS No. 123 (revised 2004), "Share-Based
      Payment". Until December 31, 2007, SAB 107 allowed the use of the
      simplified method. SAB 110 allows, under certain circumstances, to continue
      to
      accept the use of the simplified method beyond December 31, 2007. The
      Company believes that the adoption of SAB 110 will not have a material impact
      on
      its financial position and results of operations.





In
      May
      2008, the FASB issued SFAS No.162”The Hierarchy of Generally Accepted Accounting
      Principles” (“SFAS 162”). SFAS 162 identifies the sources of accounting
      principles and the framework for selecting the principles to be used in the
      preparation of financial statements of nongovernmental entities that are
      presented in conformity with generally accepted accounting principles in the
      U.S. (the GAAP hierarchy).





SFAS
      162
      iS effective sixty days following the SEC’s approval of PCAOB amendments to AU
      Section 411, “The Meaning of “Present Fairly in Conformity With Generally
      Accepted Accounting Principles””. The company is currently evaluating the
      potential impact, if any, of the adoption of SFAS 162 on its condensed
      consolidated financial statements.





***B.***
            ***Liquidity
                and Capital Resources***





Net
      cash
      used in operating activities for the twelve months ended December 31, 2007
      was
      $4,890,000 compared to $3,047,000 during the period ended December 31, 2006,
      an
      increase of $1,843,000 or 60%. Our net loss for 2007 was $11,311,000, less
      other
      adjustments reached to net cash used in operating activities for the year 2007
      of $4,890,000, compared to a net income for 2006 of $5,440,000, less a capital
      gain from the OTI Transaction in the amount of $10,536,000 and other adjustments
      reached to net cash used in operating activities in 2006 of
      $3,047,000.




Net
      cash
      provided by investing activities during the period ended December 31, 2007
      was
      $4,774,000, compared to $476,000, during the period ended December 31, 2006,
      an
      increase of $4,298,000. This increase was primarily due to the proceeds from
      the
      sale of marketable securities of other companies in the amount of $7,639,000
      during 2007, compared to $0 during 2006, the decrease in severance pay fund
      of
      $278,000 during 2007, compared to an increase of $95,000 during 2006. The
      increase was to a certain extent offset by an investment in restricted cash
      deposit, net of $2,313,000 during 2007, compared to proceeds of $229,000 during
      2006 and capitalization of software and intangible assets during 2007 in the
      amount of $509,000, compared to $0 during 2006.




Net
      cash
      used in financing activities during the year ended December 31, 2007 was
      $214,000, compared to net cash provided by financing activities of $2,721,000
      during the year ended December 31, 2006, a decrease of $2,935,000. This decrease
      was primarily due to proceeds from the issuance of convertible bonds and
      warrants, net during 2006 of $3,139,000, compared to $0 during 2007.





As
      of
      December 31, 2007, our cash and cash equivalents totaled $2,114,000, compared
      to
      $2,444,000 as of December 31, 2006. Restricted cash totaled $3,172,000 as of
      December 31, 2007, compared to $859,000 as of December 31, 2006. The main
      increase in restricted cash deposit is related to a bank deposit in the amount
      of $2,590,000 to secure a guarantee to a supplier, related to a certain project
      of the Company with a European country. Restricted cash is invested in
      certificates of deposits, which mature within one year, and is used to secure
      agreements with a customer or a bank. Marketable securities totaled $4,054,000
      as of December 31, 2007, compared to $11,077,000 as of December 31, 2006. The
      majority of the decrease in the marketable securities on December 31, 2007
      was
      due to a decline in the price of OTI shares and the sale of a portion of our
      OTI
      shares.





We
      have
      accumulated net losses of approximately $29,936,000 from our inception through
      December 31, 2007, and we have continued to accumulate net losses since December
      31, 2007. 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), from our sale of the shares of our former subsidiary, InkSure Technologies, Inc.,, and, to a lesser extent, 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 and in 2007 from the sale
      of
      OTI shares that were received from the sale of the E-ID Division to
      OTI. As of
      December 31, 2007, our principal source of liquidity was $2,114,000 of cash
      and
      cash equivalents. As of December 31, 2007, we had $478,000 of debt outstanding
      relating to obligations under our credit facility, an obligation for severance
      pay to Israeli employees of $362,000, of which $309,000 is provided by monthly
      deposits to severance pay funds, insurance policies and Convertible bonds of
      $2,441,000.




53




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 in respect of 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 issuances of two
        classes of units ,
        each consisting of convertible bonds and warrants (the “Convertible Bonds
        Transaction”). Units valued at $2,500,000 were issued to one investor ,
        and
        units valued at $656,500 were issued to Special Situation Funds (SSF), based
        on
        the participation rights provided in private placement during the year 2005,
        as
        described above, who are
        our
        existing shareholders. The Convertible Bonds of
        both
        classes mature
        three years from the date of issuance and bear interest
        at an annual rate of 8%. 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). Payment of interest will be net of any tax. Subject
        to
        certain redemption provisions, as described below, the Convertible Bonds were
        convertible at any
        time, at the option of the investors, into our ordinary shares at an
        initial conversion price of $5.00 per share .
        The
        purchasers of the Convertible Bonds were also granted warrants entitling
        them to
        acquire a total of 134,154 ordinary shares at an exercise price of $5.00
        per
        share during the next five years. In respect of this transaction, we paid
        approximately $215,000 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
        $40,000.
 
 Between
        February 10, 2008 and February 16, 2008, we had the option to call and redeem
        100% of the Convertible Bonds at a price equal to (i) the aggregate principal
        amount of the bonds plus (ii) a redemption premium equal to fifteen percent
        (15%) of the aggregate principal amount plus (iii) any accrued but unpaid
        interest on the aggregate principal amount, calculated through the date of
        redemption. We didn't exercise our
        options to redeem the Convertible Bonds.
 
 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 have 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.





54


As
        a
        result of the Convertible Bonds Transaction, we recorded an amount of $282,000
        in respect of the warrants and an amount of $632,000 as a 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, we
        reached an agreement with our investors whereby one investor waived our
        compliance with certain covenants under the Convertible Bond in exchange
        for a
        one-time payment by
        us totaling
        $276,000 (before gross-up for withheld taxes )
        and to
        the other holder, modification of the conversion ratio of the bonds to
        $4.25.
        We accounted for the amendment as a modification of the  bond.
 
 As
        of
        December 31, 2007, we were in compliance with the amended
        terms of the
        Convertible Bonds .
 
 In
        June
        2008, we
        reached an agreement
        with one of the investor (with a principle 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 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 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).
  As
        of
        June 30, 2008, we may be deemed not to be in compliance with certain covenants
        under our Convertible Bond with SSF in which case SSF could seek to accelerate
        payment of the unpaid principal amount and accrued interest under its
        Convertible Bond (an aggregate of approximately $740,000 as of June 30,
        2008).


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.





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, we sold 1,414,716 shares of OTI for a total consideration of
      $7,639,000.





Our
      budget relies on the Existing Projects for which OTI agreed to act as
      subcontractor, on the new project with a European airport and on estimated
      revenues from our new technologies and acquisitions.





As
      of
      December 31, 2007, we had credit lines from several banks in an aggregate amount
      of $550,000 including long-term loans (from time to time the bank may increase
      our credit line for a limited period), of which $120,000 is denominated in
      NIS
      and bears interest at the Prime rate plus 0.5% to 2.5%, and $430,000 is
      denominated in dollars and bears interest at a rate of LIBOR plus 2.5% to 2.9%
      (as of December 31, 2007, the rates of the U.S LIBOR and Prime were around
      4.5%
      and 5.75%, respectively) The weighted average interest rate on the credit lines
      as of December 31, 2006 and 2007 was approximately 7.85% and 6.95%,
      respectively.





We
      had an
      unused credit facility in the amount of approximately $100,000 as of December
      31, 2007. There is no fee for the unused portion of the credit facility.




55




During
      the period from January 1, 2007 to December 31, 2007, our capital expenditures
      totaled approximately $116,000 (compared to $93,000 during 2006 and $315,000
      during 2005), of which approximately $62,000 (compared to $69,000 during 2006
      and $293,000 during 2005) was expended at or upon Vuance's facilities in Israel,
      and approximately $54,000 (compared to $24,000 during 2006 and $22,000 during
      2005) was expended upon various facilities of Vuance's subsidiaries outside
      Israel. During the first financial quarter of 2008, our capital expenditures
      totaled approximately $44,000.




We
      believe that our existing capital resources together with revenue from
      operations and amounts available under our credit facility will be sufficient
      for the Company’s present requirements and will satisfy the operating capital
      needs at least till the end of 2008 based upon our anticipated business
      activities. However, we may need additional capital within 2008, if it will
      undertake large projects or have a delay in one of the anticipated projects.
      If
      we fail to raise such additional capital, there might be need to implement
      certain operational changes in order to decrease the expenditure level.





***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,
      2007
      the number of employees in our research and development activities was 12.
      We
      focus on the new technology of our RFID and Credentialing, and expect to
      maintain our current research and development efforts. We spent $1.2 million,
      $1.4 million and $1.7 on research and development in 2005, 2006 and 2007,
      respectively. These amounts were spent on the development or improvement of
      our
      technologies and products, primarily in the areas of RFID and Credentialing
      in
      2007 and during 2006 and 2005 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.





***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 2007 revenues was derived from our governmental
      projects and the remainder was derived from commercial products. Historically,
      our revenues have been concentrated in a few large orders and in a relatively
      small number of customers, a trend that has been increasing over time. We expect
      this trend to change and in the future revenues will come from larger number
      of
      orders and customers.




56




Our
      revenues from the government market for 2006 and 2007 totaled $7,947,000 and
      $10,904,000, respectively. In comparison our revenues from the commercial market
      for 2006 and 2007 totaled $848,000 and $2,057,000, respectively. We anticipate
      that our mix of revenues from government and commercial markets for 2008 will
      be
      consistent with our mix of revenues in 2007.





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 major disasters it has become increasingly important
      for agencies to track personnel, assets, and other objects on a local
      positioning basis. Our CSMS 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 in a number of counties in the U.S., including Los
      Angeles, and we are currently discussing CSMS 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 2008 revenues will be primarily derived from:





·
            Smart
                ID technologies;


·
            Passive
                RFID - Electronic Acces Control;


·
            CSMS;


·
            Active
                RFID; and


·
            High
                security solution integration.





***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.





***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 or expenses, results of operations, liquidity,
      capital expenditures or capital resources.




57




***E.***
            ***Tabular
                Disclosure of Contractual
                Obligations***





**Contractual
      Obligations**





The
      following table summarizes our contractual obligations and commitments as of
      December 31, 2007, which will require significant cash outlays in the
      future:





**Contractual Obligations**
            
            **Total**
            
            **Less than**
              **1 year**
            
            **1-3 years**
            
            **3-5 years**
            
            **More than**
              **5 years**Long-term
                debt obligations
            
            $
            82,000
            
            $
            82,000
            
            
            —
            
            
            —
            
            
            —Capital
                (finance) lease obligations
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Operating
                lease obligations
            
            $
            1,542,000
            
            $
            603,000
            
            $
            939,000
            
            
            —
            
            
            —Unconditional
                purchase obligations
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Convertible
                bonds
            
            $
            3,156,566
            
            
            —
            
            $
            3,156,566
            
            
            —
            
            
            —Total
                contractual cash obligations
            
            $
            4,780,566
            
            $
            685,000
            
            $
            4,095,566
            
            
            —
            
            
            —





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 and lease
      agreement for facilities. We are not a party to any capital leases.





**ITEM
      6.** ***Directors,
      Senior Management and Employees.***




***A.***
            ***Directors
                and Senior Management.***




**Board
      of Directors**




We
      are
      managed by our Board of Directors which, 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 reelected at the same meeting, The General Meeting may resolve
      that a director be elected for a period longer than by the next annual meeting
      but not longer than the third next annual meeting. The Board of Directors elects
      one of its members to serve as the Chairman.





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




***Name***
            **
            ***Age***
            **
            ***Position***Eli
                Rozen
            
            54
            
            Director,
                Chairman of the BoardAvi
                Landman
            
            54
            
            DirectorIlan
                Horesh
            
            56
            
            External
                Director (1)Jaime
                Shulman
            
            65
            
            DirectorMichal
                Brikman
            
            38
            
            External
                Director - October 28, 2004- October 27, 2007
                (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 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. Ms. Brikman has agreed to be reelected as our external director
      and to apply such election retroactively since October 28, 2007. Accordingly,
      we
      intend to propose to our forthcoming annual general meeting of shareholders
      to
      reelect Ms. Brikman as an external director for an additional period of three
      years commencing as of October 28, 2007. We also intend to have our board of
      directors and such committees ratify all of the actions that have been taken
      by
      them since the expiration of Ms. Brikman's initial term as our external
      director.




58




***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 joining us in 1988, Mr. Landman worked as a computer
      engineer at Gal Bakara Ltd. and prior to that as an electrical engineer at
      Eltam
      Ltd. Mr. Landman has a Bachelor of Science degree in Computer Engineering from
      the Technion - Israel Institute of Technology'.




***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 and since 2007 is a board member of Taldor
      Computer System (1986) Ltd,, 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 Bachelor of Arts degrees in Business Administration and in History
      & Geography and a Master of Arts in Political Science.




***Jaime
      Shulman*** ,
      became
      a member of the Board of Directors on September 17, 2006. From 2001 to 2003
      Mr.
      Shulman was president and C.E.O of Logisticare, Ltd. From 1998 to 2000, Mr.
      Shulman was the president and CEO of the Amcor Group. From 1993 to 1997, Mr.
      Shulman was the 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 in 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. Since 2000, Ms. Brikman has been 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.





**Executive
      Officers and Key Employees** ****





As
      of
      June 2, 2008, our executive officers and certain key employees who are not also directors are:




**Name**
            ****
            **Age**
            ****
            **Position**Eyal
                Tuchman
            
            40
            
            Chief
                Executive OfficerRon
                Peer
            
            58
            
            Deputy
                CEO, Marketing, Technology and Business DevelopmentLior
                Maza
            
            37
            
            Vice
                President of Corporate Finance, Chief Financial OfficerJoel
                Konicek*
            
            58
            
            Chief
                Operating OfficerJim
                Peroutka*
            
            54
            
            Chief
                Technology OfficerPete
                Martin*
            
            62
            
            Vice
                President, Vuance USA & President AAID Security SolutionsKyle
                John
            
            41
            
            Vice
                President Sales, North America.Thomas
                W. Connell II
            
            41
            
            Vice
                President Government Solutions




*Joined
      the Company as a result of the SHC transaction







***Eyal
      Tuchman*** ,
      Chief
      Executive Officer. In April 2006, Mr. Tuchman became Vuance’s Chief Executive
      Officer, after 4 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.




59




***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 foundations, 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 10 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, graduate 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, ID systems and Locks, the Book on Electronic Access Control in
      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.




***Pete
      Martin,*** Vice
      Presidet, Vuance USA and President AAID Security Solutions. Mr. Martin joined
      the Company in 2007. As a pioneer in the development of Intelligent Gate Control
      and Long Range Active RFID Systems, Mr. Martin has been involved with RFID
      applications and security for over 20 years. As a recognized industry leader,
      he
      has been a featured speaker at association events by ASIS, AFA, National Cargo
      Security Council (NCSC), American Association of Airport Executives (AAAE),
      RFID
      World Boston, Vartech, and the Americas’ Fire and Security Expo
      (AFSE).




