SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON D.C. 20549

                                    FORM 20-F

[_]  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, 2005

                                       OR

[_]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
     EXCHANGE ACT OF 1934

              FOR THE TRANSITION PERIOD FROM _________ TO _________

                                       OR

[_]  SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
     EXCHANGE ACT OF 1934

       DATE OF EVENT REQUIRING THIS SHELL COMPANY REPORT .................

                         COMMISSION FILE NUMBER: 0-15375

                         RADA ELECTRONIC INDUSTRIES LTD.
              (Exact Name of Registrant as Specified in Its Charter
               and Translation of Registrant's Name Into English)

                                     ISRAEL
                 (Jurisdiction of Incorporation or Organization)

                 7 GIBOREI ISRAEL STREET, NETANYA 42504, 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 0.005 PAR VALUE
                                (Title of Class)

 Securities for which there is a reporting obligation pursuant to Section 15(d)
                                of the Act: NONE
                                (Title of Class)

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:

           ORDINARY SHARES, PAR VALUE NIS 0.005 PER SHARE...26,144,027
                            (as of December 31, 2005)

<PAGE>

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

                               Yes [_]     No [X]

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

                               Yes [_]     No [X]

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

                               Yes [X]     No [_]

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

                           Item 17 [_]     Item 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_

This Report on Form 20-F is incorporated by reference into our Form F-3
Registration Statements File Nos. 333-127491, 333-117954, 333-115598 and
333-12074, and our Form S-8 Registration Statements File Nos. 333-111437 and
333-12844.

<PAGE>

                                  INTRODUCTION

     RADA Electronic Industries Ltd. develops, manufactures and sells automated
test equipment, avionics products and ground debriefing systems and provides
manufacturing services for military and commercial use, mainly in Israel, the
U.S. and Europe. We also provide test and repair services using our CATS(TM)
testers and test program sets through our Chinese subsidiary. In February 2005,
we purchased certain assets and assumed certain liabilities related to the
operations of Vectop Ltd., an Israeli company specializing in the design,
development, marketing and sale of electro-optic equipment and debriefing
systems. Such assets included the know-how, intellectual property and patents
that were used by, or connected to Vectop Ltd.'s business. Our products include
our Net Centric Digital Recorder and related recording devices, ground
information management systems, optronic products, based on technology that we
acquired from Vectop Ltd., inertial navigation products and advanced training
solutions.

     Our shares are traded on the NASDAQ Capital Market, under the symbol
"RADI." As used in this annual report, the terms "we," "us" and "our" mean RADA
Electronic Industries Ltd. and its subsidiaries, unless otherwise indicated.

     We have been using CATS(TM), ACE(TM) and FACE(TM) as trade names. We have
acquired the rights to the Israeli trademark VDS(R) and to the U.S. trademark
application for the same trademark in connection with the assets we acquired
from Vectop Ltd. in February 2005. All other trademarks and trade names
appearing in this annual report are owned by their respective holders.

     Our consolidated financial statements appearing in this annual report are
prepared in U.S. dollars and in accordance with generally accepted accounting
principles in the United States, or U.S. GAAP. All references in this annual
report to "dollars" or "$" are to U.S. dollars and all references in this annual
report to "NIS" are to New Israeli Shekels.

     Statements made in this annual report concerning the contents of any
contract, agreement or other document are summaries of such contracts,
agreements or documents and are not complete descriptions of all of their terms.
If we filed any of these documents as an exhibit to this annual report or to any
previous filing with the Securities and Exchange Commission, you may read the
document itself for a complete recitation of its terms.

                                     - i -
<PAGE>


     Except for the historical information contained in this annual report, the
statements contained in this annual report are "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, and the Private
Securities Litigation Reform Act of 1995, as amended, with respect to our
business, financial condition and results of operations. Such forward-looking
statements reflect our current view with respect to future events and financial
results. We urge you to consider that statements which use the terms
"anticipate," "believe," "do not believe," "expect," "plan," "intend,"
"estimate," "anticipate" and similar expressions are intended to identify
forward-looking statements. We remind readers that forward-looking statements
are merely predictions and therefore inherently subject to uncertainties and
other factors and involve known and unknown risks that could cause the actual
results, performance, levels of activity, or our achievements, or industry
results, to be materially different from any future results, performance, levels
of activity, or our achievements expressed or implied by such forward-looking
statements. Such forward-looking statements are also included in Item 4 -
"Information on the Company" and Item 5 - "Operating and Financial Review and
Prospects." Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. Except as
required by applicable law, including the securities laws of the United States,
we undertake no obligation to publicly release any update or revision to any
forward-looking statements to reflect new information, future events or
circumstances, or otherwise after the date hereof. We have attempted to identify
significant uncertainties and other factors affecting forward-looking statements
in the Risk Factors section that appears in Item 3D. "Key Information - Risk
Factors."

     Unless specifically indicated otherwise, all numbers of ordinary shares and
per share data in this annual report reflect a two and one half share for one
share reverse stock split of our ordinary shares effected on April 4, 2001.

                                     - ii -
<PAGE>


                                TABLE OF CONTENTS

                                                                        PAGE NO.
                                                                        --------

PART I                                                                         1

ITEM 1.  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS                 1
ITEM 2.  OFFER STATISTICS AND EXPECTED TIMETABLE                               1
ITEM 3.  KEY INFORMATION                                                       1
         A.     Selected Financial Data                                        1
         B.     Capitalization and Indebtedness                                2
         C.     Reasons for the Offer and Use of Proceeds                      2
         D.     Risk Factors                                                   2
ITEM 4.  INFORMATION ON THE COMPANY                                           14
         A.     History and Development of the Company                        14
         B.     Business Overview                                             15
         C.     Organizational Structure                                      28
         D.     Property, Plants and Equipment                                28
ITEM 4A  UNRESOLVED STAFF COMMENTS                                            28
ITEM 5.  OPERATING AND FINANCIAL REVIEW AND PROSPECTS                         29
         A.     Operating Results                                             29
         B.     Liquidity and Capital Resources                               38
         C.     Research and Development, Patents and Licenses                41
         D.     Trend Information                                             42
         E.     Off-Balance Sheet Arrangements                                42
         F.     Tabular Disclosure of Contractual Obligations                 42
ITEM 6.  DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES                           43
         A.     Directors and Senior Management                               43
         B.     Compensation                                                  46
         C.     Board Practices                                               47
         D.     Employees                                                     56
         E.     Share Ownership                                               57
ITEM 7.  MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                    60
         A.     Major Shareholders                                            60
         B.     Related Party Transactions                                    62
         C.     Interests of Experts and Counsel                              63
ITEM 8.  FINANCIAL INFORMATION                                                63
         A.     Consolidated Statements and Other Financial Information       63
         B.     Significant Changes                                           67
ITEM 9.  THE OFFER AND LISTING                                                67
         A.     Offer and Listing Details                                     67
         B.     Plan of Distribution                                          68
         C.     Markets                                                       68
         D.     Selling Shareholders                                          68
         E.     Dilution                                                      68
         F.     Expense of the Issue                                          68
ITEM 10. ADDITIONAL INFORMATION                                               69
         A.     Share Capital                                                 69
         B.     Memorandum and Articles of Association                        69
         C.     Material Contracts                                            72
         D.     Exchange Controls                                             72
         E.     Taxation                                                      72
         F.     Dividend and Paying Agents                                    84
         G.     Statement by Experts                                          84
         H.     Documents on Display                                          84
         I.     Subsidiary Information                                        84

                                    - iii -
<PAGE>


ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS           85
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES               85

PART II                                                                       85

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES                      85
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND
                USE OF PROCEEDS                                               86
ITEM 15. CONTROLS AND PROCEDURES                                              86
ITEM 16. RESERVED                                                             86
ITEM 16. AUDIT COMMITTEE FINANCIAL EXPERT                                     86
ITEM 16. CODE OF ETHICS                                                       86
ITEM 16. EXEMPTIONS FROM THE LISTING REQUIREMENTS AND STANDARDS
                FOR AUDIT COMMITTEE                                           87
ITEM 16. PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND
                AFFILIATES AND PURCHASERS                                     87
PART II                                                                       88

ITEM 17.  FINANCIAL STATEMENTS                                                88
ITEM 18.  FINANCIAL STATEMENTS                                                88
ITEM 19.  EXHIBITS                                                            88
S I G N A T U R E S                                                           90

                                     - iv -
<PAGE>


                                     PART I

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

     Not applicable.

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

     Not applicable.

ITEM 3. KEY INFORMATION

A.   SELECTED FINANCIAL DATA

     We derived the following consolidated statements of operations data for the
years ended December 31, 2003, 2004 and 2005 and the consolidated balance sheet
data as of December 31, 2004 and 2005 from our audited consolidated financial
statements included in this annual report. We derived the consolidated
statements of operations data for the years ended December 31, 2001 and 2002,
and the consolidated balance sheet data as of December 31, 2001, 2002 and 2003
from our audited consolidated financial statements that are not included in this
annual report.

<TABLE>
<CAPTION>
                                                                          YEAR ENDED DECEMBER 31,
                                                  ------------------------------------------------------------------------
                                                    2001            2002            2003            2004            2005
                                                  --------        --------        --------        --------        --------
                                                         (U.S. dollars in thousands, except share and per share data)
<S>                                               <C>             <C>             <C>             <C>             <C>
Revenues                                          $  8,342        $ 10,399        $ 12,315        $ 14,160        $ 13,421
Cost of revenues                                     7,416           9,223           9,592          10,287          12,310
                                                  --------        --------        --------        --------        --------
Gross profit                                           926           1,176           2,723           3,873           1,111
   Research and development expenses                   534             122               -               -               -
   Marketing, selling, general and
      administrative expenses                        3,617           3,809           2,698           2,854           2,866

Operating income (loss)                             (3,225)         (2,035)             25           1,019          (1,755)
Financial income (expenses), net                      (210)           (364)            708            (248)           (624)
Other income (expenses), net                           (30)           (290)             (2)             23              33

Minority interest in losses of subsidiary               96             206              27              28              17
Net income (loss)                                 $ (3,369)       $ (2,483)       $    758        $    822        $ (2,329)
                                                  ========        ========        ========        ========        ========
Basic net income (loss) per share                 $  (0.24)       $  (0.15)       $   0.04        $   0.04        $  (0.10)
                                                  ========        ========        ========        ========        ========
Diluted net income (loss) per share               $  (0.24)       $  (0.15)       $   0.04        $   0.03        $  (0.10)
                                                  ========        ========        ========        ========        ========
Weighted average number of shares used
   to compute basic net income (loss) per
   share                                            13,817          16,555          18,511          19,374          22,513
                                                  ========        ========        ========        ========        ========
Weighted average number of shares used
   to compute diluted net income (loss) per
   share                                            13,817          16,555          19,704          23,684          22,513
                                                  ========        ========        ========        ========        ========

</TABLE>

<PAGE>

<TABLE>
<CAPTION>
                                                                           AS OF DECEMBER 31,
                                                -----------------------------------------------------------------------
                                                  2001            2002            2003            2004           2005
                                                --------        --------        --------        --------       --------
                                                                      (U.S. dollars in thousands)
<S>                                             <C>             <C>             <C>             <C>            <C>
BALANCE SHEET DATA:
Working capital (deficiency)                    $ (9,446)       $ (8,055)       $ (2,716)       $  2,265       $  3,575
Total assets                                      16,332          14,607          14,549          18,297         18,890
Short-term credits and loans                       5,920           5,697           1,123              14            877
Long-term debt, net of current maturities              -               -           1,220               -              -
Convertible note                                       -               -               -           2,346          2,560
Capital Stock                                     56,749          58,893          59,247          64,184         67,016
Shareholders' equity                                 700             485           2,878           7,232          7,735
</TABLE>

B.   CAPITALIZATION AND INDEBTEDNESS

     Not applicable.

C.   REASONS FOR THE OFFER AND USE OF PROCEEDS

     Not applicable.

D.   RISK FACTORS

     INVESTING IN OUR ORDINARY SHARES INVOLVES A HIGH DEGREE OF RISK AND
UNCERTAINTY. YOU SHOULD CAREFULLY CONSIDER THE RISKS AND UNCERTAINTIES DESCRIBED
BELOW BEFORE INVESTING IN OUR ORDINARY SHARES. OUR BUSINESS, PROSPECTS,
FINANCIAL CONDITION AND RESULTS OF OPERATIONS COULD BE ADVERSELY AFFECTED DUE TO
ANY OF THE FOLLOWING RISKS. IN THAT CASE, THE VALUE OF OUR ORDINARY SHARES COULD
DECLINE, AND YOU COULD LOSE ALL OR PART OF YOUR INVESTMENT.

     RISKS RELATED TO OUR BUSINESS AND OUR INDUSTRY

     WE HAVE A HISTORY OF LOSSES, AND MAY NOT BE ABLE TO ACHIEVE OR SUSTAIN
PROFITABILITY IN THE FUTURE.

     In the year ended December 31, 2005 we recorded a net loss of $2.3 million.
We have incurred losses in three out of the last five years and as of December
31, 2005 our accumulated deficit was $59.3 million. We may not be able to
achieve or sustain profitability in the future.

     WE MAY NEED TO RAISE ADDITIONAL CAPITAL IN THE FUTURE, WHICH MAY NOT BE
AVAILABLE TO US.

     Our working capital requirements and the cash flow provided by our
operating activities are likely to vary greatly from quarter to quarter,
depending on the timing of orders and deliveries, the build-up of inventories,
and the payment terms offered to our customers. As a consequence of our
significant losses, we incurred significant bank debt and sold equity and debt
securities in private placements in the years 1997 through 2005. We may need to
raise additional funds for a number of uses, including:


                                       2
<PAGE>


     o    Working capital and operating activities;

     o    Implementing marketing and sales activities for our products;

     o    Maintaining and expanding research and development programs;

     o    Hiring additional qualified personnel; and

     o    Supporting an increased level of operations.

     We may not be able to obtain additional funds on acceptable terms or at
all. If we cannot raise needed funds on acceptable terms, we may be required to
delay, scale back or eliminate some aspects of our operations and we may not be
able to:

     o    Develop new products;

     o    Enhance our existing products;

     o    Remain current with evolving industry standards;

     o    Fulfill our contractual obligations;

     o    Take advantage of future opportunities;

     o    Respond to competitive pressures or unanticipated requirements; or

     o    Retain our listing on the NASDAQ Capital Market.

     If adequate funds are not available to us, our business, results of
operations and financial condition will be materially and adversely affected.
Any equity or debt financings, if available at all, may cause dilution to our
then-existing shareholders and may increase our financing expenses. If
additional funds are raised through the issuance of equity securities, the net
tangible book value per share of our ordinary shares would decrease and the
percentage ownership of then current shareholders would be diluted.

     WE MAY NOT BE ABLE TO IMPLEMENT OUR GROWTH STRATEGY.

     In line with our growth strategy, we have entered into teaming agreements
and other co-operation agreements with Smiths Aerospace Electronic Systems, or
Smiths, and Lockheed Martin Aerospace to increase our penetration into the
aviation market. We are currently investing and intend to continue to invest
significant resources to develop these relationships. Should our relationships
fail to materialize into significant agreements or should we fail to work
efficiently with such parties, we may lose sales and marketing opportunities and
our business, results of operations and financial condition could be adversely
affected.


                                       3
<PAGE>


     As part of our growth strategy, we seek to acquire or invest in
complementary, including competitive, businesses, products and technologies. We
acquired certain assets and assumed certain liabilities related to the
operations of Vectop Ltd., or Vectop, in the first quarter of 2005, and are
seeking additional potential acquisition candidates. We currently have no
commitments or agreements with respect to any future acquisitions or investments
and we may not be able to consummate any acquisition or investment. Even if we
do acquire or invest in these businesses, products or technology, the process of
integrating acquired assets into our operations may result in unforeseen
operating difficulties and expenditures and may absorb significant management
attention that would otherwise be available for the ongoing development of our
business.

     In addition, we have limited experience in managing acquisitions and
growth. Therefore, the anticipated benefits of any acquisition may not be
realized. Furthermore, future acquisitions by us could result in potentially
dilutive issuances of our equity securities, the incurrence of debt and
contingent liabilities and impairment related to goodwill and other intangible
assets, any of which could materially adversely affect our operating results and
financial position. Acquisitions also involve other risks, including risks
inherent in entering markets in which we have no or limited prior experience and
the potential loss of key employees and the risk that we may experience
difficulty or delays in obtaining necessary permits.

     COMPETITION IN THE MARKET FOR AUTOMATED TEST EQUIPMENT AND AVIONICS
EQUIPMENT IS INTENSE AND WE MAY BE UNABLE TO ACHIEVE PROFITABILITY.

     The market for our products is highly competitive, and we may not be able
to compete effectively in our market. Our principal competitors in the automated
test equipment market are Zaban in Israel, and Aerospatiale Avionique and Avtron
abroad. Our principal competitors in the avionics market are Harris, Rockwell
Collins, Honeywell, Elbit Systems Ltd., or Elbit, Israel Aircraft Industries
Ltd., or IAI, R.S.L. Ltd., TEAC and Elisra Systems Ltd. We expect to continue to
face competition from these and other competitors. Most, if not all, of our
competitors are far larger, have substantially greater resources including
financial, technological, marketing and distribution capabilities, and enjoy
greater market recognition than we have. These competitors may be able to
achieve greater economies of scale and may be less vulnerable to price
competition than us. We may not be able to offer our products as part of
integrated systems to the same extent as our competitors or successfully develop
or introduce new products that are more cost effective or offer better
performance than those of our competitors. Failure to do so could adversely
affect our business, financial condition and results of operations.

     OUR INITIATIVE OF PROVIDING MANUFACTURING SERVICES MAY NOT SUCCEED, AND AS
A RESULT, WE MAY BE UNABLE TO ACHIEVE PROFITABILITY IN OUR BEIT-SHE'AN
PRODUCTION FACILITY AND MAY BE FORCED TO SHUT DOWN ITS OPERATIONS.

     In June 2000, we began to provide manufacturing services to original
equipment manufacturers in Israel and the United States, using the manufacturing
capabilities of our Beit-She'an plant. The market for our manufacturing services
is highly competitive and we may not be able to compete effectively in this
market. The cost of labor and the efficiency of the production equipment and
production processes are crucial to our success in this market. Consequently,
should we fail to maintain low labor costs, enhance our production equipment and
develop new and more efficient production methods, we may have to shut down the
operations of our Beit-She'an plant, which may harm our competitiveness and
could adversely affect our business, results of operations and financial
condition.


                                       4
<PAGE>


     REDUCTION IN MILITARY BUDGETS WORLDWIDE MAY CAUSE A REDUCTION IN OUR
REVENUES, WHICH WOULD ADVERSELY AFFECT OUR BUSINESS, OPERATING RESULTS AND
FINANCIAL CONDITION.

     A significant portion of our revenues is derived from the sale of products
with military applications. These revenues, on a consolidated basis, totaled
approximately $11.8 million, or 88% of revenues in 2005, $11.8 million, or 83 %
of revenues in 2004, and $9.6 million, or 78% of revenues in 2003. The military
budgets of a number of countries may be reduced in the future. Declines in
military budgets may result in reduced demand for our products and manufacturing
services. This would result in reduction in our core business' revenues and
adversely affect our business, results of operations and financial condition.

     SALES OF OUR PRODUCTS ARE SUBJECT TO GOVERNMENTAL PROCUREMENT PROCEDURES
AND PRACTICES; TERMINATION, REDUCTION OR MODIFICATION OF CONTRACTS WITH OUR
CUSTOMERS, AND ESPECIALLY WITH THE GOVERNMENT OF ISRAEL, OR A SUBSTANTIAL
DECREASE IN OUR CUSTOMERS' BUDGETS MAY ADVERSELY AFFECT OUR BUSINESS, OPERATING
RESULTS AND FINANCIAL CONDITION.

     Our military aviation products are sold primarily to government agencies
and authorities and government-owned companies, many of which have complex and
time-consuming procurement procedures. A long period of time often elapses from
the time we begin marketing a product until we actually sell that product to a
particular customer. In addition, our sales to government agencies, authorities
and companies are directly affected by these customers' budgetary constraints
and the priority given in their budgets to the procurement of our products.

     Further, our business with the State of Israel and other governmental
entities is, in general, subject to delays in funding and performance of
contracts and the termination of contracts or subcontracts for convenience,
among others. The termination, reduction or modification of our contracts or
subcontracts with the Government of Israel in the event of change in
requirements, policies or budgetary constraints would have an adverse effect on
our business, operating results and financial condition.

     IF WE DO NOT RECEIVE THE GOVERNMENTAL APPROVALS NECESSARY FOR THE EXPORT OF
OUR PRODUCTS, OUR REVENUES MAY DECREASE. SIMILARLY IF OUR SUPPLIERS AND PARTNERS
DO NOT RECEIVE THEIR GOVERNMENT APPROVALS NECESSARY TO EXPORT THEIR PRODUCTS OR
DESIGNS TO US, OUR REVENUES MIGHT DECREASE AND WE MAY FAIL TO IMPLEMENT OUR
GROWTH STRATEGY.

     Under Israeli law, the export of certain of our products and know-how is
subject to approval by the Israeli Ministry of Defense. To initiate sales
proposals with regard to exports of our products and know-how and to export such
products or know-how, we must obtain permits from the Ministry of Defense. We
may not be able to receive in a timely manner all the required permits for which
we may apply in the future.

     Similarly, under foreign laws the export of certain military products,
technical designs and spare parts require the prior approval of, or export
license from, such foreign governments. In order to maintain our third party
production, certain co-development activities and procurements required for the
performance of certain contracts, we must receive detailed technical designs,
products or products' parts samples from our strategic partners or suppliers. We
may not be able to receive all the required permits and/or licenses in a timely
manner. Consequently, our revenues may decrease and we may fail to implement our
growth strategy.


                                       5
<PAGE>


     WE DEPEND ON SALES TO KEY CUSTOMERS AND THE LOSS OF ONE OR MORE OF OUR KEY
CUSTOMERS WOULD RESULT IN A LOSS OF A SIGNIFICANT AMOUNT OF OUR REVENUES.

     A significant portion of our revenues is derived from a small number of
customers. Our major customers during the three years ended December 31, 2005
were as follows:

                                  PERCENTAGE OF REVENUES
                                 ------------------------
                                 2003      2004      2005
                                 ----      ----      ----
Smiths Electronic Systems         22%        5%       21%
The Boeing Company                14%       10%        3%
Israeli Ministry of Defense       11%       19%       12%
Israel Aviation Industries        12%        6%       14%
Portuguese Air Force              19%       17%        -
U.S. Navy                          -        11%        -
Lockheed Martin                    6%        5%       12%

     We anticipate that a significant portion of our future revenues will
continue to be derived from sales to a small number of customers. If our
principal customers do not continue to purchase products from us at current
levels or if such customers are not retained and we are not able to derive
sufficient revenues from sales to new customers to compensate for their loss,
our revenues would be reduced and adversely affect our business, financial
condition and results of operations.

     WE DEPEND ON A LIMITED NUMBER OF SUPPLIERS OF COMPONENTS FOR OUR PRODUCTS
AND IF WE ARE UNABLE TO OBTAIN THESE COMPONENTS WHEN NEEDED, WE WOULD EXPERIENCE
DELAYS IN MANUFACTURING OUR PRODUCTS AND OUR FINANCIAL RESULTS COULD BE
ADVERSELY AFFECTED.

     We acquire most of the components for the manufacturing of our products
from a limited number of suppliers and subcontractors, most of whom are located
in Israel and the United States. Certain of these suppliers are currently the
sole source of one or more components upon which we are dependent. Suppliers of
some of the components for manufacturing require us to place orders with
significant lead-time to assure supply in accordance with our manufacturing
requirements. Inadequacy of operating funds may cause us to delays placement of
such orders and may result in delays in supply. Delays in supply may
significantly hurt our ability to fulfill our contractual obligations and may
significantly hurt our business and result of operations. We may not be able to
continue to obtain such components from these suppliers on satisfactory
commercial terms. Temporary disruptions of our manufacturing operations would
ensue if we were required to obtain components from alternative sources, which
may have an adverse effect on our financial results.

     WE RELY ON THE AIRLINE INDUSTRY AND THE CONTINUED FINANCIAL CRISES IN THIS
INDUSTRY ADVERSELY AFFECTS OUR SALES.

     The airline industry is an important market for our automated test
equipment products and product support services. Our ability to achieve growth
and profitability in this market depends in great measure on the economic
condition of the commercial aviation industry. Since 2001, and especially
following the tragic events of September 11, 2001, the airline industry has
suffered from economic decline that caused the bankruptcy of several airlines
and imposed financial constraints on the entire industry. As a result of these
conditions, the sales of our automated test equipment products have materially
decreased. The continuance of the crisis in the commercial aviation industry
will adversely affect our business, financial condition and results of
operations.


                                       6
<PAGE>


     RAPID TECHNOLOGICAL CHANGES MAY ADVERSELY AFFECT THE MARKET ACCEPTANCE OF
OUR PRODUCTS.

     The avionics market in which we compete is subject to technological
changes, introduction of new products, change in customer demands and evolving
industry standards. Our future success will depend upon our ability to keep pace
with technological developments and to timely address the increasingly
sophisticated needs of our customers by supporting existing and new technologies
and by developing and introducing enhancements to our current products and new
products. We may not be successful in developing and marketing enhancements to
our products that will respond to technological change, evolving industry
standards or customer requirements. In addition, we may experience difficulties
that could delay or prevent the successful development, introduction and sale of
such enhancements, and such enhancements may not adequately meet the
requirements of the market and may not achieve any significant degrees of market
acceptance. If release dates of our new products or enhancements are delayed or,
if when released, they fail to achieve market acceptance, our business,
operating results and financial condition would be materially adversely
affected.

     WE MAY ENCOUNTER DIFFICULTIES WITH OUR INTERNATIONAL OPERATIONS AND SALES.

     While our principal executive offices are located in Israel, exports
accounted for 59% of our sales in 2005, 65% of our sales in 2004 and 74% of our
sales in 2003. This subjects us to many risks inherent in engaging in export
international business, including:

     o    Limitations and disruptions resulting from the imposition of
          government controls;

     o    Changes in regulatory requirements;

     o    Export license requirements;

     o    Economic or political instability;

     o    Trade restrictions;

     o    Changes in tariffs;

     o    Currency fluctuations;

     o    Longer receivable collection periods and greater difficulty in
          accounts receivable collection;


                                       7
<PAGE>


     o    Greater difficulty in safeguarding intellectual property;

     o    Difficulties in managing overseas subsidiaries and international
          operations; and

     o    Potential adverse tax consequences.

     We may not be able to sustain or increase revenues from international
operations and may encounter significant difficulties in connection with the
sale of our products in international markets. Any of those events will have a
material adverse affect on our business, operating results and financial
condition.

     CURRENCY EXCHANGE RATE FLUCTUATIONS IN THE WORLD MARKETS IN WHICH WE
CONDUCT BUSINESS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, RESULTS
OF OPERATIONS AND FINANCIAL CONDITION.

     We may be adversely affected by fluctuations in currency exchange rates.
While our revenues are generally denominated in U.S. dollars, a significant
portion of our expenses is incurred in NIS. We do not currently engage in any
currency hedging transactions intended to reduce the effect of fluctuations in
foreign currency exchange rates on our results of operations. If we were to
determine that it was in our best interests to enter into any hedging
transactions in the future, we may not be able to do so. Furthermore, such
transactions, if entered into, may not materially reduce the effect of
fluctuations in foreign currency exchange rates on our results of operations. In
addition, if for any reason exchange or price controls or other restrictions on
the conversion of foreign currencies into NIS were imposed, our business could
be adversely affected. In the future, such fluctuations may have a material
adverse effect on revenues from international sales, operating expenses and
consequently, on our business, operating results and financial condition.

     WE ARE DEPENDENT ON OUR SENIOR MANAGEMENT AND KEY PERSONNEL, IN PARTICULAR
HERZLE BODINGER, OUR PRESIDENT AND CHAIRMAN OF THE BOARD, WHOSE LOSS COULD
ADVERSELY AFFECT OUR BUSINESS.

     Our future success depends in large part on the continued services of our
senior management and key personnel. In particular, we are dependent on the
services of Herzle Bodinger, our chairman and president. We do not carry key
person life insurance on our senior management or key personnel. Any loss of the
services of Herzle Bodinger, other members of senior management or other key
personnel could negatively and materially effect our business.

     OUR PROPRIETARY TECHNOLOGY IS DIFFICULT TO PROTECT AND UNAUTHORIZED USE OF
OUR PROPRIETARY TECHNOLOGY BY THIRD PARTIES MAY IMPAIR OUR ABILITY TO COMPETE
EFFECTIVELY.

     Our success and ability to compete largely depends upon protecting our
proprietary technology. We rely on a combination of trade secrets, copyright law
and confidentiality, non-disclosure and assignment-of-inventions agreements to
protect our proprietary technology. Except for a patent that relates to our
ACE(TM) system, we do not have any patents.


                                       8
<PAGE>


     OUR PRODUCTS MAY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF OTHERS.

     Third parties may assert infringement claims against us or claims that we
have violated a patent or infringed on a copyright, trademark or other
proprietary right belonging to them. In addition, any infringement claim, even
one without merit, could result in the expenditure of significant financial and
managerial resources to defend.

     WE ARE CURRENTLY IN THE PROCESS OF COMPLETING THE TRANSFER OF THE TITLE TO
THE LAND AND BUILDING OF OUR CHINESE SUBSIDIARY. WE MAY NOT BE ABLE TO OBTAIN
SUCH TITLE AND BE REQUIRED TO INITIATE LITIGATION IN ORDER TO ENFORCE OUR RIGHTS
TO RECEIVE TITLE TO SUCH PROPERTIES.

     Beijing Huarui Aircraft Components Maintenance and Services Co., Ltd. or
CACS, our Chinese subsidiary, conducts its business in an approximately 16,000
square foot facility in Beijing that includes offices and test and repair
facilities. The land for this facility was leased by Beijing Tianzu Forestry
Company or Tianzu, the minority shareholder in CACS, from the Chinese government
for 30 years. Under a joint venture agreement, and in consideration for its
equity investment in CACS, Tianzu granted CACS usage rights in the land,
constructed the building and granted CACS the ownership of this building. We are
currently in the process of completing the transfer of the title to the land and
building. Although Tianzu is legally obligated to complete such transfer of
title to the land and the building, such transfer may take additional time and
may not be completed, and we may be required to initiate litigation in order to
enforce our rights to receive title to the land and building.

     COMPLIANCE WITH CHANGING REGULATION OF CORPORATE GOVERNANCE AND PUBLIC
DISCLOSURE MAY RESULT IN ADDITIONAL EXPENSES.

     As a result of certain corporate governance scandals and the legislative
and litigation environment resulting from those scandals, the costs of being a
public company in general have increased in recent years. The Sarbanes-Oxley Act
of 2002 requires changes in some of our corporate governance and securities
disclosure or compliance practices. We expect that the on-going implementation
of these regulations will further increase our legal compliance costs and will
make some activities more time consuming. We are presently evaluating and
monitoring regulatory developments and cannot estimate the magnitude of
additional costs we may incur as a result of such developments. If we are
required to implement Section 404 of the Sarbanes-Oxley Act of 2002, which
governs internal controls and procedures for financial reporting, we will need
to expend significant management time and financial resources to comply with the
applicable requirements. This and other proposed legislation may increase the
fees of our professional advisors and our insurance premiums.

     RISK FACTORS RELATED TO OUR ORDINARY SHARES

     OUR SHARE PRICE HAS BEEN VOLATILE IN THE PAST AND MAY DECLINE IN THE
FUTURE.

     Our ordinary shares have experienced significant market price and volume
fluctuations in the past and may experience significant market price and volume
fluctuations in the future in response to factors such as the following, some of
which are beyond our control:


                                       9
<PAGE>


     o    Quarterly variations in our operating results;

     o    Operating results that vary from the expectations of securities
          analysts and investors;

     o    Changes in expectations as to our future financial performance,
          including financial estimates by securities analysts and investors;

     o    Announcements of technological innovations or new products by us or
          our competitors;

     o    Announcements by us or our competitors of significant contracts,
          acquisitions, strategic partnerships, joint ventures or capital
          commitments;

     o    Changes in the status of our intellectual property rights;

     o    Announcements by third parties of significant claims or proceedings
          against us;

     o    Additions or departures of key personnel;

     o    Future sales of our ordinary shares;

     o    De-listing of our shares from the NASDAQ Capital Market; and

     o    Stock market price and volume fluctuations.

     Domestic and international stock markets often experience extreme price and
volume fluctuations. Market fluctuations, as well as general political and
economic conditions, such as a recession or interest rate or currency rate
fluctuations or political events or hostilities in or surrounding Israel, could
adversely affect the market price of our ordinary shares.

     In the past, securities class action litigation has often been brought
against companies following periods of volatility in the market price of its
securities. We may in the future be the target of similar litigation. Securities
litigation could result in substantial costs and divert management's attention
and resources both of which could have a material adverse effect on our business
and results of operations.

     SUBSTANTIAL FUTURE SALES OF OUR ORDINARY SHARES MAY DEPRESS OUR SHARE
PRICE.

     If our shareholders sell substantial amounts of our ordinary shares,
including shares registered under effective registration statements and shares
issuable upon the exercise of outstanding warrants, or convertible notes, or if
the perception exists that our shareholders may sell a substantial number of our
ordinary shares, the market price of our ordinary shares may fall. Any
substantial sales of our shares in the public market also might make it more
difficult for us to sell equity or equity related securities in the future at a
time, in a place and on terms we deem appropriate.


                                       10
<PAGE>


     WE DO NOT INTEND TO PAY DIVIDENDS.

     We have never declared or paid cash dividends on our ordinary shares and do
not expect to do so in the foreseeable future. The declaration of dividends is
subject to the discretion of our board of directors and will depend on various
factors, including our operating results, financial condition, future prospects
and any other factors deemed relevant by our board of directors. You should not
rely on an investment in our company if you require dividend income from your
investment in our company. The success of your investment will likely depend
entirely upon any future appreciation of the market price of our ordinary
shares, which is uncertain and unpredictable. There is no guarantee that our
ordinary shares will appreciate in value or even maintain the price at which you
purchased your ordinary shares.

     RISKS RELATING TO OUR LOCATION IN ISRAEL

     CONDUCTING BUSINESS IN ISRAEL ENTAILS SPECIAL RISKS.

     We are incorporated under the laws of, and our executive offices,
manufacturing plant and research and development facilities are located in, the
State of Israel. Although a large portion of our sales are made to customers
outside Israel, we are nonetheless directly affected by the political, economic
and military conditions affecting Israel. Specifically, we could be adversely
affected by any major hostilities involving Israel, a full or partial
mobilization of the reserve forces of the Israeli army, the interruption or
curtailment of trade between Israel and its present trading partners, or a
significant downturn in the economic or financial condition of Israel.

     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 intensity and degree, has led to
security and economic problems for Israel. Since September 2000, there has been
a marked increase in violence, civil unrest and hostility, including armed
clashes, between the State of Israel and the Palestinians, and acts of terror
have been committed inside Israel and against Israeli targets in the West Bank
and Gaza. In August 2005, Israel evacuated all Israeli settlements in the Gaza
Strip and four settlements in the West Bank. In January 2006, Hamas won the
elections in the Palestinian Authority and on March 28, 2006, elections to the
Israeli parliament were held in Israel. The implications of these developments
cannot at this time be foreseen.

     There is no indication as to how long the current hostilities will last or
whether there will be any further escalation. Any continuation of, or further
escalation in, these hostilities or any future armed conflict, political
instability or violence in the region may have a negative effect on our business
condition, harm our results of operations and adversely affect our share price.


                                       11
<PAGE>


     Furthermore, there are a number of countries that restrict business with
Israel or Israeli companies. Restrictive laws or policies of those countries
directed towards Israel or Israeli businesses had, and may in the future
continue to have, an adverse impact on our operations, our financial results or
the expansion of our business. 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.

     OUR RESULTS OF OPERATIONS MAY BE NEGATIVELY AFFECTED BY THE OBLIGATION OF
OUR PERSONNEL TO PERFORM MILITARY SERVICE.

     Many of our executive officers and employees in Israel are obligated to
perform annual military reserve duty and are subject to being called for active
duty under emergency circumstances. If a military conflict or war arises, these
individuals could be required to serve in the military for extended periods of
time. Our operations could be disrupted by the absence for a significant period
of one or more of our executive officers or key employees or a significant
number of other employees due to military service. Any disruption in our
operations could adversely affect our business.