***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 terror attacks.




***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, 2007 was approximately $959 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.




60




As
      of
      December 31, 2007, we had set aside approximately $13,200 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, 2007***





During
      the twelve months ended December 31, 2007, we granted options to purchase
      267,600 ordinary shares under our Option Plan (as defined in “Share Options
      Plans” below) to nine of our Named Executive Officers at an average exercise
      price of $4.667. 61,200 options will expire in 2012 and of the remaining 206,400
      options will expire in 2017.




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




***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 Office**Eli
                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 - October 27, 2007 *





* 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. Ms. Brikman has agreed to be reelected as our external director
      and to apply such election retroactively since October 28, 2007. Accordingly,
      we
      intend to propose to our forthcoming annual general meeting of shareholders
      to
      reelect Ms. Brikman as an external director for an additional period of three
      years commencing as of October 28, 2007. We also intend to have our board of
      directors and such committees ratify all of the actions that have 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 **d** irectors
      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
      four members, one of whom was elected as external director 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 director 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 that 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).




61




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.





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, but we intend to propose to our
      forthcoming annual general meeting of shareholders to reelect Ms. Brikman as
      an
      external director for an additional period of three years commencing as of
      October 28, 2007. We also intend to have our board of directors and such
      committees ratify all of the actions that have been taken by them since the
      expiration of Ms. Brikman's initial term as 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:




62




**Audit
      Committee**





**** The
      Israeli **** Companies
      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 reelection 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
      has occurred or been taken. We intend to propose to our forthcoming annual
      general meeting of shareholders to reelect Ms. Brikman as an external director
      for an additional period of three years commencing as of October 28, 2007.
      We
      also intend to have our board of directors and Audit Committee ratify 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; 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, until
      October 27, 2007, Ms. Brikman were 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. Mr. Ilan Horesh and Mr. Jaime Shulman are at the present time the
      members of the Compensation Committee.




**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 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 and 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.




63





**** **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 Rozenblum-Holtzman as our
      internal auditor in accordance with the requirements of the Israeli Companies
      Law.





***D.    Employees***




As
      of
      December 31, 2007 and 2006, we had 67 and 56 full-time employees, respectively.
      The following table describes our employees and the employees of our
      subsidiaries by department.





**Dec. 31,**
              **2005**
            
            **Dec. 31,**
              **2006**
            
            **Dec. 31,**
              **2007**Research,
                Development & Manufacturing
            
            
            24
            
            
            26
            
            
            23Marketing
                and Sales
            
            
            23
            
            
            20
            
            
            34Administration
            
            
            10
            
            
            10
            
            
            13**Total**
            
            
            **57**
            
            
            **56**
            
            
            **70**





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





**Dec. 31,**
              **2005**
            
            **Dec. 31,**
              **2006**
            
            **Dec. 31,**
              **2007**Israel
            
            
            38
            
            
            38
            
            
            22United
                states
            
            
            5
            
            
            5
            
            
            43Rest
                of the world
            
            
            14
            
            
            13
            
            
            5**Total**
            
            
            **57**
            
            
            **56**
            
            
            **70**





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, also the employees of the E-ID Division).
      Our
      current total number of employees is 66.





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 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 circumstance s .
      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.




64




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
      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, 2008. As of that date, we had 5,151,269 ordinary shares
      outstanding.





**Name**
            
            **Ordinary**
              **Shares held**
              **directly and**
              **beneficially**
            
            **% of**
              **Outstanding**
              **Ordinary**
              **Shares as of**
              **May 31, 2008**
            
            **Number of**
              **options**
              **outstanding**
            
            **Exercise**
              **price**
            
            **Expiration date**Eli
                Rozen
            
            
            675,128
            (1)
            
            12.47
            %
            
            109,817
              8,500
              42,500
              85,000
              51,000
            
            
            2.4706
              5.0000
              5.0000
              4.1180
              5.0000
            
            
            January
                26, 2013
              January
                11, 2015
              January
                11, 2015
              April
                27, 2012
              January
                19, 2017Avi
                Landman
            
            
            422,580
            (2)
            
            8.17
            %
            
            8,500
              8,500
              20,400
            
            
            2.4706
              5.0000
              5.0000
            
            
            January
                26, 2013
              January
                11, 2015
              January
                19, 2017Eyal
                Tuchman
            
            
            120,550
            (3)
            
            2.29
            %
            
            5,100
              12,750
              25,500
              21,250
              51,000
            
            
            2.4706
              2.4706
              14.8235
              5.000
              4.4118
            
            
            June
                19, 2012
              March
                28, 2014
              November 11, 2014
              October 4, 2014
              May
                29, 2016James
                Pertuka
            
            
            131,153
            (4)
            
            2.55
            %
            
            8,000
            
            
            4.64
            
            
            December 18, 2017Joel
                Konicek
            
            
            131,153
            (5)
            
            2.55
            %
            
            8,000
            
            
            4.64
            
            
            December 18, 2017Directors
                and Named Executive Officers as a Group ([10] persons)(7)
            
            
            1,547,144
            (6)
            
            27.10
            %
            
            561,017
            
            
            2.4709
                – 14.8235
            
            
            January
                2013 –
              February
                2018





(1)
      Includes (a) 412,311 shares held directly by Eli Rozen, and (b) options to
      purchase 262,817 ordinary shares which are currently exercisable or exercisable
      within 60 days of May 31, 2008, of which 135,317 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 23,800 ordinary shares
      which are currently exercisable or exercisable within 60 days of May 31,
      2008.





(3)
      Includes (a) 4,950 shares held directly by Eyal Tuchman, and (b) options to
      purchase 115,600 ordinary shares which are currently exercisable or exercisable
      within 60 days of May 31, 2008.





(4)
      Includes 131,153 shares held directly by James Pertuka.





(5)
      Includes 131,153 shares held directly by Joel Konicek.





(6)
      Includes options to purchase 435,364 ordinary shares which are currently
      exercisable or exercisable within 60 days of May 31, 2008.





(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, 2008) and has
      therefore not been separately disclosed.




All
      of
      our ordinary shares have identical voting rights.




65





**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, 2007, 4,361,294 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.




During
      2005, the Board of Directors approved a grant of options to acquire up to 15,300
      and 8,500 ordinary shares to certain employees at exercise prices of $5.24,
      and
      $4.18 per share, respectively. An additional 68,001 options were granted during
      2005 to related parties.





On
      December 29, 2005, our Board of Directors and Audit Committee approved the
      acceleration of the vesting schedule for certain of the stock options granted
      to
      our employees and officers as an incentive. As a result, options to purchase
      a
      total of 121,126 ordinary shares became exercisable at the date of the approval.
      The acceleration did not have any effect on the financial statements since
      the
      options had a zero intrinsic value at the original date of grant and at the
      date
      of acceleration.





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.





66





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.





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





**Year
                ended December 31****2005**
            
            **2006**
            
            **2007****Number**
              **of**
              **options**
            
            **Weighted**
              **average**
              **exercise**
              **price**
            
            **Number**
              **of**
              **options**
            
            **Weighted**
              **average**
              **exercise**
              **price**
            
            **Number**
              **of**
              **options**
            
            **Weighted**
              **average**
              **exercise**
              **price**Outstanding
                at beginning of year
            
            
            569,905
            
            $
            5.71
            
            
            595,971
            
            $
            5.77
            
            
            553,902
            
            $
            5.12Granted
            
            
            91,801
            
            $
            4.95
            
            
            93,501
            
            $
            4.42
            
            
            638,205
            
            $
            3.86Exercised
            
            
            (37,684
            )
            $
            2.48
            
            
            (43,152
            )
            $
            2.48
            
            
            (25,968
            )
            $
            3.16Canceled
                and forfeited
            
            
            (28,051
            )
            $
            5.53
            
            
            (92,418
            )
            $
            9.95
            
            
            (89,383
            )
            $
            5.06Outstanding
                at end of year
            
            
            595,971
            
            $
            5.77
            
            
            553,902
            
            $
            5.12
            
            
            1,076,756
            
            $
            4.43Exercisable
                at end of year
            
            
            515,504
            
            $
            6.06
            
            
            481,651
            
            $
            5.18
            
            
            591,485
            
            $
            4.81




The
      weighted average fair value of options granted during the reported period was
      $3.08, $1.89 and $2.87, per option, for the years ended December 31, 2005,
      2006
      and 2007, 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 and 2007 grants: risk free rate of 5%, dividend yield of
      0%,
      expected volatility factor of 57.14% and 57.20% respectively, and expected
      term
      of 3.09 and 3.64 years respectively.


Regarding
      the assumptions used for the proforma information required under FAS 123 in
      2005
      see Note 2w in the financial reports below.


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





Compensation
      expenses recognized by us related to our share-based employee compensation
      awards were $47,000 based on the provisions of APB 25, 225,000 and $1,032,000
      based on the provisions of SFAS 123R for the years ended December 31, 2005,
      2006 and 2007, respectively.





67




The
      options outstanding and exercisable as of December 31, 2007, have been separated
      into ranges of exercise prices as follows:





**Range of exercise**
              **price**
            
            **Options**
              **outstanding**
              **as of**
              **December 31,**
              **2007**
            
            **Weighted**
              **average**
              **remaining**
              **contractual**
              **life (years)**
            
            **Weighted**
              **average**
              **exercise**
              **price**
            
            **Aggregate**
              **intrinsic**
              **value**
            
            **Options**
              **exercisable**
              **as of**
              **December 31,**
              **2007**
            
            **Weighted**
              **average**
              **exercise price**
            
            **Aggregate**
              **intrinsic**
              **value**$
                0.01 - $ 0.06
            
            
            109,705
            
            
            9.63
            
            $
            0.03
            
            $
            511
            
            
            23,686
            
            $
            0.06
            
            $
            110$
                2.47 - $ 3.06
            
            
            184,243
            
            
            4.69
            
            $
            2.56
            
            $
            392
            
            
            184,243
            
            $
            2.56
            
            $
            392$
                4.18 - $ 4.90
            
            
            376,900
            
            
            7.81
            
            $
            4.42
            
            $
            102
            
            
            174,248
            
            $
            4.21
            
            $
            84$
                5.00 - $ 5.89
            
            
            347,050
            
            
            6.65
            
            $
            5.05
            
            
            -
            
            
            150,450
            
            $
            5.07
            
            
            -$11.76
                - $ 14.83
            
            
            57,800
            
            
            4.62
            
            $
            14.69
            
            
            -
            
            
            57,800
            
            $
            14.69
            
            
            -$
                23.64
            
            
            1,058
            
            
            0.25
            
            $
            23.64
            
            
            -
            
            
            1,058
            
            $
            23.64
            
            
            -1,076,756
            
            
            
            
            $
            4.43
            
            
            
            
            
            591,485
            
            $
            4.81





The
      aggregate intrinsic value of the above table represents the total intrinsic
      value, based on the Company’s stock price of $4.69 as of December 31, 2007, 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, 2007 and changes during the year ended December 31, 2007 is
      presented below:





**Options**
            
            **Weighted–average**
              **grant-date fair**
              **value**Non-vested
                at January 1, 2007
            
            
            72,251
            
            $
            2.29Granted
            
            
            638,205
            
            $
            2.87Vested
            
            
            (190,853
            )
            $
            3.02Forfeited
            
            
            (34,332
            )
            $
            2.23Non-vested
                at December 31, 2007
            
            
            485,271
            
            $
            2.77





As
      of
      December 31, 2007, there was $967,000 total unrecognized compensation cost
      related to non-vested share-based compensation arrangements granted under the
      stock option plans, of which, $626,000 is expected to be recognized during
      the
      year 2008.




**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,
      2008 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 directors and executive officers 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 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, 2008 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.




68




**Name of Beneficial Owner**
            
            **Number of Shares**
              **Beneficially Owned**
            
            **Percentage of Shares**
              **Outstanding**Jacob
                Hassan (1)
            
            
            398,881
            
            
            7.74
            %Avi
                Landman (2)
            
            
            422,580
            
            
            8.17
            %Eli
                Rozen (3)
            
            
            675,128
            
            
            12.47
            %Special
                Situations Fund III, L.P. (“SSF”)(4)Special
                Situations Fund III, Q.P. (“SSFQP”)(5)
            
            
            1,498,578
            
            
            26.89
            %Special
                Situations Cayman Fund, L.P. (“Cayman”)(6)Homeland
                Security Capital Corporation ("HMSC") (7)
            
            
            692,660
            
            
            13.44
            %Investor
                through convertible bond (8)
            
            
            606,250
            
            
            10.53
            %





(1)
            Mr.
                Hassan’s address is 21 Shnat Hayovel, Hod Hasharon ,
                Israel.


(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 23,800 ordinary
                shares
                which are currently exercisable or exercisable within 60 days of
                May 31,
                2008.****


(3)
            Includes
                (a) 412,311 shares held directly by Eli Rozen, and (b) options to
                purchase
                262,817 ordinary shares which are currently exercisable or exercisable
                within 60 days of May 31, 2008, of which 118,317 ordinary shares
                are held
                by Finel.


(4)
            Includes
                (a) 63,646 ordinary shares, (b) warrants to purchase 16,871 ordinary
                shares which are currently exercisable or exercisable within 60 days
                of
                May 31, 2008, (c) convertible bond which can be convert into 7,765
                ordinary shares (d) 727,599 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, 2008,
                (f)
                convertible bond which can be convert into 115,294 ordinary shares
                (g)
                200,143 ordinary shares held by its affiliate, Cayman, (h) warrants
                held
                by Cayman to purchase 53,660 ordinary shares which are currently
                exercisable or exercisable within 60 days of May 31, 2008 and (i)
                convertible bond which can be convert into 31,427 ordinary
                shares.


(5)
            Includes
                (a) 727,599 ordinary shares, (b) warrants to purchase 197,292 ordinary
                shares which are currently exercisable or exercisable within 60 days
                of
                May 31, 2008, (c) convertible bond which can be convert into 115,294
                ordinary shares, (d) 63,646 shares held by its affiliate, SSF, (e)
                warrants held by SSF to purchase 16,871 ordinary shares which are
                currently exercisable or exercisable within 60 days of May 31, 2008,
                (f)
                convertible bond which can be convert into 7,765 ordinary shares,
                (g)
                200,143 ordinary shares held by its affiliate, Cayman, and (h) warrants
                held by Cayman to purchase 53,660 ordinary shares which are currently
                exercisable or exercisable within 60 days of May 31, 2008 and (i)
                convertible bond which can be convert into 31,427 ordinary
                shares..


(6)
            Includes
                (a) 200,143 ordinary shares, (b) warrants to purchase 53,660 ordinary
                shares which are currently exercisable or exercisable within 60 days
                of
                May 31, 2008, (c) convertible bond which can be convert into 31,427
                ordinary shares, (d) 727,599 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, 2008,
                (f)
                convertible bond which can be convert into 115,294 ordinary shares,
                (g)
                63,646 ordinary shares held by its affiliate, SSF, and (h) warrants
                held
                by SSF to purchase 16,871 ordinary shares which are currently exercisable
                or exercisable within 60 days of May 31, 2008 and (i) convertible
                bond
                which can be convert into 7,765 ordinary
                shares.


(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, 2008, (b) convertible
                bond which could be convert into 500,000 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 2004 and 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 and
      Landman.




69




As
      of
      December 31, 2007, to the best of our knowledge based on the information
      available to us, we had approximately 23 registered holders of our ordinary
      shares.





To
      the
      best of our knowledge based on the information 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 2007 we paid $ 144,000 pursuant to this
      agreement.





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,
                to
                increase the consideration set forth in the said agreement to an
                amount of
                $ 7,000 per month.


·
            Upon
                the termination of the then exciting car lease agreement, to increase
                the
                car lease, to a price of up to NIS 4,200 (approximately $ 1,100 as
                of
                December 31, 2007), (excluding tax) per
                month.


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


In
      addition the Company pays $ 1,500 per month as a director’s fee. In 2007 we paid
      $102,000 pursuant to this agreement. Also, on January 21, 2007, the General
      Shareholders Meeting approved the grant of options to acquire up to 20,400
      ordinary shares of the Company at an exercise price of $5 per share under the
      Option Plan.





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
      2007 we paid $71,000, pursuant to this agreement.





On
      January 21, 2007, the General Meeting of Shareholders 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, respectively ordinary
      shares of the Company, at an exercise price of $5.





On
      April
      29, 2007, the General Meeting of Shareholders 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 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.




***C.***
            ***Interests
                of Experts and
                Counsel***




Not
      applicable.




70




**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 2005, 2006 and 2007 was $210,000, $194,000
      and
      $371,000, respectively. Export sales during each of the years 2005, 2006 and
      2007 was $8,252,000 (98% of the total sales volume), $8,601,000 (98% of the
      total sales volume) and $12,590,000 (97% 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 labour 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.  The
      service fees sought by the Plaintiff are allegedly required on the basis of
      certain Collective Agreements that according to the Plaintiff apply to us
      through Extension Orders. On May 15, 2008, we submitted a statement of defense.
      On June 1, 2008, we sent the plaintiff a questionnaire. The lawsuit is scheduled
      for early hearing on November 9, 2008. At this point, we cannot estimate the
      outcome of the lawsuit.




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 between 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 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, as void due to defects in the proceedings by which
      we were awarded the Contract. In July 2004 the Arbitration Court declared the
      Contract as void. On April 27, 2005 we appealed the decision in the High
      Commercial Court of Ukraine. In May 2005 the Department for Resources Supply
      of
      the Ministry filed with the Arbitration Court a new statement of claim for
      restitution of $1,047,740, paid to us by the Department for Resources Supply
      of
      the Ministry under the contract. On September 27, 2005, we received a negative
      award issued by the Arbitration Court in the second claim. 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.
      During February 2007, we received from the management body of the courts of
      Israel documents that were sent from the Ministry of Internal Affairs of Ukraine
      regarding the claim for restitution of $1,047,740. Our legal advisors have
      advised us that the documents were improperly sent and not in compliance with
      Israeli law. We intend to vigorously defend any motion to enforce the
      Arbitration Court award in Israel, and if necessary, to assert claims that
      the
      Ukrainian proceedings were legally defective and that no judgment based on
      these
      proceedings can be enforced in Israel.




71




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. Therefore no provision has been made in the financial
      statements in respect of the claim for restitution of $1,047,740. However,
      due
      to the developments described above, we wrote off inventory in an amount of
      approximately $287,000 in the fourth quarter of 2005, and took possession of
      the
      remaining inventory that was previously delivered to the customer. In 2003,
      we
      increased the allowance for doubtful accounts in an aggregate amount of
      $2,133,000 for the debt the Ukrainian government owes to us.


We
      did
      not have any revenues from this project in 2005, 2006 and 2007.




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 $3,476,000 as of December 31, 2007) 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 $63,000 as of December 31, 2007) and SuperCom Slovakia's
      legal fees in the amount of EUR 63,611 (approximately $94,000 as of December
      31,
      2007). 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 6,688.50 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
      July
      14, 2003, Mr. Yaacov Pedhatzur, filed a lawsuit against us, in the Magistrate’s
      Court in Tel Aviv, Israel, claiming the we owe him commissions in respect of
      transactions between us and certain third parties On September 29, 2005 we
      reached a settlement agreement with Mr. Yaacov Pedhatzur in which we agreed
      to
      pay Mr. Pedhatzur the NIS equivalent of $ 129,000. The settlement agreement
      has
      been approved by the court. This amount was recorded in the statement of
      operations of fiscal year 2005, as litigation settlement expenses.




On
      December 16, 1999, Secu-Systems Ltd. ("Secu-systems" or the "Plaintiff") 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 the plaintiff by us and InkSure,
      misappropriation of trade secrets by us and InkSure, and damage to the
      plaintiff’s 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 the plaintiff
      compensation in the sum of NIS 100,000 ($26,000 as of December 31, 2007) and
      legal expenses as well as attorney’s fees in the sum of NIS 30,000 ($8,000 as of
      December 31, 2007). The plaintiff has filed an appeal, and we and InkSure filed
      a counter-appeal, on the ruling above. On November 1, 2007, the Supreme Court
      accepted the Plaintiff's 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.




72




On
      February 18, 2008, the Plaintiff filed a petition with the District Court asking
      the court to allow the Plaintiff to amend the amount for which it sued as stated
      in the Statement of Claims to NIS 25,000,000 (approximately $6,500,000 as of
      December 31, 2007). 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 the Plaintiff'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 the
      Plaintiff 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 the Plaintiff relates to the profit which Inksure, allegedly,
      generated from the breach of the confidentialityagreement; this argument is
      based on a gross profit of $6,400,000 according to the financial statements
      of
      Inksure for the years 2002-2007. The Company's answer to the said petition
      has
      been filed but time has not been set yet for hearing of the
      petition.


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
                consideration received from the sale of Inksure's shares in 2002,
                incorporates the value of the cash flow of Inksure following the
                sale.
                Therefore, a calculation based upon both the sale price and the future
                cash flow of Inksure is not accurate and does not reflectcustomary
                accountant standards, since it calculates the factor of the future
                cash
                flow twice.


c.
            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.


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 the Plaintiff in these proceedings.





Due
      to
      the circumstances described above, we made an allowance of $100,000 that is
      reflecting 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, out Board of Directors may from
      time to time declare and cause the Company to pay to the shareholders such
      interim or final dividend 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 the 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.




73




**ITEM
              9.**
            ***The
                Offer And Listing.***




***A.***
            ***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
                OTCBulletin Board/NASDAQ Capital Market 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 are
      currently 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 the NASDAQ Capital Market and began
      trading effective August 23, 2007. The shares are traded on the NASDQ Capital
      Market under the symbol “VUNC”.





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. (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 the NASDQ Capital Market, as applicable.





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




74


**European market (1)**
              
              **US market (2)****Per share ($)**
              
              **Per share ($)****Period**
              
              **High**
              
              **Low**
              
              **High**
              
              **Low****Annual**2003
              
              
              4.41
              
              
              1.65
              
              
              N/A
              
              
              N/A2004
              
              
              15.65
              
              
              3.24
              
              
              15.59
              
              
              12.592005
              
              
              16.41
              
              
              3.12
              
              
              15.06
              
              
              3.292006
              
              
              6.71
              
              
              3.18
              
              
              6.59
              
              
              3.242007
              
              
              5.28
              
              
              3.58
              
              
              6.18
              
              
              3.82**Financial
                  quarters****2006**First
                  quarter
              
              
              5.12
              
              
              3.18
              
              
              6.47
              
              
              3.59Second
                  quarter
              
              
              4.59
              
              
              3.29
              
              
              5.18
              
              
              3.53Third
                  quarter
              
              
              6.71
              
              
              3.29
              
              
              6.59
              
              
              3.24Forth
                  quarter
              
              
              6.00
              
              
              4.71
              
              
              5.88
              
              
              3.94**2007**First
                  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
              
              
              4.42Forth
                  quarter
              
              
              5.11
              
              
              3.74
              
              
              5.15
              
              
              4.11**2008**First
                  quarter
              
              
              4.15
              
              
              2.81
              
              
              4.69
              
              
              2.94**Most
                  recent six months**December
                  2007
              
              
              4.22
              
              
              3.74
              
              
              4.80
              
              
              4.11January
                  2008
              
              
              4.15
              
              
              3.16
              
              
              4.69
              
              
              3.39February
                  2008
              
              
              3.18
              
              
              2.97
              
              
              4.20
              
              
              3.19March
                  2008
              
              
              3.09
              
              
              2.81
              
              
              3.60
              
              
              2.94April
                  2008
              
              
              2.91
              
              
              2.83
              
              
              3.60
              
              
              2.88May
                  2008
              
              
              2.85
              
              
              2.47
              
              
              3.50
              
              
              3.00




(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.




*(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 the
      NASDAQ Capital Market 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
      20, 2008, the last reported sale price of our ordinary shares on the Euronext
      Brussels stock market was 1.56 Euro equivalent to 2.424$ per share and on the
      Nasdaq Capital Market 3.10$ per share.




75




***B.***
            ***Plan
                of Distribution***





Not
      applicable.





***C.***
            ***Markets***




Our
      ordinary shares have been listed for trade on the Euronext Brussels stock
      market, since 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 the Nasdaq Capital Market under the symbol “VUNC” and the trade on the OTC
      Bulletin Board ceased.





***D.***
            ***Selling
                Shareholders***





Not
      applicable.





***E.***
            ***Dilution***





Not
      applicable.





***F.***
            ***Expenses
                of the Issue***





Not
      applicable.




**ITEM
              10.**
            ***Additional
                Information.*******




***A.***
              ***Share
                  Capital***





Not
      applicable.





**B.    Memorandum
      and Articles of Association**




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 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.




76




**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
      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.




77




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.




78




**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.




79




**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 shall be held 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.




**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.




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.




80




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 2007, to corporate tax at the rate of 29%
      on
      their taxable income. This rate was 34% in the 2005 tax year, 31% in the 2006
      tax year and will be, 27% for the 2008 tax year, 26% for the 2009 tax year
      and
      25% thereafter.




**Special
      provisions relating to taxation under inflationary
      conditions**




The
      Income Tax Law (Inflationary Adjustments), 1985, generally referred to as the
      Inflationary Adjustments Law, represents an attempt to overcome the problems
      presented to a traditional tax system by an economy undergoing rapid inflation.
      The Inflationary Adjustments Law is highly complex. The provisions that are
      material to us, are summarized as follows:




Ø
            Where
                a company’s equity, as calculated under the Inflationary Adjustments Law,
                exceeds the depreciated cost of its fixed assets (as defined in the
                Inflationary Adjustments Law), a deduction from taxable income is
                permitted equal to the above excess multiplied by the applicable
                annual
                rate of inflation. The maximum deduction permitted in any single
                tax year
                is 70% of taxable income, with the unused portion permitted to be
                carried
                forward, linked to the Israeli consumer price
                index.




Ø
            Where
                a company’s depreciated cost of fixed assets exceeds its equity, then the
                excess multiplied by the applicable annual rate of inflation is added
                to
                taxable income.




Ø
            Subject
                to specified limitations, depreciation deductions on fixed assets
                and
                losses carried forward are adjusted for inflation based on the change
                in
                the consumer price index.




Under
      the
      Inflationary Adjustments Law, results for tax purposes are measured in real
      terms, in accordance with changes in the Israeli consumer price index. We are
      taxed under this law. The difference between the change in the Israeli consumer
      price index and the exchange rate of Israeli currency in relation to the dollar
      may in future periods cause significant differences between taxable income
      and
      the income measured in dollars as reflected in our consolidated financial
      statements.




Please
      note, The Income Tax Law (Inflationary Adjustments), 1985 will be null and
      void
      at the beginning of 2008 onward, Subject to transitions orders.




***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.




81




**Israeli
      residents**




**The
      law in effect until December 31, 2005**




**Individuals:**




Pursuant
      to the Tax Reform, generally, capital gains tax is imposed on Israeli residents
      at a rate of 15% on real gains derived on or after January 1, 2003, from the
      sale of shares in Israeli companies publicly traded on a recognized stock market
      in a country that has a treaty for the prevention of double taxation with
      Israel. (such as NASDAQ) or companies traded on both the TASE and NASDAQ or
      another recognized stock market. This tax rate is contingent upon the
      shareholder not claiming a deduction for financing expenses in connection with
      such shares, and does not apply to: (i) the sale of shares to a relative (as
      defined in the Tax Reform); (ii) the sale of shares by dealers in securities;
      (iii) the sale of shares by shareholders that report in accordance with the
      Inflationary Adjustments Law; or (iv) the sale of shares by shareholders who
      acquired their shares prior to an initial public offering (that are subject
      to a
      different tax arrangement). The tax basis of shares acquired prior to January
      1,
      2003 will be determined in accordance with the average closing share price
      in
      the three trading days preceding January 1, 2003. However, a request may be
      made
      to the tax authorities to consider the actual adjusted cost of the shares as
      the
      tax basis if it is higher than such average price.




**The
      law, commencing January 1, 2006:**




**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.




(i)  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%.




**Companies
      subject to the provisions of the Adjustment Law:**




The
      real
      capital gain on the sale of securities by a company subject to the provisions
      of
      the Adjustment Law 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%.




**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 non resident
      shareholder’s permanent establishment in Israel, (b) the ordinary shares in
      relation to which the capital gains are derived were acquired by the non
      resident 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.




82




In
      addition, pursuant to the Income Tax Treaty between Israel and the U.S., which
      we refer to as 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
      Treaty 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 Vuance 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 U.S.-Israel Tax
      Treaty, such Treaty 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 U.S.-Israel Tax Treaty does not relate to U.S. state
      or
      local taxes.




***Income
      Taxes on Dividend Distribution to Israeli and Non-Israeli
      Shareholders***




Any
      distribution of dividend from income, which is not attributed to an “Approved
      Enterprise” will be subject to tax in Israel at the rate of 20%, except for
      dividend distributed, to Individual deemed “a substantial shareholder” which
      will be subject to tax at the rate of 25%.




Under
      the
      Tax Treaty, the maximum Israeli withholding tax on dividends paid to a holder
      of
      shares who is a Treaty US Resident is 25%.




The
      Tax
      Treaty further provides that a 12.5% Israeli withholding tax would apply to
      dividends paid to a US corporation owning 10% or more of an Israeli company’s
      voting stock during, in general, the current and preceding tax years of the
      Israeli company. The lower 12.5% rate applies only to dividends from income
      not
      derived from an Approved Enterprise in the applicable period and provided that
      not more than 25% of the Israeli company’s gross income consists of interest or
      dividend.




Generally
      speaking, a non-resident of Israel who has dividend income derived from or
      accrued in Israel, from which tax was withheld at source, is generally exempt
      from the duty to file tax returns in Israel in respect of such income, provided
      such income was not derived from a business conducted in Israel by the taxpayer
      and the non-resident has no other sources of income in Israel.




Residents
      of the U.S. generally will have withholding tax in Israel deducted at source.
      As
      discussed below, they may be entitled to a credit or deduction for U.S. federal
      income tax purposes in the amount of the taxes withheld, subject to detailed
      rules contained in U.S. tax legislation.




**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).




83




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.





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.




84




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.





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).




85




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.





***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.




86




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.





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.




87




*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.





*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.





88




***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.





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.




89




***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.





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 2008. To date, most of our sales have been valued in dollars. In future
      periods, we expect our sales to be principally valued in dollars, eliminating
      foreign currency exchange risk.