     THE ECONOMIC CONDITIONS IN ISRAEL HAVE NOT BEEN STABLE IN RECENT YEARS.

     In recent years Israel has been going through a period of recession in
economic activity, resulting in low growth rates and growing unemployment.
Although economic activity in Israel has improved recently, our operations could
be adversely affected if the economic conditions in Israel begin to deteriorate
once again.

     WE MAY BE ADVERSELY AFFECTED IF THE RATE OF INFLATION IN ISRAEL EXCEEDS THE
RATE OF DEVALUATION OF THE NIS AGAINST THE U.S. DOLLAR.

     In 2005 approximately 38% of our expenses were in U.S. dollars or U.S.
dollar-linked NIS, in 2004 approximately 34% of our expenses were in U.S.
dollars or U.S. dollar-linked NIS and in 2003 approximately 25% of our expenses
were in U.S. dollars or U.S. dollar-linked NIS. In each of these years,
virtually all our remaining expenses were in unlinked NIS. Our expenses that are
denominated in U.S. dollars or paid in Israeli currency linked to the U.S.
dollar-NIS exchange rate are influenced by the extent to which any inflation in
Israel is not offset (or is offset on a lagging basis) by the devaluation of the
NIS in relation to the U.S. dollar. In 2002, the rate of devaluation of the NIS
against the dollar exceeded the rate of inflation in Israel, which benefited us.
In 2003, the rate of inflation was negative and the NIS was revaluated vis-a-vis
the dollar. In 2004 and 2005, the rate of inflation was 1.2% and 2.4%
respectively, and the NIS was reevaluated vis-a-vis the dollar. These changes,
as well as the recent world-wide devaluation of the U.S. dollar, have affected
our operations, financial condition and results of operations by decreasing the
NIS equivalents of our U.S. denominated revenues and increasing the U.S. dollar
equivalents of our NIS denominated expenses. We may be adversely affected in the
future if the rate of inflation in Israel exceeds the devaluation of the NIS
against the U.S. dollar or if the timing of this devaluation lags behind
increases in inflation in Israel.


                                       12
<PAGE>

     SERVICE AND ENFORCEMENT OF LEGAL PROCESS ON US AND OUR DIRECTORS AND
OFFICERS MAY BE DIFFICULT TO OBTAIN.

     Service of process upon our directors and officers and the Israeli experts
named herein, most of whom reside outside the United States, may be difficult to
obtain within the United States. Furthermore, since substantially all of our
assets, most of our directors and officers and the Israeli experts named in this
annual report are located outside the United States, any judgment obtained in
the United States against us or these individuals or entities may not be
collectible within the United States.

     There is doubt as to the enforceability of civil liabilities under the
Securities Act and the Securities Exchange Act in original actions instituted in
Israel. However, subject to certain time limitations and other conditions,
Israeli courts may enforce final judgments of United States courts for
liquidated amounts in civil matters, including judgments based upon the civil
liability provisions of those Acts.

     PROVISIONS OF ISRAELI LAW MAY DELAY, PREVENT OR MAKE THE ACQUISITION OF OUR
COMPANY DIFFICULT, WHICH COULD PREVENT A CHANGE OF CONTROL AND THEREFORE DEPRESS
THE PRICE OF OUR SHARES.

     Provisions of Israeli corporate and tax law may have the effect of
delaying, preventing or making more difficult a merger with, or other
acquisition of, us. This could cause our ordinary shares to trade at prices
below the price for which third parties might be willing to pay to gain control
of us. Third parties who are otherwise willing to pay a premium over prevailing
market prices to gain control of us may be unable or unwilling to do so because
of these provisions of Israeli law.

     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,
our 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 toward the company and other
shareholders and to refrain from abusing his power in the company, including,
among other things, in voting at the general meeting of shareholders on certain
matters. Israeli law provides that these duties are applicable in shareholder
votes on, among other things, amendments to a company's articles of association,
increases in a company's authorized share capital, mergers and interested party
transactions requiring shareholder approval. In addition, a shareholder who
knows that it possesses the power to determine the outcome of a shareholder vote
or to appoint or prevent the appointment of a director or executive officer in
the company has a duty of fairness toward the company. However, Israeli law does
not define the substance of this duty of 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.


                                       13
<PAGE>


     AS A FOREIGN PRIVATE ISSUER WHOSE SHARES ARE LISTED ON THE NASDAQ CAPITAL
MARKET, WE MAY FOLLOW CERTAIN HOME COUNTRY CORPORATE GOVERNANCE PRACTICES
INSTEAD OF CERTAIN NASDAQ REQUIREMENTS.

     As a foreign private issuer whose shares are listed on the NASDAQ Capital
Market, we are permitted to follow certain home country corporate governance
practices instead of certain requirements of the NASDAQ Marketplace Rules,
including the composition of our board of directors, director nomination
procedure, compensation of officers and quorum at shareholders meetings. In
addition, we may follow Israeli law instead of the NASDAQ Marketplace Rules that
require that we obtain shareholder approval for certain dilutive events, such as
for the establishment or amendment of certain equity based compensation plans,
an issuance that will result in a change of control of our company, certain
transactions other than a public offering involving issuances of a 19.9% or more
interest in our company and certain acquisitions of the stock or assets of
another company.

ITEM 4. INFORMATION ON THE COMPANY

A.   HISTORY AND DEVELOPMENT OF THE COMPANY

     We were incorporated under the laws of the State of Israel on December 8,
1970. We are a public limited liability company under the Israeli Companies Law
1999-5759, or the Israeli Companies Law, and operate under this law and
associated legislation. Our registered offices and principal place of business
are located at 7 Giborei Israel Street, Netanya 42504, Israel, and our telephone
number is 972-9-892-1111. Our address on the internet is WWW.RADA.COM. The
information on our website is not incorporated by reference into this annual
report.

     We develop, manufacture and sell automated test equipment, avionics
products and ground debriefing systems and provide manufacturing services for
military and commercial use, mainly in Israel, the U.S. and Europe. We also
provide test and repair services using our CATS(TM) testers and test program
sets through our Chinese subsidiary. Our U.S.-based subsidiaries have been
inactive since January 1, 2002.

     In April 1985, we completed an initial public offering. Our ordinary shares
are traded on the NASDAQ National Market from our initial public offering in
1985 until June 10, 2002 when the listing of our ordinary shares was transferred
to the NASDAQ Capital Market. We are listed under the symbol "RADI."

     In February 2005, we purchased certain assets and assumed certain
liabilities related to the operations of Vectop, an Israeli company specializing
in the design, development, marketing and sale of electro-optic equipment and
debriefing systems. Such assets included the know-how, intellectual property and
patents that were used by, or connected to Vectop's business, as well as full
access to customer lists related to the products acquired.


                                       14
<PAGE>

B.   BUSINESS OVERVIEW

INDUSTRY OVERVIEW

     Our activity is focused on the market for defense electronics products.
This market have been growing in recent years and is currently a large part of
the defense business. Two contradictory forces control the defense electronics
market. On the one hand, new military aircraft are equipped with significantly
more avionics systems than they used to carry ten and twenty years ago. In
addition, the increasing usage of advanced avionics on all modern aircraft,
including upgrades of existing technology and growing number of unmanned aerial
vehicles, or UAVs, provides significant growth to the market. On the other hand,
the significant reduction in the price of electronic systems is shrinking the
dollar value of the market.

     Advanced defense electronics systems are, typically, derivatives or
enhancements of consumer electronic systems. Most of the defense electronics
systems are built for commercial components and even sub-systems, a fact that
reduces the overall price and, at the same time, generates complex obsolescence
issues.

     Customers for defense electronics products in the aerospace field are
either governments or major integrators. Doing business with these customers is
complex, takes long time and requires long term commitments for future support
of delivered hardware. Production batches of these products are, usually, small
especially in the retrofit market.

     Suppliers of defense electronic systems are either providers of sub-systems
to major integrators or providers of integrated systems to the aircraft industry
or to air forces. These companies are typically very large and have diversified
product offerings.

     New products in the defense electronic market are usually developed
utilizing internal research and development funds of customers and are tailored
to specific customers' needs. In many cases, the customer who pays for the
design and adaptation limits the use of intellectual property that was funded by
it for other applications, due to either financial or security reasons.

PRODUCTS AND SERVICES

     We provide integrated avionic solutions. Our aim is to provide not only
state of the art products but also comprehensive end to end solutions for one or
more avionic systems. The first integrated system that we provided was for the
A-4 avionics upgrade program of the Israeli Air Force, or IAF. This program was
the first comprehensive and complete avionics system to be provided entirely by
us. During 2004 we increased our involvement and development efforts in the area
of unmanned aircraft vehicles. Currently we have four new product lines:

     o    Net Centric Digital Recorder and related recording devices;

     o    Ground information management systems that support our recording
          products and provide advanced data management capabilities;


                                       15
<PAGE>


     o    Optronic products, based on technology acquired as part of the Vectop
          deal, and;

     o    Inertial navigation products based on ring laser gyros, or RLG, fiber
          optic gyros, or FOG, and micro electro mechanical sensors, or MEMS.

     In addition, we continue to sell and support our traditional products
including:

     o    Advanced training solutions;

     o    Integrated trainer aircraft avionics packages;

     o    Flight data recorders and supporting ground analysis;

     o    Unmanned aerial vehicle avionics; and

     o    Automatic testing solutions.

     We also provide manufacturing services to original equipment manufacturers
in Israel and in the United States, using the manufacturing capabilities of our
Beit-She'an plant. We offer production of turnkey solutions, in "build to print"
or "build to specification" modes. To date, we have provided our manufacturing
services to, among others, Smiths, Israeli Aircraft Industries, or IAI, and
RAFAEL Armament Development Authority Ltd., or RAFAEL. Our China based
subsidiary provides test and repair services using our CATS(TM) testers and test
program sets.

NET CENTRIC DIGITAL RECORDER - NCDR

     Recent developments in digital video recording systems and the significant
reduction in size and cost of solid state memories have turned solid state
digital video recording systems into the de-facto standard solution for airborne
applications. These systems have begun penetrating the aviation industry in new
aircraft such as the F-16I, as well as in the retrofit market. Identifying this
trend, we developed the Net Centric Digital Recorder, or NCDR with the view of
capturing sales from new aircraft, that will be delivered with digital
recorders, from the retrofit market for airborne video tape recorders and from
the integration of various additional applications to the NCDR, making it an
airborne server.

     The NCDR, together with our ground debriefing system, provides advanced
debriefing at an affordable price.

     We have identified a growing need for digital video replacement of aging
analogue airborne video tape recorders, or VTR. Approximately 15,000 VTRs are
installed onboard fighter aircraft today and we have initiated a world wide
marketing effort to promote the replacement of these aging VTRs with our new
NCDR. This marketing activity has been successful in several programs around the
world, especially in our strategic markets. We were awarded the U.S. Navy T-45
advanced trainer digital recorder and processor program and we are making final
deliveries of our NCDR to the Chilean Air Force for its F-16 fleet. We have
recently won a similar NCDR program for an Indian Navy aircraft. The NCDR is
fully qualified and is continuously being demonstrated for various customers. We
currently market the NCDR jointly with Smiths, utilizing Smiths' broader access
to the market, especially in the U.S.


                                       16
<PAGE>


     Additional applications are being developed and integrated into the NCDR,
in order to provide an integrated airborne data server. These applications
include embedding data transfer capability to the system enabling the NCDR not
only to record during flight but also to provide data to the aircraft before
flight, and the integration of ground collision warning based on digital terrain
data stored in the NCDR memory.

GROUND INFORMATION MANAGEMENT SYSTEMS

     Since 1999 we have offered operational ground debriefing stations
complementing our airborne systems. The operational ground debriefing station is
a PC-based application operating in a Windows NT/2000/XP(R) environment. The
solution, provides a state-of-the-art debriefing environment, fully capitalizing
on all available digital and video information in a highly synchronized
presentation. Further capitalizing on current day technology, individual
stations have a networking capability, providing data sharing, as well as
cross-unit and inter-air force debriefing.

     The IAF and two other air forces have purchased ground debriefing systems
for their F-16 A/B, F-5 and A-4 fleets.

     As part of the Peace Marble ,or PM-V Program, with Lockheed Martin
Aerospace, we developed the next generation of our ground information management
system by advancing it to the digital video era. This modification has resulted
in significant growth in the system's capability as well as establishing our
system as a major and central device in the day to day operation of the
squadrons.

     As of December 31, 2005 we have delivered 22 systems to the PM-V Program as
well as two additional debriefing systems to Lockheed Martin Aerospace for use
in integration and flight-testing. We are in the final stages of a completing a
digital debriefing system for the new F-16s purchased by the Chilean Air Force.
As an extension of the development work completed as part of the PM-V Program,
we are supplying the Chilean Air Force with a digital video recorder for each
F-16 aircraft as well as an advanced digital video ground debriefing station.
This station will be linked to a F-5 ground debriefing station we previously
delivered to the Chilean Air Force, creating a common network debriefing
solution for both front-line aircraft.

     In addition, each NCDR system includes some derivative of our ground data
management system to enable playback of recorded data.


                                       17
<PAGE>

OPTRONIC PRODUCTS FOR AIRBORNE AND GROUND VEHICLES

     The acquisition of the Vectop's assets in February 2005 provided us with a
new product line. Airborne cameras are integral part of any training and
airborne debriefing system onboard military platforms. Our customers include
major Israeli integrators (such as IAF, IAI and Elbit) as well as foreign
customers.

     This product line includes:

     o    EYE WITNESS. An airborne head up displays, or HUD, camera, sold to
          many customers in different configurations. We believe that a
          significant part of the future revenues related to the assets
          purchased from Vectop will be derived from the Eye Witness. This
          product is currently competing in a bid by the IAF.

     o    NIGHT WITNESS. A night vision camera installed on any pair of night
          vision goggles to enable the recording of the pilot's view through the
          night vision goggles. Its unique capability has been integrated in
          several fighter aircraft and helicopter programs.

     o    ARMOR SENTRY. A video camera developed for ground armored vehicles and
          tanks. This system is being delivered to the Israeli ground forces for
          installation in the new "Merkava" battle tank and is generating
          interest in foreign markets. We recently won a bid for a continuation
          program for the "Merkava" and will start deliveries in the second
          quarter of 2006.

     o    SNIPER WITNESS. The Sniper Witness enables sniper training facilities
          to better analyze the activities of the trainees as well as accurately
          debrief the operation resulting in better training. The system is
          based on a miniature video camera attached to the sniper sight and a
          portable video recorder. The system is used by the Israeli armed
          forces training facility and is currently being demonstrated to other
          armed forces in the U.S. and Europe.

INERTIAL AND GLOBAL POSITIONING SYSTEMS BASED NAVIGATION SOLUTIONS

     During 2003, we developed low cost navigation systems based on a RLG, and
global positioning systems, or GPS. Our RLG based system is now qualified and
operational as part of the IAF A-4 upgrade program. This development provided us
with the know-how to further develop navigation solutions based on other
sensors.

     During 2005, we initiated a research and development program to integrate
the FOG and MEMS sensors into our navigation systems Navigation systems based on
these sensors are significantly more cost effective. We believe that the market
for low cost navigation systems includes significantly more installations
including ground based and marine based systems.


                                       18
<PAGE>


     Today, we offer our customers our existing RLG navigation system, or RNS,
as part of our avionics packages and as a stand alone system and we also offer
the MEMS based solution. We plan to offer the new FOG based navigation system by
the end of 2006.

ADVANCED TRAINING SOLUTIONS

     Our training solutions are based on a complete and integrated system that
incorporates an airborne component installed in the aircraft and a ground-based
component, installed in the squadron facilities. Recent technological
developments, undertaken primarily for the IAF, enable system adaptation to any
kind of aircraft, regardless of its onboard avionics systems. Our recent
solutions are based on our newly developed Net Centric Digital Recorder, which
allows the integration of our airborne digital video recordings with numerous
other digital data components and provides the essential building blocks for a
squadron information management network, or SIMNET, as a ground component.

INTEGRATED TRAINER AIRCRAFT AVIONICS PACKAGE - ACE(TM)

     Following our selection by the IAF to provide our ACE(TM) integrated
trainer aircraft avionics package for their advanced trainer, the A-4 Skyhawk,
we were awarded a follow on program aimed at total replacement of the aging
avionics package of the A-4 aircraft with a new, upgraded package. The new
avionics package replaces the legacy weapon delivery and navigation system of
the aircraft with a new state of the art system that significantly improve the
A-4 capabilities, increase its' reliability and provide it with advanced
training capabilities.

     The upgraded system includes an inertial navigation system, or INS, GPS,
HUD, camera, central weapon delivery and navigation processor based on an
enhanced flight monitoring unit, which is the core of the ACE(TM) system and a
control and display unit. The upgraded A-4 program was completed during 2005.

     We believe that this program places us among the few companies worldwide
that performed a complete aircraft avionics system upgrade. As a result of the
A-4 system development, we have proposed similar, cost effective, trainer
aircraft avionics packages to other customers. The A-4 avionics package
provides, at a very affordable price, a complete and modern avionics suite
tailored for trainer aircraft. We have already launched marketing efforts to
promote this package to different customers.

FLIGHT DATA RECORDERS AND SUPPORTING GROUND ANALYSIS

GENERAL

     Our fleet maintenance management solutions are based on existing programs
and products developed and supplied over the course of the past three years.
These programs include airborne data collection and recording equipment (such as
FACE(TM) or DAS) as well as ground support software packages (such as PERFORMS)
that provide the infrastructure for efficient data logging and analysis to
support fleet maintenance management.


                                       19
<PAGE>


FATIGUE ANALYSIS AND AUTONOMOUS AIR COMBAT EVALUATION SYSTEM - FACE(TM)

     The FACE(TM) system is an avionics system designed to acquire, process and
record data from various aircraft systems as well as from strain gauges
(sensors) affixed to an aircraft structure. This data is used to streamline and
manage the ongoing monitoring and maintenance of an aircraft and its systems.
The FACE(TM) system communicates with a squadron's ground support logistic
station, enabling downloading of data from an aircraft, analyzing the data,
managing ongoing maintenance, creating and modifying the set-up configuration
files and determining data for recording, as well as providing an interface to
other applications.

     The FACE(TM) system is capable of communicating in real time with a voice
and data recorder, which is a crash survival unit known as a "black box"
manufactured by Smiths, for the purpose of recording flight safety related data.
We are currently upgrading the FACE(TM) systems we supplied to the Royal
Netherlands Air Force for its F-16 aircraft between the years 1996 and 1999 with
this capability. During 2004 we supplied FACE(TM) systems for the F-16 fleets of
the Portuguese Air Force and for the U.S. Navy aircraft, and we believe that we
will be able to win a bid for a contract to supply FACE(TM) systems during 2006.

DATA ACQUISITION SYSTEM - DAS

     The DAS is an advanced avionics data acquisition system designed to
acquire, process and record data from various aircraft systems. We and Smith
jointly developed and marketed the DAS for the new IAF F-16I aircraft. DAS
consists of two sub-systems, a data acquisition unit, or DAU, and an enhanced
crash survival memory unit, or ECSMU. The DAU interfaces to numerous data
systems and data channels in the aircraft and acquires, processes and records
data, mostly for maintenance purposes. The ECSMU is a "black box" capable of
recording digital data and digitized audio transferred through the DAU. DAS is a
form fit replacement for the CSFDR system, which is currently installed on most
F-16 aircraft worldwide. DAS has been offered as a substitute in various
projects that require a flight data recorder with advanced capabilities and
growth potential.

     The DAS is designed to meet all commercial aviation requirements for "black
box" recorders, thus expanding its market potential. During 2004, we started
supplying production DAS units to the IAF and entered into contracts to supply
DAS units to the Polish Air Force and the Korean Air Force starting in 2005.

PERFORMS (PROCESSING, EVALUATING, AND REPORTING OF FORCE MANAGEMENT DATA
SOFTWARE)

     Starting in mid-2001 we have been the primary sub-contractor to Lockheed
Martin Aerospace in the development of a new aircraft data logging and analysis
software package, known as PERFORMS. PERFORMS is designed to replace the aging
and hard to support data processing station, or DPS, that was developed to
provide data logging and fatigue analysis for all F-16 aircraft users. PERFORMS
is a Windows 2000(R) based software package, utilizing a state of the art
graphics user interface, and provides all the required infrastructure to perform
any type of analysis on data acquired by all legacy F-16 airborne flight data
recorders.


                                       20
<PAGE>


     The analysis includes fatigue monitoring, engine usage monitoring and other
applications that may be added, as required by different users. The recorded
data is downloaded to the station and stored in a commercial off the shelf
database with an interface for "plug-in" applications, allowing those
applications to access the data, manipulate and analyze it and provide a variety
of maintenance management tools. The program is managed by Lockheed Martin
Aerospace and is supplied to F-16 users in evolving software "builds" delivered
every 12 months starting in April 2003. Under the agreement, we were granted a
non-exclusive license to use the developed software in support of our FACE(TM)
and DAS products to supply the application to our flight data recorder
customers.

     The first PERFORMS delivery in June 2003, exposed us to F-16 users at a
higher level than we had ever previously experienced. This exposure led us to
initiate business development activities with regard to add-on packages for the
PERFORMS. Since 2004, we have presented this product to the F-16 users community
in seminars and conferences.

     Updated and upgraded PERFORMS software packages were delivered during 2004
and 2005 and are scheduled for delivery in 2006. Various air force customers
currently use the software, and we expect to receive requests to support the
installation and operation of the software from these users.

UNMANNED AERIAL VEHICLES AVIONICS

     We identified the UAV avionics market as a fast growing that will gradually
replace the manned military airborne avionics. This market has many common
aspects with manned avionics product lines; however, it requires slightly
different technology and understanding of the various requirements.

     Typically, a UAV avionics package needs to be smaller, lighter, more
reliable and inexpensive than its comparable manned aircraft suite. The major
advantage of UAV avionics systems is the anticipated large number of UAVs that
will be required in the future.

     We initiated efforts to penetrate this market during 2001. Since then we
have entered into a contract with IAI to develop and provide them with an Input
Output Controller, or IOC, a unit that is part of our data acquisition systems
product line, for IAI's next generation UAV. We are continuing our efforts to
widen our participation in this important program as well as in other programs.
The development of this product was completed, and it is currently in
production.

     During 2004, we developed and delivered a miniature avionics module to IAI.
This unit is aimed at the miniature UAV market and provides complete avionics
capabilities in a single, miniaturized unit.


                                       21
<PAGE>


AUTOMATIC TESTING SOLUTIONS

     Our business expansion into the automatic test equipment, or ATE, market is
based on our existing products as well as the added value we deliver with the
dedicated expertise and the wide-range experience we have acquired in this area.
We rely on the preference indicated by OEMs in the past to outsource the
acquisition of ATE and have positioned our company as a strategic
supplier/partner to provide ATE and test solutions. We offer our ATE with our
own Advanced Test Environment, including all the required development tools.
After a long period of inactivity in this market, we see some growing interest,
especially from smaller maintenance companies rather than from airlines,
especially in the U.S.

COMMERCIAL AVIATION TEST STATIONS - CATS(TM)

     The Commercial Aviation Test Stations, or CATS(TM), is a family of
multi-purpose, computerized automatic test equipment that meets the specific
needs of airlines and third party maintenance companies. The CATS(TM) stations
test and repair a variety of electronic units in existing commercial aircraft,
incorporating tools for testing, troubleshooting, and performing diagnostic
procedures. CATS(TM) station replace or augment test stations from aircraft
manufacturers or avionics OEM suppliers, while automating multiple manual test
procedures.

MANUFACTURING SERVICES

     In 2000, we began providing manufacturing services to OEMs located in
Israel and the United States, using the excess manufacturing capacity at our
Beit-She'an plant. We offer manufacturing turnkey solutions, either in "build to
print" or "build to specification" modes. To date, we have provided our
manufacturing services to Smiths, IAI, RAFAEL, and other Israeli companies, both
in the defense and commercial sectors.

TEST AND REPAIR STATIONS

     We operate a test and repair shop based on the use of our CATS(TM) tester
in Beijing, China through CACS, our 80% owned Chinese subsidiary. CACS was
established as a joint venture company with Tianzu Forest Development Company,
which owns the remaining 20% equity interest. Pursuant to the joint venture
agreement, Tianzu Forest Development provided the facilities for CACS'
operations while we provided CATS(TM) testers and test program set services.

SALES AND MARKETING

STRATEGY

     Our sales and marketing strategy is based on the following principles:

     o    Maintaining our business focus on avionics for the military market and
          our family of testing solutions for the commercial and military
          markets.

     o    Expanding our product offerings of our four product lines, by adding
          new applications to our existing products.

     o    Expanding our customer base by including our products in solutions and
          integrated systems. This approach was successful both in Chile where,
          in 2002, we were awarded a contract to provide a complete debriefing
          solution for the F-16 aircraft purchased by the Chilean Air Force, and
          with the IAF, to whom we supply complete weapon delivery and
          navigation system for the A-4 aircraft.


                                       22
<PAGE>


     o    Establishing marketing channels with system integrators and major
          aircraft manufacturers such as The Boeing Company, Lockheed Martin
          Aerospace, Smiths, IAI, RAFAEL and others.

     o    Expanding large potential markets, especially in the military and the
          unmanned combat air vehicle areas, and developing new marketing
          channels aimed directly at these customers.

STRATEGIC RELATIONSHIPS

     As part of our strategy, we have entered into a number of strategic
relationships and have focused our marketing and sales efforts to support these
relationships.

     LOCKHEED MARTIN AEROSPACE. Our sales of avionics products focus mainly on
the F-16 aircraft manufactured by Lockheed Martin Aerospace, the most popular
fighter aircraft in the Western world today. In February 1999, we signed a
memorandum of understanding with Lockheed Martin pursuant to which we agreed to
provide certain avionics systems for the F-16 aircraft under the PM-V Program.
In September 1999, the U.S. and the State of Israel signed a letter of
acceptance pursuant to which the U.S. agreed to provide the IAF with 50 F-16I
aircraft and an option for an additional 52 aircraft, which was exercised in
June 2001 for a total of 102 F-16I aircraft. In cooperation with Smiths, we are
developing and supplying the data acquisition system that includes the advanced
data acquisition unit and an enhanced crash survivable memory unit, which will
be manufactured in our Beit-She'an facility. We are currently negotiating with
Lockheed Martin with respect to the development of additional capabilities of
this system for different applications.

     In addition, in March 2001 we signed an agreement with the Aircraft
Structural Integrity Program Group of Lockheed Martin pursuant to which we are
assisting in the development of a fatigue analysis system based on a PC computer
for analyzing structural fatigue of the F-16 aircraft. As the main
subcontractor, our principal task is to develop the software for the fatigue
analysis system. The fatigue analysis system will utilize data collected from
the data acquisition unit and our FACE(TM) system, as well as other systems used
by air forces operating F-16 aircraft. This development program will continue in
2006.

     SMITHS AEROSPACE ELECTRONIC SYSTEMS. In February 1999, we entered into an
agreement with Smiths that outlined joint marketing activities for our FACE(TM)
system and Smiths' voice and data recorder for F-16 A/B aircraft. Smiths is a
worldwide leader in avionics systems for fighter and commercial aircraft. The
two systems successfully passed flight tests conducted on the Royal Netherlands
Air Force's F-16 aircraft by Lockheed Martin and the Royal Netherlands Air
Force. The FACE(TM) system and the voice and data recorder complement each other
and are intended to serve as a data acquisition system that replace outdated
data recording systems, mechanical strain recorders and flight load recorders.


                                       23
<PAGE>


     In June 2000, we signed a memorandum of understanding with Smiths pursuant
to which we agreed to establish a team for worldwide marketing, developing and
manufacturing of the data acquisition system and its associated ground support
that is intended to grow into an infrastructure for recording, processing and
managing all data types available on board the aircraft. No sales of the system
have been made to date. We cannot assure you that we will successfully negotiate
a definitive agreement with a customer nor can we provide at present any
forecast that the agreement with Smiths will result in future sales of avionics
systems.

     In October 2003, we signed a teaming agreement with Smiths. The teaming
agreement establishes cooperation in connection with the products developed
jointly by Smiths and us for the PM-V Program and its derivatives. In addition,
the agreement details commitments made by Smiths to purchase production services
from us in the future.

     During 2004, we expanded our cooperation with Smiths to include our newly
developed Net Centric Digital Recorder and have jointly offered this product to
potential customers.

     In addition to the cooperation with Smiths in connection with the PM-V
Program, we are currently supplying the Royal Netherlands Air Force with an
integration package for our FACE(TM) System and Smiths' black box for its F-16
MLU fleet. A similar package is also being supplied to the Portuguese Air Force.

     ISRAEL AIRCRAFT INDUSTRIES. IAI was our second largest customer in 2005,
accounting for approximately 14% of our total annual revenues. We are actively
supplying avionics and test equipment to four different divisions of IAI. We
have identified the Israeli government-owned aerospace industries as potential
customers and cooperation entities. In particular the Lahav and Malat divisions
of IAI, major aircraft integrators, require our services as an avionics and test
equipment providers. During 2004, we were the prime contractor and cooperated
with IAI, as our sub-contractor, to support various parts of the IAF avionics
upgrade program.

MARKETING

     Our chairman and president, Herzle Bodinger, our chief executive officer,
Adar Azancot, and our vice president business development, Zvi Alon, lead our
marketing efforts. We currently employ five other persons in marketing our core
business products. Our engineering department supports our marketing staff with
respect to product pricing and technical demonstrations. In addition, we have
sales consultants, agents and representatives in Europe, South America, and
India who receive commissions for sales effected through them.

     The Israeli Ministry of Defense has historically supported and continues to
support our marketing efforts through its Export and Defense Assistance
division, or SIBAT, through various projects for the Israeli Defense Forces and
its related divisions. The Israeli Ministry of Industry and Commerce supports
our marketing efforts via its Industrial Cooperation Authority through the
exploitation of "offset commitments" by Lockheed Martin Aerospace and The Boeing
Company to the State of Israel. Such future assistance is not guaranteed.


                                       24
<PAGE>


PRINCIPAL CUSTOMERS

     Generally, we complete few major transactions each year, each in an amount
comprising approximately 10% of our revenues for such year. As a result, each
year a significant portion of our revenues is derived from a small number of
customers. The following table sets forth our principal customers in 2004 and
2005:

                                 2004     2005
                                 ----     ----

Smiths Electronic Systems         5%      21%
The Boeing Company               10%       3%
Israeli Ministry of Defense      19%      12%
Israel Aviation Industries        6%      14%
Portuguese Air Force             17%       -
U.S. Navy                        11%       -
Lockheed Martin                   5%      12%

     Although we are striving to increase the number of our customers, we
anticipate that a significant portion of our future revenues will continue to be
derived from sales to a small number of customers.

     Like many companies deriving a substantial portion of their revenues from
government contracts, we are subject to business risks, including changes in
governmental appropriations and changes in national defense policies and
priorities. Although many of the programs in which we participate as a
contractor or subcontractor may extend for several years, our business is
dependent upon annual appropriations and funding of new and existing contracts.
Most of the contracts are subject to termination for the convenience of the
customer, pursuant to which the customer pays only for reimbursement of costs
incurred and the applicable profit on work performed. The Israeli Government or
any other government may discontinue funding the purchase of our products over
the long term.

MARKETS

     We sell our products to various air forces and companies worldwide.

     The following table presents our revenues by geographical market for the
periods indicated:


                      2003          2004         2005
                      ----          ----         ----

Israel                 26%          35%          41%
North America          42%          33%          38%
Others                  4%          10%          16%
Europe                 28%          21%           5%


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<PAGE>


COMPETITION

     The markets for our products are highly competitive. Our principal
competitors in the avionics market are Harris, Rockwell Collins, Honeywell,
Elbit Systems Ltd., IAI, R.S.L. Ltd., TEAC and Elisra Systems Ltd. We expect to
continue to face competition from these and other competitors. Most of our
competitors are larger, have greater resources including financial,
technological, marketing and distribution capabilities, and enjoy greater market
recognition than we do. These competitors may be able to achieve greater
economies of scale and may be less vulnerable to price competition than us. We
may not be able to offer our products as part of integrated systems to the same
extent as our competitors or successfully develop or introduce new products that
are more cost effective or offer better performance than those of our
competitors. Failure to do so could adversely affect our business, financial
condition and results of operations.

EXPORT POLICY

     Exports of military related products are subject to the military export
policy of the State of Israel. Current Israeli Government policy encourages
export to approved customers of military products similar to those manufactured
by us, provided that such export does not run counter to Israeli policy or
national security considerations. We must obtain a permit to initiate a sales
proposal and ultimately an export license for the transaction is required. We
may not obtain export permits or licenses in the future and the Israeli
governmental policy with respect to military exports may be altered. However, to
date we have not encountered any significant difficulties in obtaining necessary
permits or licenses for sale of our products.

FIXED PRICE CONTRACTS

     Most of our contracts, especially with the Government of Israel, its
agencies and other foreign governments, are generally fixed-price contracts.
Under fixed-price contracts, the price is not subject to adjustment by reason of
the costs incurred in the performance of the contracts, as long as the costs
incurred and work performed fall within governmental guidelines. Under our
fixed-price contracts, we assume the risk that increased or unexpected costs may
reduce our profits or generate a loss. This risk can be particularly significant
under a fixed-price contract for research and development involving a new
technology.

     Our books and records may be subject to audits by the Israeli Ministry of
Defense and other governmental agencies including the U.S. Department of
Defense. These audits may result in adjustments to contract costs and profits.
To date, we have not incurred any liability as a result of such audits.


                                       26
<PAGE>


PROPRIETARY INFORMATION

     We hold a patent for our ACE(TM) system in both Israel and the United
States, No. 5467274. In addition, in connection with the assets we acquired from
Vectop Ltd. in February 2005, we have acquired the rights to the following
patents and patent applications: Israeli patents No. 121042, No. 116131, No.
124816 and No. 1088253, U.S. patents No. 6,061,182, No. 5,742,434, No. 6,301,052
and No. 5,699,440, European patents (France England and Italy) No. 0777142 and
No. 1088253, Indian patent application No. IN/PCT/200/00611 and Japanese patent
application No. 329384/94.. Nevertheless, we generally do not consider patent
protection significant to our current operations and rely upon a combination of
security devices, copyrights, trademarks, trade secret laws and contractual
restrictions to protect our rights in our products. Our policy is to require
employees and consultants to execute confidentiality agreements upon the
commencement of their relationships with us. These measures may not be adequate
to protect our technology from third-party infringement, and our competitors
might independently develop technologies that are substantially equivalent or
superior to ours. Additionally, our products may be sold in foreign countries
that provide less protection for intellectual property rights than that provided
under U.S. or Israeli laws.

     The Israeli Government usually retains certain rights to technologies and
inventions resulting from our performance as a prime contractor or subcontractor
under Israeli Government contracts and may generally disclose such information
to third parties, including other defense contractors. When the Israeli
Government funds research and development, it may acquire rights to proprietary
data and title to inventions; we may retain a non-exclusive, royalty-free
license for such inventions. However, if the Israeli Government purchases only
the end product, we may retain the principal rights and the Government may use
the data and take an irrevocable, non-exclusive, royalty-free license.

MANUFACTURING AND SUPPLY

     Our main production facilities are located in Beit-She'an, Israel. The
plant is equipped to handle most of our manufacturing processes and testing
requirements. For several specific processes we utilize subcontractors. This
approach is a key to our flexibility and versatility.

     We stress quality control in our product realization process. Commencing
with customer requirements and expectations via raw material inspection through
completion, specifications are repeatedly checked. We maintain a quality
assurance team that participates in every stage of the design and manufacture of
our products. Our quality management standards are certified by the Standards
Institute of Israel, or SII, pursuant to ISO 9001 for hardware design and
production and ISO 9000.3 for software, both since 1995. SII performs quality
system audits twice a year and various customers perform audits four to six
times a year. In April 2001, SII certified our environmental management system
pursuant to ISO 14001. Our quality management system was revised to comply with
ISO 9001:2000 in June 2003. During 2005 we were certified according to AS-9100,
a quality management system for aerospace requirements.

     According to the standard warranty incorporated in most of our sales
contracts, we warrant that our products will be free from defects in design,
materials or workmanship, and guarantee repair or replacement of defective parts
for a period of one to two years following delivery of a product to the
customer. We also provide maintenance services to customers who sign maintenance
contracts.


                                       27
<PAGE>


SOURCE AND AVAILABILITY OF RAW MATERIALS

     We acquire most of the components for the manufacturing of our products
from a limited number of suppliers and subcontractors, most of whom are located
in Israel and the United States. Certain of these suppliers are currently the
sole source of one or more components upon which we are dependent. Since many of
our purchases require long lead-times, a delay in supply of an item can
significantly delay the delivery of a product. To date, we have not experienced
any particular difficulty in obtaining timely deliveries of necessary
components. See Item 3D "Risk Factors." We depend on a limited number of
suppliers of components for our products and if we are unable to obtain these
components when needed, we would experience delays in manufacturing our products
and our financial results could be adversely affected.

C.   ORGANIZATIONAL STRUCTURE

     We had one active subsidiary in 2005, Beijing Huarui Aircraft Components
Maintenance and Services Co., an 80% owned subsidiary based in China that is
engaged in aircraft repair services.

D.   PROPERTY, PLANTS AND EQUIPMENT

     We own a 30,000 square feet building in Beit-She'an, Israel. The building,
which includes manufacturing facilities, warehouse space and a portion of our
development facilities, is situated on land leased from the Israel Land
Authority for a period of 49 years until 2034. The plant has sufficient capacity
to meet our current requirements. If volume was to increase significantly, we
believe that we will be able to increase the number of workers or shifts at the
plant, or use more subcontractors.

     Our executive offices and research and development facilities are located
in a 12,500 square foot office facility in Netanya, Israel. The lease for this
facility expires in January 2008.

     Our Chinese subsidiary, CACS, conducts its business in an approximately
16,000 square foot facility in Beijing that includes offices and test and repair
facilities. The land for this facility was leased by Beijing Tianzu Forestry
Company or Tianzu, the minority shareholder in CACS, from the Chinese government
for 30 years. Under a joint venture agreement, and in consideration for its
equity investment in CACS, Tianzu granted CACS usage rights in the land,
constructed the building and granted CACS the ownership of these building. We
are currently in the process of completing the transfer of the title to the land
and building. Although Tianzu is legally obligated to complete such transfer of
title to the land and the building, such transfer may take additional time and
may not be completed, and we may be required to initiate litigation in order to
enforce our rights to receive title to the land and building.

     The aggregate annual rent for our offices in Israel and China was
approximately $167,000 in 2005.

ITEM 4A. UNRESOLVED STAFF COMMENTS

     Not applicable.


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<PAGE>


ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

A.   OPERATING RESULTS

     THE FOLLOWING DISCUSSION OF OUR RESULTS OF OPERATIONS SHOULD BE READ
TOGETHER WITH OUR CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES, WHICH
APPEAR ELSEWHERE IN THIS ANNUAL REPORT. THE FOLLOWING DISCUSSION CONTAINS
FORWARD-LOOKING STATEMENTS THAT REFLECT OUR CURRENT PLANS, ESTIMATES AND BELIEFS
AND INVOLVE RISKS AND UNCERTAINTIES. OUR ACTUAL RESULTS MAY DIFFER MATERIALLY
FROM THOSE DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE
OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE THOSE DISCUSSED BELOW AND ELSEWHERE IN
THIS ANNUAL REPORT.

OVERVIEW

     We develop, manufacture and sell automated test equipment, avionics
products and ground debriefing systems and provide manufacturing services for
military and commercial use, mainly in Israel, the U.S. and Europe. We also
provide test and repair services using our CATS(TM) testers and test program
sets through our Chinese subsidiary.

GENERAL

     Our consolidated financial statements appearing in this annual report are
prepared in U.S. dollars and in accordance with generally accepted accounting
principles in the United States, or U.S. GAAP. All references in this annual
report to "dollars" or "$" are to U.S. dollars and all references in this annual
report to "NIS" are to New Israeli Shekels. Transactions and balances originally
denominated in dollars are presented at their original amounts. Transactions and
balances in other currencies are remeasured into dollars in accordance with the
principles set forth in Financial Accounting Standards Board Statement No. 52.
The majority of our sales are made outside Israel and a substantial part of them
are in dollars. In addition, a substantial portion of our costs are incurred in
dollars. Since the dollar is the primary currency of the economic environment in
which we and our subsidiary operate, the dollar is our functional and reporting
currency and, accordingly, monetary accounts maintained in currencies other than
the dollar are remeasured using the foreign exchange rate at the balance sheet
date. Operational accounts and non monetary balance sheet accounts are measured
and recorded at the exchange rate in effect at the date of the transaction. All
balance sheet accounts have been translated using the exchange rates in effect
at the balance sheet date. Statement of operations amounts have been translated
using the average exchange rate for the period.

DISCUSSION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATIONS

     Our critical accounting policies, including the assumptions and judgments
underlying them, are disclosed in the notes to our consolidated financial
statements. These policies have been consistently applied in all material
respects. While the estimates and judgments associated with the application of
these policies may be affected by different assumptions or conditions, we
believe the estimates and judgments associated with the reported amounts are
appropriate in the circumstances.


                                       29
<PAGE>


     The significant accounting policies listed in Note 2 of our consolidated
financial statements that we believe are the most critical to aid in fully
understanding and evaluating our financial condition and results of our
operations under generally accepted accounting principles are discussed below.

     INTANGIBLE ASSETS. Costs of producing our TPS software library, which can
be integrated with our CATS test station, incurred subsequent to achieving
technological feasibility, were capitalized, and are amortized by the greater of
the amount computed using the: (i) ratio that current gross revenues from sales
of the software 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. We assess the recoverability of these intangible
assets at each balance sheet date by determining whether the amortization of the
asset over its remaining life can be recovered through undiscounted future
operating cash flows from the specific software products sold. The use of
different assumptions with respect to the expected cash flows from our assets
and other economic variables may lead to different conclusions regarding the
recoverability of our assets' carrying values and to the potential need to
record an impairment loss for our intangible assets. An intangible assets
related to customer relationships has been recorded as a result of our
acquisition of certain assets and liabilities of Vectop in February 2005 and is
being amortized using a straight line basis over the expected useful life of
five years. For the year ended December 31, 2005, no impairment was required.

     IMPAIRMENT OF LONG-LIVED ASSETS. We are required to assess the impairment
of long-lived assets whenever events or changes in circumstances indicate that
the carrying value may not be recoverable. We assess the impairment of our
assets based on a number of factors, including any significant changes in the
manner of our use of the respective assets or the strategy of our overall
business and significant negative industry or economic trends. Upon
determination that the carrying value of a long-lived asset may not be
recoverable, based upon a comparison of expected undiscounted future cash flows
to the carrying amount of the asset, an impairment charge is recorded in the
amount the carrying value of the asset exceeds its fair value. Using different
assumptions with respect to the recoverability of our long-lived assets, our
determination may be different, which may negatively affect our financial
position and results of operations. For the year ended December 31, 2005, no
impairment was required.

     SHARE-BASED COMPENSATION. We account for employee share based compensation
using the intrinsic value model. Accordingly, we measure compensation cost as
the excess, if any, of the closing market price of our stock at the date of
grant over the exercise price of the option granted. We recognize compensation
cost for stock options, if any, ratably over the vesting period. We disclose pro
forma data assuming we had accounted for employee stock option grants using the
fair value-based method. We use the Black-Scholes option pricing model to value
options and warrants granted to non-employees.

                                       30
<PAGE>

     REVENUE RECOGNITION. Our revenues mainly derived from sales of automated
test equipment and avionics products and from long-term fixed price contracts
for ATE, avionics and ground debriefing systems. In addition, we lease ATE and
provide manufacturing, development and product support services. Product revenue
is recognized when there is persuasive evidence of an arrangement, the fee is
fixed or determinable, delivery of the product to the customer has occurred and
the collection of the fee is probable. If the product requires specific customer
acceptance, revenue is deferred until customer acceptance occurs or the
acceptance provisions lapse.

     Revenues from long-term fixed price contracts are recognized by the
percentage-of-completion method in accordance with the "Input Method." We apply
this method when the total of the costs and revenues of the contract can
reasonably be estimated. The percentage of completion is determined based on the
ratio of actual costs incurred to total costs estimated to be incurred over the
duration of the contract. With regard to contracts for which a loss is
anticipated, a provision is made for the entire amount of the estimated loss at
the time such loss becomes evident. Estimated gross profit or loss from
long-term contracts may change due to changes in estimates resulting from
differences between actual performance and original forecasts. Such changes in
estimated gross profit or loss are recorded in results of operations when they
are reasonably determined by management on a cumulative catch-up basis.

     Revenues from services are recognized when the service is performed.

     Revenue under operating leases of equipment are recognized ratably over the
lease period.

     Revenues from certain arrangements may include multiple elements within a
single contract. Our arrangements are accounted for as separate units of
accounting when it is possible to determine objective and reliable evidence of
fair value of the contract elements in order to separate the fees among the
elements. Revenue is recognized when the element is delivered and all other
criteria for revenue recognition are met.

     Revenues from software arrangements are recognized when persuasive evidence
of an arrangement exists, delivery of the product has occurred, the fee is fixed
or determinable, and collectability is probable. Arrangements with payment terms
extending beyond customary payment terms are considered not to be fixed or
determinable. If the fee is considered not to be fixed or determinable, revenue
is deferred and recognized when payments become due from the customer or are
actually collected when collectability is not probable, providing that all other
revenue recognition criteria have been met.

     PROVISION FOR LITIGATION. We have an outstanding balance of loans due to us
from our former chief executive officer and a former officer. Both officers
claim that they are not obliged to repay the loans. We are engaged in legal
actions with our former officers concerning, among other things, the repayment
of the loans. According to our legal consultants, we have a strong case with
regard to our claims for repayment of the outstanding loans. We recorded a
provision for the loans receivable in the amount that we believe is sufficient
to reflect the recoverability of the asset, based on management's estimation. In
addition, we have several additional legal proceedings outstanding. We have
recorded provisions for litigation for claims that were estimable and for which
there is a high probability that we will be held responsible based on our legal
consultants' opinions and management's estimations. If our estimations are
wrong, we may incur additional litigation expenses.


                                       31
<PAGE>


     FAIR VALUE OF WARRANTS. In July 2004, we consummated a private placement,
whereby we issued 1,800,000 shares, an aggregate of $3 million principal amount
of convertible notes and warrants (including additional investment rights) to
purchase an aggregate of 2,037,500 ordinary shares to investors for a total
consideration of $5.7 million, net of issuance expenses. The consideration was
allocated based on the respective fair values of the ordinary shares, notes,
warrants and additional investment rights. The fair value of the warrants and
the additional investment rights was based on a valuation prepared by an
independent, valuation expert using the Black-Scholes pricing model. The
valuation result was judged to be reasonable by our management based on
comparisons to benchmarks in similar circumstances.

SIGNIFICANT EXPENSES

     COST OF REVENUES. Cost of revenues consist primarily of manufacturing
costs, depreciation of fixed assets, project development costs, impairment
losses on long-lived assets, amortization of capitalized software, customer
relationship assets and inventories write-downs.

     MARKETING, SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Marketing and
selling expenses consist primarily of expenses for sales and marketing
personnel, sales commissions, marketing activities, public relations,
promotional materials, travel expenses and trade show exhibit expenses. General
and administrative expenses consist primarily of salaries and related expenses
for executive, accounting, administrative personnel, professional fees,
provisions for doubtful accounts, and other general corporate expenses.

     FINANCIAL INCOME (EXPENSES), NET. Financial expenses consist of interest
and bank expenses, interest on convertible note, amortization expenses of
discount on convertible note, deferred expenses and currency remeasurement
losses. Financial income consists of interest on cash and cash equivalent
balances, currency remeasurement gains and gain on restructuring of debt.

NEW UNITED STATES ACCOUNTING PRONOUNCEMENTS

     In December 2004, the Financial Accounting Standards Board issued Statement
No. 123 (revised 2004), "Share-Based Payment," or FAS 123R, which replaces FAS
123 and supersedes APB 25. FAS 123R requires all share-based payments to
employees, including grants of employee stock options, to be recognized in the
financial statements based upon their fair values, beginning with the first
interim or annual period after December 15, 2005, with early adoption
encouraged. We expect to adopt FAS 123(R) in the first quarter of 2006, using
the modified prospective method of adoption and do not expect that the adoption
of SFAS 123(R) will have a material effect on the financial position or results
of operations. Compensation cost is recognized beginning with the effective date
(a) based on the requirements of SFAS 123(R) for all share-based payments
granted after the effective date and (b) based on the requirements of SFAS 123
for all awards granted to employees prior to the effective date of SFAS 123(R)
that remain unvested on the effective date.


                                       32
<PAGE>


     In March 2005, the SEC released SEC Staff Accounting Bulletin No. 107,
"Share-Based Payment," or SAB 107. SAB 107 provides the SEC Staff's position
regarding the application of Statement 123(R) and contains interpretive guidance
related to the interaction between Statement 123(R) and certain SEC rules and
regulations, and also provides the SEC Staff's views regarding the valuation of
share-based payment arrangements for public companies. SAB 107 highlights the
importance of disclosures made relating to the accounting for share-based
payment transactions. We do not believe that the adoption of SAB 107 will have a
material effect on our financial position, results of operations or cash flows.

     In May 2005, the FASB issued Statement of Financial Accounting Standard No.
154, or SFAS 154, "Accounting Changes and Error Corrections," a replacement of
APB No. 20, "Accounting Changes" and SFAS No. 3, "Reporting Accounting Changes
in Interim Financial Statements." SFAS 154 provides guidance on the accounting
for and reporting of accounting changes and error corrections. APB No. 20
previously required that most voluntary changes in accounting principles be
recognized by including in net income for the period of the change the
cumulative effect of changing to the new accounting principle. SFAS 154 requires
retroactive application to prior periods' financial statements of a voluntary
change in accounting principles unless it is impracticable. SFAS 154 is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005.

     In November 2004, the FASB issued Statement of Financial Accounting
Standard No. 151, "Inventory Costs, an Amendment of ARB No. 43, Chapter 4," or
SFAS 151. SFAS 151 amends Accounting Research Bulletin, or ARB, No. 43, Chapter
4, to clarify that abnormal amounts of idle facility expense, freight handling
costs and wasted materials (spoilage) should be recognized as current-period
charges. In addition, SFAS 151 requires that the allocation of fixed production
overheads to the costs of conversion be based on the normal capacity of the
production facilities. SFAS 151 is effective for inventory costs incurred during
fiscal years beginning after June 15, 2005. The provisions of this Statement
shall be applied prospectively. We do not believe that the adoption of this
statement will have a material impact on our financial condition or results of
operations.

YEAR ENDED DECEMBER 31, 2005 COMPARED WITH YEAR ENDED DECEMBER 31, 2004

     REVENUES. Our revenues decreased 5% to $13.4 million in 2005 from $14.1
million in 2004. The decrease in our revenues is primarily attributable to our
being engaged in a higher proportion of development programs and a decrease in
sales of off-the-shelf products. We expect that in 2006 our revenues will be
primarily generated from sales of our new products and from the products
acquired in our purchase of certain assets of Vectop.

     COST OF REVENUES. Cost of revenues increased 20% to $12.3 million in 2005
from $10.3 million in 2004. The increase is mainly due to the increased expenses
attributable to development programs, which also have lower profit margins. In
addition, 17% of such increase is due to a write-down of inventories. In 2006,
we expect that our cost of revenues as a percentage of revenues will decrease.

     GROSS PROFIT. Our gross profit decreased 71% to approximately $1.1 million
in 2005 from $3.9 million in 2004. Our profit margin decreased to 8% in 2005
from 27% in 2004. The decrease in gross margin is due to the mix between the
traditional products that we sell and the lower margin of certain long-term
fixed price contracts whereby new products are being developed together with our
customers.


                                       33
<PAGE>


     RESEARCH AND DEVELOPMENT EXPENSES. In 2005 and 2004 we did not incur any
research and development expenses. We made a strategic decision not to engage in
internal research, and development activities, but entered into development
projects through customers orders. In 2006, we expect that we will continue to
enter into new development projects and develop products through customer
orders, but will also initiate internally funded research.

     MARKETING, SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Marketing,
selling, general and administrative expenses were approximately $2.9 million in
both 2005 and in 2004. While we continue to implement our costs savings
measures, we also continued to support our sales efforts in our current and new
markets. We expect that marketing and selling expenses will increase in 2006.

     FINANCIAL INCOME (EXPENSES), NET. Our financial expenses, net, were
$624,000 in 2005 compared to $248,000 in 2004. Our increased financial expenses
in 2005 were attributable primarily to the interest payable on the $3 million of
convertible notes issued in 2004 and to higher interest rates. Foreign currency
exchange differences and amortization expenses on convertible notes and deferred
charges also contributed to the increase of our financial expenses.

YEAR ENDED DECEMBER 31, 2004 COMPARED WITH YEAR ENDED DECEMBER 31, 2003

     REVENUES. Our revenues increased 15% to $14.1 million in 2004 from $12.3
million in 2003. The increase in our revenues is primarily attributable to the
increase of revenues from sales of our Ground Debriefing System, or GDS, to
Smith, and sale of FACE(TM) systems to the Portuguese Air Force and the U.S.
Navy.

     COST OF REVENUES. Cost of revenues increased 7% to $10.3 million in 2004
from $9.6 million in 2003 mainly due to increased revenues.

     GROSS PROFIT. Our gross profit increased 44% to approximately $ 3.9 million
in 2004 from $2.7 million in 2003. Our profit margin increased to 27% in 2004
from 22% in 2003. The increase in gross profit and profit margin are due to the
increase of sales volume and the larger mix of off the shelf products like the
FACE(TM).

     RESEARCH AND DEVELOPMENT EXPENSES. In 2003 and 2004 we did not incur any
research and development expenses. We made a strategic decision not to engage in
internal research and development activities but, rather, entered into
development projects through customers' orders.

     MARKETING, SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Marketing,
selling, general and administrative expenses increased 7% to $2.9 million in
2004 from $2.7 million in 2003. While we continued our cost savings measures in
2004, we increased our sales efforts in our existing and new markets, which
resulted in increased marketing and selling expenses.


                                       34
<PAGE>


     FINANCIAL INCOME (EXPENSES), NET. Our financial expenses, net, were
$248,000 in 2004 and our financial income, net was $708,000 in 2003. Our
financial expenses in 2004 were attributable primarily to the interest payable
on the $3 million of convertible notes issued in 2004 while the financial income
in 2003 was primarily attributable to an approximate $1 million gain on our
restructuring of debt with our banks.

CONDITIONS IN ISRAEL

     We are incorporated under the laws of, and our principal executive offices
and manufacturing and research and development facilities are located in, the
State of Israel. Accordingly, we are directly affected by political, economic
and military conditions in Israel. Specifically, we could be adversely affected
by any major hostilities involving Israel, a full or partial mobilization of the
reserve forces of the Israeli army, the interruption or curtailment of trade
between Israel and its present trading partners, and a significant downturn in
the economic or financial condition of Israel.

POLITICAL CONDITIONS

     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 intensity and degree, has led to
security and economic problems for Israel. In 1979 Israel signed a peace
agreement with Egypt under which full diplomatic relations were established. In
October 1994 a peace treaty was signed between Israel and Jordan which provides,
among other things, for the commencement of full diplomatic relations between
the two countries. To date, there are no peace treaties between Israel and Syria
or Lebanon.

     Since 1993, several agreements have been signed between Israel and the
Palestinian representatives concerning conditions in the West Bank and Gaza and
outlining several interim Palestinian self-government arrangements. The
implementation of these agreements have been subject to difficulties and delays.

     Since September 2000, there has been a marked increase in violence, civil
unrest and hostility, including armed clashes, between the State of Israel and
the Palestinians, and acts of terror have been committed inside Israel and
against Israeli targets in the West Bank and Gaza. These developments have
adversely affected the regional peace process, placed the Israeli economy under
significant stress, and have negatively influenced Israel's relationship with
several Arab countries. In August 2005, Israel evacuated all Israeli settlements
in the Gaza Strip and four settlements in the West Bank. In January 2006, Hamas
won the elections in the Palestinian Authority and on March 28, 2006, elections
to the Israeli parliament were held in Israel. The implications of these
developments cannot at this time be foreseen. Any future armed conflict,
political instability or violence in the region may have a negative effect on
our business condition, harm our results of operations and adversely affect our
share price.


                                       35
<PAGE>


     Furthermore, there are a number of countries that restrict business with
Israel or Israeli companies. Restrictive laws or policies of those countries
directed towards Israel or Israeli businesses may have an adverse impact on our
operations, our financial results or the expansion of our business.

     In addition, some of our executive officers and employees in Israel are
obligated to perform up to 36 days, depending on rank and position, of military
reserve duty annually and are subject to being called for active duty under
emergency circumstances. If a military conflict or war arises, these individuals
could be required to serve in the military for extended periods of time. Our
operations could be disrupted by the absence for a significant period of one or
more of our executive officers or key employees or a significant number of other
employees due to military service. Any disruption in our operations could
adversely affect our business.

     To date, no executive officer or key employee has been recruited for
military service for any significant time period. Any further deterioration of
the hostilities between Israel and the Palestinian Authority into a full-scale
conflict might require more significant military reserve service by some of our
employees, which may have a material adverse effect on our business.

ECONOMIC CONDITIONS

In recent years Israel has been going through a period of recession in economic
activity, resulting in low growth rates and growing unemployment. Although
economic activity in Israel has improved recently, our operations could be
adversely affected if the economic conditions in Israel begin to deteriorate
again.

TRADE RELATIONS

     Israel is a member of the United Nations, the International Monetary Fund,
the International Bank for Reconstruction and Development and the International
Finance Corporation. Israel is a member of the World Trade Organization and is a
signatory to the General Agreement on Tariffs and Trade. In addition, Israel has
been granted preferences under the Generalized System of Preferences from the
United States, Australia, Canada and Japan. These preferences allow Israel to
export the products covered by such programs either duty-free or at reduced
tariffs.

     Israel and the EEC, known now as the "European Union," concluded a Free
Trade Agreement in July 1975 that confers some advantages with respect to
Israeli exports to most European countries and obligates Israel to lower its
tariffs with respect to imports from these countries over a number of years. In
1985, Israel and the United States entered into an agreement to establish a Free
Trade Area. The Free Trade Area has eliminated all tariff and some non-tariff
barriers on most trade between the two countries. On January 1, 1993, an
agreement between Israel and the European Free Trade Association, known as the
"EFTA," established a free-trade zone between Israel and the EFTA nations. In
November 1995, Israel entered into a new agreement with the European Union,
which includes a redefinition of rules of origin and other improvements, such as
allowing Israel to become a member of the Research and Technology programs of
the European Union. In recent years, Israel has established commercial and trade
relations with a number of other nations, including Russia, China, India, Turkey
and other nations in Eastern Europe and Asia.


                                       36
<PAGE>


     Israel receives significant amounts as economic assistance from the United
States. In the last several years Israel has received from the U.S.
approximately $3 billion per year. We cannot assure you that U.S. economic
assistance will continue, or that the amounts received will not be reduced. If
U.S. economic assistance is eliminated or reduced significantly, the Israeli
economy could suffer material adverse consequences which may have material
adverse impact on our financial condition and results of operations.

CORPORATE TAX RATE

     Israeli companies are generally subject to income tax on their worldwide
taxable income. The applicable rate for 2005 was 34%, which was reduced to 31%
in 2006, and will be further reduced to 29% in 2007, 27% in 2008, 26% in 2009
and 25% in 2010 and thereafter.

     As of December 31, 2005, our net operating loss carry-forwards for Israeli
tax purposes were approximately $46 million, including a carry forward capital
loss amounting to approximately $3 million.

IMPACT OF CURRENCY FLUCTUATION AND OF INFLATION

     For many years prior to 1986, the Israeli economy was characterized by high
rates of inflation and devaluation of the Israeli currency against the dollar
and other currencies. However, since the institution of the Israeli Economic
Program in 1985, inflation, while continuing, has been significantly reduced and
the rate of devaluation has substantially diminished. Because governmental
policies in Israel linked exchange rates to a weighted basket of foreign
currencies of Israel's major trading partners, the exchange rate between the NIS
and the dollar remained relatively stable during reported periods.

     The following table sets forth, for the periods indicated, information with
respect to the rate of inflation in Israel, the rate of devaluation of the NIS
against the U.S. dollar, and the rate of inflation in Israel adjusted for such
devaluation:

                                                      ISRAELI INFLATION
YEAR ENDED    ISRAELI INFLATION   ISRAELI DEVALUATION   ADJUSTED FOR
DECEMBER 31,        RATE %               RATE %         DEVALUATION %
------------        ------               ------         -------------

  2001               1.4                  9.3              (7.8)
  2002               6.8                  7.3               0.7
  2003              (1.9)                (7.6)              6.1
  2004               1.2                 (1.6)              2.8
  2005               2.4                  6.8              (4.1)

     Since most of our sales are quoted in dollars and in other foreign
currencies, and a significant portion of our expenses are incurred in NIS, our
results are adversely affected by a change in the rate of inflation in Israel
when such change is not offset (or is offset on a lagging basis) by a
corresponding devaluation of the NIS against the dollar and other foreign
currencies. We do not use any hedging instruments in order to protect ourselves
from currency fluctuation and of inflation risks.


                                       37
<PAGE>


B.   LIQUIDITY AND CAPITAL RESOURCES

     We have historically met our financial requirements primarily through cash
generated by operations, funds generated by our public offering in 1985, private
placements of our ordinary shares and issuance of debt securities, loans from
our principal shareholders, short-term loans and credit facilities from Bank
Hapoalim B.M. and Bank Leumi Le-Israel B.M., our Banks, research and development
grants from the Government of Israel and the Israel-U.S. Binational Industrial
Research and Development Foundation, and investment grants for approved
enterprise programs and marketing grants from the Government of Israel.

     As a result of continuing losses during the period 1999 through 2002 that
amounted to $58.5 million, we were forced to incur significant debt and issue
equity securities. During the four years ended December 31, 2003, we relied
predominantly on Mr. Howard P.L Yeung and our other principal shareholders, and
to a lesser extent on new investors to provide us with working capital. During
this period, they provided us with $13.1 million in equity capital, convertible
debt and loans. In July 2004 we raised $5.88 million from institutional and
accredited investors, and in April 2005 we raised additional $3 million from the
same investors.

     On April 23, 2002, we entered into a loan agreement with Mr. Yeung,
according to which he provided us with a $550,000 loan facility. The purpose of
the facility was to provide us with short term working capital and in 2002 we
utilized $350,000 of the facility.

     At an extraordinary meeting of shareholders held on June 9, 2002, our
shareholders approved the terms of a purchase agreement between us and certain
investors, pursuant to which such investors purchased 1,938,775 of our ordinary
shares at a price of $0.49 per share, which was equal to 70% of the average
closing price of the ordinary shares for the ten (10) trading days prior to June
9, 2002. In addition, pursuant to the approval of our shareholders, we issued to
such investors warrants to purchase 4,302,041 of our ordinary shares. Such
warrants have a term of five years and are exercisable during the first 36
months after issuance at an exercise price of $2.00 per share, and during the
subsequent 24 month period, at an exercise price which will be equal to the
higher of: (i) $2.00 per share or (ii) 50% of the average closing price during
the ten (10) trading days prior to an exercise date. The warrants contain
certain anti-dilution provisions that could reduce the exercise price of the
warrants in the event that we issue securities at a price below the exercise
prices of the warrants our shareholders also approved the conversion of the
$1,350,000 of loans granted by Mr. Yeung, into 2,755,102 of our ordinary shares
at a price of $0.49 per share, which was equal to 70% of the average closing
price of our ordinary shares for the ten trading days prior to the date of
shareholder approval. As part of the transaction, we issued to Mr. Yeung on June
30, 2002 warrants to purchase 8,265,306 ordinary shares. Such warrants will be
outstanding for five years and will be exercisable during the first 36 months at
an exercise price of $2.00 per share, and during the subsequent 24 month period,
at an exercise price which shall be equal to the higher of: (i) $2.00 per share
or (ii) 50% of the average closing price of our ordinary shares during the ten
(10) trading days prior to the exercise date.


                                       38
<PAGE>


     Under the terms of the purchase agreements, we also agreed to provide the
investors and Mr. Yeung with certain registration rights.

     On June 22, 2003, we signed a memorandum of agreement with our Banks, which
agreement was approved by our shareholders at an extraordinary general meeting
of shareholders that was held on July 22, 2003. Pursuant to an agreement that
was finalized on September 24, 2003, we restructured $3,451,000 of our
outstanding debt to the Banks. We repaid $1,100,000 on account of our debt to
the Banks, and the Banks forgave $1,100,000 of debt and received warrants to
purchase 3,781,995 of our ordinary shares, at an exercise price that is equal to
the nominal (par) value of our shares, in lieu of $1,251,000 of our debt. The
Banks also granted us an additional short-term line of credit of $500,000 to
finance our cash flow requirements during 2003. As part of the agreement our
controlling shareholder, Mr. Yeung, agreed to grant the Banks a put option
allowing the Banks to require him to purchase the warrants granted to the Banks,
for the consideration of $1,251,000, exercisable within a period of 45 days
commencing on March 24, 2005 and the Banks granted Mr. Yeung a call option
allowing him to require the Banks, during a period of 18 months, commencing as
of September 24, 2003, and in the event that the Banks will not exercise their
put option, during additional 90 days period commencing as of May 9, 2005, to
sell him such warrants at a price that is not lower than $1,251,000 and not
higher then $1,770,165, depending on the average closing price of our ordinary
shares during the last 90 business days prior to such exercise. In May 2005, Mr.
Yeung exercised his call option to purchase the warrants from the Banks and in
October 2005, exercised these warrants. Upon such exercise, we issued Mr. Yeung
3,781,995 ordinary shares.

     We also agreed to grant the Banks warrants to purchase an additional
1,100,000 ordinary shares at an exercise price of $2.00 per share, exercisable
for five years, commencing as of September 24, 2003.

     As of December 31, 2005, we were indebted to our Banks under a short-term
loan of $700,000 and credit facilities of $177,000. in addition, our Banks
provided $3.5 million of guarantees on behalf of our customers and suppliers in
the ordinary course of business. The guarantees are secured by a first priority
floating charge on all our assets and by a fixed charge on goodwill (intangible
assets), unpaid share capital and insurance rights (rights to proceeds on
insured assets in the event of damage). Our agreements with the Banks prohibit
us from selling or otherwise transferring any assets except in the ordinary
course of business, from placing a lien on our assets without the Banks' consent
and from declaring dividends to our shareholders. In addition, The Israeli Tax
Authority has a first priority fixed charge on our fixed assets in the
Beit-She'an facility. This charge will be released when the litigation between
us and our former chief executive officer is resolved.

     On July 12, 2004 we entered into a stock purchase agreement with certain
institutional investors, pursuant to which such investors purchased 1.8 million
of our ordinary shares at a price of $1.60 per share, together with additional
investment rights to purchase up to an aggregate of an additional 1.1 million
ordinary shares at an exercise price of $2.10 per share, for a period of 24
months from August 11, 2004. In addition, we issued an aggregate of $3.0 million
principal amount of convertible notes. The convertible notes will mature on July
12, 2007, bear interest at a rate of six month LIBOR plus 2.5% and are
convertible at the investors' option at a conversion price of $2.10. The
investors also received warrants exercisable for a period of five years
beginning on January 12, 2005 to purchase up to an aggregate of 937,500 ordinary
shares at an exercise price of $2.50 per share.


                                       39
<PAGE>


     On April 6, 2005 we entered into a stock purchase agreement with the same
institutional investors, pursuant to which such investors purchased 965,934 of
our ordinary shares. In addition we issued to these investors new warrants to
purchase an additional 1,875,000 of our ordinary shares at a purchase price of
$2.10 per share for a period of 24 months. As part of this transaction the
investors exercised 909,066 additional investment rights that were issued to
them in the July 12, 2004 transaction, for the purchase of 909,066 ordinary
shares. As a result, we received proceeds of approximately $3,000,000.

     We had capital expenditures of $411,000 in 2005 and $349,000 in 2004. We
currently do not have any significant capital spending or purchase commitments.

     Net cash used in operating activities was $5.1 million in 2005. This was
attributable primarily to our loss of $2.3 million, an increase in trade
receivables of $2.7 million, a net increase in costs and estimated earnings in
excess of billings of $685,000, and a $568,000 decrease in deferred revenues;
offset by $200,000 decrease in inventories, and depreciation and amortization of
$1.4 million. Net cash generated from operating activities was $997,000 in 2004.
This was attributable primarily to our net income of $822,000, depreciation and
amortization of $1.07 million and a $295,000 increase in other payables and
accrued expenses; offset by, a net increase in costs and estimated earnings in
excess of billings of $2.0 million, $951,000 increase in inventories and a
$574,000 decrease in deferred revenues.

     Net cash used in investing activities was approximately $750,000 in 2005
and $1.4 million in 2004. In 2005, we purchased the net assets of Vectop for
$351,000 million and invested $411,000 in property and equipment. In 2004, we
used $1.0 million as an investment in long-term restricted cash (restricted to
secure bank guarantees issued to certain of our customers) and $349,000 for the
purchase of property and equipment.

     Net cash provided by financing activities was $2.8 million in 2005. This
amount was principally in respect of net proceeds of $2.8 million from issuance
of shares and warrants and from the exercise of warrants. Net cash provided by
financing activities was $3.4 million in 2004. This amount was principally
provided by the proceeds of the private placement and the issuance of
convertible notes in July 2004, in a total amount of $5.7 million, and was
offset in part by the repayment of $ 2.3 million of short-term bank credits and
loans with the proceeds of the private placement.

     As a result of the foregoing, at December 31, 2005, we had working capital
of $3.6 million and cash and cash equivalents of $350,000 as compared to working
capital of $2.3 million and cash and cash equivalents of $3.5 million at
December 31, 2004.


                                       40
<PAGE>


     We expect to fund our short-term liquidity needs, including our obligations
under our credit facilities, other contractual agreements and any other working
capital requirements, from our cash and cash equivalents, operating cash flow
and our credit facilities. We believe that our current cash and cash
equivalents, credit facilities and our expected cash flow from operations in
2006 will be sufficient to meet our cash requirements in 2006. However, we
cannot assure that that such funds will be sufficient to finance our operations
and that, in such event, our shareholders, other investors or the Banks will
continue to provide us with funds when requested. The failure of our principal
shareholders, other new investors or the banks, to provide us with the necessary
financing may result in a significant scale back or elimination of some aspects
of our operations.

     As of March, 31, 2006 there were 16, 670,779 warrants outstanding to
purchase 16,670,779 of our ordinary shares. Of such warrants, 13,667,345
warrants have an exercise price of $2.00 per share, 2,065,934 warrants have an
exercise price of $2.10 per share and 937,500 warrants have an exercise price of
$2.50 per share. To the extent any warrants are exercised, the proceeds will be
added to our working capital.

C.   RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES

RESEARCH AND DEVELOPMENT

     Our research and development investments focus on improvements to our
existing products and the development of complementary products that would
provide continued support for our current customers and would improve our
capability to market our products to new customers.

     In the years ended December 31, 2003, 2004 and 2005, we didn't incur
research and development costs. In 2003, we made a strategic decision not to
engage in internal research and development activities, but rather to develop
products through customer orders. In 2006, we expect that we will continue to
enter into new development projects and develop products through customer
orders, but will also initiate internally funded research.

     As of December 31, 2005, we employed 38 engineers in research and
development, which spend most of their time on research and development
activities generated through customer orders and an immaterial part of their
time on internal research and development activities.

     The Office of the Chief Scientist of the Israeli Ministry of Industry and
Trade encourages research and development by providing grants to Israeli
companies. The terms of such grants prohibit manufacture of the developed
products outside Israel and the transfer of technologies developed using the
grants to any person without the prior written consent of the Chief Scientist.
We have not received any grants from the Office of the Chief Scientist since
1996.

     Pursuant to applicable Israeli law, we are currently required to pay
royalties at the rate of 3-5% of sales of products developed with certain grants
received from the Chief Scientist, up to 100% of the amount of such grants,
linked to the U.S. dollar. As of December 31, 2005, our total obligation for
royalties payments, net of royalties paid or accrued is approximately $668,000.

     We are committed to pay royalties to the Israel - United States Binational
Industrial Research and Development Foundation at the rate of 5% of the sales
proceeds up to 150% of the research and development expenses financed by the
foundation. Our total obligation for royalties, net of royalties paid or
accrued, totaled approximately $2.1 million as of December 31, 2005.