We
      value
      expenses of 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, 2007, we have not experienced
      any
      significant negative impact on our operations as a result of fluctuations in
      foreign currency exchange rates, although we have incurred a loss of $109,000
      in
      the year ended December 31, 2007 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, 2007, 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.




90




**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.





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, 2007. Based on such evaluation, our Chief Executive
      Officer and Chief Financial Officer have concluded that, as of December 31,
      2007, our disclosure controls and procedures were effective at the reasonable
      assurance level.




During
      the period covered by this report, no changes in our internal control over
      financial reporting (as such term is defined in Rules 13a-15(f) and
      15d-15(f) under the Exchange Act) have occurred that have materially affected,
      or are reasonably likely to materially affect, our internal control over
      financial reporting.




All
      internal control systems no matter how well designed have inherent limitations.
      Therefore, even those systems determined to be effective may not prevent or
      detect misstatements and can provide only reasonable assurance with respect
      to
      financial statements preparation and presentation.


**ITEM
        16.**  ***Reserved***




**ITEM
      16A.**  ***Audit
      Committee Financial Expert***





Our
      board
      of directors has determined that Ms. Michal Brikman, who, until October 27,
      2007, chaired 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 filed as Exhibit 11.1
      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.





91




**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, 2007 and 2006:




**2007**
            
            **2006**Audit
                Fees
            
            
            108,000
            
            
            60,000Audit-Related
                Fees
            
            
            29,000
            
            
            52,500Tax
                Fees
            
            
            5,000
            
            
            5,000All
                other Fees
            
            
            -
            
            
            -**Total**
            
            
            142,000
            
            
            117,500




*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.





**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.***




92




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**




93




**REPORT
      OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**




**To
      the Board of Directors of**


**SuperCom
      Asia Pacific Limited**




We
      have
      audited the accompanying balance sheet of SuperCom Asia Pacific Limited (the
      “Company”) as of December 31, 2007, and the related statements of (loss),
      stockholders’ deficit and cash flows for the year ended December 31, 2007. 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 audit.





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. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audit provides 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,
      2007, and the results of its operations and cash flows for the year ended
      December 31, 2007 in conformity with accounting principles generally accepted
      in
      the United States of America.








PKF


Certified
      Public Accountants


Hong
      Kong, China


February
      13, 2008




94





VUANCE
      LTD. AND ITS SUBSIDIARIES





CONSOLIDATED
      FINANCIAL STATEMENTS





AS
      OF
      DECEMBER 31, 2007





IN
      U.S.
      DOLLARS





INDEX





PageReport
                of Independent Registered Public Accounting Firm
            96Consolidated
                Balance Sheets
            97-98Consolidated
                Statements of Operations
            99Statements
                of Changes in Shareholders' Equity
            100Consolidated
                Statements of Cash Flows
            101-102Notes
                to Consolidated Financial Statements
            103-141




-
      - - -
      - - - -
      - - - - - - - - - - - - -


95







**Fahn Kanne & Co.**Head OfficeLevinstein Tower23 Menachem Begin RoadTel-Aviv 66184, ISRAEL**REPORT
                  OF INDEPENDENT**
              P.O.B. 36172, 61361**REGISTERED
                  PUBLIC ACCOUNTING FIRM**
              T+972 3 7106666**TO
                  THE SHAREHOLDERS OF**
              F+972 3 7106660**VUANCE
                LTD.**
              www.gtfk.co.il





We
      have
      audited the accompanying consolidated balance sheets of Vuance Ltd. (the
      "Company") and its subsidiaries as of December 31, 2006 and 2007, and the
      related consolidated statements of operations, changes in shareholders’ equity
      and cash flows for each of the three years in the period ended December 31,
      2007. These financial statements are the responsibility of the Board of
      Directors and management of the Company. Our responsibility is to express an
      opinion on these financial statements based on our audits.




We
      did
      not audit the financial statements of Supercom Asia Pacific Limited, a
      subsidiary, whose assets included in the consolidation constituted approximately
      2% and 0.4% of total consolidated assets as of December 31, 2006 and 2007,
      respectively, and whose revenues included in the consolidation constituted
      approximately 26%, 20% and 10% of total consolidated revenues for the years
      ended December 31, 2005, 2006 and 2007, respectively. The financial
      statements of this subsidiary were audited by another independent registered
      public accounting firm, whose report has been furnished to us. Our opinion,
      insofar as it relates to the amounts included in respect of this subsidiary,
      is
      based solely on the report of the other independent registered public accounting
      firm.




We
      conducted our audits in accordance with auditing standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance as to whether the financial
      statements are free of material misstatements. 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 independent registered public accounting
      firm
      provide a reasonable basis for our opinion.




In
      our
      opinion, based on our audits and the report of the other independent registered
      public accounting firm, the consolidated financial statements referred to above
      present fairly, in all material respects, the consolidated financial position
      of
      the Company and its subsidiaries as of December 31, 2006 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, 2007, in conformity with
      accounting principles generally accepted in the United States.




Fahn
      Kanne & Co.


Certified
      Public Accountants (Isr.)




Tel-Aviv,
      ISRAEL


June
      30,
      2008




**Certified
        Public Accountants**
 **Fahn
        Kanne & Co. is the Israeli member firm of Grant Thornton International
        Ltd**


96





**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**CONSOLIDATED
      BALANCE SHEETS**





**U.S.
      dollars in thousands**




**December
                  31,****2006**
              
              **2007**ASSETSCURRENT
                  ASSETS:Cash
                  and cash equivalents
              
              $
              2,444
              
              $
              2,114Restricted
                  cash deposits
              
              
              859
              
              
              3,172Marketable
                  securities
              
              
              11,077
              
              
              4,054Trade
                  receivables (net of allowance for doubtful accounts of $ 3,487
                  and $ 3,500
                  as of December 31, 2006 and 2007, respectively)
              
              
              2,625
              
              
              2,463Other
                  accounts receivable and prepaid expenses
              
              
              717
              
              
              2,400Inventories,
                  net
              
              
              270
              
              
              566Totalcurrent assets
              
              
              17,992
              
              
              14,769INVESTMENTS
                  AND LONG-TERM RECEIVABLES:Investment
                  in restricted marketable securities of other company
              
              
              4,431
              
              
              -Long-term
                  trade receivables
              
              
              79
              
              
              -Severance
                  pay fund
              
              
              239
              
              
              309Totalinvestments and long-term receivables
              
              
              4,749
              
              
              309PROPERTY
                  AND EQUIPMENT, NET
              
              
              160
              
              
              218OTHER
                  ASSETS:Goodwill
              
              
              -
              
              
              3,644Intangible
                  assets and deferred charges, net
              
              
              197
              
              
              2,012Totalother assets
              
              
              197
              
              
              5,656Totalassets
              
              $
              23,098
              
              $
              20,952





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


97


**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**CONSOLIDATED
      BALANCE SHEETS**


**U.S.
      dollars in thousands, except share data**





**December
                31,****2006**
            
            **2007**LIABILITIES
                AND SHAREHOLDERS' EQUITYCURRENT
                LIABILITIES:Short-term
                bank credit and current maturities of long-term loan
            
            $
            668
            
            $
            478Trade
                payables
            
            
            823
            
            
            1,498Employees
                and payroll accruals
            
            
            533
            
            
            299Accrued
                expenses and other liabilities
            
            
            3,428
            
            
            6,641Totalcurrent liabilities
            
            
            5,452
            
            
            8,916LONG-TERM
                LIABILITIES:Convertible
                bonds
            
            
            2,255
            
            
            2,441Long-term
                loan, net of current maturities
            
            
            67
            
            
            -Accrued
                severance pay
            
            
            323
            
            
            362Totallong-term liabilities
            
            
            2,645
            
            
            2,803COMMITMENTS
                AND CONTINGENT LIABILITIESSHAREHOLDERS'
                EQUITY:Share
                capital:Ordinary
                shares of NIS 0.0588235 par value -Authorized
                6,800,000 and 12,000,000 shares as of December 31, 2006 and 2007,
                respectively;Issued
                and outstanding: 4,001,126 and 5,124,779 shares as of December 31,
                2006 and 2007, respectively
            
            
            64
            
            
            80Additional
                paid-in capital
            
            
            33,562
            
            
            39,089Accumulated
                deficit
            
            
            (18,625
            )
            
            (29,936
            )Totalshareholders' equity
            
            
            15,001
            
            
            9,233Totalliabilities and shareholders' equity
            
            $
            23,098
            
            $
            20,952





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


98


**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**U.S.
      dollars in thousands, except share data**




**Year
                ended**
              **December
                31,****2005**
            
            **2006**
            
            **2007**Revenues
            
            $
            8,462
            
            $
            8,795
            
            $
            12,961Cost
                of revenues
            
            
            4,293
            
            
            3,494
            
            
            5,600Inventory
                write-off
            
            
            287
            
            
            -
            
            
            -Gross
                profit
            
            
            3,882
            
            
            5,301
            
            
            7,361Operating
                expenses:Research
                and development
            
            
            1,182
            
            
            1,362
            
            
            1,716Selling
                and marketing
            
            
            3,003
            
            
            5,619
            
            
            9,041General
                and administrative
            
            
            2,968
            
            
            2,737
            
            
            3,192Restructuring
                expenses
            
            
            496
            
            
            -
            
            
            -Litigation
                settlement expenses
            
            
            129
            
            
            108
            
            
            34Total
                operating expenses
            
            
            7,778
            
            
            9,826
            
            
            13,983Capital
                gain from the sale of the e-ID Division
            
            
            -
            
            
            10,536
            
            
            -Operating
                income (loss)
            
            
            (3,896
            )
            
            6,011
            
            
            (6,622
            )Financial
                expenses, net
            
            
            (25
            )
            
            (204
            )
            
            (4,652
            )Other
                expenses, net
            
            
            (30
            )
            
            (367
            )
            
            -Income
                (loss) before taxes on income
            
            
            (3,951
            )
            
            5,440
            
            
            (11,274
            )Taxes
                on income
            
            
            -
            
            
            -
            
            
            (37
            )Net
                income (loss)
            
            $
            (3,951
            )
            $
            5,440
            
            $
            (11,311
            )Earnings
                (loss) per share:Basic
                earnings (loss) per share
            
            $
            (1.25
            )
            $
            1.37
            
            $
            (2.57
            )Diluted
                earnings (loss) per share
            
            $
            (1.25
            )
            $
            1.31
            
            $
            (2.57
            )Weighted
                average number of ordinary shares used in computing basic earnings/
                loss
                per share
            
            
            3,155,872
            
            
            3,969,212
            
            
            4,391,860Weighted
                average number of ordinary shares used in computing diluted earnings/
                loss
                per share
            
            
            3,155,872
            
            
            4,212,791
            
            
            4,391,860





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


99





**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**STATEMENTS
      OF CHANGES IN SHAREHOLDERS' EQUITY**


**U.S.
      dollars in thousands, except share data**





**Ordinary
                shares****Number
                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**Balance
                as of January 1, 2005
            
            
            3,009,548
            
            
            51
            
            
            29,094
            
            
            (59
            )
            
            (20,114
            )
            
            143
            
            
            -
            
            
            9,115Deferred
                stock compensation
            
            
            -
            
            
            -
            
            
            11
            
            
            (11
            )
            
            
            
            
            -
            
            
            -
            
            
            -Issuance
                of shares in a private placement, net
            
            
            685,485
            
            
            9
            
            
            2,047
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            2,056Exercise
                of warrants and options
            
            
            112,134
            
            
            1
            
            
            550
            
            
            -
            
            
            -
            
            
            (129
            )
            
            -
            
            
            422Receipt
                on account of shares to be allotted
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            550
            
            
            -
            
            
            550Amortization
                of stock compensation
            
            
            -
            
            
            -
            
            
            -
            
            
            55
            
            
            -
            
            
            -
            
            
            -
            
            
            55Net
                loss
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (3,951
            )
            
            -
            
            $
            (3,951
            )
            
            (3,951
            )Total
                comprehensive loss
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            (3,951
            )Balance
                as of December 31, 2005
            
            
            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 occurred
                in the
                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
            )
            $
            -
            
            
            
            
            $
            9,233





*Less
      than 1




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


100





**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**U.S.
      dollars in thousands**




**Year
                  ended December 31,****2005**
              
              **2006**
              
              **2007**Cash
                  flows from operating activities:Net
                  Income (loss)
              
              $
              (3,951
              )
              $
              5,440
              
              $
              (11,311
              )Adjustments
                  to reconcile net income (loss) to net cash used in operating
                  activities:Depreciation
                  and amortization
              
              
              772
              
              
              355
              
              
              225Accrued
                  severance pay
              
              
              52
              
              
              128
              
              
              (382
              )Stock-
                  based compensation
              
              
              55
              
              
              361
              
              
              1,072Capital
                  gain from the sale of the e-ID Division
              
              
              -
              
              
              (10,536
              )
              
              -Amortization
                  of discount on convertible bonds
              
              
              -
              
              
              30
              
              
              268Amortization
                  of deferred charges
              
              
              -
              
              
              6
              
              
              90Write
                  down of loan regarding an investment in an affiliated
                  company
              
              
              -
              
              
              275
              
              
              -Realized
                  loss from sale of marketable securities
              
              
              -
              
              
              -
              
              
              1,116Decrease
                  in value of marketable securities, net
              
              
              -
              
              
              -
              
              
              2,699Loss
                  on sale of property and equipment
              
              
              -
              
              
              8
              
              
              58Exchange
                  differences on principle of long-term loan
              
              
              -
              
              
              12
              
              
              9Decrease
                  (increase) in trade receivables
              
              
              448
              
              
              (1,442
              )
              
              883Decrease
                  (increase) in other accounts receivable and prepaid
                  expenses
              
              
              517
              
              
              254
              
              
              (1,943
              )Decrease
                  (increase) in inventories
              
              
              (40
              )
              
              212
              
              
              32Increase
                  (decrease) in trade payables
              
              
              (365
              )
              
              53
              
              
              95Increase
                  (decrease) in employees and payroll accruals
              
              
              (35
              )
              
              211
              
              
              (234
              )Increase
                  (decrease) in accrued expenses and other liabilities
              
              
              (407
              )
              
              1,586
              
              
              2,433Net
                  cash used in operating activities
              
              
              (2,954
              )
              
              (3,047
              )
              
              (4,890
              )Cash
                  flows from investing activities:Purchase
                  of property and equipment
              
              
              (315
              )
              
              (93
              )
              
              (116
              )Acquisition
                  of subsidiaries net of cash acquired.*
              
              
              -
              
              
              -
              
              
              (153
              )Decrease
                  (increase) in severance pay fund
              
              
              (64
              )
              
              (95
              )
              
              278Capitalization
                  of software and intangible assets
              
              
              -
              
              
              -
              
              
              (509
              )Restricted
                  cash deposits, net
              
              
              41
              
              
              229
              
              
              (2,313
              )Short
                  term deposits, net
              
              
              353
              
              
              -
              
              
              -Proceeds
                  from (investment in) marketable securities
              
              
              (650
              )
              
              650
              
              
              -Proceeds
                  from sale of marketable securities
              
              
              -
              
              
              -
              
              
              7,639Amounts
                  carried to deferred charges
              
              
              -
              
              
              (163
              )
              
              (52
              )Cash
                  paid in respect of sale of the e-ID Division**
              
              
              -
              
              
              (52
              )
              