                                       41
<PAGE>


D.   TREND INFORMATION

     After six years of losses, we succeeded in reducing our losses and
returning to profitable operations in the years 2003 and 2004. In 2005, we
reported a loss of $2.3 million. We cannot provide any assurances that we will
be successful in meeting our targets in the future. As a result of the
unpredictable business environment in which we operate, we are unable to provide
any specific guidance as to sales and profitability trends.

     In 2005 our revenues decreased as a result of our engaging in a higher
proportion of development programs and a decrease in sales of off-the-shelf
products. We expect that in 2006 the proportion of sales of off-the-shelf
products will increase. We believe that such change of product mix will result
in an increase of our profits.

     Our future revenues will, in great measure, be dependent upon the success
of our sales and marketing strategy. We are currently focusing our sales efforts
on:

     o    Net Centric Digital Recorder (NCDR);

     o    Ground debriefing stations;

     o    Optronics; cameras for HUD and armored vehicles;

     o    Testing solutions

     o    Manufacturing services.

     If we are unsuccessful in our sales efforts, it is unlikely that we will be
able to achieve profitability in the future and we will require additional
capital.

E.   OFF-BALANCE SHEET ARRANGEMENTS

     We are not a party to any material off-balance sheet arrangements. In
addition, we have no unconsolidated special purpose financing or partnership
entities that are likely to create material contingent obligations.

F.   TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

     The following table summarizes our minimum contractual obligations and
commercial commitments, as of December 31, 2005 and the effect we expect them to
have on our liquidity and cash flow in future periods.


                                       42
<PAGE>


<TABLE>
<CAPTION>
    CONTRACTUAL OBLIGATIONS                                    PAYMENTS DUE BY PERIOD
------------------------------    ----------------------------------------------------------------------
                                                  Less than 1                                More than 5
                                    Total             year          1-3 Years     3-5 Years     years
                                  ----------       ----------       ----------    ----------  ----------
<S>                               <C>              <C>              <C>                    <C>         <C>
Long-term debt obligations        $3,260,000       $  700,000       $2,560,000             -           -
Operating lease obligations       $1,517,000       $  576,000       $  941,000             -           -
                                  ----------       ----------       ----------    ----------  ----------
Total                             $4,777,000       $1,276,000       $3,501,000             -           -

</TABLE>

     In addition, we have long-term liabilities for severance pay that is
calculated pursuant to Israeli severance pay law generally 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 a portion thereof. As of December 31, 2005 our
severance pay liability was $2,009,000. .

     We have attempted to identify additional significant uncertainties and
other factors affecting forward-looking statements in the Risk Factors section
that appears in Item 3 - "Key Information."

ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

A.   DIRECTORS AND SENIOR MANAGEMENT

     Set forth below are the name, age, principal position and a biographical
description of each of our directors and executive officers:

NAME                 AGE    POSITION
----                 ---    --------

Herzle Bodinger (1)   63    Chairman of the board and president
Adar Azancot          41    Chief executive officer
Elan Sigal            39    Chief financial officer
Zvi Alon              52    Vice president, business development and marketing
Dov Sella             51    Vice president and chief operating officer
Adrian Berg           58    Director
Roy Kui Chuen Chan    59    Director
Ben Zion Gruber       47    Director
Michael  Letchinger   50    Director
Hava Snir             63    Outside director
Zvi Tropp             65    Outside director


                                       43
<PAGE>

     Messrs. Chan and Gruber will serve as directors until our 2006 annual
general meeting of shareholders. Messrs. Bodinger and Letchinger will serve as
directors until our 2007 annual general meeting of shareholders. Mr. Berg will
serve as a director until our 2008 annual general meeting of shareholders.

     Ms. Snir and Mr. Tropp will serve as outside directors pursuant to the
provisions of the Israeli Companies Law for three-year terms until our 2006
annual general meeting of shareholders. Thereafter, their terms of service may
not be renewed.

     HERZLE BODINGER joined us in May 1997 as the president of our U.S.
subsidiary, Rada Electronic Industries Inc., in charge of international
marketing activities and was appointed our president and chief executive officer
in June 1998. General (Res.) Bodinger has served as chairman of the board since
July 1998. General (Res.) Bodinger served as the Commander of the Israeli Air
Force from January 1992 through July 1996. During the last 35 years of his
service, he also served as a fighter pilot while holding various command
positions. General (Res.) Bodinger holds a B.A. degree in Economics and Business
Administration from the Bar-Ilan University and completed the 100th Advanced
Management Program at Harvard University.

     ADAR AZANCOT joined us in July 1997 as marketing manager in charge of
marketing activities aimed at the Israel Defense Forces and was appointed vice
president-business development in March 1999. Mr. Azancot was appointed chief
executive officer in July 2001. Mr. Azancot served for 14 years as a fighter
pilot in the Israeli Air Force while holding various command positions. Mr.
Azancot holds an LL.B. degree in Law from Tel Aviv University.

     ELAN SIGAL re-joined us in January 2004 as chief financial officer. From
May 2000 to December 2003, Mr. Sigal worked as a management consultant in the
London office of McKinsey & Co., a leading global management consulting firm.
Prior to that Mr. Sigal worked with us from July 1997 to April 2000, initially
as a system engineer developing one of our leading products, and later as a
marketing manager. For nine years Mr. Sigal served as a fighter pilot in the
Israeli Air Force. Mr. Sigal holds a B.A. degree in Economics from Tel Aviv
University.

     ZVI ALON joined us in January 2000 and served as our vice president and
chief operating officer until March 30, 2003 when he was appointed vice
president of business development and Marketing. From 1980 to 1999 (except for a
period from 1987 until 1989), Mr. Alon served in various managerial positions
with the Israel Aircraft Industries, as director of business development and
marketing, director of electrical and avionics engineering, avionics programs
manager and group leader and operational definition officer of the "Lavi"
project office. Previously, Mr. Alon served in the Israeli Air Force for ten
years. Mr. Alon holds a B.Sc. degree in Mathematics and Computer Science and an
M.Sc. degree in Computer Science, both from Tel Aviv University.


                                       44
<PAGE>


     DOV SELLA joined us in January 2003 and was appointed chief operating
officer on March 30, 2003. Mr. Sella has over 20 years of senior management and
product development experience. From 1982 until 1997 Mr. Sella worked for Elbit
Systems Ltd., a leading Israeli defense contractor. Among his roles at Elbit
were director of programs, director of avionics engineering and director of
business development. Between 1997 and 2000, Mr. Sella served UltraGuide Ltd., a
medical devices start-up, as executive vice president and vice president of
business development and vice president of research and development. During the
three years prior to joining our company, Mr. Sella was the president of
NeuroVision Inc., a medical technology start-up. Mr. Sella has a B.Sc. degree in
Computer Engineering from the Technion Israel Institute of Technology (cum
laude). He served as a fighter aircraft navigator in the Israeli Air Force.


     ADRIAN BERG has served as a director since November 1997. Mr. Berg is a
designee of Horsham Enterprises Ltd. Since 1976, Mr. Berg has been a chartered
accountant and senior partner at the U.K. firm, Alexander & Co., Chartered
Accountants. Mr. Berg holds a B.Sc. degree in Industrial Administration from the
University of Salford and received his qualification as a fellow of the U.K.
Institute of Chartered Accountants in 1973 after he completed three years of
training at Arthur Andersen & Co.

     ROY KUI CHUEN CHAN has served as a director since November 1997. Mr. Chan
is a designees of Horsham Enterprises Ltd. Mr. Chan has been legal consultant to
Yeung Chi Shing Estates Limited, a Hong Kong holding company with major
interests in hotels and real estate in Hong Kong, China, the U.S., Canada and
Australia, and its international group of companies, since 1984. Mr. Chan
presently serves as legal counsel to several Hong Kong companies, including
Horsham Enterprises Ltd. Mr. Chan received his qualification as a solicitor and
has been a member of the U.K. bar since 1979 after he completed five years of
training at Turners Solicitors.

     BEN ZION GRUBER was elected as a designee of the shareholders (excluding
Howard Yeung) that participated in our last private placement. Mr. Gruber is
founder and manager of several real estate and construction companies and an
entrepreneur involved in several hi-tech companies. Mr. Gruber is a Colonel
(Res) of the Israeli Defense Forces serving as Brigadier Commander of a tank
battalion. Mr. Gruber holds an M.A. degree in Behavioral Sciences from Tel Aviv
University, a B.Sc. degree in Engineering of microcomputers from "Lev"
Technology Institute and is currently studying for his PhD degree in Behavioral
Sciences at the University of Middlesex, England. In addition Mr. Gruber is a
graduate of a summer course in Business Administration at Harvard University, as
well as several other courses and training in management, finance and
entrepreneurship. Mr. Gruber is a member of the Board of Employment Service of
the Government of Israel. He also serves on the boards of directors of the
Company for Development of Efrat Ltd., and the Association of Friends of "Kefar
Shaul" Hospital. Mr. Gruber serves on the Ethics Committees of the Eitanim and
Kefar Shaul Hospitals as well as a director of several other charitable
organizations.

     MICHAEL LETCHINGER was elected as a designee of Horsham Enterprises Ltd. in
November 2004. Since 2000, Mr. Letchinger has been General Counsel and Senior
Vice President-Managing of Potomac Golf Properties, LLC, a company engaged in
real estate development and free standing golf facilities. From 1994 to 2000,
Mr. Letchinger was General Counsel and Senior Vice President-Managing of Potomac
Development Associates, a sister company of Potomac Golf Properties, LLC. Mr.
Letchinger holds a B.A. degree in economics from Brandeis University, Waltham,
Massachusetts, and a JD from University of Chicago Law School.


                                       45
<PAGE>

     HAVA SNIR has served as an outside director since December 2000. Ms. Snir
has been an attorney for over 25 years and has been self-employed since January
1999. From June 1989 until July 1998, Ms. Snir was a prosecutor with the
Taxation and Economics Office of the Tel Aviv District Attorney, specializing in
securities laws and white-collar crimes. Ms. Snir received her qualification as
a lawyer and has been a member of the Israel Bar since 1971. She is a member of
the Taxes Committee and the Sub-Committee for V.A.T. and Customs Duty of the
Israel Bar Association and serves as chairman of the V.A.T. and Property Tax
Appeal Committee of the Israeli Ministry of Finance and as a member of the
Ethics Committee of the Israeli Ministry of Health. Ms. Snir holds a B.A. degree
in Law from the Hebrew University of Jerusalem and spent a year at Harvard
University where she took law courses.

     ZVI TROPP has served as an outside director since December 2000. Recently,
Mr. Tropp was elected as the chairman of RAFAEL, the Israeli weapon development
agency. From November 2000 until April 2003, Mr. Tropp served as the chief
executive officer of Enavis Networks Ltd, a wholly owned subsidiary of ECI
Telecom Ltd. Since April 2003, Mr. Tropp has served as senior consultant with
Zenovar Consultants Ltd. Zenovar an Israeli company providing consultancy
services with respect to business organization, marketing and real estate. Mr.
Tropp was vice president-finance and business development of Baltimore Spice
Israel Ltd., an Israeli food additives manufacturer, from January 1994 until May
1998. Prior thereto, Mr. Tropp served in various positions in the private
sector. Prior to joining the private sector, Mr. Tropp was a government employee
for 20 years and held various positions with the Israeli Ministries of Defense
and Agriculture, the last of which was as chief economic adviser to the Ministry
of Defense. Mr. Tropp has lectured in Economics and Defense Economics at the
Hebrew University, Tel Aviv University and Bar Ilan University. Mr. Tropp serves
as a member of the board of directors of Ofek Trust Fund Ltd., an Israeli
affiliate of Bank Leumi Le-Israel B.M., whose shares trade on the Tel Aviv Stock
Exchange, of ELBIT Medical Imaging Ltd, whose shares are traded on NASDAQ, and
of several Israeli private companies. Mr. Tropp holds a B.Sc. degree in
Agriculture and an M.Sc. degree in Agricultural Economics, both from the Hebrew
University.

B.   COMPENSATION

     The following table sets forth all compensation we paid with respect to all
of our directors and executive officers as a group for the year ended December
31, 2005.


<TABLE>
<CAPTION>
                                                 Salaries, fees,            Pension, retirement
                                              commissions and bonuses      and similar benefits
                                              -----------------------      --------------------
<S>                                                  <C>                        <C>
All directors and executive officers
 as a group, consisting then of 11 persons           $808,750                   $215,530
</TABLE>

     During the year ended December 31, 2005, we paid each of our outside
directors a per meeting attendance fee of NIS 1,000
($217) plus an annual fee of NIS 18,000 ($3,910).

     As of December 31, 2005, our directors and executive officers as a group,
consisting of eleven persons, held options to purchase an aggregate of 1,374,000
ordinary shares, at exercise prices ranging from $0.69 to $1.34 per share,
vesting over three years. These options were issued under our 2003 Stock Option
Plan and expire in 2013. In 2005, 144,000 options previously granted under our
1999 Stock Option Plan were cancelled and 53,333 options were forfeited.


                                       46
<PAGE>

C.   BOARD PRACTICES

INTRODUCTION

     According to the Israeli Companies Law and our Articles of Association, the
management of our business is vested in our board of directors. The board of
directors may exercise all powers and may take all actions that are not
specifically granted to our shareholders. Our executive officers are responsible
for our day-to-day management. The executive officers have individual
responsibilities established by our chief executive officer and board of
directors. Executive officers are appointed by and serve at the discretion of
the board of directors, subject to any applicable agreements.

ELECTION OF DIRECTORS

     Our articles of association provide for a board of directors consisting of
no less than two and no more than eleven members or such other number as may be
determined from time to time at a general meeting of shareholders. Our board of
directors is currently composed of seven directors.

     Pursuant to our articles of association, the board of directors is divided
into three classes. Generally, at each annual meeting of shareholders one class
of directors is elected for a term of three years by a vote of the holders of a
majority of the voting power represented and voting at such meeting. All the
members of our board of directors (except the outside directors as detailed
below) may be reelected upon completion of their term of office. The majority of
directors may appoint additional directors to temporarily fill any vacancies in
the board of directors; provided, however that the total number of directors
will not exceed eleven, and that if the total number of directors decreases
below six, the board of directors may call a general meeting of shareholders, so
that following such meeting there will be at least six directors in office.

     Messrs. Chan and Gruber are Class A directors and will hold office until
the Annual General Meeting of Shareholders to be held in 2006. Messrs. Bodinger
and Letchinger are Class B directors and will hold office until the Annual
General Meeting of Shareholders to be held in 2007. Mr. Berg is a Class C
director and will hold office until the Annual General Meeting of Shareholders
to be held in 2008.

     Ms. Snir and Mr. Tropp are outside directors and will hold office until our
2006 Annual General Meeting of shareholders. Under the Israeli Companies Law,
their terms of service may not be renewed.

     We do not follow the requirements of the NASDAQ Marketplace Rules with
regard to the nomination process of directors and instead follow Israeli law and
practice. See below in this Item 6C. "Directors, Senior Management and Employees
- Board Practices - NASDAQ Marketplace Rules and Home Country Practices."


                                       47
<PAGE>


OUTSIDE AND INDEPENDENT DIRECTORS

     The Israeli Companies Law requires Israeli companies with shares that have
been offered to the public in or outside of Israel to appoint at least two
outside directors. No person may be appointed as an outside director if the
person or the person's relative, partner, employer 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 outside director, any affiliation with the
company or any entity controlling, controlled by or under common control with
the company. The term affiliation includes an employment relationship, a
business or professional relationship maintained on a regular basis, control and
service as an officer holder, excluding service as an outside director of a
company that is offering its shares to the public for the first time.

     No person may serve as an outside director if the person's position or
other activities create, or may create, a conflict of interest with the person's
responsibilities as an outside director or may otherwise interfere with the
person's ability to serve as an outside director. If, at the time outside
directors are to be appointed, all current members of the board of directors are
of the same gender, then at least one outside director must be of the other
gender.

     According to a March 2005 amendment to the Israeli Companies Law, effective
as of January 2006, at least one of the outside directors must be an accounting
and financial expert and the other outside directors must be professional
experts, as such terms are defined by regulations promulgated under the Israeli
Companies Law. This requirement does not apply to outside directors appointed
prior to the March 2005 amendment.

     Outside directors are elected at our annual general meeting of
shareholders. The shareholders voting in favor of their election must include at
least one-third of the shares of the non-controlling shareholders of the company
who are present at the meeting. This minority approval requirement need not be
met if the total shareholdings of those non-controlling shareholders who vote
against their election represent 1% or less of all of the voting rights in the
company. Outside directors serve for a three-year term, which may be renewed for
only one additional three-year term. Outside directors can be removed from
office only by the same special percentage of shareholders as can elect them, or
by a court, and then only if the outside directors cease to meet the statutory
qualifications with respect to their appointment or if they violate their duty
of loyalty to the company.

     Any committee of the board of directors must include at least one outside
director and the audit committee must include all of the outside directors. An
outside director is entitled to compensation as provided in regulations
promulgated under the Israeli Companies Law and is otherwise prohibited from
receiving any other compensation, directly or indirectly, in connection with
such service.


                                       48
<PAGE>


     We do not follow the requirements of the NASDAQ Marketplace Rules the
requirement to maintain a majority of independent directors within the meaning
of the NASDAQ Marketplace Rules on our board and instead follow Israeli law and
practice. See below in this Item 6C. "Directors, Senior Management and Employees
- Board Practices - NASDAQ Marketplace Rules and Home Country Practices."
However, in accordance with the rules of the Securities and Exchange Commission,
we have the mandated three independent directors, as defined by the Securities
and Exchange Commission and NASDAQ Marketplace rules, on our audit committee.
Our board of director has determined that Ms. Snir and Mr. Tropp both qualify as
independent directors under the Securities and Exchange Commission and NASDAQ
requirements and as outside directors under the Israeli Companies Law
requirements. Our board of directors has further determined that Mr. Gruber
qualifies as an independent director under the SEC and NASDAQ requirements.

     We do not follow the requirements of the NASDAQ Marketplace Rules with
regard to regularly scheduled meetings of independent directors. Under Israeli
law independent directors are not required to hold executive sessions. See below
in this Item 6C. "Directors, Senior Management and Employees - Board Practices -
NASDAQ Marketplace Rules and Home Country Practices."

AUDIT COMMITTEE

     Our audit committee, established in accordance with Section 114 of the
Israeli Companies Law and Section 3(a)(58)(A) of the Securities Exchange Act of
1934, assists our board of directors in overseeing the accounting and financial
reporting processes of our company and audits of our financial statements,
including the integrity of our financial statements, compliance with legal and
regulatory requirements, our independent public accountants' qualifications and
independence, the performance of our internal audit function and independent
public accountants, finding any defects in the business management of our
company for which purpose the audit committee may consult with our independent
auditors and internal auditor, proposing to the board of directors ways to
correct such defects, approving related-party transactions as required by
Israeli law, and such other duties as may be directed by our board of directors.

     Our audit committee also has the responsibility of approving related-party
transactions as required by law. Under Israeli law, an audit committee may not
approve an action or a transaction with a controlling shareholder, or with an
office holder, unless at the time of approval two outside directors are serving
as members of the audit committee and at least one of the outside directors was
present at the meeting in which an approval was granted.

     Our audit committee is generally authorized to investigate any matter
within the scope of its responsibilities and has the power to obtain from our
internal auditing unit, our independent auditors or any other officer or
employee any information that is relevant to such investigations.

     Our member of our audit committee are currently Ms. Hava Snir and Messrs.
Zvi Tropp and Ben Zion Gruber, each of whom satisfies the respective
"independence" requirements of the SEC and NASDAQ. We also comply with Israeli
law requirements for audit committee members. Our Board of Directors has
determined that Mr. Tropp qualifies as a financial expert. The audit committee
meets at least once each quarter.


                                       49
<PAGE>


     Under Israeli law, an audit committee may not approve an action or a
transaction with a controlling shareholder, or with an office holder, unless at
the time of approval two outside directors are serving as members of the audit
committee and at least one of the outside directors was present at the meeting
in which an approval was granted.

OTHER COMMITTEES

     Our board of directors established a compensation committee composed of Mr.
Zvi Tropp and Mr. Adrian Berg. The compensation committee is authorized to
determine all compensations issues, especially to administer our option plans
subject to general guidelines determined by our board of directors from time to
time. The compensation committee will also make recommendation to our board of
directors in connection with the terms of employment of our chief executive
officer and president.

INTERNAL AUDIT

     The Israeli Companies Law also requires the board of directors of a public
company to appoint an internal auditor nominated by the audit committee. An
internal audit must satisfy the Israeli Companies Law's independence
requirements. The role of the internal auditor is to examine, among other
things, the compliance of the company's conduct with applicable law and orderly
business practice. Our internal auditor complies with the requirements of the
Israeli Companies Law.

EMPLOYMENT AGREEMENTS

     On May 1, 1997, we entered into an employment agreement with Mr. Herzle
Bodinger who assumed the position of the general director of our international
division. Mr. Bodinger was appointed our chief executive officer and president
in June 1998. Nonetheless, his terms of employment have not changed. The
agreement provides for a base salary and a package of benefits including options
and warrants and contains certain non-competition and confidentiality
provisions. The agreement does not provide for any benefits upon termination of
employment, except for benefits to which Mr. Bodinger is entitled under Israeli
law. Such benefits include severance payments equal to one month salary per each
year of employment with us. Under the agreement, the term of Mr. Bodinger's
employment will continue until such time as it is terminated by us, subject to
providing Mr. Bodinger with a six-month's prior notice. Mr. Bodinger may
terminate the agreement on a one-month's prior notice. As of October 24, 2001,
Mr. Bodinger relinquished the chief executive officer position to Adar Azancot
retaining the positions of president and chairman of our board of directors. We
are currently negotiating a new employment agreement with Mr. Bodinger. As part
of these negotiations, Mr. Bodinger agreed, effective as of September 2003, to
reduce his monthly salary. Mr. Bodinger agreed to a further reduction in his
salary as of February 1, 2004.

     On July 9, 2001, we entered into an employment agreement with Mr. Adar
Azancot, our chief executive officer. The agreement provides for the same base
salary and a package of customary benefits Mr. Azancot had as vice president of
marketing and business development and contains certain non-competition and
confidentiality provisions. In September 2002, our board of directors resolved
to increase Mr. Azancot's base salary.


                                       50
<PAGE>


APPROVAL OF RELATED PARTY TRANSACTIONS UNDER ISRAELI LAW

     The Israeli 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 care requires an office holder to act at a level of care
that a reasonable office holder in the same position would employ under the same
circumstances. 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 gain for the office
holder or others, and disclosing 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. Each person listed as a director or executive
officer in the table under " -- Directors and Senior Management" above is an
office holder. Under the Israeli Companies Law, all arrangements as to
compensation of office holders who are not directors require approval of our
board of directors, and the compensation of office holders who are directors
must be approved by our audit committee, board of directors and shareholders.

     The Israeli Companies Law requires that an office holder 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 us. In addition, if the transaction is an extraordinary
transaction, that is, a transaction other than in the ordinary course of
business, other than on market terms, or likely to have a material impact on the
company's profitability, assets or liabilities, 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, or by any corporation in which the office holder or a relative
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. Some
transactions, actions and arrangements involving an office holder (or a third
party in which an office holder has an interest) must be approved by the board
of directors or as otherwise provided for in a company's articles of
association, as not being adverse to the company's interest. In some cases, such
a transaction must be approved by the audit committee and by the board of
directors itself (with further shareholder approval required in the case of
extraordinary transactions). An office holder who has a personal interest in a
matter, which is considered at a meeting of the board of directors or the audit
committee, may not be present during the board of directors or audit committee
discussions and may not vote on this matter, unless the majority of the members
of the board or the audit committee have a personal interest, as the case may
be.


                                       51
<PAGE>


     The Israeli Companies Law applies the same disclosure requirements to a
controlling shareholder of a public company, which is defined as a shareholder
who has the ability to direct the activities of a company, other than in
circumstances where this power derives solely from the shareholder's position on
the board of directors or any other position with the company, and includes a
shareholder that holds 50% or more of the voting rights. The Israeli Companies
Law also provides that some transactions between a public company and a
controlling shareholder, or transactions in which a controlling shareholder of
the company has a personal interest but which are between a public company and
another entity, require the approval of the board of directors and of
shareholders. Moreover, an extraordinary transaction with a controlling
shareholder or in which a controlling shareholder has a personal interest and a
transaction with a controlling shareholder or his relative regarding terms of
service and employment must be approved by the audit committee, the board of
directors and shareholders. The shareholder approval for an extraordinary
transaction must include at least one-third of the shareholders who have no
personal interest in the transaction and are present at the meeting (excluding
the vote of abstaining shareholders). The transaction can be approved by
shareholders without this one-third approval restraint, if the total
shareholdings of those shareholders who have no personal interest and voted
against the transaction do not represent more than one percent of the voting
rights in the company.

     However, under the Companies Regulations (Relief From Related Party
Transactions), 5760-2000, promulgated under the Israeli Companies Law and
amended in January 2002, certain transactions between a company and its
controlling shareholder(s) do not require shareholder approval.

     In addition, directors' compensation and employment arrangements do not
require the approval of the shareholders if both the audit committee and the
board of directors agree that such arrangements are for the benefit of the
company. If the director or the office holder is a controlling shareholder of
the company, then the employment and compensation arrangements of such director
or office holder do not require the approval of the shareholders provided that
certain criteria are met.

     The above exemptions will not apply if one or more shareholders, holding at
least 1% of the issued and outstanding share capital of the company or of the
company's voting rights, objects to the grant of such relief, provided that such
objection is submitted to the company in writing not later than seven (7) days
from the date of the filing of a report regarding the adoption of such
resolution by the company pursuant to the requirements of the Israeli Securities
Law. If such objection is duly and timely submitted, then the compensation
arrangement of the directors will require shareholders' approval as detailed
above.

     The Israeli Companies Law provides that an acquisition of shares in a
public company must be made by means of a tender offer if as a result of the
acquisition the purchaser would become a 25% or greater shareholder of the
company. This rule does not apply if there is already another 25% or greater
shareholder of the company. Similarly, the Israeli Companies Law provides that
an acquisition of shares in a public company must be made by means of a tender
offer if as a result of the acquisition the purchaser would hold greater than a
45% interest in the company, unless there is another shareholder holding more
than a 45% interest in the company. These requirements do not apply if, in
general, the acquisition (1) was made in a private placement that received
shareholder approval, (2) was from a 25% or greater shareholder of the company
which resulted in the acquiror becoming a 25% or greater shareholder of the
company, or (3) was from a shareholder holding more than a 45% interest in the
company which resulted in the acquiror becoming a holder of more than a 45%
interest in the company.


                                       52
<PAGE>


     If, as a result of an acquisition of shares, the acquirer will hold more
than 90% of a company's outstanding shares, the acquisition must be made by
means of a tender offer for all of the outstanding shares. If less than 5% of
the outstanding shares are not tendered in the tender offer, all the shares that
the acquirer offered to purchase will be transferred to the acquirer. The
Israeli Companies Law provides for appraisal rights if any shareholder files a
request in court within three months following the consummation of a full tender
offer. If more than 5% of the outstanding shares are not tendered in the tender
offer, then the acquiror may not acquire shares in the tender offer that will
cause his shareholding to exceed 90% of the outstanding shares.

EXCULPATION, INDEMNIFICATION AND INSURANCE OF DIRECTORS AND OFFICERS

     EXCULPATION OF OFFICE HOLDERS

     The Israeli Companies Law provides that an Israeli company cannot exculpate
an office holder from liability with respect to a breach of his duty of loyalty,
but may, if permitted by its articles of association, exculpate in advance an
office holder from his liability to the company, in whole or in part, with
respect to a breach of his duty of care. However, a company may not in advance
exculpate a director from his liability to the company with respect to a breach
of his duty of care in the event of distributions.

     INSURANCE OF OFFICE HOLDERS

     The Israeli Companies Law provides that a company may, if permitted by its
articles of association, enter into a contract to insure office holders in
respect of liabilities incurred by the office holder with a respect to an act
performed in his or her capacity as an office holder, as a result of:

     o    A breach of the office holder's duty of care to us or to another
          person;

     o    A breach of the office holder's duty of loyalty to us, provided that
          the office holder acted in good faith and had reasonable cause to
          assume that his or her act would not prejudice our company's
          interests; or

     o    A financial liability imposed upon the office holder in favor of
          another person in respect of an act performed by him in his capacity
          as an office holder.

     o    INDEMNIFICATION OF OFFICE HOLDERS

     The Israeli Companies Law provides that a company may, if permitted by its
articles of association, indemnify an office holder for acts or omissions
performed by the office holder in such capacity for:

     o    A financial liability imposed on the office holder in favor of another
          person by any judgment, including a settlement or an arbitrator's
          award approved by a court;


                                       53
<PAGE>


     o    Reasonable litigation expenses, including attorney's fees, actually
          incurred by the office holder as a result of an investigation or
          proceeding instituted against him or her by a competent authority,
          provided that such investigation or proceeding concluded without the
          filing of an indictment against the office holder or the imposition of
          any financial liability in lieu of criminal proceedings, or concluded
          without the filing of an indictment against the office holder and a
          financial liability was imposed on the officer holder in lieu of
          criminal proceedings with respect to a criminal offense that does not
          require proof of criminal intent; and

     o    Reasonable litigation expenses, including attorneys' fees, incurred by
          such office holder or which were imposed on him by a court, in
          proceedings we instituted against him or instituted on our behalf or
          by another person, or in a criminal charge from which he was
          acquitted, all in respect of an act performed in his capacity as an
          office holder.

     In accordance with the Israeli Companies Law, a company's articles of
association may permit the company to:

     o    Prospectively undertake to indemnify an office holder, provided that
          the undertaking is limited to types of events, which, in the opinion
          of the company's board of directors, are, at the time of the
          undertaking, foreseeable due to the company's activities and to an
          amount or standard that the board of directors has determined is
          reasonable under the circumstances; and

     o    Retroactively indemnify an office holder of our company.

     LIMITATIONS ON EXCULPATION, INSURANCE AND INDEMNIFICATION

     These provisions are specifically limited in their scope by the Israeli
Companies Law, which provides that a company may not indemnify an office holder,
nor exculpate an office holder, nor enter into an insurance contract that would
provide coverage for any monetary liability incurred as a result of any of the
following:

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

     o    A breach by the office holder of his duty of care if such breach was
          committed intentionally or recklessly, unless the breach was committed
          only negligently;

     o    Any act or omission done with the intent to unlawfully yield a
          personal benefit; or

     o    Any fine imposed on the office holder.


                                       54
<PAGE>


     Pursuant to the Israeli Companies Law, exculpation of, procurement of
insurance coverage for, and an undertaking to indemnify or indemnification of,
our office holders must be approved by our audit committee and our board of
directors and, if the office holder is a director, also by our shareholders.

     Our Articles of Association allow us to insure, indemnify and exempt our
office holders to the fullest extent permitted by law, subject to the provisions
of the Israeli Companies Law.

     Pursuant to the Israeli Companies Law, indemnification of, and procurement
of insurance coverage for, our office holders must be approved by our audit
committee and our board of directors and, if such office holder is a director,
also by our shareholders.

     We currently maintain a directors and officers liability insurance policy
with a per claim and aggregate coverage limit of $5.0 million. However, at ane
annual general meeting of our shareholders held on June, 2005, our shareholders
approved an increase of the aggregate coverage limit to $10.0 million provided
that the annual premium will not exceed $150,000.

NASDAQ MARKETPLACE RULES AND HOME COUNTRY PRACTICES

     Under NASDAQ Marketplace Rule 4350, or Rule 4350, foreign private issuers,
such as our company, are permitted to follow certain home country corporate
governance practices instead of certain provisions of Rule 4350, without the
need to seek individual exemptions from NASDAQ. A foreign private issuer that
elects to follow a home country practice instead of any of such provisions of
Rule 4350, must submit to NASDAQ, in advance, a written statement from an
independent counsel in such issuer's home country certifying that the issuer's
practices are not prohibited by the home country's laws.

     On May 5, 2005, we provided NASDAQ with a notice of non-compliance with
respect to the requirement to maintain a majority of independent directors, as
defined under the NASDAQ Marketplace Rules. Instead, under Israeli law and
practice, we are required to appoint at least two outside directors, within the
meaning of the Israeli Companies Law, to our board of directors. In addition, in
accordance with the rules of the SEC, we have the mandated three independent
directors, as defined by the SEC and NASDAQ rules, on our audit committee. See
above in this Item 6C. "Directors, Senior Management and Employees - Board
Practices - Independent and Outside Directors."

     On May and August 2005, we provided NASDAQ with a notice of non-compliance
with Rule 4350. We informed NASDAQ that we do not comply with the following
requirements of Rule 4350, and instead follow Israeli law and practice in
respect of such requirements:

     o    The requirement to maintain a majority of independent directors, as
          defined under the NASDAQ Marketplace Rules. Instead, under Israeli law
          and practice, we are required to appoint at least two outside
          directors, within the meaning of the Israeli Companies Law, to our
          board of directors. In addition, in accordance with the rules of the
          SEC, we have the mandated three independent directors, as defined by
          the SEC and NASDAQ rules, on our audit committee. See above in this
          Item 6C. "Directors, Senior Management and Employees - Board Practices
          - Independent and Outside Directors.


                                       55
<PAGE>


     o    The requirement that our independent directors will have regularly
          scheduled meetings at which only independent directors are present.
          Under Israeli law independent directors are not required to hold
          executive sessions.

     o    The requirement regarding the directors nominations process. Instead,
          we follow Israeli law and practice in accordance with which our
          directors are recommended by our board of directors for election by
          our shareholders. See above in this Item 6C. "Directors, Senior
          Management and Employees - Board Practices - Election of Directors."

     o    The requirement regarding compensation of officers. Instead, we follow
          Israeli law and practice. Under the Israeli Companies Law, all
          arrangements as to compensation of office holders who are not
          directors require the approval of the board of directors if the
          transaction is not an "extraordinary transaction," unless a company's
          articles of association provide otherwise, and if such transaction is
          an "extraordinary transaction," it requires the approval of the audit
          committee and the board of directors, in that order. The compensation
          of office holders who are directors must be approved by our Audit
          Committee, Board of Directors and shareholders, in that order.

D.   EMPLOYEES

     On December 31, 2005, we employed 109 persons, of whom 38 were employed in
research, development and engineering, 56 persons in manufacturing and
logistics, 5 persons in sales and marketing, and 10 persons in administration
and management and finance. All of our employees are located in Israel. In
addition, CACS (our 80% owned subsidiary) employed 15 persons in China.

     On December 31, 2004, we employed 106 persons, of whom 41 were employed in
research, development and engineering, 51 persons in manufacturing and
logistics, 4 persons in sales and marketing, and 10 persons in administration
and management and finance. All of our employees are located in Israel. In
addition, CACS (our 80% owned subsidiary) employed 18 persons in China.

     On December 31, 2003, we employed 99 persons, of whom 27 were employed in
research, development and engineering, 54 persons in manufacturing and
logistics, 4 persons in sales and marketing, and 11 persons in administration
and management and finance. All of our employees are located in Israel. In
addition, CACS (our 80% owned subsidiary) employed 18 persons in China.


                                       56
<PAGE>


     Our technical employees have signed nondisclosure agreements covering all
proprietary information that they might possess or to which they might have
access. Employees are not organized in any union, although they are employed
according to provisions established by the Israeli Ministry of Labor. Certain
provisions of the collective bargaining agreements between the Histadrut
(General Federation of Labor in Israel) and the Coordination Bureau of Economic
Organizations (including the Industrialists Association) are applicable to our
Israeli employees by order of the Israeli Ministry of Labor. These provisions
concern mainly the length of the workday, minimum daily wages for professional
workers, contributions to a pension fund, insurance for work-related accidents,
procedures for dismissing employees, determination of severance pay and other
conditions of employment. We generally provide our employees with benefits and
working conditions beyond the required minimums. Under the collective bargaining
agreements, the wages of most of our employees are linked to the Israeli
consumer price index, although the extent of the linkage is limited.

     Israeli law generally requires severance pay upon the retirement or death
of an employee or termination of employment without due cause. Further, Israeli
employees and employers are required to pay predetermined sums to the National
Insurance Institute which is similar to the United States Social Security
Administration, such amounts also include payments for national health
insurance. Most of our ongoing severance obligations for our Israeli employees
are provided for by monthly payments made by us for insurance policies to cover
these obligations.