              -Net
                  cash provided by (used in) investing activities
              
              
              (635
              )
              
              476
              
              
              4,774Cash
                  flows from financing activities:Short-term
                  bank credit, net
              
              
              120
              
              
              (307
              )
              
              (336
              )Proceeds
                  from issuance of convertible bonds and warrants, net
              
              
              -
              
              
              3,139
              
              
              -Issuance
                  of share capital through a private placement, net of issuance
                  costs
              
              
              2,539
              
              
              (183
              )
              
              (30
              )Proceeds
                  from exercise of options and warrants, net
              
              
              422
              
              
              92
              
              
              82Long-term
                  loan received
              
              
              500
              
              
              204
              
              
              2,850Principal
                  repayment of long-term loan
              
              
              (592
              )
              
              (224
              )
              
              (2,780
              )Net
                  cash provided by (used in) financing activities
              
              
              2,989
              
              
              2,721
              
              
              (214
              )Increase
                  (decrease) in cash and cash equivalents
              
              
              (600
              )
              
              150
              
              
              (330
              )Cash
                  and cash equivalents at the beginning of the year
              
              
              2,894
              
              
              2,294
              
              
              2,444Cash
                  and cash equivalents at the end of the year
              
              $
              2,294
              
              $
              2,444
              
              $
              2,114





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


101


**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS (Cont.)**


**U.S.
      dollars in thousands**





**Year
                ended**
              **December
                31,****2005**
            
            **2006**
            
            **2007****Supplemental
                disclosure of cash flows information:***
                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)
            
            
            -
            
            
            -
            
            $
            1,157Property
                and equipment, net
            
            
            -
            
            
            -
            
            
            (38
            )Intangible
                assets
            
            
            -
            
            
            -
            
            
            (1,531
            )Goodwill
                recognized
            
            
            -
            
            
            -
            
            
            (3,644
            )Shares
                issued
            
            
            -
            
            
            -
            
            
            3,903-
            
            
            -
            
            $
            (153
            )*****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 from the sale of the e-ID Division
            
            
            -
            
            
            10,536
            
            
            --
            
            $
            (52
            )
            
            -Cash
                paid during the year for:Interest
            
            $
            87
            
            $
            76
            
            $
            146**Supplemental
                disclosure of non-cash investing and financing
                activities:**Shares
                capital issuance against redemption of note payable to former shareholder
                of a subsidiary
            
            $
            -
            
            $
            -
            
            $
            432Accrued
                issuance costs
            
            $
            109
            
            $
            19
            
            $
            -Issuance
                of warrants to service provider
            
            $
            -
            
            $
            40
            
            $
            -





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


102


**VUANCE
      LTD. AND ITS 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 established in 1988 in
                Israel. The Company’s ordinary shares have been listed for trade on the
                Euronext Brussels stock market, since October 23, 2003 under the
                symbol “SUP”, which became “VUNC” after the corporate 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 our recent name change 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 the trade on the OTC Bulletin Board
                ceased.





The
      Company develops and markets state-of-the-art 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 successfully
      overcome the most difficult security challenges. Its Critical Situation
      Management System (CSMS) is the industry's most comprehensive 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 Rockville, MD.





The
                Company sells its products through centralized marketing offices
                in
                different regions of the world. 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 established 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., established 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.





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


103


**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**U.S.
      dollars in thousands (except per share data)**





**NOTE
                1:-**
            **GENERAL
                (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: HMSC.OB) (“HMSC”) and other minority
      shareholders (collectively, “Sellers”) for approximately $4,335 in Vuance
      ordinary shares, 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 of 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 were merged to 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
      Combinations” (“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)





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
            
            
            3,644Total
            
            $
            4,935




104




**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**


**U.S.
      dollars in thousands (except per share data)**





**NOTE
                1:-**
            **GENERAL
                (Cont.)**





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 statement of income data for the years ended
      December 31, 2007 and 2006, as if the acquisition of SHC had occurred on
      January 1, 2007 and 2006, respectively, after giving effect to: purchase
      accounting adjustments, including 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 2007 and 2006, 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). The acquisition will complement Vuance’s
      incident management solutions business and add an advanced first responder
      credentialing system (RAPTOR) to the Critical Situation Management System (CSMS)
      product portfolio.




105




**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**


**U.S.
      dollars in thousands (except per share data)**





**NOTE
                1:-**
            **GENERAL
                (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 will serve as a subcontractor for these projects. The 2,827,200 ordinary
      shares issued to the Company are subject to a lock-up agreement, whereby
      one-seventh of the shares (403,885 ordinary shares) will be released from the
      lock-up restrictions every three months beginning on the closing date, December
      31, 2006, for an aggregate period of eighteen months. 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, 2007, the Company holds 1,308,483 shares of OTI of which 108,040
      are held by the Company but relate to consultants. 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. (As of
      December 31, 2007, an amount of $1,496 out of the $2,463 trade receivables
      balance consists of one customer) See also Note 16c.





The
      Company purchases certain services and products used by the Company 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 believe that other suppliers could provide similar services
      and products on comparable terms without affecting operating
      results.





Profitability
      of the Company’s investment in OTI’s ordinary shares depends on the share price and
      the
      ability to sell the OTI ordinary shares. See Note 3.




106


**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**


**U.S.
      dollars in thousands (except per share data)**





**NOTE
              1:-**
            **GENERAL
                (Cont.)**





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. See
                Note
                13





d.
            The
                Company has incurred substantial losses and negative cash flows since
                its
                inception. The Company had an operating cash flow deficit in each
                of 2005,
                2006, and 2007. As of December 31, 2007, the Company had an accumulated
                deficit of approximately $29,936. The Company incurred net losses
                of
                approximately $3,951and $11,311in the years ended December 31, 2005
                and
                December 31, 2007, 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. However, the company
                believes that, the current working capital (including current cash
                and
                cash equivalents and marketable securities, in addition to revenues
                expected to be generated from the business operations) is sufficient
                for
                the Company’s present requirements and will satisfy the operating capital
                needs at least till the end of 2008 based upon the company anticipated
                business activities. However, the company may need additional capital
                within 2008, if it will undertake large projects or have a delay
                in one of
                the anticipated projects. If the company fail to raise such additional
                capital, there might be need to implement certain operational changes
                in
                order to decrease the expenditure level.




**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.




107


**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**


**U.S.
      dollars in thousands (except per share data)**





**NOTE
                2:-**
            **SIGNIFICANT
                ACCOUNTING POLICIES
                (Cont.)**





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.





e.
            Restricted
                cash deposits:





Restricted
      cash is invested in certificates of deposit, which mature within one year,
      and
      is used to secure agreements with customers or banks.





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, 2006 and 2007,
      consists of marketable securities received in connection with the OTI
      transaction. Marketable securities of OTI that were considered to be restricted,
      because the sale of such securities was prohibited for a period longer than
      12
      months, were accounted at cost net of write down for any permanent decrease
      in
      value. These securities were presented in the balance sheets at December 31,
      2006 as “Investment in restricted marketable securities of other company”. There
      was no such balance at December 31, 2007.


Such
      securities that were not considered restricted according to the provisions
      of
      SFAS No. 115, 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. (See note 3)




108


**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**


**U.S.
      dollars in thousands (except per share data)**





**NOTE
                2:-**
            **SIGNIFICANT
                ACCOUNTING POLICIES
                (Cont.)**





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.





i.
            Investment
                in 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.


109




**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**





**U.S.
      dollars in thousands (except per share data)**





**NOTE
      2:-**  **SIGNIFICANT
      ACCOUNTING POLICIES (Cont.)**





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 is
                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 their intrinsic value based on the effective conversion
                price as
                a result of the allocated proceeds.





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 initial recognition the discount
                on the
                convertible bonds is amortized as interest expenses over the term
                of the
                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") which was reached to a final consensus in November 2006
                  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 loans that
                  occurred
                  during November 2007 did not result in a debt extinguishment (for
                  subsequent events see note
                  19).





m.
            Long-term
                trade receivables:





Long-term
      receivables represent amounts expected to be collected 12 months or more after
      the balance sheet date. Such amounts are initially recorded at fair value
      (present value of the face amount to be received). The difference between the
      present value and the face amount is treated as a discount and amortized as
      interest expense over the term of the receivables.


110




**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**





**U.S.
      dollars in thousands (except per share data)**




**NOTE
                2:-**
            **SIGNIFICANT
                ACCOUNTING POLICIES
                (Cont.)**





n.
            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, based on the most recent
      salary of the employees, multiplied by the number of years of employment as
      of
      the balance sheet date. Employees are entitled to one month's salary for each
      year of employment, or portion thereof. The Company's liability for all its
      employees is fully covered by monthly deposits with severance pay funds,
      insurance policies and by an accrual. 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, 2005, 2006 and 2007 amounted to $115,
      $159 and $57, respectively.





As
      of
      December 31, 2006, the severance pay balance and fund relating to employees
      whose employment was terminated due to the OTI transaction were presented as
      a
      current liability and a current asset, as applicable. During fiscal 2007, the
      Company paid these liabilities.





o.
            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".





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 indicators 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.


p.
              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
                distributers 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 is not obligated to accept returned products or issue credit on returned
      products, unless such return has been approved by the Company in advance and
      according to specific term and conditions. As of December 31, 2007, the Company
      had allowance for customers returns in the amount of $57.





Based
      on
      past experience, the Company does not provide for warranty costs when revenue
      is
      recognized.  Warranty
      period is varying in length from 12 to 36 months.


111




**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**





**U.S.
      dollars in thousands (except per share data)**




**NOTE
                2:-**
            **SIGNIFICANT
                ACCOUNTING POLICIES
                (Cont.)**





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, such as
      maintenance, support and services 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.





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





The
      Company is 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).





The
      Company recognizes 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 measures the percentage of completion based
      on
      output or input criteria, such as contract milestones, percentage of engineering
      completion or number of units shipped, as stipulated 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, 2007, no such estimated losses were
      identified.




The
      Company believes that the use of the percentage of completion method is
      appropriate; as the Company has the ability, using also independent
      subcontractor's evaluation, make reasonably dependable estimates of the extent
      of progress 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 its 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
      utilizes 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 derives its 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 its 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.


112




**VUANCE
        LTD. AND ITS SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**
 
 **U.S.
        dollars in thousands (except per share data)**


**NOTE
                2:-**
            **SIGNIFICANT
                ACCOUNTING POLICIES
                (Cont.)**


q.
              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.





r.
            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).





s.
            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 financial statements. The adoption
      of FIN 48 did not have material effect on the financial position and results
      of
      operations of the Company.


t.
              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 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
      above.


113




**VUANCE
        LTD. AND ITS SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**
 
 **U.S.
        dollars in thousands (except per share data)**


**NOTE
                2:-**
            **SIGNIFICANT
                ACCOUNTING POLICIES
                (Cont.)**





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.





Regarding
      marketable securities received in connection with the OTI transaction. See
      Note
      3.





The
                Company has no significant off-balance-sheet concentration of credit
                risk,
                such as foreign exchange contracts, option contracts or other foreign
                hedging arrangements. See Note 9a regarding bank credit denominated
                in
                currencies other than U.S. dollars.


u.
              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".





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 31,2005
                
                2006
                
                2007Net
                    income (loss) used for the computation of basic earnings (loss)
                    per
                    share
                
                
                (3,951
                )
                
                5,440
                
                
                (11,311
                )Interest
                    expenses on convertible bond
                
                
                -
                
                
                75
                
                
                -Net
                    income (loss) used for the computation diluted earnings (loss)
                    per
                    share
                
                
                (3,951
                )
                
                5,515
                
                
                (11,311
                )


Year ended December 31,2005
              
              2006
              
              2007Weighted
                  average number of shares used in the computation of basic earnings
                  (loss)
                  per share
              
              
              3,155,872
              
              
              3,969,212
              
              
              4,391,860Add: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
              
              
              3,155,872
              
              
              4,212,791
              
              
              4,391,860


114




**VUANCE
        LTD. AND ITS SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**
 
 **U.S.
        dollars in thousands (except per share data)**


**NOTE
                2:-**
            **SIGNIFICANT
                ACCOUNTING POLICIES
                (Cont.)**





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 2005 and 2007 since the Company reported losses for those years.


The
      number of potential shares from the conversion of convertible bonds options
      and
      warrants that have been excluded from the calculation were 1,121,083, 795,279
      and 2,513,927 for the years ended December 31, 2005, 2006 and 2007 respectively.


v.
              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, 2007 and 2006, the carrying amounts of cash and cash equivalents,
      restricted cash deposits, m arketable
      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 above and
      3.





The
      carrying value of convertible bonds, does not approximate their fair value,
      since the proceeds received in respect to the issuance of these bonds was
      allocated to the convertible bonds and to the detachable warrants that were
      included in that issuance. In addition the carrying value of the convertible
      bonds was reduced in order to reflect the beneficial conversion feature, in
      accordance with the provisions of EITF 00-27.





w.
            Accounting
                for stock-based compensation:




Until
      December 31, 2005, the Company accounted for its employee stock option
      plans using the intrinsic value based method of accounting prescribed by
      APB 25, “Accounting for Stock Issued to Employees” and related
      interpretations.  Accordingly, the compensation cost relating to stock
      options, measured as the excess of the fair value of the underlying stock over
      the exercise price on the date of grant, if any, was charged on the date of
      grant of such options, to shareholders’ equity, under deferred compensation, and
      was thereafter amortized by the straight-line method and charged against income
      over the vesting period.




The
      Company applied SFAS No. 123 and Emerging Issue Task Force (“EITF”)
      No. 96-18, “Accounting for Equity Instruments that are Issued to Other Than
      Employees for Acquiring, or in Conjunction with Selling, Goods or Services” with
      respect to options issued to non-employees.





Effective
      January 1, 2006, the Company adopted the provisions of SFAS No. 123R,
“Share-Based Payment” (SFAS 123R), a revision of SFAS No. 123, “Accounting for
      Stock Based Compensation (SFAS 123) and Staff Accounting Bulletin No. 107
      (“SAB 107”), which was issued in March 2005 by the SEC.





SFAS
      123R
      eliminates the use of APB 25 (and related interpretations) and the intrinsic
      value method of accounting, and requires to recognize, 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.





The
      Company adopted SFAS 123R (and the relevant principles of SAB 107) using the
      modified prospective method, as permitted under FAS 123R. 
Accordingly, prior period amounts have not been restated. 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 (January 1, 2006) in accordance with the original
      provisions of SFAS 123.




115




**VUANCE
        LTD. AND ITS SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**
 
 **U.S.
        dollars in thousands (except per share data)**


**NOTE
                2:-**
            **SIGNIFICANT
                ACCOUNTING POLICIES
                (Cont.)**





As
      a
      result of adopting SFAS123R, the Company’s net income for 2006 and 2007 is $217
      and $1,034 respectively less, than if it had continued to account for
      share-based compensation under APB 25. Upon adoption of SFAS 123R, the remaining
      balance of the Additional Paid-In Capital and the offsetting amount in Deferred
      Stock-Based Compensation ($15), that were both reflected in shareholders’ equity
      at December 31, 2005, were reversed, as required by SFAS123 R. There was no
      net
      effect on total shareholders’ equity.





The
      following table summarizes relevant information for the year ended December
      31,
      2005 (prior to the adoption of SFAS 123R), under the Company's intrinsic value
      method of accounting for stock awards, with supplemental information as if
      the
      fair value recognition provisions of SFAS No. 123 had been applied:





Pro
      forma
      information under SFAS 123:




**Year ended**
              **December 31,**2005Net
                loss as reported
            
            $
            (3,951
            )Stock
                based compensation expensesdetermined
                under fair value based method
            
            
            (1,475
            )Stock
                based compensation expenses included in reported net loss
            
            
            55Pro
                forma net loss
            
            $
            (5,371
            )Basic
                and diluted net loss per share as reported
            
            $
            (1.25
            )Pro
                forma basic and diluted net loss
            
            $
            (1.70
            )





The
      fair
      value of these options was amortized over their vesting period and estimated
      at
      the date of grant using a Black-Scholes option pricing model with the following
      weighted-average assumptions: risk-free interest rates of 3.68%, with a dividend
      yield of 0%, volatility factors of the expected market price of the Company's
      ordinary shares of 101.9% and a weighted-average expected life of the option
      of
      five years.





x.
            Advertising
                costs:





The
      Company expenses advertising costs as incurred. Advertising expenses for the
      years ended December 31, 2005, 2006 and 2007, were approximately $ 21,
      $ 18 and $139, respectively.


y.
              Comprehensive
                  Income:


The
      Company has no comprehensive income components other than net income (loss)
      in
      the reporting periods.


z.
              Recently
                  issued accounting
                  pronouncements:


SFAS
      No. 157, “Fair Value Measurements”





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value
      Measurements”. This Statement clarifies the definition of fair value,
      establishes a framework for measuring fair value, and expands the disclosures
      on
      fair value measurements. However, SFAS No. 157 does not require any new
      fair value measurement. FAS No. 157 is effective for fiscal years beginning
      after November 15, 2007, and interim periods within those fiscal years and
      its provisions should be applied prospectively (with a limited retrospective
      application). The Company chose to apply the provisions of SFAS No. 157
      early, beginning January 1, 2007.





SFAS
      No. 159, “The Fair Value Option for Financial Assets and Financial
      Liabilities - Including an amendment of SFASB Statement No. 115”




116


**VUANCE
        LTD. AND ITS SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**
 
 **U.S.
        dollars in thousands (except per share data)**
  **NOTE
                    2:-**
                **SIGNIFICANT
                    ACCOUNTING POLICIES
                    (Cont.)**


In
      February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
      for Financial Assets and Financial Liabilities - Including an amendment of
      SFASB
      Statement No. 115” (“SFAS 159”). This pronouncement permits all entities to
      choose to elect, at specified election dates, to measure eligible financial
      instruments at fair value. An entity shall report unrealized gains and losses
      on
      items for which the fair value option has been elected in earnings at each
      subsequent reporting date, and recognize upfront costs and fees related to
      those
      items in earnings as incurred and not deferred. SFAS  159 applies to fiscal
      years beginning after November 15, 2007, with early adoption permitted for
      an entity that has also elected to apply the provisions of SFAS No. 157. An
      entity is prohibited from retrospectively applying SFAS No. 159, unless it
      chooses early adoption of SFAS 157 also. The Company is currently assessing
      the
      impact of SFAS No. 159 , if any on its financial position and results of
      operations.





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 has not
      yet
      evaluated this statement for the impact, if any, that SFAS 141(R) will have
      on
      its financial position and results of operations.





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 has not yet
      determined the impact, if any, that SFAS No. 160 will have on its financial
      position and results of operations.





Staff
      Accounting Bulletin No. 110


In
      December 2007, the SEC issued Staff Accounting Bulletin No. 110 (“SAB 110”)
      regarding the use of a "simplified" method, as discussed in SAB No. 107 ("SAB
      107"), in developing an estimate of expected term of "plain vanilla" share
      options in accordance with SFAS No. 123 (revised 2004), "Share-Based
      Payment". Until December 31, 2007, SAB 107 allowed the use of the
      simplified method. SAB 110 allows, under certain circumstances, to continue
      to
      accept the use of the simplified method beyond December 31, 2007. The
      Company believes that the adoption of SAB 110 will not have a material impact
      on
      its financial position and results of operations.





SFAS
      No.162, ”The Hierarchy of Generally Accepted Accounting Principles”


In
      May
      2008, the FASB issued SFAS No.162”The Hierarchy of Generally Accepted Accounting
      Principles” (“SFAS 162”). SFAS 162 identifies the sources of accounting
      principles and the framework for selecting the principles to be used in the
      preparation of financial statements of nongovernmental entities that are
      presented in conformity with generally accepted accounting principles in the
      United States (the GAAP hierarchy).


SFAS
      162
      is effective sixty days following the SEC’s approval of PCAOB amendments to AU
      Section 411, “The Meaning of “Present Fairly in Conformity With Generally
      Accepted Accounting Principles””. The company is currently evaluating the
      potential impact, if any, of the adoption of SFAS 162 on its condensed
      consolidated financial statements.





117


**VUANCE
        LTD. AND ITS SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**
 
 **U.S.
        dollars in thousands (except per share data)**


**NOTE
      3:-**  **MARKETABLE
      SECURITIES**





The
      entire balance of marketable securities as of December 31, 2006 and 2007
      consists of marketable securities received in connection with the OTI
      transaction.





As
      stated
      in note 1a above, 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 relates to its consultants).





Securities
      which were not considered restricted according to the provisions of SFAS No.
      115, were classified as available-for-sale and were stated at fair value (after
      consideration with the relevant restriction period of each portion).





Marketable
      securities of OTI that were considered to be restricted, because the sale of
      such securities is prohibited for a period longer than 12 months, were presented
      in the balance sheets as of December 31, 2006 as “Investment in restricted
      marketable securities of other company" and were accounted at cost, net of
      write
      down for any permanent decrease in value. 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. 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 is considered other than
      temporary.





As
      of
      December 31, 2007, the Company held 1,308,483 OTI shares (of which 108,040
      are
      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) are subject to the abovementioned lock-up agreement and are
      restricted for a three month and six month periods, respectively.





As
      required under SFAS No. 115 for available for sale securities, OTI securities
      (other than the portions that were considered to be restricted as of December
      31, 2006) are stated at fair value. The fair value of OTI shares is 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 with the discount.





December 312006
            
            2007Available
                for sale securities
            
            $
            11,077
            
            $
            4,054Investment
                in restricted marketable securities of other company
            
            
            4,431
            
            
            -Total
                marketable securities
            
            $
            15,508
            
            $
            4,054





See
      also
      note 19


118


**VUANCE
        LTD. AND ITS 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,****2006**
            
            **2007**Prepaid
                expenses
            
            $
            178
            
            $
            689Government
                authorities
            
            
            74
            
            
            204Advance
                payment to suppliers
            
            
            16
            
            
            1,455Severance
                pay fund – current (*)
            
            
            348
            
            
            -Others
            
            
            101
            
            
            52$
            717
            
            $
            2,400





(*)
      The
      severance pay fund related to employees that were employed in the e-ID Division.
      See Note 1a.





**NOTE
      5:-**  **INVENTORIES**





**December 31,****2006**
            
            **2007**Raw
                materials, parts and supplies
            
            $
            270
            
            $
            94Finished
                products
            
            
            -
            
            
            472$
            270
            
            $
            566





On
      December 31, 2006, as part of the sale of the e-ID Division to OTI, all
      inventory related to the e-ID Division was transferred to OTI. See Note
      1a.





As
      of
      December 31, 2007 the inventory is presented net of allowance of slow inventory
      in the amount of approximately $100,


119




**VUANCE
        LTD. AND ITS SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**
 
 **U.S.
        dollars in thousands (except per share data)**


**NOTE
                6:-**
            **INVESTMENT
                IN A CERTAIN MAJORITY OWNED SUBSIDIARY**





In
                December 1997, the Company established SuperComSlovakia
                , 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 SuperCom  Slovakia,
      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 SuperComSlovakia's
                outstanding shares. The Company has accounted for this investment
                using
                the equity method of accounting, due to the substantive participation
                rights held by the minority,which impacts 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.





**NOTE
                7:-**
            **PROPERTY
                AND EQUIPMENT**





**December 31,****2006**
            
            **2007**Cost:Computers
                and peripheral equipment
            
            $
            300
            
            $
            287Office
                furniture and equipment
            
            
            211
            
            
            193Leasehold
                improvements
            
            
            75
            
            
            33586
            
            
            513Accumulated
                depreciation:Computers
                and peripheral equipment
            
            
            259
            
            
            183Office
                furniture and equipment
            
            
            92
            
            
            92Leasehold
                improvements
            
            
            75
            
            
            20426
            
            
            295Depreciated
                cost
            
            $
            160
            
            $
            218





Depreciation
      expenses for the years ended December 31, 2005, 2006 and 2007, were $746
      (including write-down of leasehold improvements, see below), $335 and $38,
      respectively.





During
      fiscal 2005, the Company relocated its offices. As a result, the Company wrote
      down the unamortized balance of leasehold improvement in the amount of $471.
      This expense was recorded in the statement of operations as part of
“Restructuring expenses”.





On
      December 31, 2006, as part of the sale of the e-ID Division to OTI, all property
      and equipment related to the Division were transferred to OTI. See Note
      1a.


120




**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**





**U.S.
      dollars in thousands (except per share data)**


**NOTE
                8:-**
            **OTHER
                ASSETS**





The
      deferred charges were incurred in respect of issuance of convertible bonds
      during November,2006 (an additional amount of $52 was recognized during 2007
      with respect to that issuance). See Note 13





During
      the year 2007, the Company capitalized an amount of $280, related to the
      development of its CSMS product.





During
      February 2007, the Company purchased the remaining 20% of Vuance RFID, from
      the
      minority for an amount of $100, which related to patents.





During
      the third quarter of 2007, the Company acquired the Credentialing Division
      of
      Disaster Management Solutions Inc. for an amount of $100. As a result of this
      transaction the Company allocated costs to Intellectual Property.





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.





**a.****Goodwill******





The
        changes in the carrying amount of goodwill for the years ended December 31,
        2006
        and 2007 are as follows:


**December 31,****2006**
            
            **2007**Balance
                as of January 1
            
            $
            -
            
            $
            -Goodwill
                resulting from acquisition (see note 1a)
            
            
            -
            
            
            3,644Balance
                as of December 31
            
            $
            -
            
            $
            3,644


121




**VUANCE
        LTD. AND ITS 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
            
            **2006**
            
            **2007****Cost**Deferred
                charges
            
            
            Over
                the contractual life of the bond
            
            $
            203
            
            $
            255Capitalized
                research and development costs
            
            
            3
                Years
            
            
            -
            
            
            280Patents
            
            
            3
                Years
            
            
            -
            
            
            104Intellectual
                Property
            
            
            3
                Years (*)
            
            
            -
            
            
            650Brand
                name
            
            
            5
                Years (*)
            
            
            -
            
            
            500Customer
                Base
            
            
            5
                Years (*)
            
            
            -
            
            
            506$
            203
            
            $
            2,295





**Accumulated
                amortization**Deferred
                charges
            
            $
            6
            
            $
            96Capitalized
                research and development costs
            
            
            
            
            
            43Patent
            
            
            -
            
            
            16Intellectual
                Property
            
            
            -
            
            
            61Brand
            
            
            -
            
            
            33Customer
                Base
            
            
            -
            
            
            34-$
            6
            
            
            283Amortized
                cost
            
            $
            197
            
            $
            2,012





*
      Commencing on the closing date of the acquisition of SHC on August 28, 2007.
      See
      also note 1a.





Amortization
      of intangible assets amounted to $26, $20 and $277 for the years ended December
      2005, 2006 and 2007, respectively.





Estimated
      amortization expenses for the next five years are $643, $632, $403, $200 and
      $134 in the years 2008, 2009, 2010, 2011 and 2012,
      respectively.


122




**VUANCE
        LTD. AND ITS SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**
 
 **U.S.
        dollars in thousands (except per share data)**


**NOTE
                9:-**
            **BANK
                CREDIT**





a.
            As
                of December 31, 2007, the Company had credit lines from banks in
                an
                aggregate amount of $ 550 including long-term loans (from time to
                time the banks may increase the Company’s credit line for a limited
                period), of which $ 120 is denominated in NIS and bears interest at
                the prime rate plus an additional 0.5% - 2.5%, and $ 430 is
                denominated in U.S. dollars and bears interest at a rate of LIBOR
                plus
                2.5% -2.9%. As of December 31, 2007, the U.S. LIBOR and prime rates
                were
                approximately 4.5% and 5.75%
                respectively.





The
      weighted average interest rates on the credit lines as of December 31, 2006
      and
      2007, were approximately 7.85% and 6.95%, respectively.





The
      Company had an unused credit facility in an amount of approximately $ 100
      as of December 31, 2007, for which there is no fee.





b.
            Long-term
                loans:





**December 31,****2006**
            
            **2007**Banks
            
            $
            354
            
            $
            82Less
                - current maturities of long-term loans
            
            
            287
            
            
            82$
            67
            
            $
            -





As
      of
      December 31, 2007, a loan in the amount of $ 28 bears annual average interest
      at
      a rate of LIBOR + 2.875% and a loan in the amount of $54 bears annual average
      interest at a rate of PRIME + 2.75%.


c.
              Regarding
                  guarantees and liens - see Note
                  11b.





**NOTE
                10:-**
            **ACCRUED
                EXPENSES AND OTHER
                LIABILITIES**





**December 31,****2006**
            
            **2007**Customer
                advances (***)
            
            $
            310
            
            $
            4,334Deferred
                revenues
            
            
            285
            
            
            258Accrued
                expenses(*)
            
            
            2,261
            
            
            2,024Accrued
                severance pay – current (**)
            
            
            421
            
            
            -Other
            
            
            151
            
            
            25$
            3,428
            
            $
            6,641





(*)
                As of December 31, 2006 and 2007, includes $450 and $105, respectively,
                related to the transaction with OTI and $1,376 and $1,099 related
                to
                marketing expenses, respectively.





**(**)**The
                accrued severance pay related to employees that were employed in
                the e-ID
                Division. See Note 1a.





(***)As
                of December 31, 2007, an amount of $4,318 relates to advances from
                customers with respect to long term
                contracts.


123




**VUANCE
        LTD. AND ITS SUBSIDIARIES**
 **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 - 2010.





On
      April
      18, 2005, the Company signed a lease for new offices in Kadima, (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.


As
      a
      result of the SHC acquisition, as described in note 1(a), the Company's
      subsidiary in the USA has several leased facilities in the USA. The main
      facility is in Wisconsin. According to the lease, the monthly fee is $5,while
      all the monthly fee for the other facilities is $14.5.


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:





2008
            
            $
            6032009
            
            
            4942010
            
            
            445$
            1,542





Rent
      expenses for the years ended December 31, 2005, 2006 and 2007, were
      approximately $369, $355 and $376, respectively.





b.
            Guarantees,
                indemnity and liens:


1.
              The
                  Company issued bank guarantees in the amount of $59 to secure a
                  certain
                  lease of the Company. As a condition of these guarantees, the Company
                  deposited $ 52, which is included as part of the restricted cash
                  deposits.
 