E.   SHARE OWNERSHIP

BENEFICIAL OWNERSHIP OF EXECUTIVE OFFICERS AND DIRECTORS

     The following table sets forth certain information as of March 28, 2006
regarding the beneficial ownership by each of our directors and executive
officers:

                                            NUMBER OF ORDINARY
                                           SHARES BENEFICIALLY    PERCENTAGE OF
             NAME                                 OWNED (1)       OWNERSHIP (2)
             ----                                 ---------       -------------
Herzle Bodinger (3)                               300,000            1.1%
Adar Azancot (3) (4)                              300,000            1.1%
Elan Sigal (3) (5)                                 75,000              *
Zvi Alon (3) (6)                                  100,000              *
Dov Sella (3)                                     100,000              *
Adrian Berg (7) (8)                               256,600            1.0%
Roy Kui Chuen Chan (9) (10)                       176,600              *
Ben Zion Gruber (3)(11)                           254,082            1.0%
Michael Letchinger (12)                                --             --
Hava Snir (3)                                          --             --
Zvi Tropp (3)                                          --             --
All directors and executive officers as a
group (11) persons)(13)                         1,553,082            5.9%

----------
*    Less than 1%


                                       57
<PAGE>


(1)  Beneficial ownership is determined in accordance with the rules of the
     Securities and Exchange Commission and generally includes voting or
     investment power with respect to securities. Ordinary shares relating to
     options and warrants currently exercisable or exercisable within 60 days of
     the date of this table are deemed outstanding for computing the percentage
     of the person holding such securities but are not deemed outstanding for
     computing the percentage of any other person. Except as indicated by
     footnote, and subject to community property laws where applicable, the
     persons named in the table above have sole voting and investment power with
     respect to all shares shown as beneficially owned by them.

(2)  The percentages shown are based on 26,168,027 ordinary shares issued and
     outstanding as of March 28, 2006.

(3)  The business addresses of Messrs. Bodinger, Azancot, Sigal, Alon, Sella,
     Gruber, Tropp and Ms. Snir is c/o RADA Electronic Industries Ltd., 7
     Giborei Israel Street, Netanya, Israel.

(4)  All such ordinary shares are subject to currently exercisable options
     granted under our stock option plans, 200,000 options at an exercise price
     of $0.69 per share and 100,000 options at an exercise price of $1.34 per
     share. The options expire in September 2013.

(5)  All such ordinary shares are subject to currently exercisable options
     granted under our stock option plans, at an exercise price of $1.29 per
     share. The options expire in September 2013.

(6)  All such ordinary shares are subject to currently exercisable options
     granted under our stock option plan at an exercise price of $0.69 per
     share. The options expire in September 2013.

(7)  The business address of Mr. Berg is Alexander & Co., 17 St. Ann's Square,
     Manchester M2 7 PW, U.K.

(8)  Includes 252,000 ordinary shares subject to currently exercisable options
     granted under our stock option plan at an exercise price of $1.34 per
     share. The options expire in September 2013.

(9)  The business address of Mr. Chuen Chan is Gearhart Holdings (H.K.) Limited,
     2202 Kodak House II, 39 Healthy Street, E. North Point, Hong Kong.

(10) Includes 172,000 ordinary shares subject to currently exercisable options
     granted under our stock option plan at an exercise price of $1.34 per
     share. The options expire in September 2013.

(11) Includes 204,082 ordinary shares issuable upon currently exercisable
     warrants at an exercise price of $2.00 per share that were issue in
     connection with the private placement of our shares in June 2002, and
     50,000 ordinary shares subject to currently exercisable options granted
     under our stock option plans, at an exercise price of $1.34 per share. Such
     options expire in September 2013.

(12) The business address of Mr. Letchinger is 2709 Rittenhouse Street,
     Washington DC, 20015, USA.

(13) Includes 204,082 ordinary shares issuable upon the exercise of currently
     exercisable warrants, at an exercise price of $2 per share that were issued
     in connection with a private placement of our shares in June 2002. Such
     warrants expire on June 30, 2007.


                                       58
<PAGE>


STOCK OPTION PLANS

     1996 STOCK OPTION PLAN

     Our 1996 Stock Option Plan, or the 1996 Plan, authorizes the issuance of
options to purchase an aggregate of 5,600 ordinary shares, to key employees and
consultants, including officers and directors of our company and its
subsidiaries, who, are in position to contribute significantly to our success,
in the judgment of the board of directors or, if appointed in the future, a
committee which will administer the 1996 Plan.

     Options granted under the 1996 Plan may be for a maximum term of ten years
from the date of grant. The exercise price of an option granted to an employee
may not be less than 60% of the fair market value of our ordinary shares on the
date of grant of the option. The exercise price of an option to a non-employee
director or consultant may not be less than 80% of the fair market value of our
ordinary shares on the date of grant of the option. If any option expires
without having been fully exercised, the shares with respect to which such
option has not been exercised will be available for future grants.

     Options may not be transferable by the optionee otherwise than by will or
the laws of descent and distribution and during the optionee's lifetime are
exercisable only by the optionee. Options terminate before their expiration
dates one year after the optionee's death while in our employ, three months
after the optionee's retirement for reasons of age or disability or involuntary
termination of employment other than for cause, and immediately upon voluntary
termination of employment or involuntary termination of employment for cause.

     Our board of directors may, at its discretion, modify, revise or terminate
the 1996 Plan at any time, except that the aggregate number of shares issuable
pursuant to options may not be increased (except in the event of certain changes
in our capital structure), the eligibility provisions and minimum option price
may not be changed, or the permissible maximum term of options may not be
increased without the consent of our shareholders.

     The 1996 Plan also contained provisions protecting optionees against
dilution of the value of their options in the case of stock splits, stock
dividends or other changes in our capital structure, in the event of any
proposed reorganization or merger involving our company or in the event of any
spin-off or distribution of assets to our shareholders.

     The board of directors or the committee will determine the number of shares
covered by each option, and the formulation, within the limitations of the 1996
Plan, of the form of option

     As of March 28, 2006, options to purchase 4,400 ordinary shares had been
granted to two employees and directors at an average exercise price of $3.84 per
share. All of such options are currently exercisable. No options have been
exercised to date.


                                       59
<PAGE>


     1999 STOCK OPTION PLAN

     Our 1999 Stock Option Plan, or the 1999 Plan, provides for the issuance of
stock options to purchase an aggregate of 325,200 of our ordinary shares.
Options under the 1999 Plan may be issued to key employees and consultants,
including officers and directors of our company and its subsidiaries who, in the
judgment of the board of directors or, if appointed in the future, a committee
which will administer the 1999 Plan, are in a position to contribute
significantly to our success. The terms of the 1999 Plan are substantially the
same as those of the1996 Plan. As of March 28, 2006, options to purchase 279,000
ordinary shares had been granted to 39 employees at an average exercise price of
$2.39 per share. Of such options, options to purchase 250,502 ordinary shares
are currently exercisable.

     2003 STOCK OPTION PLAN

     Our 2003 Stock Option Plan, or the 2003 Plan, provides for the issuance of
stock options to purchase an aggregate of 2,000,000 of our ordinary shares.
Options under the 2003 Plan may be issued to employees including officers and
directors of our company and its subsidiaries who, in the judgment of the board
of directors based on the recommendation of our compensation committee, are in a
position to contribute significantly to our success. The provisions of our 2003
Plan are designated to allow for the tax benefits promulgated under the Israeli
Income Tax Ordinance [New Version]. Our board of directors has resolved that all
options that will be granted to Israeli residents under the 2003 Plan will be
taxable under the "capital gains path." Pursuant to this path the profit
realized by the employee is taxed as a capital gain (25%) if the options or
shares are held by a trustee for at least 24 months from the end of the tax year
in which such options were granted. If the shares are sold before the lapse of
said 24 months period, the profit is re-characterized as ordinary income. The
company is not allowed a corresponding salary expense, even in the event the
profit is taxed as ordinary income. Otherwise, the terms of the 2003 Plan are
substantially the same as those of the 1996 Plan. As of March 28, 2006 options
to purchase 2,123,000 ordinary shares had been granted. Of such options, 136,003
options have been exercised and 178,497 have been cancelled or forfeited.
Options to purchase 1,612,502 ordinary shares are currently exercisable.

ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

A.   MAJOR SHAREHOLDERS

     Mr. Howard Yeung is the beneficial holder of 46% of our outstanding shares,
and holds currently exercisable warrants to purchase an additional 8,265,306 of
our ordinary shares. Accordingly, Mr. Howard Yeung may be deemed to control our
company.

     The following table sets forth certain information as of March 28, 2006,
regarding the beneficial ownership by all shareholders known to us to own
beneficially 5% or more of our ordinary shares:

                                       NUMBER OF
                                     ORDINARY SHARES     PERCENTAGE OF
NAME                              BENEFICIALLY OWNED(1)   OWNERSHIP(2)
----                              ---------------------   ------------

Howard P.L. Yeung (3)(4)(5)             20,407,861           59.3%
Kenneth Yeung (3)(6)                     1,350,086            5.2%
Iroquuois Capital LLP (7)(8)             1,488,047            5.4%
Smithfield  Fiduciary LLC (9)(10)        1,711,190            6.2%


                                       60
<PAGE>


(1)  Beneficial ownership is determined in accordance with the rules of the
     Securities and Exchange Commission and generally includes voting or
     investment power with respect to securities. Ordinary shares relating to
     options currently exercisable or exercisable within 60 days of the date of
     this table are deemed outstanding for computing the percentage of the
     person holding such securities but are not deemed outstanding for computing
     the percentage of any other person. Except as indicated by footnote, and
     subject to community property laws where applicable, the persons named in
     the table above have sole voting and investment power with respect to all
     shares shown as beneficially owned by them.

(2)  The percentages shown are based on 26,168,027 ordinary shares outstanding
     as of March 28, 2006.

(3)  Of the 20,407,861 ordinary shares, 1,350,086 shares are held by Horsham
     Enterprises Ltd., a corporation incorporated in the British Virgin Islands.
     Messrs. Howard P.L. Yeung and his brother Kenneth Yeung are the beneficial
     owners, in equal shares, of Horsham Enterprises Ltd. Accordingly, Messrs.
     Yeung may be deemed to be the beneficial owners of the ordinary shares held
     by Horsham Enterprises Ltd.

(4)  Includes 8,265,306 ordinary shares issuable upon the exercise of currently
     exercisable warrants issued to Mr. Howard P.L. Yeung.

(5)  The address of Mr. Howard P.L. Yeung is 2202 Kodak Houge II, 39 Healthy
     Street, North Point, Hong Kong.

(6)  The address of Mr. Kenneth Yeung is 2202 Kodak Houge II, 39 Healthy Street,
     North Point, Hong Kong.

(7)  Includes 218,750 ordinary shares issuable upon currently exercisable
     warrants at an exercise price of $2.50 per share and 333,333 ordinary
     shares issuable upon currently exercisable convertible notes that were
     issued in connection with the private placement of our shares in July 2004.
     In addition, 630,259 ordinary shares issuable upon currently exercisable
     warrants at an exercise price of $2.10 per share that was issued in
     connection with the private placement of our shares in April 2005.

(8)  The address of Iroquuois Capital LLP is 641 Lexington Ave., 26th Floor, New
     York, New York, 10022.

(9)  Includes 400,000 ordinary shares issuable upon currently exercisable
     warrants at an exercise price of $2.50 per share and 609,524 ordinary
     shares issuable upon currently exercisable convertible notes that were
     issued in connection with the private placement of our shares in July 2004.
     In addition, 472,541 ordinary shares issuable upon currently exercisable
     warrants at an exercise price of $2.10 per share that was issued in
     connection with the private placement of our shares in April 2005.

(10) The address of Smithfield Fiduciary LLC is c/o Highbridge Capital
     Management LLC, 9 West 57th Street, 27th Floor, New York, New York 10019.


                                       61
<PAGE>


MAJOR SHAREHOLDERS VOTING RIGHTS

     Our major shareholders do not have different voting rights.

 RECORD HOLDERS

     Based on a review of the information provided to us by our transfer agent,
as of March 27, 2006, there were 99 holders of record of our ordinary shares, of
which 78 record holders holding approximately 22.47% of our ordinary shares had
registered addresses in the United States, including banks, brokers and
nominees. These numbers are not representative of the number of beneficial
holders of our shares nor are they representative of where such beneficial
holders reside, since many of these ordinary shares were held of record by
banks, brokers or other nominees

B.   RELATED PARTY TRANSACTIONS

     On April 23, 2002, we entered into a loan agreement with Mr. Yeung,
according to which he provided us with a $550,000 loan facility. The purpose of
the facility was to provide us with short term working capital. We utilized
$350,000 of the facility between April to June 2002. The remainder of this
facility was subsequently converted into our ordinary shares.

     On June 9, 2002, our shareholders approved the conversion of $1,350,000 of
the principal amount of loans granted by Mr. Yeung, our controlling shareholders
into 2,755,102 of our ordinary shares at a price of $0.49 per share, which is
equal to 70% of the average closing price of our ordinary shares for the ten
(10) trading days prior to June 9, 2002. In addition, we agreed to issue to Mr.
Yeung warrants to purchase 8,265,306 ordinary shares. Such warrants will be
outstanding for five years and will be exercisable during the first 36 months at
an exercise price of $2.00 per share, and during the subsequent 24 month period,
at an exercise price which shall be equal to the higher of: (i) $2.00 per share
or (ii) 50% of the average closing price of our ordinary shares during the ten
(10) trading days prior to the exercise date.

     We also agreed to provide Mr. Yeung with the right to cause us to file a
registration statement with the SEC commencing one year after the issuance date,
to register the resale of the ordinary shares issued and the ordinary shares
issuable upon exercise of the warrants.

     On June 22, 2003 we signed a memorandum of agreement with Bank Hapoalim
B.M. and Bank Leumi Le-Israel B.M., or the Banks, which agreement was approved
by our shareholders at an extraordinary general meeting of shareholders that was
held on July 22, 2003. Pursuant to the agreement that was finalized on September
24, 2003, we restructured $3,451,000 of our outstanding debt to the Banks. We
repaid $1,100,000 on account of our debt the Banks, and the Banks forgave
$1,100,000 of debt and received warrants to purchase 3,781,995 of our ordinary
shares, at an exercise price that is equal to the nominal (par) value of our
shares, in lieu of $1,251,000 of our debt. The Banks also agreed to grant us an
additional short-term line of credit of $500,000 to finance our cash flow
requirements during 2003. As part of the agreement, our controlling shareholder,
Mr. Yeung, agreed to grant the Banks a put option allowing the Banks to require
him to purchase the above warrants for the consideration of $1,251,000,
exercisable within a period of 45 days commencing on March 24, 2005 and the
Banks granted Mr. Yeung a call option allowing him to require the Banks, during
a period of 18 months, commencing as of September 24, 2003, and in the event
that the Banks do not exercise their put option, during an additional 90 day
period commencing as of May 9, 2005, to sell him such warrants at a price that
is not lower than $1,251,000 and not higher then $1,770,165, depending upon the
average close price of our ordinary shares during the 90 business days prior to
such exercise. We also granted the Banks warrants to purchase an additional
1,100,000 ordinary shares at an exercise price of $2.00 per share, exercisable
for five years, commencing as of September 24, 2003. In May 2005, Mr. Yeung
exercised his call option to purchase the warrants from the Banks and in October
2005 exercised these warrants. Upon such exercise, we issued Mr. Yeung 3,781,995
ordinary shares.


                                       62
<PAGE>


C.   INTERESTS OF EXPERTS AND COUNSEL

     Not applicable.

ITEM 8. FINANCIAL INFORMATION

A.   CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION

LEGAL PROCEEDINGS

     In December 1998, Mr. Haim Nissenson, our former president and chief
executive officer, filed a complaint against us and Mr. Herzle Bodinger, our
president, in the Regional Court for Labor Disputes of Tel Aviv (Case No.
3/4074/98 H. NISSENSON V. RADA ELECTRONIC INDUSTRIES LTD. AND OTHERS), seeking
approximately NIS 2.0 million (approximately $440,000) for salary, vacation and
severance payments and other benefits that he is allegedly entitled to pursuant
to his retirement agreement with us. In addition, Mr. Nissenson is seeking a
permanent injunction and a declarative relief, stating that a personal loan that
was provided to him by us had been forgiven. Mr. Nissenson is also asserting
that Mr. Bodinger caused the breach of the retirement agreement. In response, we
filed a statement of defense claiming, among other things, that (i) the
retirement agreement is not valid since it was not approved pursuant to the
requirements of the applicable law; (ii) Mr. Nissenson was responsible for our
company's precarious financial condition at the time he resigned and for the
concealment of these facts from our board of directors and our investors; (iii)
during the board of directors meeting in which such agreement was discussed and
approved, Mr. Nissenson misrepresented our financial and economic condition and
the nature and origins of his debt to us; and (iv) by breaching his fiduciary
duties Mr. Nissenson caused us damages in amounts that exceed the amount of the
complaint, which damages should be offset from any amounts awarded in favor of
Mr. Nissenson, if any. In addition, we asserted that in accordance to a
certificate dated March 23, 1992, Mr. Nissenson assigned all his rights to
receive employment related benefits other than salaries, including severance and
vacation payments up to the above certificate date. The hearing of this claim
was combined with the hearing of our claim for repayment of the loan granted to
Mr. Nissenson, as detailed below. After completion of the testimony of Mr.
Nissenson's witnesses, the court is currently hearing the testimony of our
witnesses. Our management believes that this claim will not have a material
adverse effect on our financial condition or results of operations. In addition,
the income tax authorities have demanded that we commence payment of the salary
tax due in respect of the retirement arrangements of Mr. Nissenson which are the
subject matter of this litigation. An agreement was reached with the tax
authority whereby the tax liability shall be discharged over several years and
that in the event that Mr. Nissenson's claim shall be dismissed, the tax payment
shall be recovered.


                                       63
<PAGE>


     In September 1999, we filed a suit in the District Court of Tel-Aviv
against Messrs. Haim Nissenson and Eles Dubronsky, a former board member, (Civil
File 2514/99 RADA ELECTRONIC INDUSTRIES LTD. V. H. NISSENSON AND OTHERS) seeking
damages in the amount of $1.4 million. In the complaint, we alleged that Messrs.
Nissenson and Dubronsky: (i) represented to our board of directors inaccurate
and incomplete information, and (ii) failed to disclose, during the course of
our board's deliberations to acquire Jetborne International, Ltd., their
personal interest in Jetborne International and Mr. Nissenson's involvement in a
previous attempt to gain control of Jetborne International several years
earlier. We alleged that our board of directors approved the acquisition based
on such inaccurate and incomplete information and that the acquisition caused
severe losses. We further alleged that in their conduct Messrs. Nissenson and
Dubronsky breached their fiduciary duty owed to us and to our shareholders while
acting as an executive and members of our board of directors. Our motion to
attach the funds deposited by Mr. Nissenson in his pension funds was denied by
the Court in May 2000. The suit is currently in its preliminary stages, and
efforts are being made to commence a mediation process in respect thereof.

     In January 2000, Vertical Integration Limited filed a claim against us with
the District Court of Tel Aviv (Case No. 1120/00 VERTICAL INTEGRATION LIMITED V.
RADA ELECTRONIC INDUSTRIES LTD) for the amount of $250,000. It is alleged that
at the beginning of 1997, they entered into an agreement with us, whereby they
were entitled to remuneration in the event that they found an investor for our
company. It is further alleged that they had initiated the negotiations that
took place during 1997 and 1998 between us and Boeing Corporation, and that the
Cooperation Agreement, which was entered into with Boeing Corporation in 1999,
was a result of their efforts and that they are entitled to a commission. The
claim was vigorously defended and the case is in its final stages pending
judgment to be delivered by the court. We believe that there will be no material
exposure or adverse effect on our financial condition as a result of this suit.

     In August 2000, we filed a claim against Mr. Haim Nissenson in the Regional
Court for Labor Disputes in Tel Aviv (Case No. 7049/00 RADA ELECTRONIC
INDUSTRIES LTD. V. NISSENSON.) for the amount of NIS 2.0 million (approximately
$440,000) for the repayment of the loan granted by us to Mr. Nissenson that
allegedly was forgiven by us in Mr. Nissenson's retirement agreement, as
mentioned above. The hearings of both Mr. Nissenson's and our claims in the
Regional Court for Labor Disputes were joined and the court is currently hearing
the testimony of our witnesses.

     In October 2000, Mr. Guy Nissenson, the son of Mr. Haim Nissenson, filed a
complaint in the District Court of Tel-Aviv against Mr. Bodinger (Civil Case
2733/99 G. NISSENSON V. H. BODINGER), alleging that Mr. Bodinger made defamatory
comments regarding him during a board meeting. The complaint seeks damages in
the amount of NIS 1.1 million (approximately $250,000). On June 2004, the
District Court completely denied the claim and compelled the plaintiff to pay
litigation costs in the amount of NIS 50,000. The plaintiff appealed the
judgment to the Israeli Supreme Court and the appeal is pending.


                                       64
<PAGE>


     In January 2001, we filed a suit against our former controller, Mr.
Mordechai Perera in the Regional Court for Labor Disputes in Tel Aviv (Case No.
1672/01 RADA ELECTRONIC INDUSTRIES LTD. V. PERERA) in the amount of
approximately $260,000 for the repayment of a loan provided to him. While Mr.
Perera does not deny that he received such amount, he claims that it was
promised to him on account of his compensation and was registered as a loan in
the books of our company for tax purposes. He further claims that Mr. Nissenson
orally promised him that such loan would be forgiven. In March 2001, Mr. Perera
filed a counter claim in the amount of approximately $520,000 for various
payments to which he is allegedly entitled in connection with his employment and
termination thereof by us, including bonus, severance payments, vacation
redemption and overtime payments. The hearing of the cases was completed and the
parties are now preparing written summations.

     In February 2001, we filed a suit against Mr. Dubronsky, in the District
Court of Tel Aviv (Civil Case 1158/01 RADA ELECTRONIC INDUSTRIES LTD. V. E.
DUBRONSKY) seeking approximately $250,000. We maintain that Mr. Dubronsky is
personally responsible for drafting and executing Mr. Nissenson's retirement
agreement and that in such capacity he breached his fiduciary duties to our
company and should the Labor Court decide that the retirement agreement is valid
and enforceable against us, Mr. Dubronsky has to indemnify us for all the
damages caused to us as a result of such Court decision. The District Court has
issued a stay of the proceedings pending resolution of the Labor Court
proceedings detailed above. In the event that a mediation process takes place,
as mentioned above, this claim will also be included in it.

     In May 2001, Mr. Haim Nissenson filed a suit against us in the District
Court of Tel Aviv (Civil Case 1715/01 H. NISSENSON V. RADA ELECTRONIC INDUSTRIES
LTD.) for damages allegedly suffered by him as a result the cancellation of an
attachment imposed by us on his pension funds in connection with the previously
mentioned Jetborne International litigation. The claim is for NIS 1.0 million
(approximately $220,000). In response, we filed a statement of defense denying
all of Mr. Nissenson's allegations. In the event that a mediation process takes
place, as mentioned above, this claim will also be included in it.

     In May 2001, Mr. David Kenig, a former member of our board of directors,
filed a claim against us in the District Court of Tel Aviv (Civil Case 1791/01
KENIG V. RADA ELECTRONIC INDUSTRIES LTD.) seeking a declaration that he is
entitled to receive options to purchase 600,000 of our ordinary shares under the
same terms and conditions as those granted by us to other directors in 1999, and
an injunction enforcing us to issue such options to him. Based on legal advice,
we believe that the claim has no merits. In July 2001 we filed a counter-claim
in the amount of NIS 500,000. In the counter-claim we maintain that Mr. Kenig is
personally responsible for executing Mr. Nissenson's retirement agreement and
that in such capacity he breached his fiduciary and care duties towards us and
should the Labor Court decide that the retirement agreement is valid and
enforceable against us, then Mr. Kenig has to indemnify us for all the damages
caused to us as a result of such Labor Court decision. The District Court has
issued a stay of the hearings pending resolution of the Labor Court proceedings
detailed above.


                                       65
<PAGE>


     In June 2001, we filed a counter claim against Mr. Haim Nissenson, his wife
and another former director for damages caused us as a result of transfers of
funds to third parties that were made in breach of fiduciary duties owed to us
by Mr. Nissenson and the other former director. In addition, we are seeking a
declaratory judgment stating that Mrs. Nissenson is liable to us for the
repayment of the loan provided to Mr. Nissenson, jointly with Mr. Nissenson. We
are also seeking a declaration that the transfer of the title to Mr. Nissenson's
house and another apartment to his wife without consideration in the beginning
of 1997 are void and were made to avoid the repayment of outstanding loans to
us. In the event that a mediation process takes place, as mentioned above, this
claim will also be included in it.

     In August 2004, Mr. Nissenson filed a suit against us, and our office
holders, Messers. Bodinger, Azancot, Agmon, Tropp, Sigal and Ms. Snir and
against our former chief financial officer, Mr. Ronen Stein, in the District
Court of Tel Aviv (Civil Case 56365/04 NISSENSON V. RADA ELECTRONIC INDUSTRIES
LTD. AND OTHERS), seeking damages in the amount of NIS 1.0 million
(approximately $220,000) and alleging that the description of the claim filed
against him and another former director in connection with the acquisition of
our formerly owned subsidiary Jetborne International, Ltd. included in our
annual reports on Form 20-F and certain press releases contains defamatory
allegations with respect to Mr. Nissenson. We believe that we and our officers
have valid defenses against these claims. According to Israeli law, the usual
award in defamatory claims is low and does not exceed NIS 500,000 (approximately
$110,000).

     In June 2005, Mr. Nissenson filed a suit in the District Court of Tel Aviv
against our chairman, Mr. Bodinger (Civil Case No. 1845/05 H. NISSENSON V. H.
BODINGER) seeking damages in an amount of NIS 2.6 million (approximately
$565,000 ). In the complaint, which was filed with the court one day before the
expiration of the statute of limitations , Mr. Nissenson alleged that Mr.
Bodinger committed fraud against him and negligent misrepresentation towards
him, as a result of which he was compelled at the time (June 1998), to retire
from his position as the chief executive officer of our company. Mr. Nissenson
further alleged that Mr. Bodinger represented to our board of directors that
Boeing Corporation would not invest in our company unless Mr. Nissenson retired
from his position as the chief executive officer. It is further alleged that as
a result, Mr. Nissenson retired from his position, losing income equal to the
claimed amount of NIS 2.6 million. In response, we filed a statement of defense,
claiming among other things, that no representation whatsoever was made by Mr.
Bodinger to the board of directors and that Mr. Nissenson was fully aware, at
all times, of all the relevant information regarding the possibility of the
investment by Boeing Corporation. We further asserted that the allegation raised
by Mr. Nissenson in this claim is inconsistent with his allegation in his claim
against us in the Regional Court for Labor Dispute (Case No. 3/4074/98) and that
there is no sufficient legal basis for his claim. Our management believes that
this claim (in respect of which Mr. Bodinger is entitled to indemnity from us),
does not carry any material exposure or adverse effect on our financial
condition. In the event that a mediation process takes place, as mentioned
above, this claim will also be included in it.

     From time to time we are involved in legal proceedings arising from the
operation of our business. Based on the advice of our legal counsel, management
believes such other current proceedings will not have a material adverse effect
on our financial position or results of operations.


                                       66
<PAGE>


DIVIDEND DISTRIBUTION

     We have never paid cash dividends to our shareholders. We intend to retain
future earnings for use in our business and do not anticipate paying cash
dividends on our ordinary shares in the foreseeable future. Any future dividend
policy will be determined by the board of directors and will be based upon
conditions then existing, including our results of operations, financial
condition, current and anticipated cash needs, contractual restrictions and
other conditions as the board of directors may deem relevant.

     According to the Israeli Companies Law, a company may distribute dividends
out of its profits, so long as the company reasonably believes that such
dividend distribution will not prevent the company from paying all its current
and future debts. Profits, for purposes of the Israeli Companies Law, means the
greater of retained earnings or earnings accumulated during the preceding two
years. In the event cash dividends are declared, such dividends will be paid in
NIS.

B.   SIGNIFICANT CHANGES

     Since the date of the annual consolidated financial statements included in
this annual report, no significant changes have occurred.

ITEM 9. THE OFFER AND LISTING

A.   OFFER AND LISTING DETAILS

     ANNUAL STOCK INFORMATION

     The following table sets forth, for each of the years indicated, the range
of high ask and low bid prices of our ordinary shares on the NASDAQ National
Market or the NASDAQ Capital Market:

YEAR           HIGH           LOW
----           ----           ---
2001          $2.58          $1.48
2002           1.80           0.54
2003           2.37           0.41
2004           3.44           1.14
2005           1.88           1.06

QUARTERLY STOCK INFORMATION

     The following table sets forth, for each of the full financial quarters in
the years indicated, the range of high ask and low bid prices of our ordinary
shares on the NASDAQ Capital Market:

2004                     HIGH           LOW
----                     ----           ---
First Quarter           $1.99          $1.44
Second Quarter           3.44           1.41
Third Quarter            2.32           1.14
Fourth Quarter           1.64           1.16


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<PAGE>


2005                     HIGH            LOW
----                     ----            ---
First Quarter           $1.88          $1.46
Second Quarter           1.74           1.29
Third Quarter            1.52           1.25
Fourth Quarter           1.33           1.06


MONTHLY STOCK INFORMATION

     The following table sets forth, for the most recent six months, the range
of high ask and low bid prices of our ordinary shares on the NASDAQ Capital
Market:

2005                                        HIGH               LOW
----                                        ----               ---
October                                    $1.33             $1.18
November                                    1.23              1.13
December                                    1.19              1.06

2006
----
January                                     1.29              1.08
February                                    1.14              1.00
March [through March 28, 2006]              1.16              0.90


B.   PLAN OF DISTRIBUTION

     Not applicable.

C.   MARKETS

     Our ordinary shares traded on the NASDAQ National Market under the symbol
"RADIF" from 1985 until June 10, 2002 when the listing of our ordinary shares
was transferred to the NASDAQ Capital Market. On December 13, 2005, we changed
our symbol to "RADI"

D.   SELLING SHAREHOLDERS

     Not applicable.

E.   DILUTION

     Not applicable.

F.   EXPENSE OF THE ISSUE

     Not applicable.


                                       68
<PAGE>


ITEM 10. ADDITIONAL INFORMATION

A.   SHARE CAPITAL

     Not applicable.

B.   MEMORANDUM AND ARTICLES OF ASSOCIATION

     We are registered with the Israeli Companies Registry and have been
assigned company number 52-003532-3. Section 2 of our memorandum of association
provides that we were established for the purpose of engaging in the business of
providing services of planning, development, consultation and instruction in the
electronics field. In addition, the purpose of our company is to perform various
corporate activities permissible under Israeli law.

     On February 1, 2000, the Israeli Companies Law came into effect and
superseded most of the provisions of the Israeli Companies Ordinance (New
Version), 5743-1983, except for certain provisions which relate to liens,
bankruptcy, dissolution and liquidation of companies. Under the Israeli
Companies Law, as recently amended, various provisions, some of which are
detailed below, overrule the current provisions of our articles of association.

     THE POWERS OF THE DIRECTORS

     Under the provisions of the Israeli Companies Law, or and our articles of
association, a director cannot participate in a meeting nor vote on a proposal,
arrangement or contract in which he or she is materially interested. In
addition, our directors cannot vote compensation to themselves or any members of
their body without the approval of our audit committee and our shareholders at a
general meeting. See "Item 6A. Directors, Senior Management and Employees -
Approval of Related Party Transactions Under Israeli Law."

     The authority of our directors to enter into borrowing arrangements on our
behalf is not limited, except in the same manner as any other transaction by us.

     Under our articles of association, retirement of directors from office is
not subject to any age limitation and our directors are not required to own
shares in our company in order to qualify to serve as directors.

     RIGHTS ATTACHED TO SHARES

     Our authorized share capital consists of 47,500,000 ordinary shares of a
nominal value of NIS 0.005 each. All outstanding ordinary shares are validly
issued, fully paid and non-assessable. The rights attached to the ordinary
shares are as follows:


                                       69
<PAGE>


     DIVIDEND RIGHTS. Holders of our ordinary shares are entitled to the full
amount of any cash or share dividend subsequently declared. The board of
directors may declare interim dividends and propose the final dividend with
respect to any fiscal year only out of the retained earnings, in accordance with
the provisions of the Israeli Companies Law. Our articles of association provide
that the declaration of a dividend requires approval by an ordinary resolution
of the shareholders, which may decrease but not increase the amount proposed by
the board of directors. See "Item 8A. Financial Information - Consolidated and
Other Financial Information - Dividend Distribution." If after one year a
dividend has been declared and it is still unclaimed, the board of directors is
entitled to invest or utilize the unclaimed amount of dividend in any manner to
our benefit until it is claimed. We are not obligated to pay interest or linkage
differentials on an unclaimed dividend.

     VOTING RIGHTS. Holders of ordinary shares have one vote for each ordinary
share held on all matters submitted to a vote of shareholders. Such voting
rights may be affected by the grant of any special voting rights to the holders
of a class of shares with preferential rights that may be authorized in the
future.

     An ordinary resolution, such as a resolution for the declaration of
dividends, requires approval by the holders of a majority of the voting rights
represented at the meeting, in person, by proxy or by written ballot and voting
thereon. Under our articles of association, a special resolution, such as
amending our memorandum of association or articles of association, approving any
change in capitalization, winding-up, authorization of a class of shares with
special rights, or other changes as specified in our articles of association,
requires approval of a special majority, representing the holders of no less
than 75% of the voting rights represented at the meeting in person, by proxy or
by written ballot, and voting thereon.

     Pursuant to our articles of association, our directors are elected at our
annual general meeting of shareholders by a vote of the holders of a majority of
the voting power represented and voting at such meeting. See "Item 6A.
Directors, Senior Management and Employees - Election of Directors."

     RIGHTS TO SHARE IN THE COMPANY'S PROFITS. Our shareholders have the right
to share in our profits distributed as a dividend and any other permitted
distribution. See "- Rights Attached to Shares - Dividend Rights."

     RIGHTS TO SHARE IN SURPLUS IN THE EVENT OF LIQUIDATION. In the event of our
liquidation, after satisfaction of liabilities to creditors, our assets will be
distributed to the holders of ordinary shares in proportion to the nominal value
of their holdings. This right may be affected by the grant of preferential
dividend or distribution rights to the holders of a class of shares with
preferential rights that may be authorized in the future.

     LIABILITY TO CAPITAL CALLS BY THE COMPANY. Under our memorandum of
association and the Israeli Companies Law, the liability of our shareholders is
limited to the par value of the shares held by them.

     LIMITATIONS ON ANY EXISTING OR PROSPECTIVE MAJOR SHAREHOLDER. See Item 6A.
"Directors and Senior Management - Approval of Related Party Transactions Under
Israeli Law."


                                       70
<PAGE>


     CHANGING RIGHTS ATTACHED TO SHARES

     According to our articles of association, in order to change the rights
attached to any class of shares, unless otherwise provided by the terms of the
class, such change must be adopted by a general meeting of the shareholders and
by a separate general meeting of the holders of the affected class with a
majority of 75% of the voting power participating in such meeting.

     ANNUAL AND EXTRAORDINARY MEETINGS

     The board of directors must convene an annual meeting of shareholders at
least once every calendar year, within fifteen months of the last annual
meeting. Notice of at least thirty days prior to the date of the meeting is
required. An extraordinary meeting may be convened by the board of directors, as
it decides or upon a demand of any two directors or 25% of the directors,
whichever is lower, or of one or more shareholders holding in the aggregate at
least 5% of our issued capital and at least 1% of the voting rights in our
company. An extraordinary meeting must be held not more than thirty-five days
from the publication date of the announcement of the meeting.

     The quorum required for an ordinary meeting of shareholders consists of at
least two shareholders present in person or represented by proxy who hold or
represent, in the aggregate, at least one third of the voting rights of the
issued share capital. A meeting adjourned for lack of a quorum generally is
adjourned to the same day in the following week at the same time and place or
any time and place as the directors designate in a notice to the shareholders.
At the reconvened meeting, the required quorum consists of any two members
present in person or by proxy.

     LIMITATIONS ON THE RIGHTS TO OWN SECURITIES IN OUR COMPANY

     Neither our memorandum of association or our articles of association nor
the laws of the State of Israel restrict in any way the ownership or voting of
shares by non-residents, except with respect to subjects of countries which are
in a state of war with Israel.