 2.
              In
                  order to secure bank credit and covenants to the bank, the Company
                  pledged
                  deposits in the amount of $481, as of December 31, 2007, in favor
                  of Bank
                  Otsar Ha-Hayal Ltd., which are included as part of restricted cash
                  deposits.
 Certain
                  loan agreements and debentures contain restrictive covenants, mainly
                  the
                  requirement to maintain certain financial ratios. As of December
                  31, 2007,
                  the Company was in compliance with all of its financial covenants.
 
 3.
              In
                  order to secure an agreement with a customer, the Company provided
                  bank
                  guarantees in the amount of $78. As a condition of this guarantee,
                  the
                  Company deposited $49 in the bank, which is included as part of
                  restricted
                  cash. The Company has granted a pledge in favor of Bank Otsar Ha-Hayal
                  Ltd. on the funds and rights that are generated from Ethiopian
                  immigration.
 
 4.
              The
                  Company issued a bank guarantee in the amount of $2,550 to a supplier,
                  related to a certain project of the Company with a European country.
                  As a
                  condition of these guarantee the Company deposited $2,590, which
                  is
                  included as part of the restricted cash
                  deposits.


124




**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**





**U.S.
      dollars in thousands (except per share data)**





**NOTE
      11:-**  **COMMITMENTS
      AND CONTINGENT LIABILITIES (Cont.)**





5.
            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 these financial statements there was
                no
                claim for breach from the OTI side.




c.
            Litigation:




1.
            In
                April 2004, the Department for Resources Supply of the Ministry of
                Ukraine
                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,
                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 for
                Resources
                Supply of the Ministry filed a new statement of claim with the Arbitration
                Court for restitution of $1,048 paid to the Company by the Department
                for
                Resources Supply of the Ministry under the Contract. On September
                27,
                2005, the Company received a negative award issued by the Arbitration
                Court in the second claim. 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.




During
      February 2007, the Company received from the management body of the courts
      of
      Israel documents that were sent from the Ministry of Internal Affairs of the
      Ukraine regarding the claim for restitution of $1,048. The Company’s legal
      advisors have advised the Company that the documents were improperly sent and
      not in compliance with Israeli law. The Company intends to vigorously defend
      any
      motion to enforce the Arbitration Court award in Israel, and if necessary,
      to
      assert claims that the Ukrainian proceedings were legally defective and that
      no
      judgment based on these proceedings can be enforced in Israel.




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. Therefore no provision has been made in
      the
      financial statements in respect of the claim for restitution of $1,048. However,
      due to the developments described above, the Company wrote off inventory in
      an
      amount of approximately $287 in the fourth quarter of 2005, and took possession
      of the remaining inventory that was previously delivered to the customer. In
      2003, the Company increased the allowance for doubtful accounts in an aggregate
      amount of $2,133 for the remaining balance of the debt the Ukrainian government
      owes the Company.




The
      Company did not have any revenues from this project in 2005, 2006 and 2007.


125




**VUANCE
        LTD. AND ITS SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**
 **U.S.
        dollars in thousands (except per share data)**





**NOTE
          11:-** **COMMITMENTS
          AND CONTINGENT LIABILITIES (Cont.)**





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 $3,476 as of December 31, 2007) 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 $63 as of December 31, 2007) and SuperCom Slovakia’s legal
                fees in the amount of EUR 63,611 (approximately $94 as of December
                31,
                2007). 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 6,688.50 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.




3.
            On
                July 14, 2003, Mr. Yaacov Pedhatzur, filed a lawsuit against the
                Company
                in the Magistrate’s Court in Tel Aviv, Israel, claiming that the Company
                owes him commissions in respect of transactions between the Company
                and
                certain third parties. On September 29, 2005, the Company reached a
                settlement agreement with Mr. Pedhatzur in which the Company agreed
                to pay
                Mr. Pedhatzur the NIS equivalent of $129. The settlement agreement
                has
                been approved by the court. This amount was recorded in the statement
                of
                operations of fiscal year 2005, as litigation settlement expenses.




4.
            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, 2007) and legal expenses as well as attorney’s
                fees in the sum of NIS 30,000 ($8 as of December 31, 2007). Secu-Systems
                has filed an appeal, and the Company 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 the Company have
                breached
                the confidentiality agreement. Consequently, the appeal that had
                been
                filed by Inksure and the Comapny 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.




126


**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**


**U.S.
      dollars in thousands (except per share data)**




**NOTE
        11:-** **COMMITMENTS
        AND CONTINGENT LIABILITIES (Cont.)**





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 $6,500 as of
      December 31, 2007). 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 a gross profit of $6,400 according to the financial
      statements of Inksure for the years 2002-2007. The Company's answer to the
      said
      petition has been filed but a date for the hearing of the petition has not
      yet
      been set.


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:


4.1.
            In
                light of the costs analysis, the Company had no economic profit from
                the
                sale of Inksure's shares.


4.2.
            The
                consideration received from the sale of Inksure's shares in 2002,
                incorporates the value of the cash flow of Inksure following the
                sale.
                Therefore, a calculation based upon both the sale price and the future
                cash flow of Inksure is not accurate and is not in line with customary
                accountant standards, since it calculates the factor of the future
                cash
                flow twice.


4.3.
            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.


In
      light
      of the above, provided that the subject matter consultant's opinion 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 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”), as to which Vuance is 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.




6.
            Regarding
                subsequent events see Note 19d.




d.
            In
                a certain transaction, the Company is obligated to pay a certain
                percentage of the revenues to third parties.


127





**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**


**U.S.
      dollars in thousands (except per share data)**





**NOTE
                12:-**
            **TAXES
                ON INCOME**





a.
            Measurement
                of results of operations for tax purposes under the Israeli Income
                Tax Law
                (Inflationary Adjustments), 1985.





Results
                of operations for tax purposes are 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 deferred income taxes
                on the
                above difference between the functional currency and the tax bases
                of
                assets and liabilities.





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%.


According
      to a previous amendment to the Income Tax Ordinance (No. 140) 2004, the tax
      rates were reduced as follows: in 2004 - 35% and in 2005 - 34%.





c.
            Non-Israeli
                subsidiaries:





Non-Israeli
      subsidiaries are taxed according to the tax laws of the country 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:**
            
            
            **2006**
            
            
            **2007**Operating
                loss carryforward
            
            $
            4,958
            
            $
            7,951Reserves
                and allowances
            
            
            930
            
            
            2,125Net
                deferred tax asset before valuation allowance
            
            
            5,888
            
            
            10,076Valuation
                allowance
            
            
            (5,888
            )
            
            (10,076
            )Net
                deferred tax asset
            
            $
            -
            
            $
            -Deferred
                income taxes consist of the following:Domestic
            
            $
            4,820
            
            $
            7,040Valuation
                allowance
            
            
            (4,820
            )
            
            (7,040
            )Foreign
            
            
            1,068
            
            
            3,036Valuation
                allowance
            
            
            (1,068
            )
            
            (3,036
            )$
            -
            
            $
            -




128




**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**


**U.S.
      dollars in thousands (except per share data)**





**NOTE
                12:-**
            **TAXES
                ON INCOME (Cont.)**





As
                of December 31, 2007, the Company and its subsidiaries have provided
                valuation allowances of $ 10,076 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, 2007,
                in
                an amount of approximately $ 19,793, 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 $4,679 which
                may
                be carried forward and offset against gains on marketable securities
                for
                an indefinite period.





As
      of
      December 31, 2007, Vuance's subsidiaries in the United States and Hong Kong
      have
      estimated total available carryforward tax losses of $8,371 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,
                2001.


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 incomeconsists
                of the following:




**Year ended December 31,****2005**
                
                **2006**
                
                **2007**Domestic
                
                $
                (2,787
                )
                $
                6,250
                
                $
                (8,526
                )Foreign
                
                
                (1,164
                )
                
                (810
                )
                
                (2,748
                )$
                (3,951
                )
                $
                5,440
                
                $
                (11,274
                )




129





**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**


**U.S.
      dollars in thousands (except per share data)**





**NOTE
                12:-**
            **TAXES
                ON INCOME (Cont.)**





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,****2005**
              
              **2006**
              
              **2007**Net
                  income (loss) before taxes on income, as reported in the consolidated
                  statements of operations
              
              $
              (3,951
              )
              $
              5,440
              
              $
              (11,274
              )Statutory
                  tax rate in Israel
              
              
              34
              %
              
              31
              %
              
              29
              %Theoretical
                  tax expenses (benefit)
              
              $
              (1,343
              )
              $
              1,686
              
              $
              (3,269
              )Carryforward
                  losses and other deferred taxes for which a full valuation allowance
                  was
                  recorded
              
              
              1,021
              
              
              384
              
              
              3,170Decrease
                  in taxes resulting from utilization of carryforward tax losses
                  for which
                  deferred taxes were not created in the past
              
              
              -
              
              
              (2,402
              )
              
              -Differences
                  in taxes resulting from rate applicable to foreign subsidiary and
                  others
              
              
              322
              
              
              332
              
              
              62Actual
                  income tax
              
              $
              -
              
              $
              -
              
              $
              (37
              )





**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 private placement during the year 2005,
      as
      described in note 14d2 ,
      which
      are existing shareholders of the Company. The Convertible Bonds mature three
      years from the date of issuance and bear interest at an annual rate of 8%.
      Any
      withholding and other taxes payable with respect to the interest will be grossed
      up and paid by the Company (approximately 3% of the principle of the bond).
      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.





Between
      February 10, 2008 and February 16, 2008, the Company has the option to call
      and
      redeem 100% of the Convertible Bonds at a price equal to (i) the aggregate
      principal amount of the bonds plus (ii) a redemption premium equal to fifteen
      percent (15%) of the aggregate principal amount plus (iii) any accrued but
      unpaid interest on the aggregate principal amount, calculated through the date
      of redemption. The Company did not realize its options to redeem the Convertible
      Bonds.


130


**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**


**U.S.
      dollars in thousands (except per share data)**




**NOTE13:-**
            **CONVERTIBLE
                BONDS (Cont.)**





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 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 bond,
      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) (any withholding and other taxes payable
      with respect to the interest will be grossed up and paid by the Company,
      (approximately 3% of the principle of the bond)) and to the other investors
      the
      Company changed the conversion ratio of the bond 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 bond. As of
      December 31, 2007, the Company is in compliance with the amendment conditions
      of
      the convertible bond.





Regarding
      subsequent events see Note 19.





**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 name change on May 14, 2007. Since
                November 5, 2004, the Company’s ordinary shares have also traded on the
                OTCBulletin
                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”.


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.
            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.


131





**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**


**U.S.
      dollars in thousands (except per share data)**





**NOTE14:-**
            **SHARE
                CAPITAL (Cont.)**





d.
            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 Remuneration 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 of December 31, 2007, 4,361,294
                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 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, 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 option. On August 15, 2007 the new option plan was approved
      by the shareholders of the Company at the general shareholders
      meeting.





2.
                During
                    2005, the Board of Directors approved a grant of options to acquire
                    up to
                    15,300 and 8,500 ordinary shares to certain employees at exercise
                    prices
                    of $5.24, and $4.18 per share, respectively. An additional 68,001
                    options
                    were granted during 2005 to related parties. See Note
                    15d.





On
      December 29, 2005, the Board of Directors and the Audit Committee approved
      the
      acceleration of the vesting schedule for certain of the stock options granted
      to
      employees and officers as an incentive. As a result, options to purchase a
      total
      of 121,126 ordinary shares became exercisable at the date of the approval.
      The
      acceleration did not have any effect on the financial statements since the
      options had a zero intrinsic value at the original date of grant and at the
      date
      of acceleration.





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.


132





**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**


**U.S.
      dollars in thousands (except per share data)**





**NOTE
      14:-**  **SHARE
      CAPITAL (Cont.)**





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.





3.
            A
                summary of the Company's stock option activity and related information
                is
                as follows:





**Year ended December 31****2005**
            
            **2006**
            
            **2007****Number**
              **of**
              **options**
            
            **Weighted**
              **average**
              **exercise**
              **price**
            
            **Number**
              **of**
              **options**
            
            **Weighted**
              **average**
              **exercise**
              **price**
            
            **Number**
              **of**
              **options**
            
            **Weighted**
              **average**
              **exercise**
              **price**Outstanding at
                beginning of year
            
            
            569,905
            
            $
            5.71
            
            
            595,971
            
            $
            5.77
            
            
            553,902
            
            $
            5.12Granted
            
            
            91,801
            
            $
            4.95
            
            
            93,501
            
            $
            4.42
            
            
            638,205
            
            $
            3.86Exercised
            
            
            (37,684
            )
            $
            2.48
            
            
            (43,152
            )
            $
            2.48
            
            
            (25,968
            )
            $
            3.16Canceled
                and forfeited
            
            
            (28,051
            )
            $
            5.53
            
            
            (92,418
            )
            $
            9.95
            
            
            (89,383
            )
            $
            5.06Outstanding
                at end of year
            
            
            595,971
            
            $
            5.77
            
            
            553,902
            
            $
            5.12
            
            
            1,076,756
            
            $
            4.43Exercisable
                at end of year
            
            
            515,504
            
            $
            6.06
            
            
            481,651
            
            $
            5.18
            
            
            591,485
            
            $
            4.81




The
      weighted average fair value of options granted during the reported periods
      was
      $3.08, $1.89 and $2.87, per option, for the years ended December 31, 2005,
      2006
      and 2007, 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 and 2007 grants: risk-free rate of 5%, dividend yield of
      0%,
      expected volatility factor of 57.14% and 57.20% respectively and expected term
      of 3.09 and 3.64 years respectively.


Regarding
      the assumptions used for the proforma information required under FAS 123 in
      2005
      see Note 2w above.


The
      expected volatility was based on the historical volatility of the Company’s
      stock. The expected term was based on the historical behavior of the employees
      and based on Management estimate.


Compensation
      expenses recognized by the Company related to its share-based employee
      compensation awards were $47 based on the provisions of APB 25, $ 225 and $1,032
      based on the provisions of SFAS 123R for the years ended December 31, 2005,
      2006 and 2007, respectively.


133


**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**


**U.S.
      dollars in thousands (except per share data)**





**NOTE
      14:-**  **SHARE
      CAPITAL (Cont.)**





The
      following table summarizes the allocation of the stock-based compensation
      charge





Year ended December 31,2005
            
            2006
            
            2007Cost
                of revenues
            
            $
            5
            
            $
            -
            
            $
            5Research
                and development expenses
            
            
            3
            
            
            32
            
            
            336Selling
                and marketing expenses
            
            
            17
            
            
            90
            
            
            158General
                and administrative expenses
            
            
            22
            
            
            103
            
            
            533$
            47
            
            $
            225
            
            $
            1,032





The
      options outstanding and exercisable as of December 31, 2007, have been separated
      into ranges of exercise prices as follows:





**Range of exercise**
              **price**
            
            **Options**
              **outstanding**
              **as of**
              **December 31,**
              **2007**
            
            **Weighted**
              **average**
              **remaining**
              **contractual**
              **life (years)**
            
            **Weighted**
              **average**
              **exercise**
              **price**
            
            **Aggregate**
              **intrinsic**
              **value**
            
            **Options**
              **exercisable**
              **as of**
              **December 31,**
              **2007**
            
            **Weighted**
              **average**
              **exercise price**
            
            **Aggregate**
              **intrinsic**
              **value**$
                0.01 - $ 0.06
            
            
            109,705
            
            
            9.63
            
            $
            0.03
            
            $
            511
            
            
            23,686
            
            $
            0.06
            
            $
            110$
                2.47 - $ 3.06
            
            
            184,243
            
            
            4.69
            
            $
            2.56
            
            $
            392
            
            
            184,243
            
            $
            2.56
            
            $
            392$
                4.18 - $ 4.90
            
            
            376,900
            
            
            7.81
            
            $
            4.42
            
            $
            102
            
            
            174,248
            
            $
            4.21
            
            $
            84$
                5.00 - $ 5.89
            
            
            347,050
            
            
            6.65
            
            $
            5.05
            
            
            -
            
            
            150,450
            
            $
            5.07
            
            
            -$11.76
                - $ 14.83
            
            
            57,800
            
            
            4.62
            
            $
            14.69
            
            
            -
            
            
            57,800
            
            $
            14.69
            
            
            -$
                23.64
            
            
            1,058
            
            
            0.25
            
            $
            23.64
            
            
            -
            
            
            1,058
            
            $
            23.64
            
            
            -1,076,756
            
            
            
            
            $
            4.43
            
            
            
            
            
            591,485
            
            $
            4.81





The
      aggregate intrinsic value of the above table represents the total intrinsic
      value, based on the Company’s stock price of $4.69 as of December 31, 2007, 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, 2007,
      2006 and 2005 was $62 ,$109 and $424 respectively, based on the Company’s
      average stock price of $5.57, $5.38 and $13.72 during the years ended
      respectively.


134





**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**


**U.S.
      dollars in thousands (except per share data)**





**NOTE
      14:-**  **SHARE
      CAPITAL (Cont.)**





A
      summary
      of the status of the Entity’s non-vested options granted to employees as of
      December 31, 2007 and changes during the year ended December 31, 2007 is
      presented below:





**Options**
            
            **Weighted-average**
              **grant-date fair**
              **value**Non-vested at January
                1, 2007
            
            
            72,251
            
            $
            2.29Granted
            
            
            638,205
            
            $
            2.87Vested
            
            
            (190,853
            )
            $
            3.02Forfeited
            
            
            (34,332
            )
            $
            2.23Non-vested
                at December 31, 2007
            
            
            485,271
            
            $
            2.77





As
      of
      December 31, 2007, there was $967 total unrecognized compensation cost related
      to non-vested share-based compensation arrangements granted under the stock
      option plans, of which, $626 is expected to be recognized during the year 2008,
      $255 during the year 2009 and $ 86 during the year 2010.





e.
            Private
                placements and warrants





1.
            In
                2004, the Company completed private placements of an aggregate of
                685,001
                of its ordinary shares to institutional and private investors at
                an
                aggregate purchase price of approximately $3.5 million at a price
                of $5
                per share. In addition, such investors were issued warrants
                exercisable for five years from the closing date of the purchase
                of an
                aggregate of up to 274,001 ordinary shares at an exercise price of
                $6.47
                per share.





Additionally,
      warrants exercisable for a period of 5 years were issued as follows: 75,601
      ordinary shares issuable upon the exercise of warrants having an exercise price
      of $5 per share to consultants and 30,240 ordinary shares issuable upon the
      exercise of warrants having an exercise price of $6.47 per share that were
      issued to Broadband Capital LLC as a portion of the placement agent fee issued
      in connection with a private placement completed on September 10, 2004; 12,751
      ordinary shares issuable upon the exercise of warrants having an exercise price
      of $6.47 per share that were issued to Meitav Capital Ltd. as a portion of
      the
      placement agent fee issued in connection with a private placement completed
      on
      July 15, 2004; and 500 ordinary shares issuable upon the exercise of warrants
      having an exercise price of $6.47 per share that were issued to Max Tech Ltd.
      as
      a portion of the placement agent fee issued in connection with a private
      placement completed on July 15, 2004.


As
      part
      of the private placement, two consultants received warrants exercisable for
      up
      to four years for the purchase of an aggregate of up to 4,251 and 17,001
      ordinary shares, respectively at an exercise price of $5 per share.


The
      warrants granted to the consultants as describe above were fully vested on
      the
      date of grant. The fair value of the warrants was $ 340 as computed using the
      Black & Scholes pricing model with the following weighted average
      assumptions: risk-free interest of 4.1%, dividend yield of 0, volatility factor
      of the excepted market price of the Company’s ordinary shares of 98.3%, and
      expected term of 2 years of the warrants. The Company recorded the issuance
      costs that resulted from the issuance of warrants to consultants during the
      reported periods, directly to additional paid in capital.


During
      the fourth quarter of 2004, 120,176 warrants were exercised for an aggregate
      amount of approximately $ 778 and approximately $ 130 was received in respect
      of
      20,000 shares that were issued in 2005.


During
      2005, 54,451 warrants were exercised for an aggregate amount of approximately
      $
      352.


During
      the years 2006 and 2007 no warrants were exercised.


135




**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**





**U.S.
      dollars in thousands (except per share data)**





**NOTE
      14:-**  **SHARE
      CAPITAL (Cont.)**




2.
            In
                November and December of2005,the Company received aggregate gross proceedsof
                $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 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 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 the Company’s 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 the option of the Company if the closing
                bid
                price per ordinary share of the Company's ordinary shares equals
                or
                exceeds $7.06 for 20 trading days during the term of the warrants.
                The
                Company may 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.





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, 2007 no warrants were exercised.





3.
            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.


136


**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**





**U.S.
      dollars in thousands (except per share data)**





**NOTE
      14:-**  **SHARE
      CAPITAL (Cont.)**





4.
            During
                2006 and 2007, the Board of Directors approved a grant of options
                to
                acquire up to 75,651 and 44,000 shares respectively, to certain
                consultants. The exercise prices under the terms of the options range
                between $ 3.42 to $ 5.47 per share. The fair market value of the
                warrants
                is $ 162 and $ 55, respectively, as computed using the Black & Scholes
                pricing model with the following weighted average assumption: risk-free
                interest of 4.00% - 4.25%, dividend yield of 0, volatility factor
                of the
                excepted market price of the Company’s ordinary shares of 73.46% and 36%,
                respectively, and expected term of the warrants of 2.47 and 2.38
                average
                years respectively. During 2006 and 2007, the Company recognized
                $131 and
                $38, as compensation expenses,
                respectively.





5.
            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 31****2005**
            
            **2006**
            
            **2007****Number**
              **of**
              **options**
            
            **Weighted**
              **average**
              **exercise**
              **price**
            
            **Number**
              **of**
              **options**
            
            **Weighted**
              **average**
              **exercise**
              **price**
            
            **Number**
              **of**
              **options**
            
            **Weighted**
              **average**
              **exercise**
              **price**Outstanding at
                beginning of year
            
            
            294,165
            
            $
            6.00
            
            
            525,111
            
            $
            4.53
            
            
            759,916
            
            $
            4.65Granted
            
            
            305,397
            
            $
            3.53
            
            
            234,805
            
            $
            4.95
            
            
            44,000
            
            $
            4.72Exercised
            
            
            (74,451
            )
            $
            6.48
            
            
            -
            
            
            -
            
            
            -
            
            
            -Canceled
                and forfeited
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            (21,231
            )
            $
            5.00Outstanding
                at end of year
            
            
            525,111
            
            $
            4.53
            
            
            759,916
            
            $
            4.65
            
            
            782,685
            
            $
            4.64Exercisable
                at end of year
            
            
            519,446
            
            $
            4.48
            
            
            737,250
            
            $
            4.65
            
            
            747,185
            
            $
            4.63





The
      warrants to consultants, investors (including warrants issued in connection
      with
      convertible bonds), outstanding and exercisable as of December 31, 2007, have
      been separated into ranges of exercise prices as follows:




**Range
                  of exercise**
                **price**
              ****
              **Options
                  outstanding**
                **as
                  of**
                **December
                  31, 2007**
              
              **Weighted
                  average**
                **remaining**
                **contractual**
                **life
                  (years)**
              
              **Weighted
                  average**
                **exercise**
                **price**
              
              **Aggregate
                  intrinsic value**
              
              **Options
                  exercisable**
                **as
                  of**
                **December
                  31, 2007**
              
              **Weighted
                  average**
                **exercise
                  price**
              
              **Aggregate
                  intrinsic value**$
                  3.42 - $ 3.53
              
              
              306,252
              
              
              3.08
              
              $
              3.53
              
              $
              355
              
              
              306,252
              
              $
              3.53
              
              $
              355$
                  4.42 - $ 4.85
              
              
              71,200
              
              
              6.33
              
              $
              4.67
              
              $
              1
              
              
              44,200
              
              $
              4.69
              
              
              -$
                  5
                  - $ 5.48
              
              
              282,355
              
              
              2.70
              
              $
              5.04
              
              
              -
              
              
              273,855
              
              $
              5.03
              
              
              -$
                  6.48
              
              
              122,878
              
              
              1.69
              
              $
              6.47
              
              
              -
              
              
              122,878
              
              $
              6.47
              
              
              -782,685
              
              
              3.02
              
              $
              4.64
              
              
              
              
              
              747,185
              
              $
              4.63


6.
            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.


137





**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**





**U.S.
      dollars in thousands (except per share data)**





**NOTE
      14:-**  **SHARE
      CAPITAL (Cont.)**


f.
              Dividends:


In
      the
      event that cash dividends are declared in the future, such dividends will be
      paid in NIS. The Company does not intend on paying cash dividends in the
      foreseeable future.


g.
              Convertible
                  bonds and warrants - see Note
                  13.





**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 2005, 2006 and 2007, the Company paid
      $144, each year, pursuant to this agreement.





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,
                to
                increase the consideration set forth in the said agreement to an
                amount of
                $7 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 as of December 31,
                2007),
                (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 $1.5 per month as a director’s fee. During 2005, 2006
      and 2007, the Company paid $132, $102 and $102, pursuant to this agreement.





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 2005, 2006 and 2007, the Company
      paid
      $71, $72 and $71 respectively, pursuant to this agreement.





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
“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.





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 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.


138





**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**





**U.S.
      dollars in thousands (except per share data)**





**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,****2005**
            
            **2006**
            
            **2007****Total**
            
            **Long-lived**
            
            **Total**
            
            **Long-lived**
            
            **Total**
            
            **Long-lived****revenues**
            
            **assets**
            
            **revenues**
            
            **assets**
            
            **revenues**
            
            **Assets(*)**Europe
            
            $
            3,719
            
            $
            -
            
            $
            5,877
            
            $
            -
            
            $
            8,650
            
            $
            -Asia
                Pacific
            
            
            2,173
            
            
            16
            
            
            1,730
            
            
            18
            
            
            1,330
            
            
            13Africa
            
            
            2,158
            
            
            -
            
            
            621
            
            
            -
            
            
            823
            
            
            -United
                States
            
            
            202
            
            
            61
            
            
            373
            
            
            54
            
            
            1,787
            
            
            5,248Israel
            
            
            210
            
            
            3,133
            
            
            194
            
            
            88
            
            
            371
            
            
            613$
            8,462
            
            $
            3,210
            
            $
            8,795
            
            $
            160
            
            $
            12,961
            
            $
            5,874





(*)  Long
      lived assets date includes allocation of intangible assets and goodwill
      amounts.





b.
            Summary
                of operations based on products and
                services:





**Year ended December 31,****2005**
            
            **2006**
            
            **2007**Raw
                materials and equipment
            
            $
            6,538
            
            $
            6,529
            
            $
            9,315Maintenance,
                royalties and project management
            
            
            1,924
            
            
            2,266
            
            
            3,646$
            8,462
            
            $
            8,795
            
            $
            12,961





c.
            Major
                customer data as a percentage of total
                sales:





**Year ended December 31,****2005**
            
            **2006**
            
            **2007**Customer
                A
            
            
            23
            %
            
            *
            
            
            *Customer
                B
            
            
            11
            %
            
            10
            %
            
            8
            %Customer
                C
            
            
            -
            
            
            -
            
            
            17
            %Customer
                D
            
            
            22
            %
            
            59
            %
            
            50
            %Customer
                E
            
            
            10
            %
            
            -
            
            
            -




*)  Less
      than
      10%.


139





**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**





**U.S.
      dollars in thousands (except per share data)**





**NOTE
                17:-**
            **FINANCIAL
                EXPENSES, NET**





**Year
                ended December 31,****2005**
            
            **2006**
            
            **2007**Financial
                expenses:Interest,
                amortization of discount, bank charges and fees (*)
            
            $
            (119
            )
            $
            (178
            )
            $
            (962
            )Exchange
                differences
            
            
            -
            
            
            (109
            )
            
            (109
            )Decrease
                in value of marketable securities, net
            
            
            -
            
            
            -
            
            
            (2,699
            )Realized
                loss from sale of marketable securities
            
            
            -
            
            
            -
            
            
            (1,116
            )Total
                financial expenses
            
            
            (119
            )
            
            (287
            )
            
            (4,886
            )Financial
                income:Exchange
                differences
            
            
            28
            
            
            -
            
            
            -Interest
            
            
            66
            
            
            83
            
            
            234Total
                financial income
            
            
            94
            
            
            83
            
            
            234Net
                total
            
            $
            (25
            )
            $
            (204
            )
            $
            (4,652
            )





*
      In 2006
      and 2007, includes $75 and $ 745 expenses related to convertible bonds,
      respectively.





**NOTE
                18:-**
            **OTHER
                EXPENSES, NET**





**2005**
            
            **2006**
            
            **2007****Year 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
            )
            
            -Decline
                in market value of held-to-maturity securities
            
            
            -
            
            
            -
            
            
            -Other
            
            
            (30
            )
            
            (38
            )
            
            -$
            (30
            )
            $
            (367
            )
            $
            -


140





**VUANCE
      LTD. AND ITS SUBSIDIARIES**


**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS (Cont.)**





**U.S.
      dollars in thousands (except per share data)**




**NOTE
                  19:-**
              **SUBSEQUENT
                  EVENTS**






a.
            After
                the balance sheet date the price of OTI share decreased
                further.b.
            In
                June 2008,the
                Company reachedanagreement
                with one of the investor (with a principle amount of $2,500),
                under which, among other things, the investor waivedthe
                Company's 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 the Company (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.The
                Company undertakes to place a fixed charge on all incomes and/or
                rights in
                connection with 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 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).
              As
                of June 30, 2008, the Company may be deemed not to be in compliance
                with
                certain covenants under our Convertible Bond with SSF in which case
                SSF
                could seek to accelerate payment of the unpaid principal amount and
                accrued interest under its Convertible Bond (an aggregate of approximately
                $740 as of June 30, 2008).  See
                also Note 13.c.
            Regarding
                the application of the Company to delist its shares from theEuronext
                Brussels stock marketsee note 1a.d.
            On
                January 20, 2008, the Manufacturers Association of Israel (the
                "Plaintiff") filed a lawsuit with the labour 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.
                The services fees sought by the Plantiff are allegedly required on
                the
                basis of certain Collective Agreements that according to the Plaintiff
                apply on the Company through Extension Orders. On May 15, 2008 the
                Company
                submitted a statement of defense. On June1, 2008 the Company sent
                the
                plaintiff a questionnaire. The lawsuit is scheduled for early hearing
                on
                November 9, 2008. At this point, the Company cannot estimate the
                outcome
                of the lawsuit.





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141






**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, 2002.8
            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
                26, 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).


142


**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 Tuchman**By:**
            
            **Eyal
                Tuchman****Its:**
            
            **Chief
                Executive Officer**




Date: June 30 ,
      2008


143