     PROVISIONS RESTRICTING CHANGE IN CONTROL OF OUR COMPANY

     The Israeli Companies Law requires that mergers between Israeli companies
be approved by the board of directors and general meeting of shareholders of
both parties to the transaction. The approval of the board of directors of both
companies is subject to such board's confirmation that there is no reasonable
doubt that after the merger the surviving company will be able to fulfill its
obligations towards its creditors. Each company must notify its creditors about
the contemplated merger. Generally, under the Israeli Companies Law, our
articles of association are deemed to include a requirement that such merger be
approved by an extraordinary resolution of the shareholders, as explained above.
The approval of the merger by the general meetings of shareholders of the
companies is also subject to additional approval requirements as specified in
the Israeli Companies Law and regulations promulgated thereunder. See also "Item
6A. Directors, Senior Management and Employees - Directors and Senior Management
- Approval of Related Party Transactions Under Israeli Law."


                                       71
<PAGE>


     DISCLOSURE OF SHAREHOLDERS OWNERSHIP

     The Israeli Securities Law and regulations promulgated thereunder do not
require a company whose shares are publicly traded solely in a stock exchange
outside of Israel, as in the case of our company, to disclose its share
ownership.

     CHANGES IN OUR CAPITAL

     Changes in our capital are subject to the approval of the shareholders at a
general meeting by a special majority of 75% of the votes of shareholders
participating and voting in the general meeting.

C.   MATERIAL CONTRACTS

     None.

D.   EXCHANGE CONTROLS

     Israeli law and regulations do not impose any material foreign exchange
restrictions on non-Israeli holders of our ordinary shares. In May 1998, a new
"general permit" was issued under the Israeli Currency Control Law, 1978, which
removed most of the restrictions that previously existed under such law, and
enabled Israeli citizens to freely invest outside of Israel and freely convert
Israeli currency into non-Israeli currencies.

     Non-residents of Israel who purchase our ordinary shares will be able to
convert dividends, if any, thereon, and any amounts payable upon our
dissolution, liquidation or winding up, as well as the proceeds of any sale in
Israel of our ordinary shares to an Israeli resident, into freely repatriable
dollars, at the exchange rate prevailing at the time of conversion, provided
that the Israeli income tax has been withheld (or paid) with respect to such
amounts or an exemption has been obtained.

E.   TAXATION

     The following is a discussion of Israeli and United States tax consequences
material to us and our shareholders. To the extent that the discussion is based
on new tax legislation which has not been subject to judicial or administrative
interpretation, the views expressed in the discussion might not 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 exhaust all
possible tax considerations.

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


                                       72
<PAGE>


ISRAELI TAX CONSIDERATIONS

     The following is a summary of the current tax structure applicable to
companies in Israel, with special reference to its effect on us. The following
also contains a discussion of the material Israeli tax consequences to
purchasers of our ordinary shares and Israeli government programs benefiting us.
This summary does not discuss all the aspects 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.

     GENERAL CORPORATE TAX RATE

     Israeli companies are subject to income tax on their worldwide income. The
applicable rate for 2005 was 34%. The rate was reduced to 31% in 2006, and will
be further reduced to 29% in 2007, 27% in 2008, 26% in 2009 and 25% in 2010 and
thereafter.

     LAW FOR THE ENCOURAGEMENT OF INDUSTRY (TAXES), 1969

     Under the Law for the Encouragement of Industry (Taxes), 1969, or the
Industry Encouragement Law, Industrial Companies are entitled to certain
corporate tax benefits, including, among others:

     o    Deduction, under certain conditions, of purchases of know-how and
          patents over an eight-year period for tax purposes;

     o    Right to elect, under specified conditions, to file a consolidated tax
          return with additional related Israeli industrial companies;

     o    Accelerated depreciation rates on equipment and buildings; and

     o    Deductions over a three-year period of expenses involved with the
          issuance and listing of shares on the Tel Aviv stock exchange or, on
          or after January 1, 2003, on a recognized stock market outside of
          Israel.

     Eligibility for benefits under the Industry Encouragement Law is not
subject to receipt of prior approval from any governmental authority. Under the
Industry Encouragement Law, an "Industrial Company" is defined as a company
resident in Israel, at least 90% of the income of which, in any tax year,
determined in Israeli currency, exclusive of income from government loans,
capital gains, interest and dividends, is derived from an "Industrial
Enterprise" owned by it. An "Industrial Enterprise" is defined as an enterprise
owned by an Industrial Company, whose major activity in a given tax year is
industrial production activity.

     We believe that we currently qualify as an Industrial Company within the
definition of the Industry Encouragement Law. No assurance can be given that we
will continue to qualify as an Industrial Company or that the benefits described
above will be available in the future.


                                       73
<PAGE>


     LAW FOR THE ENCOURAGEMENT OF INDUSTRIAL RESEARCH AND DEVELOPMENT, 1984

     The Government of Israel encourages research and development projects
through the Office of Chief Scientist of the Israeli Ministry of Industry, Trade
and Labor, or the Office of the Chief Scientist, pursuant to the Law for the
Encouragement of Industrial Research and Development, 1984, and the regulations
promulgated thereunder, commonly referred to as the Research Law. Grants
received under such programs are repaid through a mandatory royalty based on
revenues from products incorporating know-how developed with the grants. This
government support is conditioned upon the ability of the participant to comply
with certain applicable requirements and conditions specified in the Office of
the Chief Scientist's programs and with the provisions of the Research Law.

     Under the Research Law, research and development programs which meet
specified criteria and are approved by a research committee of the Office of the
Chief Scientist are eligible for grants of up to 50% of certain of the project's
approved expenditure, as determined by the research committee.

     In exchange, the recipient of such grants is required to pay the Office of
the Chief Scientist royalties from the revenues derived from products
incorporating technology developed within the framework of the approved research
and development program or derived from such program (including ancillary
services in connection with such program), usually up to100% of the U.S.
dollar-linked value of the total grants received in respect of such program,
plus LIBOR interest.

     The terms of the Israeli Government participation generally requires that
the products developed with such grants be manufactured in Israel. However,
under regulations promulgated under the Research Law, upon the approval of the
Chief Scientist, some of the manufacturing volume may be performed outside
Israel, provided that the grant recipient pays royalties at an increased rate.
The Research Law also allows for the approval of grants in cases in which the
applicant declares that part or all of the manufacturing will be performed
outside of Israel or by non-Israeli residents and the research committee is
convinced that this is essential for the execution of the program. The Research
Law also provides that know-how developed under an approved research and
development program may not be transferred to third parties in Israel without
the prior approval of the research committee. The Research Law further provides
that the know-how developed under an approved research and development program
may not be transferred to any third parties outside Israel. No approval is
required for the sale or export of any products resulting from such research and
development.

     However, in June 2005, an amendment to the Research Law became effective,
which amendment was intended to make the Research Law more compatible with the
global business environment by, among other things, relaxing restrictions on the
transfer of manufacturing rights outside Israel and on the transfer of Office of
the Chief Scientist-funded know-how outside of Israel. The amendment permits the
Office of the Chief Scientist, among other things, to approve the transfer of
manufacturing rights outside Israel in exchange for an import of different
manufacturing into Israel as a substitute, in lieu of demanding the recipient to
pay increased royalties as described above. The amendment further permits, under
certain circumstances and subject to the Office of the Chief Scientist's prior
approval, the transfer outside Israel of know-how that has been funded by Office
of the Chief Scientist, generally in the following cases: (a) the grant
recipient pays to the Office of the Chief Scientist a portion of the
consideration paid for such funded know-how (according to certain formulas), (b)
the grant recipient receives know-how from a third party in exchange for its
funded know-how, or (c) such transfer of funded know-how arises in connection
with certain types of cooperation in research and development activities.


                                       74
<PAGE>


     The Research Law imposes reporting requirements with respect to certain
changes in the ownership of a grant recipient. The law requires the grant
recipient and its controlling shareholders and interested parties to notify the
Office of the Chief Scientist of any change in control of the recipient or a
change in the holdings of the means of control of the recipient that results in
a non-Israeli becoming an interested party directly in the recipient and
requires the new interested party to undertake to the Office of the Chief
Scientist to comply with the Research Law. In addition, the rules of the Office
of the Chief Scientist may require prior approval of the Office of the Chief
Scientist or additional information or representations in respect of certain of
such events. For this purpose, "control" is defined as the ability to direct the
activities of a company other than any ability arising solely from serving as an
officer or director of the company. A person is presumed to have control if such
person holds 50% or more of the means of control of a company. "Means of
control" refers to voting rights or the right to appoint directors or the chief
executive officer. An "interested party" of a company includes a holder of 5% or
more of its outstanding share capital or voting rights, its chief executive
officer and directors, someone who has the right to appoint its chief executive
officer or at least one director, and a company with respect to which any of the
foregoing interested parties owns 25% or more of the outstanding share capital
or voting rights or has the right to appoint 25% or more of the directors.
Accordingly, any non-Israeli who acquires 5% or more of our ordinary shares will
be required to notify the Office of the Chief Scientist that it has become an
interested party and to sign an undertaking to comply with the Research Law.
Additionally, procedures regulated under the Research Law require the grant
recipient to obtain the approval of the Office of the Chief Scientist prior to a
change in the holdings of the recipient or change in the holdings of the means
of control of the recipient if the recipient's shares are being issued to a
non-Israeli person or entity and require the new non-Israeli party to undertake
to the Office of the Chief Scientist to comply with the Research Law.

     The funds available for grants from the Office of the Chief Scientist were
reduced in 1998, however the Israeli authorities have indicated in the past that
the government may increase grants from the Office of the Chief Scientist in the
future.

     In order to meet certain conditions in connection with the grants and
programs of the Office of the Chief Scientist, we have made some representations
to the Israeli government about our future plans for our Israeli operations.
From time to time the extent of our Israeli operations has differed and may in
the future differ, from our representations. If, after receiving grants under
certain of such programs, we fail to meet certain conditions to those benefits
or if there is any material deviation from the representations made by us to the
Israeli government, we could be required to refund to the State of Israel tax or
other benefits previously received (including interest and consumer price index
linkage difference) and would likely be denied receipt of such grants or
benefits, and participation of such programs, thereafter.


                                       75
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     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. Its features,
which are material to us, can be summarized as follows:

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

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

     CAPITAL GAINS TAX ON SALES OF OUR ORDINARY SHARES

     As of January 1, 2003, when the recent Israeli tax reform came into effect,
individuals and companies on which the provisions of the income tax law
(Inflationary Adjustments), 1985 are not imposed, are subject to a 15% tax rate
on the real capital gains derived on or after January 1, 2003 from the sale of
shares in Israeli companies publicly traded on a recognized stock exchange
outside of Israel. This will be the case so long as our securities remain listed
on NASDAQ or traded on a stock exchange in Israel or another country.

     Under a recent amendment to the income tax ordinance, effective as of
January 1, 2003 and with respect to sales of shares on or after January 1 2006,
individuals are subject to a 20% tax rate on the real capital gains derived on
or after January 1, 2003 from the sale of shares. Substantial individual
shareholders (who are defined as shareholders of 10% or more of the shares of
the company on the date of the sale of the shares or any date during the 12
months before the sale of the shares) are subject to a 25% tax rate on the real
capital gains derived on or after January 1, 2003 from the sale of shares.
Companies on which the provisions of the income tax law (Inflationary
Adjustments), 1985 were not imposed before January 1, 2006 are subject to 25%
tax rate on real capital gains derived on or after January 1, 2003 from the sale
of the shares. Notwithstanding the above, companies on which the provisions of
the income tax law (Inflationary Adjustments), 1985 were imposed before January
1, 2006 are subject to regular corporate tax rate on real capital gains derived
on the sale of the shares.

     Under income tax regulations Non-Israeli residents, who sell shares of an
Israeli company publicly traded on a recognized stock exchange outside of
Israel, will be exempt from tax subject to the satisfaction of all following
conditions:


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<PAGE>


     o    The capital gain is not attributable to a permanent establishment in
          Israel

     o    The shares were purchased after the first initial public offering on
          the recognized stock exchange outside of Israel

     Pursuant to the convention between the governments of the United States of
America and Israel with respect to taxes on income, as amended, referred to as
the Treaty, the sale, exchange or disposition of ordinary shares by a person who
qualifies as a resident of the United States within the meaning of the Treaty
and who is entitled to claim the benefits afforded to such person by the Treaty
generally will not be subject to the Israeli capital gains tax unless such U.S.
resident holds, directly or indirectly, shares representing 10% or more of our
voting power during any part of the 12-month period preceding such sale,
exchange or disposition, subject to particular conditions. A sale, exchange or
disposition of ordinary shares by such a U.S. resident who holds, directly or
indirectly, shares representing 10% or more of our voting power at any time
during such preceding 12-month period would be subject to such Israeli tax, to
the extent applicable; however, under such U.S. resident would be permitted to
claim a credit for such taxes against the U.S. federal income tax imposed with
respect to such sale, exchange or disposition, subject to the limitations under
U.S. laws applicable to foreign tax credits. The Treaty does not relate to U.S.
state or local taxes.

     TAXATION OF NON-RESIDENT HOLDERS OF SHARES

     Non-residents of Israel are subject to income tax on income accrued or
derived from sources in Israel. Such sources of income include passive income
such as dividends, royalties and interest, as well as non-passive income from
services rendered in Israel. On distributions of dividends after January 1 2006
other than bonus shares or stock dividends, income tax at the rate of 20% will
be withheld on dividends distributed to Israeli individual shareholders or to a
Non-resident.

     The foregoing tax rates are withheld at source, unless a different rate is
provided by a treaty between Israel and the shareholder's country of residence.
(For instance under the provisions of the treaty between Israel and the United
States 12.5% tax rate is imposed on dividends not generated by an approved
enterprise if the non-resident is a U.S. corporation that holds 10% of a
company's voting power, and 15% on dividends generated by an approved
enterprise. In addition under the Treaty, the maximum tax on dividends paid to a
holder of ordinary shares who is a U.S. resident within the meaning of the
Treaty will be 25%).

     FOREIGN EXCHANGE REGULATIONS

     Dividends (if any) paid to the holders of our ordinary shares, and any
amounts payable with respect to our ordinary shares upon dissolution,
liquidation or winding up, as well as the proceeds of any sale in Israel of the
ordinary shares to an Israeli resident, may be paid in non-Israeli currency or,
if paid in Israeli currency, may be converted into freely reparable U.S. dollars
at the rate of exchange prevailing at the time of conversion, however, Israeli
income tax is required to have been paid or withheld on these amounts.


                                       77
<PAGE>


     STAMP DUTY

     Under the Stamp Tax on Documents Law, certain documents are subject to
stamp tax. Promulgated regulations provide for a gradual phase-out of the stamp
tax by 2008. A new regulation abolished the Stamp Tax for documents signed after
January 1, 2006. We may be liable to pay stamp tax with respect to documents
that were signed in the period beginning June 1, 2003 and ending on December 31,
2005. Based on a legal advice received by us, our management believes that the
potential costs arising from this matter are not material.

     TAX REFORM

     On January 1, 2003, the Law for Amendment of the Income Tax Ordinance
(Amendment No.132), 5762-2002, known as the Tax Reform, came into effect,
following its enactment by the Israeli Parliament on July 24, 2002.

     The tax reform, aimed at broadening the categories of taxable income and
reducing the tax rates imposed on employment income, introduced the following,
among other things:

     o    Reduction of the tax rate levied on capital gains (other than gains
          deriving from the sale of listed securities) derived after January 1,
          2003, to a general rate of 25% for both individuals and corporations.
          With respect to assets acquired prior to January 1, 2003, the reduced
          tax rate will apply to a proportionate part of the gain, in accordance
          with the holding periods of the asset, before or after January 1,
          2003, on a linear basis;

     o    Imposition of Israeli tax on all income of Israeli residents,
          individuals and corporations, regardless of the territorial source of
          income, including income derived from passive sources such as
          interest, dividends and royalties;

     o    Introduction of controlled foreign corporation, or CFC, rules into the
          Israeli tax structure. Generally, under such rules, an Israeli
          resident who holds, directly of indirectly, 10% or more of the rights
          in a foreign corporation whose shares are not publicly traded, in
          which more than 50% of the rights are held directly or indirectly by
          Israeli residents, and a majority of whose income in a tax year is
          considered passive income, will be liable for tax on the portion of
          such income attributed to his holdings in such corporation, as if such
          income were distributed to him as a dividend;

     o    Imposition of capital gains tax on capital gains realized by
          individuals as of January 1, 2003, from the sale of shares of publicly
          traded companies (such gain was previously exempt from capital gains
          tax in Israel). For information with respect to the applicability of
          Israeli capital gains taxes on the sale of ordinary shares, see
          "Capital Gains Tax on Sales of Our Ordinary Shares" above; and

     o    Introduction of a new regime for the taxation of shares and options
          issued to employees and officers (including directors).


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<PAGE>


     The material consequences of the amendment applicable to our company
include, among other things, imposing a tax upon all income of Israeli
residents, individuals and corporations, regardless of the territorial source of
the income and certain modifications in the qualified taxation tracks of
employee stock options. In addition, a foreign tax credit was introduced,
allowing us to credit the income tax paid by our subsidiaries abroad against our
tax liabilities on dividends paid to us by such subsidiaries.

UNITED STATES FEDERAL INCOME TAX CONSEQUENCES

     The following is a summary of certain material U.S. federal income tax
consequences that apply to U.S. Holders who hold ordinary shares as capital
assets. This summary is based on the United States Internal Revenue Code of
1986, as amended (the "Code"), Treasury regulations promulgated thereunder,
judicial and administrative interpretations thereof, and the U.S.-Israel Tax
Treaty, all as in effect on the date hereof and all of which are subject to
change either prospectively or retroactively. This summary does not address all
tax considerations that may be relevant with respect to an investment in
ordinary shares. This summary does not discuss all the tax consequences that may
be relevant to a U.S. Holder in light of such holder's particular circumstances
or to U.S. Holders subject to special rules, including persons that are non-U.S.
Holders, broker-dealers, financial institutions, certain insurance companies,
investors liable for alternative minimum tax, tax-exempt organizations,
regulated investment companies, non-resident aliens of the U.S. or taxpayers
whose functional currency is not the U.S. dollar, persons who hold the ordinary
shares through partnerships or other pass-through entities, persons who acquired
their ordinary shares through the exercise or cancellation of employee stock
options or otherwise as compensation for services, investors that actually or
constructively own 10 percent or more of our voting shares, and investors
holding ordinary shares as part of a straddle or appreciated financial position
or as part of a hedging or conversion transaction.

     If a partnership or an entity treated as a partnership for U.S. federal
income tax purposes owns ordinary shares, the U.S. federal income tax treatment
of a partner in such a partnership will generally depend upon the status of the
partner and the activities of the partnership. A partnership that owns ordinary
shares and the partners in such partnership should consult their tax advisors
about the U.S. federal income tax consequences of holding and disposing of
ordinary shares.

     This summary does not address the effect of any U.S. federal taxation other
than U.S. federal income taxation. In addition, this summary does not include
any discussion of state, local or foreign taxation.

     You are urged to consult your tax advisors regarding the foreign and United
States federal, state and local tax considerations of an investment in ordinary
shares.

     For purposes of this summary, the term "U.S. Holder" means an individual
who is a citizen or, for U.S. federal income tax purposes, a resident of the
United States, a corporation or other entity taxable as a corporation created or
organized in or under the laws of the United States or any political subdivision
thereof, an estate whose income is subject to U.S. federal income tax regardless
of its source, or a trust that (a) is subject to the primary supervision of a
court within the United States and the control of one or more U.S. persons or
(b) has a valid election in effect under applicable U.S. Treasury regulations to
be treated as a U.S. person.


                                       79
<PAGE>


     TAXATION OF DIVIDENDS

     Subject to the discussion below under "Passive Foreign Investment
Companies," the gross amount of any distributions received with respect to
ordinary shares, including the amount of any Israeli taxes withheld therefrom,
will constitute dividends for U.S. federal income tax purposes to the extent of
our current and accumulated earnings and profits, as determined under U.S.
federal income tax principles. You will be required to include this amount of
dividends in gross income as ordinary income. Distributions in excess of our
current and accumulated earnings and profits will be treated as a non-taxable
return of capital to the extent of your tax basis in the ordinary shares and any
amount in excess of your tax basis will be treated as gain from the sale of
ordinary shares. See "-Disposition of Ordinary Shares" below for the discussion
on the taxation of capital gains. Dividends will not qualify for the
dividends-received deduction generally available to corporations under Section
243 of the Code.

     Dividends that we pay in NIS, including the amount of any Israeli taxes
withheld therefrom, will be included in your income in a U.S. dollar amount
calculated by reference to the exchange rate in effect on the day such dividends
are received. A U.S. Holder who receives payment in NIS and converts NIS into
U.S. dollars at an exchange rate other than the rate in effect on such day may
have a foreign currency exchange gain or loss that would be treated as ordinary
income or loss. U.S. Holders should consult their own tax advisors concerning
the U.S. tax consequences of acquiring, holding and disposing of NIS.

     Subject to complex limitations, any Israeli withholding tax imposed on such
dividends will be a foreign income tax eligible for credit against a U.S.
Holder's U.S. federal income tax liability (or, alternatively, for deduction
against income in determining such tax liability). The limitations set out in
the Code include computational rules under which foreign tax credits allowable
with respect to specific classes of income cannot exceed the U.S. federal income
taxes otherwise payable with respect to each such class of income. Dividends
generally will be treated as foreign-source passive income or, in the case of
certain U.S. Holders, financial services income for United States foreign tax
credit purposes. U.S. Holders should note that recently enacted legislation
eliminates the "financial services income" category with respect to taxable
years beginning after December 31, 2006. Under this legislation, the foreign tax
credit limitation categories will be limited to "passive category income" and
"general category income." Further, there are special rules for computing the
foreign tax credit limitation of a taxpayer who receives dividends subject to a
reduced tax, see discussion below. A U.S. Holder will be denied a foreign tax
credit with respect to Israeli income tax withheld from dividends received on
the ordinary shares to the extent such U.S. Holder has not held the ordinary
shares for at least 16 days of the 31-day period beginning on the date which is
15 days before the ex-dividend date or to the extent such U.S. Holder is under
an obligation to make related payments with respect to substantially similar or
related property. Any days during which a U.S. Holder has substantially
diminished its risk of loss on the ordinary shares are not counted toward
meeting the 16-day holding period required by the statute. The rules relating to
the determination of the foreign tax credit are complex, and you should consult
with your personal tax advisors to determine whether and to what extent you
would be entitled to this credit.


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<PAGE>


     Subject to certain limitations, "qualified dividend income" received by a
noncorporate U.S. Holder in tax years beginning on or before December 31, 2008
will be subject to tax at a reduced maximum tax rate of 15 percent.
Distributions taxable as dividends paid on the ordinary shares should qualify
for the 15 percent rate provided that either: (i) we are entitled to benefits
under the income tax treaty between the United States and Israel (the "Treaty")
or (ii) the ordinary shares are readily tradable on an established securities
market in the United States and certain other requirements are met. We believe
that we are entitled to benefits under the Treaty and that the ordinary shares
currently are readily tradable on an established securities market in the United
States. However, no assurance can be given that the ordinary shares will remain
readily tradable. The rate reduction does not apply unless certain holding
period requirements are satisfied. With respect to the ordinary shares, the U.S.
Holder must have held such shares for at least 61 days during the 121-day period
beginning 60 days before the ex-dividend date. The rate reduction also does not
apply to dividends received from passive foreign investment companies, see
discussion below, or in respect of certain hedged positions or in certain other
situations. The legislation enacting the reduced tax rate contains special rules
for computing the foreign tax credit limitation of a taxpayer who receives
dividends subject to the reduced tax rate. U.S. Holders of ordinary shares
should consult their own tax advisors regarding the effect of these rules in
their particular circumstances.

     DISPOSITION OF ORDINARY SHARES

     If you sell or otherwise dispose of ordinary shares, you will recognize
gain or loss for U.S. federal income tax purposes in an amount equal to the
difference between the amount realized on the sale or other disposition and your
adjusted tax basis in the ordinary shares. Subject to the discussion below under
the heading "Passive Foreign Investment Companies," such gain or loss generally
will be capital gain or loss and will be long-term capital gain or loss if you
have held the ordinary shares for more than one year at the time of the sale or
other disposition. In general, any gain that you recognize on the sale or other
disposition of ordinary shares will be U.S.-source for purposes of the foreign
tax credit limitation; losses, will generally be allocated against U.S. source
income. Deduction of capital losses is subject to certain limitations under the
Code.

     In the case of a cash basis U.S. Holder who receives NIS in connection with
the sale or disposition of ordinary shares, the amount realized will be based on
the U.S. dollar value of the NIS received with respect to the ordinary shares as
determined on the settlement date of such exchange. A U.S. Holder who receives
payment in NIS and converts NIS into United States dollars at a conversion rate
other than the rate in effect on the settlement date may have a foreign currency
exchange gain or loss that would be treated as ordinary income or loss.

     An accrual basis U.S. Holder may elect the same treatment required of cash
basis taxpayers with respect to a sale or disposition of ordinary shares,
provided that the election is applied consistently from year to year. Such
election may not be changed without the consent of the Internal Revenue Service
(the "IRS"). In the event that an accrual basis U.S. Holder does not elect to be
treated as a cash basis taxpayer (pursuant to the Treasury regulations
applicable to foreign currency transactions), such U.S. Holder may have a
foreign currency gain or loss for U.S. federal income tax purposes because of
differences between the U.S. dollar value of the currency received prevailing on
the trade date and the settlement date. Any such currency gain or loss would be
treated as ordinary income or loss and would be in addition to gain or loss, if
any, recognized by such U.S. Holder on the sale or disposition of such ordinary
shares.


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<PAGE>


     PASSIVE FOREIGN INVESTMENT COMPANIES

     For U.S. federal income tax purposes, we will be considered a passive
foreign investment company ("PFIC") for any taxable year in which either (i) 75%
or more of our gross income is passive income, or (ii) at least 50% of the
average value of all of our assets for the taxable year produce or are held for
the production of passive income. For this purpose, passive income includes
dividends, interest, royalties, rents, annuities and the excess of gains over
losses from the disposition of assets which produce passive income. If we were
determined to be a PFIC for U.S. federal income tax purposes, highly complex
rules would apply to U.S. Holders owning ordinary shares. Accordingly, you are
urged to consult your tax advisors regarding the application of such rules.

     Based on our current and projected income, assets and activities, we
believe that we are not currently a PFIC nor do we expect to become a PFIC in
the foreseeable future. However, because the determination of whether we are a
PFIC is based upon the composition of our income and assets from time to time,
there can be no assurances that we will not become a PFIC for any future taxable
year.

     If we are treated as a PFIC for any taxable year, dividends would not
qualify for the reduced maximum tax rate, discussed above, and, unless you elect
either to treat your investment in ordinary shares as an investment in a
"qualified electing fund" (a "QEF election") or to "mark-to-market" your
ordinary shares, as described below:

     o    you would be required to allocate income recognized upon receiving
          certain dividends or gain recognized upon the disposition of ordinary
          shares ratably over the holding period for such ordinary shares,

     o    the amount allocated to each year during which we are considered a
          PFIC and subsequent years, other than the year of the dividend payment
          or disposition, would be subject to tax at the highest individual or
          corporate tax rate, as the case may be, in effect for that year and an
          interest charge would be imposed with respect to the resulting tax
          liability allocated to each such year,

     o    the amount allocated to the current taxable year and any taxable year
          before we became a PFIC would be taxable as ordinary income in the
          current year, and

     o    you would be required to make an annual return on IRS Form 8621
          regarding distributions received with respect to ordinary shares and
          any gain realized on your ordinary shares.


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<PAGE>


     If you make either a timely QEF election or a timely mark-to-market
election in respect of your ordinary shares, you would not be subject to the
rules described above. If you make a timely QEF election, you would be required
to include in your income for each taxable year your pro rata share of our
ordinary earnings as ordinary income and your pro rata share of our net capital
gain as long-term capital gain, whether or not such amounts are actually
distributed to you. You would not be eligible to make a QEF election unless we
comply with certain applicable information reporting requirements.

     Alternatively, if the ordinary shares are considered "marketable stock" and
if you elect to "mark-to-market" your ordinary shares, you will generally
include in income any excess of the fair market value of the ordinary shares at
the close of each tax year over your adjusted basis in the ordinary shares. If
the fair market value of the ordinary shares had depreciated below your adjusted
basis at the close of the tax year, you may generally deduct the excess of the
adjusted basis of the ordinary shares over its fair market value at that time.
However, such deductions generally would be limited to the net mark-to-market
gains, if any, that you included in income with respect to such ordinary shares
in prior years. Income recognized and deductions allowed under the
mark-to-market provisions, as well as any gain or loss on the disposition of
ordinary shares with respect to which the mark-to-market election is made, is
treated as ordinary income or loss (except that loss on a disposition of
ordinary shares is treated as capital loss to the extent the loss exceeds the
net mark-to-market gains, if any, that you included in income with respect to
such ordinary shares in prior years). Gain or loss from the disposition of
ordinary shares (as to which a mark-to-market election was made) in a year in
which we are no longer a PFIC, will be capital gain or loss.

     BACKUP WITHHOLDING AND INFORMATION REPORTING

     Payments in respect of ordinary shares may be subject to information
reporting to the U.S. Internal Revenue Service and to U.S. backup withholding
tax at a rate equal to the fourth lowest income tax rate applicable to
individuals (which, under current law, is 28%). Backup withholding will not
apply, however, if you (i) are a corporation or come within certain exempt
categories, and demonstrate the fact when so required, or (ii) furnish a correct
taxpayer identification number and make any other required certification.

     Backup withholding is not an additional tax. Amounts withheld under the
backup withholding rules may be credited against a U.S. Holder's U.S. tax
liability, and a U.S. Holder may obtain a refund of any excess amounts withheld
under the backup withholding rules by filing the appropriate claim for refund
with the IRS.

     Any U.S. holder who holds 10% or more in vote or value of our ordinary
shares will be subject to certain additional United States information reporting
requirements.

     U.S. Gift and Estate Tax

     An individual U.S. Holder of ordinary shares will be subject to U.S. gift
and estate taxes with respect to ordinary shares in the same manner and to the
same extent as with respect to other types of personal property.


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<PAGE>


F.   DIVIDEND AND PAYING AGENTS

Not applicable.

G.   STATEMENT BY EXPERTS

Not applicable.

H.   DOCUMENTS ON DISPLAY

     We are subject to the reporting requirements of the United States
Securities Exchange Act of 1934, as amended, as applicable to "foreign private
issuers" as defined in Rule 3b-4 under the Exchange Act, and in accordance
therewith, we file annual and interim reports and other information with the
Securities and Exchange Commission.

     As a foreign private issuer, we are exempt from certain provisions of the
Exchange Act. Accordingly, our proxy solicitations are not subject to the
disclosure and procedural requirements of Regulation 14A under the Exchange Act,
transactions in our equity securities by our officers and directors are exempt
from reporting and the "short-swing" profit recovery provisions contained in
Section 16 of the Exchange Act. In addition, we are not required under the
Exchange Act to file periodic reports and financial statements as frequently or
as promptly as United States companies whose securities are registered under the
Exchange Act. However, we distribute annually to our shareholders an annual
report containing financial statements that have been examined and reported on,
with an opinion expressed by, an independent public accounting firm, and we
intend to file reports with the Securities and Exchange Commission on Form 6-K
containing unaudited financial information for the first three quarters of each
fiscal year.

     This annual report and the exhibits thereto and any other document we file
pursuant to the Exchange Act may be inspected without charge and copied at
prescribed rates at the following Securities and Exchange Commission public
reference rooms: 100 F Street, N.E., Room 1580, Washington, D.C. 20549; and on
the Securities and Exchange Commission Internet site (http://www.sec.gov) and on
our website WWW.RADA.COM. You may obtain information on the operation of the
Securities and Exchange Commission's public reference room in Washington, D.C.
by calling the Securities and Exchange Commission at 1-800-SEC-0330. The
Exchange Act file number for our Securities and Exchange Commission filings is
0-30198.

     The documents concerning our company which are referred to in this annual
report may also be inspected at our offices located at 7 Giborei Israel Street,
Netanya 42504, Israel.

I.   SUBSIDIARY INFORMATION

Not applicable.


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ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS

INTEREST RATE RISK

     We currently do not invest in, or otherwise hold, for trading or other
purposes, any financial instruments subject to market risk. We pay interest on
our credit facilities, convertible notes and short-term loans based on Libor,
for dollar-denominated loans, and Israeli prime or adjustment differences to the
Israeli consumer price index, for some of our NIS-denominated loans. As a
result, changes in the general level of interest rates directly affect the
amount of interest payable by us under these facilities. However, we expect our
exposure to market risk from changes in interest rates to be minimal and not
material. Therefore, no quantitative tabular disclosures are required.

     A devaluation of the NIS in relation to the U.S. dollar has the effect of
reducing the U.S. dollar amount of any of our expenses or liabilities which are
payable in NIS (unless such expenses or payables are linked to the U.S. dollar).
As of December 31, 2005, we had liabilities payable in NIS which are not linked
to the U.S. dollar in the amount of $2.1 million and cash and receivables in the
amount of $2.0 million denominated in NIS. Accordingly, an increase of 1% of the
NIS against the dollar would increase our financing expenses by approximately
$1,000. A devaluation of 1% of the NIS against the dollar would decrease our
financing expenses by the same amount. Neither a ten percent increase nor
decrease in current exchange rates would have a material affect on our
consolidated financial statements. However, the amount of liabilities payable
and/or cash and receivables in NIS is likely to change from time to time.

     Because exchange rates between the NIS and the U.S. dollar fluctuate
continuously (albeit with a historically declining trend in the value of the
NIS), exchange rate fluctuations and especially larger periodic devaluations
will have an impact on our profitability and period-to-period comparisons of our
results. The effects of foreign currency re-measurements are reported in our
consolidated financial statements in continuing operations.

ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

     Not applicable.

                                     PART II

ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

     None.


                                       85
<PAGE>


ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
         PROCEEDS

     None.

ITEM 15. CONTROLS AND PROCEDURES

     Our management, including our chief executive officer and chief financial
officer, evaluated the effectiveness of our disclosure controls and procedures
(as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered
by this annual report on Form 20-F. Based upon that evaluation, our chief
executive officer and chief financial officer have concluded that, as of such
date, our disclosure controls and procedures were effective to ensure that
information required to be disclosed by our company in reports that we file or
submit under the U.S. Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms and that such information
was made known to them by others within the company, as appropriate to allow
timely decisions regarding required disclosure.

     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 statement preparation and presentation. Also, projections
of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.

ITEM 16. RESERVED.

ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT

     Our board of directors has determined that Mr. Zvi Tropp, one of our
outside directors, qualifies as an independent director as this term is defined
in NASDAQ's Market Rule 4200, and meets the definition of an audit committee
financial expert, as defined in Item 401 of Regulation S-K.

     For a brief listing of Mr. Tropp's relevant experience, see Item 6.A.
"Directors, Senior Management and Employees -- Directors and Senior Management."

ITEM 16B. CODE OF ETHICS

     We have adopted a code of ethics that applies to our chief executive
officer and all senior financial officers of our company, including the chief
financial officer, chief accounting officer or controller, or persons performing
similar functions. The code of ethics is publicly available on our website at
WWW.RADA.COM. Written copies are available upon request. If we make any
substantive amendment to the code of ethics or grant any waivers, including any
implicit waiver, from a provision of the codes of ethics, we will disclose the
nature of such amendment or waiver on our website.


                                       86
<PAGE>


FEES PAID TO INDEPENDENT PUBLIC ACCOUNTANTS

     The following table sets forth, for each of the years indicated, the fees
paid to our principal independent registered public accounting firm. All of such
fees were pre-approved by our Audit Committee.

                           YEAR ENDED DECEMBER 31,
                           ------------------------
                            2004             2005
                           -------          -------
SERVICES RENDERED           FEES             FEES
-----------------          -------          -------

Audit (1)                  $66,000          $77,500
Audit-related (2)                -          $ 7,500
Tax                              -                -
Other                            -                -
                           -------          -------
Total                      $66,000          $85,000
                           =======          =======

----------

     (1)  Audit fees consist of services that would normally be provided in
          connection with statutory and regulatory filings or engagements,
          including services that generally only the independent registered
          public accounting firm can reasonably provide, such as services
          preformed in connection with documents filed with the SEC.

     (2)  Audit related fees consist of fees for assurance and related services
          by the independent registered public accounting firm that are
          reasonably related to the performance of the audit or review of the
          registrant financial statements.

PRE-APPROVAL POLICIES AND PROCEDURES

     Our Audit Committee has adopted a policy and procedures for the
pre-approval of audit and non-audit services rendered by our independent
registered accounting firm, Kost Forer Gabbay & Kasierer, a Member of Ernst &
Young Global. Pre-approval of an audit or non-audit service may be given as a
general pre-approval, as part of the audit committee's approval of the scope of
the engagement of our independent auditor, or on an individual basis. The policy
prohibits retention of the independent public accountants to perform the
prohibited non-audit functions defined in Section 201 of the Sarbanes-Oxley Act
or the rules of the SEC, and also requires the Audit Committee to consider
whether proposed services are compatible with the independence of the public
accountants.

ITEM 16D. EXEMPTIONS FROM THE LISTING REQUIREMENTS AND STANDARDS FOR AUDIT
          COMMITTEE

     Not applicable.

ITEM 16E. PURCHASE OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATES AND
          PURCHASERS

ISSUER PURCHASE OF EQUITY SECURITIES

     Neither we, nor any "affiliated purchaser" of our company, has purchased
any of our securities during 2005.


                                       87
<PAGE>


                                    PART III

ITEM 17. FINANCIAL STATEMENTS

     Not applicable.

ITEM 18. FINANCIAL STATEMENTS


CONSOLIDATED FINANCIAL STATEMENTS

Index To Financial Statements                                    F-1

Report of Independent Registered Public Accounting Firm          F-2

Consolidated Balance Sheets                                      F-3

Consolidated Statements of Operations                            F-4

Statements of Changes in Shareholders' Equity                    F-5

Consolidated Statements of Cash Flows                            F-7

Notes to Consolidated Financial Statements                       F-8

ITEM 19. EXHIBITS

                                INDEX TO EXHIBITS

EXHIBIT           DESCRIPTION

3.1*      Memorandum of Association of the Registrant

3.2*      Articles of Association of the Registrant

4.1*      Specimen of Share Certificate

8         List of Subsidiaries of the Registrant

10.1*     1994 Employee Stock Option Plan, as amended

10.2*     1996 Employee Stock Option Plan, as amended

10.3*     1999 Employee Stock Option Plan, as amended

10.4***   2003 Employee Stock Option Plan, as amended

10.8***   Memorandum of Agreement dated June 23 2003 between the Registrant and
          Bank Hapoalim B.M. and Bank Leumi Le-Israel B.M.


                                       88
<PAGE>


12.1      Certification of the Chief Executive Officer pursuant to Rule
          13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as
          amended

12.2      Certification of the Chief Financial Officer pursuant to Rule
          13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as
          amended

13.1      Certification of the Chief Executive Officer pursuant to 18 U.S.C.
          1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
          2002

13.2      Certification of the Chief Financial Officer pursuant to 18 U.S.C.
          1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
          2002

23.1      Consent of Kost Forer Gabbay & Kasierer, a Member of Ernst & Young
          Global, Independent Registered Public Accounting Firm (Israel) with
          respect to our Registration Statements on Form F-3 and S-8

----------

     * Filed as an exhibit to our Annual Report on Form 20-F for the year ended
December 31, 2000 and incorporated herein by reference.

     ** Filed as an exhibit to our Annual Report on Form 20-F for the year ended
December 31, 2001 and incorporated herein by reference.

     *** Filed as an exhibit to our Annual Report on Form 20-F for the year
ended December 31, 2002 and incorporated herein by reference.


                                       89
<PAGE>



               RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

                        CONSOLIDATED FINANCIAL STATEMENTS

                             AS OF DECEMBER 31, 2005

                            U.S. DOLLARS IN THOUSANDS

                                      INDEX

                                                                PAGE
                                                             ----------

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM         F-2

CONSOLIDATED BALANCE SHEETS                                     F-3

CONSOLIDATED STATEMENTS OF OPERATIONS                           F-4

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY      F-5

CONSOLIDATED STATEMENTS OF CASH FLOWS                        F-6 - F-7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                   F-8 - F-33

                                     F - 1

<PAGE>


[ERNST & YOUNG LOGO]

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

                             TO THE SHAREHOLDERS OF

               RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

     We have audited the accompanying consolidated balance sheets of Rada
Electronic Industries Ltd. ("the Company") and its subsidiary as of December 31,
2005 and 2004 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, 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 audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Company's internal control over financial reporting. Our
audits 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 management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.

     In our opinion, the consolidated financial statements referred to above
present fairly in all material respects, the consolidated financial position of
the Company and its subsidiary as of December 31, 2005 and 2004, and the results
of its operations and its cash flows for each of the three years in the period
ended December 31, 2005, in conformity with U.S. generally accepted accounting
principles.



                                              /S/ Kost Forer Gabbay and Kasierer
Tel-Aviv, Israel                              KOST FORER GABBAY & KASIERER
March 30, 2006                                  A Member of Ernst & Young Global


                                     F - 2
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

CONSOLIDATED BALANCE SHEETS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA

<TABLE>
<CAPTION>
                                                                                        DECEMBER 31,
                                                                                    --------------------
                                                                               NOTE   2005        2004
                                                                               ---  --------    --------
<S>                                                                            <C>  <C>         <C>
    ASSETS

CURRENT ASSETS:
  Cash and cash equivalents                                                         $    350    $  3,464
  Restricted cash                                                                      1,017           -
  Trade receivables (net of allowance for doubtful accounts of $ 6
   and $ 221 at December 31, 2005 and 2004, respectively)                              4,920       1,643
  Other accounts receivable and prepaid expenses                                         156         208
  Costs and estimated earnings in excess of billings on uncompleted
  contracts                                                                     3      1,396       1,385
  Inventories                                                                   4      1,942       1,824
                                                                                    --------    --------

TOTAL current assets                                                                   9,781       8,524
                                                                                    --------    --------

LONG-TERM RECEIVABLES AND DEPOSITS:
  Long-term receivables                                                         5        983         988
  Long-term restricted cash                                                                -       1,002
  Leasing deposits                                                                        72          94
  Severance pay fund                                                                   1,614       1,638
                                                                                    --------    --------

TOTAL long-term receivables and deposits                                               2,669       3,722
                                                                                    --------    --------

PROPERTY, PLANT AND EQUIPMENT, NET                                              6      3,931       4,283
                                                                                    --------    --------

OTHER ASSETS:
  Intangible assets, net                                                        7      2,469       1,709
  Deferred charges, net                                                                   40          59
                                                                                    --------    --------

TOTAL other assets                                                                     2,509       1,768
                                                                                    --------    --------

TOTAL assets                                                                        $ 18,890    $ 18,297
                                                                                    ========    ========

    LIABILITIES AND SHAREHOLDERS' EQUITY

CURRENT LIABILITIES:
  Short-term bank credit and  loans                                             8   $    877    $     14
  Trade payables                                                                       1,671       1,080
  Other accounts payable and accrued expenses                                   9      3,217       3,612
  Deferred revenues                                                                       50         488
  Billings in excess of costs and estimated earnings on uncompleted
    contracts                                                                   3        391       1,065
                                                                                    --------    --------

TOTAL current liabilities                                                              6,206       6,259
                                                                                    --------    --------

LONG-TERM LIABILITIES:
  Convertible note                                                             11      2,560       2,346
  Accrued severance pay                                                                2,009       2,063
                                                                                    --------    --------

TOTAL long-term liabilities                                                            4,569       4,409
                                                                                    --------    --------

COMMITMENTS AND CONTINGENT LIABILITIES                                         10

MINORITY INTERESTS                                                                       380         397
                                                                                    --------    --------

SHAREHOLDERS' EQUITY:                                                          11
  Share capital -
    Ordinary shares of NIS 0.005 par value - Authorized: 47,500,000 and
      45,000,000 shares at December 31, 2005 and 2004, respectively; Issued
      and outstanding: 26,144,027 and 20,448,364 shares at December 31,
      2005 and 2004, respectively                                                        116         110
  Additional paid-in capital                                                          66,900      64,074
  Accumulated deficit                                                                (59,281)    (56,952)
                                                                                    --------    --------

TOTAL shareholders' equity                                                             7,735       7,232
                                                                                    --------    --------

TOTAL liabilities and shareholders' equity                                          $ 18,890    $ 18,297
                                                                                    ========    ========
</TABLE>


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


                                     F - 3
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA

<TABLE>
                                                                                YEAR ENDED DECEMBER 31,
                                                                           --------------------------------
                                                                    NOTE      2005        2004        2003
                                                                    ----   --------    --------    --------
<S>                                                                   <C>  <C>         <C>         <C>
Revenues:                                                             15
  Products                                                                 $ 11,303    $ 11,123    $  8,977
  Services                                                                    2,118       3,037       3,338
                                                                           --------    --------    --------

                                                                             13,421      14,160      12,315
                                                                           --------    --------    --------
Cost of revenues:
  Products                                                                   10,829       8,669       6,933
  Services                                                                    1,481       1,618       2,659
                                                                           --------    --------    --------

                                                                             12,310      10,287       9,592
                                                                           --------    --------    --------

Gross profit                                                                  1,111       3,873       2,723
                                                                           --------    --------    --------

Operating expenses:
  Marketing and selling                                                         927         738         781
  General and administrative                                                  1,939       2,116       1,917
                                                                           --------    --------    --------

TOTAL operating expenses                                                      2,866       2,854       2,698
                                                                           --------    --------    --------

Operating income (loss)                                                      (1,755)      1,019          25
Financial income (expenses), net                                      13       (624)       (248)        708
Other income (expenses), net                                                     33          23          (2)
                                                                           --------    --------    --------

                                                                             (2,346)        794         731
Minority interests in losses of subsidiary                                       17          28          27
                                                                           --------    --------    --------

Net income (loss)                                                          $ (2,329)   $    822    $    758
                                                                           ========    ========    ========

Net earnings (loss) per share:                                        16

  Basic net earnings (loss) per share                                      $  (0.10)   $   0.04    $   0.04
                                                                           ========    ========    ========

  Diluted net earnings (loss) per share                                    $  (0.10)   $   0.03    $   0.04
                                                                           ========    ========    ========
</TABLE>


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


                                     F - 4
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE DATA


<TABLE>
<CAPTION>

                                                    NUMBER OF                ADDITIONAL                   TOTAL
                                                    ORDINARY      SHARE       PAID-IN     ACCUMULATED  SHAREHOLDERS'
                                                     SHARES      CAPITAL      CAPITAL       DEFICIT       EQUITY
                                                   ----------   ----------   ----------   ----------    ----------
<S>                                                <C>          <C>          <C>          <C>           <C>
Balance at January 1, 2003                         18,510,716   $      108   $   58,909   $  (58,532)   $      485

  Adjustment of accrual for issuance expenses               -            -          354            -           354
  Fair value of warrants issued in connection
    with settlement of debt, net *)                         -            -        1,267            -         1,267
  Fair value of warrants issued to suppliers                -            -           14            -            14
  Net income                                                -            -            -          758           758
                                                   ----------   ----------   ----------   ----------    ----------

Balance at December 31, 2003                       18,510,716          108       60,544      (57,774)        2,878

  Issuance of Ordinary shares and warrants, net
    *)                                              1,864,313            2        3,300            -         3,302
  Beneficial conversion feature
     on convertible note                                    -            -          180            -           180
  Exercise of options                                  73,335   **)      -           50            -            50
  Net income                                                -            -            -          822           822
                                                   ----------   ----------   ----------   ----------    ----------

Balance at December 31, 2004                       20,448,364          110       64,074      (56,952)        7,232

  Issuance of Ordinary shares and warrants,  net
    *)                                                965,934            1        1,005            -         1,006
  Exercise of warrants, net **)                     4,691,061            5        1,794            -         1,799
  Exercise of options                                  38,668   ***)     -           27            -            27
  Net loss                                                  -            -            -       (2,329)       (2,329)
                                                   ----------   ----------   ----------   ----------    ----------

Balance at December 31, 2005                       26,144,027   $      116   $   66,900   $  (59,281)   $    7,735
                                                   ==========   ==========   ==========   ==========    ==========
</TABLE>

*)   Net of issuance expenses of approximately $ 85, $ 95 and $ 38 for the years
     ended December 31, 2005, 2004 and 2003, respectively.

**)  Net of issuance expenses of approximately $ 148.

***) Represents and amount lower than $ 1.

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


                                     F - 5
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS


<TABLE>
<CAPTION>
                                                                           YEAR ENDED DECEMBER 31,
                                                                       -----------------------------
                                                                         2005       2004       2003
                                                                       -------    -------    -------
<S>                                                                    <C>        <C>        <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss)                                                    $(2,329)   $   822    $   758
  Adjustments required to reconcile net income (loss) to net cash
    provided by (used in) operating activities:
    Depreciation and amortization                                        1,347      1,066      2,072
    Amortization expenses on convertible note                              214        106          -
    Minority interests in losses of subsidiary                             (17)       (28)       (27)
    Gain on extinguishment of debt                                           -          -     (1,013)
    Stock compensation expense - fair value of warrants issued to
      suppliers                                                              -          -         14
    Accrued interest and translation differences on long-term
      receivables                                                            -          2        (97)
    Capital loss on property, plant and equipment                            -         16          -
    Decrease (increase) in trade receivables, net                       (2,676)     1,853     (1,664)
    Decrease (increase) in other accounts receivable and prepaid
      expenses                                                              81         42       (157)
    Decrease (increase) in costs and estimated earnings in excess of
      billings, net                                                       (685)    (1,980)     1,085
    Decrease (increase) in inventories                                     200       (951)       204
    Increase (decrease) in trade payables                                 (219)       440          5
    Increase (decrease) in other accounts payable and accrued
      expenses                                                            (444)       295        722
    Decrease in deferred revenues                                         (568)      (574)      (709)
    Accrued severance pay, net                                             (30)      (112)      (172)
                                                                       -------    -------    -------

Net cash provided by (used in) operating activities                     (5,126)       997      1,021
                                                                       -------    -------    -------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Cash paid in conjunction with the acquisition of certain assets
    and liabilities of Vectop, net (a)                                    (351)         -          -
  Investment in long-term restricted cash                                  (15)    (1,002)         -
  Purchase of property, plant and equipment                               (411)      (349)       (49)
  Increase (decrease) in leasing deposits                                   22        (23)        (1)
  Loans repaid by employees                                                  5          -          -
                                                                       -------    -------    -------

Net cash used in investing activities                                     (750)    (1,374)       (50)
                                                                       -------    -------    -------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from issuance of shares and warrants, net                     1,006      3,302          -
  Proceeds from issuance of convertible note, net                            -      2,351          -
  Proceeds from short-term loans                                           700          -        946
  Repayments of loans                                                     (933)    (1,359)    (4,096)
  Increase (decrease) in short-term bank credit, net                       163       (970)     2,076
  Exercise of warrants, net                                              1,799          -          -
  Exercise of options                                                       27         50          -
                                                                       -------    -------    -------

Net cash provided by (used in) financing activities                      2,762      3,374     (1,074)
                                                                       -------    -------    -------

Increase (decrease) in cash and cash equivalents                        (3,114)     2,997       (103)
Cash and cash equivalents at the beginning of the year                   3,464        467        570
                                                                       -------    -------    -------

Cash and cash equivalents at the end of the year                       $   350    $ 3,464    $   467
                                                                       =======    =======    =======
</TABLE>

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



                                     F - 6
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

<TABLE>
<CAPTION>
                                                                    YEAR ENDED DECEMBER 31,
                                                               --------------------------------
                                                                 2005        2004         2003
                                                               -------    -----------   -------
<S>                                                            <C>        <C>           <C>

   (a)  Cash paid in conjunction with the acquisition of
         certain assets and liabilities of Vectop, net (see
         also Note 1d):

        Working capital, net                                   $   844
        Equipment                                                  (62)
        Intangible assets                                       (1,263)
        Deferred revenues                                          130
                                                               -------

                                                               $  (351)
                                                               =======
    (b) NON-CASH TRANSACTIONS:
        Fair value of warrants issued in connection with
          settlement of debt                                   $     -    $         -   $ 1,305
                                                               =======    ===========   =======

        Adjustment of accrual for issuance expenses            $     -    $         -   $   354
                                                               =======    ===========   =======

    (c) SUPPLEMENTAL DISCLOSURES OF CASH FLOW ACTIVITIES:
        Net cash paid during the year for:
        Income taxes                                           $     3    $         3   $     5
                                                               =======    ===========   =======

        Interest                                               $   396    $       290   $   240
                                                               =======    ===========   =======
</TABLE>

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


                                     F - 7
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 1:- GENERAL

     a.   RADA Electronic Industries Ltd., an Israeli corporation ("the
          Company"), is engaged in the development, manufacture and sale of
          Automated Test Equipment ("ATE") products, avionics equipment and
          aviation data acquisition and debriefing systems.

     b.   As reflected in the consolidated financial statements, as of December
          31, 2005, the Company had an accumulated deficit of $ 59,281. During
          2005, the Company concluded a private placement of 965,934 Ordinary
          shares and issued warrants to purchase up to an aggregate of 1,875,000
          Ordinary shares in the amount of $ 1,091. In addition, additional
          investment rights to purchase 909,066 Ordinary shares were exercised
          in the amount of $ 1,909 (see Note 11a). Management believes that the
          anticipated cash flows from operations will enable the Company to
          finance its operations at least through December 31, 2006.

     c.   The Company operates a test and repair shop using its ATE products in
          Beijing, China through its 80% owned Chinese subsidiary, Beijing Huari
          Aircraft Components Maintenance and Services Co. Ltd. ("CACS" or
          "subsidiary"). CACS was established with a third party, which owns the
          remaining 20% equity interest.

     d.   On February 13, 2005, the Company purchased certain assets and assumed
          certain liabilities related to the operations of Vectop Limited
          ("Vectop") in order to increase its customer base. Vectop is an
          Israeli company specializing in the design, development, marketing and
          sale of electro-optic equipment and debriefing systems. Vectop's
          assets also include know-how, patents and intellectual property to
          produce off-the-shelf products such as cameras and video recorders,
          which are currently operational onboard aircraft and tanks in Israel
          and other countries. The Company purchased Vectop's net assets for $
          381 in cash and additional future royalties based on revenues derived
          from Vectop projects five years from the date of the agreement up to $
          500. The net assets purchased are considered to be a business, in
          accordance with EITF 98-3, "Determining Whether a Nonmonetary
          Transaction Involves Receipt of Productive Assets or Business". The
          acquisition was accounted for under the purchase method of accounting
          in accordance with FAS 141, "Business Combinations", and the results
          of Vectop operations have been included from the acquisition date
          (February 2005).

          The purchase price related to the acquisition of Vectop was allocated
          to the fair market value of tangible and intangible assets acquired
          and liabilities assumed at the date of acquisition, as detailed below.

          Cash and cash equivalents                        $   30
          Trade receivables                                   601
          Other current assets                                347
          Equipment                                            62
          Customer relationships (five-year useful life)    1,263
                                                           ------

          Total assets acquired                             2,303
                                                           ------

          Short-term bank credit and loans                    933
          Trade payables                                      810
          Other accounts payable and accrued expenses          49
          Deferred revenues                                   130
                                                           ------

          Total liabilities assumed                         1,922
                                                           ------

          Net assets acquired                              $  381
                                                           ======


                                     F - 8
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 1:- GENERAL (CONT.)

          Customer relationships were determined by Company's management using
          the discounted cash flows approach and is being amortized on a
          straight-line basis over an estimated useful life of five years (see
          also Note 7).

          The following table presents unaudited pro forma results of operations
          and gives effect to the acquisition of Vectop as if the acquisition
          had been consummated at January 1, 2004. The unaudited pro forma
          results of operations are not necessarily indicative of what would
          have occurred had the acquisition been made as of the beginning of
          this period or the results that may occur in the future. Net income
          for the period presented includes amortization of intangible assets
          related to the acquisition of $ 253. The unaudited pro forma
          information is as follows:

                                                              YEAR ENDED
                                                             DECEMBER 31,
                                                                2004
                                                               -------
                                                              UNAUDITED
                                                               -------

Revenues                                                       $17,187

Net income from continuing operations                          $   910

Basic net income per share from continuing operations          $  0.05
                                                               =======

Diluted net income per share from continuing operations        $  0.04
                                                               =======

Weighted average number of Ordinary shares in computation of
  basic net income per share                                    19,374
                                                               =======

Weighted average number of Ordinary shares in computation of
  diluted net income per share                                  23,684

     e.   In 2003, the Company changed the estimated useful life of the
          remaining intangible assets associated with its Aircraft Test Systems
          Programs Sets ("TPSs") from a range of eight to 18 years to a range of
          five to 10 years. The effect of change in estimate on the net income
          and net income per share for the years ended December 31, 2005, 2004
          and 2003 resulted in a decrease of $ 138 (or $ 0.01 per share) , $ 221
          (or $ 0.01 per share) and $ 136 (or $ 0.01 per share), respectively.

     f.   As for major customers, see Note 15.


                                     F - 9
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES

          The consolidated financial statements have been prepared in accordance
          with accounting principles generally accepted in the United States.
          The significant accounting policies followed in the preparation of the
          financial statements, applied on a consistent basis, are as follows:

          a.   Use of estimates:

               The preparation of financial statements in conformity with
               accounting principles generally accepted in the United States
               requires management to make estimates and assumptions that affect
               the reported amounts 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 subsidiary are
               generated in U.S. dollars ("dollar"). In addition, a substantial
               portion of the costs of the Company and its subsidiary is
               incurred in dollars. The Company's management believes that the
               dollar is the currency of the primary economic environment in
               which the Company and its subsidiary operate. Thus, their
               functional and reporting currency is the dollar.

               Accordingly, monetary accounts maintained in currencies other
               than the dollar are remeasured into U.S. dollars in accordance
               with Statement of the Financial Accounting Standard Board No. 52,
               "Foreign Currency Translation" ("SFAS No. 52"). All transaction
               gains and losses of the remeasured monetary balance sheet items
               are reflected in the statement of operations as financial income
               or expenses, as appropriate, in the period in which the currency
               exchange rate changes. The representative exchange rate at
               December 31, 2005 was U.S. $ 1.00 = NIS 4.603 (December 31, 2004
               - NIS 4.308 and December 31, 2003 - NIS 4.379).

          c.   Basis of consolidation:

               The consolidated financial statements include the accounts of the
               Company and its subsidiary. Inter-company transactions and
               balances have been eliminated upon consolidation.

          d.   Cash equivalents and restricted cash:

               All highly liquid investments that are readily convertible to
               cash and are not restricted as to withdrawal or use and the
               period to maturity of which did not exceed three months at time
               of deposit, are considered cash equivalents.

               Restricted cash is invested in a short-term bank deposit, which
               is used as security for the Company's guarantees to customers.
               The deposit is in U.S. dollars and bears interest at an average
               rate of 2.3%


                                     F - 10
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

          e.   Inventories:

               Inventories are stated at the lower of cost or market value.
               Inventory write-offs are provided to cover risks arising from
               slow-moving items, excess inventories, and for market prices
               lower than cost.

               Cost is determined as follows:

               Raw materials and components - using the "first-in, first-out"
               cost method.

               Work in progress and finished goods - represents the cost of
               manufacturing with the addition of allocable indirect
               manufacturing costs.

               Amounts related to long-term contracts as determined by the
               percentage of completion method of accounting are recorded as
               "Costs and estimated earnings in excess of billings."

          f.   Property, plant and equipment:

               Property and equipment are stated at cost, net of accumulated
               depreciation. Depreciation is calculated by the straight-line
               method over the estimated useful lives of the assets. Annual
               rates of depreciation are as follows:

                                                                     %
                                                                -----------
               Factory and other buildings                        2.5 - 4
               Machinery and equipment                           10 - 15, 33
               Office furniture and equipment                     6 - 15

               Leasehold improvements are depreciated over the shorter of the
               estimated useful life or the lease period.

               Assets in respect of which investment grants have been received,
               are presented at cost less the related grant amount. Depreciation
               is based on net cost.

          g.   Intangible assets:

               Capitalized software costs are amortized by the greater of the
               amount computed using the: (i) ratio of current gross revenues
               from sales of the software 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 product. The Company assesses the recoverability of these
               intangible assets on a regular basis by determining whether the
               amortization of the asset over its remaining life can be
               recovered through undiscounted future operating cash flows from
               the specific software product sold.


                                     F - 11
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

               At each balance sheet date, the unamortized capitalized costs of
               the software products are compared to the net realizable value of
               the product. If the unamortized capitalized costs of a computer
               software product exceed the net realizable value of the product,
               such excess is written off. The net realizable value is
               calculated as the estimated future gross revenues from the
               product reduced by the estimated future costs of completing and
               disposing of that product, including the costs of performing
               maintenance and customer support required to satisfy the
               Company's responsibility set forth at the time of the sale.

               A customer relationships asset (intangible asset) has been
               recorded as a result of the acquisition of Vectop and is
               amortized using the straight-line basis over the expected useful
               life of five years.

               As for impairment charges included in these financial statements,
               see Note 7.

          h.   Impairment of long-lived assets:

               The Company's long-lived assets are reviewed for impairment in
               accordance with Statement of Financial Accounting Standards 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 the assets may
               not be recoverable. Recoverability of assets to be held and used
               is measured by a comparison of the carrying amount of the assets
               to the future undiscounted cash flows expected to be generated by
               the assets. If such assets are considered to be impaired, the
               impairment to be recognized is measured by the amount by which
               the carrying amount of the assets exceeds the fair value of the
               assets. As of December 31, 2005, no impairment losses have been
               identified.

          i.   Research and development costs:

               Statement of Financial Accounting Standards No. 86, "Accounting
               for the Costs of Computer Software to be Sold, Leased or
               Otherwise Marketed" ("SFAS No. 86"), requires capitalization of
               certain software development, costs subsequent to the
               establishment of technological feasibility. Based on the
               Company's product development process, technological feasibility
               is established upon completion of a working model.

               Research and development costs incurred in the process of
               developing product masters and the Company's Test System Programs
               Sets ("TPS") software library, integrated with the Company's test
               station, are charged to expenses as incurred.

               Costs incurred by the Company between completion of the working
               model and the point at which the product is ready for general
               release, have been capitalized.


                                     F - 12
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

          j.   Income taxes:

               The Company accounts for income taxes in accordance with
               Statement of Financial Accounting Standard No. 109, "Accounting
               for Income Taxes" ("SFAS 109"). This statement prescribes the use
               of the liability method whereby deferred tax assets and liability
               account balances are determined based on differences between
               financial reporting and tax based 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
               provides a valuation allowance, if necessary, to reduce deferred
               tax assets to their estimated realizable value.

          k.   Severance pay:

               The Company's liability for severance pay is calculated pursuant
               to Israel's Severance Pay Law generally 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 a portion
               thereof. The Company's liability for all of its Israeli employees
               is partly provided by monthly deposits for insurance policies
               and/or pension funds and by an accrual. The value of these
               policies is recorded as an asset in the Company's balance sheet.
               The deposited funds of the Company's employees include profits
               accumulated up to the balance sheet date. The deposited funds may
               be withdrawn only upon the fulfillment of the obligation pursuant
               to Israel's Severance Pay Law or labor agreements.

               The value of the deposited funds is based on the cash surrendered
               value of these policies, and includes immaterial profits.

               Severance expense recorded in the statement of operations is net
               of interest and other income accumulated in the deposits.
               Severance expense for the years ended December 31, 2005, 2004 and
               2003 amounted to $ 57, $ 76 and $ 132, respectively.

          l.   Fair value of financial instruments:

               The following methods and assumptions were used by the Company in
               estimating fair value and disclosures for financial instruments.

               The carrying amount of cash and cash equivalents, restricted
               cash, trade receivables, short-term bank credit, trade payables
               approximate their fair value due to the short-term maturity of
               these instruments.

               Convertible notes are estimated by discounting the future cash
               flows using current interest rates for loans of similar terms and
               maturities. The carrying amount of the convertible notes
               approximate their fair value.


                                     F - 13
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

          m.   Concentrations of credit risk:

               Financial instruments that potentially subject the Company to
               concentrations of credit risk consist principally of cash and
               cash equivalents, long-term deposit, trade receivables and
               long-term receivables.

               The Company's cash and cash equivalents and long-term deposit are
               mainly held in U.S. dollars with major banks in Israel.
               Management believes that the financial institutions that hold the
               Company's investments are financially sound and, accordingly,
               minimal credit risk exists with respect to these investments.

               The Company's trade receivables are derived from sales to large
               and solid organizations located mainly in the United States,
               Europe and Israel. The Company performs ongoing credit
               evaluations of its customers and to date has not experienced any
               material losses. An allowance for doubtful accounts is determined
               with respect to these amounts that the Company has determined to
               be doubtful of collection. The allowance is computed for specific
               debts and the collectibility is determined based upon the
               Company's experience.

               The Company granted loans in prior years to its former CEO and a
               former officer amounting to approximately $ 983 as of December
               31, 2005 and 2004. These loans are unsecured and the Company is
               currently in litigation with these officers regarding such loans.
               If not paid, the Company will incur a loss equal to the amount of
               the loan.

               The Company has no off-balance sheet credit risks.

          n.   Warranty:

               In connection with the sale of its products, the Company provides
               product warranties for periods between one to two years. Based on
               past experience and engineering estimates, the liability from
               these warranties is immaterial at balance sheet date.

          o.   Share based compensation:

               The Company has elected to follow Accounting Principles Board
               Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB
               No. 25") and FASB Interpretation No. 44, "Accounting for Certain
               Transactions Involving Stock Compensation" ("FIN No. 44") in
               accounting for its employee stock option plans. Under APB No. 25,
               when the exercise price of the Company's stock options is less
               than the market price of the underlying shares on the date of
               grant, compensation expense is recognized.


                                     F - 14
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

               The Company adopted the disclosure provisions of SFAS No. 148,
               "Accounting for Stock-Based Compensation - Transition and
               Disclosure", which amended certain provisions of Statement of
               Accounting Standards No. 123, "Accounting for Stock-Based
               Compensation" ("SFAS No. 123") to provide alternative methods of
               transition for an entity that voluntarily changes to the fair
               value based method of accounting for stock-based employee
               compensation, effective as of the beginning of 2003. The Company
               continues to apply the provisions of APB No. 25 in accounting for
               stock-based compensation.

               Pro forma information regarding the Company's net income (loss)
               and net earnings (loss) per share is required by SFAS No. 123 and
               has been determined as if the Company had accounted for its
               employee stock options under the fair value method prescribed by
               SFAS No. 123.

               The following table illustrates the effect on net income (loss)
               and net earnings (loss) per share, assuming that the Company had
               applied the fair value recognition provisions of SFAS No. 123 on
               its stock-based employee compensation:

<TABLE>
<CAPTION>
                                                          YEAR ENDED DECEMBER 31,
                                                    ---------------------------------
                                                       2005         2004       2003
                                                    ---------    ---------  ---------
<S>                                                 <C>          <C>        <C>
Net income (loss), as reported                      $  (2,329)   $     822  $     758
Add: Stock-based employee compensation included
  in reported net income (loss)                             -            -          -
Deduct: Total stock-based employee compensation
  expense under fair value based methods                 (136)         (73)       (58)
                                                    ---------    ---------  ---------

Pro forma net income (loss)                         $  (2,465)   $     749  $     700
                                                    =========    =========  =========

Basic and diluted net earnings (loss) per share:
Basic net earnings (loss) per share as reported     $   (0.10)   $    0.04  $    0.04
Pro forma basic net earnings (loss) per share       $   (0.11)   $    0.04  $    0.04
Diluted net earnings (loss) per share as reported   $   (0.10)   $    0.03  $    0.04
Pro forma basic net earnings (loss) per share       $   (0.11)   $    0.03  $    0.04
</TABLE>


                                     F - 15
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS


NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

               The fair value for options granted in 2005, 2004 and 2003 is
               being amortized over their vesting period and is estimated at the
               date of grant using a Black-Scholes options pricing model with
               the following weighted average assumptions:

                                        YEAR ENDED DECEMBER 31,
                               ---------------------------------------
                                 2005          2004              2003
                               -------       --------          -------
Expected life of option        4 years       2 years           2 years
Dividend yield                    0%            0%                0%
Expected volatility              66%           68%               31%
Risk-free interest rate         4.4%          2.6%              1.0%

               The Company applies SFAS No. 123 and Emerging Issues Task Force
               No. 96-18, "Accounting for Equity Instruments That Are Issued to
               Other Than Employees for "Acquiring, or in Conjunction with
               Selling, Goods or Services" ("EITF 96-18"), with respect to
               options and warrants issued to non-employees. SFAS No. 123
               requires the use of option valuation models to measure the fair
               value of the options and warrants at the measurement date.

          p.   Revenue recognition:

               The Company generates revenues mainly from the sale of products
               and from long-term fixed price contracts for ATE, avionics and
               ground debriefing systems. In addition, the Company leases ATE to
               customers and provides manufacturing, development and product
               support services.

               PRODUCT REVENUES:

               The Company recognizes revenue from sales of products and
               aircraft spare parts in accordance with Staff Accounting Bulletin
               ("SAB") No. 104, "Revenue Recognition". Product revenue is
               recognized when there is persuasive evidence of an arrangement,
               the fee is fixed or determinable, delivery of the product to the
               customer has occurred and the Company has determined that
               collection of the fee is probable. If the product requires
               specific customer acceptance, revenue is deferred until customer
               acceptance occurs or the acceptance provisions lapse, unless the
               Company can objectively and reliably demonstrate that the
               criteria specified in the acceptance provisions are satisfied.

               Revenues from certain long-term fixed price contracts are
               recognized in accordance with Statement of Position No. 81-1,
               "Accounting for Performance of Construction-Type and Certain
               Production-Type Contracts" ("SOP 81-1"), using contract
               accounting on a percentage of completion method in accordance
               with the "Input Method". The percentage of completion is
               determined based on the ratio of actual costs incurred to total
               costs estimated to be incurred over the duration of the contract.
               With regard to contracts for which a loss is anticipated, a
               provision is made for the entire amount of the estimated loss at
               the time such loss becomes evident. As of December 31, 2005, the
               provision for estimated losses identified is $ 68.


                                     F - 16
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS


NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

               Estimated gross profit or loss from long-term contracts may
               change due to changes in estimates resulting from differences
               between actual performance and original forecasts. Such changes
               in estimated gross profit or loss are recorded in results of
               operations when they are reasonably determinable by management,
               on a cumulative catch-up basis.

               The Company believes that the use of the percentage of completion
               method is appropriate as the Company has the ability to 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 regarding services to be provided and received
               by the parties to the contracts, the consideration to be
               exchanged and the manner and terms of settlement. In all cases
               the Company expects to perform its contractual obligations and
               its licensees are expected to satisfy their obligations under the
               contract.

               According to SOP 81-1, costs that are incurred and are directly
               associated with a specific anticipated contract are being
               deferred, subject to evaluation of their probable recoverability,
               and recorded as unbilled contract costs.

               Revenues from certain arrangements may include multiple elements
               within a single contract. The Company's accounting policy
               complies with the provisions of Emerging Issues Task Force Issue
               00-21, "Revenue Arrangements with Multiple Deliverables" ("EITF
               00-21"), relating to the separation of multiple deliverables into
               individual accounting units with determinable fair value. The
               Company's arrangements are accounted for as separate units of
               accounting when it is possible to determine objective and
               reliable evidence of fair value of the contract elements in order
               to separate the fees among the elements. Revenue is recognized
               when the element is delivered and all other criteria for revenue
               recognition are met.

               The Company accounts for software sales (TPS's) in accordance
               with Statement of Position No. 97-2, "Software Revenue
               Recognition ("SOP No. 97-2"), as amended. Revenue from software
               arrangements is recognized when persuasive evidence of an
               arrangement exists, delivery of the product has occurred, the fee
               is fixed or determinable, and collectability is probable.
               Arrangements with payment terms extending beyond customary
               payment terms are considered not to be fixed or determinable. If
               the fee is considered not to be fixed or determinable, revenue is
               deferred and recognized when payments become due from the
               customer or are actually collected when collectability is not
               probable, providing that all other revenue recognition criteria
               have been met.

               SERVICE REVENUES:

               Revenues from services are recognized as the services are
               performed.

               Revenue under operating leases of equipment are recognized
               ratably over the lease period, in accordance with Statement of
               Financial Accounting Standard No. 13, "Accounting for Leases"
               ("SFAS No. 13").

               Deferred revenues include unearned amounts received from
               customers, but not yet recognized as revenues.


                                     F - 17
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

          q.   Basic and diluted net earnings (loss) per share:

               Basic net earnings (loss) per share are computed based on the
               weighted average number of Ordinary shares outstanding during
               each year. Diluted net earnings (loss) per share are computed
               based on the weighted average number of Ordinary shares
               outstanding during each year, plus dilutive potential Ordinary
               shares considered outstanding during the year in accordance with
               Statement of Financial Accounting Standards No. 128, "Earnings
               Per Share". Options and warrants to purchase 16,005,112 and
               14,862,237 Ordinary shares have been excluded from the
               computation of diluted net earnings per share for the years ended
               December 31, 2004 and 2003, respectively, since their effect is
               anti-dilutive. For the year ended December 31, 2005, all
               outstanding options and warrants have been excluded from the
               computation of diluted net loss per share, since their effect is
               anti-dilutive.

          r.   Recently Issued Accounting Standards:

               In December 2004, the Financial Accounting Standards Board issued
               Statement No. 123 (revised 2004), "Share-Based Payment" ("FAS
               123R"), which replaces FAS 123 and supersedes APB 25. FAS 123R
               requires all share-based payments to employees, including grants
               of employee stock options, to be recognized in the financial
               statements based upon their fair values, beginning with the first
               interim or annual period after December 15, 2005, with early
               adoption encouraged. The Company has the option to choose either
               the modified prospective or modified retrospective method. The
               Company currently expects to adopt FAS 123(R) in the first
               quarter of 2006, using the modified prospective method of
               adoption and does not expect that the adoption of SFAS 123(R)
               will have a material effect on its financial position or results
               of operations. Compensation cost is recognized beginning with the
               effective date (a) based on the requirements of SFAS 123(R) for
               all share-based payments granted after the effective date and (b)
               based on the requirements of SFAS 123 for all awards granted to
               employees prior to the effective date of SFAS 123(R) that remain
               unvested on the effective date.

               In March 2005, the SEC released SEC Staff Accounting Bulletin No.
               107, "Share-Based Payment" ("SAB 107"). SAB 107 provides the SEC
               Staff's position regarding the application of Statement 123(R)
               and contains interpretive guidance related to the interaction
               between Statement 123(R) and certain SEC rules and regulations,
               and also provides the SEC Staff's views regarding the valuation
               of share-based payment arrangements for public companies. SAB 107
               highlights the importance of disclosures made relating to the
               accounting for share-based payment transactions. The Company does
               not believe that SAB 107 will have a material effect on its
               financial position, results of operations or cash flows.


                                     F - 18
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 2:- SIGNIFICANT ACCOUNTING POLICIES (CONT.)

               In November 2004, the FASB issued Statement of Financial
               Accounting Standard No. 151, "Inventory Costs, an Amendment of
               ARB No. 43, Chapter 4" ("SFAS 151"). SFAS 151 amends Accounting
               Research Bulletin ("ARB") No. 43, Chapter 4, to clarify that
               abnormal amounts of idle facility expense, freight handling costs
               and wasted materials (spoilage) should be recognized as
               current-period charges. In addition, SFAS 151 requires that the
               allocation of fixed production overheads to the costs of
               conversion be based on the normal capacity of the production
               facilities. SFAS 151 is effective for inventory costs incurred
               during fiscal years beginning after June 15, 2005 (January 1,
               2006 for the Company). The provisions of this Statement shall be
               applied prospectively. The Company does not expect this Statement
               to have a material effect on its financial statements or its
               results of operations.

               In May 2005, the FASB issued Statement of Financial Accounting
               Standard No. 154 ("SFAS 154"), "Accounting Changes and Error
               Corrections", a replacement of APB No. 20, "Accounting Changes"
               and SFAS No. 3, "Reporting Accounting Changes in Interim
               Financial Statements". SFAS 154 provides guidance on the
               accounting for and reporting of accounting changes and error
               corrections. APB No. 20 previously required that most voluntary
               changes in accounting principles be recognized by including in
               net income for the period of the change the cumulative effect of
               changing to the new accounting principle. SFAS 154 requires
               retroactive application to prior periods' financial statements of
               a voluntary change in accounting principles unless it is
               impracticable. SFAS 154 is effective for accounting changes and
               corrections of errors made in fiscal years beginning after
               December 15, 2005.


                                     F - 19
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 3:- CONTRACTS IN PROGRESS

               Amounts included in the financial statements, which relate to
               costs and estimated earnings in excess of billings on uncompleted
               contracts are classified as current assets. Billings in excess of
               costs and estimated earnings on uncompleted contracts are
               classified as current liabilities. Summarized below are the
               components of the amounts:

          a.   Costs and estimated earnings in excess of billings on uncompleted
               contracts:

                                                           DECEMBER 31,
                                                        ------------------
                                                          2005       2004
                                                        -------    -------

    Costs incurred on uncompleted contracts             $ 7,625    $ 5,774
    Estimated earnings                                      435         50
                                                        -------    -------

                                                          7,190      5,824
    Less - billings and progress payments                 5,794      4,439
                                                        -------    -------

                                                        $ 1,396    $ 1,385
                                                        =======    =======

b. Billings in excess of costs and estimated earnings
   on uncompleted contracts:


   Costs incurred on uncompleted contracts              $ 7,426    $ 4,336
   Estimated earnings                                     1,380      1,454
                                                        -------    -------

                                                          8,806      5,790
   Less - billings and progress payments                  9,197      6,855
                                                        -------    -------

                                                        $  (391)   $(1,065)
                                                        =======    =======


NOTE 4:- INVENTORIES

                                 DECEMBER 31,
                               ---------------
                                2005     2004
                               ------   ------

Raw materials and components   $1,348   $1,178
Work in progress                  541      447
Finished goods                     53      199
                               ------   ------

                               $1,942   $1,824
                               ======   ======

               Write-downs of inventories for the years ended December 31, 2005,
               2004 and 2003 amounted to $ 342, $ 0 and $ 0, respectively. The
               write-down in 2005 was due to excess and slow-moving inventories
               and was included under the cost of revenues.


                                     F - 20
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 5:- LONG-TERM RECEIVABLES

                                            DECEMBER 31,
                                            -----------
                                            2005   2004
                                            ----   ----

Loan to former chief executive officer *)   $705   $705
Loan to a former officer *)                  278    278
Loans to employees                             -      5
                                            ----   ----

                                            $983   $988
                                            ====   ====

          *)   See also Note 10a.


NOTE 6:- PROPERTY, PLANT AND EQUIPMENT

                                      DECEMBER 31,
                                   -----------------
                                     2005      2004
                                   -------   -------
Cost:
  Factory building                 $ 1,940   $ 1,940
  Other building                     1,042     1,042
  Machinery and equipment           13,785    13,321
  Office furniture and equipment       521       512
  Leasehold improvements                23        23
                                   -------   -------

                                    17,311    16,838
                                   -------   -------
Accumulated depreciation:
  Factory building                   1,275     1,203
  Other building                       263       219
  Machinery and equipment           11,453    10,779
  Office furniture and equipment       368       334
  Leasehold improvements                21        20
                                   -------   -------

                                    13,380    12,555
                                   -------   -------

Depreciated cost                   $ 3,931   $ 4,283
                                   =======   =======

     The Company's factory building in Beit-She'an, Israel, is located on land
     leased from the Israel Lands Administration until the year 2034.

     Depreciation expense amounted to $ 825, $ 778 and $ 932 for the years ended
     December 31, 2005, 2004 and 2003, respectively. As for charges, see Note
     10e.


                                     F - 21
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                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 7:- INTANGIBLE ASSETS, NET

<TABLE>
<CAPTION>
                                    DECEMBER 31, 2005                          DECEMBER 31, 2004
                      ------------------------------------------       --------------------------------
                                 GROSS                                  GROSS
                      USEFUL    CARRYING    ACCUMULATED   AMORTIZED    CARRYING    ACCUMULATED   AMORTIZED
                       LIFE      AMOUNT    AMORTIZATION    BALANCE      AMOUNT    AMORTIZATION    BALANCE
                      ------     ------       ------       ------       ------       ------       ------
                      (YEARS)
<S>                   <C>        <C>          <C>          <C>          <C>          <C>          <C>
Amortized
  intangible
  assets:
Test Systems
  Programs Sets
  ("TPS")             5-10       $8,275       $6,841       $1,434       $8,275       $6,566       $1,709
Customer
  relationships          5        1,263          228        1,035            -            -            -
                                 ------       ------       ------       ------       ------       ------

Total                            $9,538       $7,069       $2,469       $8,275       $6,566       $1,709
                                 ======       ======       ======       ======       ======       ======
</TABLE>

               Aggregate amortization expenses were $ 503, $ 275 and $ 382 for
               the years ended December 31, 2005, 2004 and 2003, respectively.
               The expected amortization expense over the next five years is
               approximately as follows:

               2006                                 $        519
               2007                                          519
               2008                                          421
               2009                                          421
               2010                                          236
                                                    ------------

                                                    $      2,116
                                                    ============

               The weighted average useful life of the intangible assets is five
               years. Impairment of Test System Programs Sets ("TPSs") was $ 0,
               $ 0 and $ 758 for the years ended December 31, 2005, 2004 and
               2003, respectively included in cost of revenues. The impairment
               was recorded in 2003 since the Company did not anticipate future
               revenues on specific TPSs.


                                     F - 22
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 8:- SHORT-TERM BANK CREDIT AND LOANS

                                                   DECEMBER 31,
                                                 ---------------
                                                 2005       2004
                                                 ----       ----

Short-term loan in U.S. dollars (1)              $700       $  -
Short-term bank credit in NIS (2)                 166         14
Short-term bank credit in U.S. dollars (3)         11          -
                                                 ----       ----

                                                 $877       $ 14
                                                 ====       ====

               (1)  The interest rate at December 31, 2005 is 5.1%. The loan is
                    due in October 2006.

               (2)  The interest rate at December 31, 2005 is 9.3% (December 31,
                    2004 - 11.7%).

               (3)  The interest rate at December 31, 2005 is 13.6%.

               The total authorized credit line of bank guarantees provided to
               customers of the Company at December 31, 2005 is $ 5,376, out of
               which, $ 1,866 is unutilized. In addition, the Company received
               an additional revolving line of credit of $ 500, out of which, $
               177 was utilized at December 31, 2005. The revolving line of
               credit is due at December 2006 and will be renewed on an annual
               basis.

               As for collateral, see Note 10e.


NOTE 9:- OTHER ACCOUNTS PAYABLE AND ACCRUED EXPENSES

                                                                 DECEMBER 31,
                                                             -------------------
                                                              2005         2004
                                                             ------       ------

Payroll and related accruals                                 $  980       $  969
Provision for legal proceedings                                 576          567
Accrued royalties                                               691          679
Accrued commissions                                             338          480
Contracts in progress - provision for estimated losses           68          392
Other                                                           564          525
                                                             ------       ------

                                                             $3,217       $3,612
                                                             ======       ======


                                     F - 23
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                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 10:- COMMITMENTS AND CONTINGENT LIABILITIES

     a.   As of December 31, 2005, the Company was a party to various legal
          proceedings, including the following:

          1.   In June 1998, the Company's Board of Directors accepted the
               resignation of the Company's former CEO. In December 1998, the
               former CEO commenced legal proceedings against the Company in the
               Tel-Aviv Labor Court, claiming approximately $ 440 in respect of
               salary, severance pay, vacation pay and other fringe benefits.
               The former CEO also claimed that a personal loan that was
               provided to him by the Company had been forgiven and that the
               Company is to bear the tax in respect thereof. In May 2001, an
               additional claim of approximately $ 220 was filed by the former
               CEO against the Company in the Tel-Aviv District Court for
               damages allegedly caused to him as a result of attachment imposed
               on certain of his assets by the Company that was subsequently
               cancelled by the Court. In addition, in 2001, the Company filed a
               claim against a former director. In the event the former CEO's
               claim in the Labor Court is accepted by the Court, damages in the
               amount of $ 250 should be covered by the former director. The
               Company filed additional lawsuits against the former CEO and a
               former director in the amount of $ 260 for funds that they
               allegedly transferred from the Company to a third party. In
               September 1999, the Company filed a lawsuit against the former
               CEO and the former director with the District Court of Tel-Aviv
               in the amount of $ 1,400 for damages caused to the Company in the
               purchase of a subsidiary and negligence of management. In August
               2000, the Company filed an additional lawsuit against the former
               CEO in the amount of approximately $ 440 regarding the repayment
               of the loan provided to him. Management believes, based on the
               advice of its legal counsel that the Company has a valid defense
               against all claims made against it.

          2.   In 1999 and 2000, the former CEO and his son filed a number of
               complaints against the Company's president and are seeking
               damages for alleged slander by him in the amount of approximately
               $ 750. The claim by the former CEO was withdrawn and replaced by
               a new claim filed in 2004, while his son's claim was dismissed
               and an appeal is pending in the Supreme Court. Management
               believes, based on the advice of its legal counsel, that the
               Company has a strong defense against the allegations and
               accordingly, did not record any provision.

          3.   In 2001, a former employee and officer of the Company filed a
               claim against the Company with the Tel-Aviv Labor Court claiming
               approximately $ 520 in respect of severance pay, vacation pay and
               other fringe benefits. This claim was filed as a counter-claim to
               a claim filed by the Company in 2000, in the amount of $ 260 in
               respect of the repayment of a personal loan that was provided to
               the former employee. Management believes, based on the advice of
               its legal counsel, that the Company has a strong defense against
               the former employee's counterclaim and accordingly, did not
               record any provision.

          4.   In 2001, a former director filed a claim against the Company,
               claiming that he is entitled to 600,000 options to purchase
               Ordinary shares of the Company. Management believes, based on the
               advice of its legal counsel, that the claim does not have any
               merit and accordingly, did not record any provision.


                                     F - 24
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                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 10:- COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)

          5.   In 2000, a claim was filed by an individual against the Company,
               claiming that he served as a broker in an agreement signed
               between the Company and a customer and is entitled to commissions
               (or finder's fee) in the amount of $ 250. Management believes
               based on the advice of its legal counsel that the Company has a
               strong defense against the allegations.

          6.   In 2005, the former CEO of the Company filed a claim against the
               Chairman of the Company (in respect of which the Chairman is
               entitled to indemnity) alleging that the Chairman has committed
               fraud and negligent misrepresentation of him. The former CEO
               claims that, as a result, he was compelled to retire from his
               position, resulting in a loss of a salary and benefits in the
               aggregate amount of approximately $ 565. Management believes,
               based on the advice of its legal counsel, that this claim is
               entirely without merit and that the Company has a strong defense
               against the allegations and accordingly, did not record any
               provision.

          7.   The Company is involved periodically in various legal claims in
               the Ordinary course of business, including claims by agents and
               others for commissions, royalties and others The Company has
               accrued an amount which it believes is sufficient to cover
               damages, if any, that may result from these claims. The Company's
               management, based on the advice of its legal counsel, believes
               that such claims will not have a material adverse effect on the
               financial position or results of operations of the Company.

     b.   The Company's research and development efforts have been partially
          financed through royalty-bearing programs sponsored by the Office of
          the Chief Scientist of Israel's Ministry of Industry, Trade and Labor
          ("OCS"). In return for the OCS's participation, the Company is
          committed to pay royalties at a rate ranging from 3% to 5% of sales of
          the products whose research was supported by grants received from the
          OCS, up to 100% of the amount of such participation received linked to
          the U.S. dollar. The obligation to pay these royalties is contingent
          on actual sales of the products and in the absence of such sales, no
          payment is required. The Company's total obligation for royalties, net
          of royalties paid or accrued totaled approximately $ 668 as of
          December 31, 2005. The total amount of royalties charged to operations
          for the years ended December 31, 2005, 2004 and 2003 was approximately
          $ 27, $ 60 and $ 73, respectively.

     c.   Research and development projects undertaken by the Company were
          partially financed by the Binational Industrial Research and
          Development Fund ("BIRD") Foundation. The Company is committed to pay
          royalties to the BIRD Foundation at a rate of 5% of sales proceeds
          generating from projects for which the BIRD Foundation provided
          funding up to 150% of the sum financed by the BIRD Foundation. The
          Company's total obligation for royalties, net of royalties paid or
          accrued, totaled approximately $ 2,107 as of December 31, 2005. The
          obligation to pay these royalties is contingent on actual sales of the
          products and in the absence of such sales, no payment is required. The
          total amount of royalties charged to operations for the years ended
          December 31, 2005, 2004 and 2003 was approximately $ 12, $ 20 and $
          15, respectively.


                                     F - 25
<PAGE>


                               RADA ELECTRONIC INDUSTRIES LTD.AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 10:- COMMITMENTS AND CONTINGENT LIABILITIES (CONT.)

     d.   The Company's offices in Netanya are rented under a non-cancelable
          operating lease expiring January 31, 2008. In addition, the Company's
          motor vehicles are rented under operating leases. Annual minimum
          future rental commitments under these leases, at exchange rates in
          effect on December 31, 2005, are approximately as follows:

          2006                               $         576
          2007                                         576
          2008                                         365
                                             -------------

                                             $       1,517
                                             =============

          Lease expense for the years ended December 31, 2005, 2004 and 2003 was
          $ 471, $ 508 and $ 447, respectively.

     e.   Floating charges have been recorded on all of the Company's assets and
          specific charges have been recorded on certain assets in respect of
          the Company's liabilities to its banks and other creditors.

     f.   The Company provides bank guarantees to its customers in the Ordinary
          course of business. These guarantees are provided to customers to
          secure advances received at the commencement of a project or to secure
          performance of operational milestones. The total amount of bank
          guarantees provided to customers as of December 31, 2005 is
          approximately $ 3,510.

NOTE 11:- SHAREHOLDERS' EQUITY

     a.   Share capital:

          Ordinary shares confer upon their holders voting rights, the right to
          receive cash dividends and the right to share in excess assets upon
          liquidation of the Company.

          In April 2005, the Company completed a private placement to
          institutional investors. The Company issued 965,934 Ordinary shares
          for total proceeds of $ 1,091 ($ 1,006 net of issuance expenses) and
          warrants to purchase up to an aggregate of 1,875,000 Ordinary shares
          at an exercise price of $ 2.10 per share. At the same time, the
          investors exercised additional investment rights to purchase 909,066
          of the Company's Ordinary shares at an exercise price of $ 2.10 per
          share, for total amount of $ 1,909 ($ 1,761 net of issuance expenses)
          (see also c. below).

          In July 2004, the Company issued 1,800,000 shares, an aggregate of $
          3,000 principal amount of convertible notes, additional investment
          rights to purchase up to an aggregate of 1,100,000 Ordinary shares at
          an exercise price of $ 2.10 per share, (with a term of two years
          commencing six months following the closing) and warrants to purchase
          up to an aggregate of 937,500 Ordinary shares at an exercise price of
          $ 2.50 per share (for a term of five years commencing six months
          following the closing) to investors in a private placement for a total
          consideration of $ 5,880 ($ 5,712 net of issuance expenses) (see also
          c. below).


                                     F - 26
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 11:- SHAREHOLDERS' EQUITY (CONT.)

          The consideration was allocated based on the relative fair values of
          the Ordinary shares, notes, additional investment rights and warrants
          in accordance with APB No. 14, "Accounting for Convertible Debt and
          Debt Issued with Stock Purchase Warrants". The convertible notes bear
          interest at a rate of six-month LIBOR plus 2.5%. The principal is due
          in July 2007 and the interest is payable in quarterly installments
          until July 2007. The notes are convertible to Ordinary shares at a
          conversion price of $ 2.10. In connection with the issuance of the
          notes, additional investment rights and warrants, $ 180 was recorded
          as a beneficial conversion feature in accordance with EITF 98-5,
          "Accounting for Convertible Securities with Beneficial Conversion
          Features or Contingently Adjustable Conversion Ratios". The total
          amount of the deemed discount on the notes as a result of the
          allocated proceeds attributable to the warrants, additional investment
          rights and the beneficial conversion feature amounting to $ 760, is
          amortized over the term of the notes using the interest method. At
          December 31, 2005, the unamortized balance on the deemed discount on
          the convertible notes was $ 440. The fair value of the warrants and
          additional investment rights was based on a valuation prepared using
          the Black-Scholes pricing model, assuming a risk free interest of
          2.64% and 3.69%, respectively, a volatility factor of 0.67 and 0.68,
          respectively, dividend yield of 0% and contractual life of two years
          and five years, respectively. In addition, the valuation considered
          that the warrants and additional investment rights were restricted for
          the first six months, the warrants were not traded on the market at
          any time, and the underlying asset had a low marketability. The
          valuation result was judged to be reasonable by comparison to
          benchmarks in similar circumstances. The Company's management is
          responsible for the valuation.

          Costs incurred with respect to the issuance of the convertible notes
          of $ 69 have been recorded as deferred charges and are amortized as
          financial expenses over the term of the notes using the interest
          method.

     b.   Stock option plans:

          In 1996, 1999 and 2003, the Company's Board of Directors approved the
          adoption of Employee Stock Option Plans ("the Plans"), which
          authorized the grant of options to purchase up to an aggregate of
          240,000, 1,040,000 and 2,000,000 Ordinary shares, respectively, to
          officers, directors, consultants and key employees of the Company and
          its subsidiary. Options granted under the Plans expire within a
          maximum of 10 years from adoption of the plan. Options granted under
          the Company's Plans vest ratably over three years, one third on each
          anniversary of the grant.

          The exercise price of an option granted to an employee may not be less
          than 60% of the fair market value of the Ordinary shares on the date
          of grant of the option. The exercise price of an option granted to a
          non-employee director or consultant may not be less than 80% of the
          fair market value of the Ordinary shares on the date of grant of the
          option. Any options that are cancelled or forfeited before expiration
          become available for future grants. At December 31, 2005, 102,897
          options were available for grant under the Plans described above.


                                     F - 27
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 11:- SHAREHOLDERS' EQUITY (CONT.)

          In 2003, the Company granted suppliers/consultants, options to
          purchase 100,000 Ordinary shares at an exercise price ranging from $
          0.69 - $ 2.00. At the grant date, the fair value of the options was
          accounted for under EITF 96-18 and was determined using the Black and
          Scholes pricing model assuming a risk free rate of 1%, a volatility
          factor ranging from 30% to 70%, dividend yield of 0% and a contractual
          life of two to five years. In relation to the options, in 2003 the
          Company recorded $ 14 as operating expenses.

          Transactions related to the above Plans (including warrants to
          directors) during the years ended December 31, 2005, 2004 and 2003
          were as follows:

<TABLE>
<CAPTION>
                                                         YEAR ENDED DECEMBER 31,
                          -----------------------------------------------------------------------------------
                                   2005                          2004                           2003
                          -----------------------       -----------------------       -----------------------
                                           WEIGHTED                      WEIGHTED                      WEIGHTED
                                           AVERAGE        AMOUNT         AVERAGE                       AVERAGE
                          AMOUNT OF        EXERCISE        OF            EXERCISE     AMOUNT OF        EXERCISE
                           OPTIONS          PRICE        OPTIONS          PRICE        OPTIONS          PRICE
                          ----------        -----       ----------        -----       ----------        -----
<S>                        <C>              <C>          <C>              <C>            <C>            <C>
Options outstanding
   at beginning of
   year                    2,031,433        $1.56        2,223,200        $1.60          526,000        $4.89
   Granted                   342,000        $1.14          100,000        $1.29        1,852,000        $1.07
   Exercised                 (38,668)       $0.69          (73,335)       $0.69                -        $   -
   Expired                         -        $   -          (36,400)       $4.58                -        $   -
   Forfeited or
     cancelled              (218,865)       $3.77         (182,032)       $1.89         (154,800)       $6.34
                          ----------                    ----------                    ----------

Options outstanding
   at end of year          2,115,900        $1.26        2,031,433        $1.56        2,223,200        $1.60
                          ==========        =====       ==========        =====       ==========        =====

Exercisable options
   at end of year          1,854,567        $1.29        1,425,434        $1.71        1,045,200        $2.23
                          ==========        =====       ==========        =====       ==========        =====
</TABLE>

          No compensation expense was recorded for the years ended December 31,
          2005, 2004 and 2003.

          The options outstanding as of December 31, 2005 have been separated
          into ranges of exercise price, as follows:

<TABLE>
<CAPTION>
                               OPTIONS OUTSTANDING            OPTIONS EXERCISABLE
                      ---------------------------------       --------------------
                                     WEIGHTED
                                     AVERAGE     WEIGHTED                     WEIGHTED
                         AT         REMAINING    AVERAGE         AT          AVERAGE
    RANGE OF          DECEMBER 31, CONTRACTUAL   EXERCISE     DECEMBER 31,   EXERCISE
 EXERCISE PRICE         2005          LIFE        PRICE         2005          PRICE
 --------------       ---------       -----       -----       ---------       -----
                                     (YEARS)
<S>        <C>        <C>              <C>        <C>         <C>             <C>
 $  0.69 - 1.00         632,500        4.18       $0.70         632,500       $0.70
 $  1.29 - 2.00       1,371,000        6.07       $1.31       1,109,667       $1.35
 $  3.09 - 4.13          80,400        2.03       $3.41          80,400       $3.41
 $  5.00 - 6.25          32,000        2.00       $5.63          32,000       $5.63
                      ---------                               ---------

                      2,115,900                   $1.26       1,854,567       $1.29
                      =========                   =====       =========       =====
</TABLE>


                                     F - 28
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                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 11:- SHAREHOLDERS' EQUITY (CONT.)

     c.   Warrants:

          As of December 31, 2005, warrants to purchase 16,670,779 Ordinary
          shares were outstanding.

          In April 2005, in connection with the issuance of Ordinary shares
          described in a. above, the Company granted the purchasers of the
          Ordinary shares, warrants to purchase up to an aggregate of 1,875,000
          Ordinary shares at $ 2.10 per share, which expire on the later of (i)
          24 months from the date of the grant, and (ii) 24 months from the date
          of the shareholder approval, ratifying the issuance of the Ordinary
          shares and the warrants under the Securities Purchase Agreement to the
          selling shareholders and authorizing the increase of the Company's
          authorized Ordinary shares from 45,000,000 Ordinary shares to no less
          than 47,500,000 Ordinary shares

          In July 2004, in connection with the issuance of Ordinary shares and
          convertible notes described in a. above, the Company granted the
          investors additional investment rights to purchase up to an aggregate
          of 1,100,000 Ordinary shares at an exercise price of $ 2.10 per share,
          (with a term of two years commencing six months following the closing)
          and warrants to purchase up to an aggregate of 937,500 Ordinary shares
          at an exercise price of $ 2.50 per share (for a term of five years
          commencing six months following the closing). In April 2005, 909,066
          additional investment rights were exercised.

          The warrants are classified as shareholders' equity in accordance with
          EITF 09-19, "Accounting for Derivatives Financial Instruments Indexed
          to, and Potentially Settled in, a Company's Own Stock".

          In September 2003, the Company signed an agreement with Bank Hapoalim
          B.M. and Bank Leumi Le-Israel B.M. ("the banks") to restructure a
          portion of the debt owed to the banks. The carrying value of the
          restructured debt was $ 3,451. As part of the restructuring, the
          Company issued 3,781,992 warrants to the banks, paid $ 1,100 and the
          banks forgave the remaining debt. The warrants issued to the banks
          have an exercise price equal to par value of the shares and a term of
          two and a half years. The banks had a put option to sell the warrants
          to the Company's major shareholder for a consideration of $ 1,251.

          In addition, the banks granted the Company's major shareholder a call
          option that requires the banks to sell the warrants to the shareholder
          at the exercise price of the put option with an additional payment
          equal up to 25% of the increase in the market share price from the
          date of the agreement up to a maximum of $ 0.14 per warrant. In
          addition, as part of the restructuring, the Company issued to the
          banks 1,100,000 warrants having an exercise price of $ 2.00 per share,
          and a term of five years.


                                     F - 29
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                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 11:- SHAREHOLDERS' EQUITY (CONT.)

          The transaction was recorded in accordance with SFAS No. 15,
          "Accounting by Debtors and Creditors for Troubled Debt
          Restructurings". The above warrants (3,781,995 warrants and 1,100,000
          warrants) that were issued to the banks were recorded at fair value ($
          1,267, net of issuance expenses). The fair value of the warrants was
          based on a valuation prepared at the consummation date of the
          transaction. The valuation took into consideration the long lock-up
          period and a marketability discount. The valuation result was judged
          to be reasonable by comparison to benchmarks in similar circumstances.
          The Company's management is responsible for the valuation. The
          difference between the consideration paid to the banks (cash and
          warrants) and the carrying amount of the debt of $ 1,013 was
          recognized as a gain on restructuring of debt, net of issuance
          expenses, presented in financial income (expenses), net, in the
          statement of operations. In October 2005, 3,781,995 warrants were
          exercised by the major shareholders for a total consideration of $ 38.

NOTE 12:- TAXES ON INCOME

     a.   Measurement of taxable income under the Income Tax (Inflationary
          Adjustments) Law, 1985:

          Results for tax purposes are measured and adjusted in accordance with
          the change in the CPI. As explained in Note 2b, the consolidated
          financial statements are presented in U.S. dollars. The differences
          between the change in the Israeli CPI and in the NIS/U.S. dollar
          exchange rate cause a difference between taxable income or loss and
          the income or loss before taxes reflected in the consolidated
          financial statements. In accordance with paragraph 9(f) of SFAS No.
          109, the Company has not provided deferred income taxes on this
          difference between the financial reporting basis and the tax bases of
          assets and liabilities.

     b.   Tax benefits under the Law for the Encouragement of Industry (Taxes),
          1969:

          The Company is an "Industrial Company" under the Law for the
          Encouragement of Industry. The principal benefit from the above law is
          the deduction of expenses in connection with a public offering.

     c.   Israeli companies are subject to income tax at the corporate tax rate
          of 35% for the 2004 tax year and 34% for the 2005 tax year. On July
          25, 2005, the Knesset (Israeli Parliament) passed the Law for the
          Amendment of the Income Tax Ordinance (No. 147), 2005, which
          prescribes, among others, a gradual decrease in the corporate tax rate
          in Israel to the following tax rates: in 2006 - 31%, in 2007 - 29%, in
          2008 -27%, in 2009 - 26% and in 2010 and thereafter - 25%.

          As of December 31, 2005, the net operating tax loss carryforward
          relating to the Company in Israel amounted to approximately $ 45,650,
          including a carryforward capital loss amounting to approximately $
          2,650. Carryforward losses in Israel may be carried forward
          indefinitely and may be offset against future taxable income.

          As of December 31, 2005, carryforward tax losses relating to
          non-Israeli companies (U.S. and China), amounted to approximately $
          9,750.


                                     F - 30
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                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 12:- TAXES ON INCOME (CONT.)

          As the Company believes that the tax assets in respect of these
          carryforward losses amounting to approximately $ 17,935 are not more
          likely than not to be realized, the Company has recorded a valuation
          allowance in respect of the entire amount of the deferred tax asset
          relating to the carryforward losses.

     d.   Income (loss) before income taxes:

                        YEAR ENDED DECEMBER 31,
               -------------------------------------
                 2005           2004           2003
               -------        -------        -------

Domestic       $(2,254)       $   937        $   867
Foreign            (75)          (115)          (109)
               -------        -------        -------

               $(2,329)       $   822        $   758
               =======        =======        =======

     e.   The main reconciling items between the statutory tax rate of the
          Company and the effective tax rate is the valuation allowance recorded
          in respect of the tax assets relating to net operating loss
          carryforwards and other temporary differences due to the uncertainty
          of the realization of such tax assets.

NOTE 13:- FINANCIAL INCOME (EXPENSES), NET

<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31,
                                                       -------------------------------------
                                                         2005           2004           2003
                                                       -------        -------        -------
<S>                                                    <C>            <C>            <C>
Income:
   Gain on restructuring of debt, net (see Note
     11c)                                              $     -        $     -        $ 1,013
   Foreign currency exchange differences                   164            234              -
   Interest on cash equivalents and restricted
     cash                                                   20              4              9
                                                       -------        -------        -------

                                                           184            238          1,022
                                                       -------        -------        -------
Expenses:
   Interest on convertible note                            181             64              -
   Amortization expenses on convertible note and
     deferred expenses                                     234            115              -
   Foreign currency exchange differences                   156             79             22
   Interest on loans and other credit balances              68             82            230
   Bank commissions                                        100            116             59
   Others                                                   69             30              3
                                                       -------        -------        -------

                                                           808            486            314
                                                       -------        -------        -------

                                                       $  (624)       $  (248)       $   708
                                                       =======        =======        =======
</TABLE>

NOTE 14:- RELATED PARTY TRANSACTIONS

     There are no related party balances as of December 31, 2005 and 2004, and
     no related party transactions for the years ended December 31, 2005, 2004
     and 2003.


                                     F - 31
<PAGE>


                              RADA ELECTRONIC INDUSTRIES LTD. AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS

NOTE 15:- MAJOR CUSTOMERS AND GEOGRAPHIC INFORMATION

     a.   In accordance with Statement of Financial Accounting Standards No.
          131, "Disclosures About Segments of an Enterprise and Related
          Information", the Company is organized and operates as one business
          segment, which develops, manufactures and sells ATE products, avionics
          equipment and aviation data acquisition and debriefing systems.

     b.   Revenues by geographic areas:

          Revenues are attributed to geographic area based on the location of
          the end customers as follows:

                           YEAR ENDED DECEMBER 31,
                    -----------------------------------
                      2005          2004          2003
                    -------       -------       -------

North America       $ 5,096       $ 4,715       $ 5,115
Europe                  586         3,022         3,436
Israel                5,546         4,998         3,224
Others                2,193         1,425           540
                    -------       -------       -------

Total               $13,421       $14,160       $12,315
                    =======       =======       =======

     c.   Major customers:

          Revenues from single customers that exceed 10% of the total revenues
          in the reported years as a percentage of total revenues, are as
          follows:

                YEAR ENDED DECEMBER 31,
                ----------------------
                2005     2004     2003
                ----     ----     ----
                          %
                ----------------------

Customer A       12       19       11
Customer B       14       *)       12
Customer C       21       *)       22
Customer D       *)       10       14
Customer E        -       11        -
Customer F       *)       17       19
Customer G       12       *)       *)

          *)   Less than 10%.

     d.   Long-lived assets by geographic areas:

                 DECEMBER 31,
             -------------------
              2005         2004
             ------       ------

Israel       $5,332       $4,718
China         1,108        1,333
             ------       ------

             $6,440       $6,051
             ======       ======


                                     F - 32
<PAGE>


                               RADA ELECTRONIC INDUSTRIES LTD.AND ITS SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
U.S. DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA

NOTE 16:- NET EARNINGS (LOSS) PER SHARE

     The following table sets forth the computation of basic and diluted net
     earnings (loss) per share:

<TABLE>
<CAPTION>
                                                                        YEAR ENDED DECEMBER 31,
                                                              -----------------------------------------
                                                                  2005              2004          2003
                                                              ------------        -------       -------
<S>                                                           <C>                 <C>           <C>
Numerator:

Net income (loss)                                             $     (2,329)       $   822       $   758
                                                              ============        =======       =======

Denominator:

Weighted average number of Ordinary shares outstanding
   during the year used to compute basic net earnings
   (loss) per share (in thousands)                                  22,513         19,374        18,511
Incremental shares attributable to exercise of
   outstanding options and warrants (assuming proceeds
   would be used to purchase Treasury stock) (in
   thousands)                                                            -          4,310         1,193
                                                              ------------        -------       -------

Weighted average number of Ordinary shares outstanding
   during the year used to compute diluted net earnings
   (loss) per share (in thousands)                                  22,513         23,684        19,704
                                                              ============        =======       =======

Basic net earnings (loss) per share                           $      (0.10)       $  0.04       $  0.04
                                                              ============        =======       =======

Diluted net earnings (loss) per share                         $      (0.10)       $  0.03       $  0.04
                                                              ============        =======       =======
</TABLE>


                                     F - 33
<PAGE>


                               S I G N A T U R E S

     The registrant hereby certifies that it meets all of the requirements for
filing on Form 20-F and that it has duly caused and authorized the undersigned
to sign this annual report on its behalf.



                                                RADA ELECTRONIC INDUSTRIES LTD.


                                                By: /s/ Herzle Bodinger
                                                -----------------------
                                                Herzle Bodinger
                                                President


Dated:  March 30, 2006


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